Erickson Financial Solutions Blog
Timely Tax Angles To Dividends
Not all payouts to shareholders are "qualified dividends," but those that are get favorable treatment in which they're normally taxed at less than your rate for ordinary income.
But the tax rules for qualified dividends may go out the window if proposed tax reforms are enacted. The big question is whether you would fare worse under the new rules—or better.
Under current law, most dividends issued by domestic companies are qualified when paid out to shareholders and the owners of mutual funds. In some cases, qualified dividends also may come from foreign corporations, if their shares include publicly traded American Depositary Receipts (ADRs) or shares that are otherwise readily available on an established U.S. securities market.
The maximum tax rate on qualified dividends is only 15% for most investors. If you're in the top ordinary income tax bracket of 39.6%, the tax rate is 20%. Even better, though, investors in the two lowest ordinary income brackets of 10% and 15% benefit from a maximum 0% rate on qualified dividends.
To qualify for these reduced tax rates, shareholders of common stock and mutual funds must own the shares for more than 60 days, including the ex-dividend date (the annual date on which dividends are paid out). The holding period is 90 days for preferred stock. This can affect the timing of transactions if the ex-dividend date is approaching.
Other dividends, including most dividends issued by foreign corporations, are taxed at ordinary income rates. Therefore, if you received $1,000 in foreign dividends in 2016 and you're in the top tax bracket of 39.6%, you must pay $396 in tax on the dividends on your 2016 tax return. But even then, you may be eligible for a foreign credit or deduction that can offset tax paid on foreign dividends dollar for dollar.
So how does potential tax reform figure in the mix? Under campaign proposals from President Trump, the favorable tax rates for qualified dividends would be repealed, but investors would benefit from overall tax cuts. The seven-bracket structure would be scaled back to just three tax brackets with a top tax rate of 33%. It's not yet clear what changes will be enacted, however, or how particular taxpayers might fare.
The best approach is to continue to monitor developments. We will pass along vital information.
This article was written by a professional financial journalist for Erickson Financial Solutions, LLC of Columbia and Jefferson City and is not intended as legal or investment advice.
© 2017. All Rights Reserved.
17 Midyear Tax Moves You Still Can Make In '17
Winds of tax reform are blowing in Washington, but nothing has happened yet. In the meantime, take advantage of tax breaks currently on the books, including these 17 items:
1. Capital losses: If you realized capital gains from securities sales earlier this year, you can start harvesting losses. Your losses will go to offset capital gains you realize in 2017 plus up to $3,000 of highly taxed ordinary income.
2. Capital gains: Long-term capital gains that aren't offset by losses will be taxed at a maximum rate of only 15% (20% if you're in the top ordinary income tax bracket). But some upper-income investors also may owe a 3.8% tax on investment income.
3. 401(k) contributions: Reduce your tax liability by boosting contributions to a 401(k) plan. For 2017, the maximum deferral is $18,000 ($24,000 if age 50 or over). Not only do you avoid tax on the contributions, the money in your account compounds on a tax-deferred basis.
4. Roth conversions: This may be a good time to convert funds in a traditional IRA to a Roth. Future Roth IRA distributions are tax-free if they meet certain conditions. And though you'll owe income tax on the amount you convert, transferring the funds over several years could reduce the overall tax bite.
5. Higher education: Is your child going to college in the fall? Generally, you can claim one of two higher education tax credits, subject to phaseouts based on income. A tuition deduction, also off-limits to most high-income families, expired after 2016 but could be revived.
6. Monetary gifts: If you give money to charities this year—by check, credit card, or online—the donation generally is deductible in 2017. But you must observe strict recordkeeping requirements for charitable gifts of $250 or more.
7. Wash sales: If you acquire substantially identical securities within 30 days of taking a loss on a sale, you can't deduct the loss. Avoid this "wash sale" rule by waiting at least 31 days to buy back the same securities—or you might buy the securities first and wait at least 31 days before selling the original shares.
8. Dividend-paying stocks: Most stock dividends are taxed at the same preferential tax rates as long-term capital gains. To qualify for this tax break, you must hold the shares for at least 61 days.
9. Installment sales: Generally, you can defer tax on the sale of real estate or other property if you receive payments over two years or longer. Besides stretching out tax payments, you might reduce the effective tax rate if you stay below the thresholds for higher capital gains rates and the 3.8% tax.
10. Hiring your child: Does your child need a summer job? If you hire the child to work at your business, the wages are deductible by the business and taxable to your child at his or her low tax rate.
11. Qualified small business stock: If you invest in qualified small business stock (QSBS) of a fledgling company (perhaps your own) and hold it for at least five years before selling it, you can exclude 100% of any gain.
12. Vacation homes: When you rent out your vacation home, you can write off specified rental activity costs, plus depreciation, but be careful: If your personal use of the rental home exceeds the greater of 14 days or 10% of the days the home is rented out, deductions are limited to the amount of your rental income.
13. Dependency exemptions: Generally, you can claim a $4,050 dependency exemption for a child graduating from college this spring if you provide more than 50% of the child's annual support. Figure out the amount needed to clear the half-support mark.
14. Charitable gifts of property:Give furniture and clothing in good condition to charity. You normally can deduct the fair market value of property donated to a qualified organization, within certain limits.
15. Dependent care credit: If you pay expenses for the care of your under-age-13 child this year while you (and your spouse, if married) work, you may qualify for the dependent care credit. Note that the cost of summer day camp qualifies, but not overnight camp.
16. Like-kind exchanges: If you swap investment or business real estate you own for like-kind property, the exchange is tax-free, except to the extent you receive any "boot" (e.g., additional money) in the deal. Caution: The IRS imposes timing requirements for this tax break.
17. Estimated taxes: Check to see if you're withholding enough income tax from your paychecks. Make necessary adjustments to avoid owing an "estimated tax penalty" in 2017.
This article was written by a professional financial journalist for Erickson Financial Solutions, LLC and is not intended as legal or investment advice.
© 2017. All Rights Reserved
16 Of The Best Tax Moves For The Summer Of '16
Now that the Protecting Americans from Tax Hikes (PATH) Act has removed some of the uncertainty, tax planning during the summer of 2016 should be a breeze. Here are 16 tax-saving opportunities that may be available to you midway through the year:
1. Capital losses: If you cashed in stock winners earlier in the year, you can start filling up the loss side of the ledger. Your capital losses will completely offset capital gains that you realize in 2016, plus up to $3,000 of highly taxed ordinary income.
2. Capital gains: Meanwhile, if you sell securities and earn what qualify as long-term capital gains, the maximum tax rate is only 15% or 20% if you're in the top ordinary income tax bracket. But some upper-income investors also may have to pay a surtax of 3.8% on investment income.
3. Higher education: Is your child going to college in the fall? Lay the groundwork for tax breaks. You may be able to claim a higher education tax credit or a tuition deduction, though these tax advantages are phased out at relatively modest income levels. The PATH Act restores the tuition deduction and makes the American Opportunity tax credit permanent.
4. Wash sales: If you acquire substantially identical securities within 30 days of selling an investment at a loss, you can't deduct the loss. But this "wash sale" rule can be avoided by waiting at least 31 days to buy back the same securities. Or you could buy the additional securities first and wait at least 31 days before selling your original shares.
5. Dividend-paying stocks: Most stock dividends are taxed at the same preferential tax rates as long-term capital gains. To qualify for this tax break, you must hold the shares for at least 61 days.
6. Installment sales: Generally, you can defer tax on the sale of real estate or other property if you receive payments over two years or longer. Besides stretching out tax payments over time, you might reduce the effective tax rate if you stay below the thresholds for higher capital gains rates and the 3.8% surtax.
7. Hiring your child: Does your child need a summer job? If you hire the child to work at your business, your business can deduct the wages, which will be taxable to your child at his or her low tax rate.
8. 401(k) contributions: Reduce your tax liability by increasing contributions to a 401(k) plan at work. For 2016, the maximum deferral is $18,000 ($24,000 if you're 50 or older). Not only do you avoid tax on the contributions, the money in your account compounds tax-deferred until you withdraw it, probably during retirement.
9. Qualified small business stock: Invest in qualified small business stock (QSBS) of a fledgling company (perhaps your own). The PATH Act restores a 100% tax exclusion for sales of QSBS if you hold the stock at least five years before selling it.
10. Roth IRA conversions: You can convert some or all of the funds in a traditional IRA to a Roth. In return for paying income tax on the converted amount, future Roth IRA distributions will be tax-free if they meet certain conditions. To minimize the current tax impact, you could stagger taxable conversions over several years.
11. Vacation homes: You can write off certain rental activity costs, plus depreciation, but be careful: If you use the rental home for more than 14 days or for 10% of the days the home is rented out, whichever is greater, your deductions are limited to the amount of your rental income.
12. Dependency exemptions: You probably still can claim a $4,000 dependency exemption for a child graduating from college in 2016 if you provide more than 50% of the child's annual support. Figure out the amount needed to put you over the half-support mark.
13. Charitable gifts of property: Don't toss out old furniture and clothing; give items in good condition to charity. Generally, you can deduct the fair market value of property donated to a qualified organization, within certain limits.
14. Conservation easements: A special tax provision allows you to claim deductions for donating conservation easements involving property you own. Under the PATH Act, you can deduct up to 50% of your adjusted gross income (AGI) this year (100% for farmers and ranchers) instead of the usual 30%-of-AGI limit.
15. Day camps: If your under-age-13 children attend a day camp while you (and your spouse, if married) work this summer, you may qualify for the dependent child care credit. However, the cost of overnight camp isn't eligible.
16. Estimated taxes: Check to see whether you're withholding enough income tax from your paychecks and adjust the amount if necessary to avoid owing an "estimated tax penalty" in 2016.
This article was written by a professional financial journalist for Advisor Products and is not intended as legal or investment advice.
© 2016, all rights reserved.
Study These Six Higher Education Tax Breaks
Paying for college can be daunting, but federal tax rules provide some relief. With enhancements from the Protecting Americans from Tax Hikes (PATH) Act of 2015, you may benefit from one or more of these six tax provisions:
1. Section 529 Plans, available from all 50 states and the District of Columbia, encourage families to set aside savings for future education expenses. Most states set contribution limits at $300,000 or more. Generally, the investment grows without current taxes and distributions to pay for most college expenses — including tuition, fees, books, supplies, equipment, and room and board for full-time students — are completely tax-free.
You can choose a 529 plan from any state, and although college-savers often choose to save in the plan of their home state, you might be better off establishing a plan elsewhere. Still, more than half of the states offer state tax deductions or credits for Section 529 plan contributions by residents. That could be a compelling reason to stay home when choosing a plan.
2. The American Opportunity Tax Credit (AOTC) became a permanent tax break when the PATH Act became law in December 2015. The maximum annual credit is $2,500. You can get separate credits for each qualified student in your family. For example, if you have three kids in school this year, your maximum credit is $7,500. Also, under another recent tax law change, you now can claim the AOTC for up to four years of school for each child, up from two years previously.
However, the AOTC phases out between $80,000 and $90,000 of modified adjusted gross income (MAGI) for single filers and $160,000 to $180,000 for joint filers. Once you exceed the upper limit, you can't claim the AOTC.
3. The Lifetime Learning Credit (LLC) also is a permanent part of the tax code, but the maximum credit of $2,000 applies per taxpayer rather than per student. So even if you have three kids in school at the same time, the maximum credit is still $2,000.
And eligibility for the LLC also phases out, at levels lower than the AOTC. The range in 2016 is between $55,000 and $65,000 of MAGI for single filers and from $111,000 to $131,000 for joint filers.
4. Tuition deductions also permit some parents to claim deductions for tuition and related fees paid to colleges and universities. This tax provision, extended through 2016 by the PATH Act, provides a deduction of either $4,000 or $2,000, depending on MAGI. For single filers, the $4,000 deduction is available for a MAGI up to $65,000 and $2,000 between $65,000 and $80,000. Joint filers can deduct $4,000 for a MAGI up to $130,000 and $2,000 if a MAGI is between $130,000 and $160,000. Above those limits you don't get a deduction. Taxpayers may claim either higher education credit—the AOTC or the LLC—or the tuition deduction, but not more than one of these three tax breaks.
5. Student loan interest deductions allow you to deduct the annual interest you pay on a student loan, up to a maximum of $2,500. This deduction applies only to the taxpayer who's actually repaying the loan. And the deduction for student loan interest is phased out based between $65,800 and $80,000 of MAGI for single filers and between $130,000 and $160,000 of MAGI for joint filers.
6. Coverdell Education Savings Accounts (CESAs) allow annual contributions of up to $2,000. This is on the low side, especially when compared to Section 529 plans that let you make six-figure contributions. And the ability to put money into a CESA in the first place is phased out between $95,000 and $115,000 of MAGI for single filers and between $190,000 and $220,000 of MAGI for joint filers. But if you qualify, these accounts, too, shield you from current taxes on earnings and you can withdraw money tax-free to pay for tuition and fees, room and board, uniforms, transportation, books and supplies, academic tutoring, and computers.
These tax breaks may offer parents help in saving for the high cost of higher education. We can help you sort through your options and navigate the arcane rules to find the best path in your situation.
© 2016, all rights reserved.
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Four Retirement Planning Rules Of Thumb To Bend
The online Merriam-Webster dictionary offers two definitions for "rule of thumb":
- A method or procedure based on experience and common sense,
- A general principle regarded as roughly correct but not intended to be scientifically accurate.
In other words, although rules of thumb can be useful guidelines, they're not gospel on any particular issue. This is especially important to remember when you're trying to set aside enough money to last comfortably through your retirement years. And while some traditional rules of thumb that have been followed faithfully for decades may serve as starting points, they're not infallible. Consider these four examples:
1. Save one million dollars for retirement. How much will you and your spouse need to live on in retirement? That's the age-old question. In recent years, some people have seized on a million dollars as the magic number to strive for. It's a nice round figure and, after all, can't a millionaire afford an upscale lifestyle in retirement?
But a million dollars doesn't go as far as it used to. Suppose you take an income of 4% of your savings annually—another rule of thumb for using retirement savings (see below). That's just $40,000 a year, and there will be even less if you dig into your nest egg to buy a winter "snowbird" home, for example, or take a few exotic vacations. And people are living longer these days, so you may need money to sustain you for 25 or 30 years, not 20 or less.
Another option that can be used is to set aside an amount roughly equal to eight times your ending salary (or even higher). So, if you're pulling down $200,000 just before retirement, you should have $1.6 million (8 x $200,000) in your coffers. That may be a preferable goal—but even then, a 4% withdrawal will give you only $64,000 a year.
2. Replace 80% of your pre-retirement income. This rule of thumb has been amended to make some concessions for a higher cost of living. Previous estimates often were predicated on replacing 70% or 75% of your salary with savings from retirement plans at work and IRAs, investment earnings, Social Security benefits, and other sources. Again, this rule of thumb may work for some people, but not for everyone, and replacing 80% of a high salary could require very substantial savings. You want to have 80% of that $200,000 in income? That's $160,000 a year, and could require savings of $4 million or more.
Moreover, the 80% rule ignores certain variables, such as health-care needs, lifestyle choices, and family obligations. It may be more helpful to go beyond rules of thumb to estimate what your expenses really may be in retirement and work backward to figure out how much you will have to accumulate and earn annually to meet your objectives.
3. Save at least 10% of your income for retirement. The old belief is that you should pay yourself first before you pay anyone else. This rule of thumb mandates that you set aside at least 10% of your salary each year no matter what is happening in your life. For a simplified example, if you earn $150,000 a year and thus set aside $15,000 a year in a tax-deferred vehicle such as a 401(k) plan, you will have $1,470,081 after 30 years if you earn an annual 7% return. (This example is hypothetical and not indicative of any particular investments.)
There are two problems here. First, there's no guarantee that saving 10% a year will give you what you need in retirement. The second is that it may be difficult to maintain that discipline, especially if you're raising a family during your peak earning years. If your saving lags during those years or if you can't start saving until later in life, the 10% rule is very likely to give you less than you need.
4. Withdraw no more than 4% annually from your nest egg. At first blush, this principle makes perfect sense for anyone planning on a long lifetime in retirement. In theory, if you withdraw 4% a year and earn more—say, 7% or 8%, as a hypothetical example—you should be able to sustain your nest egg throughout retirement as long as inflation remains relatively low.
But there are no guarantees of what interest rate you will earn, and you might have to use more than 4% some years. Furthermore, during a sharp market downturn, taking out even the minimum 4% could put you in a deeper hole that could be hard to dig out of.
Where do you stand? Although these four guidelines can be helpful, a better idea is to work out a comprehensive plan for your future. We would be glad to provide the retirement planning assistance you need.
© 2016, all rights reserved.