Posts in category: Tax, Advisory

Taxpayers are limited in the annual amount they can contribute to a Roth IRA. The maximum contribution for 2024 is $7,000 ($8,000 if age 50 or older), but the allowable 2024 contribution for joint-filing taxpayers phases out at an adjusted gross income (AGI) between $230,000 and $240,000 (or an AGI between $0 and $9,999 for married taxpayers filing separately). For unmarried taxpayers, the phase-out is between $146,000 and $161,000. The contribution limits and phase-out limitations are inflation adjusted annually.

However, higher-income taxpayers can circumvent the phase-out income limitations by first making a traditional IRA contribution and then converting it to a Roth IRA, which is commonly referred to as a “back-door Roth IRA.” But, without advance planning, serious pitfalls associated with this maneuver can result in unexpected taxable income.

Converting a traditional Individual Retirement Account (IRA) to a Roth IRA is a financial strategy that many Americans – even those not in the higher tax brackets – consider for its potential long-term tax benefits. However, this decision is not without its complexities and should be approached with a thorough understanding of its implications, benefits, and drawbacks. This article will delve into the process of converting a traditional IRA to a Roth IRA, examining taxability, benefits, pros and cons, age considerations, and other tax-related issues.

Understanding Traditional and Roth IRAs -Before diving into the conversion process, it’s essential to understand the fundamental differences between traditional and Roth IRAs. A traditional IRA allows individuals to make pre-tax contributions, reducing their taxable income for the year the contribution is made. The funds in the account grow tax-deferred, but withdrawals are taxed as ordinary income.

Conversely, Roth IRA contributions are made with after-tax dollars, meaning there’s no tax deduction for contributions. However, the significant advantage of a Roth IRA is that the earnings grow tax-free, and qualified withdrawals are also tax-free. This feature makes Roth IRAs an attractive option for those who anticipate being in a higher tax bracket during retirement and those creating Roth accounts when they are younger.

The Conversion Process – Converting a traditional IRA to a Roth IRA involves transferring some or all the funds from a traditional IRA into a Roth IRA. When you convert, you must pay income taxes on the amount converted as if it were income for the year. This taxability is a critical consideration, as it can result in a substantial tax bill, depending on the amount converted and your current tax bracket.

Benefits of Converting

Tax-Free Withdrawals: The most significant benefit of a Roth IRA is the ability to withdraw your money tax-free in retirement, or earlier in some cases, providing a hedge against future tax rate increases.

No Required Minimum Distributions (RMDs): Roth IRAs do not require the owner to take minimum distributions starting at age 73, unlike traditional IRAs, allowing for more flexible retirement planning.

Estate Planning Advantages: Roth IRAs can be passed on to heirs, who can also benefit from tax-free withdrawals, making it an effective tool for estate planning. Inherited Roth IRA accounts are subject to the same RMD requirements as inherited traditional IRA accounts, but generally the distributions will be tax free.

Pros and Cons of Converting

Pros:

• Potential for tax-free growth and withdrawals.
• No RMDs while the owner is alive, offering more control over your retirement funds.
• Can provide tax diversification in retirement.

Cons:

• Upfront tax bill on the converted amount.
• Conversion could push you into a higher tax bracket for the year.
• If you are a Medicare beneficiary, the conversion could cause an increase in your Medicare premiums two years later, as the premiums are based on income from the tax return two years prior. 
• Increased adjusted gross income for the year can trigger limitations on other tax benefits that are reduced or eliminated for higher income taxpayers.  
• No reversal – once converted to a Roth IRA, you cannot recharacterize back to a traditional IRA.

Age Considerations – Age plays a significant role in deciding whether to convert a traditional IRA to a Roth IRA. Younger individuals who expect their income (and consequently their tax bracket) to increase over time may benefit more from conversion, as the tax-free withdrawals from a Roth IRA could outweigh the initial tax hit. For older individuals closer to retirement, the decision becomes more nuanced. They must consider whether they have enough time for the benefits of tax-free growth to offset the conversion tax bill.

Other Tax-Related Issues

Non-Deductible Traditional IRAs: Contributions to traditional IRAs can be either pre-tax (tax deductible) or post-tax (not tax deductible). Deductible contributions and earnings are taxable when converted whereas nondeductible contributions are not taxable when converted. When IRA funds are converted, they are considered withdrawn ratably from the taxable and nontaxable portions of the IRA. In addition, all traditional IRAs of a taxpayer are considered one, meaning an IRA with the most nondeductible contributions can’t be singled out for conversion. Thus, a careful analysis is required in advance to establish the taxable percentage when determining how much to convert.  

Conversion Income: The amount converted is added to your taxable income for the year, potentially increasing your tax liability or even pushing you into a higher tax bracket. When considering whether to convert to a Roth IRA, the impact on various tax benefits due to increasing AGI by the taxable conversion amount must be carefully considered.  For instance, a conversion may cause the taxpayer to lose part of or all certain tax benefits for the conversion year, like: 

• American Opportunity Tax Credit
• Lifetime Learning Tax Credits
• Earned Income Tax Credit (EIC)
• Child Tax Credit
• Saver’s Credit
• Adoption Credit
• Higher Education Interest Deduction
• Medicare B & D Premiums – 2 Years Later
• Medical Itemized Deductions
• Miscellaneous Itemized Deductions (in years after 2025)
• Nontaxable Social Security
• Favorable Tax Brackets
• Capital Gains Rates
• Loss Allowance for Rental Real Estate
  
  

Net Investment Income Surtax: Higher-income taxpayers face a potential additional tax related to the Affordable Care Act (health care) provisions: the 3.8% net investment income surtax applies when modified AGI exceeds certain thresholds. A higher AGI due to a Roth conversion could push the taxpayer over the threshold. Also, the additional income from a conversion could negatively impact taxpayers who might otherwise be eligible for credits for health care insurance premiums.

Paying the Tax on a Conversion – Where does the money come from to pay this tax liability on a conversion to a Roth?  The taxpayer can pay the liability from other funds or from IRA funds.  However, if the tax is paid from IRA funds, those funds are not part of the rollover (conversion) and therefore are not only taxable, but also subject to 10% early withdrawal penalties if the taxpayer is under 59½ at the time of the withdrawal.  

Tax Strategy: Strategic tax planning, such as spreading the conversion over several years or timing it during years of lower income, can mitigate the tax impact.

Converting a traditional IRA to a Roth IRA can offer significant benefits, particularly for those who anticipate higher tax rates in retirement or who value the flexibility. However, the decision to convert should not be taken lightly. It requires a careful analysis of your current financial situation, tax implications, and long-term retirement goals. Consulting with our office is highly recommended to navigate the complexities of this decision and to tailor a strategy that best suits your individual needs.

The Internal Revenue Code Section 25C credit, also known as the Energy Efficient Home Improvement Credit, is a valuable tax incentive for homeowners who make qualifying energy-saving improvements to their existing homes. This credit has undergone several modifications since its inception in 2006, with significant changes introduced by the Inflation Reduction Act (IR Act). Don’t confuse this credit with the one for installing home solar systems, which is in Sec 25D of the tax code. This article delves into the details of the Sec 25C credit, including credit percentages, qualified items, annual limits, home energy audits, qualifying homes, basis adjustments, and more. 

Credit Percentage – For years 2022 through 2032 the credit is 30% of the sum of the amount paid or incurred by the taxpayer for qualified energy efficiency improvements installed during that year in a home used by the taxpayer as their principal residence.  

Specific Qualified Items and Per Item Annual Limits – The following energy-efficient home improvements are eligible for the Energy Efficient Home Improvement Credit:

Components Subject to an Annual $1,200 Aggregate Credit Limit:

Windows and Skylights: $600 annual limit.

Exterior Doors: $250 per door, up to a total of $500 for all exterior doors.

Central Air Conditioners, Natural Gas, Propane, or Oil Water Heaters, and Furnaces: $600

Components Subject to an Annual $2,000 Aggregate Credit Limit:

Heat Pumps and Biomass Stoves and Boilers. 

Home Energy Audits – 30% of costs, up to a $150 annual limit.

Annual Credit Limits, $1,200 vs. $2,000 – The Sec 25C credit has two primary annual limits:

• $1,200 Annual Limit: This limit applies to most energy-efficient home improvements, including windows, skylights, exterior doors, and residential energy property expenditures. The $1,200 limit can be increased by up to $150 for a home energy audit, making the maximum potential credit $1,350 in a year when an audit is conducted.
• $2,000 Annual Limit: This higher limit applies specifically to heat pumps, heat pump water heaters, and biomass stoves and boilers.

Home Energy Audits – A home energy audit is an inspection and written report that identifies the most significant and cost-effective energy efficiency improvements for a dwelling unit. The audit must be conducted by a certified home energy auditor. The credit for a home energy audit is 30% of the cost, up to $150. Taxpayers can claim this credit once per year.  

Qualifying Homes – Credit is only allowed for components installed in or on a dwelling unit located in the United States, and for energy-efficient building envelope components such as insulation and exterior windows and doors, the taxpayer must own and use the home as the heir principal residence. In addition, the energy-efficient property must reasonably be expected to be in use for at least 5 years.  

For home energy audits, the taxpayer must own the home oruse it as a principal residence. 

To claim a credit for the costs of certain types of water heaters, heat pumps, central air conditioners, furnaces, hot water boilers, stoves, boilers, and electric system improvements and replacements (collectively termed residential energy property), the taxpayer must use the home as a residence, but does not have to own the home or use it as a principal residence.

• Manufactured Homes – The term “dwelling unit” includes a manufactured home which conforms to Federal Manufactured Home Construction and Safety Standards (part 3280 of title 24, Code of Federal Regulations) (Sec 25C(c)(4))
• Original Use -The original use of such component commences with the taxpayer.

Basis Adjustment Requirements – The basis of the property is increased by the amount of the expenditure and reduced by the amount of the credit. This creates a different basis for federal and state purposes where the state does not provide a credit or if it differs from the federal credit amount.

Nonrefundable Credit, AMT, and Carryover – The Sec 25C credit is a nonrefundable personal credit, meaning it can only reduce the taxpayer’s tax liability to zero but cannot result in a refund. The credit can offset the Alternative Minimum Tax (AMT). However, there is no carryover provision for unused credits; they must be used in the year they are claimed.

Manufacturer’s Certification and Qualified Product ID Number – Taxpayers can rely on a manufacturer’s certification that a component is eligible for the credit, provided the IRS has not withdrawn the certification. 

Starting after 2024, taxpayers must include the qualified product ID number of the item on their tax return for the year the credit is claimed. Omission of a correct product identification number is treated by the IRS as a mathematical or clerical error.

Differences Between Sec 25C Credit and Rebates – The Sec 25C credit is a federal tax credit claimed on the taxpayer’s tax return for the year the installation is made, while rebates are typically cash incentives provided by manufacturers, utilities, or government programs. Rebates reduce the out-of-pocket cost of the improvement, which in turn reduces the amount eligible for the credit. 

For example, if a taxpayer receives a rebate for purchasing an energy-efficient window, the cost of the window is reduced by the rebate amount before calculating the credit.

Installation Costs – For certain items qualified for the Section 25C credit, the cost of both installation labor and materials can count towards the credit. Specifically, the credit covers:

• Residential Energy Property – This includes items such as heat pumps, biomass stoves, and biomass boilers. For these items, the credit is 30% of the costs, including labor, up to $600 for each item, provided they meet the energy efficiency requirements specified.
• Building Envelope Components – This includes items like insulation, exterior windows, skylights and doors. However, for these components, the cost of installation labor is not included in the credit calculation—only the cost of the materials themselves is eligible.

Planning Modifications to Maximize Credits – Taxpayers can strategically plan their energy-efficient home improvements over several years to maximize the credits. By spreading out the improvements, taxpayers can take advantage of the annual limits each year.  

The Sec 25C credit for energy-efficient home modifications offers significant tax savings for homeowners who invest in energy-saving improvements. By understanding the credit percentages, qualified items, annual limits, and other requirements, taxpayers can make informed decisions and maximize their benefits. Whether it’s through home energy audits, upgrading heating systems, or installing new windows, the Sec 25C credit provides a valuable incentive for making homes more energy-efficient and reducing overall energy costs.

Please contact our office to see if and how you might benefit from this credit.

Natural disasters can strike with little warning, leaving a lasting impact on both personal and business finances. Whether it’s a hurricane, wildfire, or flood, the financial toll can be substantial. However, by taking a proactive approach, small and medium-sized businesses (SMBs) and individuals can minimize disruptions and recover more efficiently.

This guide explores crucial steps to safeguard your financial health, protect your assets, and ensure compliance with tax obligations before and after a disaster. With the right preparation, you can focus on rebuilding while avoiding financial pitfalls.

Pre-Disaster Financial and Tax Preparedness

1. Comprehensive Insurance Coverage

Insurance is your first line of defense when disaster strikes. However, many people don’t realize the gaps in their coverage until it’s too late.

• Review Your Policies Regularly: Ensure your insurance covers natural disasters specific to your region, such as hurricanes, earthquakes, or floods. Many policies exclude specific disaster types, and supplemental coverage may be necessary.
• Understand Coverage Limits: Knowing the full scope of your policy—its exclusions, limits, and deductibles—is essential. If your current policy falls short, consider purchasing riders to address potential shortfalls.

2. Safeguarding Critical Documents

Vital financial and legal documents must be secure and accessible during emergencies.

• Secure Physical Storage: Keep tax returns, insurance policies, and key financial records in a waterproof, fireproof safe. This ensures they are intact when needed most.
• Digital Backups: Create encrypted digital copies of important documents. Store these backups securely in cloud services or external hard drives, ensuring you can retrieve them remotely even if physical records are lost.

3. Data and Business Continuity Planning

For SMBs, data is the backbone of daily operations. Losing this information can severely impact your ability to recover post-disaster.

• Automated Data Backups: Implement automated, real-time data backups to cloud services. This ensures minimal downtime and protects against data loss.
• Business Continuity Plan (BCP): Develop a comprehensive BCP to ensure operations can continue during a crisis. Identify essential personnel, critical functions, and outline alternative processes to maintain service delivery during disaster recovery.

Post-Disaster Financial and Tax Considerations

1. Leveraging Government Assistance

Once a disaster has been officially declared, federal and state assistance becomes available to those affected.

• FEMA and SBA Programs: The Federal Emergency Management Agency (FEMA) and Small Business Administration (SBA) provide essential aid, including grants and low-interest disaster recovery loans. These programs offer crucial financial relief to both businesses and individuals.
• Tax Relief Opportunities: The IRS provides tax filing extensions, casualty loss deductions, and other relief for affected areas. Properly documenting losses and applying for available deductions can significantly reduce your financial burden.

2. Navigating the Rebuilding Phase

The recovery process involves making informed financial decisions while understanding potential tax consequences.

• Financial Planning for Recovery: Perform a comprehensive assessment of your financial losses and create a step-by-step plan for rebuilding. Explore options such as SBA loans, grants, and insurance payouts to determine the most viable path forward.
• Tax Implications of Insurance and Aid: Government aid and insurance payouts can have significant tax implications. Consult with our office to ensure that you’re compliant and optimizing your tax position during recovery. Missteps here could lead to unforeseen liabilities.

Leverage Local and Government Resources

Community support and government resources play a critical role during and after disasters.

• Local Business Networks: Your local chamber of commerce or small business network may offer support services, including access to recovery resources or temporary office space.
• Stay Updated on Assistance Programs: Government websites are constantly updated with new assistance programs. Checking FEMA, IRS, and SBA sites can help you stay informed of additional relief programs or extended deadlines.

Preparation is Key to Resilience

Natural disasters will continue to be a threat, but by preparing ahead of time, you can reduce their financial impact on your personal and business assets. Taking steps such as reviewing your insurance coverage, backing up critical documents, and understanding the available financial aid can help you recover swiftly and with less stress.

At our firm, we specialize in helping businesses and individuals prepare for and recover from natural disasters. Whether you need assistance with tax relief, financial planning, or navigating insurance claims, our team is here to provide personalized guidance. Contact us today to ensure you’re fully prepared for any emergency.

Now is the time of year to do everything you can to minimize taxes and maximize your financial health with proper year-end planning. In this article, we’ll look at several actions to consider taking before the end of 2022.

Thoughtfully Harvest Losses and Gains Before Year-End

Tax loss harvesting by selling securities at a loss to offset capital gains is a classic year-end planning strategy. Just make sure not to violate the wash sale rules. This means you can’t buy back the same security or a substantially identical one within 30 days of the sale. 

Reinvest Capital Gains into Opportunity Zones

Another way to offset capital gains is to reinvest those gains into a qualified opportunity fund (QOF). To be eligible, you must make the investment within 180 days of the sale of the asset-bearing gains. QOF investments allow you to defer the recognition of the capital gains tax on the original investment. The details and exact rules can be tricky, so it’s best to check with your tax advisor before making this type of transaction.

Consider Installment Sales Where Applicable

When a taxpayer sells a private asset such as real estate, a business, or private equity in exchange for a series of payments over multiple years through a promissory note, this can constitute an installment sale. Installment sales are generally taxed with each payment representing a portion of the proceeds; return of basis, interest, and gain are recognized over the life of the note.

There are situations in which installment sales can be structured so that gains are not recognized until principal payments are recouped. If you are considering selling an asset via an installment sale this year-end or next, consult with your tax advisor to determine if it’s possible to structure the sale to defer gains.

Funding Retirement

If you can contribute to a retirement account, now is the time to see if you need to make additional contributions or top-up to the full amount allowable. As you review your situation, keep in mind the annual maximum contribution limits for 2022.

• IRAs – $6,000. If you are 50 or older, it’s $7,000.
• 401(k)s/403(b)s —  $20,500. If you are 50 or older, it’s $27,000

Also, converting assets from a traditional IRA to a Roth IRA may be a smart move if: you believe your tax rate will be higher in the future; you can afford to pay the taxes now with spare cash, and you don’t plan to leave the IRA assets to charity.

Take Your Required Minimum Distributions 

The annual deadline to take required minimum distributions (RMD) from your own or inherited retirement accounts is Dec. 31, 2022. It’s important to take RMDs because there is a 50 percent penalty on amounts not distributed. The amount needed to be taken was determined on Dec. 31, 2021, even though the value of the investment has likely fluctuated significantly since that time. RMDs are based on a calculation of age and amount of assets. There are online calculators to help you figure out the amount you need to take.

Giving to Charity

Some taxpayers believe that the deduction for charitable donations is no longer applicable to them since it can be hard to make donations large enough to exceed the standard deduction. One strategy to overcome this challenge is to cluster your donations. Instead of making equal gifts every year, consider making more substantial gifts all in one year instead.

When it comes to making donations around year-end, it’s important to understand the rules on timing and when a gift is effectively deemed given for tax purposes. Here are the basic rules for the timing of charitable donations.

• To give to charity by check => the date the check is mailed
• Gifts of stock certificates => when the transfer occurs, according to the issuer’s records
• Gifts of stocks by electronic transfer => when the stock is received, according to the issuer’s records
• Gifts by credit card => date the charge is made

Conclusion

As we enter the final part of the year, now is the time to take stock of your financial and tax situation to see if there are any moves you can make to minimize your 2022 tax liabilities and maximize your wealth.

The markets are hitting all-time highs, so if you are thinking of selling stocks now or in the near future, there is a good chance that you will have capital gains on the sale. If you’ve held the stocks for more than a year, then they will qualify for the more favorable long-term capital gains tax (instead of being taxed as ordinary income rates for short-term sales). But the total tax due can still be enough to warrant some tax planning. Luckily, the tax laws provide for several ways to defer or even completely avoid paying taxes on your securities sales.

1. Using Tax Losses
Utilizing losses is the least attractive of all the options in this article since you obviously had to lose money on one security in order to avoid paying taxes on another. The real play here is what is often referred to as tax-loss harvesting. This is where you purposely sell shares that are at a loss position in order to offset the gains on profitable sales and then redeploy this capital somewhere else. You’ll need to carefully weigh where to put the money from the sale of the shares sold at a loss as you can’t just buy the same stocks back. This is considered a “wash sale” and invalidates the strategy.

2. The 10 Percent to 15 Percent Tax Bracket
For taxpayers in either the 10 percent or 12 percent income tax brackets, the long-term capital gains rate is 0 percent. The income caps for qualifying for the 12 percent income tax rate are $39,375 for single filers and $78,750 for joint filers in 2019 ($40,000 and $80,000, respectively in 2020). Also, keep in mind that the stock sales themselves add to this limit – so calculate carefully.

Aside from selling appreciated securities yourself, another way to take advantage of the 0 percent bracket is to gift the stock to someone else instead of selling the securities and then giving the cash. Beware, however, as trying to do this with your kids can disqualify the 0 percent treatment because the kiddie tax is triggered on gifted stock sold to children younger than 19 or under 24 if a full-time student.

3. Donate
Donating appreciated securities is where we start to get into the more beneficial strategies. This technique only makes sense if you were already planning to make charitable contributions. Say you are planning to donate $10,000 to an organization and are in the 25 percent tax bracket. In order to write a donation check for $10,000, you would have had to earn $13,333 in income to sell the same amount of stock in order to have $10,000 left after taxes to make a cash donation in that amount.

If you donate appreciated stock instead, you only need to donate securities valued at $10,000 and you get to deduct $10,000 as a charitable deduction. That avoids the capital gains tax completely. Plus, it generates a bigger tax deduction for the full market value of donated shares held more than one year – and it results in a larger donation.

4. Qualified Opportunity Zones
This is the newest and most complicated (as well as controversial) way to defer or avoid capital gains taxes. Opportunity Zones were created via the Tax Cuts and Jobs Act to encourage investment in low-income and distressed communities. Qualified Opportunity Zones can defer or eliminate capital gains tax by utilizing three mechanisms through Opportunity Funds – the investment vehicle that invests in Opportunity Zones.

First, they offer a temporary deferral of taxes on previously earned capital gains if investors place existing assets into Opportunity Funds. These capital gains defer taxation until the end of 2026 or whenever the asset is disposed of – whichever is first.

Second, capital gains placed in Opportunity Funds for a minimum of five years receive a step-up in basis of 10 percent – and if held for at least seven years, 15 percent.

Third, they offer an opportunity to permanently avoid taxation on new capital gains. If the opportunity fund is held for at least 10 years, the investor will pay no tax on capital gains earned through the Opportunity Fund.

Again, the caveat here is that the details of Opportunity Zone investments can be extremely complicated, so it’s best not to attempt this one on your own. Consult with your tax advisor.

5. Die with Appreciated Stock
Unfortunately, while probably the least popular method for readers, this is certainly the most effective. When a person passes away, the cost basis of their securities receives a step-up in basis to the fair market value to the date of their death. As an example, if you purchased Amazon stock for $50 per share and when you pass away it is worth $1,700 per share, your heir’s basis in the inherited stock is $1,700. This means if they sell it at $1,700, they pay no tax at all.

Conclusion
None of the above methods are loopholes or tax dodges; they are all completely legitimate. However, your ability to take advantage of these techniques will depend on your income level, personal goals and even your age. As a result, it’s best to consult with your tax advisor to see what makes sense for your personal situation.