How To Fix Your Overfunded Account

Is socking away large sums in a tax-deferred retirement account ever a bad it? It is when you exceed the annual IRS limits. Intentional or not, the penalties can be painful. Here’s how overfunding occurs and what steps to take to fix the problem.

When do overfunding situations occur? Overfunding retirement accounts happens more than you may realize. It can be the result of a job change that causes you to participate in the two different employer retirement plans. Sometimes people forget they made IRA contributions early in the year and do it again later. Others forget that the IRA limit is the total of all accounts, not per account. The rules are complicated. Traditional IRAs can’t be contributed to after age 70-1/2, while Roth IRA contributions are subject to income limits. Plus,  all contributions are predicated on having earned income.

IRAs – The annual Roth and Traditional IRA contribution limit is $5,500 ($6,500 if age 50 or older). If you surpass this amount, you pay a 6 percent penalty on the overpayment every year until it’s corrected, plus a potential 10 percent penalty on the investment income attributed to the overfunded amount.

The fix: If the overfunding is discovered before the filing deadline (plus extensions), you can withdraw the excess and any income earned on the contribution to avoid the 6 percent penalty. You will potentially owe 10 percent on the earnings of the excess contributions if you’re under age 59-1/2. You can apply the withdrawn contribution to the next year. If your issue is due to age (70-1/2 or older for a Traditional IRA), or income limit (for a Roth IRA), consider re-characterizing your contribution from one IRA type to another.

401(k)s – The rules for correcting an overfunded 401(k) are a little more rigid. You have until April 15 to return the funds, period. The nature of the penalty is also different. The excess amount is taxable in the year of the overfunding, plus taxable again when withdrawn. So, you pay tax twice on the same amount. In certain cases, overfunding a 401(k) could cause it to lose its qualified status.

The fix: If you suspect an overpayment situation, contact your employer as soon as possible. Adjust your contribution amount before the end of the year and try to get the problem resolved that way.

No matter the cause, if you are in doubt about how to handle excess contributions, be sure to consult your tax professional.

Fair Market Value (FMV): What It Is and How to Defend It

So what is fair market value (FMV)? According to the IRS, it’s the price that property would sell for on the open market. This is the price that would be agreed upon between a willing buyer and a willing seller. Neither would be required to act, and both would have reasonable knowledge of the relevant facts.

This is the standard the IRS uses to determine if an item sold or donated by you is valued correctly for income tax purposes. It is also a definition that is so broad that it is wide open to interpretation.

Understand when FMV is used

Fair market value is used whenever an item is bought, sold or donated and has tax consequences. The most common examples are:

  • Buying or selling your home, other real estate, personal property or business property
  • Establishing values of other business assets like inventory
  • Valuing charitable donations or personal goods and property like automobiles
  • Valuing bartering of services, business ownership transfers or assets in an estate of a deceased taxpayer

Know how to defend your FMV determination

If the IRS decides your FMV opinion is wrong, you are not only subject to more tax, but also penalties. Here are a few tips to help defend your FMV in case of an audit.

Properly document donations. Fair market value of non-cash charitable donations is an area that can easily be challenged by the IRS. Ensure your donated items are in good or better condition. Properly document the items donated and keep copies of published valuations from charities like the Salvation Army. Don’t forget to ask for a receipt confirming your donations.

Get an appraisal. If you sell a major asset such as a small business, collections, art, or a capital asset, make sure you get the independent appraisal of the property first. While still open to interpretation by the IRS, this appraisal can be a solid basis for defending any differences between your valuation and the IRS.

Keep pricing proof for similar items and transactions. This is especially important if you barter goods and services. If you have a copy of an advertisement for a similar items to the one you sold, it can readily support your FMV claim.

Take photos and keep detailed records. The condition of an item is often a key consideration in establishing FMV. It is fair to assume an item has wear and tear when you sell or donate it. Visual documentation can be used to support your claimed amount. Keeping copies of invoices for major purchases is also a good idea.

With proper planning, establishing FMV of an item can be done in a reasonably defendable way if ever challenged. If you are unsure about FMV of an item, consult with your tax professional.

End of College Tuition Deduction

It can be difficult to watch your child leave for college. Now you also have to say goodbye to the tuition and fees tax deduction. Congress decided not to extended this $4,000 deduction for 2017, leaving many parents worried that college will now be even more expensive.

However, Congress left in place two popular education credits that may offer a more valuable tax break:

  • The AOTC. The American Opportunity Tax Credit (AOTC) is a credit of up to $2,500 per student per year for qualified undergraduate tuition, fees and course materials. The deduction phases out at higher income levels, and is eliminated altogether for married couples with a modified adjusted gross income of $180,000 ($90,000 for singles).
  • Lifetime Learning Credit. The Lifetime Learning Credit provides an annual credit of 20 percent on the first $10,000 of tuition and fees, for either undergraduate or graduate level classes. There is no lifetime limit on the credit, but only couples making less than $131,000 per year (or singles making $65,000) qualify. Unlike the AOTC, this deduction is per tax return, not per student.

So who is affected by the loss of the tuition and fees deduction? If you are paying for your student’s graduate-level courses and are making too much to qualify for the Lifetime Learning Credit, the tuition and fees deduction is generally the only means you have to reduce your tax bill.

In addition to the two alternative education credits, there are many other tax benefits that help reduce the cost of education. There are breaks for employer-provided tuition assistance, deductions for student loan interest, tax-beneficial college savings options, and many other tax-planning alternatives. Contact your tax professional for an overview of the strategies available to you.

Consider a Mid-Year Business Self-Audit

The word “audit” makes most of us uncomfortable. But by using auditing principles within your own business, you may quickly discover ways you can enhance your firm’s full-year performance. Here are some factors to consider.

Prepare with a pre-audit. Perhaps the most obvious use of a self-audit comes to play as you prepare for a pending or potential tax audit. For example, if you receive notice of a sales tax audit, conduct your own self-audit before the auditor arrives. Your self-audit might find areas in the state sales tax code where the state actually owes you money.

Internal controls. Consider auditing areas in your company that may be tempting for potential thieves. This may be your inventory, cash register, or accounts receivable. Understand your vulnerabilities and create two different ways to independently verify their accuracy. Internal control self-audits can discover theft, but most often they will identify ways you can reduce the chance of theft ever occurring.

An eye towards ID theft. Consider auditing your data to ensure it is property protected. This has become more important as most small businesses are now using cloud-based services to take orders, pay bills, and receive payments.

Focus on key financial areas. In your self-audit, focus on the areas of your company that make the most financial sense. For most of us it’s auditing those financial processes that impact cash flow. A good place to start is an independent review of your bank accounts and their related reconciliations.

Look at performance progress. Another benefit of a mid-year self-audit can simply be creating year-to-date performance reporting, forecasting your full year, and then comparing it to your plan. If you find problems, you still have plenty of time before the end of the year to take corrective action.

If you need assistance with any of these steps, be sure to consult your tax professional.

Zombie Payer – Keep Your Automatic Payments in Control

When it comes to paying bills, many people cannot imagine returning to paying and sending bills via the U.S. Postal Service. But, the “turn it on and forget it” nature of automatic payments can create zombie payers who no longer challenge or review the details of bills. Here are some ideas to keep this from happening to you.

Create a list. Make a list of the companies you authorized to use automatic payments to pay your bills. Include in the list the card or account each company uses for the automatic payments, as well as payment amounts and frequency. If you use credit and debit cards to pay companies, record the expiration date, in case you need to update any company that has your card on file. When there is a change in a card or bank account, you will be able to consult the list to find the companies you need to notify.

Watch for fees. Make sure the bill payment system you’re using is low cost or no cost. Some companies will charge you a fee for automatic payments. If your biller wants to charge you, pay them with a traditional check.

Beware of price creep. Paying for a product or service automatically can create a situation where you do not notice when your price changes. Monitor your on-going payment amounts so you are able to question any price increase or discontinue service (if applicable).

Review underlying bills. Along with automated bill payments is the vendor’s desire to stop sending hard copies of your bill. However because you’re not receiving a bill, you may be unaware of changes. You may want to opt to continue receiving email or paper billing statements (if possible) so you can verify that your payment has not changed and there are not additional fees or errors.

Take care to review your accounts and statements to avoid zombie paying, and in turn protect yourself and keep your finances in your control.

Five Reasons Business Owners Incorporate

Most new businesses start with no thought about legal structure. In the eyes of the IRS, the default structure is a “sole proprietor,” in which your business profits are taxed on your personal tax return. This can serve you well to start, but there are several reasons business owners consider incorporating as their business grows.

  1. To protect your personal assets from creditors. When you operate your business within a corporation, creditors are often limited to corporate assets to satisfy a debt. Your home, savings, and retirement accounts are no longer fair game.
  2. To provide a personal liability firewall. The corporate form can help protect you against claims made by others for injuries or losses arising from actions of your business.
  3. To issue shares of stock. You can help build your business by issuing shares to new investors, or by offering stock options to key employees as a form of compensation.
  4. To gain tax flexibility. A corporation can provide you with more tax flexibility. Deliberate planning can help optimize the taxable division between corporate income, dividends, and your personal wages.
  5. To enhance your business presence. Being incorporated sends a signal that your business is a serious enterprise, and it could open doors to opportunities not offered to sole proprietors. Consumers, vendors, and other businesses often prefer to do business with incorporated companies.

If you are still reviewing the pros and cons of incorporating your business, be sure to consult your tax professional for advice.

New Job? Four Choices For Your Existing 401(k)

Changing jobs and companies can be an exciting opportunity, but you have a choice to make. What will you do with the retirement savings you have accrued in your 401(k) plan? Consider these four choices:

  1. Withdraw the money and don’t reinvest it. This is usually the worst choice you can make. Generally, you’ll owe taxes on the distribution at ordinary income rates. (Special rules may apply if you own company stock in the plan.) Unless you’re over age 59-1/2, you’ll pay a 10 percent penalty tax too. More importantly, you’ll lose the opportunity for future tax-deferred growth of your retirement savings. And once you have the funds readily available, it’s all too easy to spend the money instead of saving for your retirement.
  2. Roll the money into an IRA. You can avoid immediate taxes and preserve the tax-favored status of your savings by rolling the money into an IRA. This option also gives you full control over how you invest the balances in the future. You have a 60-day window to complete the rollover from the time your close out your 401(k). However, you should also ask for a “trustee-to-trustee” rollover to avoid potential problems.
  3. Roll the balance into your new employer’s plan. If your new employer allows it, you can roll the balance into your new plan and invest it according to your new investment choices. However, there may be a waiting period before you can join your new plan.
  4. Leave the money in your old employer’s plan. You may be able to leave the balance in your old plan, at least temporarily. Then you can do a rollover to an IRA or a new plan later. Check with your employer to see if this is an option.

If you need help making the right choice for your circumstances, contact your tax professional.

IRS Announces Business Vehicle Deduction Limits for 2017

The IRS has published depreciation limits for business vehicles first placed in service this year. These limits remain largely unchanged from 2016 limits. Because 50% bonus depreciation is allowed only for new vehicles, these limits are different for new and used vehicles.

  • For new business cars, the first-year limit is $11,160; for used cars, it’s $3,160. After year one, the limits are the same for both new and used cars: $5,100 in year two, $3,050 in year three, and $1,875 in all following years.
  • The 2017 first-year depreciation limit for trucks and vans is $11,560 for new vehicles and $3,560 for used vehicles. The limits for both new and used vehicles in year two are $5,700, in year three $3,450 (up $100 from 2016), and in each succeeding year $2,075.

For details relating to your 2017 business vehicle purchases, contact your tax professional.

 

Disability Insurance – What You Need to Know

Say “insurance” to most people and auto, health, home, and life are the variants that spring to mind. But what if an illness or accident were to deprive you of your income? Even a temporary setback could create havoc with your financial affairs. Statistics show your chances of being disabled for three months or longer between ages 35 and 65 are almost twice of those of dying during the same period.

Yet people with financial savvy often overlook disability insurance. Perhaps they feel adequately covered through their job benefits. However, such coverage can be woefully inadequate. The fact is, most individuals should consider disability insurance in their financial planning. When considering disability insurance, think in terms of long term and short term. Many employers provide long-term disability coverage for all employees. Find out if your employer does. If you have long-term disability insurance you need to consider short-term coverage to supplement during the period of disability before your long-term coverage begins. To get the right coverage for you, take the following steps.

Scrutinize key policy terms. First, ask how “disability” is defined. Some policies use “any occupation” to determine if you are fit for work following an illness or accident. A better definition is “own occupation,” whereby you receive benefits when you cannot perform the job you held at the time you became disabled.

Check the benefit period. Ideally, your policy should cover disabilities until you’ll be eligible for Medicare and Social Security.

Determine how much coverage you need. Tally the after-tax income you would have from all sources during a period of disability and subtract this sum from your minimum needs.

Decide what you can afford. Disability insurance is not inexpensive. Plan to forgo riders and options that boost premiums significantly. If your budget won’t support the ideal benefit payment, consider lengthening the elimination period (but be sure that accumulated sick leave, savings, etc., will carry you until the benefits kick in).

 

Four Tips for Working Beyond Retirement Age

 

Many people choose to work into their retirement years. If this is something you’re considering, here are some tips to make sure you get the greatest benefit from your efforts.

  1. Consider delaying Social Security. You can start receiving Social Security retirement benefits as early as age 62, but if you continue to work, it may make sense to delay as later as age 70. Your Social Security monthly benefit increases approximately 8 percent for every year you delay receiving them. These increases in monthly benefits stop when you reach age 70. Social Security benefits may be reduced or be subject to income tax due to your other income.
  2. Don’t get bracket-bumped. You may have multiple income streams during retirement that can bump you into a higher tax bracket and make other income taxable. For instance, Social Security benefits are only tax-free if you have less than a certain amount of adjusted gross income, otherwise up to 85 percent of your benefits are taxable. Required distributions from pensions and retirement accounts, which you are required to take at age 70-1/2, can also add to your taxable income. Be aware of how close you are to the next tax bracket and adjust accordingly.
  3. Be smart about health care. When you reach age 65, you’ll have the option of making Medicare your primary health insurance. If you continue to work, you may be able to stay on your employer’s health care plan, switch to Medicare, or adopt for a two-plan hybrid option that includes both. Consider these options to determine which makes the most sense.
  4. Consider your expenses. If you’re reducing your working hours or taking a part-time job in retirement, consider the cost of your extra income stream. The costs of parking every day, meals, clothing, dry cleaning, and other expenses should be considered in determining your pre-tax income.

These are just a few factors to consider. Contact your tax professional with questions or to discuss your particular situation.