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Topic: Taxes

Net Investment Income Tax (NIIT)

By Bob Palechek, CPA | October 2, 2020

Today’s blog is about Net Investment Income Tax, otherwise referred to as “NIIT”.   NIIT came into existence on January 1, 2013, and applies to individuals, estates, and trusts.  The focus for today is on individuals.

NIIT is a tax on certain types of investment income applied at 3.8% if the taxpayer has income above certain income thresholds.   The income thresholds for single filers is Modified Adjusted Gross Income (MAGI) above $200,000.   For married filing jointly files, the MAGI amount is $250,000.  These thresholds have been the same since 2013 and are not indexed for inflation.

The 3.8% is applied to the lower of net investment income or the amount of your MAGI that exceeds the applicable threshold amount.   For example, if a married couple has net investment income of $150,000 with a MAGI of $305,000, then the 3.8% tax will be applied to $55,000 (since $305,000-$250,000 is lower than $150,000).   In this scenario, the NIIT tax reported and owed will be $2,090.  The calculation and reporting of NIIT is found on IRS Form 8960.

Types of Investment Income included in NIIT:

-Interest and dividends (including qualified dividends)

-Capital gains and capital gain distributions

-Rent and royalty income

-Non-qualified annuities

-Income and gains from passive activities (where the owner is not involved)

-Gains from the sale or disposition of those passive activities

Types of Investment Income not included in NIIT:

-Tax-exempt interest

-Distributions from qualified plans (typical IRA’s ROTH’s, and 401(k)’s)

-Any portion of the gain on your home if excluded under Section 121.

So RMD’s from my IRA are not subject to NIIT?   Correct, but if the RMD amount raises your MAGI above the applicable threshold, it will trigger NIIT on your net investment income.  This is especially important when looking at Roth Conversions!  If this causes an additional 3.8% tax on your investment income, it should be factored into the current cost of the Roth Conversion.  Fortunately, the tax planning software we utilize factors all of this into the Roth Conversion Analysis plans we perform for our clients.

One last common item that I see preparers miss on tax returns:   If a business that you own and operate rents from real estate that you also own, a sale of that real estate that generates a capital gain is excluded from NIIT.  The IRS allows the gain to be considered as part of the business activity and not subject to the 3.8% additional tax, if applicable.

Tax Planning With Charitable Donations

By Bob Palechek, CPA | August 7, 2020

This article is to provide you a summary of how charitable deductions work, what is allowed and not allowed, limitations, and new items (see end of article).

Charitable donations are deducted on Sch A as itemized deductions.  With the increase in standard deduction amounts (now $24,800 for married filing jointly) along with a $10,000 limit on State and Local Taxes (SALT), breaking the threshold for claiming itemized deductions versus the standard deduction is harder than ever.  This means while your charitable intent is a good thing, it may not necessarily bring tax savings.  At least through 2025, after that we go back to the old rules.

It can therefore make tax planning sense to lump or bunch together charitable donations in every other year.  Trying to max out a year to receive a tax benefit.  Charity paid with a credit card counts in the year of the credit card charge and not when you pay the credit card.  Donor-advised funding can help with breaking the threshold in the year of the donation then spread the gift in smaller amounts to specific charities over several years.

Allowable donations include; money or property donated to churches, synagogues, temples, mosques, other religious organizations, non-profit schools and hospitals, public parks, and public charities.  If you are unsure, please visit WWW.IRS.GOV.  The IRS maintains a database of qualifying charities.

Non-Allowable donations include; money or property donated to civic leagues, sports clubs, chambers of commerce, most foreign organizations, individuals and politicians.  If you are unsure, please ask your tax person.  An addition to this category began in 2018, if you make a payment to a college for the right to purchase sporting event tickets, that payment is no longer deductible!

Substantiation of donations that do not exceed $250 in any one day to anyone organization can be supported by bank records.  Cash donations require written acknowledgment from the Charity as well as all donations that exceed the $250 rule.

Non-cash donations, the most popular being made to resellers of thrift goods.  Think clothing, books, household items, electronics, etc.  Best practice is to keep detailed records of precisely what you donated, exact quantities, and fair market value of each item.  Larger claimed deductions should have the best records.  The IRS has taken several taxpayers to court previously and were successful in their efforts.  The Courts believed the donations occurred but denied the deduction because there were no detailed records to back-up the donation deduction.

If you make a donation but receive something in value in return, the fair market value of what you receive needs to be deducted from the donation amount.  For example, if you bid on a gift basket at a charitable auction, only the amount you actually pay above the value of the gift basket is deductible.

There are limitations in how much you can deduct each year.  Cash donations are limited at 60% of adjusted gross income currently through 2025, then back to 50%.  Capital gains property, for example, stock in a public company is limited to 30% of adjusted gross income.  This can be a nice tax planning tool if you have some highly appreciated stock, as you get the fair market value as a possible deduction on Sch A and can avoid paying capital gains tax on the appreciation.  If you choose to only deduct the cost of the stock, you can obtain a 50% limitation, but this would be kind of unusual.  The good news, anything not allowed by virtue of a limitation can carry forward for up to five years.  The same percentage limits carry forward as well.

New for this year only (CARES Act):  The limitation for cash donations is now 100% of AGI, not 60%.  You can shelter all of your taxable income this year with a charitable donation.  The same five-year carryover rule applies.  Also, under CARES Act, anyone can claim a $300 charitable deduction without having to itemize.

Medicare Part B Benefits, IRMAA, and Tax Impacts

By Bob Palechek, CPA | June 19, 2020

Medicare benefits provided to eligible retirees come in various “parts” that apply benefits to various different health-related services.  Two parts, parts B & D, are funded primarily by general revenues (transfers from the U.S. Treasury) and premiums paid by enrollees.  Premiums paid by enrollees are either deducted from monthly social security benefits or billed separately if the enrollee is currently not receiving monthly social security benefits.

Part B beneficiary premiums are set each year to approximately equal 25% of the average expected Part B program costs for the year.  For 2020, the standard monthly Part B premium is $144.60.   Just for reference, Part B premiums started in 1966 at $3 a month!  The current estimate is for Part B premiums to increase to $234.10 a month by 2029.

Beginning in 2007, people receiving Part B benefits who are considered high-income earners can be subject to higher premiums on their monthly Part B portions.  These higher premiums are designated as income-related monthly adjustment amounts (IRMAA).  Initially, there were four levels, 35%, 50%, 65% and 80%.  So instead of paying 25% of the average expected annual costs, the “co-pay” increases to one of these higher rates, depending on income.  Beginning in 2019, a fifth bracket was added for 85%.  For 2020, the current co-pay monthly amounts for the five higher brackets are $202.40, $289.40, $376.00, $462.70, and $491.60.

For married filing jointly returns, the income test is Modified Adjusted Gross Income (MAGI) and the first tier (35%) currently begins at $174,001.  This is indexed for inflation, but legislation has been passed in the past to lock the thresholds in place.  This has been done to increase revenues, as retiree’s income rises more and more folks run into these thresholds or into higher tiers.  There is no phasing within these tiers, one dollar over the minimum or threshold level subjects you to the whole increase.

The Social Security Administration (SSA) borrows information from the IRS to find out who is subject to IRMAA.  The IRS shares MAGI for each taxpayer from the tax return filed two years in the past.   For example, for calendar year 2020 the SSA will use the MAGI from your 2018 tax return.  MAGI is essentially your Adjusted Gross Income (AGI) plus tax-exempt interest and some foreign earned income.  Once you are subject to IRMAA, it will last the full year but will be adjusted again on January of the next year based upon the amounts from the subsequent years tax return filed  (still two years behind).  There are about eight life-changing events the SSA allows for you to estimate your new current income to escape the IRMAA grasp, but you have to file a form with the SSA and provide support for your life-changing event.

Can you catch a tax deduction for either the standard Part B premium or a higher adjusted Part B premium under IRMAA?  Well perhaps!!  First of all, the premium can be deducted as a medical expense or an itemized deduction on Sch A of your 1040.  There are a couple of hurdles to jump to obtain a tax benefit this way.  Only medical expenses that exceed 7.5% of your AGI (currently expected to increase to 10% in 2021) are counted toward itemized deductions.  And the medical expenses that are allowed plus your remaining itemized deductions have to exceed your standard deduction.  Which as you know has doubled for the years 2018 to 2025.

Another better option is if you have net self-employed income, say from part-time freelance or consulting income.  Then the Part B premiums are deducted as self-employed health insurance, deductions allowed towards computing your AGI, to the extent of your self-employed net income.  This is a valuable tax benefit and should not be missed!

Investment Management: Cost Basis Choices in the Drawdown Phase

By Scott Roark, MBA, PhD | April 17, 2020

When it comes time to start living off the investment accounts you’ve spent a lifetime building up, there are some choices that can help you manage your taxes.  The rest of this article presumes that you have taxable brokerage investments – such as stocks, ETFs or mutual funds that are not part of retirement accounts.  Of course, any distributions from a retirement account, such as an IRA or 401k, will be taxable as ordinary income and the only choice you have is how much to withdraw.

In a taxable account, however, there are some other considerations.  This is because any time you sell a holding, the IRS will want to know what the tax consequence of that sale is.  There are three possible scenarios:

  • The first possibility is that you sell some shares of your investment for exactly the same price that you paid for those shares. In this case, there is no taxable gain or loss and so there is no effect on your taxes.  All the proceeds of the sale are available for whatever use you desire.
  • A second possibility is that you sell some shares of your investment for less that you paid for those shares. In this case, you have a loss that can be used to offset gains on other investments you sell or the loss can offset up to $3,000 of otherwise taxable income.
  • The third possibility is that you sell some shares of your investment for more than you paid for those shares. In this case, you have a capital gain.  Depending on how long you have held those shares, you have either a short-term capital gain (taxed at your ordinary rate) or a long-term gain (taxed at lower rates).

With those scenarios as background, there is one important choice you can make with your brokerage account that can help you manage your tax situation.  That is the choice on the cost basis.  The cost basis refers to how much was paid for a particular share.  In many accounts, particularly those with mutual funds where distributions from the mutual fund company are reinvested, there are many different transactions that occur over time.  For instance, if you purchase 1000 shares of an S&P 500 index on January 1 and you have elected to have any distributions from the fund reinvested, there will likely be four additional purchases of shares in your account over the course of a year.  This is because many of the S&P 500 firms pay dividends and these are passed through to mutual fund owners – usually on a quarterly basis.  In addition, many investors make periodic purchases by adding new money to an account over time.  So in any account with mutual funds, there are likely a rather large number of separate transactions to buy shares.

Because these shares have been purchased at different times throughout the year, there is likely a different purchase price (and cost basis) for each transaction.  In the example outlined above, there is the initial purchase, the quarterly reinvestments and the quarterly additions of new money.  In all, there are nine transactions in this simple account.  Let’s walk through the spreadsheet below and look in more detail at these transactions.  We will need this example in order to make sense of the choices an investor has when we discuss these choices later.

Here is a numerical example (roughly modeled on 2018 when there were sizable fluctuations in the market over the year):

Jan 2 – Investor makes an initial purchase of $25,000 for $25.00 per share.  The investor has a total of 1,000 shares.
Here is a numerical example (roughly modeled on 2018 when there were sizable fluctuations in the market over the year):

Mar 30 – The investor receives a dividend of $0.11 per share.  This is $110 and they can reinvest and get 4.51 shares at the new price of $24.38.  In addition, the investor puts in $5,000 of new money in and gets 205.09 additional shares.  The new share total is 1,209.60.

June 30 – Dividend of $0.117 per share.  The dividend is $141.52 (equal to 1209.60 shares x $0.117 per share).  This is reinvested at the new price of $25.10 and results in 5.64 new shares.  In addition, the investor puts in $5,000 of new money and gets 199.20 shares for a new total of 1414.44 shares.

Sept 30 – Dividend of $0.122 per share.  The dividend is $172.56 and at the new price of $26.91 per share, the reinvestment results in 6.41 new shares.  The investor also adds $5,000 of new money and gets 185.80 new shares for a total of 1606.66 shares.

Dec 30 – Dividend of $0.128 per share.  With the share total of 1606.66, the dividend is 205.65 and after a deterioration in the share price, the dividend reinvestment results in 9.48 new shares (at the new price of $21.70 per share).  With the addition of $5,000 of new money, the investor also gets 230.41 additional shares.  The total shares at the end of the year is now 1,846.55.

The total invested over the year comes in 3 flavors:  the initial purchase (of $25,000), the additional contributions of $5,000 per quarter (total of $20,000) and the reinvested dividends which total $629.74.  The cumulative invested over the year is $45,629.74.

Now to the choice you can make to help manage taxes.  There are 3 main alternatives to determining the cost basis of the mutual fund shares you sell from your taxable account:  average cost, FIFO and specific share identification.

  • Average cost means that all of the shares are treated as coming from one big bucket and the cost basis for each share is the average price paid for all the shares in the bucket (including any reinvested dividends or capital gains). In the example, this would mean the average cost per shares is $45,629.74 ÷ 1846.55 shares = $24.711 per share.  Whenever a share is sold, its cost basis will be considered $24.711 per share.
  • FIFO is short for “First In, First Out”. This means that the oldest shares are sold first.  In the example provided, any number of shares sold up to the initial 1000 purchased will have a cost basis of $25.00 per share.  After those first 1000 shares are sold, the next 209.60 shares will have a cost basis of $24.38 per share.  After that will be 204.84 shares with a cost basis of $25.10, etc.
  • Specific share identification means that you tell your brokerage firm which shares to sell – you “specify” the shares. The cost basis for the shares you sell will depend on which shares you specify.  You have some shares that have a cost basis of $25.00, some at $24.38, some at 25.10, etc.

Here is how your choice of cost basis makes a difference.  Let’s say you needed $10,000 on February 1, 2020 – when the share price of your S&P 500 index fund is $29.80 per share.  You will need to sell $10,000 ÷ 29.80 = 335.57 shares to get that money.

If your choice of cost basis is Average Cost, then for each share you sell, you will have (29.80 – 24.711) in capital gains.  In this case the total gain is $1,708 and you would pay long-term capital gains rates on this for your taxes.

If your choice of cost basis is FIFO, then for each share you sell, you will have (29.80 – 25.00) in capital gains.  In this case the total gain is $1,611.

If your choice of cost basis is Specific Share Identification, you have more flexibility.  If you want the lowest possible tax hit, you can choose to sell the highest cost shares first.  In this case, you still need to sell 335.57 shares and you can do that by selling 192.22 share you bought at $26.91 per share and sell the remaining shares (143.35) which have a cost basis of $25.10.  In this case, your gain will be only $1,229 – potentially saving you a few hundred dollars in taxes in the current year.

One quick point worth mentioning here.  If you sold ALL of the shares in any given year, the amount of the taxable gain will be EXACTLY the same.  The only thing that is changing when you select different methods is the timing of the taxes.

The big takeaway from all of this is that investors have a choice as to which cost basis method they use.  The default is likely the Average Cost Method or the FIFO method, depending on your brokerage firm.  However, the Specific Share Identification Method provides the most flexibility in managing your tax situation when selling shares from your brokerage account.  In order to change methods, you likely only need to go online and make a selection of “Specific Share ID” and you are set.  Then when it comes time to sell some of your holdings, you select which shares to sell in order to best manage your tax situation.

IRA Rollover Rules and Taxation

By Bob Palechek, CPA | April 3, 2020

You own your retirement funds.  That grants you some flexibility in what you do with the funds and where you put them.  But with flexibility comes responsibility, and you are responsible for following all of the IRS’s rules.

You may get help from plan custodians, administrators, or bankers, but that does not relieve you of the responsibility of getting it right.  And a word of caution: many actions cannot be undone.

You may decide to move your retirement funds (1) between plan types, (2) to new accounts, or (3) to a new holder or custodian of your assets.  If so, your goal is generally to achieve this without creating a taxable event and, done correctly, that should be achievable.

Our goal is to provide you with that knowledge.  Or to show why you might want to consult with a tax pro before you start.

Transfers versus Rollovers

The transfer process is relatively straightforward.  The rollover process is more complicated.  Let’s look at both.


A transfer is typically done between IRAs.  You let your new IRA know of your wish for it to ‘receive funds’ from another IRA, and you provide all the details of your original IRA.  The new IRA will pull the funds across.  No taxes are withheld, and you receive no funds.  It is a safe and easy way to transfer retirement funds.  You do not need to report a direct transfer on the IRS’s Form 1099-R, so you shouldn’t be alarmed if you don’t receive one.


All movements of funds that do not qualify as transfers are considered rollovers.  And, they are more open to having something go wrong if not handled correctly.

Employer 401(k)-related rollovers

A typical rollover occurs when you reach out to your employer 401(k) plan and request all or a portion of that money.  This may occur through an in-service withdrawal (if the employer plan allows it) or after departing from that employer.

  • If you want to preserve your funds in a retirement account, you will request a rollover and provide the name of the new qualified plan or IRA account.  The original holder of the funds will issue a direct payment to the plan or account electronically, if available, or via check.  No taxes need to be withheld. You will receive a Form 1099-R to use when reporting the rollover on your taxes.  The distribution amount is shown in Box 1, but none of the amount should be taxable, and the code in Box 7 will be a ‘G.’  All is good.
  • If you receive a check to deliver to the new custodian, you will want the check to be payable to the new custodian, and not to you personally.  That way, this will be considered a direct rollover, and no tax withholdings are required.  The same reporting of the Form 1099-R will occur.
  • If you receive the check payable to you, a 20-percent federal withholding is required.  If your goal is a tax-free transaction, you have 60 days from the ‘constructive receipt’ of the check to deposit it into the new qualified plan or IRA account.  (‘Constructive receipt’ is when you have reasonable access to possession of a check.)
  • If you should miss the 60-day window to deposit, the distribution will be taxable to you and may be subject to a 10-percent penalty if you are below age 59½.  There are no exceptions.  If the 60-day window is missed because of cause, the IRS does provide a relief process but only under strict circumstances.  It should not be relied upon if the deadline was accidentally missed or if you changed your mind.

To remedy the situation and to achieve a complete tax-free rollover in these circumstances, you will have to make up the 20-percent withholdings with other funds.  You will be able to recover the 20-percent withholdings when you file your taxes the following year if you are overpaid.

IRA-to-IRA or Roth-to-Roth rollovers

The other typical rollover is from one traditional IRA to another, or from Roth to Roth.  These rollovers can either be direct (where the check is made payable to the new custodian or IRA) or indirect (where the check is made payable to you).  The first option is preferred because the 60-day window rule is not an issue.

  • On indirect rollovers of a traditional IRA, a 10-percent federal withholding rule is standard but not mandatory.  As in the remedy described above, the 10-percent withholdings would have to be made up with other funds to achieve a tax-free rollover.
  • One inconvenience of the indirect rollover of traditional or Roth IRAs is that you are only allowed one rollover per year.  The rule that introduced that limitation in 2015 exempted rollovers from 401(k)s.
  • If you do an indirect rollover, it will generate a Form 1099-R to use when reporting the rollover on your taxes.  Since an indirect rollover is where the check is received by you and payable to you, the Form 1099-R will come with a taxable distribution code on the form.  The code in Box 7 will typically be a ‘1’ or ‘7.’ However, the issuer has no way of knowing your intentions.  It also does not know if you met the 60-day window rule or the once-per-year rule.
  • If you have someone preparing your taxes, make sure to provide them with all the details of your rollovers so you will not get taxed as though you took the money from your plan.

And if you would like help to ensure that you have followed all the rules, make sure to reach out to your tax professional.  It’s always a good idea to make sure your T’s are crossed and your I’s dotted.

Tax Scams: How Not to Be a Victim

By Jo Madonna, E.A. | January 3, 2020

Thousands of people lose personal data and millions of dollars to tax scams each year, despite the IRS publishing its ‘Dirty Dozen’ list of top scams year after year. The IRS encourages Americans to remain ever vigilant and to become aware of the scams and tactics used in order to protect personal information. While scammers are active year-round, certain activities peak around tax-filing season.

How Scammers Initiate Contact

  • Scammers use regular mail, telephone, email, or social media.
  • While tax scams take many shapes and forms, many IRS impersonators use threats to intimidate and bully people into paying a fabricated tax bill. They may even threaten to arrest or deport their would-be victim if the victim doesn’t comply.
  • For a list of recent tax scams, you can visit https://www.irs.gov/newsroom/tax-scams-consumer-alerts.

How the IRS Will Never Initiate Contact

Unlike scammers, the IRS doesn’t initiate contact with taxpayers by email, text messages, or social media channels to request personal or financial information.

The IRS will never:

  • Call to demand immediate payment through a specific payment method. (Scammers often propose using a prepaid debit card, gift card, or wire transfer.)
  • Demand payment of taxes without allowing you to question or appeal the amount they claim you owe.
  • Threaten to have you arrested by local police, immigration officers, or other law-enforcement for non-payment of taxes. Nor can they revoke your driver’s license, business licenses, or immigration status.

These are all tactics used by scammers to intimidate you into falling for one of their  tax scams.

How the IRS May Contact You

The IRS uses the U.S. Postal Service as its primary means of contacting you. Before any other contact, the IRS will have mailed a bill to anyone who legitimately owes taxes.

Under certain circumstances, the IRS may call or come to your home or place of business. However, they will never demand payment. If they call, they will provide you with an official IRS number where you can call them back. If a caller refuses to give you a contact phone number, that is a good indication that you are dealing with a scammer.

If you do receive a visit from an IRS representative, you have every right to request to see official identification. A legitimate agent will provide you with two forms of ID.

The first will be a pocket commission. This is a red leather folder with the IRS seal embossed in gold on the outside, and the words “United States Treasury Department, Internal Revenue Service.” Two inserts are attached inside and include the representative’s printed legal name and job title, plus issuing information and the representative’s photo and signature.

The other ID will be an HSPD-12 card, which is a government-issued smart card that verifies the identity of Federal employees.  You can ask the representative for the IRS phone number used to verify the information on the HSPD-12 card and confirm the representative’s identity.

If you are comfortable after examining both forms of ID, you can speak with them about your case. Again, though, remember they cannot demand payment immediately.

How to Make Payments to the IRS

If you do owe taxes, the IRS instructs taxpayers to make out payments to the “United States Treasury.” Specific guidelines on how to make tax payments can be found at irs.gov/payments.

Third-Party Collections

The IRS has contracted with four private collection agencies to collect on the tax debt. They are CBE, ConServe, Performant, and Pioneer. First, the IRS will write to you to let you know your overdue tax account was assigned to such an agency. The letter will provide the name and contact information of the agency assigned to your account. Then the private agency will write to you giving details on how to resolve your tax issue.

Both letters provide a Taxpayer Authentication Number linked to your identity. You can also use this number to check that any caller is legitimate, as a scammer will not have it.

Know Who to Contact

If you have any trepidation that someone is trying to scam you, make sure that you do not give any personal information. You can always contact someone directly at the IRS to confirm any questions that you may have. Your tax professional should also be able to determine the legitimacy of the notice or call.

Here are some Federal Government agencies you can contact to report different types of scams:

  • Contact the Treasury Inspector General for Tax Administration to report a phone scam. Use their “IRS Impersonation Scam Reporting” web page. You can also call 800-366-4484.
  • Report phone scams to the Federal Trade Commission. Use the “FTC Complaint Assistant” on FTC.gov. Please add “IRS Telephone Scam” in the notes.
  • Report an unsolicited email claiming to be from the IRS, or an IRS-related component like the Electronic Federal Tax Payment System, to the IRS at phishing@irs.gov.

Lastly, should you have monetary losses related to an IRS incident, report it to the Treasury Inspector General Administration (TIGTA). Also, file a complaint with the Federal Trade Commission (FTC) using their Complaint Assistant, so your information becomes available to investigators.

Understanding the Cap on SALT Deductions

By Jo Madonna, E.A. | November 8, 2019

Understanding the Cap on SALT Deductions

Your first thought might be: “Does this apply to me?” Well, the easiest way to know is to look for a Schedule A (the schedule used for itemized deductions) on your most recent tax return. If you have a Schedule A, then the cap on SALT Deductions will apply to you.

On the other hand, if you do not have a Schedule A, you will notice that your 1040 tax return will include a standard deduction amount. The standard deduction amount in the newest tax law, Tax Cuts and Jobs Act (TCJA), is almost double what it was previously, so many people who itemized before might now claim the standard deduction instead.

So, let’s discuss the new State-and-Local-Tax limitation or SALT. There has been much debate over the SALT provision in the new TCJA, which only allows taxpayers to deduct up to $10,000 of their state and local taxes on their federal returns if they itemize. Before the SALT cap in TCJA, taxpayers were allowed to deduct 100% of their state and local property taxes, which was a massive benefit for those who pay high state income taxes or high property taxes.

Is this Fair?

Many people believe that the SALT cap is flawed and unfair, which is why it SALT Cahas caused so much discussion. They feel this limitation is targeting high-income earners and those who live in higher-tax states like California and New Jersey.

In fact, a recent study done by the Institute on Taxation and Economic Policy (Institute on Taxation and Economic Policy, 2018) found that 63% of the effect of the SALT cap falls on the wealthiest 1% of taxpayers. And those who utilize the SALT deduction the most would undoubtedly be those in higher-taxed states or jurisdictions. The more money you earn – and the more state and local taxes you have to pay – the more the populations of those higher-taxed states would be directly affected.

But remember that the TCJA did dramatically reduce the number of filers that used itemized deductions. Because the standard deduction rate nearly doubled, many filers who would have otherwise benefited from itemizing would now utilize that deduction. So, as a result, a more significant number of those who do still itemize would be in higher-income households.

Total Itemizers in 2019
Share of Each Income Group Itemizing Share of Total Itemizers
Poorest 20% 2% 1% 1% 1%
Second 20% 9% 3% 6% 4%
Middle 20% 23% 8% 15% 11%
Fourth 20% 43% 17% 28% 24%
Next 15% 72% 33% 35% 36%
Next 4% 90% 57% 12% 16%
Richest 1% 95% 85% 3% 6%
ALL 30% 13% 100% 100%
Source: Institute on Taxation and Economic Policy

The Upside

For high-income taxpayers, this cap did increase federal taxable income and, in turn, increased their federal tax liability. However, the TCJA offers an upside in other areas, such as lower statutory tax rates, a much larger Alternative Minimum Tax exemption, and reduced corporate income tax rates.

Even with the new cap on SALT deductions, many other factors ultimately allowed taxpayers to have a lower tax liability overall.  According to the Tax Policy Center (Frank Sammartino, 2018),  65% of taxpayers were estimated to pay less in taxes in 2018 than they would have under the previous law. Only 6.3% would have a higher tax liability. So, even with the SALT cap, many taxpayers can find benefits from other areas of the TCJA.

Why is the SALT Important for the Federal Government?

Federal income taxes are revenues that our government uses to provide programs, goods, and services that benefit the American people. The importance for the federal government is how much money it will lose or gain as an impact from the capped SALT deduction.

While being developed, the TCJA was scrutinized for benefiting the wealthy and possibly decreasing federal revenues. By reducing tax rates and manipulating other provisions, policymakers were worried that the federal revenues would suffer and that the most wealthy would benefit. The SALT provision, however, was an area that policymakers suggested would keep the tax code more progressive.

The nonpartisan Joint Committee on Taxation (Eastman, 2019) estimated that the new $10,000 limitation would raise $668 billion from 2018 to 2027. If the cap were eliminated, the revenue would be lost – a major concern for those who are worried about revenue-generation within the TCJA policy.

Claiming ‘Other Dependent’ Tax Credit

By Bob Palechek, CPA | October 11, 2019

Tax Credit for Other Dependents: Tests and Tips

Tax preparers are seeing more and more people caring for their adult children or aging parents and want to claim the ‘Other Dependent’ tax credit. Let’s take a closer look at how it works.

Starting in the tax year 2018, the Tax Cuts and Jobs Act (TCJA) brought with it some good news related to taking the tax credit on other dependents who cannot be claimed for the Child Tax Credit. The new tax credit is valued at $500, plus possibly dependent care expenses. However, this is the tax code so – no surprise – a series of ‘tests’ must first be satisfied.

Tests You Must Pass to Claim a Dependent

There is really only one test you must pass to be able to claim a dependent: you cannot be claimed simultaneously as a dependent by someone else. All other tests fall upon the person who you want to take as a dependent.

Tests Your Dependent Must Pass for You to Claim Them

Assuming you are qualified to claim a dependent, then your child (or another qualifying person) must pass seven tests. For simplicity, we will refer to this person as ‘the child.’

  • Relationship Test
    • Son, daughter or a descendant of them.
    • Brother, sister or a descendant of them.
    • Parents, grandparents, siblings of parents or in-laws can also qualify as a qualifying relative.
    • A person not related to you in any way can still be claimed as your qualifying relative if they lived with you the entire year.
  • Age Test
    • Below age 19.
    • Below age 24 and a full-time student.
    • Any age and permanently and totally disabled. An individual is considered ‘permanently and totally disabled’ if he or she meets Social Security’s requirements as being unable to engage in any substantial gainful activity because of any medically determinable physical or mental impairment that can be expected to last for a continuous period of at least 12 months. A physician should substantiate the impairment. It’s a good idea to get a note from your doctor and keep it in your tax file.
  • Residency Test: The child must live with you for at least half of the year. Temporary absences due to illness, education, etc., are not considered.
  • Nationality Test: The child must be either:
  • A U.S. citizen, national or resident alien.
  • A resident of Canada or Mexico.
  • Support Test: The child cannot be providing more than half their support (scholarships, whether taxable or not, are not included in this).
  • Joint Return Test: The child cannot be filing a Married Filing Jointly return with a spouse (unless they are only doing so to claim a refund of tax withheld).
  • Tie-breaker Rules: If the child is a dependent of more than one person (as in the case of divorced parents), the tie-breaker rules will need to be followed.

While most of these tests are pretty straightforward, the Support Test warrants a little more discussion.

How to Determine the ‘Support’ Aspect

Determining the ‘support’ aspect of the qualifying tests for the ‘Other Dependent’ tax credit follows a specific process:

  • Total up all the expenses the child has (not their income). Include all of the following that they would be paying if they lived on their own:
    • Shelter, including rent at fair market value, utilities, repairs. Do not include your mortgage, property tax or insurance.
    • Medical and dental expenses above and beyond what is being paid by insurance.
    • Educational costs.
    • Other, such as travel and recreation.
  • Next, identify who is paying for which of the above: you or the child? All sources of income, even those excludable from taxable income, are included. For example, they would consider Social Security disability benefits if they are using them to cover their expenses. Also, you would include tax-exempt interest income and payments received under a state Medicaid program if you are using them to cover the child’s expenses.
  • It’s important to remember that you are identifying what source of money is actually being used to pay the expenses. If you have decided as a family that the child will put their disability income away into savings and that you will cover all of their living expenses, then none of their disability is considered support.
  • When you total up all of the child’s expenses, if you are covering more than half of their support, then the Support Test has been met.

How to Handle the Cost of Shelter

It is usually beneficial to charge the child rent because doing so will maximize their Social Security disability benefit. If you don’t, the value of the fair market rent they are not paying will be considered income to them and will be included in their income and resources for benefit amount purposes.

Rental income received from your child – or anyone – must be reported on your tax return. Where it goes on the return, however, makes a big difference in how and what can be reported.

Rent at fair market value – This is the amount of rent most people would pay in your area for the space provided. Amounts will vary greatly depending on whether you are renting the child a guesthouse, a basement or perhaps just a bedroom. If you are renting at fair market value, then you are deemed to be conducting business in pursuit of profit. Business income of the rental type is reported on Schedule E.

Here you can report not only income but all associated expenses like the utilities, cleaning, repairs, mortgage interest, property tax, insurance and depreciation as a proportion of the whole based on square footage. All of these expenses can get you down to no taxable income and sometimes even result in a tax loss.

Rent below fair market value – Rents below fair market value are not considered business income but rather Other Income and are reported directly on the 1040 form by way of Schedule 1. The limitation here is that you cannot take any expenses against this income, so the full rent amount is taxable.

Before enactment of the TCJA, expenses against Other Income could be taken on the Schedule A as Miscellaneous Itemized Deductions (but only the amount exceeding 2% of AGI, of course). Since 2018, however, itemized deductions are no longer allowed.

Taking the ‘Other Dependent’ Tax Credit

Assuming all the required tests are met, you can claim a $500 credit for each ‘other dependent.’ Do note that this credit is non-refundable so, if you didn’t have any taxes withheld or otherwise pay in anything during the year, you would not be able to get this credit.

Also, since this is a credit and not a deduction, you calculate your taxes owed and subtract $500 right off the top!

Traditional and Roth IRA Taxation

By Jo Madonna, E.A. | September 13, 2019

The Role of Traditional and Roth IRA Taxation

Ask anyone who is putting money aside for retirement what the first thing was that they invested in, and they’ll probably say, “An IRA.” It is, in fact, one of the easiest ways to save for retirement. It lets IRA owners make ongoing contributions and invest them in a portfolio of stocks, bonds, mutual funds or other instruments. Easy or not, the IRA taxation deserves a closer look.

Congress created the IRA (Individual Retirement Account) in 1974 for two purposes:

  • To provide individuals not covered by a retirement plan at work with a tax-advantaged savings plan; and
  • To act as a supportive piece to employer-sponsored retirement accounts that needed to be rolled over when individuals experienced a job change or moved into retirement.

In 1997, Congress added the Roth IRA, which offered a very different set of retirement opportunities.

Since their creation, IRAs have been a fast-growing component of the U.S. retirement market. The two most popular accounts are:

  • Traditional IRA
  • Roth IRA

For both traditional and Roth IRAs, contribution limits may change from year to year to reflect increases in the cost of living. Changes are usually made in $500 increments. In 2019, IRA contribution limits for both are:

  • Under age 50: $6,000
  • Age 50 or older: $7,000 (considered a catch-up contribution)

The tax implications of each type of IRA will determine which will offer an individual taxpayer the most significant advantage. If and when your funds and earnings get taxed may affect which you choose, and your decision could depend on whether you think your tax bracket will be higher now or later in life.

Traditional IRA Taxation

A taxpayer may contribute to a traditional IRA up to the dollar value listed above and may take a deduction, or above-the-line adjustment, when filing taxes. However, the ability to contribute may be reduced or eliminated if the taxpayer – or spouse – has a retirement plan at his or her workplace. If neither is covered at work by a plan, then the deductions are allowed. Keep in mind, though, that the deduction could be limited or phased out depending on income levels as well.

While contributing to a traditional IRA allows taxpayers to lower their tax burden a bit, it is not without tax consequences. The IRS will want to collect the taxes on the income at some point. Payment will occur when the funds (and earnings) are withdrawn from the IRA. The tax rate will depend on the taxpayer’s income level that year.

Some rules are associated with traditional IRAs:

  • You can only contribute to a traditional IRA up to age 70½.
  • You will pay a penalty of 10% above the taxes due if you withdraw funds from a traditional IRA before you turn 59½.
  • Starting at age 70½, the IRS will require you to take “required minimum distributions,” or RMDs, to finally capture its taxes.
  • The beneficiary of an IRA will eventually have to pay the taxes on the proceeds of the IRA, but depending on beneficiary status, could enjoy some flexibility in the timing of payments. 

Roth IRA Taxation

The second type of IRA, called the Roth IRA, offers some unique tax advantages. However, an immediate tax deduction is not one of them, since they cannot deduct the contribution from their taxable income. Many of the advantages stem from the fact that the taxpayer is contributing to a Roth IRA with ‘after-tax’ dollars.

Roth IRAs have contribution phase-out rules based on income thresholds. In the case of married couples filing jointly, the phase-out range in 2019 is $103,000 to $123,000 if the spouse making the IRA contribution has a retirement plan at work. The deduction is phased out if the couple’s income is between $193,000 and $203,000 when the IRA contributor has no retirement plan at work but is married to a covered individual.

The Tax Cuts and Jobs Act of 2017 has made contributions to a Roth IRA more appealing. That act lowered the tax brackets and expanded them, so those taxpayers who are eligible to contribute can take advantage of the lower tax brackets while they last. (The ‘TCJA’ is set to sunset in 2025.)

The rules associated with Roth IRAs are:

  • You can contribute to a Roth IRA regardless of your age. However, your contributions must come from earned income.
  • The earnings generated in a Roth IRA can be held ‘tax-deferred’ within the account.
  • Taxpayers are never required to take distributions, so they can continue enjoying the tax-deferred growth of assets within the account.
  • Taxpayers can take tax-free withdrawals of both contributions and earnings after age 59½.
  • Beneficiaries may inherit a Roth IRA tax-free, so a Roth IRA provides a way to leave money to heirs free of taxes.

The Impact on Retirement Planning

Your IRA investment strategy can play a vital role in providing essential retirement income. Yet, many people contribute without thinking about IRA taxation and how to put those dollars to work to greatest effect. We would welcome the opportunity to create or review your tax strategy.

A Closer Look at Social Security Taxation

By Jo Madonna, E.A. | August 16, 2019

A Closer Look at Social Security Taxation: The Importance of the Combined Income Calculation

If you’re concerned about whether – or how – your Social Security benefits will be taxed, you’re either already over 62 and living with monthly Social Security deposits into your bank account, or working on your retirement planning for when they do start arriving.

Even though we know Social Security alone is insufficient to support us in retirement, for many it still forms a consequential part of their spending plan as they move from active to passive income generation. If Social Security benefits are going to be taxed, it’s important to know so in advance.

Many assume that Social Security benefits are free of taxes, but they are wrong. Although IRS rules do provide some protection when taxing Social Security benefits, the more additional sources of taxable income you have, the more your Social Security benefits will be taxed. That income could come from wages, self-employment efforts, dividends, required distributions and any other income that you will have to report to the IRS.

Each January, the IRS will send you a Form SSA-1099, or Social Security Benefit Statement, that shows how much you received in benefits in the prior year. If you don’t receive a Form SSA-1099, a replacement is available online through your My Social Security account.

This is the information you will use, along with your other income information, to determine if you have to pay tax on your Social Security benefits or not.

Using the Combined Income Calculation

social security taxation








The first step to knowing if any of your Social Security benefit is taxable is to use a special IRS calculation called the “Combined Income Calculation.” That calculation is: adjusted gross income + nontaxable interest + ½ of your Social Security benefits.

Your adjusted gross income
+ Nontaxable interest
+ ½ of your Social Security benefits
= Your “combined income

For example, if you have $30,000 in wages, $5,000 in tax-free interest from bonds and $22,000 in Social Security benefits, $46,000 is the Combined Income number that you will use to determine if any of your Social Security benefits will be taxable.

Base Limits for Taxes Owed

You will never pay tax on more than 85 percent of your Social Security benefits. If and how much you pay depends on your filing status and two specific Combined Income ranges. The amount will be calculated on a sliding scale that is based on your income.

  • The base limits that put single filing taxpayers into taxation calculation are:
    • $25,000-$34,000, which will put up to 50% of Social Security into taxation.
    • Above $34,000, which will put up to 85% of Social Security into taxation.
  • The base limits that put married filing joint taxpayers into taxation calculation are:
    • $32,000-$44,000, which will put up to 50% of Social Security into taxation.
    • Above $44,000, which will put up to 85% of Social Security into taxation. 

Calculating the Impact on Taxable Income

If your Combined Income puts you in one of the ranges where up to 50 percent of your Social Security benefits are taxable, the exact amount you enter as taxable income (on your Form 1040) will be the lower of either (a) half of your annual Social Security benefits, or (b) half of the difference between your Combined Income and the ‘IRS base amount’ ($25,000 or $32,000, depending on how you are filing).

For example, as a single filer who received $19,000 in Social Security benefits last year, half of that would be $9,500. If your Combined Income was $33,000, the relevant ‘IRS base amount’ would be $25,000. The difference between your Combined Income ($33,000) and the ‘IRS base amount’ ($25,000) would be $8,000. You would enter $8,000 as the taxable amount on your Form 1040 because it is lower than half of your Social Security benefits last year ($9,500).

Our earlier example gave us a Combined Income figure of $46,000. Whether filing as a single taxpayer or married filing joint taxpayer, that figure put up to 85 percent of the Social Security benefits into taxation. Here calculations become far more complicated, and the IRS offers further explanations and a worksheet to help: worksheet to calculate Social Security tax liability.

What About State Taxes on Benefits?

So far we have only looked at Federal income taxes. Are Social Security benefits taxed at the state level as well? If we are calculating the net cash available for spending or for our retirement planning, we would need to know.

Thirteen states tax Social Security benefits as income. Check for details if you live in Colorado, Connecticut, Kansas, Minnesota, Missouri, Montana, Nebraska, New Mexico, North Dakota, Rhode Island, Utah, Vermont or West Virginia.

The Impact on Retirement Planning

Smart Social Security strategies are only one element of your retirement planning, but one worth developing since it becomes part of the guaranteed lifetime income you will want available for the rest of your days. As experts in Social Security and Tax Planning, we would welcome the opportunity to help you plan yours.

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