(3)_FAFSA- Grandparent Aid for College Costs

Many grandparents would like to help their grandchildren with the steep costs of higher education. That’s often a laudable goal, but some methods of providing this assistance might be more effective than other tactics.

Grand gifts

The simplest tactic is to give money to youngsters before or during their college years. In 2014, the annual gift tax exclusion is $14,000 per recipient.

            Example 1:
Cora Smith has three grandchildren. She can give each of them $14,000 this year for their college funds. Cora’s husband, Rob, can make identical gifts to each of their grandchildren. Such gifts will have no adverse tax consequences. (Larger gifts may reduce this couple’s gift tax exemption and, ultimately, their estate tax exemption.)

In addition to all of these $14,000 gifts, the Smiths can pay the college tuition for any of their grandchildren. No matter how large these outlays might be, Cora and Rob will not owe any tax or suffer any reduction in their transfer tax breaks.

Axing aid

Such grandparent gifts may have their disadvantages, though. They could result in reduced financial aid.

            Example 2: 
Over the years, Rob and Cora have made gifts to their grandson Doug. Counting investment buildup, Doug has $50,000 worth of assets when he fills out the FAFSA (see our article “Financial Aid Starts With the FAFSA”) for his first year of college. The FAFSA assesses Doug’s assets by 20%, when calculating the expected family contribution (EFC), so the $50,000 could reduce his financial aid by $10,000: the 20% assessment times $50,000 of Doug’s assets. Tuition payments by Rob and Cora for Doug’s schooling could result in even larger aid cutbacks.

For some grandparents, this won’t be a major concern. The student’s immediate family might have such extensive assets and such substantial income that need-based financial aid won’t be possible. However, today’s college costs are so high that aid might be available, even to well-off families. The possible impact on financial aid should be discussed with the student’s parents.

In addition, it should be considered that assets given to grandchildren will come under the youngsters’ control once they come of age, usually on or before age 21. Grandparents need to be comfortable with the idea that money in a grandchild’s account may or may not be used for education or other worthwhile purposes.

Grandparents to parents

Instead of making gifts directly to grandchildren, grandparents can give assets to their own children who are the student’s parents. This plan will have less impact on financial aid.

            Example 3:
Assume that Cora and Rob have made gifts to their daughter Elly, Doug’s mother, rather than making gifts directly to Doug. Such gifts have increased Elly’s assets by $50,000. A parent’s assets are assessed at no more than 5.64%, on the FAFSA, so the additional assets held in Elly’s name would reduce possible aid by $2,820: 5.64% of $50,000.

Therefore, giving money to the student’s parent would be better than giving money to the student, if financial aid is a concern, and, assuming the parents are more financially prudent, less chance exists of the transferred assets being squandered.

Focusing on 529 plans

If concerns about the security and intent of the gifted funds still exist, they may be addressed by contributing to a 529 college savings plan, instead. Such plans have many advantages.

            Example 4: 
Cora Smith creates three 529 accounts, naming a different grandchild as the beneficiary for each one. Now Cora has control over how the money will be invested and how it will be spent. Any investment earnings will be tax-free and distributions also will be untaxed if the money is used for the beneficiary’s college bills. Cora can even reclaim the funds in the 529 if she needs money, paying tax and (with some exceptions) a 10% penalty on any earnings.
What’s more, a 529 account owned by a grandparent won’t be reported on the grandchild’s FAFSA, so it will not have any initial impact on financial aid. It’s true that eventual distributions from a grandparent’s 529 will be reported on a subsequent FAFSA and will substantially reduce financial aid. That won’t be a concern for families who are not receiving need-based aid. If the student is receiving aid, distributions from the grandparent’s 529 plan can be postponed until the last FAFSA has been filed.

            Example 5:
Doug Franklin will start college in the 2015-2016 school year, so he files his first FAFSA in January 2015. Doug receives some need-based aid, so his grandmother Cora lets the 529 account continue to grow, untaxed. Doug files a new FAFSA every year until January 2018, when he submits the form for his senior year. Subsequently, Cora can tap the 529 account to pay Doug’s remaining college bills. Doug won’t be filing any more FAFSAs for financial aid, so Cora’s 529 distributions won’t be reported.

The bottom line is that grandparents have many tactics they can consider if they wish to give grandchildren a financial assist on the path towards a college degree.

(2)_Why You Need Us for Filing Out FAFSA

FAFSA or Free Application for Federal Student Aid, is a tedious and mind-numbing application that must be filled out in order to get a chance at financial aid for college.

We get phone calls and e-mails when folks hit question 85.  Well, let me take that back. Most folks can answer question 85, it is everything AFTER that where things get a bit murky (and the despair sets in).  For good reason, these questions read like the tax code:

Questions 88 and 89 ask about earnings... this information may be on the w-2 forms, or on IRS form 1040- lines 7+12+18+Box 14 (Code A) of IRS schedule K-1 (Form 1065); on 1040A-line7; or 1040EZ-line 1

I took that verbatim from a FAFSA application I printed off the internet.  We are not saying a normal person can't fill this out, we are just saying the government didn't make this thing very "intuitive". When it comes to filling out a federal application that will affect your child's future, we just want to be sure.  No one wants to be accused of submitting fraudulent information.

That being said, here are a few things we'd like to offer to help you get through this process as fast as humanly possible.

1. Deadlines, deadlines, deadlines
First things first, this thing is due June 30 at the end of each academic year. For example, the deadline to submit your FAFSA application for the 2014-15 school year would be June 30th, 2015.

  But, funds are on a first-come, first-serve basis so you want to request assistance as soon as you can after the first of the year.  **You can submit your FAFSA using estimated tax information, but you must correct it right after you file your return.

**Make sure to click on the "State Aid Deadlines" link at FAFSA website for information on the deadlines in your state.

2. IRS Data Retrieval Tool
Do not reinvent the wheel, especially if you don't have to.  Use this (if you don't fall into one of the five exceptions below).  This is the easiest way to complete or correct your FAFSA with accurate tax information.  You can view and transfer your tax info directly into the FAFSA!

Here are some cases where you will not be able to use this feature: 

1. Students or parents who are married and file as Married Filing Separately
2. Students or parents who are married and file as Head of Household
3. Students or parents filed an amended tax return
4. Students or parents filed a foreign tax return
5. Students or parents filed their tax returns electronically within the last 3 weeks or through the mail withing the last 11 weeks.

3. Who is My "Parent"/ Marital Status of Parents
Don't chuckle, this one trips a lot of folks up.  Read the remainder of Item 3 as if you were the applying student.

Parent, according to FAFSA, is your legal (biological and/or adoptive) parent or stepparent.

• If your parents are divorced or separated and DON'T live together, answer the questions about the parent with whom YOU LIVED MOST during the past 12 months.
• If you lived the same amount of time with each parent, give answers about the parent who provided MORE FINANCIAL SUPPORT during the past 12 months. (In a situation where the parents split all costs it will generally default to the parent with the greater income).
• If you have a stepparent who is married to the legal parent whose information you're reporting, you must provide that stepparent's information.  (If your father and step-mother are the ones on the return, they are your "parents" for this application)
• FAFSA asks about "Your Parents'" information. Again, since you are using ONE tax return, you will use the people on the tax return as your "Parents". 
• The only exception to the above is when FAFSA asks about your parents' education level. For this question your parents are considered your birth parents or adoptive parents. 

4. What you need
They say that as long as you have your tax return you can answer these questions... sort of, but not really.  

You should also have at the ready:

1. All Forms W-2 used on the tax return. 
2. Current cash on hand, and balances in all savings and checking accounts.  
3. Your total investments, including real estate... but don't include the home you live in.  
4. The net worth of your business(es). 
5. A total of all child support paid AND/OR received because of legal requirement.

5. Tips when answering questions 85-94 on FAFSA

• #85 is your AGI.  Line 37 on Form 1040.  
• #86 Enter your parents' income tax.  Line 55 on Form 1040  
• #87 Enter your parents' exemptions. Line 6d on Form 1040
• #88 How much did Parent 1 & Parent 2 earn.  This is where they throw you for a loop.  They want to know how much EACH parent earned.  
• Not each biological parent.  
• Not just the one parent who shares DNA with the applying student.  
• They want the amount earned by the 2 individuals on the tax return you are using.  There is no "line" for this separated wage information on a joint tax return. The best thing to do here is to use the wage information from the parent's/parents' W-2. 
• #90 Add up the current balance of cash, savings and checking accounts.
• #91 Net worth of your parents' investments, including real estate... but not the house you live in.  (NET WORTH= CURRENT VALUE less DEBT. If you net worth is negative, enter 0.)
• Investments include- (*Investment value = current balance or market value of these investments as of today.  Investment debt means only those debts that are related to the investments.)
• Real estate - raw land
• Rental property
• Trust funds
• UGMA & UTMA accounts
• Money Market, Mutual Funds, Certificates of Deposit, Stock, Stock Options, Bonds, Other Securities
• Installment and land sale contracts (including mortgages held)
• Commodities
• Qualified educations benefits or education savings accounts
• For a student who must report parental information, the accounts are reported as parental investments in #91, INCLUDING all accounts owned by the student and all accounts owned by the parents for any member of the household
• Investments DON'T INCLUDE:
• The house you live in
• The value of life insurance
• The value or retirement plans (401K, pensions, annuities, non-education IRA, Keogh)
• Cash, savings and checking accounts.
• UGMA & UTMA accounts for which you are the custodian, but not the owner.
• #92 Net worth of your parents' current business/investment farms. DON'T INCLUDE a family farm or family business with 100 or fewer full-time employees (So, this applies to virtually no one.) 
• #93 Parents' additional financial information... some of which is on the tax return.
• a. Education credits-- Line 49, Form 1040
• b. Child Support paid 
• c. Parents' need-based employment portions of fellowships
• d. Parents' taxable student grant & scholarship aid
• e. Combat or Special Combat pay
• f. Earnings from work under a cooperative education program offered by a college
• #94 Parents' Nontaxable Items (everything else...)
• a. Payments to tax-deferred pension and retirement savings plans (on W-2)
• b. IRA deductions & payments to self-employed SEP, SIMPLE, Keogh & other IRS qualified plans.  Line 28+Line 32, Form 1040
• c. Child Support Received (don't include foster or adoption payments)
• d. Tax Exempt Interest.  Line 8b, Form 1040
• e. Nontaxable portion of IRA distributions. Line 15a- Line 15b, Form 1040
• f.  Nontaxable portions of pensions. Line 16a- Line 16b, Form 1040
• g. Housing, food, and other living allowances paid to members of military, clergy, others
• h. Veterans' non-education benefits, such as Disability, Death Pension, and/or VA Education Work-Study allowances
• i. Other nontaxable income not reported like Worker's Comp, Disability, HSA deductions

If all this makes you want to cry, just give us a call... we can help.

(1)_Financial Aid Starts With FAFSA

College-bound students and their families have more work to complete beyond submitting applications and (hopefully) deciding which school to attend. Students should file the Free Application for Federal Student Aid (FAFSA) before starting college and in succeeding years. As the cost of higher education soars, filing the FAFSA may provide some valuable relief.

Why it’s important

Using the FAFSA to apply for aid opens the door to various forms of assistance, including need-based grants, merit-based scholarships, education loans, and work opportunities. Funds may come from federal or state governments or from individual colleges.

Essentially, aid applicants use the FAFSA to report the student’s assets, student’s income, parents’ assets, and parents’ income. These data are placed into a formula to determine the expected family contribution (EFC) for the coming academic year. If the cost of attending a given college exceeds the EFC, the student may be offered some form of financial aid.

Example 1: 
Arlene Walker fills out the FAFSA, which determines that her EFC for the coming school year is $22,000. If Arlene will be attending a college where the published total cost is $36,000, she might receive a $14,000 aid package to fill the gap.

Some parents may choose not to have their youngsters file the FAFSA, either because they doubt they’ll receive need-based aid or because they don’t want to deprive more deserving applicants of limited aid dollars. That’s for each family to decide, but not filing the FAFSA may have repercussions. Some merit scholarships require the FAFSA, as do federal education loans. What’s more, some colleges are so expensive that relatively affluent parents can qualify for aid, especially if more than one child will be attending college.

A matter of time

Filling out the FAFSA presents some challenges. The forms can be filled out as early as January for the following school year. Indeed, some observers recommend filing as early as possible because late filers may be competing for a depleted pool of funds. Some universities have early deadlines for submitting the FAFSA. However, families filing in January may not yet have all the relevant information, such as adjusted gross income (AGI) for the previous calendar year.

            
Example 2:
Brad Taylor is a high school senior in 2014–15 who will start college in August 2015. In January 2015, Brad fills out the FAFSA with help from his parents. They include their best estimates for 2014 financial information, including AGI. In March 2015, after the Taylors’ tax returns for 2014 are completed, they update the data on the FAFSA that was previously submitted.

Going forward, the Taylors keep submitting a new FAFSA every year, until Brad no longer will be in undergraduate or graduate school.

Application assistance

You and your student can fill out the FAFSA online at www.fafsa.ed.gov. Some colleges require still other financial aid forms, and the entire process can be time-consuming. Our office can help college students and their families to organize the required documents and submit the necessary tax related information on time. We would also be happy to help you fill in the tax-related information on the FAFSA.  We can provide a quick e-mail with our pricing at your request.

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S Corp or LLC?

Many business owners structure their companies as S corporations or limited liability companies (LLCs). On the surface there are several similarities. Both types of entities avoid corporate income tax. Instead, business income is taxed only once, on the tax return of the S corporation shareholder or the LLC member. Moreover, both S corporation shareholders and LLC members have limited liability: their financial exposure from the company’s operation generally is no greater than the amount they invest and any notes they personally sign. (In exceptional circumstances, creditors may gain access to additional personal assets of the business owner.)

            Nevertheless, there are differences between the two structures, which you should consider when choosing between them.

Looking into LLCs

In some ways, an LLC resembles a sole proprietorship or a partnership, but with the advantage of limited liability. Usually, you can form an LLC with relatively little paperwork. Once an LLC is operating, there may be few tax returns to file and other recordkeeping and reporting requirements for LLCs are generally less burdensome than for corporations. If an LLC has multiple members, the business has a great deal of flexibility in how any profits are distributed among them.

            A downside is that an LLC may have a limited life. Depending on state law and the operating agreement, the death of a member may dissolve the LLC, for instance. In addition, taxes might be relatively high for LLC members. That’s because all net income of the LLC is passed through to members as earned income on their personal tax returns, per the LLC agreement. The members are treated as if they were self-employed; they owe the employer and employee shares of items such as Social Security and Medicare tax, with a relatively small deduction as an offset.

Considering S Corps

Even after making an election to be taxed under Subchapter S of the Internal Revenue Code, an S corporation is still a corporation. There are meetings that must be held, minutes that must be kept, and extensive paperwork to process. Such efforts can be time consuming and expensive.

            In addition, S corporations must meet certain requirements. A business with more than one class of stock or a shareholder who is not a U.S. citizen or resident can’t be an S corporation, for example. Similarly, an S corporation can’t make disproportionate distributions of dividends or losses.

            On the plus side, S corporation shareholders can receive a salary, on which they owe payroll tax, and dividends, on which they don’t. Although artificially low-balling a salary will draw the ire of the IRS, S corporation owners may pay thousands of dollars less per year in payroll taxes than LLC members pay on similar company related income. What’s more, S corporations can be long-lived, and this permanent nature may make them more attractive to lenders and investors than potentially short-lived LLCs.

Choosing or combining

Your choice of business structure may come down to whether you prefer the simplicity and flexibility of an LLC or the potential tax savings and lender and investor appeal of an S corporation. State laws vary, so a tilt in one direction or another may influence your decision.

Yet another possibility is to set up your business as an LLC and then request S corporation taxation by filing IRS Form 2553, “Election By A Small Business Corporation.” Our office can go over your specific circumstances to help you decide how to structure your company.

Inherited IRAs and Bankruptcy?

Under federal law (and under the laws of most states), retirement plans such as IRAs enjoy some protection in bankruptcy proceedings. Does that same protection apply to inherited IRAs? The issue has been disputed in many court cases in recent years with mixed verdicts. Finally, in June 2014, the U.S. Supreme Court unanimously decided that bankruptcy creditors may have access to these accounts (Clark v. Rameker, No. 13–299 (U.S. 6/12/14)).

This ruling has implications for IRA owners as well as for the beneficiaries of such accounts.

           

In this case, Ruth Heffron held over $450,000 in her IRA. If Ruth had declared bankruptcy, she probably could have kept certain IRA assets. “Allowing debtors to protect funds in traditional and Roth IRAs ensures that debtors will be able to meet their basic needs during their retirement years,” the Supreme Court noted. Keeping some assets from bankruptcy creditors helps debtors “obtain a fresh start,” reducing the chance that these debtors will be “left destitute and a public charge.”

Beneficiary battle

Many IRAs still hold assets when the owner dies. Then, the IRA may pass to the designated beneficiary.

            

Here, after Ruth died, her daughter Heidi Heffron-Clark inherited the account. Nine years later, Heidi and her husband filed for bankruptcy. The couple asserted that the funds in Heidi’s inherited IRA, which now amounted to almost $300,000, should be exempt from creditors’ claims.

            

In such cases, debtors have prevailed some of the time. Retirement funds held in tax-exempt retirement accounts are protected in bankruptcy, some courts have ruled, and the funds in an Individual Retirement Account remain retirement funds even after they pass to a beneficiary and are held in an inherited IRA.

            

Other courts, including the one ruling on Heidi’s case, found that funds in an inherited IRA are no longer retirement funds because the funds are not specifically set aside for use by the beneficiary in retirement. Thus, they are not protected in bankruptcy. Heidi and her husband appealed to the Supreme Court, which upheld the ruling against them.

            

In favoring the creditors in this case, the Supreme Court gave several reasons why funds held in an inherited IRA are not funds set aside for retirement purposes. First, a beneficiary can’t contribute to an inherited IRA. An individual can put money into a Roth or traditional IRA via annual contributions or direct transfers or rollovers from other retirement accounts. Indeed, various tax incentives encourage such contributions.

            

As its second reason, the Court noted that beneficiaries are required to take minimum distributions from inherited IRAs, even if they are many years from retirement. Traditional IRA owners face required distributions only after age 70½, when they are likely to be retired, and Roth IRA owners never have to withdraw funds. Finally, the Court noted that “the holder of an inherited IRA may withdraw the entire balance of the account at any time—and use it for any purpose—without penalty.” Traditional and Roth IRA owners, on the other hand, generally are subject to penalties for early withdrawals before age 59½.

Points to consider

After this decision, people who declare bankruptcy can’t expect to protect inherited IRAs from creditors. Therefore, IRA owners should review their choice of IRA beneficiaries. If a future bankruptcy filing by a beneficiary is a concern, you might designate an irrevocable trust as the beneficiary of your IRA and name your human heir as the trust beneficiary. Such a procedure may increase the chance that the IRA will enjoy protection in bankruptcy.

           

Moreover, surviving spouses who inherit an IRA from the other spouse might be affected by this decision. A spousal beneficiary “may roll over the IRA funds into his or her own IRA, or he or she may keep the IRA as an inherited IRA,” the Supreme Court observed. Once the IRA has been rolled over into the surviving spouse’s own IRA, it probably will be protected in bankruptcy.

            

Still, some spousal beneficiaries choose to keep the account as an inherited IRA. That’s often the case if the survivor intends to take withdrawals before age 59½ and wants to avoid a 10% early withdrawal penalty. The Supreme Court’s decision does not indicate whether an inherited IRA held by a surviving spouse would get bankruptcy protection, but all of the reasons cited to disallow such protections—no future contributions, required minimum distributions at any age, no penalties for early distributions—apply to inherited IRAs held by a surviving spouse. Therefore, any widow or widower who is considering leaving a deceased spouse’s IRA as an inherited IRA might discuss creditor protection issues with a knowledgeable attorney.

            

Finally, you should keep in mind that the Supreme Court’s decision applies to bankruptcy cases, not other types of creditors’ claims. In non-bankruptcy litigation, state law usually will determine whether inherited IRAs are protected from creditors. Some states specifically protect inherited IRAs, but most states have not passed relevant legislation. Again, you should consult with counsel if this is a concern. 

Deducting Foreign Business Travel

As the world shrinks, business owners may find themselves traveling to foreign destinations. Often, such trips are vital, leading to personal visits with suppliers and potential customers. Ideally, you’ll be able to deduct all your travel costs, but that may not be the case if you venture beyond the 50 states and Washington, D.C.

The seven-day rule

If you travel outside the U.S. for a week or less, your trip will be considered entirely for business, even if you combine business and non-business activities. Then, you can deduct all of your travel costs. A week, for this purpose, is seven consecutive days, not counting the day you leave the U.S.

            

Example 1: Denise Edwards has a clothing import business in Chicago. She travels to San Francisco on Tuesday, then flies to Hong Kong on Wednesday. After spending Thursday and Friday in business discussions, Denise spends Saturday through Tuesday sightseeing. She flies back to San Francisco on Wednesday and returns to Chicago on Thursday.

            

Here, Denise was not outside the U.S. for more than a week. (The day she departed from San Francisco does not count as a day outside the   U. S.) Therefore, she can deduct all of her travel costs. She also can deduct the cost of her stay in Hong Kong for the days she worked there but not her costs for her sightseeing days.

More than one week

Business trips longer than one week trigger another set of rules. As long as 75% or more of the trip’s total days are business days, you can deduct all your travel costs. Days traveling to and from your destination count as business days, for the purpose of reaching the 75% mark. Again, your costs for non-business days are not tax deductible.

            

If your trip is primarily for business, but you fail both the one week and the 75% tests for the travel, calculating your deduction becomes more complicated. 
You can only deduct the business portion of your cost of getting to and from your destination and must allocate your travel time on a day-to-day basis between business days and non-business days.

            

Example 2: Henry Jackson owns a restaurant supply business in Boston. He flies to Berlin on March 7 for a conference and spends time there on business until March 17. That day, Henry flies to Brussels to see friends and tour the local museums. On March 24, he returns to Boston from Brussels.

            

As the IRS looks at Henry’s itinerary, it appears that Henry could have returned to Boston on March 17, after completing his business. Thus, 11 days of the trip (March 7–17) count as business days while the other seven days (March 18–24) are non-business days.

            

With this reasoning, 7 out of 18 days of the trip were non-business days, so ⁷/₁₈ of what it would have cost him to travel round-trip between Boston and Brussels is not tax deductible.

Assume Henry’s total airfare costs were $2,000, whereas roun-dtrip airfare between Boston and Brussels would have been $1,500. Henry must subtract ⁷/₁₈ of this round-trip fare ($1,500 x ⁷/₁₈ = $583) from his actual travel expenses. 
Because Henry spent $2,000, subtracting $583 gives him a $1,417 deduction for his airfare. He can deduct his costs while in Berlin on business but not his costs while in Brussels for other purposes.

As you can see, calculating foreign business travel deductions can be complex. If you will be outside the United States for business, our office can help you set up a schedule for optimal tax benefits. 

Tougher Rules on Reverse Mortgages

The Federal Housing Administration (FHA) has imposed more stringent requirements on reverse mortgages, making them increasingly difficult to obtain. For qualified borrowers, though, continued low rates and the spread of so-called “purchase loans” can make it worthwhile to consider this type of debt.

Income instead of outflow

As the name suggests, a reverse mortgage is the opposite of a traditional home loan. With a reverse mortgage, you get cash instead of making payments to the lender. You can get a lump sum, a line of credit, or regular monthly income. The amount you borrow will be secured by your home, so reverse mortgages are for homeowners with little or no debt on their home. Most reverse mortgages are Home Equity Conversion Mortgages (HECMs), which are offered by private lenders and insured by the FHA; borrowers must be at least age 62.

            
The amount you’ll receive will be determined by current interest rates, your age, and your home equity. Interest rates are relatively low now (around 5% for a fixed-rate loan and under 3% for a loan with a variable rate that adjusts monthly), but you’ll pay an added 1.25% of the balance for mortgage insurance. The older you are and the greater your home equity, the more you’ll be able to borrow on a reverse mortgage.

            
Many reverse mortgage calculators can be found online. Near mid-year 2014, the calculator at reversemortgage.org was asked what a married couple in Indianapolis, both aged 68, could borrow against a $320,000 debt-free home. 

• A fixed-rate loan would permit an upfront payout of over $97,000, whereas a variable-rate loan would provide $971 in monthly cash flow. 
• If that couple were both age 78, the numbers would be about $106,000 upfront and $1,236 a month, respectively. In any case, no tax would be due on the borrowed funds. 

With a HECM, an owner occupant doesn’t have to make any debt repayment while still living in the home. No matter how large the loan balance becomes, the outstanding loan balance won’t be due until the borrower dies, sells the home, or is no longer using the home as a primary residence. 
Naturally, the loan balance will keep mounting: that $97,000 or $106,000 loan against a $320,000 house will approximately double in 11 years, at today’s fixed interest rates.

Higher hurdles

A reverse mortgage borrower still owns the home, which means continuing to have ownership responsibility.

 Example 1: 
Frank and Robin Grant receive a reverse mortgage that will pay them $1,000 a month. They still own their home, so they still must pay homeowners insurance premiums, local property taxes, and association dues.

             
 Under new FHA rules, reverse mortgage applicants must undergo a financial assessment in order to qualify for a loan. Lenders have to check to see that borrowers can afford to pay the required taxes and insurance bills, based on their assets and cash flow. Borrowers with questionable resources may be asked to put money into escrow or may have their application rejected.

Borrowing to buy

Reverse mortgages are aimed at seniors who wish to stay in their home as they grow older. In effect, they can use their home equity for added cash in retirement so they won’t have to move into an unfamiliar place, perhaps one that’s away from friends and family.

That’s not the case for all seniors. Some want to buy a different home that’s easier to maintain or move to a less expensive region.

 Example 2: 

Helen Parker is a widow living in a large house. She wants to buy a place in a seniors’ community, but she lacks the income to qualify for a traditional mortgage, and she is having a difficult time selling the house where she now lives.

            
Fortunately, Helen has enough assets to qualify for a reverse mortgage purchase loan, which will enable her to buy into the seniors’ community now. Helen still plans to sell her old home, but she can move right away and not have to make payments on the reverse mortgage purchase loan.

            
Reverse mortgages can be complicated, and they require various fees, but they may offer a practical way to tap home equity in specific circumstances. 

Delayed Deduction

[] Because reverse mortgages are considered loan advances and not income, the amount you receive is not taxable.

[] Any interest accrued on a reverse mortgage is not deductible until the interest is actually paid, which is usually when the loan is paid off in full. Such a payment might be made by the borrower, by an heir, or by the borrower’s estate.

[] For the party repaying the loan, the deduction may be limited because a reverse mortgage loan generally is subject to the limit on home equity debt. That limit caps deductions to the interest on $100,000 of debt.

Equipment Expensing & Bonus Depreciation

As of this this writing, the status of equipment expensing for 2014 is unclear. The same is true for bonus depreciation. The ongoing uncertainty on these issues may have an impact on your year-end plans to acquire business equipment.

           

Section 179 of the tax code allows certain types of equipment to be expensed: the purchase price is fully tax deductible when the item is placed in service, rather than deducted over a multi-year depreciation schedule. New and used equipment qualify for this tax benefit, with some exceptions (such as real estate).

            

In recent years, Congress has consistently expanded the reach of Section 179. By 2013, up to $500,000 of purchases of equipment eligible for the deduction could be expensed; a business could buy up to $2 million worth of eligible equipment that year before losing any of this benefit.

           

Example 1:
In 2013, DEF Corp. bought $2,085,000 of business equipment eligible for the Section 179 expense deduction and elected to not take bonus depreciation on the equipment. This was $85,000 over the Section 179 limit, so DEF could deduct only $415,000 (the $500,000 ceiling minus $85,000) as an expense in 2013 under Section 179. DEF must recover the other $1,670,000 of the costs of its 2013 purchases through depreciation methods.

            

The $500,000 and $2 million limits for Section 179 expired after 2013. Under current law, the 2014 limit for expensing is $25,000 worth of purchases (plus an inflation adjustment) with a phaseout beginning at $200,000 worth of purchases.

            

Similarly, bonus depreciation was available for new equipment until expiration after 2013. This provision allowed a 50% depreciation deduction on purchases of new equipment, before using an extended schedule to depreciate the balance. Currently, bonus depreciation is not permitted in 2014.

Dealing with doubts

Both houses of Congress have indicated interest in restoring an expanded Section 179 deduction as well as bonus depreciation for 2014. However, any updates probably won’t be announced until late in the year. If that’s the case, how should business owners and self-employed individuals proceed?

           

Start by acquiring any equipment that your company truly needs for current and future profitability. If your business needs the item now, buy it now, and deduct the cost as the tax law permits.

           

If the timing isn’t urgent, consider limiting purchases to those that will bring 2014 acquisitions up to $25,000, which will be the Section 179 ceiling if no extension is passed. Contact our office in late November or early December for an update on relevant legislation.

            

Keep in mind that equipment must be placed in service by the end of 2014 to qualify for depreciation deductions (if reinstated) or expensing this year, so merely paying for equipment in 2014 does not entitle you to a deduction. However, this also means that you can get the 2014 tax benefits for equipment placed in service in 2014 even if you defer payment for the equipment until 2015.

Is It Time to Tack?

I recently read an interesting article about "tacking."  I guess it will be helpful to define this term for those of you who aren't familiar with sailboats.

Tack (n.) : The act of changing from one position or direction to another

First off, I'm not familiar with sailboats either.  I have never actually been on a sailboat.  I can imagine that it might be difficult to turn any ship or boat when there is severe wind or an immediate need to change course. I'm not a sailor, but even I know you would run the risk of capsizing.  

Tacking, as defined by multiple websites, is also known as "coming about."  The process involves turning the bow of a sailboat up through the wind to change course.  However, the danger you face is in not having enough speed to carry the boat through the turn.  If you turn too sharply, you'll lose speed and stall.  I also read that a turn of the rudder by 33 degrees will provide a smooth and controlled turn without much loss of speed.

Why in the world am I telling you this?

Godwin & Associates, CPA is in the process of changing its business model.  If you've looked at our website lately (www.godwincpa.com) you've no doubt noticed the changes.  We are focused entirely on businesses and the owners of those businesses.  No longer do we accept individual tax clients who are not also working with us on business issues.  This was a HUGE change from our old business model, and certainly a massive change from what most CPA firms do.  But we decided that we didn't want to be "most CPA firms."  We wanted to make a difference in our clients' lives, and you can't accomplish that by preparing a 1040.  We can't change your world with something that a here-today, gone-tomorrow tax preparation office in a strip mall can do for you.  We can't add value to your life with a well-done Schedule A. But if you own a business, we can change your life.  That's strong stuff.

To make a change like that takes intentional and purposeful work....hard work....and a vision that is unaffected by fear or queasiness.  Believe me, there was a lot of fear and heartburn when the thought first crossed my mind.  But the benefits far outweighed the potential risks.  So, with the wind at our backs, we decided to change course.  With some fantastic business coaching from a CPA friend of mine, we have begun our 33 degree turn, hoping that we can maintain speed and not stall.  When the turn is complete, I'll let you know how it went.

I have such a great career, and as I have mentioned on many occasions, I work with some fantastic entrepreneurs who share their stories with me.  Just today, I had breakfast with two owners of a company that started almost a year ago.  One of the owners remarked that the work he's doing now is nothing like what he thought he'd be doing when he drafted his business plan, but he absolutely loves it.  He hasn't given up on the other work, but the income-producing work just didn't fall into that category.  It will later, but not today.  In a start-up, sometimes the tacking is done more out of necessity than just desire to change things up.  You need income; you change course from looking at type A work because type B work just walked in the door; you dive into type B work and then take type A work as it arrives.  Done.

Existing businesses that change course have it a little tougher because breaking habits is hard.  Tie your income to that habit and you have some serious decisions to make.  We were fortunate enough to be able to consciously decide to change our business model.  Is there anything about your current business model that needs adjustment?  Is it time for you to tack? 

Jason Fried of 37 Signals, Basecamp & Rework fame spoke about this at the GROWCO conference in Nashville, TN in May.  We liked what he had to say.  If you have 6 1/2 minutes, you might to! Check it out:

http://www.inc.com/jason-fried/inc-live-why-you-should-power-pivot-your-mission.html

Keeping Wealth in Your Family's Future

According to a new study by Merrill Lynch’s Private Banking and Investment Group, family wealth fails to outlive the generation following the one that created that wealth in more than two out of three instances; 90% of the time, “assets are exhausted before the end of the third generation.” 

This report focuses on investors with more than $5 million, but the principles apply just as well to those with $500,000 or even $50,000 to invest. If you are concerned about the financial security of your children and grandchildren, you should set a good example and discuss money matters regularly with your descendants.

Savvy spending

One reason that family wealth may not last very long is simple: people spend too much. 

In the Merrill Lynch study, more than half of the respondents either expressed confidence that a 6% distribution rate could sustain an investment portfolio indefinitely or did not have any idea of how much could be withdrawn prudently. 
To put this in perspective, research indicates that a sustainable distribution rate might be as low as 2% of portfolio value a year.

           
 Obviously, the less you spend the more that can pass to a surviving spouse and to your descendants. Spending moderately will signal to your loved ones that this is how one builds and maintains net worth. In addition, you can make sure that your heirs know that your spending habits are designed to minimize the chance of depleting the family’s coffers.

Continuing the conversation

Indeed, perhaps the most important thing you can do to preserve wealth in your family is to regularly talk to your children about finances. Remember to keep the discussions age appropriate. With very young children, you might talk about how money is earned by working, how some money goes to taxes to pay for schools and other services, and how what’s left might be either saved or spent. Avoid getting into too much detail with youngsters, who probably will be overwhelmed and, therefore, intimidated rather than educated.

           
 Once your children are ready for college, you can have practical conversations about their choice of study and eventual career path. A student who knows a substantial inheritance lies in the future, or who can play a possible role in a thriving family business, might be inclined to consider a course of study that relates to a personal passion; another student, one who understands that his or her lifestyle will depend on his or her earnings, could go in another direction.

            
Similar conversations might take place when children are about to become parents or are shopping for a home. The more they know about your finances, and about their own prospects for an inheritance, the greater the likelihood they’ll make informed decisions.

            
On the flip side, holding these ongoing conversations with your children can educate you, too. You might discover a need for gifts or loans that you hadn’t known about. Conversely, you might realize that your children are uninterested in financial matters and may make poor decisions if they inherit money outright. If so, you may have the opportunity to build safeguards into your estate plan, such as giving or leaving money to a trust for a child’s benefit.

Hitting the highlights

Of course, some parents will not want to reveal all the details of their financial affairs to their children. In truth, that’s not really necessary. You might give your children an overview, with enough information to impart what you are willing and able to provide during your life and a general idea of what they might inherit someday. In addition, you can tell your children where to find key documents and also provide contact information for your professional advisors.

           
 Once you bring your advisors into the inheritance conversation, keep in mind that some studies show that both parents and children may be more comfortable discussing their circumstances with a financial professional (CPA, attorney, financial planner) than with each other. If that’s the case in your situation, you might ask a professional with whom you work to suggest and even host a meeting of the generations. Our office would be pleased to help you get the conversation started.

Ask us for our Personal Cash Flow spreadsheet to help keep track of your expenses!

"Reasonbable Compensation" for S Corp Owners

For regular C corporations, “reasonable compensation” can be a troublesome tax issue. The IRS doesn't want shareholder executives to inflate their deductible salaries while minimizing the corporation’s nondeductible dividend payouts.

            
For S corporation owners, the opposite is true. If owner employees take what the IRS considers “unreasonably low” compensation, the IRS may recast the earnings to reflect higher payroll taxes, along with interest and penalties.

One pocket to pick

Eligible corporations that elect S status avoid corporate income taxes. Instead, all income flows through to the shareholders’ personal tax returns.

            
Example 1: 
Ivan Nelson owns a plumbing supply firm structured as an S corporation. Ivan’s salary is $250,000 a year while the company’s profits are $400,000. The $650,000 total is reported on Ivan’s personal tax return.

            
In 2014, Ivan pays 12.4% as the employer and employee shares of Social Security tax on $117,000 of earnings. He also pays 2.9% Medicare tax on his $250,000 of salary. As a result of recent tax legislation, Ivan—who is not married—owes an additional 0.9% Medicare tax on $50,000, the amount over the $200,000 earnings threshold (the threshold is $250,000 on a joint tax return). Altogether, Ivan pays well over $20,000 in these payroll taxes.

Going low

Often, S corporation owners have a great deal of leeway in determining their salary and any bonus. Holding down these earnings may reduce payroll taxes.

 Example 2: 
Jenny Maxwell owns an electrical supply firm across the street from Ivan’s business. Jenny’s company also is an S corporation. She reports the same $650,000 of income from the business but Jenny classes only $75,000 as salary and $575,000 as profits from the business. Thus, she pays thousands of dollars less than Ivan pays for Social Security and Medicare taxes.

Proving your payout

As mentioned, the IRS might target S corporation owners suspected of lowballing earned income. Therefore, all S corporation shareholders should take steps to justify the reasonableness of their compensation.

If you own an S corporation, consider spelling out your salary level in your corporate minutes. Where possible, give examples and quote industry statistics that show your compensation is in line with the amounts paid to executives at similar firms. Other explanations also might help.

            

• Depending on the situation, you might say that business is slow, in the current economy, so the minutes will report that you are keeping your salary low to provide working capital for the company. 
• If your business is young, the minutes could explain that you’re holding fixed costs down, so the company can grow, but you expect to earn more in the future. 
• In still another scenario, you might say that you are nearing retirement and making an effort to rely more on valued employees, so a modest level of earnings reflects the actual work you’re now contributing.

As illustrated above, holding down S corporation compensation can result in sizable payroll tax savings. (Our office can help you establish a reasonable, tax-efficient plan for your salary and bonus.)

Calculating coverage

Beyond compensation, health insurance also may affect the payroll tax paid by an S corporation owner. Special rules apply to anyone owning more than 2% of the company’s stock.

            
If the company has a health plan and pays some or all of the costs for coverage of such a so-called “2% shareholder,” the payments will be reported to the IRS as taxable income. However, that amount will not be subject to payroll taxes, including those for Medicare and Social Security. 
The company can take a deduction for these payments, effectively reducing corporate profits passed through as taxable income for the shareholder.

            
In addition, the S corporation shareholder may be able to deduct the premiums paid by the company—this deduction can be taken on page 1 of his or her personal tax return, which may provide other tax benefits. However, such an “above-the-line” deduction cannot be taken in any month when the shareholder or spouse is eligible to participate in another employer-sponsored health plan. Also, this deduction can’t exceed the amount of the shareholder’s earned income for the year.

            
This can be a complicated issue, especially if your state law prevents a corporation from buying group health insurance for a single employee. If you own an S corporation, our office can help you decide the best way to hold down payroll tax as well as income tax from your health plan.

             

5 Ways to Use Us More Effectively

We meet with new entrepreneurs on a regular basis, and I had the pleasure of speaking with three new business owners recently who had never worked with a CPA before.  

One of the owners said, "What do you do? I mean, I know you do taxes and stuff, but what else do you do?" 

After our meeting ended, I began to wonder how our clients view us through the lens of their daily challenges as business owners. When a financial decision is about to be made, does our client think, "You know, I should run this by Jonathan to see what he thinks?"
I wasn't sure.

We are knowledge workers, and our most valuable asset is the knowledge and experience that we draw upon and share as part of our small business engagements.  When clients engage us to work with them, depending on how involved we are, that knowledge is theirs when they need it....via email, phone or face-to-face.  No by-the-hour billing; no invoices with 7 lines on them showing you what we did last month.  A flat fee and BAM!  Our knowledge is theirs.  In that situation, why in the world would you not call?

Here are five scenarios in which we feel our clients could better utilize our talents to their advantage:

1.  I'm About to Spend a Lot of Money:

If the decision involves spending a large amount of money, you should probably discuss it with us before you commit to it.  I'm not saying that we need to be involved in the smaller decisions, like where you buy your paper clips and how much you spend on them, but I wouldn't decide to change my investment strategy or invest a large sum of money in the market without speaking to my financial planner first.  Why would you, as a small business owner and the one responsible for the financial health of your business, decide to commit a large sum of money to these things without running it by us first?

A new employee

A new piece of equipment

A new rental property or commercial building

A new business opportunity

Emptying your IRA to buy a new house or investment property....

I have a client to whom we provide outsourced CFO services.  He won't take on a new customer without first calling me and allowing me to run a margin analysis, to make sure he's obtaining the margins that his company needs to produce profit and grow.  So, with each new proposal, he contacts me and we run the numbers.  He knows that if he takes on a new customer, he has costs involved:  a new employee, technology costs, maybe travel expenses.  We have built a model for determining whether each new customer is profitable, so he knows with certainty what's going to happen when he makes a decision.

2. I'm About to Receive Money:

I'm not talking about revenue you receive in the normal course of business.  I'm talking about something extraordinary....a life insurance settlement, a loan from your mother, or (heaven forbid) an early distribution from a retirement account.  These are not run-of-the-mill occurrences.  I have been in meetings that went something like this:

"So, is there anything out of the ordinary that I need to know about?"

"Not really....no, wait.  I did take $50,000 out of my IRA in September to help me fund the business and didn't have any withholding taken out."

"OK, how old are you again?"

"I'm 49."

"OK, are you prepared to pay the $16,000 in federal and SC taxes that come along with that?"

Silence.

Lesson to be learned here:  if you are about to receive money that you don't normally receive, it helps to contact your CPA and ask questions regarding how your financial picture will be impacted.

3.  I've Formed an LLC.  Hooray!

I hear this statement about once every, um, 36 seconds.  While the states have made it SO EASY to set up an LLC, there is hardly any guidance that the average person can find that addresses the tax issues surrounding such a decision.  This is how the conversation usually goes:

"So, you said in your email that you have set up an LLC?"

"Yes, I did.  I knew it was something I needed to do."

"Who told you that?"

"LegalZoom."

"OK, how is your LLC taxed?"

"Um, as an LLC."

"You know that an LLC can be taxed four different ways, right?"

"No, I guess LegalZoom didn't tell me that."

And we're off!  I love tax planning, so I don't have any problem whatsoever having this conversation with a client.  It never fails that they leave the office knowing way more than when they came in, because LLC's are the most used and least understood entity choice around.  But, before you form one, you really should come in and discuss it with us.  Fixing a mistake down the road because you weren't informed can cost you more in time and heartache, I promise you.

4.  I'm Worried About My Business' Cash Flow: (Why don't I have any money?)

My biggest point of frustration with my career is that people consider a CPA to be the bean-counter or the tax guy.  I only like to eat beans, and while I like the world of tax, I don't live and die with each scintillating tax return I prepare.

When we decided to price our business engagements differently about four years ago, I make purposeful statements like "It doesn't have to involve taxes for you to call me" or "Anything to do with your business' cash flow is important, and we need to talk about it."  Here is a snippet from a recent meeting:

"So, how are things going?"

"Well, cash has been tight lately and I've been really stressed out about it."

"Really?  When did you notice the slowdown in your cash flow?"

"About six months ago."

" Six months! Why didn't you call me?"

"I don't know.  It didn't really have anything to do with taxes, so I didn't want to bother you. I just figured things would right themselves."

Bother me?  What is it you think you pay for?

When you work with Godwin & Associates, you never have to worry about "bothering" us.  If you were a bother, we wouldn't be working with you.  Life is too short.  So, assuming you're not a bother, we have an open knowledge policy.  If there is a concern about your business' cash flow, we need to know about it.  Because guess what?  We've all been there. I might know of a way to help that you haven't yet thought of.

A man is walking down the street and falls into a hole.

He sits there for hours, calling out to people for help.

A priest walks by and throws in a prayer written on a sticky note.

A doctor walks by and throws down a prescription.

A friend walks by, then jumps in the hole with the man.

The man asks "What are you doing?  Now we're both stuck in here."

The friend says "Yes, but I've been in here before and I know the way out."

5.  I'm Frustrated and I Don't Know What To Do: (Nothing is happening.)

Sometimes I'm a cheerleader; sometimes I'm a counselor; sometimes I serve as a sounding board; sometimes I am the good angel to your bad angel.  

I'm always a truth-teller, however.  I won't sugarcoat the truth no matter how much you want me to, and I'm going to ask the hard questions.

Sometimes, a sole proprietor or the sole owner of a corporation just needs someone to talk with. Things happen that throw us off our game.  The biggest problem with being a solo owner is the risk of isolation, and making too many decisions in a vacuum.

If you always have your head down, doing work and just getting by, it's easy to just make decisions on the go and not consider the far-reaching effect of what you're about to do. You've been trained to look down and keep moving, but decisions have consequences that serve as dominos for your life.

I've had meetings where a sole owner comes by, and just sits there....silent....for a few minutes.  The consternation is obvious, but they've been sitting by themselves for so long they don't know how to tell me what's wrong.  I consider myself a good listener, so I just wait until the right time and start asking questions to coax the issue out of my client.  As painful as it might have seemed in the beginning, some wonderful things come out of those meetings.  Insight....a new way to think about the problem....a laugh or two....and the comfort of knowing that as a small business owner myself and fellow entrepreneur, I am right there with you.

 Our goal is to help you prosper, so when the phone rings or the email pops up and you need us, we want to help.  To help your business grow, to help your employees continue to make money so they can support their families, and to help you provide the wonderful service or product to our community and the world.  If we don't do our job, other people (not just you) suffer.  

So, the next time you wonder whether or not the question of the day is something we can help you with, drop us a line.

How can we help you today?

Why you aren't using your accountant