March 30, 2020 By

Q&A: Those IRS coronavirus-extended deadlines apply to more than just taxes

Dear Liz: Now that we’re not required to file our taxes until July 15 this year, has anything been said about pushing back the 2019 contribution deadline for IRAs and Roth IRAs?

Answer: The IRS recently confirmed that the deadline for making contributions to IRAs has also been extended to July 15. The deadlines were pushed back from April 15 because of stay-at-home orders and other disruptions stemming from the coronavirus outbreak.

You can contribute up to $6,000 to IRAs for 2019 if you’re under 50, or $7,000 if you’re 50 or older. The limits are the same for 2020.

You didn’t ask, but the deadline for contributing to a health savings account also has been extended.

HSAs allow people with qualifying high-deductible health insurance plans to put away money that can be used tax-free for eligible medical expenses. The maximum amount individuals can contribute to an HSA is $3,500 for individual coverage and $7,000 for family coverage. The “catch up” provision for people 55 and older allows an additional $1,000 contribution.

Filed Under: Q&A, Taxes Tagged With: , ,
March 9, 2020 By

Q&A: How IRS Free File works

Dear Liz: I wanted to alert you to the fact that online tax preparation companies are up to their old tricks again this year despite being called out last year for deceptively hiding their free tax filing from eligible filers. My son, who qualifies for free filing, was redirected to the paid “deluxe” version when it turned out he qualifies for a “Savers Tax Credit.” He makes modest tax-deferred contributions through an employer that matched contributions. (He’s a low-income student who works in retail.) He logged out of that website and instead successfully used a competitor provider for free.

Answer: The way to access the IRS’ Free File program is through the IRS website, which directs people to the private tax preparation companies that have agreed to offer this service. Unfortunately, many of those same companies spend a lot of money trying to obscure that fact that most Americans can file for free.

Independent news organization ProPublica reported last year that tax preparation companies were hiding their free file options from online search engines and steering people instead into paid tax preparation. A government report in February confirmed that more than 14 million taxpayers paid for tax preparation last year that they could have received free.

The companies have since been banned from hiding the free option and are supposed to include a link that returns people to the IRS Free File site if they don’t qualify for the company’s free offer. But ProPublica found that they continue to steer people away from free filing in various ways, including advertising that misuses the word “free.”

Also, many people like your son discover only late in the tax preparation process — often after they’ve added most of their information — that they don’t qualify for that company’s free option, although they would qualify elsewhere.

Here’s what people need to know about free filing:

People with adjusted gross incomes under $69,000 a year can qualify for free filing, but they should start their search at the IRS Free File webpage.

People in the military and their families can use MilTax, provided by the Department of Defense.

They can also get advice from a tax professional at (800) 342-9647.

In addition, people may qualify for the IRS’ Volunteer Income Tax Assistance if they make less than $56,000, live with a disability or speak limited English. Use the Volunteer Income Tax Assistance locator tool or call (800) 906-9887.

People who don’t qualify for the above services can still use free fillable forms. In addition, some tax preparation companies may have free options for people filing basic forms. The types of income and credits that allow someone to file for free should be prominently displayed on the company’s free file page.

Filed Under: Q&A, Taxes Tagged With: , , ,
February 17, 2020 By

Q&A: Tax tips for hybrid owners

Dear Liz: Not a question, but a tip for your readers. I bought a plug-in hybrid in 2018. I couldn’t take advantage of the $7,500 federal tax credit because my income was too low to pay much in federal taxes. So I converted $30,000 of my IRA to a Roth IRA, which added that money to my income for 2018, allowing me to take full advantage of the credit. Hey, I even got some money back. I can’t touch that Roth account for five years, or else the income it generates won’t be tax-free, but when the time comes for my mandatory withdrawals, I’ll tap into the remainder of my regular IRA. This might be of help to some of your readers.

Answer: Normally conversions from a regular IRA to a Roth trigger a hefty tax bill, but your credit allowed you to convert tax-free. Leasing is another option to consider with hybrids and other cars that offer a federal tax credit. The value of the credit typically is built into the deal, so you benefit even if you don’t have a federal tax bill to offset.

Filed Under: Q&A, Taxes Tagged With: , ,
January 27, 2020 By

Q&A:Don’t make this mistake with your retirement savings

Dear Liz: My wife and I are in our mid-40s and planning to buy what likely will be the last house we’ll purchase. I’ve decided to withdraw around $15,000 from my IRA to buy down the rate, which will guarantee returns in the form of interest savings, even if those will be less than the returns I would earn if I left the money in the account. My real question is about our current house. We owe around $77,000 on a house that could likely fetch in the low $200,000 range. I’ve looked at it up, down and sideways. Would it make more sense to rent, sell, or rent then sell after a couple of years to avoid the capital gains tax?

Answer: Sometimes it can make sense to buy down a mortgage interest rate by paying more upfront if you plan to stay in the home for many years. The deals vary by lender, but you might pay 1% of the loan amount (one point) to get a rate that’s 0.25% lower, or 2% (two points) to get the rate reduced by 0.5%. For example, paying two points on a $200,000 mortgage, or $4,000, could lower the rate from 4.5% to 4%. You would drop the monthly payment about $59, and it would take you nearly six years for the slightly lower monthly payments to offset what you paid upfront.

You complicate the math, though, when the money used to buy down the rate comes out of a retirement account. That money is taxed as income and would likely be penalized as well because you aren’t yet 59½. (There’s an exception to the penalty for first-time home buyers who withdraw up to $10,000, but they’ll still owe income tax on the withdrawal.) The tax bill varies according to your tax bracket and your state, but you can expect it to equal roughly one-quarter to one-half of the amount withdrawn.

In addition to the tax bill, you’ve also given up future tax-deferred returns on the money. And because most people’s incomes drop in retirement, you’re probably paying a higher tax rate than you would if you withdrew the money later.

A good rule of thumb is to consult a tax pro before you take any money out of a retirement account. The rules can be complex and it’s easy to make an expensive mistake. A tax pro also could advise you about the tax implications of renting vs. selling, although you might also want to talk to anyone you know who’s a landlord about what’s involved with renting out a property.

The simplest solution may be to sell your current home and use the equity to reduce the size of the loan you’ll need on the next residence, rather than raiding a retirement fund to get a slightly lower rate.

Filed Under: Q&A, Real Estate, Retirement, Taxes Tagged With: , , ,
January 20, 2020 By

Q&A: How to keep tax benefits when renting out your primary residence

Dear Liz: If my wife and I sell our primary residence of 12 years, I understand we can exclude up to $500,000 in home sale profits from taxes. But if we rent it for a year or two, then sell, have we lost that tax break by converting it to income property?

Answer: As long as you lived in the property at least two of the five years before the sale, you can use the home sale exclusion that allows each owner to protect $250,000 of profits from taxation.

You would pay capital gains rates on profits above that amount, but a big home sale profit could have other tax implications.

If you’re covered by Medicare, for example, profits above the exclusion amounts could temporarily increase your monthly premiums. This is because the income-related monthly adjustment amount, which is added to premiums when modified adjusted gross income exceeds $87,000 for singles or $174,000 for married couples.

If you might be affected, you’d be smart to consult a tax professional to see if there’s a way to structure the sale to reduce these effects.

Also, renting property has its own set of tax rules, making it even more important to have a tax pro who can assist you.

Filed Under: Q&A, Real Estate, Taxes Tagged With: , , ,
January 6, 2020 By

Q&A: This retiree got a big surprise: taxes

Dear Liz: I’m 76 and retired. During the decades I worked, I contributed to my IRA yearly using my tax refund or having money deducted from my paycheck. No one told me I would have to pay taxes on this when I turned 70. For the past six years, I have been required to withdraw a certain percentage of this IRA money and pay taxes on it. Is there ever going to be an end to this? Do I have to keep paying taxes on the same money every year? And what about when I pass away, do my children have to keep paying?

Answer: Ever heard the expression, “There’s no such thing as a free lunch”?

You got tax deductions on the money you contributed to your IRA over the years, and the earnings were allowed to grow tax deferred. Those tax breaks are designed to encourage people to save, but eventually Uncle Sam wants his cut.

Also, you aren’t “paying taxes on the same money every year,” because the money you withdraw has never been taxed. Plus, you’re required to take out only a small portion of your IRA each year starting at 70½. The required minimum distribution starts at 3.65% and creeps up a bit every year, but even at age 100 it’s only 15.87% of the total. You can leave the bulk of your IRA alone so it can continue to grow and bequeath the balance to your children.

Your heirs won’t get the money tax free. They typically will be required to make withdrawals to empty the account within 10 years and pay income taxes on those withdrawals. Previously, they were allowed to spread required minimum distributions over their own lifetimes. Congress recently changed that to require faster payouts because the intent of IRA deductions was to encourage saving for retirement, not transfer large sums to heirs.

The Roth IRA is an exception to the above rules. There’s no tax deduction when you contribute the money, but the money can be withdrawn tax-free in retirement or left alone — there are no required minimum distributions. Your children would be required to start distributions, but wouldn’t owe taxes on those withdrawals.

Filed Under: Q&A, Retirement, Taxes Tagged With: , ,
December 9, 2019 By

Q&A: This generous gift has no tax effects

Dear Liz: If I give $15,000 to my grandson, do I report it on my tax return? Is it deductible? Does my grandson report the gift on his tax return and does he owe tax on it? What if three sets of grandparents (parents and stepparents of his parents) do the same?

Answer: No, no, no, no and it doesn’t matter for tax purposes (although obviously your grandson should be delighted he has such generous grandparents).

Gifts to individuals aren’t tax deductible, but neither are they taxable to the recipient.

People can give a certain amount each year to as many recipients as they like without having to report the gifts via a gift tax return. In 2019 and 2020, the limit is $15,000. Each grandparent could give up to that amount to your grandson; he wouldn’t have to report the income on his tax returns, and it wouldn’t cause any of you to have to file gift tax returns.

There’s no limit to the number of people who can give $15,000 to your grandson this way.

You wouldn’t owe gift taxes until the amount you’d given away above the annual exemption limit exceeded $11.4 million.

Filed Under: Q&A, Taxes Tagged With: , ,
November 11, 2019 By

Q&A: Working past 70

Dear Liz: If I continue to work after 70, will Social Security taxes still be deducted from my check? I understand my benefits will cap out at 70, so why would I need to still pay into the fund?

Answer: Because Social Security is insurance, not a bank account.

And it may not be true that your benefit maxes out at 70, if you continue to work. It’s true that delayed retirement credits no longer increase your benefit if you delay starting Social Security past age 70. But as long as you continue working, you’re potentially growing your benefit.

Your Social Security check is based on your 35 highest-earning years, adjusted for inflation. If you make more in a current year than you made in one of those previous highest-earning years, the current year will be substituted for the earlier one. That in turn can increase your benefit. This can happen at any age, including after you start benefits.

You might not see much increase, of course, or any increase at all if you’ve earned a high income for a long time. If you exceeded the maximum income limits subject to Social Security taxation every year for 35 years, your benefit wouldn’t increase with additional work. (In 2019, for example, the maximum income limit is $132,900; you don’t pay Social Security tax on earnings above that level, although you continue to pay Medicare tax.)

On the other hand, your benefits won’t be stopped once you collect as much from the system as you paid in. You will continue receiving benefits for as long as you live, even if that amount far exceeds what you’ve paid in taxes. That’s insurance worth paying for.

Filed Under: Q&A, Social Security, Taxes Tagged With: , ,
October 21, 2019 By

Q&A: Death doesn’t take a financial holiday. Here’s a cautionary tale

Dear Liz: My daughter has two children, ages 2 and 4. Recently the children’s father took his own life. He was 27. The job he worked as long as I knew him paid him in cash, so he didn’t pay into Social Security. Does this mean the children cannot receive survivor benefits from Social Security?

Answer: If the father never worked at a job that paid into Social Security, your grandchildren — and your daughter — won’t qualify for the survivor benefits they could have received had he been paid legally rather than under the table.

Their one hope is if he had a previous job that did pay into Social Security.

At 27, he would have needed at least six quarters of coverage to trigger survivor benefits, says Bill Meyer, founder of Social Security Solutions, a claiming strategies site.

The older a person is, the more quarters are needed to qualify for benefits, but no one needs more than 40 quarters. The amount of earnings required for a quarter of coverage is $1,360 in 2019. Once you earn $5,440, you’ve earned your four quarters for the year.

If the father had earned those six quarters, his death would trigger survivor benefits for his children that typically last until age 18 (or until 19, if they are still in high school full time). Your daughter also would be entitled to benefits until the younger child turned 16, because she’s caring for the deceased person’s minor children.

It’s possible this young man was paid under the table because he was not able to work legally in the U.S. If that’s the case, he and his family wouldn’t qualify for Social Security benefits even if payroll taxes had been deducted. If he opted for cash because he or his employer didn’t want to pay taxes, though, that was a choice that had expensive repercussions for the people he left behind.

Filed Under: Q&A, Social Security, Taxes Tagged With: , ,
October 7, 2019 By

Q&A: Don’t keep a mortgage just for the tax deduction

Dear Liz: Does the new tax law, with its increased standard deduction, change the calculus of maintaining my mortgage? I owe about $250,000 at 3.25% on a 30-year mortgage. I no longer itemize, so I don’t get the benefit of the tax deduction for the interest. My payments are about $1,500 a month, but I could easily pay it off.

Answer: It never made much sense to keep a mortgage just for the tax deduction. The tax savings offset only a portion of the interest you pay. (If you’re in a 33% combined state and federal tax bracket, for example, you’d get at most 33 cents back for every $1 in mortgage interest you paid.)

A more compelling reason to keep a mortgage would be if you were able to get a better return on your money by investing it, or if you didn’t want to have a big chunk of your wealth tied up in a single, illiquid asset.

Filed Under: Mortgages, Q&A, Taxes Tagged With: , , ,