Tax Planning

43% of Americans don’t have to file a federal tax return–are you one of them?

While the IRS expects to receive 148 million tax returns to be filed this year, it is estimated that nearly 43% of Americans don’t have to file a federal tax return, down from 47% in 2009. This figure comes from the Urban Institute and Brookings Institution’s Tax Policy Center (TPC), an organization based in Washington D.C. that was formed in 2002 to analyze tax issues in the United States.

So how are millions of Americans avoiding this annual tedious task of having to prepare and file a tax return?

Who is off the taxpaying hook?

The recent recession had a lot to do with the fact that nearly half the country is off the hook when it comes to filing a tax return. Many people faced a drastic reduction in their earned income, and now simply do not make enough money to meet the minimum requirements to file. Additionally, President Obama teamed up with Congress to boost existing credits and create new stimulus measures which have resulted in many people qualifying for tax benefits and credits which eliminate their tax obligation entirely.

Whether you are required to file a federal income tax return or not depends mainly on three things: your filing status, your age on December 31, 2013, and your gross income for the year. 

If you are age 64 or younger, are filing as single and earned more than $10,000.00 in 2013 ($11,500.00 if age 65 or older), then you are among those who have to file a tax return with the IRS this year. If you were married at the end of 2013 and you plan on filing separate returns, you must file if you earned more than $3,900.00 in 2013. 

[table caption=”Do you have to file a tax return?” width=”600″ colwidth=”20|100|100″ colalign=”left|left|left”]
If your filing status is…,and at the end of 2013 you were…,you must file if your gross income is at least…
Single,under 65 / 65 or older, $10000 / 11500
Married Filing Jointly,under 65 (both spouses) / 65 or older (one spouse) / 65 or older (both spouses), $20000 / 21200 /22400
Married Filing Separately,any age, $3900
Head of Household,under 65 / 65 or older, $12850 / 14350
Qualifying widow(er) with Dependent Child, under 65 / 65 or older, $16100 / 17300
[/table]

* If you turn 65 on January 1, 2014, you are considered to be age 65 at the end of 2013.

These days there are more and more children working each year, oftentimes earning enough throughout the year to require that they file a return as well. This can be a complicated matter when trying to decide if the child should file a return and how that could affect their parents claiming them as dependents on their own return. Basically a child must file a tax return if their earned income was over $6,100, however parents are still able to claim these children as dependents on their tax return if the child lived with them.

Even if you’re not required to file…

One important thing to consider is even if you are not required to file a federal tax return for 2013, you may want to still file a return as it may result in a refund owed to you. If you had income tax withheld from your paycheck or if you qualify for the EITC, additional child tax credit, health coverage tax credit, or refundable American opportunity education credit, filing a return will most likely result in the IRS sending you a refund check.

A major tax credit that helps Americans reduce their tax liability is the Earned Income Tax Credit (EITC).  The EITC was originally approved by Congress in 1975 to help working Americans (with a low to moderate income level) keep more of what they earned. According to the TPC, about 1 in 5 tax returns (close to 28 million) that were filed in 2010 claimed the EITC, resulting in over 60 million dollars in credit to Americans. For the 2013 tax year, working families with children that have annual incomes below $37,870 to $51,567 (depending on number of children) will be eligible for the federal EITC, as well as those without children that have incomes below $14,340.

According to the IRS, about three out of four people who file a tax return this year will receive a refund. Last year taxpayers received an average refund of $2,744, and the IRS is typically able to process that refund within 3 weeks. To get your refund from the IRS the quickest, be sure to e-file your tax return and opt for direct depositing your refund into your bank account.

Filing your annual income tax return can be a complicated and tedious task, but there are many benefits and credits available now to help reduce or even eliminate your tax liability. Even if you are not required to file a return, these tax credits can result in an unexpected refund from Uncle Sam. But you have to file the return to receive the cash, so be sure to explore all of the available credits and deductions when preparing your return this year.

Major Tax Changes in 2014 for the Uber-Wealthy

Since its inception in 1861 — as a “temporary” measure to finance the Union’s war effort – legislating federal income tax law has been a political and social battlefield that creates new winners and losers out of every new tax bill, amendment or repeal. So, what about this season? What major tax changes in 2014 should you worry about?

New Tax Bracket, Obamacare, and the Slow Death of Personal Exemptions

A new marginal tax rate of 39.6 percent for those with incomes above $400,000, $450,000 for married couples filing jointly, was the price Republicans paid for permanently extending the George W. Bush-era tax cuts for taxpayers with incomes under $400,000.

Additionally, two new taxes start this year to pay for the new healthcare acts of 2010. One charges a 0.9 percent tax on any income over $200,000, $250,000 for married couples; and the other hits investors with a 3.8 percent tax on investment income over those same thresholds.

Another sacrifice on the altar of Bush-era tax cuts was the phaseout of personal exemptions, which reduces personal exemptions by 2 percent for every $2,500 above a threshold of $250,00 in adjusted gross income — $300,000 for couples. All things considered, the compromise was a great deal for high-income taxpayers, which the ultra-wealthy ended up paying for.

Marriage Penalty

Thanks to the 2013 landmark wins in the Supreme Court for gay marriage, many same-sex legally married couples will start to feel the burn of the marriage penalty. Although many married couples benefit from filing jointly and pay lower tax rates than single taxpayers, when both spouses have high incomes their overall tax rate can be higher.

To illustrate, if two single people earn $400,000 of taxable income, they will not have to pay the new 39.6 percent tax bracket. If those two same people happen to be married, they will have to pay the 39.6 percent rate on $350,000 of their income, which translates into a marriage penalty of more than $30,000.

According to research by The William Institute at UCLA, people in same sex-sex marriages are more likely to be in the work force and their median income is significantly higher ($94,000) than for heterosexual couples ($86,000). This makes legally married gay taxpayers prime targets for a marriage penalty.

Medical Expenses

Although we can still deduct our medical expenses from our taxable income, it will be more difficult to qualify. Last year the threshold for deducting medical costs was 7.5 percent. This year the threshold rises to 10 percent. However, taxpayers who are older than 65 can keep the previous rate until 2017.

2013 Tax Legislation Losers

So let’s add up the score. A new top tax bracket with a marginal tax rate of 39.6 percent; the phasing out of personal exemptions and the limitation of itemized deductions previously enjoyed by those with incomes above $250,000; and two new “Obamacare” taxes for those with incomes above $200,000; would make you think the wealthy are the biggest tax losers of 2013. And you would be right, with one caveat: it could have been so much worse if Bush-era cuts had not been extended.

In any case, high-income taxpayers are not alone. Same-sex married couples start this year to feel a thorn in the flesh that is the marriage penalty, and we all will have a harder time taking medical deductions.

There is good news, though. Most of the education credits and deductions, such as the American Opportunity Credit, were extended in 2013. The alternative minimum tax exemptions were permanently indexed to inflation, which saved many middle income families from getting sucked into a higher tax rate. Finally, several aspects of filing your taxes, such as the much-maligned home office deduction and the reporting of stock sales, have been streamlined and are now easier to calculate.

Photo: GQ

Save Tax Green By Going Green

If you are eco-conscious, you probably sort your disposables for recycling, wash your clothes in cold water, carry reusable shopping bags to the grocery or perform other environmentally-friendly actions. But did you know that you may also be eligible to receive tax credits and deductions from Uncle Sam? While tax breaks for going green are not nearly as generous as they were in past years, it is still worth your while to investigate possible savings from the IRS for projects that you plan to carry out anyway.

Make Home Improvements

Did you recently replace one or more drafty windows or reinforce the insulation on your home? If so, you may qualify for tax credits through the Non-Business Energy Property Credit, which covers 10 percent of costs associated with purchasing and installing qualified energy-efficient insulation, doors, metal and asphalt roofs and windows.

The credit is also available for non-solar heating, ventilating and air conditioning (HVAC) systems, biomass stoves and non-solar water heaters. A maximum of $200 in credits can be claimed for window installation, with a $500 lifetime limit in total credits. The credit can only be applied to improvements made on your existing primary residence located within the United States. The Non-Business Energy Property Credit expired at end of December, 2013; new projects will not qualify unless Congress votes to renew the credit.

Update to Energy Efficient Appliances

 

Have you resorted to showering with cold water to save money on your utility bills? Perhaps you should consider installing an energy-efficient solar hot water heater.The Residential Energy Efficient Property Credit covers up to 30 percent of the cost of purchasing and installing a solar hot water heater, along with costs associated with solar electricity arrays, residential wind turbines and geothermal heat pumps.

There is no upper limit to the amount of tax credits you can claim, and the credit is applicable to new and existing residential construction. You can also claim up to 30 percent of the cost of installing residential fuel cells and microturbine systems up to a limit of $500 under the program. The Residential Energy Efficient Property Credit remains in effect through the end of December 2016, so you have plenty of time to make those improvements.

Optima Tax Relief has more about how you can get credit for making your home energy efficient in this post.

Green Up Your Ride

If you missed out on the recent Cash for Clunkers program, you may still have a chance to collect tax breaks for buying an energy-efficient car – as long as the car you buy is either a plug-in hybrid or an all-electric model. The Plug-In Electric Drive Vehicle Credit (IRC 30D) applies to four-wheeled passenger vehicles acquired by individuals and businesses after December 31, 2009. Some two-wheeled and three-wheeled vehicles acquired after December 31, 2011 and before January 1, 2014 also qualify for the program. Tax credits for non-plug-in hybrids, diesel-powered vehicles and alternative fuel vehicles (AFVs) expired at the end of 2010.

You may claim $2,500 for all eligible vehicles. In addition, for a vehicle that draws what the IRS calls “propulsion energy” from a battery with a capacity of at least 5 kilowatt hours, you may claim an additional $417. You may claim an additional $417 for each additional kilowatt hour capacity up to a maximum credit of $7,500.

The IRS will begin phasing out the credit over a one-year period beginning with the calendar quarter following a calendar quarter during which a specific manufacturer sells at least 200,000 qualifying vehicles in the United States. (The clock starts after December 31, 2009). During the first two quarters of the phase-out period, individuals who purchase qualifying vehicles may claim 50 percent of the applicable credit; during the second two quarters of the phase-out period, taxpayers may claim 25 percent of the applicable credit. No credit may be claimed after the end of the phase-out period.

As of January 2014, there is little danger of sales triggering the phase-out stage of the Plug-In Electric Drive Vehicle Credit program. The most popular plug-in electric car, the Chevrolet Volt, has sold approximately 56,000 units since it was introduced to the consumer market in December 2010. (Chevy representatives made an announcement at the 2014 Detroit Auto Show that mass production of the all-electric Volt has been suspended; instead, the car will be reclassified as a “niche” model targeted for specific audiences, much like the iconic Corvette.) The Ford Focus electric model had sold just under 21,000 cumulative units in the United States as of November 2013, according to the IRS website.

How to Claim Your Tax Breaks

To claim tax breaks for home improvements and energy-efficient appliances, file Form 5695, Residential Energy Credits.

To claim tax breaks under the Plug-In Electric Drive Vehicle Credit program, individual taxpayers submit Form 8936, Qualified Plug-In Electric Drive Motor Vehicle Credit along with their federal income tax returns. Under the American Recovery and Reinvestment Act (the “stimulus”), individuals who purchase qualified vehicles during 2010 or later may apply the credit toward payment of the Alternative Minimum Tax (AMT), if they are subject to the tax. To claim the credit for vehicles purchased for business use, submit Form 3800, General Business Credit.

Going green doesn’t reap the same rewards it used to, but there’s still money on the table if you’ve made any of these changes. Don’t let these tax credits fall through the cracks!

Photos: Flickr, Al.com

How to Spot a Shady Tax Preparer

According to the IRS, about 60 percent of taxpayers use tax professionals each year. While most are honest and well-trained, this is an area ripe for fraud if you choose poorly. After all, getting your taxes done by someone else means handing over a lot of personal information, your Social Security number (the Holy Grail for thieves), and those of your spouse and dependents, possibly your birth date, and your bank account information. The IRS wants you to remember, even if you hire someone to do your taxes, you bear the responsibility for what is in your return.

Until recently, anyone could hang out a shingle calling themselves a tax/financial professional, with zero experience or qualifications.  That’s why the IRS now requires tax preparers to get an IRS-issued Preparer Tax Identification Number (PTIN).  This helps, but where thieves smell money, there will always be unscrupulous people who slither past the rules. No determined thief is going to let a little thing like an IRS requirement stop him or her from scamming you.

But it’s not too difficult nowadays to spot a shady tax preparer and avoid them altogether.

Here are three red flags the IRS wants you to watch for:

  1. Is the preparer willing to provide you with his or her PTIN?
  2. Is the preparer willing to sign your return and provide his/her PTIN?
  3. Will the preparer ask you to sign an incomplete return? The IRS warns, a reputable preparer will never do this.

If the answers to any of these questions are unsatisfactory, don’t walk away. Run!

Others Points to Watch For

Ask the preparer about his or her qualifications.

  • Where did you get your training, and have you stayed up with the tax changes through continuing education?
  • How long have you been doing this?
  • What professional groups do you belong to?

Get a full list of the fees you will pay.

  • A reputable preparer will be upfront about fees.  You need to be upfront too, by explaining the extent of your return. If you have multiple small businesses, special credits which require extra forms, or a fistful of W-2s, say so.
  • Your fee should never be a percentage of your expected refund.  That encourages unscrupulous preparers to fraudulently jack up your refund. The preparer may initiate the fraud, but again, you are ultimately responsible and will be left holding the bag.
  • What is the expected time frame till your return is done?
  • Will the preparer review the completed return with you?
  • Will he/she be available for questions after the tax season?
  • If you are due a refund, will it be issued in your name?  Beware a preparer who says the refund will be issued to him/her, and you will be paid in cash. There’s no way for you to know if the refund was actually much larger than what you are paid.  If it’s a cash-only set up, say no and find another preparer.

Your prospective tax preparer needs to pass your inspection. If you feel uncomfortable during the initial meeting, trust your instincts and go elsewhere. You can do a simple background check of a preparer by contacting your local Better Business Bureau. If you have doubts, check the standing of a CPA by contacting the state board of accountancy. For attorneys, contact your state bar association, and for Enrolled Agents, check with the IRS Office of Enrollment.

You can read more about how to spot a shady tax preparer by checking with the IRS. If you feel you have stumbled upon a bad apple tax preparer, you can report the individual with the IRS by clicking here.

“If you feel that you have been a victim of a bad tax preparer or you feel that the IRS may flag a return you filed for inaccuracies, you may want to contact a professional to review your situation,” says David King, President of Optima Tax Relief. “Remember, the IRS is much more accommodating to individuals/businesses that voluntarily amend a past return as opposed to them amending it themselves.”

Photo: Commercial Appeal

The Rich Pay All the Taxes and Then Some

If you thought Mitt Romney’s comment during the 2013 presidential campaign that 47 percent of Americans don’t pay taxes was controversial, you’re going to want to check out this gem from the latest report on tax burdens published by the Congressional Budget Office Report (CBO).

According to the report, the rich don’t just pay more taxes, they pay them all. On page 13 of The Distribution of Household Income and Federal Taxes report of 2010, it clearly states that the richest 40 percent of American earners paid 106 percent of individual income taxes.

Negative Tax Rate?

These figures, which are based on 2010 IRS census data, show that the bottom 40 percent didn’t pay anything toward income taxes. In fact, they paid a negative 9 percent. How do you pay less than 0 percent? The formula used by the CBO gives a negative percentage to taxpayers who get back in benefits more than what they pay in income taxes.

To illustrate, according to the same report, in 2010, the poorest 20 percent earned an average of $8,100 but also received $25,000 in federal benefits. Actually, a quarter of the taxpayers in this group had a -15% tax rate. That means that for every $100 they paid, they received $115 back in benefits.

Fair Analysis?

Do these statistics give a fair picture of America’s tax code? According to the Center on Budget and Policy Priorities the significance and policy implications of figures like these, are unfair and widely misunderstood.

For instance, although much is made from the fact that the poorest taxpayers do not earn enough to pay federal income tax, this doesn’t mean they don’t pay toward other federal taxes. Based on data from the same CBO report, the bottom 40% paid 15.4 percent of all Social Insurance taxes, 4.8% of corporate income taxes and 28.8% of all federal excise taxes, such as fuel, communications and environmental taxes. Once you take into account these other taxes, the bottom 40 percent of taxpayers paid 4.2 percent of all federal taxes in 2010; which doesn’t seem so outrageous, particularly when you consider they only earned a 9.7 percent share of the market income.

Reports that highlight the fact that that low-income households don’t pay federal income taxes generally fail to mention the taxes they do have to pay, such as state and local taxes. According to data from the Institute on Taxation and Economic Policy, in 2011, the poorest fifth of American households paid 12.3 percent of their income toward state and local taxes. If you include federal, state and local taxes, the percentage of their income dedicated to paying for taxes is 16 percent. A stunning figure when you consider how modest their wages are to start with.

The Bottom Line

Yes, the richest 20 percent do pay nearly 93 percent of all federal income taxes. And yes, the poorest 40 percent pay less in income taxes than they get back in federal benefits; but only if you choose to ignore what they pay in payroll, excise and corporate taxes. A rather arbitrary way of presenting the data when you consider that payroll taxes are used to fund federal benefits, such as Social Security and Medicare.

The bottom line is that the rich do pay the lion’s share of taxes. However, when you consider the top 20 percent earns over half the total market income and the wealthiest 1% saw their income grow by 16% — compared to the 1% increase most taxpayers experienced –it’s hard to feel too sorry for the poor rich folk.

Photo: Chicago Now

How Hollywood Saves Billions on Production Costs through Tax Credits

You’ve heard the saying, it’s all about location, location, location. But for filmmakers these days, the shooting location is more about state tax breaks than scenery or terrain. Nearly 40 states get film credits from the fed, which they can use to lure the entertainment industry to within their borders. Some say this is a bad practice, while others say it is just sharing the wealth.

Seeing Stars

The use of film credits has skyrocketed, from $2 million a decade ago, to $1.5 billion in 2012, according to the non-profit Tax Foundation. Sharing the wealth is a good thing, it seems, though many entertainment industry trade workers in California disagree. With the majority of the biggest movies now shot elsewhere, many are finding it harder to make a living.

In fourteen of the states receiving film credits, those credits can be sold, giving rise to a new endeavor, that of brokering the credits. Brokers sell the credits to wealthy individuals looking for tax saving, and who may have no connection whatsoever to the movie industry. The buyers pay a discount price for the credits, and end up with state tax savings, often around 15%. Filmmakers get their money faster than if they waited for the related tax refunds, which is frequently the deciding factor in whether a movie gets made at all.

“Film producers, who often cannot use the credit themselves, particularly if their projects show losses, can form limited partnerships with wealthy investors who have passive income to shelter. The partnerships allow filmmakers to trade the credits for the investors’ cash.” (LA Times)

Money generated by the credits may cover one-third of the movie production costs and may add several weeks of shooting time that would otherwise be unaffordable. Actor/director Ben Affleck told the Los Angeles Times, part of his new movie “Live by Night” will be filmed in Georgia, a popular state based on the film credit availability. “It comes down to the fact that you have X amount of money to make your movie in a business where the margins are really thin.”

Another director told the Times it’s no longer about which location has the right scenery. Instead, they “recreate” the scenery they want, and pursue the best tax credits.

An interesting side note is, Affleck and his friend and fellow director Matt Damon, are both big supporters of the film tax credits which reduce taxes. Yet they have both on record saying their taxes should be raised.

How Do Film Credits Work?

Here’s an example culled from the LA Times.

A wealthy Georgia oncologist purchases a film credit voucher which represents a credit against his state tax bill. The face value of the voucher is $92,840 and the purchase price is $81,699 (88 cents/dollar). The difference is his tax savings, of $11,141. Out of the total paid, the broker takes a commission of $1,857, and the rest of the purchase price goes to the filmmaker. The filmmaker gets funding immediately, rather than waiting for a state tax refund. The broker gets a cut. And the oncologist saves taxes. Win/win/win.

Yet, it’s not all rosy. Here are some points made by critics of film credit practices:

  • Hollywood trade workers, like electricians, carpenters, caterers, and other behind the scene workers say they are losing their livelihood. The top grossing films shot in California have dropped 60% in 15 years.
  • Some say the credits don’t produce long- term benefits for the communities where filming occurs.
  • Others say the main beneficiaries are those not connected with the film industries.
  • Still others say this practice allows corporations to shelter income from something unrelated to their activities.

All valid criticisms, but since the deals are only made with the cooperation of movie making insiders, the entertainment industry may just be cannibalizing itself in an effort to stay alive.

One Tax Credit Expires, Hollywood Scrambles

A real-time example of Hollywood cannibalizing itself to stay alive is the recent news that, at the end of 2013, one of the many tax credits (worth millions) Hollywood uses is expiring. In an industry that depends heavily on packaged federal and state film credits, to see even just one expire is causing a bit of a panic.

Though not recommended, as long as a filmmaker has a day’s worth of filming with dialogue completed this year, along with a script, budget, and investor documents, they can still use the credit next year. This means that many are rushing to meet the deadline. “Some financial planners who package the deals have pushed producers … to start shooting in hopes of keeping their projects eligible for the write-off even after it passes from the scene” This way, even if the people filmed aren’t actually in the final cut, and even if the movie flops at the box office, investors still make money. (LA Times)

So how does this work? Why do federal and state governments offer these lucrative film tax credits to keep the movie biz afloat, and in turn, keep the wealthy investors’ pockets padded? Maybe to keep the filming on US soil, or to keep the art form alive, or just because it’s good for business.

Or maybe because, without these credits, the industry would fold.

Photo: DigitalTrends

Tax Free Retirement Plan Gifting Opportunity to Soon Expire

If you want to donate to a worthy cause this year and have retirement money available to do so, you might be able to make the experience even more satisfying by legally dodging taxes

Thanks to the American Taxpayer Relief Act of 2012, individuals over 70 ½ years old can donate up to $100,000 from their retirement plan (a traditional or Roth IRA)  now until December 31st without paying the taxes you would normally have to pay with such a transaction.

Give and avoid taxes

“This gifting opportunity provides a tax-free way to give money to a near and dear cause,” says Gregg R. Wind, CPA, a partner in Wind & Stern LLP. “Taxpayers who are 70 ½ or older can give away as much as $100,000 from their IRA to an eligible charity, without having to include any of the transfer in their gross taxable income,” he says. 

This means that you won’t pay any taxes, your tax bracket will not be affected, you don’t have to itemize the deduction on your tax return and additional tax will not be incurred on your Social Security income. (Conversely, it also means that you can’t write the deduction off on your income taxes.)

Substantial tax savings

The tax savings you can enjoy by taking advantage of this incentive can be considerable, says Wind. “Tax rates go up to 39.6 percent, depending on a variety of factors, and then there are other taxes to consider, such as state taxes, which can often push the tax percentage to 50 percent. This means that your $100,000 donation could turn into about $50,000, whereas taking advantage of this tax relief opportunity would mean gifting the entire $100,000 to the charity.”

Considering that retirees over the age of 70 ½ must begin taking minimum distributions each year, this incentive can be particularly beneficial on a number of levels, says Wind. “If you don’t need the minimum distribution, this gives you a chance to donate the money where it’s needed, as the amount you give counts toward your minimum required distribution.”

Requirements

The donation must be made directly from the IRA to the charitable organization, says Wind. “You can’t cash out your IRA and write a check. And it must be from an IRA, not a 401K. If you want to donate money from a 401K, you can roll it over into an IRA and then the donation must be made directly from the IRA.”

Eligible organizations for receiving your nontaxable IRA funds are those with a 501(c)(3) designation, which includes many charities, nonprofits, religious organizations and most private and public colleges and universities.

“Many people are loyal to their Alma mater and are glad to donate as a way of thanking the school for helping them be successful, so schools are a popular choice for donations,” says Wind, who suggests checking on the organization you are considering donating to on www.Guidestar.org, which lists recognized registered charities and provides pertinent information.

Act now

This tax incentive has been around since the Pension Protection Act of 2006, but has expired a few times, including at the end of 2011. At that time, it was extended to the end of this year as part of the fiscal cliff agreement. Currently, there is no sign of the incentive being resurrected, so it’s important to act fast. 

“This is an expiring provision at the end of this year, so if you want the satisfaction of helping a worthy cause and saving on taxes, you’ll have to move quickly before the opportunity is gone,” advises Wind. “The window to help support charities on a tax-free basis will be closing soon.”

Photo: Enewsspot

3 Special Gifts That Will Earn You Money Back

It’s better to give than to receive, except when it comes to taxes.

Fortunately, the holiday season provides the perfect opportunity to give more to those you care about and less to greedy Uncle Sam. Here are a few options for tax-deductible gifts.

Build a Child’s College Fund

A great gift that fits the bill is a contribution to a 529 plan. These plans allow a child’s college fund to grow tax free, and reduce state income taxes for contributors across the country.

Under federal law, individuals can contribute up to $14,000 a year to a 529 plan, and married couples can give as much as $28,000 a year. When their child is ready for college, parents can withdraw money from the plan and pay no taxes on it. They just have to be sure to use the money for tuition and other expenses required to attend college.

Parents and grandparents are the ones who most often contribute to the plans, and they can receive multiple tax breaks. Working parents are able to avoid paying a federal gift tax and in many states, can deduct the contribution from their state income tax. Retired grandparents can reduce the estate tax their children will have to pay.

There is even the opportunity for married parents or grandparents to contribute a lump sum of $140,000 for the next five years. This lump sum option can generate a much larger return on investment. But it could also leave money on the table if the IRS increases the maximum allowable contribution during the next five years.

Send Gifts to your Business Contacts

Parents and grandparents, though, aren’t the only ones who can benefit from giving money during the holidays. The federal government allows individuals to deduct as much as $25 per gift to business associates and customers during the holidays. That means if you want to give to those who have helped you at your job this year, feel free. And you will also receive something special: a reduction in income taxes. Just remember that the maximum deduction is $25 per recipient each year, so if you sent someone a $25 business gift earlier in the year, you won’t be able to deduct your holiday gift to them.

Donate to Charity

Making a donation to charity, whether it’s giving a bag of old clothes or some cash, is often a tax write-off. Of course, not every charitable gift will give back to you. Donating to political causes and candidates, purchasing raffle tickets for a fundraiser and in-kind donations of your talent and expertise are not tax deductible.

So when you make your list this Christmas, check it twice. Once to make sure you bought all the gifts for your family, and again to make sure you’ve set yourself up for every tax break tyou can get. After all, it is the giving season.

Photo: Oxclock

529 Plans: Facts and Tax Benefits

If you are a grandparent, opening a 529 plan with a grandchild as a beneficiary can have both direct and indirect tax benefits for you while providing a valuable benefit for your grandchild. Best of all, you shouldn’t hear any protests about how you’re spoiling your grandson or granddaughter again. Still, watch out for pitfalls associated with 529 plans imposed by the Internal Revenue Service and by individual states that can potentially ruin your gift.

Types of 529 Plans

There are two types of 529 plans: prepaid tuition and savings account assistance. Both types of plans are administered by individual states. Unlike in-state tuition rates, there are no residency restrictions imposed for purchasing either type of 529 plan. You or your grandchild can live in any state or even in two different states. You can also change beneficiaries for 529 plans as long as the new beneficiary is part of the same family. So when Jeanine finishes college, you can make her brother Billy the new beneficiary. However, some states place age restrictions on beneficiaries, which may be an issue if you intend to fund a plan for a grown grandchild.

Prepaid tuition plans provide funds that can be applied to pay tuition for colleges and universities located within the state. The growth rate for a prepaid tuition plan is pegged to the tuition rate of the particular educational institution to which it is linked.

If the tuition at a particular school quadruples by the time the beneficiary is ready to attend, the value of the 529 plan quadruples as well.

Financial aid assistance plans provide cash benefits that the beneficiary can use for qualified expenses at eligible financial institutions. Eligible educational expenses include all the usual suspects – tuition, fees, room and board. In addition, under the American Recovery and Reinvestment Act of 2009 (commonly called the stimulus), computer equipment, software, peripherals and the cost of Internet access also count as eligible educational expenses. So, purchasing accounting software for finance major is totally OK. That Wii Fit game console on the other hand, not so much, unless the beneficiary is majoring in physical therapy.

Both types of plans are administered by individual states. Unlike in-state tuition rates, there are no residency restrictions imposed for purchasing either type of 529 plan. You or your grandchild can live in any state or even in two different states. You can also change beneficiaries for 529 plans as long as the new beneficiary is part of the same family. So when Jeanine finishes college, you can make her brother Billy the new beneficiary. However, some states place age restrictions on beneficiaries, which may be an issue if you intend to fund a plan for a grown grandchild.

Establishing and Funding a 529 Plan

As a grandparent, you may fund a separate 529 plan and contribute as much as $14,000 (for 2013) to each 529 plan fund without incurring gift taxes. You and your spouse can contribute up to $28,000 in a 529 plan for each grandchild without incurring gift taxes. As an alternative, you an fund up to $65,000 (or $130,000 for married couples) in the first year of a five-year period without incurring the gift tax, as long as there are no other gifts made to that particular beneficiary within the same five-year window. If the cost to attend a particular educational institution is lower than the limit set by the IRS, though, you can only fund the plan to meet the lower amount.

State Tax Benefits and Federal Estate Tax Benefits

Some states allow grandparents to deduct contributions to 529 plans from their state income tax returns. Inquire with a plan administrator for the details. However, a prominent myth is that federal income taxes are also deductible. This is absolutely NOT true. But grandparents do receive indirect tax breaks from contributing to 529 plans – so long as the funds are used for qualified educational expenses by the beneficiary.

There are also no capital gains taxes on earnings. Plus, each contribution reduces the value of your estate, which may result in lower or no gift taxes for your heirs. But if the funds are use for non-qualified expenses, the owners of the funds are hit with income taxes plus a penalty of 10 percent on any investment gains.

The Gift That Keeps on Giving

Instead of braving the crowds trying to find that elusive gadget that happens to be the “it” gift this year, give the gift that keeps on giving – to you as well as your grandchildren. Even if you start off with a small cash gift now, by the time your grandchild is ready for college, he or she will have a tidy sum stashed away with no adverse affect on financial aid eligibility. You will save wear and tear on your nerves while providing a gift that can truly change your grandchild’s life for the better.

Photo: New York Times

US Exit Tax: Tax Planning Strategies for Expats

New tax rules on American expats are causing many to give up their citizenship. American expatriates have always been required to report and pay taxes on their international assets. That is, after all, why Earl Tupper, founder of Tupperware, bought an island off the coast of Costa Rica and gave up his citizenship back in 1958. It’s also why Tina Turner is now a Swiss citizen and no longer American.  However, the new rules give the IRS additional powers which may require taxpayers to be more accurate when declaring their offshore assets. 

As of July 2014, a new tax law called the Foreign Accounts Tax Compliance Act, FATCA, will require all financial institutions to report to the IRS all the assets and income of US citizens who have more than $50,000 on their books. The law allows the IRS to withhold 30% of the dividends and interest payments due to financial institutions who do not comply with this requirement. 

The US Exit Tax

Renouncing your citizenship does not exempt you from the taxes you already owe, and if you are wealthy, you may have to pay additional taxes. The Heroes Earnings Assistance and Relief Tax Act of 2008 created an exit or “expatriation” tax on the unrealized gains on all the assets – US and worldwide – of US citizens and permanent residents who renounced their citizenship or permanent residence status.

The exit tax is calculated by estimating the market value of all assets on the day before expatriation. Any gains arising from the hypothetical sale of the assets is then taxed as if it were income on the taxpayer’s tax return for that year. For wealthy expatriates, this can mean a 30% tax rate on their worldwide assets. The silver lining is that, as of 2013, the first $663,000 of a taxpayer’s assets are exempt from taxation. The exclusion amount adjusts for inflation and therefore varies from year to year.

Timing can have a huge effect on the value of many assets, such as real estate, stocks and bonds. Taxpayers can minimize their tax burden by timing their expatriation to when the market value of their assets is low, particularly when this places them below the exit tax threshold.

However, there is another tax strategy expatriates can follow to minimize the tax burden on their worldwide assets that do not require them to renounce their citizenship.

Foreign Grantor Trusts

Foreign grantor trusts are becoming popular with wealthy US families who want to avoid taxation on their worldwide assets but have members who wish to keep their US citizenship. These trusts require a settlor, usually a family member, who isn’t a U.S. citizen and who has complete control over the assets in the trust. This is because foreign trusts are revocable – which means the settlor can remove the assets at will – US beneficiaries aren’t considered owners of the assets so the IRS doesn’t tax them until the assets are distributed to them. 

The catch with foreign grantor trusts is that when the assets are distributed to the beneficiaries the IRS may impose an ultra-high tax rate on the income generated by the previously tax-exempt assets and require the trust to withhold the tax before distributing it. Many beneficiaries create pour-over trusts designed to receive foreign asset without incurring in punitive tax rates. 

Foreign grantor trusts as well as other tax planning instruments are complex and can easily blow up in your face if not properly managed. Therefore, taxpayers should seek the advice of accountants and tax lawyers who are experienced with the complexities of international tax issues before committing to a particular taxation strategy.

Photo: Alan Cleaver