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22 June 2016
Many people know “529” accounts are available as a tax-advantaged way to save money for higher education. If you’ve been reading this blog you also know I am a BIG fan of the 529 college savings programs, even though there are some pitfalls 529 investors need to watch out for when taking money out of a 529 to pay for college expenses.
What I suspect many people don’t know, however, is that in December 2014 Congress expanded authorities under Section 529 for states to establish another type of tax-deferred savings program. This program is for people with disabilities. It’s called the 529 ABLE program – and I like it just as well as the 529 College Savings programs. Maybe more.
When Congress creates a tax (or a tax break), they will usually give it a name like “The Affordable Care Act” or “The Child and Dependent Care Credit”. If the media picks up on it, the name sticks. When they don’t we tend to default to calling it by the section of the Internal Revenue Code (IRC) that was added or modified to create it. For example, if I ask people if they have an “employer-sponsored retirement plan” they usually look at me with a blank stare. If I ask “do you have a 401K?” they know exactly what I mean. (Modern employer-sponsored retirement plans were created under section 401K of the IRC.)
The Affording a Better Life Experience (ABLE) Act was passed by congress in December 2014. It didn’t get much news time, so the name didn’t stick. The ABLE Act was passed by expanding state authorities under Section 529 of the IRC – the same section that authorizes states to establish tax-qualified accounts for college savings. Thus, we default to calling them 529 ABLE accounts. (I’ve seen them called “529A” accounts in a few places. Perhaps that will ultimately stick as a name.)
The primary issue being addressed by Congress was that many people with disabilities end up requiring social services (Social Security Income, Social Security Disability Insurance, Medicaid, etc.) to get by. Many social services are “means tested” – if you have money or assets, you don’t qualify to receive benefits under the programs. This created a disincentive for people with disabilities to save for their future. Sticking a few thousand in a retirement account could cost you tens of thousands in social services support. Wealthier families could create complex trusts to support a disabled child or relative without jeopardizing their access to social services, but most families either skirted the law by (illegally) keeping assets in someone else’s name or just not saving anything at all for the person with a disability.
That’s where the 529 ABLE account comes in. A person with a disability (or their family) can now save money in a tax-deferred account without it impacting their access to social services*. It’s a great incentive to be independent and self-supportive.
Each state will develop its own 529 ABLE program, so there will be variations among the individual programs offered by each state. They must all follow the IRS guidance, however, so there will also be a lot of common ground. Some states are making their program available nationwide. You don’t necessarily have to be a resident of a particular state to participate in their 529 ABLE program.
To be eligible for a 529 ABLE account an individual must meet one of the following criteria:
If you are eligible, you can open a 529 ABLE account. Once the account is open, up to $14,000 can be deposited to it annually as long as the total account balance is below the state’s established limit. Ohio has the first 529 ABLE program, and their established account limit is $426,000. If you have an Ohio ABLE account and the balance is greater than $426,000 no further contributions can be made to the account until the balance is below $426,000. That’s a generous limit. Not one most individuals will need to be concerned with. Other states may have other limits. The $14,000 annual limit is on the account, not the contributor. Total annual contributions from all sources cannot exceed $14,000.
Withdrawals (tax geeks like the word ‘distributions’, but it means the same thing as a withdrawal) from the account are tax free as long as the money is used on expenses meeting the following criteria:
Fortunately, the IRS guidance on the 529 ABLE accounts made a very broad interpretation of the above rules. 529 ABLE withdrawals can be used for housing, transportation, employment support, healthcare & wellness, legal fees, financial management, oversight, communication services, etc. Just about anything that supports the life and well-being of the disabled person qualifies as a legitimate expense.
This is a really great program for taxpayers with disabilities. My brother, Tom, has Down Syndrome and our family has been chomping at the bit for the 529 ABLE program to come online since the law was passed by Congress in 2014. Although Tom has been working and saving for nearly 30 years, we didn’t want his money in a retirement account (like an IRA) because we are concerned he may need the money before he is 59 ½ - the minimum age for withdrawal without tax penalties.
Tom is a resident of Ohio, and we were lucky that Ohio had the first 529 ABLE program made available to the public. I reviewed the program and was very satisfied with the job Ohio had done in terms of simplicity, value, and convenience. We started moving Tom’s assets into his Ohio 529 ABLE account just a few weeks ago.
Virginia is scheduled to roll out their 529 program later this summer. You can expect me to review it when it does. In the meantime, if you want additional information about 529 ABLE accounts, please contact me.
*Individuals receiving SSI should be aware that once the balance of the account exceeds $100,000 it starts to impact SSI eligibility. The first $100,000 is discounted, but above that eligibility is impacted. If the account balance is $102,000 then $2,000 is counted as an asset toward SSI eligibility.
27 May 2016
The deduction for mileage one of the tax breaks I see taxpayers not taking as often as they should be. More people qualify for it than they realize, and I am writing this article because I want more people to realize it! It can make a tremendous difference in your tax bill at the end of the year.
People who drive as part of their job are generally aware they can deduct mileage as a business expense, but many don’t fully grasp the significance of the deduction. It can be huge. I had a client this year who mentioned his mileage as an afterthought. I had prepared his taxes and reviewed the return with him. Then he mentioned that he frequently drives to temporary work locations as part of his job. He had records of the mileage in his car. I had him go get them and he sat and watched me add the deduction to his tax return. He was able to see in real time as $1,800 came off his tax bill. I doubt he’ll ever forget to mention his mileage to me again!
It’s a bit of a trick question. There really isn’t a mileage deduction, but there are deductions for vehicle expenses if you used your vehicle for work/business, for moving, or to support a charity. In all of those situations you can either deduct the actual vehicle expenses or you can take a standard deduction based on the number of miles driven for the specific activity. The standard mileage rate is much simpler to calculate and track, and it often provides a larger deduction than the actual expenses.
No matter which method you are using to deduct your vehicle expenses be sure to track your tolls and parking separately. You can deduct the cost of those items even if you are using the standard mileage rate to figure your deduction.
Driving for work or business – 57.5 cents per mile (drops to 54 cents per mile in 2016 – the cost of operating a vehicle is cheaper than it used to be).
I love this diagram. It comes from IRS pub 17 and makes determining whether or not your mileage is deductible as work or business a breeze. I think it should go into the Smithsonian. It is a national treasure.
Driving to your regular work location (your normal commute) and then back home is never deductible. But if you leave your normal work location to go to a temporary work site or a second job, that mileage is deductible. If you drive from home to a temporary work location that mileage is deductible. If you drive from your temporary work location to your second job, that mileage is deductible.
Moving Mileage – 23 cents per mile.
As I mentioned in a recent post, you can deduct moving expenses associated with starting a new job. You can refer to that post if you want more details.
Charitable Mileage – 14 cents per mile (18 cents per mile in Virginia!)
If you use your vehicle in the service of a qualified charitable organization, you can deduct the actual expenses of the gas and oil or you can take a standard mileage rate deduction of 14 cents per mile. So, if you drove your kid’s scout pack down to Kitty Hawk to see the Wright Brothers museum, keep track of that mileage because at tax time you can write that off as a charitable contribution.
Virginia allows a deduction of 18 cents per mile for charitable driving, so if you’re filing in Virginia be sure to get your extra 4 cents per mile deducted from your Virginia taxable income.
In order to take the deductions for work/business miles or charitable driving miles you will need to itemize your deductions on Schedule A. Moving expenses are an adjustment to income, so you don’t need to use schedule A in order to deduct those miles.
If your employer reimburses you for mileage you may still be able to deduct vehicle expenses at the standard mileage rate. It all depends on the manner of the reimbursement. If your employer uses an accountable plan to reimburse employees for travel, then your mileage won’t be deductible. Many employers, however, don’t use an accountable plan. Many will just bump up an employee’s salary to compensate them for using their personal vehicle for company business. In that case, you are not actually being reimbursed for mileage, and you can take the deduction. (If you aren’t sure whether or not you are reimbursed on an accountable plan, ask your employer.)
The IRS requires taxpayers to have adequate records to substantiate their mileage deductions. What exactly does adequate records mean?
For claiming vehicle expenses, including the standard mileage rate, the IRS wants you to have a mileage log. Your mileage log needs to have all of your business mileage logged and it also needs to have the total mileage that you drove for the year. (Even if you are claiming the standard mileage rate deduction the IRS wants you to report the total mileage for your vehicle for the year.)
There’s an app for that! In fact, there are several apps for tracking mileage. I use one known as MileIQ. It uses the GPS in my phone to track individual drives and distances. After I arrive at my destination I get a phone alert that a new drive was recorded. I tap the alert to open the app and review the drive. If it was a drive for personal reasons I swipe left. If it was for business I swipe right, and the drive is recorded as such. I typically just clear all my drives at the end of the day. It takes 30 seconds and I have a driving log.
The app is free for up to 40 drives per month. If you drive more than 40 times per month (and you probably do) then it’s $60/year. It is available from Apple and the Google Play store.
If you think you might be able to deduct some of your driving miles as a business, moving or charitable donation – but aren’t sure – contact me. We’ll get it sorted out.
19 May 2016
Wow! Almost a month since I have published a blog post. I've been rather busy getting the financial planning side of the business set up. Additionally, there were some management changes with the office I rent and I had to spend some time figuring out if I would be able to stay here at 582 Lynnhaven Pkwy or if I was going to have to find a new office. (That's all settled, and I am staying right here!) And lastly, I had a kidney stone. A big, nasty 7 mm one that attacked during the evening of the last day of tax season! That had me out of commission for a while, but now I am back at full stride. Time to start posting again.
I thought I'd ease back into the tax blog with a little history on the ordinary and necessary requirement for business expenses.
Harold Lloyd Jenkins made a significant impact on the federal tax code when he won his lawsuit against the Commissioner of the IRS. In its ruling favoring Jenkins the tax court defined the standard for Internal Revenue Code section 162 ordinary and necessary business expenses. That standard is still in effect today. If none of this seems interesting, keep reading – it gets better.
Harold Lloyd Jenkins was much better known by his stage name Conway Twitty. As a singer, songwriter, and producer Twitty collaborated on 55 number one country, pop, and R&B music records during his career. He may be best known for a series of country duets he did with Loretta Lynn in the early 1970s. What he is not remembered for is Twitty Burger.
Twitty Burger was a string of hamburger restaurants Jenkins/Twitty opened with investor backing in 1968. By 1971 it was evident the restaurants had no future and were closed. In 1973 and 1974 Twitty repaid some of his Twitty Burger investors with money he earned as a recording artist. He deducted those payments to investors as an expense to his business of being a recording star.
The IRS disagreed that repayments to investors for a previous failed business were an ordinary and necessary business expense for a recording artist and demanded Twitty adjust his tax returns and pay the taxes on that money. Twitty and his lawyers took the case to Tax Court where they argued that a country music singer’s reputation was essential to the success of his business/career, and that failing to repay the Twitty Burger investors would have damaged Twitty’s reputation within his industry. Therefore, the repayments met the standard for being ordinary and necessary business expenses for a country music singer.
The tax court agreed. The court ruled that two questions need to be taken into consideration when determining ordinary and necessary:
1) What is the motive for making the payments
2) Is there is a sufficient connection between the expenditure and the business from which it is deducted
In Twitty’s case the court ruled that Twitty made the repayments to investors to protect his reputation, and that his reputation was essential to his business as a recording artist.
In short, the court set the standard that being ordinary and necessary was dependent on the particular profession. Expenditures that are not ordinary and necessary in one profession may be ordinary and necessary in another. An insurance salesman can’t claim fire-proof pants are an ordinary and necessary expense, but a fire fighter can. This ordinary and necessary standard remains in effect today.
As an odd footnote to this story, the Tax Court concluded their written ruling on the case in the form of a country music ballad.
"Ode to Conway Twitty"
Twitty Burger went belly up
But Conway remained true
He repaid his investors, one and all
It was the moral thing to do.
His fans would not have liked it
It could have hurt his fame
Had any investors sued him
Like Merle Haggard or Sonny James.
When it was time to file taxes
Conway thought what he would do
Was deduct those payments as a business expense
Under section one-sixty-two.
In order to allow these deductions
Goes the argument of the Commissioner
The payments must be ordinary and necessary
To a business of the petitioner.
Had Conway not repaid the investors
His career would have been under cloud,
Under the unique facts of this case
Held: The deductions are allowed.
20 April 2016
My first tax season out on my own is in the books, and I want to thank the people of Hampton Roads for making it a great success!
I previously worked for The Big Box, so I wasn’t new to taxes, but opening my own tax firm took a leap of faith. I had to find my own office, get my own software, develop my own processes, and then hope that some clients would not just find me, but trust me with their finances. These are not small things if you’re serious about building your own tax business.
Back in January I wondered if this Grand Plan of mine was going to work. I have to confess I even worried a little bit. Now that tax season is over I look back with a great deal of satisfaction at how things went.
Not that there weren’t some bumps in the road. Some growing pains. There were. I learned some things along the way that I plan to use to make next year even better.
But for now I just want to take this opportunity to thank my inaugural year clients. Nearly all from Virginia Beach, but a few from other parts of Hampton Roads. It was great to get to know each and every one of you. The feedback you provided was essential in helping me build the practice I want to build.
There are some amazing people doing amazing things in the world. It is inspiring to discover so many of them are my neighbors. I hope to see you all again next year.
And I hope to see some of you even sooner than that. Somewhere around the middle of tax season the state of Virginia approved my application for PIM Financial Partners to be a Registered Investment Advisor. Some of you expressed an interest in financial planning while we reviewed your taxes, and those services will soon be available.
Thanks and VR,
13 April 2016
I read about it all the time and I have made several Facebook posts about it this tax season, but identity theft got personal for us this year. Our tax return could not be e-filed with the IRS because Tade’s social security number had already been used by someone else. Someone stole her social security number and filed a tax return in her name, which blocks us from being able to file our return electronically.
It’s strange when it happens. I do our own taxes, of course, so I was the first person to see the rejection notice from the IRS stating that her social security number had already been used. My first reaction was equal parts shock and outrage – HOW DARE SOMEONE DO THIS! That first reaction hasn’t changed much over the last week or so since it happened. It has transformed a bit into fear there could be additional damage, but the anger remains. I’d like to find and throttle the criminal who did this.
Back in olden times criminals were placed in stocks in the town square and passing citizens could hurl rotten vegetables at them. Could we bring that back for situations like this? It seems like an appropriate way to punish menaces who prey upon the public. I’m not a mean guy, but I’d love a shot at this clown. I could work on my fast ball with a bushel of wormy old tomatoes while simultaneously discouraging a scoundrel from further d-baggery. Seems like a win-win to me. (Can you tell I’ve been thinking about this for a while?)
Sadly, I hold out little hope this jackwagon will ever be found. Cyber thieves are very hard to track down.
We can’t let that stop us from taking action, however. There are things to be done to get our taxes completed, protect our future tax filings, and prevent any further damage to our credit and finances. Let me outline the steps to take when you are the victim of a fraudulent tax return filed in your name.
Step 1. Tell the IRS
Our tax return was rejected within 20 minutes of being filed. The IRS computer took a look at the social security numbers on our return and compared them with the SSNs on tax returns already filed. As soon as the computer found a match our return was rejected. That doesn’t mean the IRS knows our return was the correct one and the one they already have is the fake one. We know it, but the IRS doesn’t. We have to tell them. (We also still need to file our taxes!)
Generally, you ‘tell’ the IRS by mailing them a paper copy of your tax return. Include with it a form 14039 Identity Theft Affidavit. There is space on the form to tell the IRS what happened that alerted you to the fact that your identity was used by someone else to commit tax fraud. You will also need to include a photocopy of your ID to prove that you are who you say you are. Instructions for including your ID are spelled out on the form.
Filing form 14039 tells the IRS your identity was stolen and your SSN was compromised. This puts you in the IRS’s database as requiring a separate PIN in order to file your taxes. The IRS currently issues these in December. You will get your PIN in the mail, and YOU MUST HAVE IT in order to file your taxes electronically next year. Don’t lose it!
Depending on how and when you filed your taxes you might first discover the identity theft by receiving a 5071C letter from the IRS. This letter informs you the IRS suspects someone may have committed tax fraud using your information and that you need to verify your identity in order for your tax return to be processed. Follow the instructions in the letter.
Step 2. Protecting Yourself from Further Harm
Even after you have things squared away with the IRS you should take additional measures to protect yourself from further harm. A criminal has your personal information. You have no idea what their intent might be, but we already know they are willing to use it to steal tax money from the government. Are you willing to gamble they are just going to stop right there?
You should file a complaint with the Federal Trade Commission (FTC). You can do this online at identitytheft.gov.
You should also contact at least one of the major credit bureaus to put a fraud alert on your records. (Note: The IRS won’t do this for you!) The major credit bureaus are:
Get a copy of your credit report from at least one of the bureaus and review it. They are required to give you one free copy each year. Verify all of the open credit and financial accounts in your name. If you see one you don’t recognize, close it. Especially if it was opened recently.
Step 3. Continue Monitoring
Even if there is no suspicious activity on your credit report you must remain vigilant. Your information is still in the hands of a criminal. They might just be waiting until they think you’ve forgotten about that fact to strike. You will need to stay on top of this for the rest of your life.
The credit reporting agencies have to give you a free report once a year. I have set up a schedule to get a report from a different agency every 4 months; Equifax in February, Experian in June, TransUnion in October. Rinse and repeat each year. That way I get my free report from each of them, and I also have year-round coverage.
Additionally, I use CreditKarma.com to monitor our credit scores. I can check every week (for free) to see if our credit scores have changed. A new account opened in your name would change your credit score, so monitoring it could provide an earlier warning than the 4-month credit report interval. (Hint: you might want to use an e-mail account you don’t mind getting a lot of offers sent to when you register for Credit Karma. It’s free to use, but the helpful offers just keep on coming.)
If you’re able you might want to consider one of the credit monitoring services available. You pay a fee for that service, but any time there is activity in your financial world they will send you an alert. Tade and I signed up for one of these, but I am not overly impressed, so I am not going to recommend them by name. If you’re interested, you can do some research and find one you think is suitable for your needs.
Getting your identity stolen stinks. It really stinks. If it has happened to you then you know exactly what I mean. I hope they catch the guy who did it. If they catch your guy give me a call and I’ll go in 50-50 on the bushel of rotten tomatoes with you.
If you need help with getting your tax situation straightened out with the IRS, give me a call.
01 April 2016
Tax Preparation is an oxymoron. In the English language the word prepare means to make yourself ready for something you will be doing in the future; to get ready for upcoming events. Tax return preparation is about what happened last year. When we generate the return we are looking backward, not forward. Even though I think it should, tax preparation usually has nothing to do with getting ready for upcoming events.
A better description for generating a tax return would be tax reconciliation. You are comparing what you paid in taxes for the previous year to what your final tax bill actually was, and then you reconcile the difference. If you paid too much you get a refund. If you did not pay enough, you owe.
I don’t want to make too big a deal of this. Fussing about the language is like howling at the moon. I am known as a tax preparer, and most people understand that to mean I assist with the reconciliation of last year’s taxes, generate the tax returns, and get them filed with the appropriate federal, state, and local authorities. All of that is true, and I see no reason to go on a crusade to try to change what it is called. My inner Sheldon finds it curious, though, and I would stress that one of the primary advantages of hiring a professional tax preparer over do-it-yourself tax preparation software is that a professional tax preparer can, in fact, help you prepare for the future.
I would like to dispel a different tax myth, however, and that is the myth that all tax preparers are also accountants. Some are, but many are not. I, for example, am not an accountant.
The opposite is also true – not all accountants are tax preparers. Many accountants are, but not all. I have a client who is an accountant. He works in the accounting department of a large corporation. He seems sharp and I suspect he is good at his job, but he doesn’t know individual income tax law, so he hires me because I do.
It’s rarely a problem being confused with an accountant, but from time to time I will get a call from a potential client who does not understand there is a difference between accounting and tax preparation. They assume that since I do one, I must do the other. I think the easiest way to explain the difference is this:
An accountant tracks and assesses your financial situation. They keep track of income and expenses, assets, debts, and equity. They can tell you your financial status at any time, to include the end of the tax year. (Accountants do much more than this, but I think my brief description will suffice for this article. My apologies to any accountants who disagree!)
A tax preparer applies your financial situation (your annual income, expenses, etc.) to the tax law to reconcile your taxes in the manner that is both legal and most advantageous to you. A true tax professional, such as an Enrolled Agent, can also provide you with tax advice so you can actually prepare for taxes in future years.
In short, accounting gets you ready for the preparation of your tax return.
The vast majority of my clients are essentially their own accountant. They keep track of their finances and bring me the results from the previous year so that I can apply them to the tax laws and generate their tax return.
A few, usually with a rental property or a home business, will bring me a box (or an accordion file) of receipts that need to be sorted and totaled before I can begin generating the tax return. This is an accounting function, not tax preparation.If they bring me a lot of receipts this can be quite time-consuming, so I charge a bookkeeping fee to compensate me for the time. (I call it a bookkeeping fee to distinguish the fact that I am not an accountant.) My bookkeeping fees (currently $120/hour) are quite reasonable when compared to the fees most actual accountants charge for a similar service, but can add quite a bit to the cost of tax preparation for a client.
An easy way to avoid paying me (or another tax preparer) bookkeeping fees is to sort and total your receipts prior to engaging me as your tax preparer. I encourage all part-time landlords and small/home business owners to do this.* I have some helpful guides available for download if you need assistance with understanding the categories of business and/or rental expenses the IRS wants you to track. Or you can always call or visit my office and ask. There’s no charge for helping you get prepared for your tax appointment.
Don’t sweat the small stuff. I don’t look for excuses to charge for bookkeeping. You don’t have to build a master spreadsheet to total a handful of charity receipts or two semesters of college books. It only takes me a few minutes to add those up and put them on a tax return. I consider that just part of the tax prep fee. I like to think I apply common sense to when and where I charge for bookkeeping. I also never surprise people with bookkeeping fees. If I don’t mention it when I give you a price quote, there won’t be a charge for it.
Most people want to keep their tax preparation fees as low as possible, and I completely understand that. I’ve said for a long time I think most tax preparation fees are ridiculous. I don’t charge for bookkeeping to drive up my fees. I charge for bookkeeping because the time I spend doing it cuts into the time I have available to assist others with reconciling last year’s taxes or preparing for next year’s taxes – my primary service area.
If you have any questions about tax preparation or bookkeeping, please contact me.
*If your business is an S corporation or a C corporation, you should probably consider using an actual accountant. The complexity of those entities typically makes hiring a professional accountant a bargain.
26 March 2016
As big a fan as I am of the Virginia 529 plans, I think I am an even bigger fan of TSP. TSP is the Thrift Savings Plan, the federal government’s version of a 401(K) style retirement plan. It is open to all federal civilian employees as well as military personnel.
Here is my simple piece of advice regarding TSP – use it!
I was born a skeptic, and then I worked for the government for almost 3 decades. That time was full of disappointment about the systemic waste and mismanagement I witnessed on a daily basis. When I first heard the government had implemented a 401(K) style retirement program my first thought was I wonder how screwed up that’s gonna be.
To my extreme delight I discovered it was not screwed up at all. It’s very very good. In fact, for accumulation purposes it is quite likely the best employer-sponsored defined contribution retirement plan in America. If you are eligible to participate in TSP, but not participating, you are making a mistake.
Super Low Costs. Retirement plans traditionally invest in funds, and the funds charge a management fee. The management fees in the TSP plan are the lowest I have ever found; 0.029% as of this writing. The cheapest management fee in a fund my wife, Tade, can buy through her employer-sponsored retirement plan is 0.50%. These may seem like small numbers, but they are not. Over time they really add up. But even just at face value Tade is paying more than 17 times the management fees for her fund than a TSP participant pays – and that’s for the cheapest fund available to her!
Simple Selections. Studies have shown that the more fund choices an employer puts in the retirement plan offered to employees, the lower the plan participation rates. Employees experience choice overload, and some respond by not participating in the plan. Others respond by making selections of the easiest and safest sounding funds – which may not be the best choice for them based on their individual situation. TSP keeps it simple – there are 5 funds from which to choose. If you still can’t decide what to do, TSP will set up a life-cycle fund for you. All you do is select your retirement year and they choose the funds for you and change them over time as your retirement date gets closer. Very, very simple.
The G Fund. Would you like a guarantee that you’ll never lose money on your investment? If so, then the G-Fund might be for you. The G Fund invests in US Government Bonds, but with a twist. While government bonds can decrease in value, the G Fund comes with a guarantee that it will never be worth less than you put in it. In the current low interest rate environment government bonds aren’t paying very much, but that guarantee to never lose money makes the G Fund worth a second look if you need stability in your retirement portfolio.
TSP comes in two flavors – Traditional and Roth. Just like IRAs of the same flavors, the difference between the two is the timing of the taxes you pay to participate. With Traditional TSP you get a current year deduction, but you pay the taxes later when you withdraw the money in retirement. With Roth TSP you pay the taxes now, but future retirement withdrawals are tax free.
If you are under age 59 ½ and considering a TSP withdrawal for anything other than your retirement, please contact me first. There are a lot of rules about early withdrawals, the circumstances surrounding them, and the tax penalties that might result. Talk to me first before you make an early withdrawal. I prepare taxes for several clients each year who wish they had!
Combat Pay and TSP
If you are in the military and deployed to a tax-free combat zone for part of the year, there are some special rules you should be aware of.
If there's one area in which I think TSP could get better it's in the area of distributions. TSP isn't as flexible as some other plans. You can set up periodic withdrawals, or you can take a lump sum, but you can't do both. For most people these options will probably work out just fine, but if you want maximum flexibility to do something spontaneous like travel whenever you want you can't just make a withdrawal from your TSP account to do it. If you need that kind of flexibility you might want to roll your TSP account assets out to an IRA when you retire.
TSP is a fantastic retirement plan for many reasons. There are also many tax breaks, tips, and tricks associated with TSP that can help you out in different situations. If you want to know more about your TSP and taxes, contact me.
16 March 2016
I am big fan of the Virginia 529 program. It offers a lot of flexibility and a variety of opportunities to get tax breaks to save for higher education. Unfortunately, it also offers a lot of opportunities to screw up when you are taking the money out to spend on college. If not done properly you could find yourself paying both taxes and tax penalties on money that should have been (and was planned to be) tax free.
The biggest penalties may not come from the IRS, either. If you took a Virginia state tax deduction for your past contributions, you have to pay Virginia back the amount of tax you originally saved plus interest. You might have made that contribution 15 or more years in the past. That could add up to a lot of interest. The normal six-year statute of limitations on Virginia back taxes does not apply, either. It doesn't matter when the contributions were made, if you don't use that money for higher education (or have a qualifying exemption) you have to pay Richmond back. That could be very very painful.
This article is going to walk you through some of the things that can go wrong and what you can do to fix them if they happen. It's a little embarrassing to admit, being a knowledgeable tax professional and all, but I have been guilty of several of the examples below. So when I say it's easy to screw up the spending part of the Virginia 529 plan, I speak from experience. (What was even worse was that when I called the Virginia 529 help line they told me to speak with my tax professional. D'Oh!)
Problem - You took money out of your Virginia 529 in December for tuition you paid in January. Seems harmless enough, but that’s two different tax years. Money withdrawn in 2015 needs to get matched against qualifying expenses paid in 2015. If you can’t match up your tax qualified money against qualifying expenses on your tax return you may be in line for some taxes and penalties.
Solution – Put it into a different 529 account. If you put the money back into another 529 account within 60 days of withdrawing it then it counts as a rollover and you are not taxed. You can put it back in an account with the same beneficiary only once per year. You could also put it in another beneficiary’s account (i.e. a sibling) as long as the new beneficiary is a family member. You could even open an account for yourself and stick it in there. In a future year you can always withdraw it again and put it back in the original account. Just remember that you cannot take another tax deduction for the money if you are rolling it over. The Virginia state tax deduction only counts toward original contributions.
Problem – You paid tuition with money you withdrew from your Virginia 529 account and now you don’t have enough qualifying expenses left to claim the American Opportunity Credit. This mistake is easy to make because you might be paying the tuition in January and you won’t be filing for the American Opportunity Credit on your tax return until March or April of the next year. You’re probably not thinking about your taxes 15 months out when you’re paying the tuition. While there are several different higher education tax benefits, the IRS generally allows us to take only one tax benefit on each dollar spent on higher education.
Solution 1 – Dig for additional college-related expenses. It would be pretty rare for the tax-free character of the Virginia 529 withdrawal to be more valuable than the very generous American Opportunity Credit (AOC), so you will want to be able to claim the AOC. The list of qualifying expenses for AOC is much more limited than it is for the 529 money, so apply up to $4,000 (the max) of expenses that qualify for AOC against the AOC, and then look for additional expenses to match up to the 529 money. Room and board, parking passes, and computers are some of the expenses that qualify under Virginia 529 plan.
Solution 2 – Pay the tax on the Virginia 529 money. If you can’t come up with enough qualifying expenses to justify your Virginia 529 withdrawal, then you either have to not claim AOC or pay the tax on the Virginia 529 money. Given that situation your best choice is likely to pay the Virginia 529 tax. Fortunately, the IRS waives the penalty (not the tax, though) if your 529 money is disqualified because you took a different tax credit. Always run the numbers to be sure, but the AOC is so valuable you will nearly always come out ahead by claiming it and disqualifying all or part of your Virginia 529 withdrawal.
Problem – You didn’t take out enough money. Your child has graduated and everything is paid for, but there is still some money in the Virginia 529 account. I put this in the category of good problems to have, but it is still a problem. If you take that money out for anything other than qualified higher education expenses you are going to have to pay taxes and penalties.
Solution 1 – Leave it within the 529 system. There are multiple scenarios under this option.
a) If the original beneficiary has a sibling the money can be rolled over to the sibling’s account.
b) If you want to start saving for your grandchild(ren)’s college you can use this account even if the grandchild is not yet born. Simply leave the account with the originally named beneficiary until the grandchild is born and then change the beneficiary to the newborn. (Keep in mind that if there is substantial money involved you might run into transfer taxes – currently 40%. Come see me first if that is the case!)
c) You can open an account in another person’s name and move the money there.
Solution 2 – Withdraw the money as efficiently as possible. If you want to get the money out of the Virginia 529 program, but don’t have qualifying higher education expenses, at least try to be as tax efficient as possible with your withdrawals. Don’t withdraw so much in one year that it moves you to a higher tax bracket. You might also consider whether you or the beneficiary would pay more taxes on the distribution. Either of you can make the withdrawal and the tax is owed by the recipient. It might be more beneficial for your child to take the distribution and pay the taxes than it would be for you to do it.
The Virginia 529 plan is a fantastic program. It offers some great tax savings for parents in the accumulation phase of college planning for their children, with no income-based restrictions. But the rules are complex, and unsuspecting parents/taxpayers will sometimes unwittingly fall into a trap during the distribution phase of the college plan.
If you have questions about using your Virginia 529 plan as efficiently as possible, please contact me.
11 March 2016
I have recently found myself giving long explanations to some of my clients who have fallen into an area of the tax code I call “the crease”. It always seems to be a married couple filing jointly, and on the rise. They are at a point in their lives when the hard work is starting to pay off. They are getting the job, the promotion, or the pay raise they want. There’s a little bit of money left over at the end of the month. They are starting to think about retirement planning, college funding, a house with more room, a car that doesn’t sputter, maybe even a family vacation.
And then they do their taxes and discover that instead of the $1,500 refund they got last year they are going to have to pay $1,500 this year. A $3,000 turnaround in one year! How could this happen?
They have fallen into the crease.
For married couples filing jointly the crease is that area of income from roughly $100,000 to $130,000. That’s where some commonly used deductions and credits go away, exposing more and more of the couples’ income to taxation. Below $100,000 a married couple filing jointly typically qualifies for most (or all) of the commonly used tax deductions and credits.
• The IRA Deduction
• Tuition and Fees Deduction
• American Opportunity Credit
• Lifetime Learning Credit
• Student Loan Interest Deduction
• Child Tax Credit
• Deduction for Mortgage Insurance
• Special Allowance for Passive Activity (i.e. Rental) Losses
By the time a married couple reaches $130,000 many of these tax benefits are partially phased out or gone completely, causing a dramatic increase in the couple’s tax liability. As their pay increases, they are having taxes withheld at the same rate as the previous year, but it's not enough to cover the taxes they owe. Their rate of tax burden growth is faster than their rate of pay increases. They are still in the same top marginal tax rate bracket, but more and more of their income is being exposed to taxes, and they are getting fewer and fewer tax credits on the back end. Without realizing it, in the course of a year they have gone from a tax refund to stroking a check to settle up with the IRS.
If you ever want to deal with angry, bewildered, irritated people – become a tax preparer and tell someone who thought they were getting a $1,500 refund (just like they did last year) that they need to write a check to the IRS for $1,500 instead. That’s not fun for either of us.
I understand that frustration. Tade and I went through it some years ago. Money we thought was going toward a trip to Disney World went to the IRS. I was seeing red for days. I wanted to club somebody. (Somebody at the IRS!)
In retrospect, taking a broader view of the situation would have been helpful. The fact of the matter is that when you fall into that crease you are punching through to a new chapter in your lives. One where you are enjoying more of the American Dream. Despite the higher taxes you are earning more and prospering. No longer living paycheck to paycheck. Able to plan for the vacation or the retirement fund. The initial shock of your tax bill is rough, but it wears off. Try to see the bigger picture.
Being in the crease is also a great time to take advantage of a tax planner. Not a seasonal worker at a tax mill, and not a software program, but an actual tax professional. A tax lawyer, a CPA, or an Enrolled Agent. Someone who can look over your entire financial situation and provide you with some strategies to reduce your tax liability while helping you make progress toward your financial goals. That new and shocking tax bill could serve as a wake up call to get serious about your financial plan.
Earlier this tax season I saw some of my clients had fallen into the crease. I was able to provide them with a simple strategy that erased nearly $2,000 from their tax bill. It didn’t cost them a dime out of pocket to implement, either. They just didn’t know about this particular strategy until I explained it. The value of using a trained tax professional isn’t just making sure this year’s tax forms are filled out correctly. It’s also about devising a way forward that makes the most efficient use of YOUR money.
I certainly can't promise those results to everybody. Each taxpayer's situation is unique, so what worked for a previous client may not fit your particular situation. But you never know unless you ask.
If you would like professional assistance with your tax preparation and tax strategy, please contact me.
Paul D. Allen is a founding member of the Military Financial Advisors Association, as well as a member of the National Association of Enrolled Agents, the National Association of Tax Professionals, the Financial Planning Association of Hampton Roads, the National Association of Personal Financial Advisors (NAPFA), and the XY Planning Network. Paul is the Director of the CFP Board-Registered Program at The Regent University School of Law where he also teaches the Capstone Course in Financial Planning. You can read more about Paul's background here.
PIM Tax Services LLC is a professional tax planning and preparation service in Virginia Beach, but through the magic of the internet, we serve clients around the world!