Timing Social Security Benefits by Carolyn Flaherty

Many people wonder when they should begin taking their Social Security benefits. Most people believe that they should wait as long as possible before tapping into Social Security so that payments will be higher. However, choosing when to begin collecting is actually more complex than deferring as long as possible. In reality, timing must be analyzed based on the facts and circumstances of each individual including what other assets the individual has, the taxability of the other assets, what income streams can be generated in retirement and how much income the individual requires.

Although it is estimated that those who begin collecting at age 62 reduce their overall Social Security benefits by 20-30%, in some cases it is actually still more beneficial to begin collecting as early as possible.

For example: the lower income earner in a married couple may wish to begin collecting as early as possible. Why collect early? Because when the higher earner passes away, the lower earner’s benefit level becomes irrelevant anyway and they instead obtain survivor benefits that are essentially an inheritance of the higher income earner's benefits.

This can be particularly true for women who have taken time out of the workforce and therefore have lower total career earnings and hence lower social security benefit levels. Women also generally tend to outlive their male spouses. Therefore, they should consider starting their own benefits as soon as they are eligible.

Taking survivor benefits as early as possible is another scenario where taking early benefits may be financially savvy. Surviving spouses should consider taking survivor benefits while letting their own Social Security benefits continue to grow until age 70, at which point they can switch over to their own benefits.

You can begin collecting Social Security while continuing to work. However, your benefits will be reduced based on the amount your earned income exceeds certain levels established on an annual basis. For example, for the tax year 2012, a person under full retirement age may earn up to $14,640 and NOT lose any benefits. After that threshold your benefits are reduced $1 for every $2 you earn. A beneficiary who is of full retirement age can earn up to $38,880 in 2012 and NOT lose any benefits. After the threshold the benefits are reduced $1 for every $3 earned. Note that these thresholds relate to earned income and not to investment income. For more information visit the frequently asked questions section of the Social Security Administration site at http://ssa-custhelp.ssa.gov/app/home/session/L2F2LzEvdGltZS8xMzM1MzY0Nzc4L3NpZC9qaHhIZHhXaw%3D%3D .

There is no “right” answer that applies to everyone when deciding how to time your Social Security benefits. Therefore, you must do your research and consider consulting an advisor.

Another Season Passes by Carolyn Flaherty (as first posted 4/15/2011)

As the tax season comes to a close, we have decided to recycle this blog which first appeared in April of 2011. We wish you all a lovely spring full of sunshine, hope and happiness...

Most New Englanders can relate to the awaking that public accountants, (particularly those living in New England), experience upon the passing of each tax season. For months we have been entombed in a winter hibernation necessitated by the harsh New England winter and always stalling spring; and for those of us in public accounting, also by our work. Due to shortened days and a heavy workload, for months on end, many of us drive to work in the dark and leave the office in the dark. If we are fortunate enough to have a window in our proximity; we occasionally see the sun.

In New England at least, we can feel comfortable with our pasty pallor and lack of vitamin D. As the deadline approaches we celebrate the rain and cold that clings to our area because it is much easier to concentrate when the outdoors is not calling us to come and play.

Then, the fated day arrives and a feeling like the first day of summer vacation settles upon us all. We are free. We leave the office with a smile instead of a sigh. For the first time in months we are not thinking of the piles of work waiting for us. We are not prioritizing deadlines. We can sleep. We can make plans. We can spend time with our families and savor the moments rather than think of what we “should” be doing. We see the world like someone who has just gotten a pair of glasses and looks in wonderment at the outline of individual leaves on trees rather than the familiar blur of green. All things are brighter and crisper.

We are fortunate that the date often corresponds with April vacation for our youngsters and many of us embark on much needed vacations, in search of sunshine and repose. It is also rather symbolic that as we emerge, the days have begun to lengthen, crocus and tulips are rising from their winter sleep, the Red Sox are back on the field and the world is blossoming all around. Almost as if the world around us is celebrating as well.

I myself find that the energy I have poured into the tax season is now an available resource for the rest of my life and I rapidly throw myself into spring cleaning, landscaping, and a much needed return to physical fitness. As the energy ebbs so does the arrival of summer come upon me and I come in to a routine that matches the flow of the season once again.

Most people would consider a career choice as a public accountant to be a safe and secure career choice with a great deal of potential for advancement and financial gain. All this is true. The career path can also garner a great deal of flexibility. However, I would place a large wager that no college professor or recruiting company ever advises that being a CPA will cause you to appreciate life and routine and simple freedoms the way it does each April 15th.

Are you Due an Unexpected Refund of RI TDI? by Carolyn Flaherty

In March of 2012 a court ruling caused a significant Massachusetts tax law change. Prior to the change, RI Temporary Disability Insurance payments (often referred to as TDI and SDI), were not deductible under a 1977 Letter Ruling. As a result of the change, thousands of employees who reside in Massachusetts but have worked in Rhode Island between the years of 2008 and the current year are eligible for refunds.

How do you I know if I paid TDI? TDI, also reported as SDI, is reported in Box 14 of your Form W2.

The tax is calculated based on the employee’s wages. The TDI payments are placed in a Fund and used by the state to provide relief for the disabled and unemployed. Payments are used to defray the cost of government in Rhode Island by assisting the state in providing income to qualified disabled and unemployed residents. Therefore, the payments are, by definition, a state income tax and are hence eligible as a credit on your home state return.

Retroactive implementation: The refund for RI TDI is available for all open tax years. Therefore, you can apply for a refund for amounts paid all the way back to 2008. However, time is running out. The 2008 tax year closes as of the upcoming filing deadline: for Massachusetts as of April 17, 2012. When that deadline passes 2009 and 2010 tax years remain open for amendment until their statutes run out in upcoming years.

Can I claim the credit on my 2011 Return? Unfortunately you cannot simply claim a credit for previous years on your 2011 return.

How Can I get my money back? If you utilize the services of a professional, they will be able to amend prior year returns for you. The Massachusetts Department of Revenue is suggesting an abatement of tax online at: http://www.mass.gov/dor/forms/electronic-ca-6-notice.html

To file online you will have to set up an account and then follow the steps indicated. Our office has used the online service and found the process easy to follow and quite efficient. You may also file a paper Application for Abatement/Amended Return, Form CA-6 which can be found in the Forms section at www.mass.gov/dor.

How is my refund calculated? The computation of the credit is based on comparing the Massachusetts income tax on income reported to Rhode Island to the actual tax plus TDI paid to Rhode Island; the credit is limited to the smaller of these two amounts. To recalculate the credit, the TDI should be included as part of the total tax paid to Rhode Island.

Rhode Island employees residing in Massachusetts are the most likely beneficiaries of this law change. However, other states that have similar disability insurance funds include NewYork, New Jersey, Illinois, California, Hawaii and Puerto Rico. Therefore, Massachusetts residents that have worked in any of these states may also be affected and should review their tax returns.

Eight Things to Know about Medical and Dental Expenses and Your Taxes IRS Tax Tip 2012-30

If you, your spouse or dependents had significant medical or dental costs in 2011, you may be able to deduct those expenses when you file your tax return. Here are eight things the IRS wants you to know about medical and dental expenses and other benefits.

1. You must itemize You deduct qualifying medical and dental expenses if you itemize on Form 1040, Schedule A.

2. Deduction is limited You can deduct total medical care expenses that exceed 7.5 percent of your adjusted gross income for the year. You figure this on Form 1040, Schedule A.

3. Expenses must have been paid in 2011 You can include the medical and dental expenses you paid during the year, regardless of when the services were provided. You’ll need to have good receipts or records to substantiate your expenses.

4. You can’t deduct reimbursed expenses Your total medical expenses for the year must be reduced by any reimbursement. Normally, it makes no difference if you receive the reimbursement or if it is paid directly to the doctor or hospital.

5. Whose expenses qualify You may include qualified medical expenses you pay for yourself, your spouse and your dependents. Some exceptions and special rules apply to divorced or separated parents, taxpayers with a multiple support agreement or those with a qualifying relative who is not your child.

6. Types of expenses that qualify You can deduct expenses primarily paid for the diagnosis, cure, mitigation, treatment or prevention of disease, or treatment affecting any structure or function of the body. For drugs, you can only deduct prescription medication and insulin. You can also include premiums for medical, dental and some long-term care insurance in your expenses. Starting in 2011, you can also include lactation supplies.

7. Transportation costs may qualify You may deduct transportation costs primarily for and essential to medical care that qualify as medical expenses. You can deduct the actual fare for a taxi, bus, train, plane or ambulance as well as tolls and parking fees. If you use your car for medical transportation, you can deduct actual out-of-pocket expenses such as gas and oil, or you can deduct the standard mileage rate for medical expenses, which is 19 cents per mile for 2011.

8. Tax-favored saving for medical expenses Distributions from Health Savings Accounts and withdrawals from Flexible Spending Arrangements may be tax free if used to pay qualified medical expenses including prescription medication and insulin.

For additional information, see Publication 502, Medical and Dental Expenses or Publication 969, Health Savings Accounts and Other Tax-Favored Health Plans, available at www.irs.gov or by calling 800-TAX-FORM (800-829-3676).

Links:
•Publication 502, Medical and Dental Expenses (PDF)
•Publication 969, Health Savings Accounts and Other Tax-Favored Health Plans (PDF)

The Tax After “math” of Divorce by Carolyn Flaherty

Perhaps the last thing on the mind of a recently divorced couple is tax considerations. However, when you sit down to prepare your taxes separately there are several important issues that will likely arise. Though many items may be spelled out in your settlement, others will need to be negotiated prior to the filing of either return.

First and foremost is your filing status. This is an important consideration because there are major advantages to certain filing status options. In the year the divorce is final you are considered divorced for the entire year and therefore your filing options are generally restricted to head of household or single.

Filing status needs to be carefully distinguished from dependency exemptions. While a dependency exemption and the child tax credit can be released by a custodial parent to the noncustodial parent, (a formal release on Form 8332 must be signed and attached to the tax return); the filing status cannot be released. Only the custodial parent can claim a child for head of household status, the credit for dependent care expenses, the exclusion for dependent care benefits and the earned income credit.

The custodial parent by definition is the parent with whom the child lived for the greater number of nights during the year. If the child lived equally with both parents, the custodial parent is the parent with the higher adjusted gross income. Typically the custodial parent is defined as part of your divorce agreement.

Filing as head of household gives you the following advantages over filing single:

• Your standard deduction is higher
• Your tax rate will usually be lower
• You may be able to claim certain credits (such as the dependent care credit and the earned income credit) that you cannot claim if you file as single
• Income limits that reduce your child tax credit and retirement savings contributions credit are higher

Once you have determined your filing status, a common question relates to the taxability of child support and alimony. Child support is not taxable to the recipient nor deductible by the payer. On the other hand alimony is taxable to the recipient and deductible for the payer. There are specific rules for what qualifies as alimony and therefore those rules and your divorce instrument should be carefully reviewed to ensure payments are being properly classified.

Another common inquiry is whether the legal fees of divorce are deductible. Unfortunately, legal fees and court costs for getting a divorce are not deductible. However, you may be able to deduct legal fees paid for tax advice in connection with a divorce and legal fees incurred specifically to get alimony. In addition, you may be able to deduct fees paid to appraisers, actuaries and accountants for services incurred to determine your correct tax or in helping you to get alimony.

Something most people don’t consider is how to “split” items such as last year’s tax refund that may need to be claimed as income this year, or an alternative minimum tax credit carryover that arose during marriage. The guidance on how to treat such joint items after your tax status has separated is unclear.

Based on our practice, we have found that you should not split a tax refund 50/50 on each spouses return. The IRS will not be able to match the split refund and therefore, you are likely to get IRS notices which will be tedious to resolve especially because both spouses will have to be involved. Instead, you should choose one spouse to claim said income and then work out the financial impact to equalize any tax due as a result.

The alternative minimum tax credit is more complex. In fact, in researching the issue I ran across several instances in which people had contacted the IRS to determine how to claim the credit and were unable to obtain guidance. In fact, one preparer asserted that he called three times and got three different answers! Some sources say that you should determine the reason the alternative minimum tax was due and hence the source and then attribute the credit back to the source spouse. This could be a complex and time consuming calculation. Other advisors assert that, like the taxable refund scenario above, you should select a spouse on whose return to claim the credit and equalize the tax impact in an outside agreement. Whatever you decide, it would be prudent to consult a tax advisor, document your position and make sure you have taken a defensible position.

The financial considerations of a divorce and the resulting tax issues are complex and this blog is not intended to be all inclusive. Furthermore, community property states have complex regulations of their own. Additional information can be found in IRS Publication 504 “Divorced or Separated Individuals” at http://www.irs.gov/pub/irs-pdf/p504.pdf .

IRS Offers Four Tips on Unemployment Benefits IRS Tax Tip 2012-31

Unemployment can be stressful enough without having to figure out the tax treatment of the unemployment benefits you receive.

Unemployment compensation generally includes, among other forms, state unemployment compensation benefits, but the tax implications depend on the type of program paying the benefits. You must report unemployment compensation on line 19 of Form 1040, line 13 of Form 1040A, or line 3 of Form 1040EZ.

Here are four tips from the IRS about unemployment benefits.

1. You must include all unemployment compensation you receive in your total income for the year. You should receive a Form 1099-G, with the total unemployment compensation paid to you shown in box 1.

2. Other types of unemployment benefits include:
•Benefits paid by a state or the District of Columbia from the Federal Unemployment Trust Fund
•Railroad unemployment compensation benefits
•Disability payments from a government program paid as a substitute for unemployment compensation
•Trade readjustment allowances under the Trade Act of 1974
•Unemployment assistance under the Disaster Relief and Emergency Assistance Act

For complete information on each of the benefits listed, see chapter 12 in IRS Publication 17, Your Federal Income Tax, or Publication 525, Taxable and Nontaxable Income.

3. You must report benefits paid to you as an unemployed member of a union from regular union dues. However, if you contribute to a special union fund and your payments to the fund are not deductible, you only need to include in your income the unemployment benefits that exceed the amount of your contributions.

4. You can choose to have federal income tax withheld from your unemployment compensation. To make this choice, complete Form W-4V, Voluntary Withholding Request, and give it to the paying office. Tax will be withheld at 10 percent of your payment. If you choose not to have tax withheld, you may have to make estimated tax payments throughout the year.

For more information on unemployment compensation see IRS Publications 17 and 525. Forms and publications can be downloaded from the IRS Website at www.irs.gov or can be ordered by calling 1-800-829-3676.

Considerations for a US Domestic LLC with Foreign Members by Carolyn Flaherty

Below are some requirements that should be considered when foreign investors are members in a US limited liability company (LLC):

Individual Taxpayer Identification Numbers Required: A foreign individual invested in a U.S. LLC is required to apply for an individual taxpayer identification number (ITIN). The ITIN is required for the Form 1065 filing of the LLC. Form W-7 is used to apply for an IRS ITIN.

LLC withholding Requirements: Under withholding rules, the LLC must calculate its income and remit withholding for the foreign investors on a quarterly basis. The withholding is required regardless of cash flow and even if no actual distributions are made to the foreign members. The payment can be up to 30% of the foreign member’s allocated income and is made on Form 8813. The LLC must also file Form 8804, reporting the total withholding tax required to be withheld and paid, and Form(s) 8805, reporting the payment attributable to each foreign partner on whose behalf the tax was withheld, by the 15th day of the 4th month after the close of the partnership’s tax year.

If prior year losses exist, the withholding can potentially be adjusted, but the procedures for approval are cumbersome. The foreign investor may be entitled to a reduced rate of withholding or an exemption from withholding. A valid Form W-8 must be provided by the foreign member to the LLC to avoid any unnecessary withholding.

If a member’s investment in the partnership is the only activity producing effectively connected income and the IRC section 1446 tax is less than $1,000, the partnership is not required to withhold. However, certification requirements apply.

Form W-8: A partner that is a foreign person should provide the appropriate Form W-8 to the partnership. The partnership may not rely on the certification if it has actual knowledge or has reason to know that any information on the form is incorrect or unreliable. The partnership must keep the certification for as long as it may be relevant to the partnership's withholding requirements.

Foreign Member Filing Requirements: A domestic LLC causes a foreign member to have effectively connected income as a result of the US LLC’s business operations within the United States. Said differently, the member’s ownership interest in the LLC is considered by the Internal Revenue Code to be engagement in a trade or business within the United States.

Therefore, Non-U.S. resident individual members are required to file Form 1040NR to report their respective income of the LLC. They may also be required to file state income tax returns, depending on the laws of the state in which the LLC operates.

Disclosure Requirement: The LLC must file a Form 8886 disclosure statements with the IRS if it has participated in certain transactions such as a sale, exchange, retirement or other taxable dispositions considered reportable transactions under the Internal Revenue Code’s tax shelter provisions. Failure to disclose a reportable transaction can incur a penalty of $10,000 to $50,000.

Foreign Investment Real Property Act: FIRPTA withholding rules were enacted to impose tax payment and reporting liability on the transferee of real property, (and certain others involved in the transaction), to ensure collection of a foreign transferor’s tax on the disposition of U.S. real property. Unless a transaction is exempt from withholding, the transferee must report the transaction and pay the required FIRPTA withholding to the IRS usually within 20 days.

The FRPTA rate is generally 10% of property’s fair market value at the time of the transfer regardless of the amount of gain. A reduced rate withholding certificate can be obtained when the 10% withholding is expected to substantially exceed the actual liability, (the certificate should be requested well in advance of the transaction). The foreign investor will need to file a US tax return to determine the correct amount of income tax on the gain if there was any, and if not to obtain a refund.