Author: Alexis Long

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Keep Your Customers Satisfied

Over the past few years, community banking has withstood rapid technological changes, unprecedented economic challenges during a pandemic and new demands from its customer base. To maintain profitability amidst all this turmoil, you need to ensure that your bank retains its existing customers. After all, studies show that attracting a new customer typically costs five times more than retaining an existing one.

Here are three fundamental questions to help improve customer satisfaction and, ultimately, retention.

  1. What’s your core deposit base?

A good first step is to identify your core deposits and develop an understanding of customer behaviors. Differentiate loyal, long-term customers from those motivated primarily by interest rates. A core deposit study can help you distinguish between the two types of depositors and predict the impact of fluctuating interest rates on customer retention. Banking regulators strongly encourage banks to conduct these studies as part of their overall asset-liability management efforts.

Core deposit studies assess how much of your bank’s deposit base is interest-rate-sensitive by examining past depositor behavior. They also look at factors that tend to predict depositor longevity. For example, customers may be less likely to switch banks if they have higher average deposit balances and use multiple banking products (such as checking and savings accounts, mortgages and auto loans).

  1. How can you get to know your customers better?

To build customer loyalty, it’s critical to ensure that customers are engaged. According to research by Gallup, engaged customers are more loyal, and they’re more likely to recommend the bank to family and friends. They also represent a bigger “share of wallet” (that is, the percentage of a customer’s banking business captured by the bank).

Recent retail banking studies show that fewer than half of customers at community banks and small regional banks (less than $40 billion in deposits) are actively engaged. The percentages are even smaller at large regional banks (over $90 billion in deposits) and nationwide banks (over $500 billion in deposits). That’s the good news. The bad news is that 50% of customers at online-only banks are fully engaged.

So, how can community banks do a better job of engaging their customers to compete with online banks? The answer lies in leveraging their “local touch” by knowing their customers, delivering superior service, and providing customized solutions and advice. To do that, banks must ensure that their front-line employees — tellers, loan officers, branch managers and call center representatives — are fully engaged in their jobs.

Encouraging employees to engage with customers has little to do with competitive salaries and benefits. Rather, it means providing employees with opportunities for challenging work, responsibility, recognition and personal growth.

  1. How can you develop your online presence?

An increasing number of customers — younger people in particular — use multiple channels and devices to interact with their banks. These include online banking, mobile banking applications and two-way texting.

To build loyalty, banks should enable customers to use their preferred channels and ensure that their experiences across channels are seamless. And don’t overlook the importance of social media platforms. Younger customers are more likely to use these platforms to recommend your bank to their friends and families.

Ask the right questions

Your customer retention strategies shouldn’t be based on guesswork. Consider periodically engaging with customers concerning their level of satisfaction with your current systems and processes. Ask what they’d like to see improved. A brief survey, or even a short conversation, can provide valuable input on ways to keep your customers satisfied with your bank’s services over the long term.

©2021

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Helpful Articles Tax

Planning for Year-End Gifts

As we approach the holidays, many people plan to donate to their favorite charities or give money or assets to their loved ones. Here are the basic tax rules involved in these transactions.

Donating to charity

Normally, if you take the standard deduction and don’t itemize, you can’t claim a deduction for charitable contributions. But for 2021 under a COVID-19 relief law, you’re allowed to claim a limited deduction on your tax return for cash contributions made to qualifying charitable organizations. You can claim a deduction of up to $300 for cash contributions made during this year. This deduction increases to $600 for a married couple filing jointly in 2021.

What if you want to give gifts of investments to your favorite charities? There are a couple of points to keep in mind.

First, don’t give away investments in taxable brokerage accounts that are currently worth less than what you paid for them. Instead, sell the shares and claim the resulting capital loss on your tax return. Then, give the cash proceeds from the sale to charity. In addition, if you itemize, you can claim a full tax-saving charitable deduction. The second point applies to securities that have appreciated in value. These should be donated directly to charity.

The reason: If you itemize, donations of publicly traded shares that you’ve owned for over a year result in charitable deductions equal to the full current market value of the shares at the time the gift is made. In addition, if you donate appreciated stock, you escape any capital gains tax on those shares. Meanwhile, the tax-exempt charity can sell the donated shares without owing any federal income tax.

Donating from your IRA

IRA owners and beneficiaries who’ve reached age 70½ are allowed to make cash donations of up to $100,000 a year to qualified charities directly out of their IRAs. You don’t owe income tax on these qualified charitable distributions (QCDs), but you also don’t receive an itemized charitable contribution deduction.

Gifting assets to family and other loved ones

The principles for tax-smart gifts to charities also apply to gifts to relatives. That is, you should sell investments that are currently worth less than what you paid for them and claim the resulting tax-saving capital losses. Then, give the cash proceeds from the sale to your children, grandchildren or other loved ones. Likewise, you should give appreciated stock directly to those to whom you want to give gifts. When they sell the shares, they’ll pay a lower tax rate than you would if they’re in a lower tax bracket.

In 2021, the amount you can give to one person without gift tax implications is $15,000 per recipient. The annual gift exclusion is available to each taxpayer. So if you’re married and make a joint gift with your spouse, the exclusion amount is doubled to $30,000 per recipient for 2021.

Make gifts wisely Whether you’re giving to charity or loved ones this holiday season (or both), it’s important to understand the tax implications of gifts. For more guidance about year-end giving and tax planning, contact one of our experts today.

© 2021

Categories
Helpful Articles Tax

Tax Consequences for Overfunding Your 529 Plan

If money is held too long in a Section 529 college savings plan, there could be tax consequences. This article describes alternatives for savers who have overfunded their accounts.

Oops, you overfunded your 529 plan

Some might consider it a good problem to have: saving too much money for college. But if the money is held in a Section 529 college savings plan, there could be tax consequences to overfunding the account.

The tax man giveth

529 plans are tax-advantaged accounts designed to help families save money for college education expenses. Savings grow on a tax-deferred basis, and withdrawals are made tax-free if the money is used to pay for qualified education expenses such as college tuition, fees, books, and, generally, room and board. Further, some states offer tax incentives for contributions to 529s.

The tax consequences come into play if 529 funds are used for anything other than qualified education expenses. Specifically, earnings on investments held in the account will be taxable and a 10% penalty will be assessed if the money is used for noneducation-related expenses.

Note that only the earnings portion of the account will be subject to taxes and penalties. Funds you’ve contributed to the account (or principal) won’t be taxed upon withdrawal regardless of what they’re used for, because contributions were made with after-tax dollars.

Your alternatives

So what should you do if your child graduates from college and there are funds left in your 529 account? Here are a few options to consider:

Change the beneficiary. The flexibility that characterizes 529 plans includes the ability to name someone else as the account’s beneficiary. So if you have other children in college now or who’re planning to attend college, you can simply make them the beneficiaries of the account.

You can even change the beneficiary to yourself. This would allow you to use the funds for qualified expenses for your own education.

Use the funds to pay for private school education. The Tax Cuts and Jobs Act changed the 529 plan rules so that up to $10,000 of funds per year can now be used for private K-12 tuition. Therefore, if you have younger children, you can potentially make beneficiary changes so you can use the 529 plan funds to send them to a private school. But beware that, depending on the state, there could be state tax consequences.

Investigate non-qualified 529 plan withdrawal options. The law specifies certain situations where non-qualified withdrawals can be made from 529 plans penalty-free. These include a child’s death or disability and a graduate’s attendance at a U.S. military academy.

Also, if your child is awarded an academic or athletic scholarship, you can use withdrawals up to the scholarship amount for expenses that aren’t education-related and avoid the 10% penalty on earnings. But you’ll still have to pay income tax on the earnings when you file your federal tax return.

There’s also a new provision that allows — subject to restrictions, of course — 529 plans to be used to repay student loans.

Leave the money alone. There’s no deadline for 529 account withdrawals, so you can leave funds in the account to pay for future education expenses. The money will continue to grow tax-deferred as long as it stays in the account.

So if your child decides later to attend graduate school, funds can be used to help cover these expenses. You can even keep funds in the account for the long term to help pay education expenses for your future grandchildren. This will give your children a good head start on college saving for their kids.

If all else fails

If none of these strategies are ideal for your situation, you may just have to withdraw excess 529 funds and pay the taxes and penalties due. Since they apply only to the earnings portion of the account, the tax hit may not be too severe.

To develop your best course of action regarding your overfunded 529 plan, contact a tax expert today.

© 2021

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Financial Institutions and Banking Financial News

Is Your Bank in Compliance?

The Dodd-Frank Act gives the Consumer Financial Protection Bureau (CFPB) broad authority to prosecute unfair, deceptive or abusive acts or practices (UDAAP) by banks and other financial providers. Early last year, the CFPB announced a new policy that gave institutions a reprieve from UDAAP enforcement actions. But in March 2021, it rescinded this policy, signaling a return to more aggressive enforcement.

UDAAP refresher

During the COVID-19 pandemic, many banks have changed the way they do business — for example, by reducing lobby hours, closing branches, and relying more on mobile banking apps and online transactions — and many of these changes may be here to stay. So, given the CFPB’s more aggressive enforcement stance, it’s a good idea for banks to review their UDAAP compliance policies and update them to reflect current business practices.

One reason UDAAP might be problematic is that its restrictions are quite broad and, in some cases, vague. Generally, an act or practice is unfair if it causes, or is likely to cause, substantial injury to consumers and such injury isn’t reasonably avoidable. Deceptive acts or practices are those that mislead or are likely to mislead consumers, provided the consumer’s interpretation is reasonable under the circumstances and the act or practice is material.

An act or practice is abusive if it materially interferes with a consumer’s ability to understand a product or service’s terms or conditions. Alternatively, abusive acts or practices may take unreasonable advantage of consumers’ 1) lack of understanding, 2) inability to protect their interests, or 3) reasonable reliance on banks to act in their interests.

CFPB guidance provides a nonexhaustive list of examples of conduct that may, depending on the facts and circumstances, constitute UDAAPs. They include:

  • Collecting or assessing a debt or additional amounts in connection with a debt (for example, interest, fees or charges) not expressly authorized by the agreement or permitted by law,
  • Failing to credit a consumer’s account with timely submitted payments and then imposing late fees,
  • Taking possession of property without the legal right to do so,
  • Revealing the consumer’s debt, without consent, to the consumer’s employer or coworkers,
  • Falsely representing the character, amount or legal status of the debt, and
  • Threatening any action that isn’t intended or authorized, including false threats of lawsuits, arrest, prosecution or imprisonment for nonpayment of debt.

Certain misrepresentations also may qualify as UDAAPs. For instance, a bank can’t falsely claim that a debt collection communication is from an attorney or government-affilitated source. Banks also can’t lie about whether information about a payment or nonpayment would be furnished to a credit reporting agency — or falsely promise to waive or forgive debts if consumers accept a settlement offer.

COVID-related updates

The COVID-19 pandemic has caused most businesses, including banks, to change the way they do things — so now’s a good time for a review. For example, have you permitted borrowers to skip loan payments under certain circumstances? Will that policy continue even after the pandemic ends? If so, you need to ensure that your policy is designed and communicated in a manner that isn’t unfair, deceptive or abusive to your customers.

During the pandemic, many banks have relied more heavily on electronic transactions in light of social distancing guidelines, a practice that may continue post-pandemic. If your bank permits customers to receive disclosures and other documents electronically, be sure that your policies and practices are fair, clearly communicated and don’t negatively impact customers without access to the necessary technology.

Even physical access and security practices may raise UDAAP concerns. For example, could reducing branch hours be perceived as unfair or abusive to specific customers? And what about masks or other face coverings? Ordinarily, banks prohibit them. But by necessity, exceptions have been made pursuant to mask mandates during the pandemic. In the absence of a mandate, what will your bank’s policy be going forward? Will you require customers to remove their masks, even if they’re at higher risk or simply feel more comfortable wearing one? Whatever your policy, it should be carefully designed and communicated to avoid UDAAP issues.

Training is key

Any time a bank changes its business practices or establishes new ones, it’s important to evaluate whether those changes raise UDAAP concerns. Even if your policies are fair on paper, they can still trigger UDAAP liability if they’re not put into practice properly. So be sure that bank staff or other representatives are adequately trained.

To ensure that your bank is still compliant after all of the recent changes, contact one of our financial institution experts today.

 

CFPB renews focus on UDAAP enforcement

In January 2020, the Consumer Financial Protection Bureau (CFPB) issued a policy statement providing some relief to banks for unfair, deceptive, or abusive acts or practices (UDAAP). Pursuant to the statement, the CFPB said it wouldn’t challenge conduct as abusive unless the harm to consumers outweighed the benefits. It also pledged to end “dual pleading” — that is, charging a bank with both abusiveness and unfairness or deception based on the same conduct — and to refrain from seeking monetary relief when a bank made a good-faith effort to comply with the law.

In March 2021, the CFPB rescinded the policy statement, finding it inconsistent with the CFPB’s mission. Going forward, it will exercise the “full scope” of its enforcement authority, although it will consider good faith and other relevant factors in using its prosecutorial discretion.

©2021

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General

Worker Classification Is Still Important

In 2020 and 2021, many companies have experienced “workforce fluctuations.” If your business has engaged independent contractors to address staffing needs, be careful that these workers are properly classified for federal tax purposes.

Tax obligations

The question of whether a worker is an independent contractor or an employee for federal income and employment tax purposes is a complex one. If a worker is an employee, the company must withhold federal income and payroll taxes, and pay the employer’s share of FICA taxes on the wages, plus FUTA tax. Often, a business must also provide the worker with the fringe benefits that it makes available to other employees. And there may be state tax obligations as well.

These obligations don’t apply if a worker is an independent contractor. In that case, the business simply sends the contractor a Form 1099-NEC for the year showing the amount paid (if the amount is $600 or more).

No uniform definition

The IRS and courts have generally ruled that individuals are employees if the organization they work for has the right to control and direct them in the jobs they’re performing. Otherwise, the individuals are generally independent contractors, though other factors are considered.

Some employers that have misclassified workers as independent contractors may get some relief from employment tax liabilities under Internal Revenue Code Section 530. In general, this protection applies only if an employer filed all federal returns consistent with its treatment of a worker as a contractor and treated all similarly situated workers as contractors.

The employer must also have a “reasonable basis” for not treating the worker as an employee. For example, a “reasonable basis” exists if a significant segment of the employer’s industry traditionally treats similar workers as contractors. (Note: Sec. 530 doesn’t apply to certain types of technical services workers. And some categories of individuals are subject to special rules because of their occupations or identities.)

Asking for a determination

Under certain circumstances, you may want to ask the IRS (on Form SS-8) to rule on whether a worker is an independent contractor or employee. However, be aware that the IRS has a history of classifying workers as employees rather than independent contractors.

Consult a CPA before filing Form SS-8 because filing the form may alert the IRS that your company has worker classification issues — and inadvertently trigger an employment tax audit. It may be better to properly treat a worker as an independent contractor so that the relationship complies with the tax rules.

Latest developments

In January 2021, the Trump Administration published a final rule revising the Fair Labor Standards Act’s employee classification provision. The rule change was considered favorable to employers.

The Biden Administration initially delayed the effective date and then issued a Notice of Proposed Rulemaking (NPRM) to withdraw the rule. After reviewing approximately 1,000 comments submitted in response to the NPRM, it withdrew the rule change before the deferred effective date. Contact your tax advisor for any help you may need with employee classification.

© 2021

Categories
Helpful Articles Tax

Boost Your Cash Flow with a Cost Segregation Study

For businesses planning to buy, build or substantially improve real property, a cost segregation study can help accelerate depreciation deductions, reduce taxes and boost cash flow. Lookback studies can also be done for prior years. This article explains how cost segregation studies work and how tax deductions are recovered.

A cost segregation study is one way to boost cash flow

If your business is planning to buy, build or substantially improve real property, a cost segregation study can help you accelerate depreciation deductions, reduce your taxes and boost your cash flow. Even if you’ve invested in real property in previous years, you may have an opportunity to do a lookback study and catch up on the deductions you missed.

How it works

Generally, commercial real property (other than land) is depreciable over 39 years, and residential real property is depreciable over 27.5 years. A cost segregation study identifies real estate components that are properly treated as personal property depreciable over, say, five or seven years, or land improvements depreciable over 15 years. By allocating a portion of your costs to these shorter-lived assets, you can accelerate depreciation deductions and substantially reduce your tax bill. And if these assets qualify for bonus depreciation, the tax savings can be even greater.

In some cases, assets that qualify as personal property are apparent. Examples include furniture, fixtures, equipment and machinery. But often, property eligible for accelerated depreciation is less obvious. For example, building components that ordinarily would be treated as real property depreciable over 39 years may be classified as five- or seven-year property if they’re essential to special business functions.

An example: A manufacturing company built a $20 million factory and placed it in service in June 2021. To accommodate its manufacturing processes, the design called for a reinforced foundation, specialized electrical and plumbing systems, and other structural components closely related to manufacturing functions.

A cost segregation study supports allocation of $6 million of the factory’s cost to these components, which are depreciable over seven years rather than 39 years. As a result, the company increases its depreciation deductions by approximately $774,000 in Year 1, $1.05 million in Year 2 and $895,000 in year three (not counting any available bonus depreciation).

Recovering deductions

Suppose you invested in a building several years ago but allocated the entire cost to real property. Depending on how much time has passed and the documentation you have available, it may be possible to conduct a lookback study and reallocate a portion of the cost to shorter-lived personal property. Applying to the IRS for a change in accounting method may allow you to claim a catch-up deduction for the extra depreciation deductions you missed over the years.

Is it right for you?

Are you wondering if a cost segregation study would pay off for your business? Our tax experts can help you weigh the potential tax savings against the cost of a study.

© 2021

Categories
Helpful Articles Tax

Are you liable for “nanny taxes”?

If you employ household workers — which may include nannies, babysitters, housekeepers, cooks, gardeners, health care workers and other employees — it’s important to understand your tax obligations, commonly referred to as “nanny taxes.” Here’s a quick review.

Which workers are covered?

Simply working in your home doesn’t necessarily make a worker a household employee. You’re not required to withhold or pay taxes for independent contractors — such as occasional babysitters who work for many different families.

But the rules for distinguishing between employees (who trigger nanny tax obligations) and independent contractors (who don’t) are complicated, So be sure to consult your tax advisor if you’re uncertain.

Which taxes must you pay?

Your nanny tax obligations vary depending on the type of tax:

Income tax. You’re not required to withhold federal income taxes (or, usually, state income taxes) from a household employee’s pay, unless the employee asks you to and you agree. In that case, you’ll need to have the employee complete Form W-4 and you’ll need to withhold income taxes on both cash and noncash wages (other than certain meals and lodging).

FICA taxes. You must withhold and pay FICA taxes (Social Security and Medicare) if your household employee’s cash wages reach a specified threshold ($2,300 for 2021). If you meet the threshold, you must pay the employer’s share of Social Security taxes (6.2%) and Medicare taxes (1.45%) on the employee’s cash wages (but not on meals, lodging or other noncash wages). In addition, you’re responsible for withholding the employee’s share of these taxes (also 6.2% and 1.45%, respectively), although you may opt to pay the employee’s share rather than withholding it.

Note: There’s no FICA tax liability for wages you pay to certain family members or to household employees under the age of 18 if working for you isn’t their principal occupation. A student who babysits on the side would be one example.

Unemployment taxes. You must pay federal unemployment tax (FUTA) if you pay total cash wages to household employees (other than certain family members) of $1,000 or more in any quarter in the current or preceding calendar year. The tax applies to the first $7,000 of an employee’s cash wages at a 6% rate, although credits reduce that rate to 0.6% in most cases.

How are taxes reported and paid?

Unlike businesses, you generally don’t need to file quarterly employment tax returns for household employees. Rather, you report household employment taxes on Schedule H of your personal income tax return. However, if you own a business as a sole proprietor, you may add the taxes for household employees to the deposits or payments you make for your business employees and include household employees on Forms 940 and 941.

Even if you report household employment taxes on Schedule H, you’re still responsible for paying the tax throughout the year, either through quarterly estimated tax payments or by increasing withholdings from your wages. Otherwise, you’ll have to pay the tax when you file your return and be subjected to penalties for underpayment of estimated tax.

You’ll also need to file Form W-2 if you’re required to withhold FICA taxes or agree to withhold income taxes for a household employee.

Know your obligations as an employer

In addition to the tax requirements discussed above, there may be other obligations that come with being an employer. These may include complying with minimum wage and overtime requirements, and documenting immigration status. Turn to your tax advisor for more information.

© 2021

Categories
Helpful Articles Tax

Business Meal Expense Deductions

The TCJA permanently eliminated deductions for most business-related entertainment expenses paid or incurred after 2017. But it didn’t specifically address the meals, beverages and snacks that often accompany entertainment activities. Then, the CAA temporarily increased the deduction for certain business-related meal expenses. Many business owners today aren’t sure what they can deduct or how much they can deduct.

When can you deduct business-related meals . . . and how much can you deduct?

The Tax Cuts and Jobs Act (TCJA) permanently eliminated deductions for most business-related entertainment expenses paid or incurred after 2017. For example, you can no longer deduct any of the cost of taking clients out for a round of golf, to the theater or for a football game. But the TCJA didn’t specifically address the meals, beverages and snacks that often accompany entertainment activities.

Then the Consolidated Appropriations Act (CAA), which was signed into at law in December of 2020, temporarily increased the deduction for certain business-related meal expenses.

If you’re like many business owners today, you may not be sure what you can deduct or how much you can deduct. Here’s what you need to know.

A 100% deduction

The CAA allows taxpayers to deduct 100% of the cost of business-related food and beverage expenses incurred at restaurants in 2021 and 2022. In previous years, deductions for business meals at restaurants were limited to only 50% of the cost.

Under the new law, for 2021 and 2022, business meals provided by restaurants are 100% deductible, subject to the considerations identified in preexisting IRS regulations. IRS guidance in Notice 2021-25, released in April, defines “restaurants” for the purpose of this tax break to  include businesses that prepare and sell food or beverages to retail customers for immediate on-premises and/or off-premises consumption.

However, restaurants don’t include businesses that primarily sell pre-packaged goods not for immediate consumption, such as grocery stores and convenience stores. Additionally, an employer may not treat certain employer-operated eating facilities as restaurants, even if these facilities are operated by a third party under contract with the employer.

Pre-CAA regulations

In October 2020, the IRS issued final regulations which clarified that taxpayers could still deduct 50% of business-related meal expenses under the TCJA. These regs were written before the CAA change that allows 100% deductions for business-related restaurant meals provided in 2021 and 2022, but they still provide some useful guidance on the following issues:

Definition of food and beverage costs. Food or beverages means all food and beverage items, regardless of whether they are characterized as meals, snacks, or other types of food and beverages. Food or beverage costs mean the full cost of food or beverages, including any delivery fees, tips and sales tax.

Treatment of food and beverages provided with entertainment. For purposes of the general disallowance rule for entertainment expenses, the term “entertainment” includes food or beverages only if the food or beverages are provided at or during an entertainment activity (such as a sporting event) and the costs of the food or beverages aren’t separately stated.

Specifically, to be deductible, amounts paid for food and beverages provided at or during an entertainment activity must be:

  • Purchased separately from the entertainment, or
  • Stated separately on a bill, invoice or receipt that reflects the venue’s usual selling price for such items if they were purchased separately from the entertainment or the approximate reasonable value of the items.

Otherwise, the entire cost is treated as a nondeductible entertainment expense; the taxpayer can’t attempt to allocate costs between the entertainment and the food or beverages.

Treatment of business meals. Under the final regs, a deduction is allowed for business-related food or beverages only if:

  • The expense isn’t lavish or extravagant under the circumstances,
  • The taxpayer or an employee of the taxpayer is present at the furnishing of the food or beverages, and
  • The food or beverages are provided to the taxpayer or a business associate.

A business associate means a person with whom the taxpayer could reasonably expect to engage or deal with in the active conduct of the taxpayer’s business such as a customer, client, supplier, employee, agent, partner or professional advisor — whether established or prospective.

Treatment of meals while traveling on business. Under the final regs, the long-standing rules for substantiating meal expenses still applies and they can be deductible.

The regs also reiterate the long-standing rule that no deductions are allowed for meal expenses incurred for spouses, dependents or other individuals accompanying the taxpayer on business travel (or accompanying an officer or employee of the taxpayer on business travel), unless the expenses would otherwise be deductible by the spouse, dependent or other individual. For example, meal expenses for the taxpayer’s spouse would be deductible if the spouse works in the taxpayer’s unincorporated business and accompanies the taxpayer for business reasons.

Under the new law, for 2021 and 2022, meals provided by restaurants while traveling on business are 100% deductible, subject to the preceding considerations.

Need help?

There are additional circumstances under which your business can deduct 100% of the cost of meals, other food and beverages. Contact your tax advisor if you have questions or want more information.

© 2021

Categories
Helpful Articles Tax

5 Tax Planning Tips for Retirees

5 tax planning tips for retirees

There’s a common misconception that, when you retire, your tax bills shrink, your tax returns become simpler and tax planning is a thing of the past. That may be true for some, but many people find that the combination of Social Security, pensions and withdrawals from retirement accounts increases their income in retirement and may even push them into a higher tax bracket.

If you’re retired or approaching retirement, consider these five tax-planning tips:

  1. Take inventory. Estimate how much money you’ll need in retirement for living expenses and inventory your income sources. These sources may include taxable assets, such as mutual funds and brokerage accounts; tax-deferred assets, such as IRAs, 401(k) plan accounts and pensions; and nontaxable assets, such as Roth IRAs, Roth 401(k) plans or tax-exempt municipal bonds. Social Security benefits may be nontaxable or partially taxable, depending on your other sources of income.

Develop a plan for drawing retirement income in a tax-efficient manner, being sure to keep state income tax, if applicable, in mind. For example, you might minimize current taxes by tapping nontaxable assets first, followed by assets that generate capital gains, and putting off withdrawals from tax-deferred accounts as long as possible.

On the other hand, if you’re approaching age 72 and will have substantial required minimum distributions (RMDs) from tax-deferred accounts when you reach that age (see No. 3 below), it may make sense to withdraw some of those funds earlier. Why? It can help you avoid having large RMDs that would push you into a higher tax bracket later.

For example, you might withdraw as much as you can from IRAs or 401(k) accounts each year without exceeding the lower tax brackets. That way, you keep current taxes on those funds at a reasonable level while reducing the size of your accounts and, in turn, the size of your RMDs down the road. You can obtain additional funds from nontaxable or capital gains assets, if needed.

  1. Consider the timing of Social Security benefits. You can begin receiving Social Security benefits as early as age 62 or as late as age 70. The later you start, the larger the benefit amount — so, if you don’t need the money right away, putting it off may be a good investment. Also, benefits are reduced if you start them before you reach full retirement age and continue to work.

Keep in mind that, if your income from other sources exceeds certain thresholds, your Social Security benefits will become partially taxable. For example, married couples filing jointly with combined income over $44,000 are taxed on up to 85% of their Social Security benefits. (Combined income is adjusted gross income plus nontaxable interest plus half of Social Security benefits.)

  1. Make qualified charitable distributions. You’re required to begin RMDs from tax-deferred retirement accounts once you reach age 72 (up from 70½ for people born before July1, 1949) though you’re able to defer your first distribution until April 1 of the year following the year you reach age 72. RMDs generally are taxed as ordinary income and you must take them regardless of whether you need the money. As noted in No. 1, a large RMD can push you into a higher tax bracket.

One strategy for reducing the amount of RMDs, at least if you’re charitably inclined, is to make a qualified charitable distribution (QCD). If you’re age 70½ or older (this age didn’t increase when the RMD age increased), a QCD allows you to distribute up to $100,000 tax-free directly from an IRA to a qualified charity and to apply that amount toward your RMDs.

The funds aren’t included in your income, so you avoid tax on the entire amount, regardless of whether you itemize. In addition, the income-based limits on charitable deductions don’t apply. Any amount excluded from your income by virtue of the QCD is similarly excluded from being treated as a charitable deduction.

  1. Pay estimated taxes. Your retirement income sources may or may not withhold income taxes. To avoid tax surprises and penalties, estimate whether your withholdings will be sufficient to pay your tax liability for the year and make quarterly estimated tax payments to cover any expected shortfall.
  2. Track your medical expenses. Currently, medical expenses are deductible only if you itemize and only to the extent they exceed 7.5% of your adjusted gross income. If you have significant medical expenses, track them carefully. Then if you exceed this threshold or are close to exceeding it, consider bunching elective expenses into the year to maximize potential deductions.

If you are nearing retirement age and have questions on how your tax situation may change, contact one of our expert tax advisors.

© 2021

Categories
Helpful Articles Tax

Rental Real Estate: Investment or Business?

If you own rental real estate, its classification as a trade or business rather than an investment can have a big impact on your tax bill. The distinction is especially important because of the 20% Sec. 199A deduction for certain sole proprietors and pass-through entity owners. This article provides a brief overview of the deduction and rental real estate guidance related to it.

Determining if a property is a business or an investment

If you own rental real estate, its classification as a trade or business rather than an investment can have a big impact on your tax bill. The distinction is especially important because of the 20% Section 199A deduction for certain sole proprietors and pass-through entity owners.

The 199A deduction is available for qualified business income (QBI), which can come from an eligible trade or business, but not from an investment. So, assuming you otherwise meet the requirements, qualifying your rental real estate activities as a trade or business may yield substantial tax savings. Fortunately, an IRS Revenue Procedure establishes a safe harbor.

A brief review

The 199A deduction is too complex to cover fully here. But, in general, it allows owners of sole proprietorships and pass-through entities — partnerships, S corporations and, generally limited liability companies (LLCs) — to deduct as much as 20% of their net business income, without the need to itemize.

Eligible owners are entitled to the full deduction so long as their taxable income doesn’t exceed an inflation-adjusted threshold (for tax year 2021, $164,900 for singles and heads of households; $329,800 for joint filers). Above the threshold, the deduction may be reduced or eliminated for businesses that perform certain services or lack sufficient W-2 wages or depreciable property.

Rental real estate guidance

According to the IRS, for purposes of the 199A deduction, an enterprise is a trade or business if it qualifies as such under Internal Revenue Code Section 162. That section doesn’t expressly define “trade or business” — it’s determined on a case-by-case basis based on various factors. Generally, a trade or business is an activity conducted “on a regular, continuous and substantial basis” with the aim of earning a profit.

Uncertainty over whether rental real estate qualifies, especially for taxpayers with one or two properties, prompted the IRS to issue Revenue Procedure 2019-38 to establish a safe harbor. Under the Revenue Procedure, a rental real estate enterprise (RREE) is deemed a trade or business if the taxpayer (you or a “relevant pass-through entity” in which you own an interest):

  • Maintains separate books and records for the enterprise,
  • Performs at least 250 hours of rental services per year (for an enterprise that’s at least four years old, this requirement is satisfied if you meet the 250-hour test in at least three of the last five years),
  • Keeps logs, time reports or other contemporaneous records detailing the services performed, and
  • Files a statement with his or her tax return.

The Revenue Procedure lists the types of services that count toward the 250-hour minimum and clarifies that they may be performed by the owner or by employees or contractors. It also defines an RREE as one or more rental properties held directly by the taxpayer or through disregarded entities (for example, a single-member LLC).

Generally, taxpayers must either treat each rental property as a separate enterprise or treat all similar properties as a single enterprise. Commercial and residential properties, for example, can’t be combined in the same enterprise.

Planning opportunities

There may be opportunities to restructure rental activities to take full advantage of the safe harbor. For example, Marilyn owns a rental residential building and a rental commercial building and performs 125 hours of rental services per year for each property. As noted, she can’t combine the properties into a single enterprise, so she doesn’t pass the 250-hour test.

But let’s say she exchanges the residential building for another commercial building for which she provides 125 hours of services. Then she can treat the two commercial buildings as a single enterprise and qualify for the safe harbor (provided the other requirements are met).

Don’t try this at home

The tax treatment of rental real estate is complex. To take advantage of the 199A deduction or other tax benefits for rental real estate, consult your tax advisor.

Sidebar: Are you a real estate professional?

Ordinarily, taxpayers who “materially participate” in a trade or business are entitled to deduct losses against wages or other ordinary income and to avoid net investment income tax on income from the business. The IRS uses several tests to measure material participation. For example, you materially participate in an activity if you devote more than 500 hours per year, or if you devote more than 100 hours and no one else participates more.

Rental real estate, however, is generally deemed to be a passive activity — that is, one in which you don’t materially participate — regardless of how much time you spend on it. There’s an exception, however, for “real estate professionals.”

To qualify for the exception, you must spend at least 750 hours per year — and more than half of your total working hours — on real estate businesses (such as development, construction, leasing, brokerage or management) in which you materially participate. (The hours you spend as an employee don’t count, unless you own at least 5% of the business.)

© 2021

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