Estate Planning Techniques and Tax Strategies

Individuals might begin thinking about their estate plan, regardless of how soon it is likely to be used. Advance planning will help minimize the amount of tax paid and ensure that all distributions of property and money occur according to the decedent’s personal wishes.

Why do you need an estate plan?

If the individual has a business, middle age is the time to start thinking about a succession plan that will dictate what happens with the business upon retirement. Instead of continuing the business, another option is to sell the business and use the sale proceeds for retirement or bequests to subsequent generations.


When to start an Estate Plan?

As adults enter middle-age, they should begin to think about formulating an estate plan or revising an existing plan. An individual’s assets and goals influence the need for estate planning. By middle-age, adults may have children and extended family that they need to provide for and hopefully they have sufficient assets to accomplish this goal. Various estate planning techniques can be used to help a taxpayer prepare to pass her estate while lowering the potential tax imposed on her estate.


Life Insurance and Estate Planning

The impact of life insurance on an estate or an estate plan depends on who is named as the insurance beneficiary. If the estate or the executor of the estate is the beneficiary, the value of the life insurance must be included in the estate. If the beneficiary of the life insurance is not the estate, the proceeds are not included in the estate. However, even if there is a nonestate beneficiary, the proceeds are included in the estate if the estate has any “incidents of ownership.” Among the possible incidents of ownership that will require the inclusion of the insurance proceeds in the estate are:

  • A reversionary interest that is greater than five percent of the value of the policy.
  • The power to change the beneficiary.
  • The power to cancel the policy.
  • The power to surrender the policy.
  • The right to use the policy as security on a loan or to borrow against the policy.
  • The power to assign the policy.
  • The power to rescind an assignment of the policy.
  • The power to change, convert, or purchase a policy.
  • The power to receive dividends on the policy.
  • The right to choose among settlement options.


Creating Trusts for Estate Planning

Trusts are frequently used as a means to transfer assets at the death of the trustor. Under state law, the trust assets generally pass outside the probate estate, often smoothing the transfer process. The comparative convenience of transfer makes this technique appealing to those planning their estates.


Why Create a Trust for Estate Planning?

Trusts can also be used to accomplish a variety of goals. For instance, a charitable remainder trust allows the grantor to receive a charitable deduction for the present value of the charitable remainder. This is the case unless it is likely that the value of the remainder will be five percent or less than the trust’s value. Charitable remainder trusts can be in the form of an annuity trust or a unitrust.


Current Transfers of Property and Gift Tax

Current transfers as well as future transfers should be considered as part of the estate planning process. The most important consideration in determining whether inter vivos transfers need to be considered and planned for is the individual’s goals. Among the objectives that will influence the choice of inter vivos or post mortem transfers are:

  • Desire to keep a business in the family.
  • Desire to provide for children, grandchildren, or others both before and after death.
  • Desire to minimize the amount of estate taxes that are paid.
  • Desire to retain as much control as possible for as long as possible.

Achieving a Better Life Experience (ABLE) account

The tax laws have long encouraged Americans to save for college for their kids and to save for their retirement, but for families of those with disabilities, there was no tax-advantaged way for them to save for those individuals. The recently enacted Tax Increase Prevention Act of 2014 contains an important new provision which changes that.


What is an ABLE account?

The new law, which applies for tax years beginning after December 31, 2014, allows for the creation of “Achieving a Better Life Experience” (ABLE) accounts, which are tax-free accounts that can be used to save for disability-related expenses. Here are the key features of ABLE accounts:

  • ABLE accounts can be created by individuals to support themselves or by families to support their dependents.
  • There is no federal taxation on funds held in an ABLE account. Assets can be accumulated, invested, grown and distributed free from federal taxes. Contributions to the accounts are made on an after-tax basis (i.e., contributions aren’t deductible), but assets in the account grow tax free and are protected from tax as long as they are used to pay qualified expenses.
  • No federal tax benefits are provided for those who contribute to an ABLE account.

IRS Rules of ABLE Accounts

Money in an ABLE account can be withdrawn tax free if the money is used for disability-related expenses. Expenses qualify as disability related if they are for the benefit of an individual with a disability and are related to the disability. They include education; housing; transportation; employment support; health, prevention, and wellness costs; assistive technology and personal support services; and other expenses.


Distributions from ABLE Accounts

  • Distributions used for nonqualified expenses are subject to income tax on the portion of such distributions attributable to earnings from the account, plus a 10% penalty on that portion.
  • Each disabled person is limited to one ABLE account, and total annual contributions by all individuals to any one ABLE account can be made up to the gift tax exclusion amount ($14,000 in 2014, which is adjusted annually for inflation). Aggregate contributions are subject to the State limit for education-related Section 529 accounts.
  • ABLE accounts can generally be rolled over only into another ABLE account for the same individual or into an ABLE account for a sibling who is also an eligible individual.
  • Eligible individuals must be blind or severely disabled, and must have become so before turning 26, based on marked and severe functional limitation or receipt of benefits under the Supplemental Security Income (SSI) or Social Security Disability Insurance (DI) programs. An individual doesn’t need to receive SSI or DI to open or maintain an ABLE account, nor does the ownership of an account confer eligibility for those programs.


ABLE Account Impact on Medicaid

  • ABLE accounts have no impact on Medicaid, but, in certain cases, SSI payments are suspended while a beneficiary maintains excess resources in an ABLE account. More specifically, the first $100,000 in ABLE account balances is exempted from being counted toward the SSI program’s $2,000 individual resource limit. However, account distributions for housing expenses are counted as income for SSI purposes. Assuming the individual has no other assets, if the balance of an individual’s ABLE account exceeds $102,000, the individual is suspended, but not terminated, from eligibility for SSI benefits but remains eligible for Medicaid.
  • Upon the death of an eligible individual, any amounts remaining in the account (after Medicaid reimbursements) will go to the deceased’s estate or to a designated beneficiary and will be subject to income tax on investment earnings, but not to a penalty.
  • Contributions to an ABLE account by a parent or grandparent of a designated beneficiary are protected in bankruptcy. In order to be protected, ABLE account contributions must be made more than 365 days prior to the bankruptcy filing.

Top 10 ways to prepare for retirement

The financial security in retirement does not happen by itself. Planning and commitment are needed and, yes, money. One way to have more retirement money is to pay less in taxes and plan tax smart retirement strategies that not only manage investments, but the taxes associated with them 


Data on American Retirement Planning

  • Less than half of Americans have calculated how much they need to save for retirement.
  • In 2012, 30 percent of workers in private industry with access to a defined contribution plan (such as a 401 (k)) did not participate.
  • The average American spends 20 years in retirement.

Start saving for retirement and maintain objectives

If you are already saving, whether for retirement or another goal, keep doing it! You know that saving is a compensatory habit. If you are not saving, it is time to start doing it. Start small if necessary and try to increase the amount you save each month. The sooner you start saving, the more time your money has to grow. Make saving for retirement a priority. Create a plan, keep it and set goals. Remember, it is never too early or too late to start saving.


Know your retirement needs

Retirement is expensive. Experts estimate that need at least 70 percent of their pre-retirement income – for people asalariodos low, 90 percent or more – to maintain your lifestyle when you stop working. Take responsibility for your financial future. The key to a secure retirement is to plan in advance. 


Contribute to plan retirement savings from their employer

If your employer offers a savings plan for retirement, such as a 401 (k), register and contribute what you can. Your taxes will be lower, your company may provide more and automatic deductions facilitate the process. Over time, compound interest and tax deferrals make much difference in the amount you manage to accumulate. Find out your plan. For example, how would it help to get the full employer contribution and how long would you stay in the plan for that money.

Learn about the pension plan from your employer

If your employer has a traditional pension plan, find out if you are covered by the plan and how it works. Ask for a personal statement to know how much it benefits your benefit. Before you change jobs, find out what happens to your pension benefit. Find out what benefits can be had from a previous employer. Find out if entitled to benefits from your spouse’s plan. 


Consider basic investment principles together with tax implications

How savings can be as important as how much you save. Inflation and the type of investments you make play an important role in how much will be saved at retirement. Learn how your savings or retirement plan are invested. Meet the investment options your plan and ask questions. Put your savings in different types of investments. By diversifying thus is more likely to decrease the risk and improve the return. Your investment mix may change over time depending on a number of factors such as your age, objectives and financial circumstances. Financial security and financial literacy go hand given.


Do not touch your retirement savings

If you withdraw your savings for retirement now, you will lose principal and interest and may lose tax benefits or pay fines for retirement. If you change jobs, leave your savings invested in your current retirement plan or transfer to an IRA or your new employer’s plan.

Ask your employer to start a retirement plan

If your employer does not offer a retirement plan, suggest they start one. There are a number of plan options available retirement savings. It is possible that your employer can initiate a simplified plan that can help both you and your employer. 


Invest money into an Individual Retirement Account (IRA)

You can deposit up to $ 5.500 per year in Individual Retirement Account (IRA, for its acronym in English); can contribute more, even if you are 50 years of age or older. You can also start with much less. IRAs also provide tax advantages.

By opening an IRA, you have two options – a traditional IRA or a Roth IRA. The tax treatment of contributions and withdrawals will depend on the option you select. Also, the after-tax value of retirement will depend on inflation and the type of IRA you choose. IRAs can also provide an easy way to save. You can set it so that sum automatically from your checking or savings account is deducted and such amount is deposited in the IRA.


Find out about your Social Security benefits

Social Security pays benefits that are, on average, equivalent to about 40 percent of what you earned before retirement. May estimate their benefit on retirement estimator on the website of the Social Security Administration.


Ask questions about retirement planning

While these points are meant to point you in the right direction, you need more information. Read our publications listed in the back panel. Talk to your employer, your bank, your union or financial advisor. Ask questions and understand the answers. Get practical advice and act now.

Taxation of Variable Annuities

The income tax treatment of annuities under § 72 is similar to the taxation of life insurance proceeds received by a beneficiary under a settlement option in that the installment payments in both cases contain return-of-capital and income components. In the case of an annuity contract, the amount paid to the insurer, whether as a single premium or as a series of premium payments, is returned to the annuitant in annual or more frequent installments combined with an interest element, commencing either immediately or at a deferred date and continuing for the annuitant’s life or, if the contract so provides, for the lives of two or more annuitants.


Variable annuities are subject to certain types of taxation.

If the amount to be paid under an annuity contract varies in response to the insurer’s investment experience, cost-of-living indexes, or other fluctuating criteria, the “expected return” cannot be predicted with accuracy; and this in turn makes it impossible to compute an exclusion ratio in the usual manner. The regulations cope with this problem by (1) treating the amount received by the beneficiary as an annuity payment only to the extent that it does not exceed a taxpayer’s investment in the contract (less the value of any refund feature), divided by the number of anticipated periodic payments; (2) applying an exclusion ratio of 100 percent to this amount, thus excluding it from gross income in its entirety; and (3) requiring any additional amounts received to be included in gross income.


How are Variable Annuities Taxed?

Because the amount excluded in any taxable year cannot exceed the larger of (1) the amount actually received or (2) the ratable portion of the taxpayer’s investment, a taxpayer would not recover his investment tax-free if he received less than the excludable amount in any year and lived no longer than his life expectancy. To correct for this deficiency, the regulations permit a taxpayer to elect to recompute the excludable annuity portion of payments received after a shortfall, thus restoring the possibility of recovering his investment tax-free if investment experience under the contract improves.


Variable Annuity Contracts

Variable annuity contracts giving the policyholder control over the insurer’s investment decisions are not treated as genuine annuity contracts subject to § 72. They are taxed as custodial accounts generating income that is includable in the policyholder’s gross income as realized. If, however, the investor merely has the ability to allocate premiums paid among various sub-accounts available under the contract (in none of which any person can invest directly), and does not have the power to control or influence the investments made by the company in any of the sub-accounts themselves, then the contract will be recognized as a life insurance or annuity contract.

What are Profit Sharing Plans?

A profit-sharing plan, by name, suggests that it’s a way for an employer to share the company profits with the employees that maybe helped build that company. However, a plan sponsor can make a contribution even if they did not have a profit that year. Any employer with one or more employees can offer a profitsharing plan, and it generally must be offered to all employees at least age 21 who worked at least 1,000 hours in a previous year.

What are Profit Sharing Plans?

Employer contributions are discretionary. And since profits vary from year to year, there’s no set annual contribution. And contributions made to the plan must be allocated by a formula that’s set out in that plan document. An allocation formula would be percentage-based on the participant’s compensation divided by the total of all participant’s compensation times the total employer contribution. And what we find in most small profit-sharing plans, they’ll just pick a percentage, like five percent or 10 percent of compensation, and contribute that amount to each employee.


2014 Profit Sharing Plan Contribution Limits

For 2014, the amount of compensation taken into account is limited to $260,000. Employer contributions are limited to the lesser of 100 percent of compensation or $52,000 per employee for 2014. The employer’s deduction for contributions made to a profitsharing plan cannot exceed 25 percent of the aggregate compensation for all eligible participants.

Profit-sharing plans require more administration and management than IRA-based plans. These plans generally must file a 5500- series return. Profit-sharing plans must be amended from time to time to comply with changes to retirement plan laws. It’s not hard to find a plan that’s been pre-approved by the IRS. These plans are available from many financial institutions.

A profit-sharing plan can be designed to be a better fit to the needs of the owner and the employees. A profit-sharing plan can exclude employees that work less than 1,000 hours, compared to a SEP that must include all employees that earn just $550 in three of the five years. Five hundred and fifty dollars in a year may not even be two weeks worth of work.


Excluding Certain Employees from Profit Sharing Plan

A profit-sharing plan can exclude many of those temporary employees. Also unlike a SEP, a profit-sharing plan can have a vesting schedule, which can require participants to work for the employer for several years before they own the contributions. You end up rewarding the employees that stay with you that are longer contributors to the success of your business.

Also, profit-sharing plans can be designed to provide contribution allocations that are not the same for all compensation levels. They may also allow loans to participants. Like all qualified plans, money in a profit-sharing plan is covered by ERISA, the Employee Retirement Income Security Act. It is the ultimate protection from creditors. Money in an IRA is subject to each state’s law.


Form 5500 and Profit Sharing Plans

Again, profit-sharing plans have the Form 5500 return filing requirement while SEPs do not. And laws that affect profitsharing plans are changed more often than those affecting SEPs. In a profit-sharing plan, to make a contribution for 2014, the plan must be adopted by December 31, 2014. A straight profit-sharing plan – that’s one that doesn’t try to exclude classes of employees, counts all compensation, doesn’t require participants to be employed on the last day of the plan year and allocates the same contribution percentage to each participant – can be very easy to administer. If you choose to design your plan to exclude compensation, for instance, excluding bonuses, for example, or certain employees and maximize contributions towards the higher paid employees, the administrative complexity grows considerably.


SIMPLE IRA and SEP IRA Retirement Plans

Payroll deduction IRAs, SEP IRAs, SARSEPs and SIMPLE IRAs – they all use IRAs as the investment vehicle. And IRAs are going to be set up for each participant, and any contributions will be made to that IRA. The participant has complete control of the IRA, and they can take a distribution at any time.


SIMPLE IRA and SEP IRA Retirement Plans

A payroll deduction IRA is really nothing more than an IRA, and whether an employee’s contributions to this payroll deduction IRA are deductible is going to be determined by their income. So, if you have a client that doesn’t have a retirement plan and they don’t have any interest in adopting a retirement plan, maybe you can convince them or encourage them to save through this payroll deduction IRA.


What is a Simplified Employee Pension SEP?

SEP has to be formally adopted by that plan’s sponsor. And this can be done by adopting the IRS model – that’s a 5305-SEP – or an approved SEP that’s offered by that financial institution. A SEP allows any employer to set up an IRA for themselves and their employees as long as they meet the eligibility requirements in the plan. A SEP is allowed to only include those employees who are at least 21 years of age, employed by the employer for three of the last five years and who earned $550 or more during the year. There is no hours-of-service requirement, and employees who meet these requirements must be allowed to participate. An employer can choose less restrictive eligibility requirements if they like. Contributions are limited to the lesser of $52,000 or 25 percent of compensation for 2014.

Employers must contribute a uniform percentage of pay for each employee who has met those eligibility requirements. If the owner received a 10 percent contribution, then everyone in the plan should get a 10 percent contribution. In a SEP, an owner is not required to make a contribution every year.


What is Savings Incentive Match Plan for Employees SIMPLE IRA?

This plan’s available to any employer with 100 or fewer employees that does not maintain another type of retirement plan at any time during the year. This one’s easily established using a Form 5304-SIMPLE or a 5305-SIMPLE. One of these model forms allows the employer to designate the financial institution where the IRA money is sent, and the other allows your employees to designate that financial institution. A SIMPLE IRA plan must be offered to all employees who have compensation of at least $5,000 in any prior two years and who are reasonably expected to earn at least $5,000 during the current year. There’s no age or hours of service requirement in this type of plan.


SIMPLE IRA versus 401k Plan

Now, a SIMPLE IRA is really like a very simple version of a 401(k) plan. Eligible employees contribute a percentage of their pay to the plan through payroll deductions, up to $12,000 in 2014. Employees who are 50 or older during the year can contribute an extra $2,500 in 2014. An employee’s contributions in the SIMPLE IRA are subject to the FICA payroll taxes, but they are exempt from current income tax.

Employers are required to make an annual contribution in a SIMPLE using one of two formulas. They can either match employee contributions dollar-for-dollar up to three percent of pay, or they can make a fixed contribution of two percent of pay for all eligible employees, even those who elect not to defer.


SIMPLE IRA vs SEP IRA Differences

A SIMPLE IRA plan is limited to a business with less than 100 employees while a payroll deduction IRA and a SEP do not have that limit. In Employee Plans exams, we don’t look at payroll dedications IRAs, but I’m guessing you would find those in the smallest companies. SEPs can be found in any sized company but are more likely to be found in very small businesses, especially if there are no other employees. A SIMPLE IRA plan may be adopted by a business with less than 100 employees, but you’ll most likely see them in a business with less than 20 employees. At some point with more participants, the economies of scale make a 401(k) plan more affordable there. The trade-offs for this low administration are fewer options. There are no loans allowed in an IRA-based plan.

The contributions are very limited in a payroll deduction IRA and SIMPLE IRA plan, although a SEP does allow a contribution of up to 25 percent of compensation or $52,000 for the year 2014. A big advantage with a SEP is that it can be set up as late as the due date, including extensions, of your business income tax return for that year. They are very easy to adopt. With a SIMPLE IRA plan, it’s a little more complicated. If the employer adopts a SIMPLE IRA plan, it cannot have any other plan during the year where it has the SIMPLE IRA plan. Also, you can terminate your SEP plan whenever you choose. There really aren’t any restrictions. But terminating a SIMPLE IRA plan can be a challenge. If you have a SIMPLE IRA plan in 2013 and you decide you would rather have a SEP or a 401(k), you have to terminate your plan before November 1. If not, you have a SIMPLE IRA plan for 2014 and, again, cannot have another type of plan.



One big factor with SEPs and SIMPLE IRA plans is that the eligibility requirements are very easy to meet, so employees that work a very limited schedule with a business become participants in the plan. For some that may be good. For some employers that may be bad. It just depends; if you have a lot of high turnover, you might not want to have one of these types of plans.


Which is better, a SEP or SIMPLE IRA?

A common mistake among SEP and SIMPLE IRA plans is using the wrong compensation amount to determine contributions. The instructions to the form and the selections you make on the adoption agreement will help determine the correct compensation to use. An IRA-based plan covers all employees. If a plan’s sponsor is a member of a controlled group, all employees of the businesses in that controlled group that have met the eligibility requirement must participate in the SEP or SIMPLE IRA. Don’t make the mistake of excluding those related employees. They cannot be excluded. If you want to make a contribution to a SEP, you have until the due date of your return, including extensions, to make that contribution. The timing of contributions to a SIMPLE IRA is very important.

Employee’s salary deferrals must be deposited into the plan no later than 30 days following the month the money was withheld from the employee’s paychecks. If the plan’s sponsor is a Schedule C owner, their deferrals must be deposited into the plan within 30 days of the end of the year. So, for the year 2014, the deposit must be made by January 30, 2015.


Information About Health Savings Account HSA

What is a Health Care Savings Account (HSA)?

Heath Care Savings Accounts (HSAs) are ideal for Americans in certain situations. Health-care is front and center on the minds of many Americans. A Health Savings Account (HSA) is one tax-preferred vehicle that can be used to pay for healthcare expenses.

Advantages of a a health savings account (HSA)

A health savings account (HSA) combines high deductible health insurance with a tax-favored savings account. Most importantly, money in the savings account can help pay the deductible. Once the deductible is met, the insurance starts paying. Money left in the savings account earns interest and is yours to keep. These funds can be used in future years for future medical expenses.


What are the Tax Benefits of Health Care Savings Accounts?

For eligible individuals, HSAs offer a tax-favorable way to set aside funds (or have their employer do so) to meet future medical needs. Here are the key tax-related elements:

  • contributions you make to an HSA are deductible, within limits,
  • contributions your employer makes aren’t taxed to you,
  • earnings on the funds within the HSA are not taxed, and
  • distributions from the HSA to cover qualified medical expenses are not taxed.

Unlike a flexible spending account (FSA), unused money in your HSA isn’t forfeited at the end of the year; it continues to grow tax-deferred.


Who is Eligible for an HSA?

To be eligible for an HSA, you must be covered by a “high deductible health plan.” This is the first and most important qualifying element of an HSA. You must also not be covered by a plan which:

  • is not a high deductible health plan, and
  • provides coverage for any benefit covered by your high deductible plan. It is permissible to get an HSA and to be covered by a high deductible plan along with separate coverage, through insurance or otherwise, for accidents, disability, or dental, vision, or long-term care.

What is Considered a “high deductible health plan”?

For 2014, taxes a “high deductible health plan” is a plan with an annual deductible of at least $1,250 for self-only coverage, or at least $2,500 for family coverage. For self-only coverage, the 2014 limit on deductible contributions is $3,250. For family coverage, the 2014 limit on deductible contributions is $6,450. Additionally, annual out-of-pocket expenses required to be paid (other than for premiums) for covered benefits cannot exceed $6,250 for self-only coverage or $12,500 for family coverage.


Catch up Contributions to HSA

An individual (and the individual’s covered spouse as well) who has reached age 55 before the close of the tax year (and is an eligible HSA contributor) may make additional “catch-up” contributions for 2014 of up to $1,000. A high deductible health plan does not include a plan if substantially all of the plan’s coverage is for accidents, disability, or dental, vision, or long-term care, insurance for a specified disease or illness, or insurance paying a fixed amount per day (or other period) of hospitalization. HSAs may be established by, or on behalf of, any eligible individual under a high deductible plan.


HSA Tax Deduction Limits

Deduction limits. You can deduct contributions to a health savings account for the year up to the total of your monthly limitations for the months you were eligible. For 2014, the monthly limitation on deductible contributions for a person with self-only coverage is 1/12 of $3,300. For an individual with family coverage, the monthly limitation on deductible contributions is 1/12 of $6,550. Thus, deductible contributions are not limited by the amount of the annual deductible under the high deductible health plan.


Claiming HSA deduction on tax return

Also, taxpayers who are eligible individuals during the last month of the tax year are treated as having been eligible individuals for the entire year for purposes of computing the annual HSA contribution. However, if an individual is enrolled in Medicare, he is no longer an eligible individual under the HSA rules, and so contributions to his HSA can no longer be made. Contributions may be made to an HSA by or on behalf of an eligible individual even if the individual has no compensation, or if the contributions exceed the individual’s compensation. Contributions made by a family member on behalf of an eligible individual to an HSA are deductible by the eligible individual in computing adjusted gross income.


Transferring IRA Funds to HSA

HSA have more nifty tax benefits. Taxpayers can withdraw funds from an IRA, and transfer them tax-free to an HSA. The amount transferred can be up to the maximum deductible HSA contribution for the type of coverage in effect at the time of the transfer. The amount so transferred is excluded from the taxpayer’s gross income, and is not subject to the 10% early withdrawal penalty on IRA distributions before retirement age.


Employer Contributions to HSA

Employer contributions. If you are an eligible individual, and your employer contributes to your HSA, the employer’s contribution is treated as employer-provided coverage for medical expenses under an accident or health plan and is excludable from your gross income up to the deduction limitation, as described above. Further, the employer contributions are not subject to withholding from wages for income tax or subject to FICA or FUTA. The eligible individual cannot deduct employer contributions on his federal income tax return as HSA contributions or as medical expense deductions. An employer that decides to make contributions on its employees’ behalf must make comparable contributions to the HSAs of all comparable participating employees for that calendar year or be subject to penalties. Employer contributions are also excludable if made at the election of the employee under a salary reduction arrangement that is part of a cafeteria plan (i.e., a plan which allows you to elect to use part of your salary towards a variety of benefits).


How are Earnings on Health Savings Accounts Taxed?

Earnings. If the HSA is set up properly, it is generally exempt from taxation, and there is no tax on earnings. This means that earnings can grow tax free which is very advantageous. This money can grow tax free for 10, 20, even 30 years before healthcare expenses in retirement may need to be paid for. However, taxes may apply if contribution limitations are exceeded, required reports are not provided, or prohibited transactions occur.


What Happens to Distributions from HSAs?

Distributions from the HSA to cover an eligible individual’s qualified medical expenses, or those of his spouse or dependents, are not taxed. Qualified medical expenses for these purposes generally mean those that would qualify for the medical expense itemized deduction. There are many different medical expenses that qualify. The IRS publishes a list of these expenses. If funds are withdrawn from the HSA for other reasons, the withdrawal is taxable. Additionally, an extra 20% tax will apply to the withdrawal, unless it is made after reaching age 65, or in the event of death or disability.

Distributions from an HSA exclusively to pay for qualified medical expenses are excludable from the gross income of the account beneficiary even though the beneficiary is no longer an “eligible individual,” e.g., the individual is over age 65 and entitled to Medicare benefits, or no longer has a high deductible health plan.

Tax on Distributions from Traditional IRA Retirement Accounts

Distributions from traditional IRA retirement accounts is something that most taxpayers who used these accounts will encounter one day. There are several very important items to remember when taking distributions from traditional IRA accounts in order to avoid tax surprises.


Tax on Distributions from Traditional IRA Retirement Accounts

Although advance planning is needed to help accumulate the biggest possible retirement savings in an IRA, it is essential to plan for distributions from these tax-deferred retirement planning vehicles. There are three areas where knowing the ins and outs of the IRA distribution rules can make a big difference in how much you and your family will keep after taxes.


Taking Early Distributions from a Traditional IRA

Early distributions from traditional IRA. If you need to take money out of a traditional IRA before age 59-1/2, any distribution to you will be fully taxable at your ordinary income tax rate (unless nondeductible contributions were made, in which case part of each payout will be tax-free). In addition, distributions before age 59-1/2 may be subject to a 10% penalty tax. You can avoid this penalty tax by proving conditions such as hardship or that the IRA contribution was required to pay for education expenses.  Although there are way to avoid the penalty tax, there is no way to avoid the ordinary income tax. This makes sense because the money was put into the IRA pretax and will need to be taxed when it is taken out of the traditional IRA account. This would be very different if it were a Roth IRA account.


Naming IRA Beneficiaries

Naming beneficiaries. Who you designate as a beneficiary of your IRA is very important because it ultimately decides where the IRA will end up after the death of the original IRA owner.  This decision affects the minimum amounts you must withdraw from the IRA when you reach age 70-1/2, who will get what remains in the account at your death, and how that IRA balance can be paid out. It is essential to change the beneficiary of an IRA to reflect changes in a taxpayers overall estate plan. It is often hard to change who will receive an IRA via will and this must be done with the IRA account provider instead. Confusion in these area could lead to significant hassles after the original IRA owner dies.


Taking Required Distributions (RMDs) from Traditional IRA

Required distributions from Traditional IRA. Once you attain age 70-1/2, distributions from your traditional IRAs must begin. If you don’t withdraw the minimum amount each year, you may have to pay a 50% penalty tax  on what should have been paid out, but was not. This penalty is severe, however, it is possible to ask the IRS for leeway if you forget to take a RMD in a particular year.  In planning for these required distributions, your income needs must be weighed against the desirable goal of keeping the tax shelter of the IRA going for as long as possible for both yourself and your beneficiaries. This means that traditional IRAs should be coordinated with other retirement assets.


IRA Minimum Distribution Rules (RMDs)

Minimum distribution rules are imposed to prevent participants from unreasonably deferring the tax on their retirement savings. Under these rules, distributions are required to begin, for a participant other than a 5-percent owner, no later than April 1 of the calendar year following the later of:

  1. the calendar year in which the participant reaches age 70 1/2, or
  1. the calendar year in which the participant retires.

The minimum distribution rules do not apply to Roth IRAs while the account owner is alive, but do apply to traditional IRAs, deferred compensation plans, tax sheltered annuities, and qualified retirement plans

Calculating Capital Gains and Deducting Capital Losses

Planning for capital gains and deducting capital losses is a way to increase your long-term investment return. However, to calculate capital gains and understand capital losses correctly, taxpayers must understand several different tax laws. Taxes are often overlooked, but are a vital component of long term investment returns.


Offsetting Capital Gains with Capital Loss

The basic offsetting rule is pretty simple: Long-term capital losses offset long-term capital gains before they offset short-term capital gains. Similarly, short-term capital losses offset short-term capital gains before they offset long-term capital gains. One part of the rule is that you may use up to $3,000 of total capital losses in excess of total capital gains as a deduction against ordinary income in computing your adjusted gross income or AGI. This can be a great benefit for people in any income tax bracket. It will provide an immediate tax savings and realizing capital losses is quite easy.


Offsetting Capital Gains Rules

  • long-term gain with short-term gain
  • long-term loss with short-term gain
  • long-term gain with short-term loss
  • long-term loss with short-term loss

Individuals are subject to tax at a rate as high as 39.6% on short-term capital gains and ordinary income. The same rate as ordinary income will be used on short-term capital gains.


Long-term Capital Gains Rates

For most individuals long-term capital gains on most types of investment assets are taxed at a maximum rate of 15%. However, that 15% rate is

  • zero % to the extent the gain would otherwise be taxed at a rate below 25% if it were ordinary income and
  • 20% to the extent that the gain would be taxed at a 39.6% rate if it were ordinary income.

Taxpayers should try to avoid having long-term capital losses offset long-term capital gains since those losses will be more valuable if they are used to offset short-term capital gains or up to $3,000 per year of ordinary income. Make sure that the long-term capital losses are not taken in the same year as the long-term capital gains are taken.Remember to think about investment considerations before tax. It might not always make sense to do what is best tax wise that might lead to disastrous investment results.


Realizing Capital Losses (Tax Harvesting)

To the extent that taking long-term capital losses in a different year than long-term capital gains is consistent with good investment planning, you should take steps to prevent those losses from offsetting those gains. If you have yet to realize net capital losses for 2014, but expect to realize net capital losses in 2015 well in excess of the $3,000 ceiling, you should consider shifting some of the excess losses into 2014. That way the losses can offset 2014 gains and up to $3,000 of any excess loss will become deductible against ordinary income in 2014 The big hurdle is Internal Revenue Code Section 1211, which caps the deduction at $3,000 for both married couples and single filers. (Married couples who file separate returns are limited to a maximum deduction of $1,500 per person.)


Using Wash Sale Rule

Paper losses or gains on stocks may be worth recognizing this year in some situations. But suppose the stock is also an attractive investment worth holding for the long term. There is no way to precisely preserve a stock investment position while at the same time gaining the benefit of the tax loss, because the so-called “wash sale” rule precludes recognition of loss where substantially identical securities are bought and sold within a 61-day period (30 days before or 30 days after the date of sale). Thus, you can’t sell stock to establish a tax loss and simply buy it back the next day.

How to Avoid the Wash Sale Rule

However, you can substantially preserve an investment position while realizing a tax loss by using one of these techniques:

  1. Sell the original holding and then buy the same securities at least 31 days later. The risk is upward price movement.
  2. Buy more of the same stocks or bonds, then sell the original holding at least 31 days later. The risk here is downward price movement.
  3. Sell the original holding and buy similar securities in different companies in the same line of business. This approach trades on the prospects of the industry as a whole, rather than the particular stock held.

For mutual fund shares or ETFs, sell the original holding and buy shares in another mutual fund that uses a similar investment strategy.

Inherited Property Basis Rules for Stock and Other Assets

What happens when you inherit stocks or other property?

 A special provision of the tax code, known as step-up in basis, applies to appreciated taxable assets at death.


Step-up in Basis at Death

Under IRC § 1014(a) the general rule applied to property a beneficiary receives from a benefactor is that the beneficiary’s basis equals the fair market value of the property at the time the decedent dies. The fair market value basis rules (also known as the “step-up and step-down” rules), the heir receives a basis in inherited property equal to its date of death value. The fair market value basis rules apply to inherited property that’s includible in the deceased’s gross estate, whether or not a federal estate tax return was filed, and those rules also apply to property inherited from foreign persons, who aren’t subject to U.S. estate tax.


Who gets a step up in basis at death?

The rules apply to the inherited portion of property owned by the inheriting taxpayer jointly with the deceased, but not the portion of jointly held property that the inheriting taxpayer owned before his inheritance. The fair market value basis rules also don’t apply to reinvestments of estate assets by fiduciaries.


Step-down in Basis at Death

Under § 1014(a), if a decedent’s adjusted basis in property is higher than the fair market value, the beneficiary’s basis will equal the fair market value of the property at the time the decedent dies.A “step-down,” instead of a “step-up,” occurs if a decedent dies owning property that has declined in value. In that case the basis is lowered to the date of death value.  The best idea for property which has declined in value, therefore, is for the owner to sell it before death so he can enjoy the tax benefits of the loss.


§ 2032 Election for Alternate Valuation

Section 2032 provides an alternate method of determining the property’s new basis. If the property is not disposed of within six months of the decedent’s death, the executor may elect to use the property’s fair market value six months after the date of death. If the executor does not so elect, or if the property is disposed of before the six months have passed, then the property will still assume a basis equal to its fair market value at the time of death.