Ask Liz Weston

Get smart with your money

Taxes

Q&A: Advisor may have overlooked tax bill alternatives

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Dear Readers: The following comment was prompted by my response to the letter from a couple in their 70s asking if they had made a mistake moving their $2-million portfolio, including $340,000 in a taxable account, to a new advisor. The advisor recommended investment sales that resulted in a $50,000 capital gain tax bill, and their accountant disapproved. I wrote that the tax pro might not be in the best position to judge whether the sales were necessary, since accountants are typically focused on reducing tax bills but sometimes diversification is necessary to avoid even bigger financial consequences down the road. Here’s another perspective.

Dear Liz: The comment that the accountant is not in the best position to evaluate is correct, as the accountant is only looking at the taxes. However, as a retired portfolio manager and chartered financial analyst, I really doubt that it was appropriate for the investment manager to take this large of an amount of capital gains. It would only make sense if this taxable portfolio had nothing but speculative issues in it, which I would find doubtful for a couple in their late 70s. If the taxable account was too high in equities or poorly diversified by industry weightings, adjustments can be made in the larger retirement account to bring the combined account into better balance. It may have been appropriate to take some gains, but they can certainly be spread out over several years, as taking them all at once likely puts the couple in a higher tax bracket.

Answer: You’re making a good point that the couple had other options besides “ripping off the Band-Aid” and incurring one big tax bill rather than taking the gains more gradually. Their new advisor, as a fiduciary, should have discussed the options with them and helped them understand the impacts, including the expected tax bills and potential impact on Medicare premiums. If those discussions didn’t happen, that’s all the more reason to seek out a second opinion from another fee-only financial planner.

Q&A: Are IRS quarterly payments mandatory?

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Dear Liz: I live totally on my investment income. I receive the majority of my income at the end of the year, mostly dividends from my brokerage account.

A couple of years ago, when talking to an IRS agent about another matter, I asked when I should make my estimated tax payment. I was told that I had to make the payments quarterly. This year, when I was talking to my accountant, she told me that I could make a lump-sum payment at the end of the year without incurring a penalty. Who is correct, the IRS agent or my accountant?

Answer: Ours is a pay-as-you-go system, and the IRS assumes that your income is received evenly throughout the year, says Mark Luscombe, principal analyst for Wolters Kluwer Tax & Accounting. Therefore, the agency typically expects four estimated tax payments of roughly equal size, with the payments due April 15, June 15, Sept. 15 and Jan. 15. If the payments aren’t made as expected, you can get hit with an underpayment penalty.

However, the IRS allows a taxpayer to show that their income is not earned equally throughout the year by filing a Form 2210 with a related Schedule AI (Annualized Income Installment Method), Luscombe says. Schedule AI allows you to show when income was earned during the year so you can match your estimated payment dates to when you actually received the money.

Schedule AI is more work, since it requires you to report adjusted gross income for each of the four quarters, as well as your itemized deductions and other tax details items, Luscombe notes. But if your income comes at the end of the year and the corresponding estimated tax payment was made on Jan. 15 of the following year, filing this paperwork may be sufficient to avoid a penalty for underpaying estimated taxes, he says.

Q&A: How do I avoid a Medicare surcharge?

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Dear Liz: I will be applying for Medicare next year. Last year I received an inheritance, and also sold a second home which increased our taxable income for the year. I once read that there is a form that needs to be completed to let Medicare know that this is only a one-time occurrence. However, my tax advisor said that there is no need to let Medicare know and he had not heard of any such form. I feel he does not understand that the higher income might affect our Medicare premiums. My understanding is that if I don’t submit the form, my Medicare payment will be a lot higher than expected. Can you suggest what I should do?

Answer: There is such a form, but it’s unlikely to help in your situation.

Medicare premiums are based on your income from two years earlier, as shown on your tax returns. People with higher incomes face “income related monthly adjustment amounts” (IRMAA) that can substantially increase their Medicare Part B and Part D premiums. (Part B covers doctor’s visits and Part D covers prescriptions.)

Form SSA-44 is designed to help people whose income has taken a hit because of major life changes, such as retirement, divorce or the death of a spouse. It’s not designed to spare people who had taxable windfalls, such as capital gains from a property sale.

Inheritances generally aren’t taxable events, however, with a few exceptions. If you inherit someone’s IRA, for example, you generally must start withdrawals which are typically taxable. Otherwise, inherited money and assets typically don’t show up on your tax returns or affect your Medicare premiums.

Q&A: Why tell the IRS if you sell gold coins?

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Dear Liz: Regarding the inherited gold coins question, why would anybody tell the IRS they inherited coins and subject themselves to a 28% capital gains tax? That seems very illogical.

Answer: To clarify, the original reader was asking about selling gold coins which had risen dramatically in value since she inherited them. Coins are considered collectibles so the difference between the inherited value and the sale price would be subject to a 28% federal capital gains tax.

How would the IRS know if you’ve sold gold coins for a profit? A dealer who buys the coins might be required to file a form with the IRS that’s designed to thwart money laundering. Also, payments are typically made through bank transfers or checks, unless you’re planning to walk out with a bag of cash like a cartoon bank robber. Bank transactions could be examined if you’re ever audited.

Even if you calculate the odds of getting caught as low, the question remains: Do you only do the right and lawful thing when you have to?

Most people who aren’t sociopaths have a sense of integrity. Doing something they know to be wrong damages that integrity, even if no one else ever knows. You may be able to save a bit of money by cheating on your taxes, but you can’t put a price on a clear conscience.

Q&A: What should I do with inherited gold coins?

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Dear Liz: When my mother passed away nine years ago, I inherited some gold coins. At the time, it was difficult to go through her life’s belongings and part with things. Now that gold prices are so high, I’m wondering if it makes sense to sell those coins? I’m not sure holding on to them makes a lot of sense, but would appreciate any advice you might have.

Answer: Gold coins can be a good hedge against inflation as well as a portable source of wealth. But you need to store them securely to guard against theft and they probably should be insured, which can raise the costs of ownership.

If you want to turn your coins into cash, make sure to get at least three quotes from different sources such as reputable coin shops and jewelers. Also discuss the sale in advance with your tax pro. The difference between the value of the coins when you inherited them and their sale price would be considered a capital gain. Gold coins are taxed as collectibles, which means they’re subject to a 28% federal capital gains tax rate.