Tax

Is Your Business Still the Right Entity Under the New Tax Rule? Part 2

More tips about determining the right corporate, partnership or other structure that’s best for your business—and where you are in life.

Key Takeaways:

  • The legal structure of your business operations can have a significant impact on your annual income tax and estate planning.

  • When you and/or your heirs expect to be at or near the maximum income tax rates, you will generally want to leave appreciated and appreciating assets in the taxable estate, rather than transfer them prior to death.

  • In general, assets with the potential to appreciate in value should not be placed into an S or C Corporation.

As many of you know, The Tax Act of 2017 created a host of changes and considerations for successful business owners in their families. There are six widely used business operating structure. In Part 1 of this article we discussed Sole Proprietorships (Schedule C), Limited Liability Companies (LLC) and Limited Partnerships. Here will take a closer look at the other three entities: General Partnerships, Subchapter S Corporations and Subchapter C Corporations.

4) General Partnership

The rules are similar to LLCs and Limited Partnerships discussed above, except that all of the partners will generally have more liability exposure.

The partners are subject to self-employment taxes on most of their allocable K-1 income, other than certain rental real estate/passive/investment/portfolio income. As noted above, Partnerships are eligible for the potential 20 percent deduction against Qualified Business Income.

Estate and Gift Tax – See Limited Partnership discussion in Part 1 of this article.

5) S Corporation

An S Corp is generally the least costly and easiest type of entity to set up and operate. Like an LLC, income and losses flow to shareholders, and tax is generally paid at the owner level rather than at the entity level.

One of the biggest tax breaks in this type of structure is that the S Corp shareholders can take a portion of the profits as distributions rather than as W-2 income, and payroll tax savings ranging from a minimum of 2.9 percent to 15.3 percent can be achieved.

Company-level debt does not factor into member tax basis here. Distributions must parallel the S Corp’s stock ownership. Shares can only be owned by U.S. resident individuals and certain trusts. S Corps have many restrictive rules and care must be exercised in keeping distributions in the exact proportion as stock ownership. Also, S Corps with excess passive income from rents, royalties and investments can lose their S Corp status. Further, an S Corporation may have no more than 100 members. As noted above, S Corporations are eligible for the potential 20% deduction against Qualified Business Income.

Estate and Gift Tax – Unlike in an LLC, when an S Corp shareholder dies, his or her heirs will only receive a revaluation in the “outside ” basis in their corporate shares – not on the underlying S Corp assets. This is also an issue for any potential buyers of the entity. This can create significant income tax problems for your heirs. Furthermore, complexities of retaining S Corp status can occur if an ineligible owner comes into the mix – e.g., an ineligible trust or nonresident alien.

6) C Corporation

C Corps are similar to S Corps with respect to the reasonable cost of formation and operation. The big difference between S Corps and C Corps is that C Corps pay tax at the entity level; however, the 2017 Tax Act dramatically dropped the C Corp rates to a flat 21 percent. C Corp shareholders will still pay taxes on W-2 earnings and certain dividends and other distributions made from the C Corp– making them vulnerable to the highly tax inefficient “double taxation.”

It is important to note that “personal service” businesses such as attorneys, doctors, accountants and consultants can operate as C Corps. Unlike the pre-2018 rules, the 2017 Tax Act will allow Personal Service Corps (PSC) to benefit from the new 21-percent rate on retained taxable income, rather than the maximum individual rate imposed under the old rules.

An unlimited number of shareholders are allowed and the C Corp can generally choose any tax year-end. Most other entities are generally limited to calendar year-ends.

Estate and Gift Tax – Similar to S Corps, a negative characteristic of C Corps is that upon the death of an owner, there is a revaluation of only the stock, not the underlying assets. Lack of restrictions on ownership make C Corps more flexible from an inheritance standpoint.

Conclusion

Congrats on building such a successful and rewarding business enterprise. Make sure you and your advisors evaluate specific facts and changing life circumstances to make sure the goals you have for yourself, your family and your heirs remains on track under the new tax landscape.

Robert J. Pyle, CFP®, CFA is president of Diversified Asset Management, Inc. (DAMI). DAMI is licensed as an investment adviser with the State of Colorado Division of Securities, and its investment advisory representatives are licensed by the State of Colorado. DAMI will only transact business in other states to the extent DAMI has made the requisite notice filings or obtained the necessary licensing in such state. No follow up or individualized responses to persons in other jurisdictions that involve either rendering or attempting to render personalized investment advice for compensation will be made absent compliance with applicable legal requirements, or an applicable exemption or exclusion. It does not constitute investment or tax advice. To contact Robert, call 303-440-2906 or e-mail info@diversifiedassetmanagement.com.

 

The views, opinion, information and content provided here are solely those of the respective authors, and may not represent the views or opinions of Diversified Asset Management, Inc.  The selection of any posts or articles should not be regarded as an explicit or implicit endorsement or recommendation of any such posts or articles, or services provided or referenced and statements made by the authors of such posts or articles.  Diversified Asset Management, Inc. cannot guarantee the accuracy or currency of any such third party information or content, and does not undertake to verify or update such information or content. Any such information or other content should not be construed as investment, legal, accounting or tax advice.

Will I Get a Step-Up in Basis for this Inherited Property?

Receiving inherited property often comes with a tax advantage: receiving a step-up in basis.  Whether you are receiving property from a spouse or family friend, you may be eligible to minimize future taxes by taking a step-up in basis. Read on to see if your inherited property qualifies:

Did you inherit property from your spouse?

If the inherited property is from your spouse and you live in a community property state (Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, Wisconsin), then both halves of the property receive a step-up in basis as long as at least half is included in the decedent’s gross estate (full step-up in basis to FMV).  If you don’t live in a community property, skip to “Is the property an IRA, 401(k), pension, annuity, or irrevocable trust?” question.

Did you or your spouse gift the property to the decedent within one year before their death?

If you answered “yes,” then your original basis is carried over, and you will not receive a step-up.  If not, move on to the next question.

Is the property an IRA, 401(k), pension, annuity, or irrevocable trust?

If you answered “yes,” then you will not receive a step-up in basis.  If not, you will likely be eligible for either a half or full step-up in basis. 

Receiving a step-up in basis can potentially save you thousands of dollars in taxes. Check out this flowchart to learn more.

If you would like to schedule a call to talk about the best tax strategies for your inherited property, please give us a call at 303-440-2906 or click here to schedule a time to speak with us.

Robert J. Pyle, CFP®, CFA is president of Diversified Asset Management, Inc. (DAMI). DAMI is licensed as an investment adviser with the State of Colorado Division of Securities, and its investment advisory representatives are licensed by the State of Colorado. DAMI will only transact business in other states to the extent DAMI has made the requisite notice filings or obtained the necessary licensing in such state. No follow up or individualized responses to persons in other jurisdictions that involve either rendering or attempting to render personalized investment advice for compensation will be made absent compliance with applicable legal requirements, or an applicable exemption or exclusion. It does not constitute investment or tax advice. To contact Robert, call 303-440-2906 or e-mail info@diversifiedassetmanagement.com.

 

The views, opinion, information and content provided here are solely those of the respective authors, and may not represent the views or opinions of Diversified Asset Management, Inc.  The selection of any posts or articles should not be regarded as an explicit or implicit endorsement or recommendation of any such posts or articles, or services provided or referenced and statements made by the authors of such posts or articles.  Diversified Asset Management, Inc. cannot guarantee the accuracy or currency of any such third party information or content, and does not undertake to verify or update such information or content. Any such information or other content should not be construed as investment, legal, accounting or tax advice.

Is Your Business Still the Right Entity Under the New Tax Rule? Part 1

What you need to know about corporations, partnerships and other structures under which you do business

Key Takeaways:

  • There are six widely used business operating structures. Each has pros and cons depending on the owner’s income and estate planning options.

  • Choosing the right legal form for your business is critical for both legal and tax purposes

  • The Tax Cuts and Jobs Act of 2017 (2017 Tax Act) made significant changes that should be factored into your entity choice.


As many of you know, The 2017 Tax Act made significant changes to the tax code. Most significantly individual tax rates have dropped and now cap out at 37 percent (vs. prior 39.6 percent). Here are some of the other highlights:

  • The C Corp tax rate has decreased from 35 percent to 21 percent

  • Flow-Through entities and Sole Proprietors are generally eligible for 20 percent taxable income reduction which results in a maximum tax of 29.6 percent (vs. 37 percent) on up to $315,000 of Qualified Business Income.

  • Estate and gift tax rates have decreased from 45 percent to 40 percent (but only on net assets exceeding $11.18 million per spouse for 2018 – nearly doubling the prior exemption). However, most of these provisions will sunset in 2026, making long-term planning even more important – and challenging.

One of the most common questions we get from clients and friends is: “Which legal structure should is best for my new or existing business? My standard answer is: “Well, it depends on your specific facts.”

There are a multitude of legal, tax and operating issues to consider, and one size certainly does not fit all. The general choices for operating a business include the following:

1.     Sole Proprietorship – Schedule C

2.     Limited Liability Company (LLC)

3.     Limited Partnership

4.     General Partnership

5.     Subchapter S Corporation

6.     Subchapter C Corporation

There are also other legal entities that may be worth investigating for certain operations, including trusts, cooperatives and joint ventures in unincorporated form.

Following is a general summary of the pros and cons of the most common forms of operations and how structure may impact income tax and estate tax planning.

1) Sole Proprietorship

This is by far the simplest form of doing business and requires very little in the way of startup costs. While legal liability exposure is highest in this form, owners can still have employees, pay themselves a W-2 and fund various benefits in a Schedule C business. As noted above, Sole Proprietors are eligible for the potential 20% deduction against Qualified Business Income, with limitations phased in once taxable income exceeds $315,000 per taxpayer (not available to certain “specified service businesses”).

Estate and Gift Tax – Upon the death of the owner(s), the legal entities’ business and personal assets will transfer to trusts or heirs as outlined in the taxpayer’s trust and estate documents. Various minority and marketability discounts available to other legal structures are not available in a Sole Proprietorship.

2) Limited Liability Company (LLC)

LLCs are by far the most popular form of doing business for a variety of reasons, including limited legal liability for other members’ bad behavior, as well as flexibility in modifying the tax structure as your business plan evolves. There are various federal elections available to treat the entity in a variety of ways for tax purposes – see IRS Form 8832. The remaining discussion assumes a Partnership election is made.

Taxable income and losses (as well as credits) flow through to LLC members (and retain their “ordinary” or “capital” character) and member tax basis is adjusted. In addition, both partner and third-party loans can increase member tax basis. Also, moving assets and members in and out of the LLC is generally easier from a tax perspective than it is for a Corporation. As noted above, LLC’s are eligible for the potential 20 percent deduction against qualified business income, with limitations phased in once taxable income exceeds $315,000 per taxpayer (not available to certain “specified service businesses”).

Estate and Gift Tax – The most significant estate tax advantage associated with operating as an LLC that’s taxed as a Partnership is that upon the death of an LLC member, both the “outside” tax basis in the LLC units inherited and the tax basis in the assets held by the LLC on the date of death will be revalued to their fair market values. This offers a very significant advantage to your heirs when the LLC has increased in value during your lifetime. As discussed later, this “step-up” in basis of the underlying assets of an LLC is not afforded to either S Corporations or C Corporations.

3) Limited Partnership

A Limited Partnership must still have a General Partner (GP). LPs are generally not subject to self-employment tax on their K-1 income as is the case with most GP and LLC members. As noted above, Partnerships are eligible for the potential 20 percent deduction against Qualified Business Income.

Estate and Gift Tax – The value of the general and limited units will vary much more than the LLC units, based on the specific partnership terms.

Conclusion

An LLC or Limited Partnership generally provides you with the most flexible lifetime and post-mortem planning opportunities for your business. But you and your advisors must fully evaluate your specific facts and options based on the type of business operations you own and your overall estate plan. It is not uncommon for successful owners to have a variety of entities to achieve the most beneficial operational and income/ estate tax results. In Part 2 of this article we will discuss the other three common entity options: General Partnerships, Subchapter S Corporations and Subchapter C Corporations.

If you or someone close to you has concerns about the tax implications of their business structure, please don’t hesitate to at 303-440-2906 or schedule a call by clicking here.

Robert J. Pyle, CFP®, CFA is president of Diversified Asset Management, Inc. (DAMI). DAMI is licensed as an investment adviser with the State of Colorado Division of Securities, and its investment advisory representatives are licensed by the State of Colorado. DAMI will only transact business in other states to the extent DAMI has made the requisite notice filings or obtained the necessary licensing in such state. No follow up or individualized responses to persons in other jurisdictions that involve either rendering or attempting to render personalized investment advice for compensation will be made absent compliance with applicable legal requirements, or an applicable exemption or exclusion. It does not constitute investment or tax advice. To contact Robert, call 303-440-2906 or e-mail info@diversifiedassetmanagement.com.

 

The views, opinion, information and content provided here are solely those of the respective authors, and may not represent the views or opinions of Diversified Asset Management, Inc.  The selection of any posts or articles should not be regarded as an explicit or implicit endorsement or recommendation of any such posts or articles, or services provided or referenced and statements made by the authors of such posts or articles.  Diversified Asset Management, Inc. cannot guarantee the accuracy or currency of any such third party information or content, and does not undertake to verify or update such information or content. Any such information or other content should not be construed as investment, legal, accounting or tax advice.

Well-Traveled? Don’t Get Tripped Up by Taxes, Part 2

More cross-border issues for you and your advisor to remember for next tax season or extension time

Key Takeaways:

  • While total global income must be reported on the relevant lines of the 1040, some forms are specific to global tax reporting.

  • Form 8938 relating to foreign asset reporting is now in its second year.

  • PFIC reporting—Form 8621 for all foreign mutual funds and private equities held by U.S. residents and citizens—is slowly becoming important.

  • You must also declare your financial interest in foreign entities via Form 5471.

 

As we discussed in Part 1 of this article series, if you are a U.S. resident or U.S. citizen (whether NRI, PIO or OCI), you must pay taxes in the U.S. on all of your global income. Here we’ll look closer at the important forms that apply to you.

Foreign assets reporting—Form 8938


Form 8938, Statement of Specified Foreign Financial Assets, must be filed along with the income tax return.

Experts agree that Form 8938, which has been around for half a dozen years, will become a significant tool for the IRS to identify the scope of international tax noncompliance of a given U.S. taxpayer. This form requires a taxpayer to disclose more information that connects various parts of a taxpayer’s international tax compliance, including the information that escaped disclosure on other forms earlier.

Schedule B is a typical example where you may have failed to report foreign financial accounts. Moreover, Form 8938 is far more detailed and asks the opening date of a certain financial account. This can become a tricky situation if you have held a foreign account for a significantly long period of time–and haven’t disclosed it in earlier returns.

What must be reported in 8938?

Foreign financial assets that must be declared in Form 8938 include shareholdings, mutual fund holdings, insurance policy holdings, pension plans and bank balances abroad.

Specified foreign financial assets do not include physical assets such as gold and real estate. However, if you own gold is held in the form of ETFs, it should be included as a specified foreign financial asset.

Tip: Form 8938 is exhaustive and requires you and your tax advisor to enter detailed values of financial assets. Make sure you get in touch with your overseas bankers or financial companies to gather this information ASAP.

PFIC reporting—Form 8621

 

The U.S. has a peculiar reporting requirement for all foreign mutual funds and private equities held by its residents and citizens. In the U.S., these funds are considered “passive foreign investment companies” (PFICs). According to PFIC rules, any notional gains from a mutual fund or private equity fund holding must be declared every year, and tax must be paid on such notional gains.

If you fail to comply, your gains on sales will be treated under the “excessive distribution” option, which is also the default method. Suppose you did not make any election on PFICs and, throughout the holding period, did not complete Form 8621 for PFIC holdings.

Let’s say you held the PFIC units for, say, 10 years and did not receive any distributions during those 10 years. In the year of sale, let’s say you made a gain of $100. In the year of sale, gains will be distributed over the past 10 years, that is, $10 per year. It will be treated as though you did not pay tax on $10 per year, and hence in Year 10, must pay tax for each of these years plus interest on the delay. Essentially, this default method kicks in at the year of sale.

Tip: If you own foreign mutual funds, collect information such as opening and closing values. If dividends were paid, gather that information as well. It can be a long, drawn-out exercise. The sooner you begin the better.

Declaration of financial interest in Indian entities


Forms 5471 and 8865 are triggered when a U.S. resident, citizen or green card holder has financial interest in foreign corporations or foreign partnerships. So if you have a stake in an overseas company, or are a director or officer of foreign company, you may need to file Form 5471 (for companies) or 8865 (for partnerships) and declare the interest. There are certain conditions that apply to both forms. What is important is that the penalties are very high. There is a penalty of $10,000 for each year for failing to file the form.

Another form, the 926, was also introduced a few years ago. Form 926 captures information on any transfers of property or funds by a U.S. taxpayer to a foreign corporation.

Conclusion
As I mentioned at the beginning of this article series, foreign income compliance is becoming increasingly important to the IRS. As the Foreign Account Tax Compliance Act (FATCA) gathers steam, opportunities to come into compliance without facing harsh penalties will start to diminish. So the sooner you and your tax advisors act, the better.

Robert J. Pyle, CFP®, CFA is president of Diversified Asset Management, Inc. (DAMI). DAMI is licensed as an investment adviser with the State of Colorado Division of Securities, and its investment advisory representatives are licensed by the State of Colorado. DAMI will only transact business in other states to the extent DAMI has made the requisite notice filings or obtained the necessary licensing in such state. No follow up or individualized responses to persons in other jurisdictions that involve either rendering or attempting to render personalized investment advice for compensation will be made absent compliance with applicable legal requirements, or an applicable exemption or exclusion. It does not constitute investment or tax advice. To contact Robert, call 303-440-2906 or e-mail info@diversifiedassetmanagement.com.

 

The views, opinion, information and content provided here are solely those of the respective authors, and may not represent the views or opinions of Diversified Asset Management, Inc.  The selection of any posts or articles should not be regarded as an explicit or implicit endorsement or recommendation of any such posts or articles, or services provided or referenced and statements made by the authors of such posts or articles.  Diversified Asset Management, Inc. cannot guarantee the accuracy or currency of any such third party information or content, and does not undertake to verify or update such information or content. Any such information or other content should not be construed as investment, legal, accounting or tax advice.

Am I Eligible for Medicare Part A & Part B?

The Medicare program can provide healthcare for elderly or disabled individuals at a greatly reduced cost.  Medicare Part A covers hospital insurance, and Part B covers medical insurance.  Read below to see if you are eligible for Medicare.

Are you a US citizen and age 65 or older?

If you are under 65 and are not disabled, then you are not eligible for Medicare Part A or Part B.  If you are under 65 and disabled you may be eligible for Medicare benefits.  If you are over 65 and not disabled, move on to the next question.

Are you entitled to Social Security benefits (you have 40 work credits; about 10 years of work history)?

If you answered “yes,” you will be eligible for Medicare Part A & Part B.  If not, then you may still be eligible, depending on your spouse’s eligibility for Medicare and several other factors.

If you’ve made it this far, there is a good chance you are eligible for Medicare Part A & Part B.  Check out this flowchart to learn more.

If you would like to schedule a call to talk about planning strategies that incorporate Medicare, please give us a call at 303-440-2906 or click here to schedule a time to speak with us.

 

Robert J. Pyle, CFP®, CFA is president of Diversified Asset Management, Inc. (DAMI). DAMI is licensed as an investment adviser with the State of Colorado Division of Securities, and its investment advisory representatives are licensed by the State of Colorado. DAMI will only transact business in other states to the extent DAMI has made the requisite notice filings or obtained the necessary licensing in such state. No follow up or individualized responses to persons in other jurisdictions that involve either rendering or attempting to render personalized investment advice for compensation will be made absent compliance with applicable legal requirements, or an applicable exemption or exclusion. It does not constitute investment or tax advice. To contact Robert, call 303-440-2906 or e-mail info@diversifiedassetmanagement.com.

 

The views, opinion, information and content provided here are solely those of the respective authors, and may not represent the views or opinions of Diversified Asset Management, Inc.  The selection of any posts or articles should not be regarded as an explicit or implicit endorsement or recommendation of any such posts or articles, or services provided or referenced and statements made by the authors of such posts or articles.  Diversified Asset Management, Inc. cannot guarantee the accuracy or currency of any such third party information or content, and does not undertake to verify or update such information or content. Any such information or other content should not be construed as investment, legal, accounting or tax advice.

Can I Delay the RMD from the Traditional IRA I Inherited?

Traditional IRAs allow the owner several tax advantages: it allows for an upfront tax deduction as well as tax-deferred growth.  Upon withdrawal of funds, the account owner is taxed at ordinary income rates. Inherited IRAs require the new account owner to begin taking withdrawals over their lifetime regardless whether or not they need the funds.  Why?  Because Uncle Sam wants to collect his share.  Here are some potential strategies for delaying RMDs from Traditional IRAs as long as possible.

Are you the beneficiary of a Traditional IRA from someone other than your spouse?

If you inherited a Traditional IRA from a spouse, you are likely able to delay taking RMDs until you reach 70.5 years of age.  Check out our “Should I Inherit my Deceased Spouse’s IRA?” flowchartIf you inherited the IRA from a non-spouse, move on to the next question.

Did the person pass away before their Required Beginning Date (April 1st, the year after turning 70.5)?

They have reached their Required Beginning Date

This allows you two options: electing the “5 Year Distribution Rule” or taking RMDs based on your life expectancy using the IRS Single Life Expectancy Table.  The “5 Year Distribution Rule” means all assets must be out of the account at the end of 5 years.  You could withdraw all funds immediately, spread them out over the 5 years, or take them all out just before the end of 5 years.  Keep in mind you will need to pay ordinary income tax on the whole amount distributed. 

If you take RMDs based on your life expectancy it will spread out the tax burden.

They have not reached their Required Beginning Date

You will be required to open an Inherited IRA and take RMDs based on your life expectancy according to the IRS Single Life Expectancy Table.  Depending if the deceased had satisfied their RMD for the year of their death, you may be required to take one this year.

If you’ve made it this far, you may be able to delay the RMD from your inherited IRA.  Check out this flowchart to learn more.

If you would like to schedule a call to talk about the best strategy for delaying RMDs from Inherited IRAs, give us a call at 303-440-2906 or click here to schedule a time to speak with us.

 

 

 Robert J. Pyle, CFP®, CFA is president of Diversified Asset Management, Inc. (DAMI). DAMI is licensed as an investment adviser with the State of Colorado Division of Securities, and its investment advisory representatives are licensed by the State of Colorado. DAMI will only transact business in other states to the extent DAMI has made the requisite notice filings or obtained the necessary licensing in such state. No follow up or individualized responses to persons in other jurisdictions that involve either rendering or attempting to render personalized investment advice for compensation will be made absent compliance with applicable legal requirements, or an applicable exemption or exclusion. It does not constitute investment or tax advice. To contact Robert, call 303-440-2906 or e-mail info@diversifiedassetmanagement.com.

 

The views, opinion, information and content provided here are solely those of the respective authors, and may not represent the views or opinions of Diversified Asset Management, Inc.  The selection of any posts or articles should not be regarded as an explicit or implicit endorsement or recommendation of any such posts or articles, or services provided or referenced and statements made by the authors of such posts or articles.  Diversified Asset Management, Inc. cannot guarantee the accuracy or currency of any such third party information or content, and does not undertake to verify or update such information or content. Any such information or other content should not be construed as investment, legal, accounting or tax advice.

 

 

Future of Charitable Planning

Key Takeaways

  • Studies show that one in four affluent people (23%) consulted with at least one advisor about charitable donations last year.

  • A confused donor is an unhappy donor.

  • Always review your goals and check with your advisors before whipping out your checkbook

 

Generally planned giving CRTs (charitable remainder trusts) and CLTs (charitable lead trusts) immediately come to mind. We seldom think about charitable giving in the context of non-charitable trusts, but according to Al W. King III, co-founder and co-CEO of South Dakota Trust Company, the amount of wealth that high-net-worth individuals own in trusts is surprising.

  • “The top 1 percent currently have 38 percent of their assets in trusts, and

  • The next 9 percent have 43 percent of their assets in trust,” observed King.

Some families intentionally incorporate charitable planning and provisions into trusts they create. You can too by:

  • Setting a target value for the trust that will be available for family members with any growth and appreciation above that amount being directed to charity

  • Supplementing distributions to family members who work for a charitable organization

  • Matching beneficiaries’ personal charitable contributions

Families are also discovering strategies to incorporate charitable goals and objectives into trusts that were initially created with no charitable intentions. This is often achieved by changing the trust’s situs (legal jurisdiction), reforming or modifying the trust, or “decanting” in states with flexible decanting statutes that allow trustees to change the terms of an otherwise irrevocable trust, which may include adding discretionary charitable beneficiaries.

Common trusts and trust strategies that are increasingly incorporating charitable goals, objectives and planning include:

  • Dynasty trusts—Because of the long-term nature of these trusts, families often desire to make provisions and provide flexibility for both family and charitable goals and objectives.

  • Existing non-charitable trusts—Irrevocable trusts can sometimes be reformed or modified to allow for distributions to charitable organizations. Depending on the applicable state law governing the trusts, it may be necessary or helpful to change the situs of a trust to a state that has more flexible trust decanting laws.

  • Purpose trusts—Some trusts are created for a specific purpose, often to care for “something” rather than for “someone.” For example, a trust may be created to care for a pet; to maintain family property such as antiques, cars, jewelry or memorabilia; or to maintain a family residence or vacation home. Once the pet dies or the property is sold or otherwise disposed of, the remaining assets might pass to charity.

  • Health and education exclusion trusts—These trusts provide support to beneficiaries over multiple generations for certain education and health-related costs. As long as distributions to cover such costs are made directly to an educational or health care institution, then gift taxes and generation-skipping transfer taxes can be avoided indefinitely. However, in order for the vehicle to qualify as a health and education exclusion trust, one or more charitable beneficiaries must have a substantial present economic interest.

Laura Peebles, former tax director of the national office of Deloitte and a consultant to Charitable Solutions, shared these nuggets of wisdom gained from nearly four decades in the charitable planning arena:

  • The donor’s charitable intent determines whether a gift is made. However, the tax benefits can influence the fulfillment of the giver’s charitable intent in terms of the asset that is ultimately given, when the asset is given, and the manner and structure through which the asset is given.

  • A confused donor is not a happy donor.

  • Some tax aspects of charitable giving don’t have good answers, some don’t have inexpensive answers and some don’t have any answers at all.

Charitable giving with retirement benefits

According to author and attorney Natalie Choate, an estate planning and retirement benefits consultant, advisors and many charitably inclined people are well-aware of the substantial tax advantages of giving retirement benefits to charity, particularly in a testamentary capacity. In addition to avoiding any estate tax liability that might otherwise apply, the charity also avoids tax on “income in respect of a decedent” that would otherwise result in the imposition of income tax on retirement benefits received by the owner’s children or other heirs.

In some cases planning charitably with retirement benefits can be quite simple; for example, if a charity is named as the sole retirement plan beneficiary. However, other planning scenarios can involve complex issues and obstacles that must be carefully navigated. For instance:

  • When there are charitable and non-charitable beneficiaries of the same plan

  • When using formula bequests in beneficiary designations

  • When leaving retirement benefits to charity through a trust or estate, and

  • When using disclaimer-activated gifts to charity.

 

Conclusion


A recent study by U.S. Trust and the Philanthropic Initiative found that one in four wealthy individuals (23%) consulted with at least one advisor about charitable donations in the past year. In addition, nearly 70 percent of charitable remainder trust donors reported learning about the planning vehicle from their advisors.

These trends indicate a growing opportunity for investors and their advisors to have a regular dialogue about charitable methods that meet personal planning goals. Call us at 303-440-2906 if you or someone close to you would like to incorporate a strategic and regular giving strategy into your overall financial plan.



Robert J. Pyle, CFP®, CFA is president of Diversified Asset Management, Inc. (DAMI). DAMI is licensed as an investment adviser with the State of Colorado Division of Securities, and its investment advisory representatives are licensed by the State of Colorado. DAMI will only transact business in other states to the extent DAMI has made the requisite notice filings or obtained the necessary licensing in such state. No follow up or individualized responses to persons in other jurisdictions that involve either rendering or attempting to render personalized investment advice for compensation will be made absent compliance with applicable legal requirements, or an applicable exemption or exclusion. It does not constitute investment or tax advice. To contact Robert, call 303-440-2906 or e-mail info@diversifiedassetmanagement.com.

 

The views, opinion, information and content provided here are solely those of the respective authors, and may not represent the views or opinions of Diversified Asset Management, Inc.  The selection of any posts or articles should not be regarded as an explicit or implicit endorsement or recommendation of any such posts or articles, or services provided or referenced and statements made by the authors of such posts or articles.  Diversified Asset Management, Inc. cannot guarantee the accuracy or currency of any such third party information or content, and does not undertake to verify or update such information or content. Any such information or other content should not be construed as investment, legal, accounting or tax advice.

Should I Inherited My Deceased Spouse’s IRA?

When a spouse is the beneficiary of the IRA of their deceased spouse’s IRA, there are several options available. Each option has its own advantages, depending on the needs of the surviving spouse.  Read below to see which option benefits you best.

Are you the sole beneficiary to your spouse’s Traditional IRA?

If you are not the sole beneficiary, your situation is a bit more complicated.  Check out our “Can I Delay the RMD from the Traditional IRA I Inherited?” flowchart here If you are the sole beneficiary, move on to the next question.

What best describes your situation:

You plan to use all the assets in five years

Consider electing the 5 year rule if you expect significant expenses over the next five years that will deplete the account.  This allows you to take distributions at any time over the next five years of any amount, provided the account is depleted at the end of five years.  Keep in mind you will need to pay ordinary income tax on all distributions in the year they are taken.

You want income and are younger than 59.5 years old

Consider inheriting the IRA, which will allow you to take distributions from the IRA penalty-free.  You will be required to take RMDs based on the IRS Single Life Expectancy table.  Of course, you can take any amount of distributions that you need as long as the distribution is greater than or equal to the RMD.

You don’t want income and/or are younger than your deceased spouse

Consider rolling over the IRA into your own IRA.  This will allow you to avoid taking RMDs until the year after you turn 70.5.  If needed, you can take distributions as soon as you hit 59.5.

 

There are a lot of factors to consider when deciding which option is best for you.  Check out this flowchart to learn more.

If you would like to schedule a call to talk about the best strategy for an IRA you have inherited, give us a call at 303-440-2906 or click here to schedule a time to speak with us.

 

 Robert J. Pyle, CFP®, CFA is president of Diversified Asset Management, Inc. (DAMI). DAMI is licensed as an investment adviser with the State of Colorado Division of Securities, and its investment advisory representatives are licensed by the State of Colorado. DAMI will only transact business in other states to the extent DAMI has made the requisite notice filings or obtained the necessary licensing in such state. No follow up or individualized responses to persons in other jurisdictions that involve either rendering or attempting to render personalized investment advice for compensation will be made absent compliance with applicable legal requirements, or an applicable exemption or exclusion. It does not constitute investment or tax advice. To contact Robert, call 303-440-2906 or e-mail info@diversifiedassetmanagement.com.

 

The views, opinion, information and content provided here are solely those of the respective authors, and may not represent the views or opinions of Diversified Asset Management, Inc.  The selection of any posts or articles should not be regarded as an explicit or implicit endorsement or recommendation of any such posts or articles, or services provided or referenced and statements made by the authors of such posts or articles.  Diversified Asset Management, Inc. cannot guarantee the accuracy or currency of any such third party information or content, and does not undertake to verify or update such information or content. Any such information or other content should not be construed as investment, legal, accounting or tax advice.

 

Well-Traveled? Don’t Get Tripped Up on Tax Day

Cross-border issues to remember while filing U.S. taxes (first in a series)


Key Takeaways:

  • The IRS takes the definition of “global” seriously. All global income, including employee stock option plans, must be reported.

  • There is an increased focus on offshore income tax compliance.

  • The IRS also expects to hear from all U.S. citizens and green card holders living overseas.

  • Taxpayers might be failing this compliance simply because they are not aware of the rules.

  • Make sure your advisors are staying up to date on offshore income rules. 

 

As you get ready to put the final touches on your tax return, here are some important things that you and your financial advisors should remember with respect to global income compliance.

All global income must be reported

If you are a U.S. resident or U.S. citizens (whether NRI, PIO or OCI), you must pay taxes in the U.S. on all global income. A U.S. resident is a green card holder and/or someone who has been physically present in the United States for at least 31 days during the current year and for at least 183 days during the three-year period that includes the current year and the two preceding years. To satisfy the 183-day requirement, count all the days that you were present in the current year, add one-third of the days you were present in the first year before the current year, and then add one-sixth of the days you were present in the second year before the current year.

Global income will include:

  • Any salary partly received in another country.

  • Any income received overseas for freelance or consulting work.

  • Interest on bank deposits and other securities held overseas.

  • Dividends from shares and mutual funds.

  • Capital gains from sale of assets.

  • Rent from property.

Remember, your global income will be taxed in the U.S. as per rules that apply to similar income in the U.S. For instance, while dividends may be tax-free in India, they are taxed in the U.S., and hence your dividends from India will be taxed in the U.S. The same goes for capital gains. According to U.S. law, the definition of “long term” is one year for all assets, but it may be different in other countries. When you file tax returns in the U.S., you must take into account this difference and treat overseas capital gains as per the time period specified in U.S. law.

If you have paid tax in the overseas country from which the income described above is derived, you must check the Double Taxation Avoidance Agreement to see if you are eligible to claim a foreign tax credit.

Tip: When you fill in Schedule B of your tax return Form 1040, pay close attention to line 7. Line 7 asks if the taxpayer had, during the tax year, held any financial interest in or signature authority over a foreign financial account (such as a bank account, securities account or brokerage account). Make sure you confirm that you indeed had overseas investments.

ESOP taxation

Did you exercise an employee stock option plan (ESOP) in 2017? If so, that’s one more thing you must declare on your U.S. tax return. In the U.S., the value of ESOPs granted is taxed at the time when the employee exercises the option.

You must add the total value of their ESOP compensation to your total income in the U.S. Since you may have also paid tax in the country where the ESOP originated, you will be eligible to claim a tax credit in their U.S. tax returns. You must refer to the Double Taxation Avoidance Agreement.

Tip: You can disclose this as other income in Form 1040. You can claim foreign tax credit using Form 1116.

U.S. citizens and green card holders living overseas

In this connected world, you may be constantly on the move. This is a red flag.

Regardless of where you live, all U.S. citizens and green card holders must file tax returns in the U.S. based on their total global income. You must pay taxes on such foreign income unless a treaty or statutory exclusion or foreign tax credit applies to reduce your U.S. tax liability to zero.

In such cases, if you are a U.S. citizen or a green card holder residing overseas, on the regular due date of your return, you are allowed an automatic two-month extension to file your return and to pay any amount due without requesting an extension. So this year, the automatic two-month extension goes to June 15. But remember, while no penalty is charged, interest is still charged on the balance due between April 15 and June 15.

If you are unable to file a return by the automatic two-month extension date, you can request an additional extension to October 15 by filing Form 4868 before the automatic two-month extension date. However, any tax due payments made after June 15 will be subject to both interest charges and failure-to-pay penalties.

Tip: Filing U.S. tax returns from overseas can be quite a challenge. Not all software is equipped to handle foreign tax issues such as earned income exclusions—Form 2555, foreign tax credit—Form 1116, Form 8938, Form 8833 and so on. In such cases, you and your advisors will need to file a paper return.

Conclusion

Foreign income compliance is becoming increasingly important to the IRS. As the Foreign Account Tax Compliance Act (FATCA) gathers steam, opportunities to come into compliance without harsh penalties will diminish. The sooner you act the better.

In the next installment of this article series, we’ll look at the various additional forms that must be included with the 1040 to be compliant with global income reporting.



DISCLAIMER: The views expressed in this article do not necessarily express the views of our firm and should not be construed as professional tax advice.

 

Robert J. Pyle, CFP®, CFA is president of Diversified Asset Management, Inc. (DAMI). DAMI is licensed as an investment adviser with the State of Colorado Division of Securities, and its investment advisory representatives are licensed by the State of Colorado. DAMI will only transact business in other states to the extent DAMI has made the requisite notice filings or obtained the necessary licensing in such state. No follow up or individualized responses to persons in other jurisdictions that involve either rendering or attempting to render personalized investment advice for compensation will be made absent compliance with applicable legal requirements, or an applicable exemption or exclusion. It does not constitute investment or tax advice. To contact Robert, call 303-440-2906 or e-mail info@diversifiedassetmanagement.com.

 

The views, opinion, information and content provided here are solely those of the respective authors, and may not represent the views or opinions of Diversified Asset Management, Inc.  The selection of any posts or articles should not be regarded as an explicit or implicit endorsement or recommendation of any such posts or articles, or services provided or referenced and statements made by the authors of such posts or articles.  Diversified Asset Management, Inc. cannot guarantee the accuracy or currency of any such third party information or content, and does not undertake to verify or update such information or content. Any such information or other content should not be construed as investment, legal, accounting or tax advice.

Home Office Deductions

“Safe harbor” option may be easier, but number crunching is still worth it for many

 

Key Takeaways:

  • The IRS simplified option for home office deductions five years ago and million or taxpayers are taking advantage. Just be careful if you do.

  • This option can significantly reduce paperwork.

  • However, the annual limit is $1,500, and those with higher home office expenses may still be better off slogging through the detailed Form 8829.



According to the IRS, more than 3.4 million taxpayers claimed deductions totaling just over $9.6 billion for business use of a home, commonly referred to as the “home office deduction.”

Introduced in tax year 2013, the optional deduction is designed to reduce the paperwork and recordkeeping burden for small businesses. The optional deduction is capped at $1,500 per year, based on $5 a square foot for up to 300 square feet.

Back in 2013, the IRS announced a new, simplified method for claiming home office deductions. According to the IRS, this safe harbor method is an alternative to the existing requirement of calculation, allocation and substantiation of actual expenses, including mortgage payments and depreciation that is done in Form 8829.

Moreover, there is an annual limitation of $1,500 under this new method, thus making this a viable option for those with offices in apartments or smaller homes. Still, there is merit to understanding this option now and evaluating the best course for your business deductions.

Which method is best for me?

Before we look at the new option, let’s run through the existing method. The existing method involves several steps before you can arrive at the total for a home office deduction.

Step 1: Figure the percentage of your home used for business
Divide the total square footage of your home that you use for business by the square footage of your entire house. That percentage is what you’ll need for Step 3 below.

Step 2: Sum up all the expenses
This step involves the most paperwork. You need to list the various expenses such as rent and utilities or—in the case of ownership—mortgage interest, real estate taxes, insurance, repairs, utilities and the big one—depreciation. Lines 36 to 41 on Form 8829 involve going back and forth between the instructions several times to arrive at appropriate depreciation numbers.

Step 3: Apply the percentage from Step 1 to Step 2
You will use the percentage from Step 1 to figure the business part of the expenses for operating your entire home.

Now the new safe harbor option lets you claim a flat deduction of $5 per square foot of the home office, up to 300 square feet. That means if you use this method and have a home office of more than 300 square feet, you will be able to claim a maximum deduction of $1,500.

Some of the benefits of this method are:

  • You drastically reduce paperwork and compliance burden.

  • If you itemize deductions and use the safe harbor method, those expenses related to your home, such as mortgage interest and real estate taxes, can be itemized without allocating them between personal and business expenses.

  • You can choose either method from year to year depending on which one is beneficial in a particular year. A change from using the safe harbor method in one year to actual expenses in a succeeding taxable year or vice versa is not a change in your method of accounting and does not require the consent of the IRS.

Some of the limitations of this method are:

  • You are limited to claiming $1,500 per year irrespective of actual expenses incurred on the home office.

  • If you have a loss and cannot claim the entire deduction of $1,500 in a year, you cannot carry forward the home office expense to the following year. This would be possible if you claim actual expenses. Moreover, if you choose the safe harbor method, you cannot set off office expense carried forward from an earlier year.


The definition of what qualifies as a home office has not changed. In short, the home office

  • Must be used as your principal place of business.

  • It must be used “regularly and exclusively” for business

  • It cannot double as a place that you use for business as well as for personal purposes.

If you’re a professional, you may face various scenarios. You might be working from home for the most part of your practice, or you might be working from an office location but sometimes doing work at home. Each scenario is dealt with differently from a home office deduction point of view.

  • Home as your principal place of business: If you work from home for the most part of your business or practice, that is, you perform all important activities at this place and spend relatively more time there, then your home would be your principal place of business. In such a case, you can claim a deduction for the portion of your home that you use regularly and exclusively for your business.

  • Business at office location while doing some work at home: If you have separate office premises for conducting your business, then that would be your principal place of business. You cannot claim a deduction for use of your home during weekends or after office hours.

However, there is an important exception for professionals who also use their home for client meetings.

If you meet or deal with clients or customers in your home in the normal course of your business, even though you also carry on business at another location, you can deduct your expenses for the part of your home used exclusively and regularly for business if you meet both of these tests:

  • You physically meet with patients, clients or customers on your premises.

  • Their use of your home is substantial and integral to the conduct of your business.

The part of your home that you use exclusively and regularly to meet clients or customers does not have to be your principal place of business. Using your home for occasional meetings and telephone calls will not qualify you to deduct expenses for the business use of your home.

You and your tax advisor can make a decision regarding which method to choose, depending on a few pointers:

  • Do a back-of-the-envelope calculation of your home office expenses under both methods. Calculate the deduction under the safe harbor method by multiplying the area of your home office by $5 (limited to $1,500). If that is significantly less than the amount you claimed as a deduction in your most recent tax return, it might make sense to go through the trouble of filling out Form 8829.

  • If you have a loss from your business and would like to carry forward the home office expense, choose the actual expense method. If you have home office expenses from an earlier year that you would like to set off, use the actual expense method.

Conclusion

Claiming home office deductions is widely believed to be a common cause for an IRS audit. At the same time, genuine use of your home for business purposes can hand you a valuable deduction. The new method can significantly reduce paperwork and compliance burden for those with small home offices. But those with bigger spaces may want to choose the actual expense method. Cumbersome as it may seem, it might well be worth the effort.

DISCLAIMER: The views expressed in this article do not necessarily express the views of our firm and should not be construed as professional tax advice.

Robert J. Pyle, CFP®, CFA is president of Diversified Asset Management, Inc. (DAMI). DAMI is licensed as an investment adviser with the State of Colorado Division of Securities, and its investment advisory representatives are licensed by the State of Colorado. DAMI will only transact business in other states to the extent DAMI has made the requisite notice filings or obtained the necessary licensing in such state. No follow up or individualized responses to persons in other jurisdictions that involve either rendering or attempting to render personalized investment advice for compensation will be made absent compliance with applicable legal requirements, or an applicable exemption or exclusion. It does not constitute investment or tax advice. To contact Robert, call 303-440-2906 or e-mail info@diversifiedassetmanagement.com.

 

The views, opinion, information and content provided here are solely those of the respective authors, and may not represent the views or opinions of Diversified Asset Management, Inc.  The selection of any posts or articles should not be regarded as an explicit or implicit endorsement or recommendation of any such posts or articles, or services provided or referenced and statements made by the authors of such posts or articles.  Diversified Asset Management, Inc. cannot guarantee the accuracy or currency of any such third party information or content, and does not undertake to verify or update such information or content. Any such information or other content should not be construed as investment, legal, accounting or tax advice.

Staying Organized and Financial Planning Are Keys to Success

11 tactics to make this your best year ever

Key Takeaways:

  • The beginning of a new year is a particularly good time for you and your family to review finances and to update financial plans.

  • Staying organized and planning finances are lifelong processes, and the keys to reaching and maintaining financial success.

  • Sensible financial management is more than budgeting and saving for retirement. It’s about being ready to handle a lifetime of financial challenges, needs and changes.

Happy New Year to you and your family!

The beginning of a new year is a good time to review your finances and update financial strategies and plans. This year is especially important as financially challenging times continue for many individuals and businesses, rich and poor, big and small.

Even if the 2017 Tax Cut and Jobs Act (TCJA) had not been passed, most would say that managing their personal finances is more complicated and more important than ever before. We’re living longer, but saving proportionately less. Many of us feel less secure in our jobs and homes than we did in the past. We see our money being drained by the high cost of housing, taxes, education and health care. We worry about the future, or unfortunately, in too many cases, we simply try not to think about it.

More than simply budgeting and saving

Sensible financial management means much more than budgeting and putting money away for retirement. It means being equipped to handle a lifetime of financial challenges, needs and changes; figuring out how to build assets and staying ahead of inflation; taking advantage of deflation; and choosing wisely from a constantly widening field of savings, investment and insurance options. When it comes to finances, you are faced with more pressures and more possibilities than ever before.

The good news is that as complex as today’s financial world is, there’s no real mystery to sound personal money management. What you need is a solid foundation of organization and decision-making, plus the willingness to put those two things into action. I’ll talk about those core principles in just a minute.

Effective financial management involves certain procedures that you don’t usually learn from your parents or friends—and unfortunately they aren’t currently taught in our schools. It’s more than just a matter of gathering enough information and then making a logical decision. In fact, for many people, the constant barrage of economic news, fragmented financial information and investment product advertisements is part of the problem. Information overload can be a major obstacle to sorting out choices and making wise decisions.

The Financial Awareness Foundation, a California-based not-for-profit organization developed a simple personal financial management system that’s designed to help you save time and money, while providing a systematic approach to help you better manage finances. The key is to stay organized, remain aware of money issues, and make deliberate choices about ways to spend, save, insure and invest your assets. That’s so much smarter than simply following your emotions or “going with the flow.”

Getting organized

1. Paperwork. Everyone has primary financial documents—birth certificates, marriage certificates, current year net-worth statement, retirement plan beneficiary statements, deeds of trust, certificates of vehicle title, last three tax returns, gift tax returns, insurance policies, wills, trusts, powers of attorney, passwords, digital paperwork, etc. Organize this information and keep it in a safe central location that ties into your paper and digital filing systems.

2. Net Worth. Know where you stand by inventorying what you own and what you owe. The beginning of a new year is an excellent time to do this, but you can do it any time. Just be sure to do this personal inventory at least once a year.

3. Cash Flow. Gain control of cash flow by spending according to a plan, not spending impulsively.

4. Employment Benefits. Make sure you fully understand employee benefits (the “hidden paycheck”) at your company. Maximize any dollar amounts that your employer contributes toward health insurance, life insurance, retirement plans and other benefits.

Financial planning

5. Goal Setting. Before you begin the financial planning process, ask yourself what’s really important to you financially and personally. These are key elements of planning for your future; they affect your options, strategies and implementation decisions.

6. Financial Independence and Retirement Planning. A comfortable retirement, perhaps at an early age, is one of the most common reasons people become interested in financial planning. Determine how much money is a reasonable nest egg to reach and maintain your financial independence. Then work with your advisors to determine the right strategy to make that goal a reality.

7. Major Expenditures Planning. A home, a car, and a child’s or grandchild’s college education—these are all big-ticket items that are best planned for in advance. Develop sound financial strategies early on for effectively achieving the funding you need for those big bills down the road.

8. Investments Planning. For most of us, wise investing is the key to achieving and maintaining our financial independence as well as our other financial goals. Establish and refresh investment goals, risk tolerance and asset allocation models that best fit your situation.

9. Tax Planning. Your financial planning should include tax considerations, regardless of your level of wealth. Proactively take advantage of opportunities for minimizing tax obligations.

10. Insurance Planning. Decide what to self-insure and which risks to pass off to insurance companies—and at what price you’re willing to do so.

11. Estate Planning. Develop or update your estate plan. If you get sick or die without an up-to-date estate plan, the management and distribution of assets can become a time-consuming and costly financial challenge for loved ones and survivors.

It is estimated that over 120 million Americans do not have up-to-date estate plans to protect themselves and their families. This makes estate planning one of the most overlooked areas of personal financial management. Estate and financial planning is not just for the wealthy; it is an important process for everyone. With advance planning, issues such as guardianship of children, management of bill-paying and assets—including businesses and practices—care of a child with special needs or a parent, long-term care needs, wealth preservation, and distribution of retirement assets can all be handled with sensitivity and care and at a reasonable cost.

Conclusion

Staying organized and planning wisely are the keys to financial success. Short of winning the lottery or inheriting millions, few people can attain and maintain financial security without some forethought, strategy and ongoing management. The beginning of a new year is an excellent time for you and your family to review finances and update financial plans.


Let’s have a great 2019!

Robert J. Pyle, CFP®, CFA is president of Diversified Asset Management, Inc. (DAMI). DAMI is licensed as an investment adviser with the State of Colorado Division of Securities, and its investment advisory representatives are licensed by the State of Colorado. DAMI will only transact business in other states to the extent DAMI has made the requisite notice filings or obtained the necessary licensing in such state. No follow up or individualized responses to persons in other jurisdictions that involve either rendering or attempting to render personalized investment advice for compensation will be made absent compliance with applicable legal requirements, or an applicable exemption or exclusion. It does not constitute investment or tax advice. To contact Robert, call 303-440-2906 or e-mail info@diversifiedassetmanagement.com.

 

The views, opinion, information and content provided here are solely those of the respective authors, and may not represent the views or opinions of Diversified Asset Management, Inc.  The selection of any posts or articles should not be regarded as an explicit or implicit endorsement or recommendation of any such posts or articles, or services provided or referenced and statements made by the authors of such posts or articles.  Diversified Asset Management, Inc. cannot guarantee the accuracy or currency of any such third party information or content, and does not undertake to verify or update such information or content. Any such information or other content should not be construed as investment, legal, accounting or tax advice.

 

Optimizing Your Capital Gain Treatment Part 2

It’s a new world. When it comes to carried interest, real estate and collectibles, carefully document your purpose for holding these assets

Key Takeaways:

  • Long-term capital gains associated with assets held over one year are generally taxed at a maximum federal rate of 20 percent — not the top ordinary rate of 37 percent.

  • Just be careful if you are planning to sell collectibles, gold futures or foreign currency. The tax rate is generally higher.

  • The more you can document your purpose for holding your assets (at the time of purchase and disposition), the better your chances of a favorable tax result.

  • The deductibility of net capital losses in excess of $3,000 is generally deferred to future years.

There’s no shortage of confusion about the current tax landscape—both short-term and long term—but here are some steps you can take to protect yourself from paying a higher tax rate than necessary as we march into a new normal world.

 

Carried Interest

The Tax Cuts and Jobs Act lengthens the long-term holding period with respect to partnership interests received in connection with the performance of services. Profit interests held for three years or less at the time of disposition will generate short-term capital gain, taxed at ordinary income rates, regardless of whether or not a section 83(b) election was made. Prior law required a holding period greater than one-year to secure the beneficial maximum (20%) federal long-term capital gain tax rate.

Real estate

Real estate case law is too technical for the purposes of this article. Let’s just say the courts look at the following factors when trying to determine a personal real-estate owner’s intent:

  • Number and frequency of sales.

  • Extent of improvements.

  • Sales efforts, including through an agent.

  • Purpose for acquiring, holding and selling.

  • Manner in which property is acquired.

  • Length of holding period.

  • Investment of taxpayer’s time and effort, compared to time and effort devoted to other activities.

Unfortunately, the cases do not lay out a consistent weighting of these general factors. Always check with your legal and tax advisors before engaging in any type of real-estate transaction.


Collectibles

Works of art, rare vehicles, antiques, gems, stamps, coins, etc., may be purchased for personal enjoyment, but gains or losses from their sale are generally taxed as capital gains and losses. But, here’s the rub: Collectibles are a special class of capital asset to which a capital gain rate of 28 percent (not 20%) applies if the collectible items are sold after being held for more than one year (i.e. long-term).

Note that recently popular investments in gold and silver, whether in the form of coins, bullion or held through an exchange-traded fund, are generally treated as “collectibles” subject to the higher 28 percent rate. However, gold mining stocks are subject to the general capital gains rate applicable to other securities. Gold futures, foreign currency and other commodities are generally subject to a blended rate of capital gains tax (60 percent long-term, 40 percent short-term).

Bitcoin and other cryptocurrencies are treated as “property” rather than currency and will trigger long-term or short-term capital gains when the funds are sold, traded or spent. Cryptocurrencies are NOT classified as collectibles.

The difficulties arise if you get to the point that you are considered a dealer rather than a collector, or if you are a legitimate dealer but start selling items from your personal collection. In most cases, the following factors in determining whether sales of collectibles result in capital gain or ordinary income:

  • Extent of time and effort devoted to enhancing the collectible items

  • Extent of advertising, versus unsolicited offers

  • Holding period and frequency of sales from personal collection

  • Sales of collectibles as sole or primary source of taxpayer’s income

The Tax Cuts and Jobs Act, will end any further discussion about whether gain on the sale of collectibles can be deferred through the use of a like-kind exchange. The tax bill limits the application of section 1031 to real property disposed of after December 31, 2017.

Recommended steps to preserve capital gain treatment:

  • Clearly identify assets held for investment in books and records, segregating them from assets held for sale or development.

  • In the case of collectibles, physically segregate and document the personal collection from inventory held for sale.

  • Memorialize the reason(s) for a change in intent for holding: e.g., death or divorce of principals, legal entanglements, economic changes or new alternate opportunities presented.

  • If a property acquired with the intent to rent is sold prematurely, then retain documentation that supports the decision to sell: e.g., unsuccessful marketing and advertising, failed leases, news clippings of an adverse event or sluggish rental market.

  • If a property is rented out after making substantial improvements, then document all efforts to rent, and list or advertise it for sale only after a reasonable period of rental.

  • Consider selling appreciated/unimproved property to a separate entity before undertaking development. This would necessitate early gain recognition, but may preserve the capital gain treatment on the appreciation that’s realized during the predevelopment period.

  • Consider the application of Section 1237, a limited safe harbor, permitting certain non-C Corporation investors to divide unimproved land into parcels or lots before sale, without resulting in a conversion to dealer status.

Conclusion

Characterizing an asset as ordinary or capital can result in a significant tax rate differential. It can also affect your ability to net gains and losses against other taxable activities. So you must spend the time and effort needed to document the intent of the acquisition of an asset, as well as any facts that might change the character of the asset, during the holding period.

Sure, we’re all busy. But, in today’s new regulatory and tax landscape, don’t you think it’s worth taking the time to do so in order to potentially cut your future tax rate in half?

 

Robert J. Pyle, CFP®, CFA is president of Diversified Asset Management, Inc. (DAMI). DAMI is licensed as an investment adviser with the State of Colorado Division of Securities, and its investment advisory representatives are licensed by the State of Colorado. DAMI will only transact business in other states to the extent DAMI has made the requisite notice filings or obtained the necessary licensing in such state. No follow up or individualized responses to persons in other jurisdictions that involve either rendering or attempting to render personalized investment advice for compensation will be made absent compliance with applicable legal requirements, or an applicable exemption or exclusion. It does not constitute investment or tax advice. To contact Robert, call 303-440-2906 or e-mail info@diversifiedassetmanagement.com.

 

The views, opinion, information and content provided here are solely those of the respective authors, and may not represent the views or opinions of Diversified Asset Management, Inc.  The selection of any posts or articles should not be regarded as an explicit or implicit endorsement or recommendation of any such posts or articles, or services provided or referenced and statements made by the authors of such posts or articles.  Diversified Asset Management, Inc. cannot guarantee the accuracy or currency of any such third party information or content, and does not undertake to verify or update such information or content. Any such information or other content should not be construed as investment, legal, accounting or tax advice.

 

Withdrawal Strategies: Tax-Efficient Withdrawal Sequence

Key Takeaways:

  • Retirees’ portfolios may last longer if they incur the least amount of income tax possible over their retirement period.

  • Retirees should focus on minimizing the government’s share of their tax-deferred accounts.

  • Make sure your advisor is helping you select the appropriate dollar amount and the appropriate assets to liquidate in order to fund your retirement lifestyle.

Asset Placement Decision

A winning investment strategy is about much more than choosing the asset allocation that will provide the greatest chance of achieving one’s financial goals. It also involves what is called the asset location decision. Academic literature on asset location commonly suggests that investors should place their highly taxed assets, such as bonds and REITs, in tax-deferred accounts and place their tax-preferred assets, such as stocks, in taxable accounts.

In general, your most tax-efficient equities should be held in taxable accounts whenever possible. Holding them in tax-deferred accounts can result in the following disadvantages:

  • The potential for favorable capital gains treatment is lost.

  • The possibility of a step-up in basis at death for income tax purposes is lost.

  • For foreign equities, foreign tax credit is lost.

  • The potential to perform tax-loss harvesting is lost.

  • The potential to donate appreciated shares to charities and avoid taxation is lost.

Asset location decisions can benefit both your asset accumulation phase and retirement withdrawal phase. During the withdrawal phase, the decision about where to remove assets in order to fund your lifestyle should be combined with a plan to avoid income-tax-bracket creeping. This will ensure that your financial portfolio can last as long as possible.

Tax-Efficient Withdrawal Sequence

Baylor University Professor, William Reichenstein, PhD, CFA wrote a landmark paper in 2008 that’s still highly relevant today. It’s called: Tax-Efficient Sequencing of Accounts to Tap in Retirement. It’s fairly technical, but it provides some answers about the most income-tax-efficient withdrawal sequence to fund retirement that are still valid today. According to Reichenstein, “Returns on funds held in Roth IRAs and traditional IRAs grow effectively tax exempt, while funds held in taxable accounts are usually taxed at a positive effective tax rate.”

Reichenstein also noted that only part of a traditional IRA’s principal belongs to the investor. The IRS “owns” the remaining portion, so the goal is to minimize the government’s share, he argued.

Tax-Efficient Withdrawal Sequence Checklist

In our experience, retirees should combine the goal of preventing income-tax-bracket creeping over their retirement years with the goal of minimizing the government’s share of tax-deferred accounts.

To achieve this goal, the dollar amount of non-portfolio sources of income that are required to be reported in the retiree’s income tax return must be understood. These income sources can include defined-benefit plan proceeds, employee deferred income, rental income, business income and required minimum distribution from tax-deferred accounts. Reporting this income, less income tax deductions, is the starting point of the retiree’s income tax bracket before withdrawal-strategy planning.

The balance of the retiree’s lifestyle should be funded from his or her portfolio assets by managing tax-bracket creeping and by lowering the government ownership of the tax-deferred accounts. The following checklist can assist the retiree in achieving this goal:

  1. Avoid future bracket creeping by filling up the lower (10% and 12%) income tax brackets by adding income from the retiree’s tax-deferred accounts.

  2. If the retiree has sufficient cash flow to fund lifestyle expenses but needs additional income, convert traditional IRAs into Roth IRAs to avoid tax-bracket creeping in the future. This will also allow heirs to avoid income taxes on the inherited account balance.

  3. Locate bonds in traditional IRAs rather than in taxable accounts. This will reduce the annual reporting of taxable interest income on the tax return.

  4. Manage the income taxation of Social Security benefits by understanding the amount of reportable income based on the retiree’s adjusted gross income level.

  5. Liquidate high-basis securities rather than low-basis securities to fund the lifestyle for a retiree who needs cash but is sensitive to additional taxable income.

  6. Aggressively create capital losses when the opportunity occurs to carry forward to future years to offset future capital gains.

  7. Allow the compounding of tax-free growth in Roth IRAs by deferring distributions from these accounts.

  8. Consider a distribution from a Roth for a year in which cash is needed but the retiree is in a high income tax bracket.

  9. Consider funding charitable gifts by transferring assets from a traditional IRA directly to the charity. This avoids the ordinary income on the IRA growth.

  10. Consider funding charitable gifts by selecting low-basis securities out of the taxable accounts in lieu of cash. This avoids capital gains on the growth.

  11. Manage capital gains in taxable accounts by avoiding short-term gains.

Conclusion

You and your advisor should work together closely to make prudent, tax-efficient withdrawal decisions to ensure your money lasts throughout your retirement years. Contact us any time if you have questions about your retirement funding plans or important changes in your life circumstances.

Robert J. Pyle, CFP®, CFA is president of Diversified Asset Management, Inc. (DAMI). DAMI is licensed as an investment adviser with the State of Colorado Division of Securities, and its investment advisory representatives are licensed by the State of Colorado. DAMI will only transact business in other states to the extent DAMI has made the requisite notice filings or obtained the necessary licensing in such state. No follow up or individualized responses to persons in other jurisdictions that involve either rendering or attempting to render personalized investment advice for compensation will be made absent compliance with applicable legal requirements, or an applicable exemption or exclusion. It does not constitute investment or tax advice. To contact Robert, call 303-440-2906 or e-mail info@diversifiedassetmanagement.com.

 

The views, opinion, information and content provided here are solely those of the respective authors, and may not represent the views or opinions of Diversified Asset Management, Inc.  The selection of any posts or articles should not be regarded as an explicit or implicit endorsement or recommendation of any such posts or articles, or services provided or referenced and statements made by the authors of such posts or articles.  Diversified Asset Management, Inc. cannot guarantee the accuracy or currency of any such third party information or content, and does not undertake to verify or update such information or content. Any such information or other content should not be construed as investment, legal, accounting or tax advice.

 

Qualified Opportunity Funds

Impact investing—using wealth to create positive change in the world while also benefiting financially—has become increasingly popular, as the idea of “doing well by doing good” has gained traction among investors.

Now there’s a new type of impact investment—called Qualified Opportunity Funds—that is worth checking out if you’re looking to build wealth, reduce a capital gains tax, and improve communities across the country. For investors with these goals, the funds can potentially be a powerful part of an overall wealth plan.

Sparking economic growth

Qualified Opportunity Funds invest in properties in economically distressed communities categorized as Qualified Opportunity Zones, which have been targeted for economic development.

These funds, which are generally formed as partnerships or corporations, can own a broad range of properties—from apartment buildings to start-up businesses—that exist in Qualified Opportunity Zones. By investing in these funds, you can help give communities a much-needed economic boost.

The full article can be read here: Qualified Opportunity Funds

Robert J. Pyle, CFP®, CFA is president of Diversified Asset Management, Inc. (DAMI). DAMI is licensed as an investment adviser with the State of Colorado Division of Securities, and its investment advisory representatives are licensed by the State of Colorado. DAMI will only transact business in other states to the extent DAMI has made the requisite notice filings or obtained the necessary licensing in such state. No follow up or individualized responses to persons in other jurisdictions that involve either rendering or attempting to render personalized investment advice for compensation will be made absent compliance with applicable legal requirements, or an applicable exemption or exclusion. It does not constitute investment or tax advice. To contact Robert, call 303-440-2906 or e-mail info@diversifiedassetmanagement.com.

 

The views, opinion, information and content provided here are solely those of the respective authors, and may not represent the views or opinions of Diversified Asset Management, Inc.  The selection of any posts or articles should not be regarded as an explicit or implicit endorsement or recommendation of any such posts or articles, or services provided or referenced and statements made by the authors of such posts or articles.  Diversified Asset Management, Inc. cannot guarantee the accuracy or currency of any such third party information or content, and does not undertake to verify or update such information or content. Any such information or other content should not be construed as investment, legal, accounting or tax advice.

Diversified Asset Management, Inc. - 2019 1st Quarter Newsletter

New Year's Resolution: Review Your Estate Plan

Before you ring in another New Year, you may want to take time out of your busy schedule to observe another annual ritual: a review of your estate plan. If you're like most people, you probably stuck your will and other documents in a drawer or a safe deposit box as soon as you had them drawn up-and have rarely thought about them since. But changes in your personal circumstances or other events could mean it's time for an update.

Good Riddance To The Alternative Minimum Tax

Perhaps the most despised federal levy is the alternative minimum tax, which Congress passed in 1969 to prevent the loophole- savvy ultra-wealthy from shortchanging Uncle Sam.

Over the years, AMT's reach expanded to include households with more than $200,000 in AGI (adjusted gross income) annually and two- earner couples with children in high- tax states.

Reduce Your Widow’s Tax Bill Materially Annually

This is a good time to consider converting a traditional individual retirement account into a Roth IRA. Tax rates are low but unlikely to stay that way. Here's a long- term strategy that takes advantage of the current tax policy and economic fundamentals - a tax-efficient retirement investment and avoids a new twist in the Tax Cut And Jobs Act that penalizes widows.

Giving More to Loved Ones- Tax Free

While it may be better to give than to receive, as the adage contends, both givers and receivers should be happy with the new tax law. The annual amount you can give someone tax-free has been raised to $15,000, from $14,000 in 2017.

Protect Yourself Against Spearphishing

The Russian conspiracy to meddle in the 2016 presidential campaign relied on a common scam called "spearphishing." While the history-making scam may sound sophisticated, this form of digital fraud is running rampant. Anyone using email is likely to be attacked these days. Here are some tips to protect yourself.

Sidestepping New Limits on Charitable Donations

If you think you're no longer allowed to deduct items like charitable donations on your income tax return, think again.

The new tax law doubled the standard deduction, slashing the number of Americans eligible to itemize deductions from 37 million to 16 million.

To read the full newsletter click here.

Robert J. Pyle, CFP®, CFA is president of Diversified Asset Management, Inc. (DAMI). DAMI is licensed as an investment adviser with the State of Colorado Division of Securities, and its investment advisory representatives are licensed by the State of Colorado. DAMI will only transact business in other states to the extent DAMI has made the requisite notice filings or obtained the necessary licensing in such state. No follow up or individualized responses to persons in other jurisdictions that involve either rendering or attempting to render personalized investment advice for compensation will be made absent compliance with applicable legal requirements, or an applicable exemption or exclusion. It does not constitute investment or tax advice. To contact Robert, call 303-440-2906 or e-mail info@diversifiedassetmanagement.com.

 

The views, opinion, information and content provided here are solely those of the respective authors, and may not represent the views or opinions of Diversified Asset Management, Inc.  The selection of any posts or articles should not be regarded as an explicit or implicit endorsement or recommendation of any such posts or articles, or services provided or referenced and statements made by the authors of such posts or articles.  Diversified Asset Management, Inc. cannot guarantee the accuracy or currency of any such third party information or content, and does not undertake to verify or update such information or content. Any such information or other content should not be construed as investment, legal, accounting or tax advice.

 

Optimize Your Capital Gain Treatment

Carefully document the purpose for holding your assets


Key Takeaways:

  • Long-term capital gains associated with assets held over one year are generally taxed at a maximum federal rate of 20 percent — not the top ordinary rate of 39.6 percent.

  • Just be careful if you are planning to sell collectibles, gold futures or foreign currency. The tax rate is generally higher.

  • The more you can document your purpose for holding your assets (at the time of purchase and disposition), the better your chances of a favorable tax result.

  • The deductibility of net capital losses in excess of $3,000 is generally deferred to future years.

 

There’s no shortage of confusion about the current tax landscape—both short-term and long term—but here are some steps you can take to protect yourself from paying a higher tax rate than necessary as we march into a new normal world.

Capital assets vs. ordinary income assets

The IRS oddly defines a capital asset by describing what it is not, rather than describing what it is. For instance, the following “ordinary income” assets are not considered capital assets: Inventory, property held for sale to customers, artistic compositions created by the taxpayer’s personal efforts, and accounts or notes receivable acquired or originating in the ordinary course of a trade or business. With the 2017 Tax Cuts and Jobs Act signed into law, self-created patents and other intellectual property will be added to this list.

Assets used in a trade or business that qualify for depreciation, also known as “Section 1231 Assets,” are not capital assets. However, a disposition of such property that results in a gain may enjoy, at least partially, capital gain treatment.

Most other noncash assets are considered capital assets. However, the tax consequences upon disposition are further dependent on whether these assets are held for investment or personal use.

Personal assets

Assets acquired primarily for personal use are generally not purchased with the primary intent of anticipating future appreciation. Nevertheless, if such an asset does appreciate, the gain from its sale is taxed as a capital gain. In the case of a gain on the sale of a personal residence, the capital gain is first reduced by a generous exclusion, in most cases up to $500,000 for joint filers. Losses on sales of personal assets, however, are rarely deductible.

Investment assets

In addition to creating wealth through appreciation, investment assets may also produce a current income stream in the form of interest, dividends, royalties or rents. The most common investments are:

  • Real property

  • Securities

  • Collectibles

Dealer vs. investor vs. trader

In the case of the three asset categories above, whether a holding is considered an “ordinary income asset” or a “capital asset” depends primarily on what you intend to do with those assets. Intent is most important at the time of disposition (i.e. sale), but asset re-characterization during the holding period may be more closely scrutinized in an audit.

In general, a “dealer” acts as a merchant or middleman, purchasing assets at one price and selling them to customers at a higher price to reflect compensation (“markup”) for risk, handling costs and other services. An “investor” holds property to benefit from the appreciation upon a later disposition. Difficulties arise when you, the taxpayer, act as a dealer in some transactions and as an investor in others—or if you acquire an asset with the intent to resell it, and then decide later to retain it as an investment.

Conclusion

Characterizing an asset as ordinary or capital can result in a significant tax rate differential. It can also affect your ability to net gains and losses against other taxable activities. So you must spend the time and effort needed to document the intent of the acquisition of an asset, as well as any facts that might change the character of the asset, during the holding period.

Sure, we’re all busy. But, in today’s unpredictable regulatory and tax landscape, don’t you think it’s worth taking the time to do so in order to potentially cut your future tax rate in half?’

Robert J. Pyle, CFP®, CFA is president of Diversified Asset Management, Inc. (DAMI). DAMI is licensed as an investment adviser with the State of Colorado Division of Securities, and its investment advisory representatives are licensed by the State of Colorado. DAMI will only transact business in other states to the extent DAMI has made the requisite notice filings or obtained the necessary licensing in such state. No follow up or individualized responses to persons in other jurisdictions that involve either rendering or attempting to render personalized investment advice for compensation will be made absent compliance with applicable legal requirements, or an applicable exemption or exclusion. It does not constitute investment or tax advice. To contact Robert, call 303-440-2906 or e-mail info@diversifiedassetmanagement.com.

The views, opinion, information and content provided here are solely those of the respective authors, and may not represent the views or opinions of Diversified Asset Management, Inc.  The selection of any posts or articles should not be regarded as an explicit or implicit endorsement or recommendation of any such posts or articles, or services provided or referenced and statements made by the authors of such posts or articles.  Diversified Asset Management, Inc. cannot guarantee the accuracy or currency of any such third party information or content, and does not undertake to verify or update such information or content. Any such information or other content should not be construed as investment, legal, accounting or tax advice.

Year End Tax Loss Harvesting

A gift you can accept any time of year

Robert J. Pyle, CFP®, CFA, AEP®


Now is the time of year that thoughts turn to Holiday spirit, snow covered landscapes and cozy fireplaces. It’s also a great time to consider some tax-loss harvesting—maybe not what you expected in your Holiday stocking, but often a more valuable gift, courtesy of Uncle Sam. Even better, loss harvesting is a gift that you can give yourself all year round. Just make sure to ask your advisor for assistance. This is not an area in which you want to be a do-it-yourselfer.

The term “loss harvesting” can have unpleasant connotations, but a well-diversified portfolio will periodically have positions at a loss. Harvesting those losing positions helps mitigate their impact on your overall portfolio by providing a tangible tax benefit. Losses from positions sold below their cost basis can be used to offset gains from elsewhere in your portfolio—plus an additional $3,000 of remaining losses each year can be carried over to reduce your taxable income. Losses can be carried forward into future years. So, having a large chunk of losses stored up can allow for tax-free realization of subsequent gains such as when you rebalance your portfolio, sell a highly appreciated position, or want to make a gift to a child, grandchild or favorite cause.

Despite all the recent gyrations in the market, the year 2018 has been pretty flat overall for U.S. stocks. So, no tax loss harvesting opportunities this year, right? Not so fast. Chances are you have some international holdings in your portfolio that you purchased in the last year. Based on what’s happened to global markets recently, those holdings are probably down for the year. That’s going to be your first place to look for losses.

Why it’s so hard to let go

Behavioral finance studies show that people feel the pain of a loss much more than they enjoy the thrill of a gain. Investors will keep holding on to a losing position hoping the stock will eventually get back to the price at which they purchased it. Behavioral finance experts call that “anchoring.” If it’s the stock of a company they used to work for, investors will wait months, even years, to get back to breakeven (i.e. “gamblers fallacy”), because they think they know the company better than outside investors and “it’s only a matter of time” before the stock rebounds.

Don’t let your emotions and personal biases get in the way of sound decision-making. That’s why we recommend that most clients hold diversified mutual funds rather than individual stocks. You’ll get much less emotionally attached to funds than to equities, which makes it easier psychologically to sell losing positions--individual stocks are just too volatile.

Tax lot accounting

If you periodically invest in a fund, say after a biweekly paycheck, then you will have many, many positions at various cost bases. Following a market correction, your overall holding may still be showing a gain, but some of the positions are at a loss. It all depends on when you bought them. Designating the highest-cost basis lots for sales can increase the amount of loss harvesting you and your advisor can do. We have a powerful computer program that helps us scan all the different lots of the investments you purchased over the years. Then we use the HIFO cost basis (highest in first out), to sell the ones lots with the highest cost basis in order to minimize your taxes.


Wash rule

Just make sure you and your advisor are adhering to the “wash rule,” which disallows the recognition of a loss if the same, or substantially similar, security is purchased within 30 days of the sale (before or after). Through our partners at Dimensional Fund Advisors, we can offer you both tax-managed and non-tax managed funds that are similar, but which serve different purposes for tax planning.

For example, if you’re taking a loss on the tax managed fund, we can buy the non-tax managed fund and your overall asset allocation won’t change at all. Again, your overall allocation will be nearly identical, but the funds are essentially different and so the wash rule doesn’t come into play.

Your greater goals

When harvesting a loss, make sure you remain true to your existing investment plan. To prevent a tax-loss harvest from knocking your carefully structured portfolio out of balance, we reinvest the proceeds of any tax-loss harvest sale into a similar position (but not one that is “substantially identical,” as defined by the IRS). We also do this on the same day so your proceeds are not sitting in cash and you are out of the market for a day. Typically, we return the proceeds to your original position no sooner than 31 days later (after the IRS’s “wash sale rule” period has passed).


Conclusion

Loss harvesting is especially valuable when markets are highly volatile and peppered with steep drops. More often than not, we can find a position you can sell at a loss. With the left over proceeds, we can help you find a buying opportunity elsewhere that meets your investment plan and retirement goals—just not in the same fund.

Now that’s a gift that keeps on giving!

Robert J. Pyle, CFP®, CFA, AEP® is president of Diversified Asset Management, Inc. Contact Robert at 303-440-2906 | info@diversifiedassetmanagement.com.

Robert J. Pyle, CFP®, CFA is president of Diversified Asset Management, Inc. (DAMI). DAMI is licensed as an investment adviser with the State of Colorado Division of Securities, and its investment advisory representatives are licensed by the State of Colorado. DAMI will only transact business in other states to the extent DAMI has made the requisite notice filings or obtained the necessary licensing in such state. No follow up or individualized responses to persons in other jurisdictions that involve either rendering or attempting to render personalized investment advice for compensation will be made absent compliance with applicable legal requirements, or an applicable exemption or exclusion. It does not constitute investment or tax advice. To contact Robert, call 303-440-2906 or e-mail info@diversifiedassetmanagement.com.

The views, opinion, information and content provided here are solely those of the respective authors, and may not represent the views or opinions of Diversified Asset Management, Inc.  The selection of any posts or articles should not be regarded as an explicit or implicit endorsement or recommendation of any such posts or articles, or services provided or referenced and statements made by the authors of such posts or articles.  Diversified Asset Management, Inc. cannot guarantee the accuracy or currency of any such third party information or content, and does not undertake to verify or update such information or content. Any such information or other content should not be construed as investment, legal, accounting or tax advice.

 

 

Diversified Asset Management, Inc. - 2018 3rd Quarter Newsletter

New Ways To Influence The Next Generation

The Tax Cuts And Jobs Act of 2018 (TCJA) gives you more good reasons to help you children, grandchildren, great nieces and nephews. Any amount you give to a 529 account that's used to pay for qualified expenses for college as well as private or religious schooling before college is deductible. With tax reform eliminating all or a large chunk of state income-tax deductions for many individuals in 2018, giving to a 529 lightens your state income-tax load while perhaps changing a life of a family member or friend and influencing their values.

Are You “Rich” Or Not? New Survey Hits The High Points

Do you consider yourself rich? If you own a couple of mansions, a fleet of luxury cars, and financial accounts reaching high into the millions, it may be easy to answer that question. But other well-to-do people might struggle with the issue of whether they are "rich" or not. 

New Deduction Rules For Business Owners

If you are a small business owner, Washington, D.C. has changed tax rules to lower your burden but the new rules are fairly complex. Many small businesses, and some that aren't so small, are "pass-through companies," tax-jargon that means the entity's net income isn't taxed at the corporate level but flows straight to their owners' personal returns. That income is taxed at personal income tax rates, as opposed to corporate rates that are generally lower.

Five Retirement Questions To Answer

How much money do you need to save to live comfortably in retirement? Some experts base estimates on multiple of your current salary or income, while others focus on a flat amount such as a million dollars. Either way, the task can be daunting.

A Guide To The New Rules On Tax Deductions In 2018

Uncle Sam giveth, and Uncle Sam taketh away. New federal tax code, which went into effect in 2018 and affects the return you'll file in spring 2019, lowers taxes by expanding some deductions, but restricts or outright eliminates others.

Giving More To Loved Ones – Tax-Free

While it may be better to give than to receive, as the adage contends, both givers and receivers should be happy with the new tax law. The annual amount you can give someone tax-free has been raised to $15,000, from $14,000 in 2017.

To read the newsletter click on the link below:

Diversified Asset Management, Inc. - 2018 3rd Quarter Newsletter

Robert J. Pyle, CFP®, CFA is president of Diversified Asset Management, Inc. (DAMI). DAMI is licensed as an investment adviser with the State of Colorado Division of Securities, and its investment advisory representatives are licensed by the State of Colorado. DAMI will only transact business in other states to the extent DAMI has made the requisite notice filings or obtained the necessary licensing in such state. No follow up or individualized responses to persons in other jurisdictions that involve either rendering or attempting to render personalized investment advice for compensation will be made absent compliance with applicable legal requirements, or an applicable exemption or exclusion. It does not constitute investment or tax advice. To contact Robert, call 303-440-2906 or e-mail info@diversifiedassetmanagement.com.

 

The views, opinion, information and content provided here are solely those of the respective authors, and may not represent the views or opinions of Diversified Asset Management, Inc.  The selection of any posts or articles should not be regarded as an explicit or implicit endorsement or recommendation of any such posts or articles, or services provided or referenced and statements made by the authors of such posts or articles.  Diversified Asset Management, Inc. cannot guarantee the accuracy or currency of any such third party information or content, and does not undertake to verify or update such information or content. Any such information or other content should not be construed as investment, legal, accounting or tax advice.

17 Red Flags for IRS Auditors

Here is a nice article provided by Joy Taylor of Kiplinger:

 

By Joy Taylor, Assistant Editor | March 2017

 

Ever wonder why some tax returns are eyeballed by the Internal Revenue Service while most are ignored? Short on personnel and funding, the IRS audited only 0.70% of all individual tax returns in 2016. So the odds are pretty low that your return will be singled out for review. And, of course, the only reason filers should worry about an audit is if they are fudging on their taxes.

 

That said, your chances of being audited or otherwise hearing from the IRS escalate depending on various factors, including your income level, the types of deductions or losses you claim, the business you're engaged in, and whether you own foreign assets. Math errors may draw IRS inquiry, but they'll rarely lead to a full-blown exam. Although there's no sure way to avoid an IRS audit, these 17 red flags could increase your chances of unwanted attention from the IRS.

 

1. Making a Lot of Money

Although the overall individual audit rate is only about one in 143 returns, the odds increase dramatically as your income goes up. IRS statistics for 2016 show that people with an income of $200,000 or higher had an audit rate of 1.70%, or one out of every 59 returns. Report $1 million or more of income? There's a one-in-17 chance your return will be audited. The audit rate drops significantly for filers making less than $200,000: Only 0.65% (one out of 154) of such returns were audited during 2016, and the vast majority of these exams were conducted by mail.

We're not saying you should try to make less money — everyone wants to be a millionaire. Just understand that the more income shown on your return, the more likely it is that you'll be hearing from the IRS.

2. Failing to Report All Taxable Income

The IRS gets copies of all of the 1099s and W-2s you receive, so be sure you report all required income on your return. IRS computers are pretty good at matching the numbers on the forms with the income shown on your return. A mismatch sends up a red flag and causes the IRS computers to spit out a bill. If you receive a 1099 showing income that isn't yours or listing incorrect income, get the issuer to file a correct form with the IRS.

3. Taking Higher-than-Average Deductions

If the deductions on your return are disproportionately large compared with your income, the IRS may pull your return for review. But if you have the proper documentation for your deduction, don't be afraid to claim it. There's no reason to ever pay the IRS more tax than you actually owe.

4. Running a Small Business

Schedule C is a treasure trove of tax deductions for self-employed people. But it's also a gold mine for IRS agents, who know from experience that self-employed people sometimes claim excessive deductions and don’t report all of their income. The IRS looks at both higher-grossing sole proprietorships and smaller ones.

Special scrutiny is also given to cash-intensive businesses (taxis, car washes, bars, hair salons, restaurants and the like) as well as to small business owners who report a substantial net loss on Schedule C.

Other small businesses also face extra audit heat, as the IRS shifts its focus away from auditing regular corporations. The agency thinks it can get more bang for its audit buck by examining S corporations, partnerships and limited liability companies. So it’s spending more resources on training examiners about issues commonly encountered with pass-through firms.

5. Taking Large Charitable Deductions

We all know that charitable contributions are a great write-off and help you feel all warm and fuzzy inside. However, if your charitable deductions are disproportionately large compared with your income, it raises a red flag.

That's because the IRS knows what the average charitable donation is for folks at your income level. Also, if you don't get an appraisal for donations of valuable property, or if you fail to file Form 8283 for noncash donations over $500, you become an even bigger audit target. And if you've donated a conservation or façade easement to a charity, chances are good that you'll hear from the IRS. Be sure to keep all of your supporting documents, including receipts for cash and property contributions made during the year.

6. Claiming Rental Losses

Normally, the passive loss rules prevent the deduction of rental real estate losses. But there are two important exceptions. If you actively participate in the renting of your property, you can deduct up to $25,000 of loss against your other income. This $25,000 allowance phases out as adjusted gross income exceeds $100,000 and disappears entirely once your AGI reaches $150,000. A second exception applies to real estate professionals who spend more than 50% of their working hours and over 750 hours each year materially participating in real estate as developers, brokers, landlords or the like. They can write off losses without limitation.

The IRS actively scrutinizes rental real estate losses, especially those written off by taxpayers claiming to be real estate pros. It’s pulling returns of individuals who claim they are real estate professionals and whose W-2 forms or other non-real estate Schedule C businesses show lots of income. Agents are checking to see whether these filers worked the necessary hours, especially in cases of landlords whose day jobs are not in the real estate business. The IRS started its real estate professional audit project several years ago, and this successful program continues to bear fruit.

7. Taking an Alimony Deduction

Alimony paid by cash or check is deductible by the payer and taxable to the recipient, provided certain requirements are met. For instance, the payments must be made under a divorce or separate maintenance decree or written separation agreement. The document can’t say the payment isn’t alimony. And the payer’s liability for the payments must end when the former spouse dies. You’d be surprised how many divorce decrees run afoul of this rule.

Alimony doesn’t include child support or noncash property settlements. The rules on deducting alimony are complicated, and the IRS knows that some filers who claim this write-off don’t satisfy the requirements. It also wants to make sure that both the payer and the recipient properly reported alimony on their respective returns. A mismatch in reporting by ex-spouses will almost certainly trigger an audit.

8. Writing Off a Loss for a Hobby

You must report any income you earn from a hobby, and you can deduct expenses up to the level of that income. But the law bans writing off losses from a hobby. To be eligible to deduct a loss, you must be running the activity in a business-like manner and have a reasonable expectation of making a profit. If your activity generates profit three out of every five years (or two out of seven years for horse breeding), the law presumes that you're in business to make a profit, unless the IRS establishes otherwise. Be sure to keep supporting documents for all expenses.

9. Deducting Business Meals, Travel and Entertainment

Big deductions for meals, travel and entertainment are always ripe for audit, whether taken on Schedule C by business owners or on Schedule A by employees.

A large write-off will set off alarm bells, especially if the amount seems too high for the business or profession. Agents are on the lookout for personal meals or claims that don't satisfy the strict substantiation rules. To qualify for meal or entertainment deductions, you must keep detailed records that document for each expense the amount, place, people attending, business purpose, and nature of the discussion or meeting. Also, you must keep receipts for expenditures over $75 or for any expense for lodging while traveling away from home. Without proper documentation, your deduction is toast

10. Failing to Report a Foreign Bank Account

The IRS is intensely interested in people with money stashed outside the U.S., especially in countries with the reputation of being tax havens, and U.S. authorities have had lots of success getting foreign banks to disclose account information. The IRS also uses voluntary compliance programs to encourage folks with undisclosed foreign accounts to come clean — in exchange for reduced penalties. The IRS has learned a lot from these amnesty programs and has been collecting a boatload of money (we’re talking billions of dollars). It’s scrutinizing information from amnesty seekers and is targeting the banks they used to get names of even more U.S. owners of foreign accounts.

Failure to report a foreign bank account can lead to severe penalties. Make sure that if you have any such accounts, you properly report them. This means electronically filing FinCEN Form 114 by April 15 to report foreign accounts that combined total more than $10,000 at any time during the previous year. And taxpayers with a lot more financial assets abroad may also have to attach IRS Form 8938 to their timely filed tax returns.

11. Claiming 100% Business Use of a Vehicle

When you depreciate a car, you have to list on Form 4562 the percentage of its use during the year was for business. Claiming 100% business use of an automobile is red meat for IRS agents. They know that it's rare for someone to actually use a vehicle 100% of the time for business, especially if no other vehicle is available for personal use.

The IRS also targets heavy SUVs and large trucks used for business, especially those bought late in the year. That’s because these vehicles are eligible for favorable depreciation and expensing write-offs. Be sure you keep detailed mileage logs and precise calendar entries for the purpose of every road trip. Sloppy recordkeeping makes it easy for a revenue agent to disallow your deduction.

As a reminder, if you use the IRS's standard mileage rate, you can't also claim actual expenses for maintenance, insurance and the like. The IRS has seen such shenanigans and is on the lookout for more.

12. Taking an Early Payout from an IRA or 401(k) Account

The IRS wants to be sure that owners of traditional IRAs and participants in 401(k)s and other workplace retirement plans are properly reporting and paying tax on distributions. Special attention is being given to payouts before age 59½, which, unless an exception applies, are subject to a 10% penalty on top of the regular income tax. An IRS sampling found that nearly 40% of individuals scrutinized made errors on their income tax returns with respect to retirement payouts, with most of the mistakes coming from taxpayers who didn’t qualify for an exception to the 10% additional tax on early distributions. So the IRS will be looking at this issue closely.

The IRS has a chart listing withdrawals taken before the age of 59½ that escape the 10% penalty, such as payouts made to cover very large medical costs, total and permanent disability of the account owner, or a series of substantially equal payments that run for five years or until age 59½, whichever is later.

13. Claiming Day-Trading Losses on Schedule C

People who trade in securities have significant tax advantages compared with investors. The expenses of traders are fully deductible and are reported on Schedule C (investors report their expenses as a miscellaneous itemized deduction on Schedule A, subject to an offset of 2% of adjusted gross income), and traders’ profits are exempt from self-employment tax. Losses of traders who make a special section 475(f) election are fully deductible and are treated as ordinary losses that aren’t subject to the $3,000 cap on capital losses. And there are other tax benefits.

But to qualify as a trader, you must buy and sell securities frequently and look to make money on short-term swings in prices. And the trading activities must be continuous. This is different from an investor, who profits mainly on long-term appreciation and dividends. Investors hold their securities for longer periods and sell much less often than traders.

The IRS knows that many filers who report trading losses or expenses on Schedule C are actually investors. So it’s pulling returns and checking to see that the taxpayer meets all of the rules to qualify as a bona fide trader.

14. Failing to Report Gambling Winnings or Claiming Big Gambling Losses

Whether you’re playing the slots or betting on the horses, one sure thing you can count on is that Uncle Sam wants his cut. Recreational gamblers must report winnings as other income on the front page of the 1040 form. Professional gamblers show their winnings on Schedule C. Failure to report gambling winnings can draw IRS attention, especially if the casino or other venue reported the amounts on Form W-2G.

Claiming large gambling losses can also be risky. You can deduct these only to the extent that you report gambling winnings (and recreational gamblers must also itemize). But the costs of lodging, meals and other gambling-related expenses can only be written off by professional gamblers. The IRS is looking at returns of filers who report large miscellaneous deductions on Schedule A Line 28 from recreational gambling, but aren’t including the winnings in income. Also, taxpayers who report large losses from their gambling-related activity on Schedule C get extra scrutiny from IRS examiners, who want to make sure these folks really are gaming for a living.

15. Claiming the Home Office Deduction

The IRS is drawn to returns that claim home office write-offs because it has historically found success knocking down the deduction. Your audit risk increases if the deduction is taken on a return that reports a Schedule C loss and/or shows income from wages. If you qualify for these savings, you can deduct a percentage of your rent, real estate taxes, utilities, phone bills, insurance and other costs that are properly allocated to the home office. That's a great deal.

Alternatively, you have a simplified option for claiming this deduction: The write-off can be based on a standard rate of $5 per square foot of space used for business, with a maximum deduction of $1,500.

To take advantage of this tax benefit, you must use the space exclusively and regularly as your principal place of business. That makes it difficult to successfully claim a guest bedroom or children's playroom as a home office, even if you also use the space to do your work. "Exclusive use" means that a specific area of the home is used only for trade or business, not also for the family to watch TV at night.

16. Engaging in Currency Transactions

The IRS gets many reports of cash transactions in excess of $10,000 involving banks, casinos, car dealers and other businesses, plus suspicious-activity reports from banks and disclosures of foreign accounts. So if you make large cash purchases or deposits, be prepared for IRS scrutiny. Also, be aware that banks and other institutions file reports on suspicious activities that appear to avoid the currency transaction rules (such as a person depositing $9,500 in cash one day and an additional $9,500 in cash two days later).

17. Claiming the Foreign Earned Income Exclusion

U.S. citizens who work overseas can exclude on 2016 returns up to $101,300 of their income earned abroad if they were bona fide residents of another country for the entire year or they were outside of the U.S. for at least 330 complete days in a 12-month span. Additionally, the taxpayer must have a tax home in the foreign country. The tax break doesn’t apply to amounts paid by the U.S. or one of its agencies to its employees who work abroad.

IRS agents actively sniff out people who are erroneously taking this break, and the issue keeps coming up in disputes before the Tax Court. Among the areas of IRS focus: filers with minimal ties to the foreign country they work in and who keep an abode in the U.S.; flight attendants and pilots; and employees of U.S. government agencies who mistakenly claim the exclusion when they are working overseas.

 

Robert J. Pyle, CFP®, CFA is president of Diversified Asset Management, Inc. (DAMI). DAMI is licensed as an investment adviser with the State of Colorado Division of Securities, and its investment advisory representatives are licensed by the State of Colorado. DAMI will only transact business in other states to the extent DAMI has made the requisite notice filings or obtained the necessary licensing in such state. No follow up or individualized responses to persons in other jurisdictions that involve either rendering or attempting to render personalized investment advice for compensation will be made absent compliance with applicable legal requirements, or an applicable exemption or exclusion. It does not constitute investment or tax advice. To contact Robert, call 303-440-2906 or e-mail  info@diversifiedassetmanagement.com.

 

The views, opinion, information and content provided here are solely those of the respective authors, and may not represent the views or opinions of Diversified Asset Management, Inc. The selection of any posts or articles should not be regarded as an explicit or implicit endorsement or recommendation of any such posts or articles, or services provided or referenced and statements made by the authors of such posts or articles. Diversified Asset Management, Inc. cannot guarantee the accuracy or currency of any such third party information or content, and does not undertake to verify or update such information or content. Any such information or other content should not be construed as investment, legal, accounting or tax advice.

10 Worst States To Live In For Taxes

Here is a nice article provided by Sandra Block of Kiplinger:

 

By Sandra Block, Senior Associate Editor | October 2016

 

Lots of people fret about how much they have to pay Uncle Sam, but he’s not the only tax man you have to worry about: Your state can squeeze you for plenty of taxes, too.

 

State income taxes or property taxes could cost you thousands of dollars every year. High sales taxes or gas taxes could slowly drain your funds every time you pull out your wallet.

 

Updated for 2016, here is our list of the 10 least tax-friendly states in the U.S., where you’ll pay above-average taxes on income, property, gas and almost everything you buy. The same states occupy the five “top” spots on our list as they did in 2015; Minnesota is the biggest mover on the list, now the No. 6 least-friendly state for taxes, in part due to a new top tax rate on the state’s highest earners. In many cases, taxes may rise even higher in the years ahead. Our review of states’ fiscal health reveals crippling deficits and pension liabilities that could lead to future tax hikes, service cuts or both.

 

Take a look. It’s not pretty.

 

Our calculation of each state’s effective tax rate is based on hypothetical individual and joint taxpayers with a variety of income sources. See last slide for a full explanation of our methodology.

 

1. California

State income tax: 1% (on income of up to $7,850/individual, $15,700/joint) - 13.3% (on income more than $1 million/individual, $1,052,886/joint)

Effective income tax rate: 3.2%/individual, 5.2%/joint

Average state and local sales tax: 8.48%

Gas taxes and fees: 38 cents per gallon (national average is 30 cents)

California tops our least-friendly list, thanks to a combination of high income taxes and hefty taxes on purchases and gas. California’s top income tax rate of 13.3% (the highest in the U.S.) doesn’t kick in until income exceeds $1 million; still, a married couple with earned income of $150,000 would pay about $7,500 a year in state income taxes.

California also has the highest statewide sales tax, at 7.5%. The average state and local combined rate is 8.48%; in some cities, the combined rate is as high as 10%, according to the Tax Foundation. Food and prescription drugs are exempt.

California’s gas taxes are down from a year ago, but they’re still the fifth-highest in the country. California also hits car owners with an annual vehicle license fee (VLF) of 0.65% of the purchase price of the vehicle (or the value when it was acquired) that’s reduced each year for the first 11 years of car ownership. For example, the VLF on a two-year-old vehicle purchased for $25,000 would be $147.

Californians pay lower property taxes than residents of other high-tax states, but in a state with some of the highest real estate prices in the U.S., they’re no bargain. The property tax on the state’s median home value of $412,700 is $3,160.

 

2. Hawaii

State income tax: 1.4% (on income of up to $2,400/individual, $4,800/joint) - 8.25% (on income of more than $48,000/individual, $96,000/joint)

Effective income tax rate: 6.5%/individual, 7.1%/joint

Average state and local sales tax: 4.35%

Gas taxes and fees: 44 cents per gallon (varies by county)

Hawaii has the highest effective income tax rate of all 50 states (only Washington, D.C., has a higher rate). A married couple with taxable income of $150,000 a year, two children, $5,000 in dividend income and mortgage interest of $10,000 would pay more than $9,300 a year in state income taxes. A single resident with $45,000 in earned income would pay more than $2,700.

Hawaii’s average combined state and local sales tax rate is 4.35%, among the lowest in the U.S. However, that’s misleading because few purchases, other than prescription drugs, are exempt from tax. Vehicles are subject to a 4% sales tax (technically an excise tax levied on businesses), even if they’re purchased on the mainland.

While property values are high, property taxes as a percentage of home value are the lowest in the U.S. The property tax on the state's median home value of $528,000 is $1,401, according to the Tax Foundation.

 

3. Connecticut

State income tax: 3% (on income of up to $10,000/individual, $20,000/joint) - 6.99% (on income of more than $500,000/individual, $1 million/joint)

Effective tax rate: 4.1%/individual, 5.2%/joint

State sales tax: 6.35%

Gas taxes and fees: 38 cents per gallon

The Constitution State is an expensive place to live. Connecticut’s property taxes are the fourth-highest in the U.S. The median property tax on the state’s median home value of $267,200 is $5,369.

There are no local sales taxes in Connecticut, so you’ll pay only the statewide rate of 6.35% on most of your purchases. Luxury items, such as cars valued at $50,000 or more or jewelry worth more than $5,000, are taxed at 7.75%, which means a $6,000 engagement ring would cost you $6,465. And if those baubles are a gift, keep in mind that Connecticut is the only state with a gift tax (the other is Minnesota), which applies to real and tangible personal property in Connecticut and intangible personal property anywhere for permanent residents.

Connecticut faces serious financial pressures that could force it to raise taxes even more. The state has more than $83 billion in unfunded pensions, and total liabilities exceed its assets by 34%, according to the Mercatus Center at George Mason University, which ranks Connecticut 50th in its analysis of states’ fiscal health.

 

4. New York

State income tax: 4.0% (on income of up to $8,450/individual, $17,050/joint) - 8.82% (on income of more than $1,070,350/individual, $2,140,900/joint). New York allows localities to impose their own income tax; the average levy is 2.11%, according to the Tax Foundation.

Effective income tax rate: 5.5%/individual, 6.4%/joint

Average state and local sales tax: 8.49%

Gas taxes and fees: 43 cents per gallon (varies by county)

The Empire State has a hefty effective income tax rate, and its average sales tax rate is the ninth-highest in the country, according to the Tax Foundation. Food and prescription and nonprescription drugs are exempt from taxes, as are greens fees, health club memberships, and most arts and entertainment tickets.

The property tax on the state's median home value of $279,100 is $4,703, the 10th-highest in the U.S.

The tax on cigarettes is $4.35 per pack, the highest in the U.S. New York City tacks on an additional $1.50 per pack.

 

5. New Jersey

State income tax: 1.4% (on income of up to $20,000) - 8.97% (on income of more than $500,000). New Jersey allows localities to impose their own income tax; the average levy is 0.5%, according to the Tax Foundation.

Effective income tax rate: 2.1% individual, 3.7%/joint

Average state and local sales tax: 6.97%

Gas taxes and fees: 38 cents per gallon

The effective tax rate for Garden State residents is relatively low compared with some other tax-unfriendly states. But while New Jersey gives residents a break on income taxes, it brings the hammer down when they buy a home. New Jersey’s property taxes are the highest in the U.S.; the property tax on the state’s median home value of $313,200 is $7,452.

Food, prescription and nonprescription drugs, clothing and footwear are exempt from the 7% state sales tax. Because some designated Urban Enterprise Zones, such as Newark, charge a reduced 3.5% sales tax on certain sales, New Jersey’s average state and local combined sales tax rate is actually 6.97%, according to the Tax Foundation.

Plus, with more than $188 billion in unfunded pension liabilities, the state’s long-term financial prospects are grim. A report by J.P. Morgan estimates that, in order to cover its massive debts, New Jersey would need to raise taxes by 26%, cut spending by 24% or increase pension plan participants’ contributions by 471%.

 

6. Minnesota

State income tax: 5.35% (on income of up to $25,180/individual, $36,820/joint) - 9.85% (on income of more than $155,650/individual, $259,420/joint)

Effective income tax rate: 5.8%/individual, 6.6%/joint

Average state and local sales tax: 7.27%

Gas taxes and fees: 29 cents per gallon

The North Star State added a new top income tax rate of 9.85% for high earners in 2015. But what makes Minnesota really stand out is its relatively high income tax rate of 5.35% even for the state’s lowest earners.

Food, clothing, and prescription and nonprescription drugs are exempt from the state sales tax of 6.875%. A few cities and counties add their own local sales tax. The average combined state and local sales tax rate is 7.27%, according to the Tax Foundation. The sales tax for vehicles is 6.5%, slightly lower than the overall state sales tax, and vehicles are not subject to local sales taxes.

The property tax on Minnesota's median home value of $188,300 is $2,148, the 20th-highest in the U.S.

Minnesota offers some property-tax relief for qualified homeowners. Homeowners whose property taxes are high relative to their incomes are eligible for a property tax refund.

 

7. Maine

State income tax: 5.8% (on income of up to $21,050/individual, $42,100/joint) - 7.15% (on income of more than $37,500/individual, $75,000/joint)

Effective income tax rate: 6.1%/individual, 6.6%/joint

State sales tax: 5.5%

Gas taxes and fees: 30 cents per gallon

Maine has been working to lower its income tax bite: In 2016, the top rate fell from 7.95% to 7.15%. However, the state’s “low” rate is 5.8% — higher than some other states’ top rate.

Maine is one of only a few states that prohibit local jurisdictions from imposing their own sales tax, so you won’t pay more than 5.5%, no matter where you live or shop. Food for home consumption and prescription drugs are exempt from sales taxes, but prepared foods in restaurants are taxed at 7%.

Maine imposes an annual excise tax on vehicles that’s based on the car’s age and value. The owner of a three-year-old car with a manufacturer’s suggested retail price of $19,500 would pay $263.25.

The property tax on Maine's median home value of $174,800 is $2,335, the 16th-highest in the country.

 

8. Vermont

State income tax: 3.55% (on income of up to $39,900/individual, $69,900/joint) - 8.95% (on income of more than $415,600/individual, $421,900/joint)

Effective income tax rate: 3.5%/individual, 5.2%/joint

Average state and local sales tax: 6.17%

Gas taxes and fees: 31 cents per gallon

Vermont’s effective tax rates are lower than those imposed in nearby New York, but it’s a pricey place to live if you’re wealthy. Vermont limits deductions to $15,500 for single residents and $31,000 for married couples — costing millionaires about $5,000 in additional state taxes every year.

The Green Mountain State is also an expensive place to own a home. The property tax on the state's median home value of $214,600 is $3,797, the eighth-highest in the U.S.

The average state and local combined sales tax rate is 6.17%, according to the Tax Foundation. Food, clothing, and prescription and nonprescription drugs are exempt from sales tax. Under a law that took effect in 2015, soft drinks aren’t exempt from sales tax. Restaurant meals are taxed at 9%; the tax on alcoholic beverages served in restaurants is 10%.

 

9. Illinois

State income tax: 3.75%

Average state and local sales tax: 8.64%

Gas taxes and fees: 34 cents per gallon

The Prairie State’s income tax dropped to a flat rate of 3.75% from 5% on Jan. 1, 2015.

The bad news is that taxes on just about everything else in Illinois are high and could go higher as lawmakers grapple with the largest state budget deficit in the U.S. And the low flat tax may not last: With total liabilities exceeding assets by 48%, the state needs to raise taxes by 17%, cut services by 16% or increase worker pension contributions by 400%, according to a report by J.P. Morgan.

Property taxes in Illinois are the second-highest in the nation. The property tax on the state’s median home value of $171,900 is $3,952.

And the combined average state and local sales tax is 8.64%, the 7th-highest rate in the U.S, according to the Tax Foundation. In some municipalities, combined state and local sales taxes are as high as 10%. Qualifying food and prescription and nonprescription drugs are taxed at 1%.

 

10. Rhode Island

State income tax: 3.75% (on income of up to $60,850) - 5.99% (on income of more than $138,300)

Effective income tax rate: 3.8%/individual, 4.3%/joint

State sales tax: 7%

Gas taxes and fees: 34 cents per gallon

The Ocean State’s 7% state sales tax rate is the second-highest in the U.S., but the state has no local sales taxes to add to it. Groceries, most clothing and footwear, and prescription drugs are exempt. Over-the-counter drugs, such as aspirin, are taxed unless you have a prescription. The tax also applies to the portion of any individual sale of clothing and footwear that exceeds $250. The sales tax on vehicles is 7%.

Rhode Island is expensive for homeowners. The property tax on the state’s median home value of $236,000 is $3,855, the 11th-highest in the U.S.

 

About our methodology

To create our rankings, we evaluated data and state tax-policy details from a wide range of sources. These include:

Income Taxes - We looked at each state's tax agency, plus this helpful document from the Tax Foundation. To help us rank the most- and least-friendly states, The Tax Institute at H&R Block prepared an analysis that determined the effective tax rate for two income scenarios: One for a single filer making $45,000 a year taking the standard deduction, and one for a more complex tax profile: a married couple filing jointly, with two dependent children, an earned income of $150,000, qualified dividends of $5,000, and $10,000 of mortgage interest to deduct.

Property Tax - Median income tax paid and median home values come from U.S. Census' American Community Survey and are 2014 data.

Sales Taxes - We also cite the Tax Foundation's figure for average sales tax, which is a a population-weighted average of local sales taxes. In states that let municipalities add sales taxes, this gives an estimate of what most people in a given state actually pay, as those rates can vary widely.

Fuel Tax - The American Petroleum Institute

Sin Taxes - Each state's tax agency as well at the Tax Foundation

Inheritance & Gift Taxes - Each state's tax agency.

Wireless Taxes - The Tax Foundation

Travel Taxes - Each state's tax agency, plus a lodging tax study published in 2015 by HVS Convention Sports and Entertainment Consulting.

Fiscal Stability - Each state's balance sheet gives an indication of what its tax future might look like. We drew on the study Ranking the States by Fiscal Condition by the Mercatus Center at George Mason University.

 

Robert J. Pyle, CFP®, CFA is president of Diversified Asset Management, Inc. (DAMI). DAMI is licensed as an investment adviser with the State of Colorado Division of Securities, and its investment advisory representatives are licensed by the State of Colorado. DAMI will only transact business in other states to the extent DAMI has made the requisite notice filings or obtained the necessary licensing in such state. No follow up or individualized responses to persons in other jurisdictions that involve either rendering or attempting to render personalized investment advice for compensation will be made absent compliance with applicable legal requirements, or an applicable exemption or exclusion. It does not constitute investment or tax advice. To contact Robert, call 303-440-2906 or e-mail  info@diversifiedassetmanagement.com.

 

The views, opinion, information and content provided here are solely those of the respective authors, and may not represent the views or opinions of Diversified Asset Management, Inc. The selection of any posts or articles should not be regarded as an explicit or implicit endorsement or recommendation of any such posts or articles, or services provided or referenced and statements made by the authors of such posts or articles. Diversified Asset Management, Inc. cannot guarantee the accuracy or currency of any such third party information or content, and does not undertake to verify or update such information or content. Any such information or other content should not be construed as investment, legal, accounting or tax advice.