Why You Can’t Always Take a Tax Deduction on an IRA

On deadline day for filing your taxes, you may be considering making last-minute Traditional IRA contribution.  Most people contribute to an IRA to 1) save for retirement and 2) take a tax deduction on the contribution to hopefully lower one’s overall tax bill.  Many people, however, are not aware that there is a good chance that the IRA contribution they are intending to make or have made in the past, does not allow for a tax deduction. This happens if you are above IRS adjusted gross income (AGI) thresholds.  Eligibility to deduct depends on income and whether or not you are covered under an employer sponsored retirement plan, such as 401k or 403b.

Married Filing Jointly

Both spouses are covered under an employer sponsored retirement plan at work

• Income limit to be able to fully deduct an IRA contribution - $96,000

Only one spouse is covered under an employer sponsored retirement plan at work

• Income limit to be able to fully deduct an IRA contribution - $181,000

Neither spouse is covered under an employer sponsored retirement plan at work

• No income limit to be able to fully deduct an IRA contribution

Single

Individual is covered under an employer sponsored retirement plan at work

• Income limit to be able to fully deduct an IRA contribution - $60,000

Individual is not covered under an employer sponsored retirement plan at work

• No income limit to be able to fully deduct an IRA contribution

There’s a reason the IRS limits the amount that can be deducted by someone who is covered under an employer retirement plan. The IRS tries to prohibit investors who are in higher tax brackets from sheltering “too much” income that won’t be taxed until funds are ultimately withdrawn upon retirement. 

You must also have earned income equal to or greater than the IRA contribution being made during the year in which the contribution will be coded.  For example, for someone to be eligible to make a full IRA contribution, their earned income from work throughout the year must be greater than or equal to $5,500, if under the age of 50, or $6,500 if over the age of 50.  Another important note – Social Security, pension benefits, IRA distributions, dividends, interest, etc. are NOT considered earned income items.  The IRS prevents retirees from contributing to qualified retirement accounts that grow tax-deferred unless they are working. 

In my next blog post, I’ll discuss ins and outs of contributing and withdrawing funds from an IRA where non-deductible contributions were made…this is where things can tricky.  Stay tuned. 

Nick Defenthaler, CFP® is a Support Associate at Center for Financial Planning, Inc. Nick currently assists Center planners and clients, and is a contributor to Money Centered and Center Connections.

The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. Please note, changes in tax laws may occur at any time and could have a substantial impact upon each person’s situation. While we are familiar with the tax provisions of the issues presented herein, as Financial Advisors of RJFS, we are not qualified to render advice on tax or legal matters. You should discuss tax or legal matters with the appropriate professional. C14-009199

5 Steps to Being Cautious While Still Taking Life’s Chances

In the arena of finance, risk is inherent.  Think about the risks you take everyday. When it comes to investment expectations there is always the risk that the outcome will be different than anticipated. When it comes to the income your family depends upon, there is always the risk of job loss. When it comes to budgeting, there is always the risk of inflation, which could leave you without enough to keep up with the rising cost of things around you. When it comes to your family, there is always the risk that someone could face a health challenge or a long-term illness.

Learning About Risk

After 25 years working with people, I have seen families lose children and grandchildren to tragedy.  I have witnessed divorce and marriage and have seen first-hand financial windfall and destruction. Helping clients through all this has helped me gain a better understanding of risk tolerance and realize that risk preferences vary greatly.  Most people want to avoid risk as much as possible, but many have to learn that the hard way.  Remember your first loss? The big one? How did it affect you? If it was truly the big one, then it made you sit up and take notice.  It left an impression on you and your decisions.  And it may have given you a deeper understanding of what risk really means.

5 Steps to Managing Risk

Despite the fact that we all must learn to live with risk, there are steps we can take to help mitigate the downside when it comes to financial planning:

1. Diversification, asset allocation and rebalancing: While this won’t make you rich quick, it should help reduce overall portfolio volatility.

2. Insurance: For a relatively small cost you can provide for the safety of a young and growing family for many years and provide protection in case of premature death or disability.

3. Emergency Funds: Always maintain the appropriate emergency balance for your situation.  A simple rule of thumb is 3-6 months of expenses. Then you may want to consider choosing investments that are marketable and liquid for your taxable portfolios.

4. Long-term Care Insurance: To avoid a catastrophic financial blow if a spouse develops a long-term illness and needs expensive health assistance, consider long-term care insurance when you’re in your late 50s.

5. Estate Planning:  By taking just a few minutes to write out a plan, there’s a better chance of things happening as you wish. Write a holographic will (handwritten and signed) or go to your state website and pull off the appropriate documents (like wills, powers of attorney, patient advocate designations, etc.). Complete them or set up a meeting with an estate planning attorney to help you with this process. 

If you need help getting started with any of these steps or making a personal plan to help you prepare for life’s inherent risks, contact me at matthew.chope@centerfinplan.com.

Matthew E. Chope, CFP ® is a Partner and Financial Planner at Center for Financial Planning, Inc. Matt has been quoted in various investment professional newspapers and magazines. He is active in the community and his profession and helps local corporations and nonprofits in the areas of strategic planning and money and business management decisions. In 2012 and 2013, Matt was named to the Five Star Wealth Managers list in Detroit Hour magazine.

Five Star Award is based on advisor being credentialed as an investment advisory representative (IAR), a FINRA registered representative, a CPA or a licensed attorney, including education and professional designations, actively employed in the industry for five years, favorable regulatory and complaint history review, fulfillment of firm review based on internal firm standards, accepting new clients, one- and five-year client retention rates, non-institutional discretionary and/or non-discretionary client assets administered, number of client households served.

Any information is not a complete summary or statement of all available data necessary for making an investment decision and does not constitute investment advice. Any opinions are those of Center for Financial Planning, Inc. and not necessarily those of Raymond James. Diversification and asset allocation do not ensure a profit or protection against loss. Rebalancing a non-retirement account could be a taxable event that may increase your tax liability. Investing involves risk and you may incur a profit or loss regardless of strategy selected. C14-005525

6 Tips for Your Tax Return

This March, in honor of Women’s History Month, I’d like to share a little about Muriel Siebert, a legend on Wall Street and a trailblazer for women.  In 1967, she was the first woman to buy a seat on the New York Stock Exchange. This accomplishment, as well as her other successful business ventures and philanthropic activities, helped to expand opportunities for women in finance. 

As March exits and we transition to April, many of us are busy with tax preparation leading up to the April 15th deadline for filing. Now is the time to follow the trailblazing example of Muriel Siebert and blaze a path to your own financial independence. Are you getting a refund?

Here are some tips to help you make the most of this once in a year windfall:

• Ask why you have a refund.  Did you pay too much in the first place? Has something changed in your financial picture? Or is it a forced saving strategy?

• Set some aside. Treat the refund as income and save a minimum of 15% for longer-term goals that are important to you.

• Pay down debt obligations. Especially credit card debt or student loan debt with high interest charges.

• Not maxing out your 401k? A strategy for reducing future taxes is to increase your 401k contribution and then set aside the current refund to help with monthly cash flow if needed.

• Are you saving for college educations? If additional funds are needed, use the refund to put savings goals back on track.

• Splurge! Set it aside for gifts, vacations and other lifestyle choices.

As Women’s History month comes to an end and April  15th approaches, celebrate your commitment to making the most of your financial opportunities. Take a look back at the success you have experienced along the way and continue to step forward into your financial plan for the future.

Laurie Renchik, CFP®, MBA is a Partner and Senior Financial Planner at Center for Financial Planning, Inc. In addition to working with women who are in the midst of a transition (career change, receiving an inheritance, losing a life partner, divorce or remarriage), Laurie works with clients who are planning for retirement. Laurie was named to the 2013 Five Star Wealth Managers list in Detroit Hour magazine, is a member of the Leadership Oakland Alumni Association and in addition to her frequent contributions to Money Centered, she manages and is a frequent contributor to Center Connections at The Center.

Five Star Award is based on advisor being credentialed as an investment advisory representative (IAR), a FINRA registered representative, a CPA or a licensed attorney, including education and professional designations, actively employed in the industry for five years, favorable regulatory and complaint history review, fulfillment of firm review based on internal firm standards, accepting new clients, one- and five-year client retention rates, non-institutional discretionary and/or non-discretionary client assets administered, number of client households served. C14-006593

Back Door Roth IRA Conversion

A well-planned tax strategy has become increasingly important to investors, especially with overwhelming uncertainty of what tax rates could potentially increase to in the future. That’s why some investors look to Roth IRAs, a fairly new arrival to the investment world.  They were first released in 1997 and have become more and more popular.

A Quick Roth IRA Refresher

Contributions to a Roth IRA do not receive an immediate tax deduction like a 401(k) or deductible Traditional IRA.  However, earnings grow tax-deferred and if holding requirements are met, all withdrawals (including contributions and earnings) can be withdrawn 100% tax free.  Roth IRAs are an unbelievably attractive investment vehicle for those who believe they are currently in a lower tax bracket than they will be in retirement.  More specifically, young people, who are years away from their high earning years and wish to forego tax deductions (while most likely in the lowest tax bracket of their lifetime) now reap the benefits of tax-deferred growth and tax-free withdrawals upon retirement.  As a young person myself, I cannot stress enough how attractive the Roth IRA can be for investors if they fit the “Roth mold”.    

Who Is Right for a Roth?

There are income limitations on who can contribute to a Roth IRA.  For 2014, a married couple filing their taxes jointly must have an AGI less than $181,000 to be able to contribute the maximum to a Roth IRA. In 2014, individual contributions max out at $5,500, or $6,500 if you are over the age of 50.  The AGI limit for singles in 2014 is $114,000.  If you make over this income level, there is a tax “work around” in place that could still allow you to contribute to a Roth, depending on your personal situation.  Prior to 2010, there was an income limitation on who could convert Traditional IRA dollars to a Roth IRA.  Since 2010, theincome limitation has been completely lifted for conversions, meaning anyone, regardless of their income, can convert funds from a Traditional IRA to a Roth IRA.  This raised the eyebrows for number geeks like myself, who viewed this ruling as an excellent planning opportunity for clients. 

Lifting the Income Limit for Roth Conversions

The abolishment of the income limit on Roth conversions means that if you are over the income limit to contribute to a Roth IRA, you could open a Traditional IRA and immediately convert the funds to a Roth IRA.  There is, however, a catch to this “work around”.  The conversion would typically only make sense if the client did NOT have an existing Traditional IRA.  The tax calculation on the conversion gets very messy if the client does in fact already have a Traditional IRA and typically, it doesn’t make sense if they do.  One main point to also keep in mind is that employer sponsored plans such as a 401(k) or 403(b) are not taken into consideration like a Traditional IRA is when calculating tax due for completing the conversion.  

Back Door Roth Conversion Criteria

☑ If you are over the income limit to contribute to a Roth IRA ($181,00 for couples and $114,000 for singles)

☑ And you do not have an existing Traditional IRA because you are taking full advantage of employer retirement plans (401(k), 403(b), etc.)

☑ And you have additional funds to save

If you can check all three boxes above, the “back door” Roth IRA is something you may want to consider based on your individual situation and long-term goals. Since this is a fairly new planning opportunity, this type of conversion is something we are closely monitoring for our clients on an individual basis.  As with any financial decision, it won’t make sense for everyone.  But it is our job as your advisory team to walk you through your options and help you make a smart financial decision. 

Nick Defenthaler, CFP® is a Support Associate at Center for Financial Planning, Inc. Nick currently assists Center planners and clients, and is a contributor to Money Centered and Center Connections.

Unless certain criteria are met, Roth IRA owners must be 59 ½ or older and have held the IRA for five years before tax-free withdrawals are permitted. Additionally, each converted amount may be subject to its own five-year holding period. Converting a traditional IRA into a Roth IRA has tax implications. Investors should consult a tax advisor before deciding to do a conversion.

The foregoing information has been obtained from sources considered to be reliable, but we do not guarantee that it is accurate or complete, it is not a statement of all available data necessary for making an investment decision, and it does not constitute a recommendation. Any opinions are those of Center for Financial Planning, Inc. and not necessarily those of Raymond James. C14-004799

Tax Prep: New Laws & Recent Changes to Help You File

Here at The Center, we think of tax season as the most magical and exciting part of the year, but you might not see it that way.  As you prepare to get your taxes in order, it is important to discuss some of the new laws going into effect for 2014 and to revisit some changes from 2013. Earlier this month, Matt Trujillo and Nick Defenthaler attended a portion of the University of Michigan tax seminar to brush up on the ever-changing landscape in the world of taxes.  Below are a few key points that they felt may impact you:

Expiring Provisions in 2014

• Deduction for expenses of elementary and secondary school teachers

• Option to deduct state and local general sales taxes

• Tax credit for energy efficient home goods (windows, doors, appliances, furnaces, etc.)

  • Don’t let home improvement sales people lead you to believe that the new product they are trying to sell you will generate a tax credit!

  • Elimination of private mortgage insurance (PMI) deduction

    • Consider checking a website such as Zillow or consult with a real estate agent to get an idea of what your home may now be worth.  With the housing market improving, you may now have greater than 20% equity in your home.  Consult with your lender to determine the best steps to eliminating your PMI. 

Reminder of changes from 2013

In 2013, the Medicare tax changes went into effect for “high income earners” based on certain thresholds:

• Single – Modified Adjusted Gross Income (MAGI) greater than $200,000

• Married Filing Jointly – Modified Adjusted Gross Income (MAGI) greater than $250,000

This tax has two components, one based on wages earned above the thresholds and another based on net investment income above the thresholds.

• 0.9% additional Medicare tax on wages above thresholds

• 3.8% tax on the lesser of total net investment income or the amount of earnings above the thresholds (net investment income consists of dividends, interest, capital gains, rental income, etc.  It does NOT include distributions from qualified retirement plans such as an IRA or 401k)

• Ex.  A married client’s MAGI for 2013 is $300,000.  They also have $20,000 of net investment income.  They are $50,000 over the $250,000 threshold.  However, the $20,000 is less than the $50,000 overage; therefore, the 3.8% tax is based on the $20,000, resulting in an additional tax of $760 ($20,000 x 3.8%). 

Affordable Care Act (Obamacare)

One of the biggest tax talking points for 2014 are the tax ramifications of the Affordable care act or “Obamacare”. A few key take-aways for 2014:

• it's widely known that the penalty (in 2014) for not having insurance is the greater of $95 or 1% of income - this penalty will increase for the next several years to entice people to get health insurance.

• For those individuals or families that are between 100% and 400% of the federal poverty level, you may qualify for a government subsidy to help offset your insurance premium costs.

• In 2014 you will need to use a combination of last year’s earned income, and your projections of this year’s income to figure out whether or not you qualify.

• If you find you are right on the cusp of qualifying for a subsidy, but are concerned about having to pay back the subsidy in full if you underestimate your income ... fear not!  The rules regarding income are a “cliff”, meaning if you are wrong by $1 dollar you are subject to a penalty. However, the maximum penalty for 2014 is $400.

Example: Joe and Jane are 55 with no dependents.  They estimate their income to be $62,000 and that qualifies them for a government subsidy.  However, Joe gets an unexpected bonus at the end of 2014 and his income ends up being higher than 400% of the federal poverty level.  In this scenario, Joe and Jane will be subject to a maximum $400 penalty.

Tax planning can be very confusing, especially since the IRS seems to change the tax code more often than electronics companies push new products.  Please don’t hesitate to contact us if you have questions about your personal tax situation. Although we are not CPAs, we can still help to make your overall financial plan as tax efficient as possible and work together as a team with your tax professional to ensure we are all on the same page.

Nick Defenthaler, CFP® is a Support Associate at Center for Financial Planning, Inc. Nick currently assists Center planners and clients, and is a contributor to Money Centered and Center Connections.

Matthew Trujillo is a Registered Support Associate at Center for Financial Planning, Inc. Matt currently assists Center planners and clients, and is a contributor to Money Centered.

The information contained in this report does not purport to be a complete description of the securities, markets, or developments referred to in this material. The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. Any opinions are those of Center for Financial Planning, Inc. and not necessarily those of RJFS or Raymond James. Please note, changes in tax laws may occur at any time and could have substantial impact upon each person’s situation. While we are familiar with the tax provisions of the issues presented herein, as Financial Advisors of RJFS, we are not qualified to render advice on tax or legal matters. All examples are hypothetical. Please consult the appropriate professional if you have questions about these examples and how they relate to your own financial situation. C14-002577

Where Do I Take Cash From Next? The 72(t) Option

A longtime client, we will call her “Joan”, called last month needing to set aside money for her 2014 income needs. She had nothing left in the bank.  She had been through a life transition recently, out of work for over a year, and helping family with some health concerns.  Nearing retirement but not quite at the point at which she could access her retirement moneys without penalty (she was in her late 50’s, but not quite 59 1/2), she was concerned because her only choices were a Roth IRA and a traditional IRA.  So her normal reaction was to go for the Roth because it had fewer penalties or tax (she had established the Roth over 5 years ago and could access her contributed portion without penalty; she would likely experience a penalty if drawing on earnings portion). 

Penalty-free IRA Withdrawals

I offered a rarely used suggestion to establish a section 72(t) distribution (as authorized under the IRS tax code). This rule allows for penalty-free withdrawals from an IRA account. The rule requires that, in order for the IRA owner to take penalty-free early withdrawals, he or she must take at least five "substantially equal periodic payments" (SEPPs). The amount depends on the IRA owner's life expectancy calculated with various IRS-approved methods.

Rule 72(t) allows you to take advantage of your retirement savings before the age of 59 1/2, when there is otherwise a 10% penalty on early withdrawal. The withdrawals, however, are still taxed at your income rate.

How to Use Rule 72(t)

The substantially equal period payments must generally continue for at least five full years, or if later, until age 59 ½. For example, if you began taking payments at age 56 on December 1, 2006, you may not take a different distribution or alter the amount of the payment until December 1, 2011, even though your fifth payment was taken on December 1, 2010.

If you begin taking substantially equal periodic payments on December 1, 2005, and you turn 59 ½ on July 1, 2011, you may not take a different distribution or alter the amount of the payment until July 1, 2011.

This works well for Joan because she did not have any earned income in 2013 so we actually started her distribution in December for the 1st of 5 distributions.  We plan to take the next one immediately in January of 2014 and this should fulfill her income requirements needed for 2014.  She also does not plan on finding work in 2014 so the taxes on these dollars will be small since she had no other income.   The Roth arguably would also have fewer tax implications, but we suggested taking from the Roth IRA after this if additional income was needed in the year as she climbs the tax bracket wall.

Matthew E. Chope, CFP ® is a Partner and Financial Planner at Center for Financial Planning, Inc. Matt has been quoted in various investment professional newspapers and magazines. He is active in the community and his profession and helps local corporations and nonprofits in the areas of strategic planning and money and business management decisions. In 2012 and 2013, Matt was named to the Five Star Wealth Managers list in Detroit Hour magazine.

Five Star Award is based on advisor being credentialed as an investment advisory representative (IAR), a FINRA registered representative, a CPA or a licensed attorney, including education and professional designations, actively employed in the industry for five years, favorable regulatory and complaint history review, fulfillment of firm review based on internal firm standards, accepting new clients, one- and five-year client retention rates, non-institutional discretionary and/or non-discretionary client assets administered, number of client households served.

Any information is not a complete summary or statement of all available data necessary for making an investment decision and does not constitute a recommendation. A 72(t) distribution may not be right for everyone. Investors should take into consideration the possibility of depleting their retirement account before the end of their life expectancy. In addition, any withdraws are taxed at the investor’s income rate and may raise their tax bracket. Please discuss any tax or financial matters with the appropriate professional before making a decision. #C14-001634

Health Savings Account Basics

With the Affordable Care Act becoming effective in 2014, healthcare seems to be top of mind with a lot of people.  But there are still many kinks to be worked out and many questions left unanswered.  In a world of uncertainty, why not consider utilizing a savings vehicle to help with medical costs that you can control? 

Using an HSA

A Health Savings Account, or HSA, is a fairly new type of account that is available to those who are enrolled in a high deductible health care plan.  Many confuse an HSA with a Flex Spending Account or FSA – don’t make that mistake!  A Health Savings Account is typically much more flexible and allows you to roll any unused funds over year to year, something a Flex Spending Account does not offer – it is a “use it or lose it” plan. 

What an HSA Can Cover

Many employers who offer high deductible plans will often contribute a certain amount to the employee’s HSA each year as an added benefit, somewhat like a 401k match.  Dollars contributed to the account are pre-tax and earnings accumulate tax deferred.  Funds withdrawn, if used for qualified medical expenses (including earnings), are tax-free.  The list of qualified medical expenses can be found at irs.gov, however, just to give you an idea, a few include:  expenses to cover your deductible (not premiums), co-payments, prescription drugs, various dental and vision care expenses, etc.  As always, consult with your financial advisor, tax advisor and health savings account institution to verify what expenses are considered qualified.  If you make a withdrawal that is considered “non-qualified”, you will be subject to taxes and a 20% penalty on the withdrawal amount. 

Here are the details for 2014:

Individuals

• Must have a plan with a minimum deductible of $1,250

• $3,300 contribution limit ($1,000 catch-up contribution if 55 or older)

• Maximum out-of-pocket expenses cannot exceed $6,350

Family

• Must have a plan with a minimum deductible of $2,500

• $6,550 contribution limit ($1,000 catch-up contribution if 55 or older)

• Maximum out-of-pocket expenses cannot exceed $12,700

Withdrawing from an HSA

Once you reach age 65 and enroll in Medicare, you can no longer contribute to an HSA.  However, once you are 65, funds can be withdrawn for any purpose, medical related or not, and you will no longer be subject to the 20% penalty.  However, the withdrawal will be included in taxable income, like an IRA or 401k distribution. This can present a great planning opportunity for clients who may want to defer additional money but have already maximized their 401k plans or IRAs for the year.  Although you have to wait 5 ½ years longer to access the funds from a HSA than a traditional retirement plan (age 59 ½) to avoid penalty, this is just another investment vehicle that could reduce taxable income in the year contributions were made while earnings have the opportunity to grow tax-deferred and tax free.  

As you can see, a Health Savings Account can be a great addition to an overall financial plan and should be considered if you are covered under a high deductible health plan.  No one likes medical expenses; this can be a vehicle that can potentially soften of medical expenses. 

Nick Defenthaler, CFP® is a Support Associate at Center for Financial Planning, Inc. Nick currently assists Center planners and clients, and is a contributor to Money Centered and Center Connections.

Any information is not a complete summary or statement of all available data necessary for making an investment decision and does not constitute a recommendation.  The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete.  Any opinions are those of Center for Financial Planning, Inc., and not necessarily those of RJFS or Raymond James.  You should discuss any tax or legal matters with the appropriate professional. #C13-002464

How to Make Net Unrealized Appreciation Work for You

The financial planning profession is full of acronyms such as RMD, IRA, TSA and NUA.  One acronym making a comeback due to the increase in the US Equity market is “NUA”.  NUA stands for net unrealized appreciation and anyone with a 401k account containing stock might want to better understand it.  NUA comes into play when a person retires or otherwise leaves an employer sponsored 401k plan.  In many cases, 401k funds are rolled over to an IRA.  However, if you hold company stock in the 401k plan, you might be best served by rolling the company stock out separately. 

Before getting to an example, here are the gory details: The net unrealized appreciation in securities is the excess of the fair market value over the cost basis and may be excluded from the participant's income. Further, it is not subject to the 10% penalty tax even though the participant is under age 59-1/2, since, with limited exceptions; the 10% tax only applies to amounts included in income.  The cost basis is added to income and subject to the 10% penalty, if the participant is under 59.5 and the securities are not rolled over to an IRA.

Suppose Mary age 62 works for a large company that offers a 401k plan.  Over the years she has purchased $50,000 of XYZ company stock and it has appreciated over the years with a current value of $150,000.  Therefore, Mary has a basis of $50,000 and net unrealized appreciation of $100,000. 

If Mary rolls XYZ stock over to an IRA at retirement or termination, the full $150,000 will be taxed like the other funds at ordinary income tax rates when distributed.  However, if Mary rolls XYZ stock out separately the tax rules are different and potentially more favorable.  In the example above, if Mary rolls XYZ out she will pay ordinary income tax immediately on $50,000 but may obtain long term capital treatment on the $100,000 appreciation when the stock is sold; thus potentially saving several thousand dollars in income tax.

A NUA transaction is complex so care and professional guidance is encouraged.   

Timothy Wyman, CFP®, JD is the Managing Partner and Financial Planner at Center for Financial Planning, Inc. and is a frequent contributor to national media including appearances on Good Morning America Weekend Edition and WDIV Channel 4 News and published articles including Forbes and The Wall Street Journal. A leader in his profession, Tim served on the National Board of Directors for the 28,000 member Financial Planning Association™ (FPA®), trained and mentored hundreds of CFP® practitioners and is a frequent speaker to organizations and businesses on various financial planning topics.

The information contained in this report does not purport to be a complete description of the securities, markets or developments referred to in this material, is not a complete summary or statement of all available data necessary for making an investment decision, and does not constitute a recommendation.  The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete.  Any opinions are those of Center for Financial Planning, Inc., and not necessarily those of RJFS or Raymond James.  You should discuss any tax or legal matters with the appropriate professional.

Is Too Much Success a Penalty at Tax Time?

Many investors have been so successful they may face a potentially hefty tax bill for 2013.  This bull market we are experiencing in the U.S. has had such strong legs for a long period of time many investors have few, if any, capital losses to harvest to help offset the gains they have accumulated in their equity investments. In some ways this is a great problem to have. 

Tax Increases

This year there were a couple of noteworthy tax increases to keep in mind.  The maximum tax rate on capital gains has increased from 15% to 20%.  Taxpayers with taxable income north of $400,000 ($450,000 for couples) will be affected by this increase.  There is also the new Medicare investment income “surtax” affecting taxpayers with modified adjusted gross income over $200,000 ($250,000 for couples).  This tax is an additional 3.8% on investment income (interest, capital gains, dividends etc.).

Look for Bond Losses

Some taxpayers may still have tax losses from 2008-2009 to help offset gains, but for many these have run out during the successful run the markets have enjoyed for the past 4 ½ years.  One place to look for some losses this year may be in the bond portion of your portfolio (if applicable).  There may be an opportunity to swap to a similar investment for a short period of time, at least 31 days, to harvest those losses to help offset other gains you may have. 

Harvesting Losses

Make sure you are reviewing your portfolio throughout the year for tax losses to harvest.  Bond losses were at their peak during late summer and into the fall, but if you wait until December to harvest those losses, they could be much diminished from what they were.  The end of the year is rarely the best time of the year to harvest tax losses.  Personal circumstances vary widely so it is critical to work with your tax professional and financial advisor today to prepare for the risk of higher taxes in your future.

Angela Palacios, CFP®is the Portfolio Manager at Center for Financial Planning, Inc. Angela specializes in Investment and Macro economic research. She is a frequent contributor to Money Centered as well asinvestment updates at The Center.

The information contained in this report does not purport to be a complete description of the securities, markets, or developments referred to in this material.  The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete.  Any information is not a complete summary or statement of all available data necessary for making an investment decision and does not constitute a recommendation.  Any opinions are those of Center for Financial Planning, Inc., and not necessarily those of RJFS or Raymond James.  You should discuss any tax or legal matters with the appropriate professional.

Step Up in Basis Part 2

In Part 1, we covered a “step up in cost basis” principles with regards to real estate. In this post we will address step up in basis rules pertaining to marketable securities such as stocks, bonds, and mutual funds.

Your cost basis in a security is what you initially purchased it for plus any reinvested dividends.  So if mom bought 1,000 shares of Ford Motor Company back in 1980 when it was trading at $1.00 a share her cost basis is exactly $1,000 (trading costs such as commissions can also be included).   As of 10/25/2013 Ford was trading at $17.60 a share so if mom sold it today she would receive $17,600 from the sale of the Ford stock.  She would be able to subtract her basis for tax purposes ($1,000) and she would have a long term realized capital gain of $16,600.  At today’s long-term capital gains rates mom would owe Uncle Sam as much as 20% of that gain or $3,320.  However, let’s say mom never sold her Ford stock and left it to you after her death.  If mom died on October 25th 2013 your new inherited basis would be the closing market price of Ford on the date of death ($17.60).  Assuming you sold Ford stock at $17.60 you would owe nothing in capital gains thanks to the step up in basis rule.  Please remember that this analysis is only relevant if you are inheriting assets in a taxable account. If you are inheriting Ford stock inside of an IRA (or other similar tax deferred account) then the cost basis is irrelevant – at least for income tax purposes. 

What if mom is feeling generous and decides she wants to gift you the shares of Ford Stock while she is alive?  In this instance you would also receive mom’s cost basis of $1.00 rather than the higher step up in basis at death. 

As always, income tax consequences alone should not dictate financial decisions.  However, care should be taken to maximize both gifts and inheritances. Please speak with a financial advisor about cost basis and other tax-related issues.

Matthew Trujillo is a Registered Support Associate at Center for Financial Planning, Inc. Matt currently assists Center planners and clients, and is a contributor to Money Centered.

The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete.  Any opinions are those of Center for Financial Planning, Inc., and not necessarily those of RJFS or Raymond James.  Please note, changes in tax laws may occur at any time and could have a substantial impact upon each person’s situation.  While we are familiar with the tax provisions of the issues presented herein, as Financial Advisors of RJFS, we are not qualified to render advice on tax or legal matters.  You should discuss tax or legal matters with the appropriate professional.  The illustration is hypothetical.  Individual results will vary.  This information is not intended as a solicitation or an offer to buy or sell any security referred to herein.  Individual results will vary.   This information is not intended as a solicitation or an offer to buy or sell any security referred to herein.  Center for Financial Planning, Inc., Raymond James Financial Services, Inc., its affiliates, officers, directors or branch offices may in the course of business have a position in any securities mentioned in this report.