If your traditional IRA holds a mixture of deductible (after-tax) and nondeductible (pretax) contributions, it’s important to track your contributions to avoid double taxation of distributions. Why? Because the IRS treats distributions as a blend of pretax and after-tax dollars. If you treat distributions as fully taxable, you’ll end up overpaying. One way to track and report your deductible and nondeductible IRA contributions is to complete and file Form 8606, “Nondeductible IRAs,” with your federal income tax return each year. If you have several IRAs, you can’t avoid tax by taking distributions from those accounts. All your traditional IRAs are treated as a single IRA for tax purposes.
If, like many people, your traditional IRA holds a mixture of deductible (after-tax) and nondeductible (pretax) contributions, it’s important to track your contributions carefully to avoid double taxation of distributions. Why? Because the IRS treats distributions as a blend of pretax and after-tax dollars. If you treat distributions as fully taxable, you’ll end up overpaying.
Dan, age 62, withdraws $40,000 from his traditional IRA on August 1, 2019. At the time, his IRA balance is $200,000, consisting of $50,000 in deductible contributions, $80,000 in nondeductible contributions and $70,000 in investment earnings. On December 31, 2019, the IRA’s balance is $170,000 — $200,000 minus the $40,000 distribution plus additional contributions and earnings after August 1.
To ensure that his distribution is taxed correctly, Dan must calculate the portion attributable to nondeductible contributions. These are the contributions that were made with after-tax dollars and, therefore, aren’t taxable again. First, he takes the IRA’s year-end balance, $170,000, and adds back the $40,000 distribution, to arrive at $210,000. Next, he divides his nondeductible contributions ($80,000) by $210,000 and multiplies the resulting percentage (38%) by the amount of the distribution. The result — $15,200 — is the nondeductible portion of his distribution, which is tax-free. For purposes of future distributions, Dan’s nondeductible contributions are reduced by $15,200 to $64,800.
Be aware that, if you have several IRAs, including one or more that are funded exclusively with nondeductible contributions, you can’t avoid tax by taking distributions from those accounts. All your traditional IRAs are treated as a single IRA for tax purposes, so your distributions are deemed to be a combination of taxable and nontaxable funds, regardless of the account they’re withdrawn from.
The easiest way to track and report your deductible and nondeductible IRA contributions is to complete and file Form 8606, “Nondeductible IRAs,” with your federal income tax return each year.
Contact us with any questions you many have regarding your IRAs.
While you were celebrating the holidays, you may not have noticed that Congress passed a law with a grab bag of provisions that provide tax relief to businesses and employers. The “Further Consolidated Appropriations Act, 2020” was signed into law on December 20, 2019. It makes many changes to the tax code, including an extension (generally through 2020) of more than 30 provisions that were set to expire or already expired.
Two other laws were passed as part of the law (The Taxpayer Certainty and Disaster Tax Relief Act of 2019 and the Setting Every Community Up for Retirement Enhancement Act).
Here are five highlights.
Long-term part-timers can participate in 401(k)s.
Under current law, employers generally can exclude part-time employees (those who work less than 1,000 hours per year) when providing a 401(k) plan to their employees. A qualified retirement plan can generally delay participation in the plan based on an employee attaining a certain age or completing a certain number of years of service but not beyond the later of completion of one year of service (that is, a 12-month period with at least 1,000 hours of service) or reaching age 21.
Qualified retirement plans are subject to various other requirements involving who can participate.
For plan years beginning after December 31, 2020, the new law requires a 401(k) plan to allow an employee to make elective deferrals if the employee has worked with the employer for at least 500 hours per year for at least three consecutive years and has met the age-21 requirement by the end of the three-consecutive-year period. There are a number of other rules involved that will determine whether a part-time employee qualifies to participate in a 401(k) plan.
The employer tax credit for paid family and medical leave is extended.
Tax law provides an employer credit for paid family and medical leave. It permits eligible employers to claim an elective general business credit based on eligible wages paid to qualifying employees with respect to family and medical leave. The credit is equal to 12.5% of eligible wages if the rate of payment is 50% of such wages and is increased by 0.25 percentage points (but not above 25%) for each percentage point that the rate of payment exceeds 50%. The maximum leave amount that can be taken into account for a qualifying employee is 12 weeks per year.
The credit was set to expire on December 31, 2019. The new law extends it through 2020.
The Work Opportunity Tax Credit (WOTC) is extended.
Under the WOTC, an elective general business credit is provided to employers hiring individuals who are members of one or more of 10 targeted groups. The new law extends this credit through 2020.
The medical device excise tax is repealed.
The Affordable Care Act (ACA) contained a provision that required that the sale of a taxable medical device by the manufacturer, producer or importer is subject to a tax equal to 2.3% of the price for which it is sold. This medical device excise tax originally applied to sales of taxable medical devices after December 31, 2012.
The new law repeals the excise tax for sales occurring after December 31, 2019.
The high-cost, employer-sponsored health coverage tax is repealed.
The ACA also added a nondeductible excise tax on insurers when the aggregate value of employer-sponsored health insurance coverage for an employee, former employee, surviving spouse or other primary insured individual exceeded a threshold amount. This tax is commonly referred to as the tax on “Cadillac” plans.
The new law repeals the Cadillac tax for tax years beginning after December 31, 2019.
These are only some of the provisions of the new law. We will be covering them in the coming weeks. If you have questions about your situation, don’t hesitate to contact us.
A significant law was recently passed that adds tax breaks and makes changes to employer-provided retirement plans. If your small business has a current plan for employees or if you’re thinking about adding one, you should familiarize yourself with the new rules.
The Setting Every Community Up for Retirement Enhancement Act (SECURE Act) was signed into law on December 20, 2019 as part of a larger spending bill. Here are three provisions of interest to small businesses.
Employers that are unrelated will be able to join together to create one retirement plan. Beginning in 2021, new rules will make it easier to create and maintain a multiple employer plan (MEP). A MEP is a single plan operated by two or more unrelated employers. But there were barriers that made it difficult to setting up and running these plans. Soon, there will be increased opportunities for small employers to join together to receive better investment results, while allowing for less expensive and more efficient management services.
There’s an increased tax credit for small employer retirement plan startup costs. If you want to set up a retirement plan, but haven’t gotten around to it yet, new rules increase the tax credit for retirement plan start-up costs to make it more affordable for small businesses to set them up. Starting in 2020, the credit is increased by changing the calculation of the flat dollar amount limit to: The greater of $500, or the lesser of: a) $250 multiplied by the number of non-highly compensated employees of the eligible employer who are eligible to participate in the plan, or b) $5,000.
There’s a new small employer automatic plan enrollment tax credit. Not surprisingly, when employers automatically enroll employees in retirement plans, there is more participation and higher retirement savings. Beginning in 2020, there’s a new tax credit of up to $500 per year to employers to defray start-up costs for new 401(k) plans and SIMPLE IRA plans that include automatic enrollment. This credit is on top of an existing plan start-up credit described above and is available for three years. It is also available to employers who convert an existing plan to a plan with automatic enrollment.
These are only some of the retirement plan provisions in the SECURE Act. There have also been changes to the auto enrollment safe harbor cap, nondiscrimination rules, new rules that allow certain part-timers to participate in 401(k) plans, increased penalties for failing to file retirement plan returns and more. Contact us to learn more about your situation.
The Tax Cuts and Jobs Act created a new program to encourage investment in economically distressed areas through generous tax incentives. The Qualified Opportunity Zone (QOZ) program relies on investments in Qualified Opportunity Funds (QOFs) — funds that can provide wealthy taxpayers with some new avenues for estate planning.
3 big tax benefits
Investors in QOFs stand to reap three significant tax breaks:
They can defer capital gains on the disposition of appreciated property by reinvesting the gains in a QOF within 180 days of disposition. The tax is deferred until the QOF investment is sold or Dec. 31, 2026, whichever is earlier.
Depending on how long they hold their QOF investment, they can eliminate 10% to 15% of the tax.
After 10 years, post-acquisition appreciation on the investment is tax-exempt.
By incorporating QOFs in your estate planning, you can reduce both capital gains and transfer tax liabilities.
Estate planning implications
Proposed regulations make clear that a QOF investor’s death isn’t an “inclusion event” that would trigger tax on the deferred gains. In addition, most of the activities involved in administering an estate or trust (for example, transferring the interest to the estate or distributing the interest) won’t trigger the gain. But the sale of the QOF interest by the estate, the trust or a beneficiary would. Gifts of QOF interests also are generally considered inclusion events that make the deferred gains immediately taxable.
You could avoid this, though, by gifting your interest to a grantor trust. Both revocable living trusts and irrevocable grantor trusts qualify. However, transfers to the latter are completed gifts and therefore produce greater potential tax savings in situations where the income and gains of the trust are taxed to the grantor, in turn reducing the grantor’s estate by the amount of income taxes paid. (Note, though, that the termination of grantor trust status for reasons other than the grantor’s death is treated as an inclusion event.)
For example, you could transfer a highly appreciated asset to an irrevocable trust with no gift tax under the federal gift and estate tax exemption ($11.40 million for 2019 and $11.58 million for 2020). The trust could sell the asset and defer the gains into a QOF investment.
Another option for transferring QOF interests is the grantor retained annuity trust (GRAT), which allows you to make a gift to a trust and receive an annuity interest roughly equal to the fair market value of the gift. Any appreciation beyond the amount required to pay the annuity also passes to the beneficiaries without gift tax.
Contact us for additional information.
Depreciation is a deduction from income tax that lets you recover the cost of property. Click through to see how the IRS allows for the wear and tear, deterioration or even obsolescence of items.
Depreciation of tangible property — buildings, machinery, vehicles, furniture and equipment, even cell phones — as well as intangible property, such as patents, copyrights and computer software, in some situations, is allowed by the IRS and can be used to offset income from your business. Does your property meet these requirements?
- You own the property.
- Or you lease the property and make capital improvements.
- You use the property in business and for personal purposes. (In this case, you can only deduct depreciation for business use of the property.)
- The property must have a determinable useful life of more than one year.
However, not everything can be depreciated. For example, land is off the table: It doesn’t get used up and is not subject to wear and tear. Inventory is not depreciated either.
You depreciate an asset over time. When you place property in service to use in your business or trade or to produce income, that’s when depreciation begins. However, property stops being depreciable when you’ve fully recovered the property’s cost or other basis or when you retire it from service — whichever happens first.
There are different schedules for different items: For computers, office equipment, cars, trucks and appliances, the recovery time is up to five years; office furniture and fixtures work on a seven-year schedule. Residential rental properties can be recovered over 27.5 years, while commercial buildings and nonresidential properties can be recovered over 39 years, depending on the year you acquired them.
You need to know the initial cost of the asset and how long you can depreciate it for. There are three depreciation methods summarized below. Particular situations will dictate which ones are most appropriate for you.
- Straight line — depreciate the property an equal amount each year over its useful life.
- Accelerated method — take larger depreciation deductions in the first few years of the property’s useful life and smaller deductions later on.
- Section 179 deduction — deduct the entire cost of the asset the year it’s acquired.
And to ensure that you properly depreciate property, you need to consider:
- The depreciation method for the property.
- The class life of the asset.
- Whether the property is Listed Property (as defined by the IRS)
- Whether you’ve elected to expense any portion of the asset.
- Whether you qualify for any bonus first-year depreciation.
- The depreciable basis of the property.
Use depreciation to decrease your tax burden — you are lowering your overall taxable income. Depreciation doesn’t affect your company’s cash flow or its actual cash balance — it’s a noncash expense. However, before making any decisions, keep in mind that this is just an introduction to a very complex topic, and the provisions and methods described here are not applicable in every situation. Give us a call to discuss them further.
Call us at 512-255-7110 now to discuss how we can formulate an effective tax strategy for you or your business. You can also request your free consultation online.