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IRS offers Tips for year-end Gift Giving
By Bob15 December, 2011Financial Planning, Individuals, Small Businesses, Tax Planning, Tax Savings Opportunities

Individuals and businesses making charitable contributions should keep in mind several important tax law provisions that have taken effect in recent years. Some of these changes include the following:

Special Charitable Contributions for Certain IRA Owners

This provision, currently scheduled to expire at the end of 2011, offers older owners of individual retirement accounts (IRAs) a different way to give to charity. An IRA owner, age 70½ or over, can directly transfer tax-free up to $100,000 per year to an eligible charity. This option, created in 2006, is available for distributions from IRAs, regardless of whether the owners itemize their deductions. Distributions from employer-sponsored retirement plans, including SIMPLE IRAs and simplified employee pension (SEP) plans, are not eligible.

To qualify, the funds must be contributed directly by the IRA trustee to the eligible charity. Amounts so transferred are not taxable and no deduction is available for the transfer.

Not all charities are eligible. For example, donor-advised funds and supporting organizations are not eligible recipients.

Amounts transferred to a charity from an IRA are counted in determining whether the owner has met the IRA’s required minimum distribution. Where individuals have made nondeductible contributions to their traditional IRAs, a special rule treats transferred amounts as coming first from taxable funds, instead of proportionately from taxable and nontaxable funds, as would be the case with regular distributions. See Publication 590, Individual Retirement Arrangements (IRAs), for more information on qualified charitable distributions.

Rules for Clothing and Household Items

To be deductible, clothing and household items donated to charity generally must be in good used condition or better. A clothing or household item for which a taxpayer claims a deduction of over $500 does not have to meet this standard if the taxpayer includes a qualified appraisal of the item with the return. Household items include furniture, furnishings, electronics, appliances and linens.

Guidelines for Monetary Donations

To deduct any charitable donation of money, regardless of amount, a taxpayer must have a bank record or a written communication from the charity showing the name of the charity and the date and amount of the contribution. Bank records include canceled checks, bank or credit union statements, and credit card statements. Bank or credit union statements should show the name of the charity, the date, and the amount paid. Credit card statements should show the name of the charity, the date, and the transaction posting date.

Donations of money include those made in cash or by check, electronic funds transfer, credit card and payroll deduction. For payroll deductions, the taxpayer should retain a pay stub, a Form W-2 wage statement or other document furnished by the employer showing the total amount withheld for charity, along with the pledge card showing the name of the charity.

These requirements for the deduction of monetary donations do not change the long-standing requirement that a taxpayer obtain an acknowledgment from a charity for each deductible donation (either money or property) of $250 or more. However, one statement containing all of the required information may meet both requirements.

Reminders

To help taxpayers plan their holiday-season and year-end giving, the IRS offers the following additional reminders:

Contributions are deductible in the year made. Thus, donations charged to a credit card before the end of 2011 count for 2011. This is true even if the credit card bill isn’t paid until 2012. Also, checks count for 2011 as long as they are mailed in 2011.

Check that the organization is qualified. Only donations to qualified organizations are tax-deductible. IRS Publication 78, searchable and available online, lists most organizations that are qualified to receive deductible contributions. It can be found at IRS.gov under Search for Charities. In addition, churches, synagogues, temples, mosques and government agencies are eligible to receive deductible donations, even if they are not listed in Publication 78.

For individuals, only taxpayers who itemize their deductions on Form 1040 Schedule A can claim deductions for charitable contributions. This deduction is not available to individuals who choose the standard deduction, including anyone who files a short form (Form 1040A or 1040EZ). A taxpayer will have a tax savings only if the total itemized deductions (mortgage interest, charitable contributions, state and local taxes, etc.) exceed the standard deduction. Use the 2011 Form 1040 Schedule A to determine whether itemizing is better than claiming the standard deduction.

For all donations of property, including clothing and household items, get from the charity, if possible, a receipt that includes the name of the charity, date of the contribution, and a reasonably-detailed description of the donated property. If a donation is left at a charity’s unattended drop site, keep a written record of the donation that includes this information, as well as the fair market value of the property at the time of the donation and the method used to determine that value. Additional rules apply for a contribution of $250 or more.

The deduction for a motor vehicle, boat or airplane donated to charity is usually limited to the gross proceeds from its sale. This rule applies if the claimed value is more than $500. Form 1098-C, or a similar statement, must be provided to the donor by the organization and attached to the donor’s tax return.

If the amount of a taxpayer’s deduction for all noncash contributions is over $500, a properly-completed Form 8283 must be submitted with the tax return.

And, as always it’s important to keep good records and receipts.

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7 Planning Ideas for Young Parents
By Bob31 August, 2011Estate Planning, Financial Planning, Individuals, Married Couples, Tax Planning

One of my oldest and best friends had his first child last week (a boy, everyone is healthy and doing great). He is the first of my closest friends to reach this milestone. While it is a bit surreal to think of this young man as a father, he and his wife are certainly ready to be parents – both are successful professionals, they are homeowners, the nursery is set up, etc., etc.

Like most young parents, however, they still have room for improvement in their long-term planning. Long-term planning should extend beyond simply saving for retirement; it must also include thoughtful consideration of other important matters, including:

1. Obtain Wills for Both Parents

Choosing a guardian for your child is the first thing new parents should do. But please keep in mind: unless your decision is in writing, it is not likely to hold up in court. In other words, if you do not have a will, a Judge will decide who raises your child. New parents should also specify where their money should go. Many parents assume that their savings will automatically go to their spouse if something should happen. In many cases, however, half of the money would automatically be put into a trust for the child. In order to retrieve the money, the surviving spouse would have to petition the court, which can be a complicated process.

2. Pay Off Existing Debt and Keep Saving For Retirement

New parents must set a budget and actually live by it. One easy way to help ensure you actually live by your budget is to set up automatic payments for your monthly expenses. This can be done for just about every household expense. Part of your budget should include actively paying off credit card debt and trying not to incur more. Further, as a general rule of thumb: 10 to 15 percent of your income should go into your 401(k) plan or IRA. Only after you have set aside that money should you begin to save for your child’s college tuition.

3. Open a College Savings Plan for Your Child

Most states sponsor what is commonly known as a “Section 529 Plan.” These plans are a great way for parents to save for college and, in most states, a tax deduction is allowed for annual contributions to the plan. In New York State, married couples that file joint tax returns can take up to a $10,000 deduction for contributions to a Section 529 Plan.

4. Re-evaluate your Insurance Needs

Life Insurance – As soon as your first child is born, your life insurance needs dramatically increase. For this reason, among others, your needs should be reviewed by a competent financial planner. There are many options available (e.g. permanent and term policies), which can be tailored to meet your needs, as well as your resources.

Disability Insurance – One in three American adults will become disabled for 90 days or more before reaching the age of 65. Disability insurance will help cover the loss of income. Many employers offer it, but make sure the policy is enough for you and your family.

5. Consider Dependent Care Flexible Spending Accounts; the “Cafeteria Plan”

Many employers offer a Section 125 Plan, which allows employees to pay for medical expenses and childcare expenses pre-tax. Different plans have different rules, so make sure the plan is appropriate for your situation.

6. Choose a Quality School System

When searching for your first (or next) home, look in an area with quality public schools. The property taxes may be higher, but this is a good investment in the future value of your home and it will help you avoid the need for private schools.

7. Consider the following Tax Matters

Paycheck Withholding – Once your child is born, you should update your W-4 (the Employee’s Withholding Certificate), to reflect your additional dependent. Doing so will increase the amount you receive from each paycheck.

Social Security Number – You will need a Social Security Number for your child in order to take advantage of available tax savings opportunities. A Social Security Number is also required to open a bank or investment account for your child. The easiest way to apply for your child’s Social Security Number is at the hospital. When you supply the information for your child’s birth certificate, tell the hospital representative that you would also like to apply for a Social Security Number for your child. The hospital will send the required information to the Social Security Administration and your child’s new card will be sent to you in the mail.

Tax Exemption – You can claim an exemption on your tax return for each dependent child. For 2011, the dependent exemption is $3,700. You may also qualify for a child tax credit of up to $1,000. Both the dependent exemption and the child tax credit start to phase out when your income exceeds certain levels. If you return to work and require childcare, you may be eligible for the dependent care tax credit as well.

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Tax News affecting Your 2010 Tax Refund
By Bob12 January, 2011Individuals, Married Couples, New Legislation, Small Businesses, Tax Planning

For most taxpayers, Congress’ bipartisan, election-year posturing during 2010 was a good thing.  Despite the restoration of many Bush-era tax rules, there were also many changes made to the tax code; some by new legislation and some by expiration.  Below is a list of some of the more interesting changes that occurred in 2010:

1.  The 2010 Tax Relief Act retains, for another two years at least, the Bush-era favorable tax rates on long term capital gains and qualified dividends.

2.  We will all see a two-percent increase in disposable income as a result of a lower FICA withholding rate in 2011. 

3.  First-time homebuyers who claimed the tax credit for homes bought after April 8, 2008 and before January 1, 2009 must, generally, begin recapturing that credit on their 2010 tax returns in equal installments over a 15-year period.

4.  Married people have something new to cheer about – their standard deduction is now equal to twice the individual’s standard deduction.  In addition, the full utilization of itemized deductions and personal exemptions are back in play regardless of one’s Adjusted Gross Income.  Finally, while the Alternative Minimum Tax exemption has increased again, parity for married versus single taxpayers has finally been realized.

5.  If you have children, and if you can keep them from aging past 17 until 2012, the Child Tax Credit is yours to enjoy.  Should they continue to grow up and move onto higher education this year, you may qualify for the expanded American Opportunity Tax Credit.

6.  IRA distributions may be tax-free when they are made directly to a charity.  This includes required minimum distributions (RMDs) from Traditional, SEP and Simple IRAs.

7.  This last item is not a change in legislation, but rather a unique situation created by legislation.  Under a federal statute enacted decades ago, holidays observed by the District of Columbia impact the entire Nation.  Therefore, with the District recognizing Emancipation Day, April 16th, as a legal holiday and using the 15th to celebrate it this year, the IRS will close all of its offices and push the filing deadline to April 18th.

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Deferred Compensation Plans
By Bob11 January, 2011Compensation Plans, Small Businesses, Tax Planning

Assuming a deferred compensation plan is “non-qualified” (it is only offered to certain high-level employees and, thus, does not qualify for certain tax preferences), here is a brief explanation of how FICA and FUTA should be applied:

Background

FICA actually includes two taxes:  Social Security and Medicare. 

The SS tax rate for 2010 was 6.2% for both the employer and employee.  In 2011, the employer SS tax rate remains at 6.2%, while the employee SS tax rate is now 4.2%.  SS tax is subject to a maximum income limit, which is $106,800 in both 2010 and 2011.  As a result, SS tax is paid on only the first $106,800 of annual income earned by each employee in 2010 and 2011. 

The Medicare rate for 2010 and 2011, for both employers and employees, is 1.45% (for a combined rate of 2.9%).  There is no maximum income limit on Medicare; whether you make 100k or 1 million a year, you are subject to Medicare tax at a rate of 1.45% (combined at 2.9%).

FUTA is a single tax applied only to the first $7,000 of annual income earned by each employee.  FUTA is only paid by the employer; it is NOT withheld from the employees’ wages.  The tax rate is 6.2% on wages paid prior to July 1, 2011.  As of that date, the tax rate will decrease to 6%.

Application to Non-qualified Deferred Compensation

Non-qualified deferred compensation, will be deemed to be subject to FICA and FUTA at the later of when the related services are performed or when there is no longer a “substantial risk of forfeiture” of the employee’s right to receive the compensation (basically, when the right to the compensation has fully vested).

When determining whether FICA (both SS and Medicare) and FUTA actually apply to the deferred comp, we must first look at whether the employee’s other regular wages (outside of the deferred comp) already exceed the applicable maximum income limit.  If the employee has already exceeded the relevant income limits, no additional SS tax and no additional FUTA tax will result from the deferred comp.  However, Medicare tax, which has no maximum income limit, will still be imposed on both the employer and employee at a combined rate of 2.9%. 

Timing of Medicare

Assuming the employee’s income has already exceeded the maximum income limitations for SS tax and FUTA, the only remaining issue is the timing of the imposition of the Medicare tax.  The employer has a choice on whether to withhold and pay the Medicare tax at the time of the deferral of the compensation or to withhold and pay the tax at the time of the ultimate distribution to the employee.   If the Medicare tax is withheld at the time of the deferral (Year 1), the compensation is considered to have been “taken into account” as wages for FICA and FUTA purposes.  Once it has been “taken into account” as wages for FICA and FUTA purposes, neither deferred compensation nor any earnings attributable to it will be treated as taxable wages when ultimately distributed (in Year 3, for example).  Thus, if the FICA amount (often only the Medicare portion, as noted above) has been timely taken into account during Year 1, no FICA will be due on the ultimate distribution during Year 3.

The benefit of withholding in Year 1 is that the combined 2.9% tax will only be on the actual amount of the deferred compensation, rather than on the deferred compensation plus earnings that would have accrued through Year 3.  The downside, however, is that the employer will be accelerating a cost that could have otherwise been deferred (although the cost will continue to grow during the deferral period).

Conclusion

Generally, I recommend determining the employer’s actual cost of withholding Medicare tax in Year 1 and comparing that amount to the projected cost in Year 3 (based upon anticipated earnings on that deferred comp over the next few years).   The analysis must weigh the benefits of a smaller tax liability in Year 1 versus the benefits of deferring that cost to Year 3.

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