A Social Security Safety Net by Karla Hopkins

FDR said Social Security was not intended to be the only means of support for the aged but rather a Social Security safety net.  Many today though regard Social Security as a major part of their retirement funding.

In 2009 the poverty rate for people over age 65 was just under 10%.  Without Social Security, the rate would be 45%.  Today, members of the Baby Boom generation are beginning to turn 65 and this group, which is known for spending and not saving, will put a strain on society and the Social Security system.  Today’s need for a Social Security net is as great as it was during the Great Depression.  The difference is that this time the Social Security system’s ability to pay full benefits beyond a 25-year horizon is doubtful. 

Some projections indicate that by 2036 the system will only be able to pay benefits at a 77% rate rather than a 100% rate. Therefore, when you prepare a long term budget, you should be conservative and assume your benefits will only be 75% of the amount calculated.

Taxation of Social Security benefits began in 1983. The dollar limits that determine the taxable portion of Social Security have remained constant such that many must pay income tax on their benefits.  So how do you minimize the taxation of your benefits?

First, you must understand the rules.  In general, an individual or married couple adds one-half of their Social Security benefit to their modified gross income.  If the total exceeds $25,000 for a single person or $32,000 for a married couple, 50% of the Social Security benefits are taxable.  If the total exceeds $34,000 for a single filer or $44,000 for a joint filer then 85% of your Social Security benefits are taxable.  Planning for receiving Social Security benefits could reduce or eliminate taxation of the benefits for some.

A few planning ideas to reduce your income each year when collecting Social Security follow:

You may be able to begin taking distributions from other pretax retirement accounts before turning 70 ½.  Doing so could reduce the required distributions once you turn 70.  You may also want to wait until you are 70 to begin taking Social Security benefits. This could increase your benefit by 8% per year.  The higher Social Security benefit will offset the lower required minimum distribution from another pretax retirement plan that you may be required to take.

Additionally, you could convert taxable IRA’s into Roth IRA’s. You will pay tax now, but at retirement age you  will not be required to take a minimum distribution from a Roth IRA, nor are any of the distributions taxable if you are over age 59 ½.  To calculate the amount of IRA that you convert, calculate the maximum amount that does not increase your marginal tax rate in the year of the conversion. 

Also, you may wish to reposition your after-tax investment portfolio by investing in more growth oriented stocks.  Using your pretax portfolios for income generating investing can help reduce your adjusted gross income.  Carefully planning your capital gain and loss recognition can also minimize your gross income. 

Other issues to consider when planning for Social Security include when to begin benefits, any government pension offset and divorce issues.  It is never too early to think ahead to your retirement years and the taxes that can be avoided or deferred with good tax planning.

Did You Say Accelerate My Income? Part II by Carolyn Flaherty

On May 10^th I published an article on accelerating income. The article discusses some of the provisions that are due to “sunset” as of January 1, 2013 and what their impact will be. As promised, if you anticipate being affected (and there are few people who would not be), here are some suggestions to discuss with your accountant.
Those whose tax rate will increase due to marginal tax rate changes should explore accelerating income to 2012 and/or deferring deductions to 2013. Some ways to do this would be to bill clients earlier, sell appreciated property, avoid installment sales that defer gain, and accelerate bonuses.

Considering charitable contributions? If you are planning to give to charity toward the end of 2012, you may want to defer and contribute in January 2013 when tax rates are higher.

Note also that if tax rates do indeed increase, pre-paying the annual property bills at year end will not be advantageous in 2012.

Furthermore, individuals should review their withholding rate or consider larger estimated tax payments starting in 2013. Married couples and taxpayers with qualifying dependent children should pay particular attention as the child tax credit is slated to revert to $500 per qualifying child and the Marriage Relief Penalty may not be renewed.

If your portfolio includes appreciated capital property, 2012 is a good year to sell. Maximum capital gains rates are slated to jump from 15% to 20% in 2013. As long as the sale is bona fide and the proceeds are received in 2012 you will obtain considerable tax advantage. However, you cannot sell and then immediately after re-acquire without invoking the wash sales rules.
Corporations may want to explore declaring a special dividend before January 1, 2013 to get cash out of the company while it is still taxable to shareholders at the reduced rates. As of January 2013, all dividends will be taxed at the applicable ordinary income tax rates unless legislation is passed.

As advisors, we find it very hard to direct clients during uncertain times such as these. There is always the possibility that some or all of the tax relief provisions will be extended. In which case, the planning and speculation is null and void. Therefore, don’t rush out and sell off your portfolio. However, you should consult your advisor and consider some “what if” scenarios. As year-end approaches, the tax landscape will become clear and if you have a plan in place, you will be able to execute it effectively. Without a plan, you just may end up in a difficult tax situation in 2013.

Did you say Accelerate my Income? PART I: By Carolyn Flaherty

Historically the theme of taxation is defer, defer, defer. After all one in the hand is worth two in the bush so the saying goes. So why might your financial advisors be encouraging you to accelerate income in 2012?

Remember all those Bush-era tax cuts put in place back in 2001 and 2003? The cuts impacted individual, capital gains, and dividend and estate tax rates and made an additional thirty plus tax savings changes to the Tax Code. All those provisions are set to expire at the end of 2012.

The loss of these savings will not only impact the wealthy. On the contrary they impact every single tax payer and quite possible the knockout punch lands more solid on the middle class. Some areas that may affect you:

·         Marginal tax rates are currently 10, 15, 25, 28, 33 and 35 percent. They will increase to 15, 28, 31, 36 and 39.6 percent.

·         While your marginal tax rate inflates your payroll tax is also scheduled to increase 2% as the payroll tax cut enacted under the Middle Class Tax Relief and Job Creation Act of 2012 expires.

·         “Marriage Penalty” relief disappears.

·         Fewer people will qualify for the Earned income Credit.

·         The Child Tax Credit will be reduced from $1000 to $500.

·         Maximum capital gains rates will revert from 15% to 20%.

·         Tax on dividends will go from 15% to the ordinary income rates; or a maximum tax rate of 39.6%.

·         More taxpayers will be subject to the dreaded Alternative Minimum Tax.

·         Coverdell Education Accounts maximum contribution will go from $2000 to $500.

·         The student loan interest deduction will be available to few individuals.

·         Elimination of 100% bonus depreciation, research credit, State and local sales tax deduction, teacher’s classroom expense deduction, mortgage insurance premium deduction, energy tax incentives AND cancellation of mortgage indebtedness exclusion for personal residence.

This is not intended to be and is not an all-inclusive list of the sunset provisions that will impact individuals. Yet, I’m sure each and every person reading this realizes the gravity of the situation. There are also many provisions that will impact businesses that will be discussed in a subsequent blog.

Extending these tax cuts is estimated to cost the government 2.84 million over the next 10 years. To complicate matters, Congress is currently confronted with mandatory reductions in federal spending under the Budget Control Act of 2011. Financially it seems unlikely that government can extend the provisions. However, the impact on individuals will be severe enough that to not extend at least some of the provisions may have dire political impact for the parties. Democrats and Republicans are at a standoff as to how to proceed and agreement before the November elections does not seem likely.

Next week we will explore some ways that you can plan for the sun setting of these provisions and perhaps accelerate some of your income during 2012 to take advantage of the still existing tax breaks before they expire. Tune in for more next Thursday and please comment with any questions you may have about the provisions set to sunset.

Ensuring Alimony Classification by Carolyn Flaherty

Just because a settlement refers to a payment as alimony does not make that payment deductible for income tax purposes. While a payment may indeed be alimony under domestic relations statutes or bankruptcy statutes, it may not be qualified alimony under the Internal Revenue Code. So how do you know the difference?

There are eight requirements, listed below, that ALL must be met in order for a payment to be considered alimony for tax purposes. Each payment is reviewed individually to determine if it meets the criteria to be characterized as alimony. Intent of the parties controls only the property rights of the payment and NOT the classification or deductibility for income tax purposes.

1. Payments must be made under a divorce decree or other written instrument pursuant to such a decree or under a written separation agreement.
2. After divorce or legal separation has been finalized, spouses cannot be members of the same household.
3. Payments must be made in cash or a cash equivalent.
4. The payments must be made to the former spouse or on behalf of the former spouse.
5. The written agreement cannot specifically state that the payments are not alimony.
6. Spouses must file separate income tax returns.
7. The payments cannot be referred to as or deemed to be child support.
8. Payments must terminate upon death of the receiving spouse.

Why does the characterization as alimony matter so much?
The designation effects whether or not the payment is deductible by the payer for federal income tax purposes and includable in income by the recipient. Alimony payments are deductible while child support and other payments are not. Though not commonly utilized, there is an option to elect out of this the alimony classification. In which case the payer agrees not to deduct the payment and the recipient does not include the amounts as income on their return even though the amount qualifies as alimony.

Some common mistakes or stumbling blocks are as follows:

• Any payments that are made before a written agreement is executed are NOT deductible EVEN IF the agreement is made retroactive to the date earlier payments were made.
• Payments made over the amount stipulated in the agreement are NOT deductible. Changes to the amount of alimony must be done via formal modifications of your agreement because an oral agreement is not enough for tax purposes.
• Payments in the form of bonds, annuity contracts, promissory notes, property or services are not deductible.
• Paying the mortgage on a house you own that your former spouse lives in is NOT deductible as alimony. However, if your former spouse owns the home and you pay the mortgage directly to the mortgage company, that payment likely qualifies as a deductible alimony payment.
• Any payments that are automatically reduced upon events related to a child such as a child maintaining a specified age, the death or marriage of a child, completion of child’s schooling, child leaving the household, or a child’s income are deemed child support even if stipulated as alimony by your agreement and are therefore non-deductible.
• When alimony payments stop or drastically reduce within the first three years of your agreement, you may invoke mandatory alimony recapture. Learn more and utilize a recapture calculator at http://www.smartmoney.com/personal-finance/marriage-divorce/deductible-alimony-calculator-9661/

Divorce is messy and confusing emotionally and financially. Properly navigating your settlement agreement and completing your income taxes, particularly in the initial year in which you file separately from your former spouse, will likely require the assistance of a professional. We also recommend that you consult not only an attorney or mediator, but also a tax professional during the preparation of your agreement so that you do not encounter unpleasant and unexpected tax or financial consequences.

Note: Rules as stipulated in this article govern divorce instruments written after January1, 1985. For law prior to that date refer to the prior tax code. Furthermore, the article discusses only federal tax code and does not address state law. Payments qualifying as alimony under federal law do not automatically qualify under state law.