Mixing IRA Distributions With Social Security

Many workers save for the future in a 401(k) or another employer sponsored retirement plan. Contributions avoid income tax, and the same is true for investment earnings inside the plan. Often, 401(k) participants roll over the money to a traditional IRA after they retire, which extends the tax deferral.

Many people try to keep their IRAs intact as long as possible, continuing tax free buildup inside the plan.

Example 1: Alice Wells retired at age 62. To make up for her lost earnings, Alice draws down her taxable accounts, so her IRA can keep growing untaxed. Alice’s plan is to wait as long as possible before taking distributions from her IRA. (She’ll have to take at least the required minimum distributions from her traditional IRA after age 70½.)

However, once she retires, Alice finds that she is still short of cash flow. She can start to receive Social Security retirement benefits as early as age 62, so Alice puts in her claim to get the additional monthly income. 

Lower brackets are likely

Alice’s strategy, as described, is followed by many seniors. That is, they take Social Security early and eventually tap their IRA. That may not always be the best approach.

What might indicate taking a different route? Taxes, for one thing. The value of tax deferral depends on your tax bracket. The higher your bracket, the more putting off the IRS makes sense.

Suppose Alice typically was in a 28% or 33% tax bracket during her working years. In 2014, those brackets cover single taxpayers with about $90,000 to $400,000 of taxable income after deductions. Deferring income tax while she worked saved Alice 28 cents or 33 cents on the dollar.

Now that she’s retired, Alice’s taxable income is sharply reduced. In our example, Alice can tap her IRA for cash flow and keep taxable income below $90,000, which would put her in the 25% bracket. At 25 cents on the dollar, tax deferral isn’t as valuable as it was during her working years. On the other hand, taking IRA distributions and paying 25% tax isn’t as painful as it would be in a higher bracket.

Indeed, many retired couples are in the 15% bracket now, which goes up to nearly $75,000 of taxable income, after deductions. Such couples will owe even less tax on IRA distributions.

A plumper pension

There’s another reason to consider reversing the plan to take Social Security early and IRA distributions late. The longer you wait to start Social Security, the larger your monthly benefits will be.

Example 2: Suppose that Alice Wells has an earnings history that would qualify her to receive $2,000 a month at 66, which Social Security considers the “full retirement age” for people now in their 60s. If Alice starts Social Security at age 62, she’ll get only 75% of that benefit: $1,500 a month, plus cost-of-living adjustments (COLAs), for the rest of her life.

On the other hand, Alice can wait as late as age 70 to start Social Security. That would increase the monthly payment from her full retirement age by 32%, from $2,000 to $2,640 a month, plus all the COLAs along the way.

 Not counting COLAs, waiting from 62 to 70 will increase Alice’s annual benefit from $18,000 a year to $31,680 a year, which she’ll receive for the rest of her life.

Once Alice starts to receive Social Security, those much larger payments may reduce the amounts she’ll need from her IRA. If that’s the case, Alice will be substituting Social Security dollars, which are partially taxed under current law, for traditional IRA distributions, which usually are fully taxable.  

    

Building up Social Security benefits might have another appeal for married couples. When the first spouse dies, the survivor will receive the decedent’s Social Security payments, if they are larger than the benefits the survivor had been receiving. Thus, waiting to start Social Security may provide extra cash flow for a surviving spouse.

This plan to tap your IRA early and wait to start Social Security will help some people but not others. Calculations involve each individual’s health and work history as well as some complicated navigation through the tax code. When you are ready to make your decision, our office can help you determine a course of action likely to maximize cash flow and income security as you grow older.

SEP- Self-Employed Pension

Simplified employee pension (SEP)  plans are commonly used by self-employed individuals and others with part-time self-employment income. In addition, SEPs can offer many benefits to small companies, so business owners may want to consider using a SEP for themselves and the firm’s workers.

On your own

Self-employed individuals choose SEPs for several reasons. 

• There are virtually no costs or paperwork to setting up and maintaining a SEP. 
• Many financial firms offer them, and the investment options are broad. 
• Contribution limits are generous, with a $52,000 maximum for 2014.

 (SEP contributions may be as high as 25% of compensation, but special rules effectively limit contributions to around 20% of your net self-employment income.)

 In addition, SEPs offer a rare opportunity to make retroactive tax deductions. Each year, you can deduct SEP contributions made until the filing date of your tax return, including extensions.

            Example 1: Beth Carson, a freelance graphic artist, qualifies for a $15,000 SEP contribution based on her 2013 earnings. On April 1, 2014, Beth contacts a mutual fund company and creates a SEP, funded with a check for $15,000. As long as Beth makes the contribution by the time she files her 2013 tax return on April 15, she can take a $15,000 tax deduction on that return. If Beth can’t make that deadline, she can request an automatic filing extension until October 15, giving her an extra six months to make a deductible SEP contribution.

Strictly business

Small companies also can use SEPs . Again, the simplicity of such plans, the flexibility, and the high ceiling for contributions may make SEPs appealing to business owners. Employers must fill out and retain IRS Form 5305-SEP to establish the plan, but there are no subsequent required filings with the IRS. The downside is that a SEP is funded entirely by employer contributions; SEPs are different from 401(k)s and similar plans, which are funded largely by employees’ salary deferrals.

 To set up a SEP for your company, you merely have to sign a document with the financial firm you have chosen. Then you must notify each eligible employee about the plan and create an account (a SEP-IRA) for each qualified employee at the financial firm. Once the plan is established, your company must make equivalent contributions for each eligible employee, as a percentage of compensation.

 Example 2: ABC Corp. has two co-owners and four employees. If the owners want maximum SEP contributions of 25% of their pay, the company also must contribute 25% of pay to the SEP-IRAs of the other four employees. (See the Trusted Advice box for guidelines for which employees must be included in a SEP.)

Fortunately, SEP-IRAs are flexible. Even if ABC makes a 25% contribution in a given year, it can make a contribution of any percentage of pay in the following year. The company also can skip contributions altogether, if cash is tight.

 With a SEP, business owners have plenty of time to decide about contribution levels. You can set up and make deductible contributions to a SEP plan as late as the due date (including extensions) of your company’s income tax return for that year. Therefore, your company still has time to set up a SEP plan and make deductible contributions for 2013. 

SEP Requirements

When a company has a SEP plan, it must include all employees who have done all of the following:

o   Reached age 21

o   Worked for the company in at least 3 of the last 5 years

o   Received at least $550 in compensation from your business for the year, subject to annual cost-of-living adjustments in later years

Your company can impose less restrictive requirements, such as reaching age 18 or working there for 3 months.

Certain union members and nonresident aliens may be excluded.

Miles, and Miles, and Miles

Scene 1, Godwin & Associates, CPA offices.  March 10, 2013.  Jonathan Godwin is meeting with a small business client regarding tax deductions for his company’s 2012 corporate tax returns.

Jonathan – “So, I see you have indicated your business mileage at 24,650 for 2012.”

Client – “Yes, I have.  I know that sounds high, but I was on the road a tremendous amount last year.”

Jonathan – “I have no problem with that at all.  Can you get me a copy of your mileage log so I have it for my files?”

Client – Crickets…

Jonathan – “You do maintain a mileage log, right?  We talked about this last year as I recall.”

Client – More crickets…

This isn’t an uncommon conversation for me during tax season.  I ask that question of everyone who claims mileage, knowing that in the event of an audit, if there was no mileage log the deduction would be disallowed without even a second thought.  The rules are clear…no log, no deduction.

The federal mileage rate for 2013 is $.565/mile for business travel.  Deductible mileage includes travel to meet with a client; your trip to the bank to make a deposit; your trip to my office to meet and discuss your tax situation; your trip to an open house; your trip to show a house….you get the picture. Just don’t include any personal travel in there, and if your primary office is at your real estate company’s home office, then don’t deduct travel from your personal residence to the office (that’s commuting, not business travel). To say that this deduction is valuable to my real estate clients is a massive understatement, so please do yourself a favor and keep the mileage log.

Last year, Meghan bought several and placed them in our main conference room.  So, if you don’t want to buy one, then come by here and get one for free.  I won’t judge you.  After all, it cost the actor in the above scene a tax deduction of $13,927 at today’s mileage rate for not having the log.  That’s worth a trip to our office….we’ll even throw in some coffee to go.

You Complete Me

I played tennis throughout my childhood and teenage years....and I mean, I played all the time.  These days, when I play, there is no comparison between the talent I displayed then and now.  One thing hasn't changed, however.  I can tell immediately when I hit a shot in the sweet spot of the racket....that perfect point where the ball flies off the racket at an optimal speed and lands exactly where I intended.

I discovered a new sweet spot for my CPA firm the other day when a new client decided to expand its engagement with us to include CFO services.  When the owners first posed the question to me, I was very intrigued but wary because everyone has a different definition of "CFO services."  They wanted a true financial partner, someone with whom they could share and discuss new business ideas, and someone who would share an opinion with them even if it went against their own.  Of course they need tax preparation and planning, but those necessary compliance services take a back seat to the "big picture work" that adds an extreme amount of value to their business.

We started working with this new client three months ago and I'm as excited as I have ever been about an engagement.  I'm also excited about what this means for us as we build a new practice specialty.  I felt confident after our initial meeting that we would work well with this new client for a common cause. But, it was brought home after a conversation where I brought him an idea and he said to me:

"You complete me."

 It's a match made in heaven in my opinion.

Is it time to discover your new sweet spot?

IRS Tax Tip: Home Office Dedcution

Simplified Option for Home Office Deduction

Do you work from home? If so, you may be familiar with the home office deduction, available for taxpayers who use their home for business. Beginning this year, there is a new, simpler option to figure the business use of your home.
This simplified option does not change the rules for who may claim a home office deduction. It merely simplifies the calculation and recordkeeping requirements. The new option can save you a lot of time and will require less paperwork and recordkeeping. 
Here are six facts the IRS wants you to know about the new, simplified method to claim the home office deduction.
1. You may use the simplified method when you file your 2013 tax return next year. If you use this method to claim the home office deduction, you will not need to calculate your deduction based on actual expenses. You may instead multiply the square footage of your home office by a prescribed rate.
2. The rate is $5 per square foot of the part of your home used for business. The maximum footage allowed is 300 square feet. This means the most you can deduct using the new method is $1,500 per year.
3. You may choose either the simplified method or the actual expense method for any tax year. Once you use a method for a specific tax year, you cannot later change to the other method for that same year.
4. If you use the simplified method and you own your home, you cannot depreciate your home office. You can still deduct other qualified home expenses, such as mortgage interest and real estate taxes. You will not need to allocate these expenses between personal and business use. This allocation is required if you use the actual expense method. You’ll claim these deductions on Schedule A, Itemized Deductions.
5. You can still fully deduct business expenses that are unrelated to the home if you use the simplified method. These may include costs such as advertising, supplies and wages paid to employees.
6. If you use more than one home with a qualified home office in the same year, you can use the simplified method for only one in that year. However, you may use the simplified method for one and actual expenses for any others in that year.

Visit IRS.gov for more about this easier way to deduct your home office.
http://content.govdelivery.com/accounts/USIRS/bulletins/84fc7d#.UfgJo4XzJaU.email

Letting Go.

I recently had the opportunity to meet with a business owner who has been at the helm of a growing and profitable business for almost three years.  I could tell by talking with him that he was very proud of what he had accomplished in that time....and why shouldn't he be?  His business doubled from 2011 to 2012 and he is considering opening a second location.

In speaking with this gentleman, it became clear that like the rest of us he started out wearing all the hats.  As he grew, he hired someone to first answer the telephones....then someone to work at the front desk...and finally other professionals who could do what he was doing.  His final relinquishment...the tax returns.  What I saw was a business owner who prepares his own tax returns. Why, you might ask?  He has an accounting degree along with a past career in a very complex area of finance.  This man had actually "made it" more than once, which is such a fantastic accomplishment.  He feels as though he is qualified to do them.

The roadblocks he is facing are the same ones we all face at some point in our entrepreneurial journeys.  What do I have to let go of so I can grow?  Even though I "can" do this task, is it the best and highest use of my time?  Am I ready to let someone else who is an expert at this task step in and free up my time to be an entrepreneur again?

Letting go is very difficult to do, but not letting go also has it's down side.

I know this business owner will be successful whether or not he works with my firm.  I just hate to see business owners feeling stuck and overwhelmed when I know I can help them.

Will Structure Also Matters

I had a meeting with a wonderful client last week, and while most meetings in general are not depressing by nature, this one had some heavy overtones.  His mother had passed away recently and he was in charge of "everything."

I can't say that I started my business and immediately sat down with my estate planner to write my last will and testament.  I wasn't that smart about it.  I didn't have a will prepared until much later, after I had a business, a child and a wife.  That wasn't all that smart, in my opinion.  What would have happened if I had died before I had a will in place?  It could have been a nightmare for those sorting out the pieces afterward.

My client's mother had a will and a couple of trusts set up.  Her intentions were good, but they were not fulfilled to the extent possible.  She hadn't received the best advice on how to structure things and now my client had some serious heartburn as he was reading through everything.  Based on what I know right now, he won't experience horribly adverse tax consequences as a result of anything that happened, but the time he has spent chasing his tail and reading power bill receipts from 1987 is irreplaceable.  I can only imagine how much happier he would be spending his time at the helm of his business as opposed to emptying 4 filing cabinets of useless paper.

I have asked some of you about the existence of your wills.  I will do a better job of asking all of you as the year wears on.  If you need a referral, I have some great ones.  But, for the love and sanity of your loved ones, review the will you have now and make sure it does its job (because things change over time, and the will you wrote in 1980 may need revising); or sit down with a trusted attorney and prepare it for the first time.  There are cases where serious tax problems can emerge from the improper handling of your assets upon your death, because tax structure matters.

http://www.accountingtoday.com/debits_credits/Gandolfini-Will-Leaves-Family-Exposed-Heavy-Estate-Taxes-67362-1.html?ET=webcpa:e7377:53503a:&st=email