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Taxes

Friday’s need-to-know money news

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Today’s top story: Tax planning for beginners – 6 concepts to know. Also in the news: Credit score up? How to build your credit smarts too, why it’s time to find a safety deposit box alternative, and here’s how much money Americans say you need to be ‘rich’.

Tax Planning for Beginners: 6 Concepts to Know
Basic steps to shrink your tax bill.

It’s Time to Find a Safe Deposit Box Alternative
Not as secure as we once thought.

Here’s how much money Americans say you need to be ‘rich’
Do you qualify?

Monday’s need-to-know money news

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Today’s top story: Logical credit moves that can lead to trouble. Also in the news: Investing is within Millennials’ reach, ditch the dealership with online used car sellers, and what you should know about the qualified small business stock tax exclusion.

5 ‘Logical’ Credit Moves That Can Lead to Trouble
Common sense doesn’t always work in your favor.

Take Heart, Millennials — Investing Is Within Your Reach
Just make sure your financial foundation is strong.

Ditch the Dealership With Online Used Car Sellers
Get in the driver’s seat from your couch.

If Your Compensation Package Includes Stock, You Should Know About This Tax Rule
The qualified small business stock exclusion.

Q&A: Escaping California’s tax auditors is tough even after leaving the state

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Dear Liz: My husband and I will be trying out several different areas after the sale of our Los Angeles area house, which will be some time this summer. What happens if we end up renting in three different states? I’m under the impression that we need to be able to prove that we resided in a particular state for six months and one day in order to say we are residents of that state. Even though my husband has been retired for many years, he still does a small amount of business through a company based in Southern California. Will we be forced to pay California tax even though we are residing elsewhere?

Answer: California, like other higher-tax states, has residency auditors whose specialty is asserting that affluent people who have left the state are still legal residents and thus are subject to its taxes. The audits can be stunningly thorough, looking at everything from the doctors you visit to where your artwork and other valuable possessions are stored.

If audited, you would need to prove that you have a fixed, permanent residence elsewhere and that it’s truly your home. And yes, it’s up to the taxpayer to prove this — there’s no presumption of innocence in tax audits, says tax attorney Mark Klein, chairman of Hodgson Russ LLP in New York City. (New York is another state with notoriously hard-nosed residency auditors.)

Just leaving the state for six months and registering to vote elsewhere typically won’t be enough. You likely would need to spend substantially more time in your new “home” state than in California. Klein, who recently taught a session on establishing residency at the AICPA’s annual ENGAGE conference, tells his clients to spend at least two months in the new place for every month they spend in the old one.

Also, you should “stick the landing,” in Klein’s words. Let’s say you try to establish residency in Nevada but then move to Florida by the time California’s auditors find you. They may well decide that your Nevada stay was temporary and that you were still subject to California taxes during the time you lived in the Silver State.

Escaping the long arm of California’s tax auditors could be tough while you’re still figuring out where to live next. You’d be smart to consult a CPA experienced with California residency audits for advice on how to cut ties to the state cleanly.

Q&A: Consult a pro when planning elder care

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Dear Liz: My parents and I are discussing the best ways to protect their assets if one of them must live in a nursing home. Their home is paid off, and we were wondering if adding my name on the deed will secure the home from a mandatory sale for caregiving expenses. Please note, I am the only child. Also, I may want to live there someday to care for the other parent. Looking for the best options for saving money and avoiding inheritance tax for this asset.

Answer: Please consult an elder law attorney before you take any steps to “protect” assets because the wrong moves could come back to haunt you (and your parents).

It sounds like you’re contemplating the possibility that one of your parents may wind up on Medicaid, the government health program for the poor that covers nursing home costs. Medicaid has a very low asset limit and uses a “look back” period to discourage people from transferring money or property just so they can qualify. In most states, transfers made within 60 months of the application are examined and, if found to be in violation of the rules, used to determine a penalty period to prevent someone from qualifying for Medicaid coverage. In California, the look-back period is 30 months.

The state can attempt to recoup Medicaid costs from people’s estates by putting liens against their homes. You might see that as an “inheritance tax,” but inheritance taxes are taxes imposed in a few states on people who inherit money or property. Although all states try to recoup Medicaid costs, only six — Iowa, Kentucky, Maryland, Nebraska, New Jersey and Pennsylvania — have inheritance taxes, and these either exempt or give favorable rates to children who inherit.

Having your name added to the deed can cause problems, as well. Your creditors could go after the home if you’re sued, and you could lose a portion of the step up in tax basis you would get if you inherited the house instead. If you’re married and get divorced, your portion of your parents’ home could be considered a “marital asset” that has to be divided.

It’s great that you and your parents are trying to plan for long-term care, but you should seek out professional guidance.

Selling mom’s house may require an appraisal first

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Dear Liz: My mother recently passed away. The title to her home was held in the family trust. My siblings and I are in the process of clearing out the house in preparation for a sale. Do we need to obtain a “step-up” basis appraisal before the sale to use in determining capital gain on the home? We do not know the original price paid for the home in the late 1960s. Alternatively, could we use an appraisal made in November 2016 as a basis and apply the one-time $250,000 capital gain exclusion?

Answer: You definitely need to establish a property’s value for income tax purposes soon after the owner’s death. If you sell within a year, you could use the fair market value as the home’s new basis, said estate planning attorney Burton Mitchell.

“There is no law about this one-year period,” Mitchell said. “It is just what is often used by both IRS and practitioners.”

You may want more certainty or think the sale may not happen within a year. Estate planning attorney Jennifer Sawday of Long Beach recommends you immediately reach out to a real estate agent to get a broker opinion value letter or hire a certified real estate appraiser to determine the exact value of the home at the date of your mother’s death.

“If you are able to sell the home close to or not much higher than the date of death valuation, the trust will not have any capital gains,” she said. “Plus real estate expenses and other trust administration fees will be computed against the home selling price to minimize any capital gains as well.”

A tax pro can help you figure this all out. The costs of hiring tax and legal help can be charged to the estate.

All the gain in value from the past five decades won’t be taxed. In some parts of the country where home prices are high, such as California, that step-up in basis is far more valuable than the $250,000 home sale exclusion, which you wouldn’t be able to use anyway unless you lived in and owned the home for at least two of the previous five years.

Q&A: Here’s a big tax mistake you can easily avoid

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Dear Liz: I’m self-employed and my wife wasn’t working last year. In December, we returned to California and found a small home to purchase using $107,000 I took out of my IRA. Since we weren’t quite certain of what our income would be, we received our health insurance in Oregon through an Affordable Care Act exchange.

When we filed our taxes we got hit with a $20,000 bill for the insurance, because we earned too much to qualify for subsidies, and a $10,000 bill for the IRA withdrawal. Our goal was to own our home outright, which we do, but now we have a $30,000 tax bill hanging over us.

Can we work with the IRS somehow on this? We didn’t “earn” the $107,000; we invested it in a home. It wasn’t income, so why should we be punished for using our savings to purchase a home?

Answer: If you mean, “Can I talk the IRS out of following the law?” then the answer is pretty clearly no. The IRA withdrawal was income. It doesn’t matter what you did with it.

Consider that you probably got a tax deduction when you contributed to the IRA, which means you didn’t pay income taxes on that money. The gains have been growing tax deferred, which means you didn’t pay tax on those, either.

Uncle Sam gave you those breaks to encourage you to save for retirement, but he wants to get paid eventually. That’s why IRAs and most other retirement accounts are subject to required minimum distributions and don’t get the step-up in tax basis that other investments typically get when the account owner dies.

(If you did not get a tax deduction on your contributions, by the way, then part of your withdrawal should have been tax-free. If you’d contributed to a Roth IRA, your contributions would not have been deductible but withdrawals in retirement would be tax-free.)

The IRS does offer long-term payment plans that may help. People who owe less than $50,000 can get up to six years to pay their balances off. You would file Form 9465 to request a payment plan. The IRS’ site has details.

Here’s a good rule to follow in the future: If you’re considering taking any money from a retirement account, talk to a tax professional first. People often dramatically underestimate the cost of tapping their 401(k)s and IRAs; a tax pro can set you straight.