Your tax return opens the door to savings

Preparing your tax return each year is not much fun; however, it does provide an opportunity each year to look at your financial situation and find ways to plan to take advantage of tax laws that provide substantial savings. If you or your accountant is not using the tax return preparation process in this manner, it might be time to consult with a tax attorney to have a review of your financial situation.

The tax law, regulations and explanations have over 9 million words in them. In this labyrinth of words, there are many opportunities for tax savings. Engaging the services of lawyers experienced with issues that wealth brings can help immensely with this process.

Tax laws change rapidly and keeping current with these laws is a big part of this battle in understanding this complex area of law. We have seen a major overhaul of the IRS’s structure; significant changes in taxpayer’s rights; and changes in business tax credits and deductions, capital gains, Roth IRAs, the home office deduction, the child tax credit, education tax breaks, the $500,000 exclusion for gain on sale of a home, and expanded credits and incentives for “going green,” over the past few years. It is important to keep up to date with all these changes to keep your tax bill to the minimum.

Having the right tax lawyer to provide sound tax planning can help you navigate through these ever-changing rules and open doors to new opportunities.

The Basics of Tax Planning

Tax planning is a process of looking at various tax options to determine when, whether and how to conduct business and personal transactions so that taxes are eliminated or reduced. As an individual taxpayer, and as a business owner, you will often have the option of completing a taxable transaction by more than one method. The courts strongly back your right to arrange your financial affairs in a manner that will result in the lowest legal tax liability. In other words, tax avoidance is entirely proper, so long as you have done it within the law.

Involving Your Tax Attorney With Your Investments

Ask your Tax Attorney about timing your stock sales to take advantage of low Capital Gains tax rates and Loss Planning:

With a possible increase in the capital gains tax rate, you might want to consider selling appreciated stocks this year. Similarly, taxpayers could consider pushing those losses into next year by delaying the sale of these assets if this would result in a more beneficial outcome.

Donation of appreciated securities can also be a tax-wise charitable contribution strategy.

Please get us involved with legally minimizing your tax bill. Call our firm at 855-935-5945.

Involve Your Tax Attorney in Re-evaluating Your Investment Portfolio

Preparing for potentially higher taxes on dividends could include investing a larger portion of your income-producing accounts in tax-exempt municipal bonds instead of dividend-producing stocks, or locating dividend-producing stocks in tax advantaged retirement accounts. Again, taxpayers should also pay close attention to this strategy’s potential impact on your AMT exposure. Please get us involved with legally minimizing your tax bill. Contact our firm at 855-935-5945.

We routinely provide tax advice for investments involving:

  • Interest
  • Dividends
  • Foreign bank account and investment accounts and foreign trusts and estates
  • Stock, bond and other capital asset sales
  • Income from estates and trusts
  • Income from partnerships, LLCs and S corporations
  • Royalty income
  • Income from REMICS
  • Investment-related deductions for interest, investment advice, financial publications or software, or custodial fees

Use the Sale of Your Business as a Tax Planning Opportunity

The sale of a business creates many opportunities for estate planning, wealth transfer planning, business succession planning and income tax planning. Business owners and their tax advisers frequently convert the sale of a business into cash. Unfortunately, having this as a primary goal does not fully take into account repositioning the business owner’s equity in the business into income-producing investments that produce a more tax-efficient return on equity. In many cases, there may be tax savings opportunities. Discuss the sale of your business before it happens with a tax attorney. For a consultation regarding tax opportunities as related to the sale of your business, contact our firm.

Involve Your Tax Attorney With Retirement Planning

As tax attorneys we are often asked to help our clients with planning for retirement. Due to the ups, downs and other unpredictable changes in a small business or working as an employee in a modern corporation, we all need to plan carefully to meet your retirement needs. Having a good retirement plan allows you to build up a solid investment portfolio outside of your business and gain significant tax benefits along the way — and as an added benefit, qualified retirement plans offer some protection from creditors should some unexpected event threaten your business and personal assets. Choosing a retirement community is a big decision. Your choice will affect your or your loved ones finances, quality of life, and in many cases, health and longevity.

Distributions from a Pension Plan or Annuity can be difficult to understand — Ask your Tax Attorney about the tax consequences before making these transactions

Distributions from retirement and annuity plans can be made in several ways, depending on the terms of the plan. The typical types of distribution choices are:

  • Annuities — Usually paid under a contract, this alternative makes regular distributions, generally in equal monthly amounts based on the life expectancy of the beneficiary.
  • Installments — This alternative can offer a variety of payout periods and equal or unequal payments.
  • Lump sum — This form of payout distributes the entire vested balance in one payment. It can be made in cash, in securities or both.

Common types of annuities are:

  • Fixed period — Distributions are made at regular intervals and have a predetermined amount and period of duration.
  • Single life — Distributions are made at regular intervals, but payouts end at the beneficiary’s date of death.
  • Joint and survivor — The first annuitant receives a predetermined amount at regular intervals for life. After his or her death, the survivor receives a predetermined amount at regular intervals for life, which can be the same as, or different from, the original amount.
  • Variable — Distributions may fluctuate as a function of profits or economic indices, but the payout period is either fixed in duration or set only for the recipient’s life. Employer-provided plans generally do not permit variable distributions, but some annuities purchased through insurance companies may.

Generally, installment payments distributed by any of these types of plans are taxable in the year they are received.

Ask Your Tax Attorney About the Tax Consequences of Lump-Sum Distributions

If you received a lump-sum distribution from a qualified retirement plan, or from an annuity or endowment policy you bought from an insurance company, you may have several choices to make that can significantly affect the tax on your benefits.

You will not be taxed on any portion of the payment that represents your cost of the plan (i.e., any premiums you paid or after-tax contributions you made).

Generally, you have these options:

  • Roll the payment over into an IRA or another qualified plan (such as a new employer’s 401(k) plan, or one established by your own business). The amount that represents your investment in the contract is not eligible for a rollover, however. The plan sponsor will report only the taxable amount in Box 2a of Form 1099-R, and that is the amount you can roll over to an IRA.
  • Receive your payment in cash, and don’t roll it over. The taxable portion of it will be taxed as ordinary income in the year it is received.
  • You may have to pay an extra 10 percent penalty if the distribution was made “prematurely.” In any case, 20 percent of your payment will be withheld for income taxes.

If you roll the amount over into an IRA, you can generally avoid current taxation on the lump-sum, and the amount invested in the IRA will build up tax free. However, you will be taxed at ordinary rates on all withdrawals as you take money out of the IRA, unless you elect to convert the IRA to a Roth IRA.

Contact our firm to obtain a consultation before making the decision to receive a lump-sum distribution from your qualified retirement plan.

Discuss IRA Rollovers With a Tax Attorney Before Making Them

You can avoid current tax on some or all of your lump-sum pension distribution by rolling it over into an IRA account.

There are some tricky rules in the tax code that will require that you make the rollover within 60 days of receiving the lump sum and you cannot revoke this decision once you make it.

If you make a direct, trustee-to-trustee rollover from your retirement plan to the IRA sponsor, there will be no income tax withholding on your lump-sum payment.

However, if you accept the lump sum in cash with the intention of rolling it over within 60 days, the retirement plan sponsor must withhold 20 percent of the payment for income taxes. To avoid all taxes on your lump sum, you will need to roll over 100 percent of the amount, which means that you will have to find some other source (perhaps even a loan) to temporarily replace the 20 percent that was sent to the IRS. Then, when you get your tax refund for the year, you can replenish the other source or repay the loan.

If you do roll over a lump sum you received in a particular year, you will receive Form 1099-R from the plan sponsor that shows the amount paid to you in Box 1. Report the total amount on Line 15a of Form 1040, or 11a of Form 1040A. Report any amount that was not rolled over on Line 15b or Line 11b (if you rolled over the entire amount, enter a zero on Line 15b or 11b). You will also need to write the word “rollover” in the margin of your tax return, next to Line 15 or 11.

If you don’t roll over the entire amount and you are under age 59-1/2, you may have to pay a 10 percent premature distribution tax on the amounts you took in cash. Contact Freeman Tax Law to request a consultation regarding this very routine transaction to ensure it is handled correctly.

Lump Sums Are Taxed as Ordinary Income

Generally, if you receive a lump-sum pension distribution, any portion that is not rolled over into an IRA will be taxed as ordinary income. This can have the effect of pushing you into a much higher tax bracket.

In addition, a 10-year averaging option is available to figure the tax on the ordinary income part. The averaging treatment usually has the effect of taxing your payment in a lower tax bracket than you would otherwise face. Contact our firm to get a consultation as to how this can work to reduce your tax bill.

Individual Retirement Accounts (IRAs), 401(k), Simplified Employee Pension (SEP) or some similar retirement savings plan makes tax sense:

Contributing as much as you can to an IRA, 401(k), Simplified Employee Pension (SEP) or some similar retirement savings plan typically makes sense for most people in any tax environment. Individual Retirement Accounts (IRAs) function as personal, tax-qualified retirement savings plans. The earnings on these investments grow, tax-deferred, until the eventual date of distribution. Moreover, certain individuals are permitted to deduct all or part of their contributions to the IRA.

IRAs are set up as trusts or custodial accounts for the exclusive benefit of an individual and his or her beneficiaries. You can set up an IRA simply by choosing a bank, mutual fund company, brokerage house or other financial institution to act as trustee or custodian. The institution will give you the necessary forms to complete. A lesser-known alternative is to purchase an individual retirement annuity contract from a life insurance company. An individual cannot be his own trustee.

As an alternative option, you may be able to set up a “Roth IRA,” contributions to which are not deductible, but from which withdrawals at retirement won’t be taxed.

We suggest discussing these options with a tax attorney to determine how maximizing tax deferral can help you reach your retirement goals.

Contributing to Your IRA

An IRA can be established, and/or a contribution made, after year-end. It must be made no later than the due date for filing the income tax return for that year, not including extensions. This generally means that you have until April 15th of the following year to make the contribution, and to deduct it on your tax return if you qualify for the deduction.

You don’t have to contribute the full amount every year. You may skip a year or even several years. You may resume making contributions in a later year, but you cannot “catch up” for years when no contribution was made.

If you contribute more than the allowable amount, a 6 percent excise tax penalty will be assessed. This penalty is due for the year of the excess contribution and for each year thereafter until corrected. However, you can generally avoid this tax by removing any excess contributions by the due date of the return for the tax year for which they were made.

No contributions may be made: (1) to an inherited IRA, (2) in a form other than cash, or (3) during or after the year in which the individual reaches age 70-1/2.

Again, having a tax attorney or wealth manager involved in help in making these decisions can provide you with savings.

IRA Transfers and Rollovers

The shifting of funds from one IRA trustee/custodian directly to another trustee/custodian is called a transfer. It is not considered a rollover because nothing was paid over to you. You can have as many transfers as you like each year; transfers are tax-free, and there is no waiting periods between transfers. They don’t have to be reported on your tax return.

A rollover, in contrast, is a tax-free distribution to you of assets from one IRA or retirement plan that you then contribute to a different IRA or retirement plan. Under certain circumstances, you may either roll over assets withdrawn from one IRA into another, or roll over a distribution from a qualified retirement plan into an IRA. Distributions of pretax assets from certain qualified plans that were rolled into an IRA can generally be rolled back to that qualified plan.

Consultation with a tax attorney is recommended before making these decisions to ensure that the transaction occurs with the least tax consequences. Contact our firm today if you are considering making this type of transaction.

Withdrawals/Distributions From an IRA

All withdrawals from a regular, deductible IRA account are fully taxable and reported on Line 15b of Form 1040, or Line 11b of Form 1040A.

However, if you made any nondeductible contributions to IRAs over the years, a portion of your withdrawal will be treated as a withdrawal of the nontaxable cost basis of your IRAs, and no tax or penalties will apply to this portion.

You must compute the taxable and nontaxable portions of the withdrawals by completing IRS Form 8606, Nondeductible IRAs, and attaching it to your tax return. This can be a complicated process, so make sure that you follow the instructions to the form very closely.

  • A 10 percent penalty applies to withdrawals considered premature, but there are several exceptions that avoid the penalty.
  • Withdrawals from Roth IRAs are subject to another set of rules.
  • If taxable contributions were made to any of the IRAs, more complications exist.
  • Mandatory withdrawals must be made after you turn 70-1/2.

Consult with an experienced tax attorney for advice before making these decisions.

Prepare Estate Planning Documents

Of all the tax uncertainties, the estate tax rules could have the greatest financial impact on high-net-worth taxpayers who are unprepared. If you have significant net worth that you want to protect and pass along to future generations, you should seek the advice of a tax attorney in developing an estate plan. A wealth-transfer plan takes advantage of the many tools involving wills, trusts and life insurance that could potentially significantly reduce the tax exposure for you, your spouse and your heirs.

If you’re single and have a taxable estate worth more than $1 million, or if you’re married with a taxable estate worth more than $2 million, you should be thinking about the implications sooner rather than later, and get your estate planning documents in order before the end of the year to ensure that you have the proper protections in place to minimize tax on death.

Maximize Tax-Advantaged Savings

You might also consider a health savings account (HSA). Contributions to an HSA and the earnings in the account are tax free as long as the money is used for qualified medical expenses.

Another tax-saving option if you have children or grandchildren who plan to attend college is a 529 plan, which allows tax-free earnings withdrawals if the money is used for qualified higher education expenses.

Also, consider using life insurance and annuities to take advantage of tax deferral and tax-free growth of assets.

Accelerate Income Into This Year

If you think that the tax rate might be higher next year, and you had the ability, it might be wise to consider pulling income into this year by exercising a stock option, or receiving a bonus early, etc. Use a financial adviser and be careful when exercising stock options, however, because they are inherently complex and may have a range of potential tax implications, including exposure to the alternative minimum tax (AMT).

If you have reached retirement age and been considering taking an elective distribution (as opposed to a required minimum distribution) from a qualified retirement plan, doing so could be a wise move if you think your tax rate will be higher next year. Make sure the distribution fits into your long-term plan, however.

Contact our office to receive a consultation with an experienced tax attorney to discuss this type of transaction.

A grantor retained annuity trust (GRAT): A GRAT is an irrevocable trust that pays a fixed annuity to the grantor for a defined period, and then pays the remainder to a noncharitable beneficiary. A GRAT allows a grantor to place cash, securities or other assets with significant potential to appreciate in value into the trust. As the grantor, you receive a regular payment — the “annuity amount” — at least annually from the trust for a set number of years. The present value of the balance in the trust — after all annuity amounts have been paid back to you — will count as a taxable gift against your lifetime gift tax exemption. It is computed using an assumed rate of investment return provided by the IRS.

However, by adjusting the annuity amount payable back to you (the higher the retained annuity amount, the lower the taxable gift), that taxable gift amount can be adjusted as well. Once the GRAT term is up, your beneficiaries will receive the balance of the trust, including any appreciation, without incurring any further gift or estate tax consequences, but only if you are still living at that time. If your GRAT is set up so that essentially no taxable gift is deemed made at the time of funding, then the GRAT will pass on value at the end of its term, basically only to the extent that actual investment results exceed the IRS’s assumed rate of return.

“A GRAT is typically used by high-net-worth individuals who have an estate over the lifetime gift tax exemption amount,” says Haley. “It primarily offers them a way to move appreciation on their assets out of their estate without incurring significant taxable gifts.” If the grantor passes away prior to the termination of the GRAT, a significant portion, and often all, of the value of the GRAT’s assets at the time of the grantor’s death is included in the grantor’s estate.

Using the 2012 gift tax exemption, a grantor can potentially put even more money into a GRAT without having to pay gift taxes. Currently, the low IRS assumed rate of return, which changes monthly, benefits a GRAT. The lower the rate, the lower the retained annuity amount needed to provide the desired taxable gift. While the term of a GRAT typically ranges from three to five years, Congress has also considered lengthening this term to a minimum of 10 years, which would increase the mortality risk of you surviving until the term of the GRAT is up. This is currently not part of the tax changes scheduled to take effect on January 1, 2013.

A qualified personal residence trust (QPRT): A QPRT streamlines the process of gifting a primary residence or vacation home to your beneficiaries. Let’s say you want to ensure that your children inherit the family home. You want to pass it on to them without incurring estate and gift taxes on any future appreciation. A QPRT allows you to place the house in a trust for a specified term of years. Only the present value of the house — at the IRS’s assumed rate of investment return and assumed mortality rates after the QPRT term has expired — will be a taxable gift that counts against your $5,120,000 lifetime gift tax exemption ($10,240,000 for married couples) in 2012. Once the QPRT term is up, assuming you are still living, ownership is transferred to the heirs without any further gift or estate tax consequences.

As a result, the full value of the house, including any appreciation, is transferred to your heirs at a reduced gift tax cost. On the other hand, if you pass away prior to the expiration of the QPRT, the house will be included in your estate. You are allowed to live rent free in the residence for the term of the QPRT, but if you still want to live in the house after the QPRT term has expired, typically you will have to pay fair market rent. Under the 2012 gift tax exemption, it is much easier now to put higher-value homes into these trusts without incurring the gift tax. This is good news for people with high-value primary residences or vacation homes.

Making immediate outright gifts: You may want to consider making an immediate gift in order to use all, or part of, the $5,120,000 individual (or $10,240,000 per couple) 2012 federal lifetime gift tax exemption. This gift can be made outright to individuals or into an irrevocable trust. Under current law, in order to use the higher exemption, a gift would have to be completed by December 31, 2012.

Gifting into an irrevocable trust: Gifting assets into an irrevocable trust can enable a grantor to set forth the provisions of when, and under what circumstances, beneficiaries can receive distributions. The principal of the gift, as well as the growth on gifted assets, will be outside your estate, and no federal gift or estate tax will have been assessed on the gift. But, by making a gift, you are giving up ownership and control of the gifted amount, and, once given, typically the gift cannot be undone.

Gifting strategies to consider every year:

For investors with an eye on reducing taxes, there are certain gifting vehicles that make it possible to pass assets to the next generation or to charities of their choice tax free. These strategies include:

  1. Front-loading 529 college savings plans. These accounts can be especially useful because you can front-load them with five years’ worth of annual exclusion gifts at one time, without incurring any taxable gift. You effectively remove these funds from your estate, the earnings in the accounts grow tax deferred, and, as long as distributions are used for qualified higher education expenses, distributions are federal income tax free. Note that if the donor of the front-loaded five-year gift dies within the five-year period, the prorated portion of the transferred amount for the years after death will be included in the donor’s estate for estate tax purposes.
  2. Making tax-wise charitable year-end contributions. Closer to year end, donating long-term appreciated securities may be a particularly tax-efficient strategy. As a general rule, donations of long-term appreciated securities (either stocks or mutual funds) directly to a qualified charity are deductible at their fair market value on the date of contribution, and you don’t pay capital gains taxes on them. If the limitation on certain itemized deductions is reinstated this next year and your modified adjusted gross income (MAGI) exceeds certain thresholds, deductions could be reduced in future years.
  3. Direct payments of educational or medical costs. Direct tuition payments to a loved one’s school are not treated as taxable gifts and, therefore, do not count against your annual or lifetime gift tax exemption. Similarly, direct payments to a loved one’s medical care provider are not treated as taxable gifts.

Discuss your gifting and charitable contribution strategy with an experienced tax attorney. Contact us for a consultation.

Estimated Tax Payments

If you are a small-business owner or someone who receives a large amount of investment or pension income, chances are good that you will have to make estimated tax payments.

Consultation with a tax attorney is recommended when dealing with large sums of money because there are substantial penalties for underestimating one’s correct amount of tax. The complexity of investing makes having a tax attorney involved in these transactions beneficial to properly plan to minimize your tax obligation.

Contact Us

The involvement of a tax attorney in your investments can help you to properly plan to align your tax strategy with your overall financial plan. Please contact us if you would like to review your financial plan, create a wealth transfer plan or discuss tax planning opportunities.