Category: Tax Services

Posted on Feb 2, 2019

Over the years, real estate has proven to be a lucrative investment for many households. And, in some parts of the country, current market values have surpassed levels seen prior to the 2008 financial crisis.

If your principal residence has appreciated significantly in value, you may be subject to capital gains tax when it’s sold. If your gain will be too big to be sheltered by the federal home sale gain exclusion, you might consider a tax-deferred Section 1031 like-kind exchange. However, this strategy isn’t for everyone, and executing it requires some proactive planning.

Timing is Critical

Substantial tax savings can be reaped on the sale of a highly appreciated principal residence when you can combine the home sale gain exclusion and Section 1031 like-kind exchange breaks. To cash in, a former principal residence must be properly converted into a rental property; then it must be swapped for replacement property in an exchange, as described in the main article.

This strategy can’t be done overnight. Without explicitly saying so, IRS guidance on like-kind exchanges has apparently established a two-year safe-harbor rental period rule. A shorter rental period might work, but it could be challenged by the IRS.

Time is also limited on the rental period. That is, a former principal residence can’t be rented out for more than three years after you vacate the premises. To qualify for the home sale gain exclusion, a property must have been used as the taxpayer’s principal residence for at least  two years during the five-year period ending on the exchange date.

Avoid Tax with the Home Sale Gain Exclusion

If you have a capital gain from the sale of your principal residence, you may qualify to exclude up to $250,000 of that gain from your federal taxable income, or up to $500,000 of that gain if you file a joint return with your spouse.

To qualify for this exclusion, you must meet both the ownership and use tests. In general, you’re eligible for the exclusion if you’ve owned and used your home as your main residence for a period aggregating at least two years out of the five years prior to its date of sale. You can meet the ownership and use tests during different two-year periods. However, you must meet both tests during the five-year period ending on the date of the sale.

Generally, you’re not eligible for the exclusion if you excluded the gain from the sale of another home during the two-year period prior to the sale of your home.

Defer Tax with a Like-Kind Exchange

If your gain exceeds the $250,000/$500,000 home sale gain exclusion, you might consider combining the exclusion tax break with a Sec. 1031 like-kind exchange. With proper planning, you can accomplish a tax-saving double play with full IRS approval.

This strategy is available to homeowners who can arrange property exchanges that satisfy the requirements for both the principal residence gain exclusion break and tax deferral under the Sec. 1031 like-kind exchange rules. The kicker is that like-kind exchange treatment is allowed only when both the relinquished property (what you give up in the exchange) and the replacement property (what you acquire in the exchange) are used for business or investment purposes.

That means you must show that you have converted your former principal residence into property held for productive use in a business or for investment before you make the exchange. According to IRS guidance, such a conversion takes two years.

Important note: The Tax Cuts and Jobs Act disallows Sec. 1031 like-kind exchange treatment for exchanges of personal property (not real estate) that are completed after December 31, 2017. However, properly structured exchanges of real property completed after that date still qualify for tax-deferred Sec. 1031 treatment.

The Mechanics

According to the IRS, the principal residence gain exclusion rules must be applied before the Sec. 1031 like-kind exchange rules when you’re able to combine both breaks.

In applying the Sec. 1031 rules, “boot” (meaning cash or property other than real estate received in exchange for your relinquished former personal residence) is taken into account only to the extent the boot exceeds the gain that you can exclude under the home sale gain exclusion rules.

In determining your tax basis in the replacement property, any gain that you can exclude under the principal residence gain exclusion rules is added to the basis of the replacement property. Any cash boot that you receive is subtracted from your basis in the replacement property.

The gain that’s deferred under the like-kind exchange rules is also effectively subtracted from your basis in the replacement property. But that’s OK, because you’ve successfully deferred what would have been a taxable gain upon the disposition of your former personal residence.

Let’s Look at an Example

To illustrate how this strategy works, suppose you and your spouse have owned a home for several years. Your basis in the property is $400,000. But, it’s worth $3.3 million today, so you’re rightfully worried about the tax hit when you sell.

Rather than sell now, you decide to convert your home into a rental property. You rent it out for two years, and then exchange it for a small apartment building worth $3 million plus $300,000 of cash boot (paid to you to equalize the values in the exchange).

When the property is sold in 2021, you realize a $2.9 million gain on the exchange. That’s equal to the sale proceeds of $3.3 million (apartment building worth $3 million plus $300,000 in cash) minus your basis in the relinquished property of $400,000.

On your joint federal income tax return for the year of the exchange, you exclude $500,000 of the $2.9 million gain under the principal residence gain exclusion rules.

Because the relinquished property was investment property at the time of the exchange (due to the two-year rental period before the exchange), you can defer the remaining gain of $2.4 million under the Sec. 1031 like-kind exchange rules.

You aren’t required to recognize any taxable gain, because the $300,000 of cash boot you received is taken into account only to the extent it exceeds the gain you excluded under the principal residence gain exclusion rules. Since the $300,000 of boot is less than the $500,000 excluded gain, you have no taxable gain from the boot.

Tax results from the exchange can be summarized as follows:

Amount realized: $3,300,000

Less basis of relinquished property: ($400,000)

Realized gain: $2,900,000

Home sale gain exclusion: ($500,000)

Deferred gain under Sec. 1031: $2,400,000

Your basis in the apartment building (replacement property) is $600,000 ($400,000 basis of relinquished former principal residence plus $500,000 gain excluded under principal residence gain exclusion rules minus $300,000 of cash boot received). Put another way, your basis in the  apartment building equals its fair market value of $3 million at the time of the exchange minus the $2.4 million gain that’s deferred under the like-kind exchange rules.

Important note: Tax on the gain has only been deferred, not avoided. You’ll owe tax on the $2.4 million gain when the property is eventually sold (unless you execute another like-kind exchange, which further defers the tax hit). However, if you hang on to the replacement property (the apartment building in the example) until you die, the deferred gain will be eliminated thanks to the date-of-death basis step-up rule.

Under that rule, the basis of the building is stepped up to its fair market value as of the date of your death (or the alternate valuation date, which is six months after you die). So, your heirs could sell the building shortly after you pass away and owe little or no tax on the sale. They would owe tax only on postdeath appreciation, if any.

Right for You?

Under the right circumstances, combining the home sale gain exclusion with a tax-deferred Sec. 1031 like-kind exchange can save significant taxes if you plan to sell a highly appreciated principal residence. If you think this strategy might work for you, consult your tax advisor to discuss the right time to convert your home into a rental property. He or she can help execute this strategy under current tax law.

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Posted on Jan 23, 2019

The IRS announced that it is waiving the estimated tax penalty for many taxpayers whose 2018 federal income tax withholding and estimated tax payments fell short of their total tax liability for the year.

The IRS is generally waiving the penalty for any taxpayer who paid at least 85% of their total tax liability during the year through federal income tax withholding, quarterly estimated tax payments or a combination of the two. The usual percentage threshold is 90% to avoid a penalty. (IRS Notice 2019-11)

The move addresses concerns expressed by various parties. A July 2018 Government Accountability Office (GAO) report projected that nearly 30 million taxpayers will owe money when they file their 2018 personal income tax returns due to underwithholding. A wide range of changes from the Tax Cuts and Jobs Act (TCJA) caused many taxpayers to be underwithheld.

A recent letter to the IRS from U.S. Senator Ron Wyden (D-OR) noted that millions of taxpayers would face unexpected tax bills and penalties. He wrote: “It seems unavoidable that millions of taxpayers who are expecting critical tax refunds will instead owe taxes” when they file.

The American Institute of CPAs and the National Conference of CPA Practitioners, in separate letters to the IRS, also asked the tax agency to forgo imposing penalties related to certain underpayments and under-withholding due to the TCJA, which was enacted in December 2017.

Software Integration

The waiver computation announced by the IRS on January 16 will be integrated into commercially available tax software and reflected in the forthcoming revision of Form 2210, “Underpayment of Estimated Tax by Individuals, Estates, and Trusts,” as well as its instructions.

This relief is designed to help taxpayers who were unable to properly adjust their withholding and estimated tax payments to reflect changes under the TCJA.

“We realize there were many changes that affected people last year, and this penalty waiver will help taxpayers who inadvertently didn’t have enough tax withheld,” said IRS Commissioner Chuck Rettig. “We urge people to check their withholding again this year to make sure they are having the right amount of tax withheld for 2019.”

The updated federal tax withholding tables, released in early 2018, largely reflected the lower tax rates and the increased standard deduction that are part of the new law. In general, that meant taxpayers had less tax withheld in 2018 and saw more in their paychecks.

However, the IRS explained that “withholding tables couldn’t fully factor in other changes, such as the suspension of dependency exemptions and reduced itemized deductions.” As a result, some taxpayers could have paid too little tax during the year, if they didn’t submit a properly-revised W-4 withholding form to their employers or increase their estimated tax payments. The IRS conducted an extensive outreach and education campaign throughout 2018 to encourage taxpayers to do a “Paycheck Checkup” to avoid a situation where they had too much or too little tax withheld when they file their tax returns.

“Although most 2018 tax filers are still expected to get refunds, some taxpayers will unexpectedly owe additional tax when they file their returns,” the IRS stated.

Pay-As-You-Go System

Because the U.S. tax system is pay-as-you-go, taxpayers are required, by law, to pay most of their tax liability during the year — rather than at the end of the year. This can be done by either having tax withheld from paychecks or pension payments, or by making estimated tax payments.

Usually, a penalty applies at tax filing if too little is paid during the year. Normally, the penalty wouldn’t apply for 2018 if tax payments during the year met one of the following tests:

  • The person’s tax payments were at least 90% of the tax liability for 2018, or
  • The person’s tax payments were at least 100% of the prior year’s tax liability, in this case from 2017. However, the 100% threshold is increased to 110% if a taxpayer’s adjusted gross income is more than $150,000 ($75,000 if married and filing separately).

For waiver purposes only, the IRS relief lowers the 90% threshold to 85%. This means that a taxpayer won’t owe a penalty if he or she paid at least 85% of his or her total 2018 tax liability. If the taxpayer paid less than 85%, then he or she isn’t eligible for the waiver and the penalty will be calculated as it normally would be, using the 90% threshold.

When it comes to withholding, the IRS wants taxpayers to check their situation again for 2019. This is especially important for anyone who faces an unexpected tax bill when they file a 2018 return this filing season. It’s also an important step for those who made withholding adjustments last year or had a major life change. You want to make sure the correct tax is still being withheld.

Who Could Have a Tax Season Surprise?

Those most at risk of having too little tax withheld from their pay include:

  • Taxpayers who itemized in the past but now take the increased standard deduction,
  • Two-wage-earner households,
  • Employees with non-wage sources of income, and
  • Taxpayers with complex tax situations.

To help get withholding right in 2019, an updated version of the agency’s online withholding calculator is now available on the IRS website. To access it, go to: https://www.irs.gov/individuals/irs-withholding-calculator.

The IRS previously announced that this year’s tax season starts on January 28. Although the IRS won’t begin processing 2018 returns until that date, your tax advisor can accept and prepare returns before then and answer any questions you have about your situation.

 

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Posted on Jan 8, 2019

Have you ever kept a New Year’s resolution for the entire year? Every January, millions of Americans make promises to eat less, exercise more and save for the future. But most resolutions are forgotten by spring.

However, there are ten promises that relate to your financial health that you can’t afford to abandon.

1. Make a financial plan. Creating a financial plan forces you to set goals and identifies a path to reach them. Your plan should combine general objectives — like your preferred retirement age and lifestyle. In turn, these general objectives will help you create a ballpark estimate for how much you’ll need to save each year, and whether your current savings are on track to achieve those goals.

2. Seek input from a financial professional. A competent, ethical financial advisor can help you flesh out and achieve your plan. If you don’t already have a financial advisor, look for someone with strategic and tactical advice on saving, investing, budgeting and managing financial risks. Even if you consider yourself savvy about money, prove it by sharing your detailed financial plan with a pro. He or she can give it a reality check and point out potential changes under today’s tax laws.

3. Review financial plans annually. Expected rates of return and annual contributions aren’t guaranteed, especially under volatile market conditions. Life circumstances also might change, such as having a new child or grandchild, getting laid off from a job or receiving an unexpected raise. If you veer off course, tactical adjustments might be needed to reach your goals.

4. Try to be fiscally responsible. It may be tempting to spend your 2018 bonus or tax refund on an extravagant purchase, like a new luxury SUV or multi-carat diamond necklace. But it’s important to differentiate needs from wants. Hold on tight to your wallet and consult your financial plan before making a costly impulse buy.

5. Allocate investments based on age and risk tolerance. Asset allocation refers to the proportion of different categories of investments — stocks, bonds and cash-equivalents — in an investment portfolio. After deciding on the right asset allocation for your situation, align your investments accordingly. Thereafter, to maintain that balance, consider the need to adjust periodically for additions to your portfolio and changes in the assets’ market values.

6. Monitor investment fees and commissions … and don’t overpay. Studies of mutual fund  investments generally don’t show a consistent relationship between operating costs and return on investment. Unless higher fees result in a higher return, why would you agree to pay more for investment management services, brokerage commissions and mutual fund “loads” (sales charges) when you buy or sell securities? By minimizing these fees, you’ll maximize the value of your portfolio. A few extra dollars here and there add up over time.

7. Become financially literate. Personal finance may be a tedious topic for some people. But a little knowledge can help you avoid mistakes and recognize opportunities. Financial literacy also provides the peace of mind that you’re not just relying on gut instinct. Want to learn more? Stick to books and publications from reputable sources that describe trends and principles of personal finance. Avoid doomsday advice or too-good-to-be-true trends.

With long-term investments, slow, steady and responsible usually wins the race. Financial literacy takes ongoing effort to stay atop new types of investments, market trends and changes in the tax law.

8. Purchase adequate insurance. Wise people expect the unexpected. Who expects to die young or become paralyzed in a car accident? While going through life with a sense of foreboding would be tragic, rose-colored glasses aren’t the only alternative. Find a happy medium and insure yourself accordingly.

9. Pay attention to taxes. Tax evasion is criminal. But minimizing your taxes by legal means is smart. Although federal and state tax issues shouldn’t drive every decision, they’re an important variable to factor into the equation.

Remember, the Tax Cuts and Jobs Act (TCJA) brought sweeping changes to the tax law that generally are effective from 2018 to 2025 for individual taxpayers. It’s important to discuss the changes with your financial advisor to determine whether your current plans need to be adjusted.

10. Carpe diem. It’s smart to have a financial plan and be fiscally responsible. But don’t set your savings goals so high that you’re unable to enjoy life today. Budget some discretionary (fun) money to spend on friends, family, travel, pets and anything else you love. 

There are two kinds of New Year’s resolutions: Those you keep and those you quickly abandon. So, the ultimate resolution should be: I will keep all of my New Year’s resolutions in 2019. Best of luck in the year ahead.

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Posted on Jan 8, 2019

The trust fund penalty is one of the more onerous tax provisions on the books. In short, a company owner or officer, or another “responsible person,” may be held personally liable for any unpaid payroll taxes. Because the assessment is for 100% of the tax due, this provision is sometimes called the “100% penalty.”

The IRS is allowed to pursue more than one person for this tax obligation. In a recent Third Circuit Court of Appeals case, USA v. Darren Commander, the court imposed the trust fund penalty against a corporate co-owner even though it was the other owner who was responsible for payroll. The U.S. Supreme Court has declined to review the appeals court’s decision, so the decision stands.

Who’s Responsible

Can You Settle with the IRS?

As with other types of tax debt, taxpayers who owe the trust fund penalty have options. For instance, if you can’t pay the full amount owed, you may apply for a payment plan or installment agreement. Alternatively, you can try to settle the debt for less than you owe through the “offer-in-compromise” program or a partial payment installment agreement.

The most important thing is to contact the IRS and set up an arrangement before the agency tries to garnish your wages or seize your assets. You can’t discharge those penalties in bankruptcy.

The trust fund penalty may be assessed against any person who:

  1. Is responsible for collecting or paying withheld income and employment taxes or for paying collected excise taxes, and
  2. Willfully fails to collect or pay those taxes.

Typically, this liability is imposed on a company owner or president, but it potentially could extend down the ranks to a mid-level manager or bookkeeper.

Notably, a responsible person for these purposes is any person — or group of people — who has the duty to perform and the power to direct the collecting, accounting and paying of trust fund taxes. Accordingly, the IRS says this could be:

  • An officer or employee of a corporation,
  • A member or employee of a partnership,
  • A corporate director or shareholder,
  • A board of trustees member of a not-for-profit organization,
  • Someone with authority and control over funds to direct their disbursement,
  • Another corporation or third-party payer,
  • Payroll Service Providers (PSP) or responsible parties within a PSP,
  • Professional Employer Organizations (PEO) or responsible parties within a PEO, or
  • Responsible parties within the common law employer (PSP/PEO client).

The IRS broadly interprets “willful failure.” The failure doesn’t have to be intentional. For example, the trust fund penalty may be applied in situations where someone knew, or should have known, about the taxes that should have been paid, but weren’t. In other words, the penalty may be imposed on someone regardless of their intentions. 

Summary Judgment

In Darren Commander, a trial court granted summary judgment against a 50% owner of a woodwork fabrication and installation business.

He and his co-owner (who died during the court proceedings) formed the woodworking company in New Jersey in 2003. They were the sole officers and owners. All decisions and actions, as well as most significant financial transactions, could only be made with the consent of both parties. However, the other co-owner was responsible for hiring field employees, assigning employees to each job, ensuring work was completed in the field, recording hours worked and distributing paychecks to employees.

From 2007 through 2009, the company failed to pay income and employment taxes for its employees even though workers were being paid. The IRS imposed trust fund penalties totaling $1.6 million against the defendant in 2010.  

The trial court granted summary judgment to the government. It concluded that there is no factual dispute that the defendant was a responsible person who willfully failed to pay the company’s taxes. In support of this decision, the court noted that:

  • The defendant was a 50% owner and one of two officers of the company.
  • His approval was required for all company decisions and actions and many significant financial transactions, and
  • He had check-signing authority and power to pay the company’s bills and sign paychecks.

The defendant argued that his co-owner was solely responsible for paying the taxes. But the court found this to be irrelevant because the defendant was, in fact, a responsible person. The court concluded that the defendant had actual knowledge, or should have known, that the taxes weren’t being paid and that he acted willfully within the meaning of the trust fund penalty provision.

The appeals court rejected the defendant’s arguments and upheld the trial court’s grant of summary judgment for the government. Critical to the court’s decision: Liability for the trust fund penalty can be extended to more than one person.

The appeals court also dismissed the defendant’s claim that he had originally misspoken in saying that he was aware of the tax deficiencies during the tax years in question and actually learned of it “later.” The court determined that the defendant didn’t produce any evidence to substantiate this assertion. Finally, it disagreed with the defendant’s complaint that he wasn’t granted sufficient opportunity to prove his arguments.

The defendant appealed the Third Circuit’s decision to the U.S. Supreme Court. The Court has declined to review the case.

Letter of the Law

If the IRS determines in a payroll tax dispute that you’re a responsible person, it will issue a letter stating that it plans to assess the trust fund penalty against you. You then have 60 days (75 days if the letter is sent to an address outside the U.S.) from the date of the letter to appeal. This communication will explain your appeal rights. If you don’t respond to the letter, the IRS will assess the penalty against you and send you a Notice and Demand for Payment.

Once the trust fund penalty is assessed, the IRS can take collection action against your personal assets. For example, it may file a federal tax lien or take levy or seizure action.

You should, of course, do everything in your power to avoid the trust fund penalty. Prioritize the IRS over any other creditors you might have. And if you can’t meet your payroll tax obligations, arrange to meet with the IRS to investigate your options (see right-hand box). Also contact your professional advisors for guidance.

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Posted on Jan 1, 2019

Private companies that follow U.S. Generally Accepted Accounting Principles (GAAP) must implement new revenue recognition rules in fiscal years that start after December 15, 2018. Are your accounting systems and personnel ready for this fundamental shift in financial reporting? The effects will likely be more far-reaching than expected, based on feedback from public companies that implemented the changes in 2018.

What Will Change

Accounting Standards Update (ASU) No. 2014-09, Revenue From Contracts With Customers, ushered in a fundamental change to how companies report one of the most important indicators of their financial performance. Public companies adopted the standard for fiscal years starting after December 15, 2017. Private companies were given a one-year reprieve.

Under prior rules, GAAP provided complex, detailed and disparate revenue recognition requirements, causing different industries to use different accounting for economically similar transactions. The updated standard replaces most of the industry-specific revenue guidance developed prior to 2014 with a single, principles-based model by which most companies must report the top line in their income statements.

The objective of the new guidance is to remove inconsistencies and weaknesses in existing revenue requirements. It also improves comparability of revenue recognition practices across entities, industries, jurisdictions and capital markets.

The updated standard doesn’t change the underlying economics of a business transaction or when a customer pays for a good or service. Rather, the new rules can change the timing of when a business is able to record the receipts from a customer. Depending on the line of business, this could mean earlier or later recognition of revenues compared to current practices.

How to Recognize Revenue from Contracts

Recognizing revenue under the new guidance requires these steps:

  • Identify the contract and the company’s performance obligations (or promises) under the contract.
  • Determine the transaction price (including the effects of any variable payment or significant financing components).
  • Allocate the transaction price to the performance obligations in the contract.
  • Recognize revenue when (or as) performance obligations are satisfied.

ASU 2014-09 is expected to have a major effect on companies that enter into long-term contracts with customers. Examples include construction firms, software and wireless providers, and media companies.

Though some entities won’t notice a significant change on their income statements, virtually everyone will be affected by the standard’s expanded disclosure requirements. The new guidance calls for more disclosures about the nature, amount, timing and uncertainty of revenue that’s recognized.

Why Revenue Recognition Is a Priority

Unfortunately, some private companies still aren’t up-to-speed with the new rules. Too often, smaller companies underestimate the amount of work involved with implementing the standard — or mistakenly presume that the changes apply to only public companies and large private entities.

Even if the changes will have a minimal impact on your company’s bottom line, it’s critical to evaluate controls and policies for estimating revenue before year end. One solid reason to onboard the changes as soon as possible is to forewarn your lenders about changes to the timing of revenue recognition that could affect the company’s loan covenants. In turn, such proactive measures may help persuade lenders to waive loan covenant violations and ensure that access to credit isn’t disrupted.

Human Resources Implications

The standard could also have spillover effects on the human resources department. To the extent that sales commissions and bonuses are based on revenue, the updated standard could affect the timing of when the performance-based compensation payments are made.

For example, if revenue recognition is delayed by the standard, managers and salespeople who must wait longer to receive part of their compensation won’t be happy. Conversely, if revenue recognition is accelerated by the standard, commissions and bonuses tied to revenue recognition must be paid sooner, possibly causing small employers to incur cash flow shortages.  

Ready, Set, Implement

Don’t underestimate the scope of change under ASU 2014-09. If your company hasn’t yet started implementing the new revenue recognition guidance, contact your accounting professional as soon as possible to ensure a smooth transition and anticipate any adverse side effects.     

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Posted on Dec 15, 2018

A whopping 75% of all child support is collected through employer-based income withholding orders (IWOs), according to the federal Office of Child Support Enforcement (OCSE). In the most recent year for which figures are available, that amounted to $32 billion. The latest information from the Census Bureau indicates that nearly half of the country’s 13.4 million custodial single parents have some type of child support arrangement in place, with the average monthly payment at around $480.

One reason those numbers are so large, besides a high divorce rate, is that systems have been established that help state agencies find people who might otherwise not live up to their child support obligations. Those systems involve you, through a requirement that you provide basic information about new hires within 20 days of their start date (and possibly sooner, depending on your state).

Required Data

Mandated reporting of new hire data has been on the books since the passage of the Personal Responsibility and Work Opportunity Reconciliation Act of 1996. The data elements you need to report to the state agency that handles these matters are: the employee’s name, address, Social Security number and date of hire, along with your company’s name, address and federal ID number. Basically, this is the same data you collect on a Form W-4, so you may be able to just submit that form. 

Requirements vary by state. Some will also allow you to file electronically while others want paper filing. Failure to comply with your reporting obligation can result in civil penalties and even criminal penalties in extreme cases.

If you have employees in multiple states, you can either send reports to each state where employees work or send all the forms to one state. The latter, however, obligates you to file electronically and to notify the OCSE which state you’re sending the information to.

This employee database, which is pooled nationally, helps state agencies track down parents who have failed to live up to their child support obligations. When that happens and one is on your payroll, you’ll receive a four-page IWO form that may be accompanied by a seven-page set of instructions. It could come from a state agency, a court, an attorney or possibly even just an individual.

Note: A “new” hire includes people you have rehired after they’ve been off your payroll, if they haven’t been working for you for at least the last 60 consecutive days. Also, even if a new employee quits before the 20-day reporting deadline has elapsed, as long as the person earned wages from you, you still need to file the report.

Next Steps

What needs to happen next is for you to:

  • Document the date you received the IWO (in case any issues arise about how quickly you fulfill its requirements).
  • Verify that you currently employ the named individual or have in the past. Although this may seem like an obvious step, it’s important that you fill in the relevant sections and return the form even if the individual no longer works for you.
  • Make sure that the form is “regular on its face,” legal jargon that essentially means it contains all required information. (The instructions provide details.)

If the form was sent by anyone besides a court or state agency, the IWO is considered a “notice” and not an order. If it isn’t accompanied by a bona fide order, you should return it to the source. Also, if the IWO came from another state, or if the appropriate box is checked on the form, you’ll need to give a copy to the employee.

Finally, if everything is acceptable, you’ll simply need to comply with the terms of the order. A general requirement is that you’ll need to start withholding child support funds by the first pay period that begins 14 working days after the IWO was mailed to you. Then you have seven business days to relay the withheld amount to the state agency that disburses the funds to the recipient. (Some states might require faster turnaround.)

You are within your rights to also deduct from the employee’s paycheck an administrative fee to recoup your added cost, though limits apply to those charges.

What happens if an employee changes his or her withholding allowances to reduce the amount of the child support payment? It’s not up to you to try to counteract that. The IRS may withhold unfulfilled required child support payment amounts from the employee’s tax refund.

Final Thoughts

Handling issues involving delinquent child support can be simple … or complex. Doing so might elicit emotional outbursts from the targeted employee, but it must be done. If necessary, talk the matter over with your payroll advisor to ensure you’re meeting your reporting and withholding obligations.

 

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Posted on Dec 5, 2018

On January 1, 2019, many states and localities are increasing their minimum wage amounts. In some areas, the amounts paid to tipped employees is also increasing and garnishment limits may also be changing.

This chart briefly details the changes that will kick in on New Year’s Day. For more information about your situation, consult with your payroll advisor.

State Change on January 1, 2019
Alaska    The minimum wage will increase from $9.84 to $9.89 per hour. Tipped employees must be paid this same rate.
Arizona    The minimum wage will increase from $10.50 to $11 per hour. The cash minimum wage for tipped employees will increase from $7.50 per hour to $8 per hour. In Flagstaff, the minimum wage will increase in from $11 to $12 per hour.
Arkansas    The minimum wage will increase from $8.50 to $9.25 per hour. For tipped employees, the cash minimum wage will remain at $2.63 per hour.
California    The minimum wage will rise from $11 to $12 per hour for employers with more than 25 employees. It will increase from $10.50 to $11 per hour for employers with fewer than 26 employees. Tipped employees must also be paid this rate. The minimum wage will also increase in Belmont, Cupertino, El Cerrito, Los Altos, Mountain View, Palo Alto, Redwood City, Richmond, San Diego, San Jose, San Mateo, Santa Clara and Sunnyvale.
Garnishment limits may also change. In CA, the maximum amount subject to garnishment can’t exceed the lesser of 25% of weekly disposable income, or 50% of the amount by which the individual’s disposable earnings for the week exceed 40 times the greater of either the state or local minimum wage rate in effect where the debtor works when the earnings are payable.
Colorado    The minimum wage will increase from $10.20 to $11.10 per hour. The cash minimum wage for tipped employees will increase from $7.18 per hour to $8.08 per hour. The garnishment limit is also changing.
Delaware    The minimum wage will rise from $8.25 to $8.75 per hour. For tipped employees, the cash minimum wage rate will remain at $2.23 per hour.
Florida    The minimum wage will increase from $8.25 to $8.46 per hour. The cash minimum wage for tipped employees will increase from $5.23 per hour to $5.44 per hour.
Maine    The minimum wage will increase from $10 to $11 per hour. The cash minimum wage for tipped employees will increase from $5 per hour to $5.50 per hour. The garnishment limit is also changing.
Massachusetts    The minimum wage will rise from $11 to $12 per hour. The cash minimum wage rate for tipped employees will increase from $3.75 per hour to $4.35 per hour.
Minnesota    The minimum wage will increase from $9.65 to $9.86 per hour for large employers (those with annual gross sales of $500,000 or more, exclusive of retail excise taxes). The minimum wage for small employers will increase from $7.87 per hour to $8.04 per hour. Tipped employees must also be paid these rates.
Missouri    The minimum wage will increase from $7.85 to $8.60 per hour. For tipped employees, the cash minimum wage will increase from $3.925 per hour to $4.30 per hour.
Montana    The minimum wage will increase from $8.30 to $8.50 per hour. Tipped employees must also be paid this rate.
New Jersey    The minimum wage will increase from $8.60 to $8.85 per hour. The cash minimum wage for tipped employees will remain at $2.13 per hour.
New Mexico The state minimum wage will remain at $7.50 per hour, but the minimum wage rate will increase in Albuquerque, Bernalillo County and Las Cruces.
New York    On December 31, 2018, the minimum wage will rise from: 1) $13 to $15 per hour for NY city employers with 11 or more employees; 2) $12 to $13.50 per hour for NY city employers with 10 or fewer employees; 3) $11 to $12 per hour for Nassau, Suffolk and Westchester county employers, and 4) $10.40 to $11.10 per hour for employers in areas not noted above. The cash minimum wage for tipped employees varies by industry. The garnishment limits will also change on January 1.
Ohio    The minimum wage will increase from $8.30 to $8.55 per hour. The cash minimum wage rate for tipped employees will increase from $4.15 per hour to $4.30 per hour.
Rhode Island    The minimum wage will increase from $10.10 to $10.50 per hour. However, the minimum cash wage for tipped employees will remain at $3.89 per hour.
South Dakota    The minimum wage will increase from $8.85 to $9.10 per hour. The cash minimum wage for tipped employees will increase from $4.425 per hour to $4.55 per hour. The garnishment limit will also change.
Vermont    The minimum wage will increase from $10.50 per hour to $10.78 per hour. The cash minimum wage for tipped employees will increase from $5.25 to $5.39 per hour.
Washington    The minimum wage will increase from $11.50 to $12 per hour. Tipped employees must also be paid this rate. The minimum wage will also increase in Seattle, SeaTac and Tacoma.

Looking Ahead in 2019

On July 1, 2019, the minimum wage will go up in the District of Columbia from $13.25 to $14 per hour.

In Oregon, the minimum wage will increase in July of next year to various amounts, depending on where an employer is located. For employers located within the Portland metro urban growth boundary, the minimum wage will go from $12 per hour to $12.50. In smaller cities, it will go from $10.75 to $11.25 per hour. And in non-urban counties, the minimum wage will rise from $10.50 to $11 per hour. All of the changes in Oregon are effective on July 1, 2019.

In addition, both houses of the Michigan legislature have approved legislation that would increase the state’s minimum wage rate from $9.25 per hour to $10 per hour, effective March 1, 2019, with annual increases until it reaches $12 per hour, effective January 1, 2022. The legislation had the effect of keeping an approved ballot measure off the November 6 election ballot that would have allowed voters to decide whether to increase the minimum wage rate. However, several published reports say that the Republican-controlled legislature passed the bill not only to keep voters from determining the issue, but with the intention of later killing the measure. They are reportedly working to scale back the minimum wage legislation and paid sick legislation before they leave office in December.

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Posted on Dec 1, 2018

The countdown to year end has begun. Have you positioned yourself to minimize your 2018 tax bill? The Tax Cuts and Jobs Act (TCJA) made sweeping changes to the federal tax laws that will affect virtually all individual taxpayers — and most of those changes went into effect for this tax year. Here are four tried-and-true tax planning strategies, tweaked to account for the TCJA. 

1. Game the Standard Deduction

As the following table shows, the TCJA almost doubled the standard deduction amounts from 2017 to 2018.

Standard Deduction Allowances: 2017 vs. 2018

Filing Status
 2017 2018
Single or married filing separately $6,350 $12,000
Married joint filers $12,700 $24,000
Head of household $9,350 $18,000

If your total itemizable deductions for 2018 will be close to your standard deduction amount, consider making enough additional expenditures for itemized deduction items before year end to exceed the standard deduction. Those moves will help lower this year’s tax bill. (Next year, you may decide to claim the standard deduction, which will be increased to account for inflation.)

Itemizable deductions that you can potentially “bunch” in alternating tax years are:

Charitable contributions. Consider making bigger donations this year so that this year’s itemizable deductions will exceed the standard deduction. Then, next year, if your itemized deductions are less than the standard deduction, you can claim it.

Medical expenses. Elective medical procedures — such as dental work and vision care — can be performed before year end to boost your itemized deductions. For 2018, you can deduct medical expenses to the extent that they exceed 7.5% of your adjusted gross income (AGI) if you itemize. In 2019, the AGI threshold for itemizing medical expenses is scheduled to increase to 10%.

Home mortgage interest. Making your January 2019 mortgage payment this year will give you 13 months of interest expense to deduct in 2018. Although the TCJA put new limits on itemized deductions for home mortgage interest, you’re probably unaffected (because of the grandfather rules that apply to pre-existing mortgages). But double-check with your tax advisor to be sure. 

SALT expenses. You also can prepay state and local income and property tax (SALT) expenses that are due early next year. Paying those bills before year end can lower your 2018 federal income tax bill, because your itemized deductions will be that much higher. However, the TCJA decreased the maximum amount you can deduct for state and local taxes to $10,000 (or $5,000 for married people who file separately). Unfortunately, many taxpayers will be affected by this limitation, so for them it’s probably not as effective as prepaying other itemizable expenses.

Important note: The SALT prepayment strategy can be a bad idea if you’ll owe alternative minimum tax (AMT) this year. That’s because SALT write-offs are completely disallowed under the AMT rules. Ask your tax advisor if you’re likely to be in the AMT zone for 2018.  

It’s also important to note that some itemizable deductions — such as deductions for unreimbursed business expenses and other miscellaneous expenses — were suspended for 2018 through 2025 under the TCJA.

2. Manage Investment Gains and Losses  

If you hold investments in taxable brokerage firm accounts, consider selling appreciated securities that have been held for over 12 months. In 2018, the maximum federal income tax rate on long-term capital gains is 20%. But many people will incur a federal tax rate of only 15%.

 
2018 Federal Tax Rates on Long-Term Capital Gains and Qualified Dividends
Tax Rates Single Married Joint Filers Head of Household
0% $0 – $38,600 $0 – $77,200 $0 – $51,700
15% $38,601 – $425,800 $77,201 – $479,000 $51,701 – $452,400
20% $425,801 and up $479,001 and up $452,401 and up

For 2018 through 2025, the federal tax rates on long-term capital gains are no longer tied to the federal income tax brackets. After 2018, these brackets will be indexed for inflation. The 3.8% net investment income tax (NIIT) can also apply to long-term capital gains at higher income levels.

To the extent you have capital losses from earlier this year or capital loss carryovers from pre-2018 years, selling investments that have appreciated in value this year won’t result in any tax hit. In particular, sheltering net short-term capital gains with capital losses is a smart tax move, because net short-term gains would otherwise be taxed at higher ordinary-income rates of up to 37% (plus the 3.8% NIIT if applicable).     

If you have investments that would generate a tax loss if they were sold, you might consider unloading them before year end to shelter any capital gains from sales earlier this year, including high-taxed short-term gains.

If selling your losing investments would cause your capital losses to exceed capital gains, the result would be a net capital loss for the year. Your 2018 net capital loss can be used to shelter up to $3,000 of 2018 ordinary income ($1,500 for married people who file separately). This income may be in the form of salaries, bonuses, self-employment income, interest income and royalties. Any excess net capital loss from this year is then carried forward indefinitely until you have gains to offset against it.    

Net capital loss carryforwards can give you investing flexibility in the future, because you won’t have to hold appreciated securities for over a year to get a preferential tax rate. The top two federal rates on net short-term capital gains recognized in 2019 and beyond are 35% and 37% (plus the 3.8% NIIT if applicable). So, it could be particularly beneficial to have a capital loss carryover to shelter high-taxed short-term gains recognized in future years. 

3. Set up Loved Ones for a 0% Tax Rate on Investment Income

Under the TCJA, the federal income tax rate on long-term capital gains and qualified dividends from securities held in taxable brokerage firm accounts is still 0% if the gains and dividends fall within the 0% bracket. (See the chart above.)

While your income may be too high to benefit from the 0% rate, you may have children, grandchildren and other loved ones in the 0% bracket. If the object of your generosity is in the 0% bracket, consider gifting that person some appreciated stock or mutual fund shares that can be sold without incurring tax on the resulting long-term capital gains. Gains will be long term if your ownership period plus the gift recipient’s ownership period (before the recipient sells) equals at least a year and a day. 

Giving away stocks that pay dividends is another tax-smart idea. If the dividends fall within the gift recipient’s 0% rate bracket, they will be federal-income-tax-free.

Important notes: If you give securities to someone who is under age 24, the so-called “kiddie tax” rules could potentially cause some of the resulting capital gains and dividends to be taxed at the higher rates that apply to trusts and estates.

Many states don’t have a 0% tax bracket for capital gains and qualified dividends. Be aware that state taxes could apply.

4. Make Tax-Wise Gifts to Loved Ones and Charities

Generous people who are looking to share their wealth often ask: Is it better to give investments directly to family members and charities — or to sell them and give away the proceeds? From a tax perspective, the answer depends on whether you’ll incur a gain or loss on the sale of an investment.

In general, it’s better to sell shares that would incur a loss and then give away the proceeds. Conversely, appreciated shares should be donated directly to recipients that would incur no tax (or be taxed at a lower rate).

For example, Sam owns stock that’s decreased substantially in value since he bought it in 2016. He wants to make a year-end gift to his niece Barb. Sam’s tax advisor recommends that he sell the investment and book the resulting tax-saving capital loss (to offset capital gains in 2018 and beyond). Then Sam can give the proceeds from the sale directly to Barb.

On the flipside, Samantha owns stock that’s increased substantially in value over the last two years. She wants to make a year-end gift to her nephew Bob. In this scenario, Aunt Samantha’s tax advisor recommends giving the shares directly to Bob, because he’s in the 0% federal income tax bracket for long-term capital gains and qualified dividends. (Even if the stock had been owned for less than a year before it was sold, Bob is in a much lower ordinary-income tax bracket than his wealthy aunt.)    

The same general principles also apply to donations to IRS-approved charities. But there’s an extra tax benefit: You also can claim tax-saving charitable donation deductions, if you itemize deductions on your federal income tax return. If you donate shares that you’ve held for more than a year, your itemized deduction equals the current market value of the shares at the time of the gift — and you’ll avoid paying capital gains taxes on those shares. Meanwhile, the tax-exempt charitable organization can sell the donated shares without owing anything to the IRS.

Meet with a Tax Pro

These are just a handful of year-end strategies for individual taxpayers. Your tax advisor may offer more suggestions based on your unique tax situation. Act fast, however, because some tax planning moves take time to execute before December 31.      

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Posted on Nov 25, 2018

With the holidays fast approaching, you might want to reward your employees for all their hard work in 2018. Gift-giving ideas include gift cards, holiday turkeys and achievement awards. Although your intent may be essentially the same in all these situations, the tax outcome for recipients of your goodwill may be quite different. Typically, it depends on the value and type of gift or award. The Tax Cuts and Jobs Act (TCJA) clarifies the tax treatment of certain achievement awards of property. This provision applies to amounts paid or incurred after 2017, including gifts made during this holiday season.

What Are the Rules for Business Gifts to Customers?

  • If your business gives gifts to customers,  clients or other contacts during the holiday season, you may be able to deduct all or part of the cost. But there are strict tax-law limits to your generosity.
  • In general, the deduction for these types of business gifts is limited to $25 per recipient during the tax year. A gift to a company that is intended for a particular person is considered an indirect gift to that person. 
  • If you give a gift to a member of a customer’s family, the gift is generally considered an indirect gift to the customer. However, this rule doesn’t apply if you have a bona fide, independent business relationship with the family member and the gift isn’t intended for the customer’s eventual use.
  • If you and your spouse both give gifts to a customer, the two of you are treated as a single taxpayer. Thus, your combined limit is $25 per recipient. It doesn’t matter if you have separate businesses, are separately employed or whether you each have an independent connection to the customer. Similarly, if a partnership gives a gift to a customer, the partnership and its partners are treated as one taxpayer.
  • Finally, there’s some leeway on the $25 limit. Incidental expenses — such as engraving, packaging, insurance and shipping costs — don’t count towards the cost of a gift.

Tax Rules

As a general rule, amounts effectively paid for  services rendered are taxable, similar to other forms of compensation. Therefore, year-end bonuses, commissions and similar payments made in 2018 are subject to tax in 2018. They’re also deductible by the employer in 2018.

However, if a year-end bonus is delayed until January, it’s taxable to the employee in 2019. And a calendar-year business can’t deduct it until 2019.

The tax rules for achievement awards are slightly more complicated. For these purposes, an “achievement award” is an item of tangible personal property given to employees for length of service or for promoting safety. Examples include watches, electronic devices, golf clubs and jewelry. In the past, there was some uncertainty about other types of property.

Clarity under the TCJA

The TCJA specifically excludes the following items from its definition of “tangible personal property”:

  • Cash and cash equivalents,
  • Gifts cards, gift coupons and gift certificates (other than those where from the employer preselected or preapproved a limited selection),
  • Vacations,
  • Meals,
  • Lodging,
  • Tickets for theater or sporting events, and
  • Stocks, bonds or similar items.

This TCJA provision is similar to proposed regulations that were issued under prior law. It’s also comparable to the position stated by the IRS in Publication 15-B, Employer’s Tax Guide to Fringe Benefits. That publication has no formal authority, however.

There other tax rules pertaining to achievement awards provided through a company plan. To qualify for tax-free treatment to recipients, the following requirements must be met:

  • Any employee can receive a length-of-service award, but safety awards can’t be made to managers, administrators, clerical workers and other professional employees.
  • The award doesn’t qualify if the company granted safety awards to more than 10% of the eligible employees during the same year.
  • The award must be part of a meaningful presentation.
  • The employee must have worked for the company for a minimum of five years to receive a length of service award.

Additionally, if a company uses a “nonqualified plan,” an employee may receive up to $400 in awards without owing any tax. This tax-free amount is quadrupled to $1,600 for awards through a “qualified plan.” Any amount above these limits is taxable to the employee and can’t be deducted by the employer.

Two additional requirements must be met for qualified plans.

  • The award must be paid under a written plan that doesn’t discriminate in favor of highly-compensated employees (HCEs).
  • The average cost of all employee achievement awards granted during the year can’t exceed $400.

De Minimis Gifts

How about small tangible gifts, such as turkeys or hams, given to employees? Such gifts may be excluded from taxable income under a special “de minimis rule.” A de minimis benefit is one that is so small as to make accounting for it unreasonable or impractical. Many small holiday gifts are covered by this exception.

In determining whether the de minimis rule applies, consider the frequency and the value of the gifts. One critical factor is whether the benefit is occasional or unusual. Also, the gift can’t be a form of disguised compensation.

If a benefit is too large to qualify as a de minimis benefit, the entire value is taxable to the employee, not just the excess over a designated de minimis amount. Previously, the IRS has ruled that items with a value exceeding $100 could not be considered a de minimis benefit, even under unusual circumstances.

‘Tis the Season

Make this a happy holiday season from both a gift-giving and tax viewpoint. Stay within the boundaries discussed above to maximize the benefits for employees and employers. If you have questions about the business gift-giving rules, contact your tax advisor.

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Posted on Nov 20, 2018

For married people with large estates, the Tax Cuts and Jobs Act (TCJA) brings welcome relief from federal estate and gift taxes, as well as the generation-skipping transfer (GST) tax. Here’s what you need to know and how to take advantage of the favorable changes.

Estate and Gift Tax Basics

The TCJA sets the unified federal estate and gift tax exemption at $11.4 million per person for 2019 (up from $11.18 million for 2018). For married couples, the exemption is effectively doubled to $22.8 million for 2019 (up from $22.36 million for 2018). The exemption amounts will be adjusted annually for inflation from 2020 through 2025. In 2026, the exemption is set to return to an inflation-adjusted $5 million, unless Congress extends it.

Under the unlimited marital deduction, transfers between spouses are federal-estate-and-gift-tax-free. But the unlimited marital deduction is available only if the surviving spouse is a U.S. citizen.Taxable estates that exceed the exemption amount will have the excess taxed at a flat 40% rate. In addition, cumulative lifetime taxable gifts that exceed the exemption amount will be taxed at a flat 40% rate. Taxable gifts are those that exceed the annual federal gift tax exclusion, which is $15,000 for 2018 and 2019. If you make gifts in excess of what can be sheltered with the annual gift tax exclusion amount, the excess reduces your lifetime unified federal estate and gift tax exemption dollar-for-dollar.

Important: Some states also charge inheritance or death taxes, and the exemptions may be much lower than the federal exemption. Discuss state tax issues with your tax advisor to avoid an unexpected tax liability or other unintended consequences of an asset transfer.

What’s the GST Tax?

The generation-skipping transfer (GST) tax generally applies to transfers made to people two generations or more below you, such as your grandchildren or great-grandchildren. Transfers made both during your lifetime and at death can trigger this tax — and it’s above and beyond any gift or estate tax due.

Under the Tax Cuts and Jobs Act (TCJA), the GST tax continues to follow the estate tax. So, the GST tax exemption also increases under the TCJA. For 2018, both exemptions are $11.4 million per person, or effectively $22.8 million for a married couple. The GST exemption can be a valuable tax-saving tool for taxpayers with large estates whose children also have large estates. With proper planning, they can use the GST exemption to make transfers to grandchildren and avoid any estate or gift tax at their children’s generation.

Exemption Portability

For married couples, any unused unified federal estate and gift tax exemption of the first spouse to die can be left to the surviving spouse, thanks to the so-called “exemption portability” privilege. The executor of the estate of the first spouse to die must make the exemption portability election to pass along the unused exemption to the surviving spouse.

The portability privilege — combined with the increased unified exemption amounts and the unlimited marital deduction — will make federal estate and gift tax bills for married folks a rarity, at least through 2025. That’s because the portability privilege effectively doubles your estate and gift tax exemption to a whopping $22.8 million for 2019 (with inflation adjustments for 2020 through 2025).

Important: Exemption portability isn’t a new privilege under the TCJA. It existed under prior law, and it will continue to exist after the increased estate and gift tax exemptions expire at the end of 2025.  

Estates below $11.4 Million

If your joint estate is worth less than $11.4 million, there won’t be any federal estate tax due even if you and your spouse both die in 2019. That’s because the unified estate and gift tax exemption allows either of you to leave up to $11.4 million to your children and other relatives and loved ones without federal estate tax or any planning moves.

But there are still many reasons for you to create (or review) your estate plan. For example, if you have minor children, you need a will to appoint someone to be their guardian if you die. Or you might want to draft a will to designate specific assets for specific individuals. Likewise, if you’re concerned about leaving money to a spouse or other individual who isn’t financially astute, you might want to set up a trust to manage assets that person will inherit.

Estates between $11.4 Million and $22.8 Million

Couples with joint estates between $11.4 million and $22.8 million are positioned to benefit greatly from exemption portability. If you die in 2019 before your spouse, you can direct the executor of your estate to give any unused exemption to your surviving spouse. If your spouse dies before you, he or she can do the same.

The portability privilege effectively doubles your exemption. That means you and your spouse can transfer up to $22.8 million for 2019 (with inflation adjustments for 2020 through 2025) without incurring estate or gift tax. 

Estates over $22.8 Million

What if your joint estate is worth more than $22.8 million? The generous $11.4 million federal estate tax exemption, the unlimited marital deduction and the exemption portability privilege will work to your advantage. But you may need to take additional steps to postpone (or minimize) federal estate taxes.

For example, Leon and Lucy are a married couple with adult children and a joint estate worth $30 million. They both die in 2019.

Leon dies in February 2019, leaving his entire $15 million estate to Lucy. The transfer is federal-estate-tax-free, thanks to the unlimited marital deduction. Leon also leaves Lucy his unused $11.4 million exemption.

When Lucy dies in November 2019, how much can she leave to her loved ones without incurring federal estate tax? Lucy’s estate tax exemption is $11.4 million; she also has the portable exemption ($11.4 million) that Leon left when he died in February. So, she can leave up to $22.8 million to her beneficiaries without incurring any federal estate tax. Minimizing federal estate taxes on the remaining $7.2 million in Lucy’s estate would require some additional estate planning moves.

Alternatively, Leon could leave $11.4 million to his children (federal-estate-tax-free thanks to his $11.4 million exemption) and $3.6 million to Lucy (federal estate-tax-free thanks to the unlimited marital deduction). That way, when Lucy dies in November 2019, her estate would be worth $18.6 million (her own $15 million plus the $3.6 million from Leon). Then her exemption would shelter $11.4 million from the federal estate tax. Again, minimizing federal estate tax on the remaining $7.2 million in Lucy’s estate would require some additional steps.

Important: The same considerations apply if Lucy is the first to die.

Smart Moves for Big Estates

People with joint estates worth more than $22.8 million should consider planning strategies designed to lower federal estate and gift taxes. Here are a few:

Make annual gifts. Each year, you and your spouse can make annual gifts up to the federal gift tax exclusion amount. The current annual federal gift tax exclusion is $15,000. Annual gifts help reduce the taxable value of your estate without reducing your unified federal estate and gift tax exemption.

For example, suppose you have two adult children and four grandkids. You and your spouse could give them each $15,000 in 2019. That would remove a grand total of $180,000 from your estate ($15,000 × six recipients × two donors) with no adverse federal estate or gift tax consequences. This strategy can be repeated each year, and can dramatically reduce your taxable estate over time.

Pay college tuition or medical expenses. You can pay unlimited amounts of college tuition and medical expenses without reducing your unified federal estate and gift tax exemption. But you must make the payments directly to the college or medical service provider. These amounts can’t be used to pay for college room and board expenses, however.

Give away appreciating assets before you die. In 2019, a married couple, combined, can give away up to $22.8 million worth of appreciating assets (such as stocks and real estate) without triggering federal gift taxes (assuming they’ve never tapped into their unified federal estate and gift tax exemption before). This can be on top of 1) cash gifts to loved ones that take advantage of the annual gift tax exclusion, and 2) cash gifts to directly pay college tuition or medical expenses for loved ones.

To illustrate, say you give stock worth $2 million to your adult son in 2019. That uses up $1.985 million of your $11.4 million lifetime unified federal estate and gift tax exemption ($2 million – $15,000). Your spouse does the same. When it comes to gifts of appreciating assets, using up some of your lifetime exemption can be a smart tax move, because the future appreciation is kept out of your taxable estate.

Set up an irrevocable life insurance trust. Life insurance death benefits are federal-income-tax-free. However, the death benefit from any policy on your own life is included in your estate for federal estate tax purposes if you have so-called “incidents of ownership” in the policy. It makes no difference if all the insurance money goes straight to your adult children or other beneficiaries.

It doesn’t take much to have incidents of ownership. For example, you have incidents of ownership if you have the power to:

  • Change beneficiaries,
  • Borrow against the policy,
  • Cancel the policy, or
  • Select payment options.

This unfavorable life insurance ownership rule can inadvertently cause unwary taxpayers to be exposed to the federal estate tax.

To avoid this pitfall, a married individual can name his or her surviving spouse as the life insurance policy beneficiary. That way, under the unlimited marital deduction, the death benefit can be received by the surviving spouse free of any federal estate tax. However, this maneuver  can cause too much money to pile up in the surviving spouse’s estate and expose it to a major federal estate tax hit when he or she dies.

Alternatively, large estates can set up an irrevocable life insurance trust to buy coverage on the lives of both spouses. The death benefits can then be used to cover part or all of the estate tax bill. This is accomplished by authorizing the trustee of the life insurance trust to purchase assets from the estate or make loans to the estate. The extra liquidity is then used to cover the estate tax bill.

The irrevocable life insurance trust is later liquidated by distributing its assets to the trust beneficiaries (your loved ones). Then, the beneficiaries wind up with the assets purchased from the estate or with liabilities owed to themselves. And the estate tax bill gets paid with money that wasn’t itself subject to federal estate tax.

Bottom Line

The TCJA generally improves the federal estate tax posture of taxpayers for 2018 through 2025. But, to achieve optimal results and cover all your bases, you may need to meet with your tax and legal advisors to create or update your estate plan.      

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