Ask Liz Weston

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Taxes

Q&A: With tax day coming, here’s what to know about the difference between an enrolled agent and a CPA

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Dear Liz: What is the difference between using an enrolled agent and a certified public accountant to file income taxes? I have used a CPA in the past to file my federal and state income taxes but I need to find a new person for this job. My financial situation is fairly simple: single, no dependents and no real estate. Is an EA qualified to file income taxes? Do they look for possible tax credits? What happens if there is an audit?

Answer: Enrolled agents specialize in taxes. They can prepare returns, provide tax advice and represent you in an audit. (In fact, many enrolled agents used to work for the IRS, giving them intimate knowledge of the agency’s policies and practices.)

CPAs have broader education requirements and don’t necessarily specialize in taxes. They may be auditors, financial planners or business consultants, for example.

If you have complex financial or tax needs, a CPA could be a good fit. Otherwise, an EA could fill the bill and may be more economical. You can get referrals from the National Assn. of Enrolled Agents.

Q&A: How to pay taxes electronically

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Dear Liz: You recently wrote about check theft and the fraud possibilities when paying with checks through the mail. The largest checks that I send are to the IRS and California’s Franchise Tax Board. Is there a way to send in tax payments electronically rather than by check?

Answer: Absolutely, and tax authorities typically encourage you to use these electronic payment methods.

The IRS has a number of options. Its Direct Pay service allows you to schedule payments from your bank account at no cost. You also can pay using a credit card, debit card or digital wallet service such as PayPal, although these methods incur a processing fee. California’s FTB also has electronic options. (Electronic payment options for other states can be found by searching for the state tax agency’s name and the word “payment.”)

Q&A: What to know about capital gains tax on a house sale

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Dear Liz: My husband died in November 2022. I was told that if I sell the house within two years of his death, I can benefit from two capital gains exclusions, his and mine, each for $250,000. The house was appraised at $912,000 based on his date of death. I don’t imagine it would sell for much more than that now. Can you tell me approximately what I would owe in capital gains? My tax rate is 24%.

Answer: That’s a great question to ask a tax pro, since there are a number of variables involved.

If you live in a community property state such as California, then both halves of the property got a favorable step-up in tax basis when your husband died. That means the house’s new tax basis would be $912,000.

If you don’t live in a community property state, then only half of the house got the step up at his death (to $456,000, or half of $912,000). The other half — yours — retains its original tax basis. If the original purchase price of the home was $300,000, for example, your basis would be $150,000. The home’s total basis would be $606,000 (which is $456,000 plus $150,000). If you sold the house for $912,000, your capital gain could be $306,000, which would be well below the $500,000 exemption you could take if you sell the house within two years of the death. If you sell after the two-year mark, the gain above your single $250,000 exemption would be taxable.

The rate you would pay depends on your taxable income and what state you live in.

For example, a single person with taxable income of between $47,026 and $518,900 in 2023 would pay a 15% federal capital gains rate, plus whatever rate their state imposes. (California doesn’t have a separate capital gains tax system, so any taxable gain would be subject to the state’s regular income tax.)

These numbers are just to give you an idea of how capital gains taxes work. Your mileage may vary. If you renovated the kitchen or did any other significant improvements on the home, those costs could be added to your tax basis to reduce any potentially taxable gain. Also, selling costs will reduce what you actually pocket from the sale and your potentially taxable gain. For more information, see IRS Publication 523, Selling Your Home.

Taxes shouldn’t be your only consideration, of course. Relocating can be disruptive and expensive. Getting the house sold before the two-year mark makes sense if you were planning to move anyway, but don’t let fear of taxes scare you out of a home that otherwise suits you.

Q&A: Their 529 college savings plans have a problem: The students graduated. Now what?

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Dear Liz: My adult children both have money left in 529 accounts that I control as well as uncashed savings bonds given by generous grandparents. We were able to get them through college without needing the funds, but neither has decided to continue with graduate education and the funds have been stranded because of the high tax rate on non-education use. With the recent rule change for 2024, we plan to start converting the 529s into Roth IRAs, but this will take several years as we understand the contribution limits. Can you please discuss the IRA conversion process and make suggestions for cashing or converting the mature savings bonds to minimize the tax burden?

Answer: As you may know, interest on savings bonds isn’t subject to state or local taxes. Federal tax can be paid annually on savings bond interest, but most savers defer paying tax until the bonds are cashed in or reach final maturity, which happens 30 years after their issue date. Savings bond interest can be tax free if used for qualified education expenses, but there are a number of restrictions. For example, bond buyers must be 24 or older; if the bonds were registered in the children’s names, the qualified education exemption wouldn’t be available. (See IRS Publication 970 for details.)

You have more options for preserving tax-free use of the 529 funds. Starting next year, you’ll be able to roll up to $7,000 from each child’s 529 into a Roth IRA for them. The child must have been a beneficiary on the 529 for at least 15 years and contributions made within 5 years, plus their earnings, aren’t eligible to be rolled over. Any amounts they contribute to their own IRA or Roth IRA would reduce the amount you could roll over.

You can continue annual rollovers up to the Roth IRA contribution limit until a total of $35,000 has been transferred. The rollover must be direct or “trustee-to-trustee” — don’t ask the 529 plan to send you a check.

If you have money left over in the accounts after these rollovers, you could consider changing the trustee to a relative of the beneficiary. Eligible relatives include the child’s spouse, children and other descendants, parents and ancestors, in-laws, cousins, aunts, uncles, nephews and nieces and spouses of those relatives.

Even if you decide to pull the money out and pay the penalty, the taxes may not be as exorbitant as you fear. You’ll typically pay income tax and a 10% penalty, but only on the earnings, not the original contributions.

Q&A: Here’s how a health savings account works. Spoiler: It can be a stealth retirement fund

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Dear Liz: For the first time, I signed up for a high-deductible insurance plan along with a health savings account. However, I don’t quite understand a couple of key concepts. When our medical bills roll in, will we pay using our personal credit card or the HSA card provided by my employer? We have no trouble using our personal card but is that the right way to use an HSA — by not using it, in effect? Also, I read that the unused HSA funds can be invested to grow tax-deferred. How does the money get invested? Does my employer have a relationship with a specific broker? Or can I invest unused HSA funds with any broker?

Answer: If you want your HSA balance to grow for retirement, then paying your medical bills out of pocket is the way to go. If you use your credit card to pay medical bills, however, make sure you can pay off the balances in full. The benefits of an HSA would be diluted if you were paying double-digit interest rates.

If you do need to access your HSA funds, you can use your employer-provided card to pay medical bills or submit receipts to the HSA administrator for reimbursement.

As you probably know, HSAs offer a rare triple tax break. Contributions are pre-tax, your account can grow tax-deferred and withdrawals for qualifying medical expenses are tax-free. Because the account can be invested and balances rolled over from year to year, many people treat their HSAs as an additional way to save for retirement.

Your employer has chosen an HSA provider that typically will offer some investment options, but usually you can transfer your balances to a different provider if you wish. Compare fees, minimum balance requirements and investment options. If you decide to move your account, ask your current provider to set up a “trustee-to-trustee” transfer.

Q&A: Explaining required minimum distributions

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Dear Liz: When my wife reached age 59½, we initiated required minimum distributions for all of her retirement funds. During the process, the investment company representative stated that as long as she was still working and contributing to her 401(k) and 403(b) at work, she was not required to take RMDs for those accounts. With all the changes lately in those types of accounts, is that still the case, or has the law changed?

Answer: Minimum distributions have never been required at age 59½ from any retirement fund. That’s the age at which people no longer have to pay penalties for accessing their retirement funds, not the age at which they must start taking money out.

The current age at which retired minimum distributions must begin is 73, and it rises to 75 for people born in 1960 and later. If your wife is still working at that point, she can put off RMDs from the retirement plans sponsored by her current employer. RMDs will still be required on other retirement accounts, such as IRAs and 401(k)s or 403(b)s from a previous employer. The other RMD exception is for Roth accounts, which don’t have RMDs for the account owner.

Generally you want money to stay in tax-deferred retirement accounts as long as possible. Unnecessary distributions just increase your tax bill and can reduce the amount you have to live on later in life.

If your wife has already taken a distribution, she has 60 days to roll it over into an IRA and avoid taxation.

Tax law can be confusing and mistakes can be expensive. Please use this experience as a reason to hire a good tax pro who can answer your questions and ensure you don’t make another potentially expensive misstep.