Tax Tips for Retirees San Diego CRA Chapter February 14, 2012 Herb Farrington, EA, CFP ® Cell:...

Tax Tips for RetireesTax Tips for Retirees

San Diego CRA ChapterSan Diego CRA ChapterFebruary 14, 2012February 14, 2012

Herb Farrington, Herb Farrington, EA, CFPEA, CFP®®

Cell: (714) 904-5825Cell: (714) [email protected]

This presentation is for educational purposes only; it is not individual tax or investment advice. Attendees should consult with This presentation is for educational purposes only; it is not individual tax or investment advice. Attendees should consult with

their personal financial advisor to determine whether any of the issues presented are appropriate to their own situation. their personal financial advisor to determine whether any of the issues presented are appropriate to their own situation. Use of Use of

these materials in any other manner or context is neither recommended nor authorized by the author. these materials in any other manner or context is neither recommended nor authorized by the author.

© 2012 Herbert D. Farrington© 2012 Herbert D. Farrington

Income TaxesIncome Taxes

Over and over again the Courts have said that there Over and over again the Courts have said that there is nothing sinister in so arranging affairs as to keep is nothing sinister in so arranging affairs as to keep taxes as low as possible. Everyone does it, rich taxes as low as possible. Everyone does it, rich and poor alike and all do right, for nobody owes and poor alike and all do right, for nobody owes any public duty to pay more than the law any public duty to pay more than the law demands: Taxes are enforced exactions, not demands: Taxes are enforced exactions, not voluntary contributions.voluntary contributions.

-- Learned Hand, US Appeals Court Judge-- Learned Hand, US Appeals Court Judge

The Undocumented The Undocumented SecretarySecretary

Political Statement:Political Statement: My secretary pays a higher tax rate than me (35% vs. 17.4%).My secretary pays a higher tax rate than me (35% vs. 17.4%).

Truth:Truth: The 35% tax bracket The 35% tax bracket startsstarts at income of $379,151 at income of $379,151 $379,151 in taxable income results in tax of $110,017 (29%)$379,151 in taxable income results in tax of $110,017 (29%) Is Buffet’s secretary really making that much ?Is Buffet’s secretary really making that much ?

Is she married? If so, what does her husband make?Is she married? If so, what does her husband make? Warren Buffett’s salary is $100,000Warren Buffett’s salary is $100,000

Very low for the CEO of a multi-billion dollar companyVery low for the CEO of a multi-billion dollar company He’s structured his “compensation” to be through capital He’s structured his “compensation” to be through capital

gains and dividends (15% tax rate).gains and dividends (15% tax rate). Buffett’s AGI: $63 million, Taxable Income: $39 million, $24 Buffett’s AGI: $63 million, Taxable Income: $39 million, $24

million?million? Did he pay too little? Berkshire paid $5.6 billion in income taxes Did he pay too little? Berkshire paid $5.6 billion in income taxes

in 2010 (35%), Buffet owns 37% x $5.6 billion = his share $2.07 in 2010 (35%), Buffet owns 37% x $5.6 billion = his share $2.07 billionbillion

Oranges vs. Apples “Figures Don’t Lie, but Liars Figure”Oranges vs. Apples “Figures Don’t Lie, but Liars Figure” Is he comparing his effective tax rate vs. his secretary’s top Is he comparing his effective tax rate vs. his secretary’s top

marginal rate marginal rate plusplus her Social Security tax? her Social Security tax?

Unintended ConsequencesUnintended ConsequencesAny item of income or loss can affect taxes on other Any item of income or loss can affect taxes on other

income.income.The tax code is complex, sneaky, illogical & unfair !The tax code is complex, sneaky, illogical & unfair !

Higher income can put you into a higher tax bracketHigher income can put you into a higher tax bracket Social Security can go from 0% taxable to 50% or 85% Social Security can go from 0% taxable to 50% or 85% Medicare: you can be subject to:Medicare: you can be subject to:

Surcharge on your Medicare premiumsSurcharge on your Medicare premiums Obamacare tax on investment incomeObamacare tax on investment income

Phase-out of deductions for residential rental lossesPhase-out of deductions for residential rental losses Can make you subject to AMTCan make you subject to AMT Returning in 2013: Phase-out of personal exemptionsReturning in 2013: Phase-out of personal exemptions Returning in 2013: Phase-out of itemized deductionsReturning in 2013: Phase-out of itemized deductions

Strategies:Strategies: Defer recognition of taxable incomeDefer recognition of taxable income Convert taxable income to tax-deferred income or tax-free Convert taxable income to tax-deferred income or tax-free

incomeincome

The Big Picture: Overall Asset The Big Picture: Overall Asset AllocationAllocation

Where to Hold Your InvestmentsWhere to Hold Your InvestmentsTaxable AccountsTaxable Accounts

Stocks, Mutual Funds, ETFsStocks, Mutual Funds, ETFs LT Capital Gains receive 0-15% tax rateLT Capital Gains receive 0-15% tax rate Qualified Dividends receive 0-15% tax rateQualified Dividends receive 0-15% tax rate Capital Losses can offset other incomeCapital Losses can offset other income If these investments are in an IRA: ordinary tax rates (up to 35%)If these investments are in an IRA: ordinary tax rates (up to 35%)

Tax-free Municipal BondsTax-free Municipal Bonds Can avoid both Federal and California income taxationCan avoid both Federal and California income taxation Private activity bonds are subject to AMTPrivate activity bonds are subject to AMT

Tax-deferred Accounts: Traditional IRAs, 401(k)s, Tax-deferred Accounts: Traditional IRAs, 401(k)s, AnnuitiesAnnuities Bonds, Money Markets, CDs, ETNsBonds, Money Markets, CDs, ETNs

Earnings within these accounts are tax-deferredEarnings within these accounts are tax-deferred Put your “income” (interest) investment allocation herePut your “income” (interest) investment allocation here Upon withdrawal, all income is taxed at ordinary tax rates (up to 35%)Upon withdrawal, all income is taxed at ordinary tax rates (up to 35%)

Tax-free Accounts (Roth IRAs)Tax-free Accounts (Roth IRAs) No income tax consequences (usually)No income tax consequences (usually) Focus only on maximum investment returnFocus only on maximum investment return

Taxable Investment AccountsTaxable Investment Accounts

FederalFederal Qualifying Dividends & Long Term Capital Gains:Qualifying Dividends & Long Term Capital Gains:

0%0% if Taxable Income <$34,500 single, <$69,000 MFJ if Taxable Income <$34,500 single, <$69,000 MFJ 15% if Taxable Income higher15% if Taxable Income higher

Non-qualifying Dividends, Interest & Short Term Gains: up Non-qualifying Dividends, Interest & Short Term Gains: up to 35%+ tax rateto 35%+ tax rate

Rental real estate: Accumulated Depreciation upon sale: Rental real estate: Accumulated Depreciation upon sale: 25% rate25% rate

Collectibles: 28% rateCollectibles: 28% rate $3000 maximum deductible capital loss per year (since $3000 maximum deductible capital loss per year (since

1978)1978) 2013: LTCG rate goes to 20% + 3.8% = 23.8%2013: LTCG rate goes to 20% + 3.8% = 23.8% 2013: Dividends: Up to 35% + 3.8% = 38.5%2013: Dividends: Up to 35% + 3.8% = 38.5%

CaliforniaCalifornia There is no special rate for dividends & capital gains Ordinary income tax rates apply: up to 9.3%

Tax Planning Tip for a Taxable Tax Planning Tip for a Taxable AccountAccount

Get the 0% Federal income tax rateGet the 0% Federal income tax rate Keep your “Taxable Income” below $69,000 (MFJ) and:Keep your “Taxable Income” below $69,000 (MFJ) and:

Qualifying Dividends & Long Term Capital Gains will Qualifying Dividends & Long Term Capital Gains will have a 0% tax rate !have a 0% tax rate !

Example:Example:If your other Taxable Income is $40,000 then you If your other Taxable Income is $40,000 then you

could have $29,000 in capital gains and/or qualified could have $29,000 in capital gains and/or qualified dividends that will have a 0% tax for federal dividends that will have a 0% tax for federal purposespurposes

CaliforniaCalifornia There is no special rate for dividends & capital gains, so

there would be California income tax on your capital gains and dividends.

IRAs: Traditional vs. RothIRAs: Traditional vs. Roth

Traditional IRATraditional IRA Investment gains are Investment gains are tax-tax-

deferreddeferred Withdrawals are Withdrawals are taxedtaxed

at ordinary income tax at ordinary income tax ratesrates

RMDs after age 70RMDs after age 70½½ Withdrawals by Withdrawals by

beneficiary are beneficiary are taxedtaxed at at ordinary income tax ratesordinary income tax rates

IRA balance at death is IRA balance at death is subject to estate taxessubject to estate taxes

Roth IRARoth IRA Investment gains are Investment gains are tax-tax-

freefree Withdrawals are Withdrawals are tax-freetax-free NoNo age 70 age 70½ RMDs RMDs Withdrawals by Withdrawals by

beneficiary are beneficiary are tax-freetax-free IRA balance at death is IRA balance at death is

subject to estate taxessubject to estate taxes Each dollar in a Roth IRA Each dollar in a Roth IRA

is more valuable than a is more valuable than a dollar in a traditional IRAdollar in a traditional IRA

Traditional IRAs:Traditional IRAs: Required Minimum DistributionsRequired Minimum Distributions

Age 70 ½ before 2012Age 70 ½ before 2012 RMD for 2012 due on or before December 31, 2012RMD for 2012 due on or before December 31, 2012

Age 70½ in 2012Age 70½ in 2012 RMD for 2012 must be made on or before April 1, 2013RMD for 2012 must be made on or before April 1, 2013 RMD for 2013 on or before December 31, 2013RMD for 2013 on or before December 31, 2013 Therefore, 2 RMDs may be required in 2013 if you delay Therefore, 2 RMDs may be required in 2013 if you delay

first distribution (double income, double or more tax) first distribution (double income, double or more tax)

Have You Hugged Your 8606 Lately?Have You Hugged Your 8606 Lately?

It Can Save You Thousands of DollarsIt Can Save You Thousands of Dollars Nondeductible IRA Contributions to Traditional Nondeductible IRA Contributions to Traditional

IRAsIRAs Such contributions are recovered tax-free Such contributions are recovered tax-free

over lifeover life

1.1. Amounts for current year and prior yearsAmounts for current year and prior years

2.2. Total market value of your traditional IRAsTotal market value of your traditional IRAs

3.3. 1. divided by 2. equals tax-free ratio1. divided by 2. equals tax-free ratio

Roth Conversion InformationRoth Conversion Information

Roth IRA DistributionsRoth IRA Distributions

Worksheet for Form 8606Worksheet for Form 8606IRA Contributions: Deductible & Nondeductible

Federal & California

Tax Year Maximum Deductible Contribution Comments Federala California

1975 $ 1500 $ 0b No California deduction

1976 -1981 1500 1500b If active participant (AP) in employer retirement plan: No Federal and No California deduction.

1982 - 1986 2000 1500b If AP: Federal deduction allowed, No California deduction

1987 - 1993 2000 2000 If AP: Amount deductible depends on MAGI. Calif. deduction, if any, based on Calif. net income.

1994 - 2001 2000 2000 If AP: Amount deductible depends on MAGI.

2002 - 2004 3000 + 500

3000 + 500

If AP: Amount deductible depends on MAGI. If age 50+ then an extra $500

2005 4000 + 500

4000 + 500


2006 - 2007 4000 +1000

4000 + 1000


2008 – 2011 5000 +1000

5000 + 1000


Reasons to Convert to a Roth IRAReasons to Convert to a Roth IRA

1.1. Avoids RMDs after age 70 ½ Avoids RMDs after age 70 ½

2.2. If you have a special tax situationIf you have a special tax situation• Low year of incomeLow year of income• Business LossesBusiness Losses• Tax creditsTax credits• Suspended real estate rental lossesSuspended real estate rental losses• High Charitable Contributions (current or carry-overs)High Charitable Contributions (current or carry-overs)

3.3. If you have non-deductible contributions in your IRAIf you have non-deductible contributions in your IRA• They are They are notnot taxable at conversion taxable at conversion

4.4. Have non-IRA funds available to pay income tax on Have non-IRA funds available to pay income tax on conversionconversion

5.5. If you think income tax rates will rise in the futureIf you think income tax rates will rise in the future• 2013 rates are scheduled to go up2013 rates are scheduled to go up

Reasons to Convert to a Roth IRAReasons to Convert to a Roth IRA

(continued)(continued)

6.6. Exposure to AMT can be reduced in future yearsExposure to AMT can be reduced in future years

7.7. Avoiding higher income taxes after one spouse diesAvoiding higher income taxes after one spouse dies• Married joint tax rates are lower than single ratesMarried joint tax rates are lower than single rates• Pay tax now at lower rates married joint ratePay tax now at lower rates married joint rate

8.8. Large estates: pay income taxes now, reduces estateLarge estates: pay income taxes now, reduces estate• After-tax value of traditional IRA = total value of Roth After-tax value of traditional IRA = total value of Roth

IRAIRA

9.9. Time is on the side of Roth IRAs (tax-free compounding Time is on the side of Roth IRAs (tax-free compounding of returns)of returns)

• Your lifetimeYour lifetime• Spouse’s lifetimeSpouse’s lifetime• Children’s lifetimeChildren’s lifetime

Roth IRA Conversion StrategiesRoth IRA Conversion Strategies1.1. Start-of-Year Strategy: Convert Annual Cash Need AmountStart-of-Year Strategy: Convert Annual Cash Need Amount

Anyone withdrawing from their IRA should consider this option !Anyone withdrawing from their IRA should consider this option ! Determine cash needed for year from Traditional IRADetermine cash needed for year from Traditional IRA Convert (transfer) that amount from Traditional IRA to Roth IRAConvert (transfer) that amount from Traditional IRA to Roth IRA Withdraw cash, as needed, during year from Roth IRAWithdraw cash, as needed, during year from Roth IRA Income tax on conversion: same as monthly withdrawalsIncome tax on conversion: same as monthly withdrawals Tax saving: current year investment earnings are in Roth (tax-Tax saving: current year investment earnings are in Roth (tax-

free) instead of Traditional (tax-deferred)free) instead of Traditional (tax-deferred)Example:Example:Annual cash need:Annual cash need: $ 84,000$ 84,000Convert in January:Convert in January: $ 84,000$ 84,000Withdraw monthly:Withdraw monthly: $ 7,000$ 7,000Total Roth withdrawals:Total Roth withdrawals: $ 84,000$ 84,000Year end Roth balance:Year end Roth balance: $ 3,241* (future tax-free withdrawal)$ 3,241* (future tax-free withdrawal)

* 8% rate of return, withdrawals on first of each month* 8% rate of return, withdrawals on first of each month

Speaking of Investment ReturnsSpeaking of Investment Returns““Dividend Aristocrats”Dividend Aristocrats”

NameName SymbolSymbol DividendDividend 5 Year5 YearDividendDividend

YieldYield ReturnReturnIncreasedIncreased

3 M3 M MMMMMM 2.5 %2.5 % 27 %27 % 5353

Altria*Altria* MOMO 5.85.8 9595 4646

ChevronChevron CVXCVX 3.13.1 6767 2424

Coca Cola*Coca Cola* KOKO 2.82.8 6363 4949

Colgate PalmoliveColgate Palmolive CLCL 2.62.6 5050 4747

ExxonExxon XOMXOM 2.32.3 2626 2929

Johnson & JohnsonJohnson & Johnson JNJJNJ 3.53.5 1515 4949

Kraft*Kraft* KFTKFT 3.03.0 3434 4949

McDonalds*McDonalds* MCDMCD 2.82.8 167167 3535

Pepsico*Pepsico* PEPPEP 3.13.1 1717 3939

Phillip Morris Intl.*Phillip Morris Intl.* PMPM 4.14.1 116 116 Altria spin offAltria spin off

Proctor & Gamble*Proctor & Gamble* PGPG 3.33.3 1414 5555

Walmart*Walmart* WMTWMT 2.42.4 4242 3737Average of Above:Average of Above: 56%56%

* Owns a top 20 most valuable brand in the world* Owns a top 20 most valuable brand in the world

Roth IRA Conversion StrategiesRoth IRA Conversion Strategies

2.2. Larger Amount Strategy, Consider:Larger Amount Strategy, Consider: If you have a low income yearIf you have a low income year

If you think future tax rates will be higherIf you think future tax rates will be higher

Be careful not to convert too much in a yearBe careful not to convert too much in a year Income tax rates are progressiveIncome tax rates are progressive Remember “unintended consequences”Remember “unintended consequences”

Can adjust or reverse amount converted until Oct. 15 of Can adjust or reverse amount converted until Oct. 15 of following yearfollowing year

How About a Do-Over ?How About a Do-Over ?

Roth IRA Conversion and Do Over StrategyRoth IRA Conversion and Do Over Strategy

1.1. Convert Traditional IRA to a Roth IRAConvert Traditional IRA to a Roth IRA• All, or a portionAll, or a portion

2.2. Amount converted is taxableAmount converted is taxable

3.3. Conversion can be reversed (Recharacterization)Conversion can be reversed (Recharacterization)• If you later find that taxes are too much, orIf you later find that taxes are too much, or• Investments have not done wellInvestments have not done well• Eliminates taxable eventEliminates taxable event

Roth IRA RecharacterizationRoth IRA Recharacterization

To Do-Over or Not , that is the questionTo Do-Over or Not , that is the question

Will the tax laws change in the future ?Will the tax laws change in the future ? If tax rates increase = reason to retain conversionIf tax rates increase = reason to retain conversion If tax rates go down = reason to recharacterizeIf tax rates go down = reason to recharacterize

Return on investments in Roth IRAReturn on investments in Roth IRA Gains = reason to retain conversionGains = reason to retain conversion Losses = reason to recharacterizeLosses = reason to recharacterize

You have until October 15 of the year following You have until October 15 of the year following conversion to decide whether to keep conversion or conversion to decide whether to keep conversion or recharacterizerecharacterize

Roth IRA Conversion – Roth IRA Conversion – RecharacterizationRecharacterization

StrategyStrategy Segregate your IRA by investment classSegregate your IRA by investment class

Divide your Traditional IRA into 2 or more IRAsDivide your Traditional IRA into 2 or more IRAs Place “growth” assets in one IRA, “income” assets in Place “growth” assets in one IRA, “income” assets in

other IRAother IRA Convert some or all of each typeConvert some or all of each type

Convert twice as much as you would like to keep Convert twice as much as you would like to keep convertedconverted

Several months later: Several months later: Keep the Roth with the greatest gainKeep the Roth with the greatest gain Recharacterize the Roth with the lower gainsRecharacterize the Roth with the lower gains

Other incomeOther income Amount of other income will affect decisionsAmount of other income will affect decisions Recommend paying conversion taxes from non-IRA Recommend paying conversion taxes from non-IRA

accountsaccounts If 59½ + : 5 years since first Roth IRAIf 59½ + : 5 years since first Roth IRA If under 59½ : 5 years since conversionIf under 59½ : 5 years since conversion Can recharacterize all or a portionCan recharacterize all or a portion

Roth IRA ExampleRoth IRA Example

Roth IRA valuesRoth IRA valuesAt Conversion:At Conversion: 10/15/2012:10/15/2012:

IRA A:IRA A: $ 30,000$ 30,000 $ 68,000$ 68,000

IRA B:IRA B: $ 30,000$ 30,000 $ 28,000$ 28,000

Combined:Combined: $ 60,000$ 60,000 $ 96,000$ 96,000

Choices:Choices:1.1. Keep both Roth IRAs: Taxed on $60,000; the $ 36,000 Keep both Roth IRAs: Taxed on $60,000; the $ 36,000

gain is tax-free and future gains on $96,000 balance are gain is tax-free and future gains on $96,000 balance are tax-free.tax-free.

2.2. Full recharacterization: No amount is currently taxable, Full recharacterization: No amount is currently taxable, but full $96,000 is taxable in the future.but full $96,000 is taxable in the future.

3.3. Best: Best: Recharacterize IRA B only: Taxed on $30,000; Recharacterize IRA B only: Taxed on $30,000; $38,000 is tax-free and future earnings on $68,000 will $38,000 is tax-free and future earnings on $68,000 will be tax-freebe tax-free

Has Your Roth IRA Lost Money ?Has Your Roth IRA Lost Money ?(When You Have Lemons, Make Lemonade )(When You Have Lemons, Make Lemonade )

Roth IRA investment losses can be tax deductible!Roth IRA investment losses can be tax deductible! Roth contributions + converted amounts less cash withdrawn Roth contributions + converted amounts less cash withdrawn

from Roth IRAfrom Roth IRA Miscellaneous Itemized Deduction, subject to 2% AGI limitationMiscellaneous Itemized Deduction, subject to 2% AGI limitation Requires tax-free withdrawal of all remaining balances in Roth Requires tax-free withdrawal of all remaining balances in Roth

IRAIRA

Roth IRAs: Convert previously and now have a loss?Roth IRAs: Convert previously and now have a loss? Recharacterize (unwind) prior conversionRecharacterize (unwind) prior conversion Reconvert and use the new market value as the taxable amountReconvert and use the new market value as the taxable amount

2012 premium based on 2010 MAGI (AGI plus “tax-exempt” 2012 premium based on 2010 MAGI (AGI plus “tax-exempt” income)income)

Medicare monthly premiums for 2012:Medicare monthly premiums for 2012:

Single Taxpayer:Single Taxpayer: Married Taxpayer:Married Taxpayer:Mo. Premium:Mo. Premium:

MAGI under $85,001MAGI under $85,001 MAGI under $170,001MAGI under $170,001 $ 99.90$ 99.90

$ 85,001- $107,000 $ 85,001- $107,000 $ 170,001-214,000$ 170,001-214,000 $ 139.90$ 139.90

$ 107,001- $160,000$ 107,001- $160,000 $ 214,001-$320,000$ 214,001-$320,000 $ 199.80$ 199.80

$ 160,001- $214,000 $ 160,001- $214,000 $ 320,001-$428,000$ 320,001-$428,000 $ 259.70$ 259.70

$ 214,000+ $ 214,000+ $ 428,000+$ 428,000+ $ 319.70$ 319.70 You can appeal surcharge if “Life Changing Event” (LCE)You can appeal surcharge if “Life Changing Event” (LCE)

Marriage, Divorce, Death of Spouse, Stopping WorkMarriage, Divorce, Death of Spouse, Stopping Work InvoluntaryInvoluntary loss of income (natural disaster, insolvent loss of income (natural disaster, insolvent

pension)pension) High income due to sale of property is High income due to sale of property is notnot a LCE a LCE

Medicare Part B Premium Medicare Part B Premium SurchargeSurcharge

““Obamacare” TaxesObamacare” Taxes (1)(1)

““Let’s pass this bill so we can find out Let’s pass this bill so we can find out what’s in it.”what’s in it.”

-- Nancy Pelosi-- Nancy Pelosi

““Obamacare” TaxesObamacare” Taxes (2)(2)

New taxesNew taxes 10% excise tax on indoor tanning services10% excise tax on indoor tanning services 2.3% excise tax on medical devices sold to hospitals, 2.3% excise tax on medical devices sold to hospitals,

clinicsclinics 2013: Additional Medicare tax of .9% on wages & self-2013: Additional Medicare tax of .9% on wages & self-

employment income (from 2.9% to 3.8%)employment income (from 2.9% to 3.8%) Singles: MAGI over $200,000Singles: MAGI over $200,000 Married-joint: $250,000Married-joint: $250,000

2013: medical deduction threshold rises from 7.5% to 2013: medical deduction threshold rises from 7.5% to 10%10% This reduces your chance of using as itemized This reduces your chance of using as itemized

deductionsdeductions If age 65+, 7.5% applies until 2017If age 65+, 7.5% applies until 2017

No delay for AMT purposesNo delay for AMT purposes

““Obamacare” Taxes Obamacare” Taxes (3)(3)

New Taxes – continuedNew Taxes – continued EmployersEmployers

40% “Cadillac tax” on rich plans, effective 201840% “Cadillac tax” on rich plans, effective 2018 Employers must report value of health plans on W-2sEmployers must report value of health plans on W-2s

Not taxable… yetNot taxable… yet Doesn’t apply to President’s or Congress’ medical plansDoesn’t apply to President’s or Congress’ medical plans

Penalty tax for no medical insurancePenalty tax for no medical insurance Starting in 2014Starting in 2014 Paid with tax returnPaid with tax return $95 - $695 (or % calculation)$95 - $695 (or % calculation) Court challenges & decisions as “unconstitutional” ?Court challenges & decisions as “unconstitutional” ?

New Tax on investment incomeNew Tax on investment income Effective 2013Effective 2013 Dividends, interest, annuities, royalties, rents, capital gainsDividends, interest, annuities, royalties, rents, capital gains Rate: 3.8%Rate: 3.8% Singles: MAGI over $200,000Singles: MAGI over $200,000 Married-joint: $250,000Married-joint: $250,000 Sale of personal residenceSale of personal residence

Excluded gain ($250,000 or $500,000) not taxedExcluded gain ($250,000 or $500,000) not taxed Excess of above Excess of above isis subject to this new tax subject to this new tax Gain over above limits: 20% + 3.8% = 23.8% federal taxGain over above limits: 20% + 3.8% = 23.8% federal tax Thinking of selling your home?Thinking of selling your home?

Think about selling before 2013Think about selling before 2013 Especially when you add California income taxesEspecially when you add California income taxes

Sale of second or vacation homeSale of second or vacation home EntireEntire gain subject to new investment income tax gain subject to new investment income tax

““Obamacare” Taxes Obamacare” Taxes (4)(4)

Are You Dying to Save Taxes?Are You Dying to Save Taxes?

2011 & 2012:2011 & 2012: Good time to die? $5 million exclusion on estate taxesGood time to die? $5 million exclusion on estate taxes

2013: 2013: Estate tax exclusion drops to $1 millionEstate tax exclusion drops to $1 million

"It's not personal, it’s just business.”"It's not personal, it’s just business.” -- the Godfather-- the Godfather

Estate TaxesEstate Taxes

Pre-2010Pre-2010 Exemptions ranged from $600,000 - $3,500,000Exemptions ranged from $600,000 - $3,500,000 Estate tax rate up to 55%Estate tax rate up to 55% Basis of assets received by inheritanceBasis of assets received by inheritance

Fair market value on date of deathFair market value on date of death

20102010 No estate tax, No estate tax, oror Use 2011 rulesUse 2011 rules

Estate Tax ChangesEstate Tax ChangesTax Relief Act of 2010Tax Relief Act of 2010

2011 -20122011 -2012 $5,000,000 exemption$5,000,000 exemption Married couple: $10,000,000 exemption availableMarried couple: $10,000,000 exemption available

Pre-2010 wills and trusts may be out-of-date and self-defeatingPre-2010 wills and trusts may be out-of-date and self-defeating Most A-B trusts were designed with lower limit assumptionsMost A-B trusts were designed with lower limit assumptions

May result no money transferring to surviving spouseMay result no money transferring to surviving spouse All money might go to irrevocable trust for childrenAll money might go to irrevocable trust for children You need to review your will and trust with an attorneyYou need to review your will and trust with an attorney

Up to 35% estate tax rate on amounts over exemptionUp to 35% estate tax rate on amounts over exemption Unused exemption upon death of first spouse can be Unused exemption upon death of first spouse can be

carried over to estate of surviving spousecarried over to estate of surviving spouse Basis of assets received by inheritance:Basis of assets received by inheritance:

Fair market value on date of deathFair market value on date of death Sale of Principal Residence:Sale of Principal Residence:

Estate can get a separate $250,000 gain exclusion Estate can get a separate $250,000 gain exclusion under §121under §121

Estate Tax ChangesEstate Tax ChangesTax Relief Act of 2010Tax Relief Act of 2010

2013 & after2013 & after $1,000,000 exemption$1,000,000 exemption Up to 55% estate tax rateUp to 55% estate tax rate

Watch for new legislation (hopefully) Watch for new legislation (hopefully) May require will and trust changes againMay require will and trust changes again

Estates: Hidden Trap for Surviving Estates: Hidden Trap for Surviving SpouseSpouse

Principal ResidencePrincipal Residence $500,000 exclusion on gain for married couple$500,000 exclusion on gain for married couple $250,000 exclusion on gain for single person$250,000 exclusion on gain for single person Widow / WidowerWidow / Widower

Sale in year of death of spouse: survivor is considered Sale in year of death of spouse: survivor is considered marriedmarried

Sale in year after death: survivor get “married exclusion Sale in year after death: survivor get “married exclusion amountamount

Sale after year after death: survivor is treated as Sale after year after death: survivor is treated as singlesingle

Example (actual case)Example (actual case) Couple married 40 yearsCouple married 40 years Bought modest home 35 years ago for $60,000Bought modest home 35 years ago for $60,000 Husband passes away 7 years agoHusband passes away 7 years ago House sells for $700,000, third year after death (Gain House sells for $700,000, third year after death (Gain

$640,000)$640,000) $250,000 exclusion applies ($250,000 exclusion applies (notnot $500,000) $500,000) Surviving spouse has huge tax bill, Federal and CaliforniaSurviving spouse has huge tax bill, Federal and California

Deceased Retiree with a Wife under Deceased Retiree with a Wife under 59 ½ 59 ½

Treating a deceased spouse’s IRA as your own IRA can Treating a deceased spouse’s IRA as your own IRA can reduce or delay the RMDs and taxes but…reduce or delay the RMDs and taxes but… Tax trapTax trap if the surviving spouse needs money now if the surviving spouse needs money now

Withdrawals taken before age 59 ½ are subject to the 10% Withdrawals taken before age 59 ½ are subject to the 10% early withdrawal tax (plus 2% for California)early withdrawal tax (plus 2% for California)

RMDs are not required until spouse turns 70 ½ RMDs are not required until spouse turns 70 ½

Alternatively, you can treat IRA as an inherited IRAAlternatively, you can treat IRA as an inherited IRA RMDs start year after death and based on beneficiary’s age, RMDs start year after death and based on beneficiary’s age, oror Beneficiary may receive entire distribution within 5 years of deathBeneficiary may receive entire distribution within 5 years of death

No RMDs or early withdrawal penalty taxNo RMDs or early withdrawal penalty tax Distribution is taxable in year receivedDistribution is taxable in year received

Federal Tax Inflation Provisions Federal Tax Inflation Provisions 20112011

Personal exemptionPersonal exemption $3700 per person (up $50 from 2010)$3700 per person (up $50 from 2010)

Standard DeductionStandard Deduction Single/MFS: $5800 (up $100 from 2010)Single/MFS: $5800 (up $100 from 2010) MFJ: $11,600 (up $200 from 2010) First 4 years of college onlyMFJ: $11,600 (up $200 from 2010) First 4 years of college only Head of Household: $8500 (up $100 from 2010)Head of Household: $8500 (up $100 from 2010) Additional Standard Deduction for Blind or Age 65+:Additional Standard Deduction for Blind or Age 65+:

Single/Head of Household: $1450 (up $50 from 2010)Single/Head of Household: $1450 (up $50 from 2010) MFJ: $1150 (up $50 from 2010)MFJ: $1150 (up $50 from 2010)

Tax BracketsTax Brackets Income brackets increased:Income brackets increased:

Single, from 15% to 25%: $34,500 (up $500)Single, from 15% to 25%: $34,500 (up $500) MFJ: $69,000 (up $1000)MFJ: $69,000 (up $1000)

Earned Income Tax CreditEarned Income Tax Credit Maximum credit: $5751 (refundable)Maximum credit: $5751 (refundable) Maximum income: $49,078Maximum income: $49,078

California Income TaxesCalifornia Income Taxes

Tax rates up to 9.3Tax rates up to 9.3%% Starting at: Single: $48,029 MFJ: $96,058Starting at: Single: $48,029 MFJ: $96,058

NoNo special capital gains rate special capital gains rate Additional 1% tax if income over $1 million (mental Additional 1% tax if income over $1 million (mental

health services)health services) Personal exemption: $102 each spouse, $315 dependentPersonal exemption: $102 each spouse, $315 dependent Age 65 additional personal exemption: $102Age 65 additional personal exemption: $102 Personal exemption phase-out: Single: $166,565 MFJ: Personal exemption phase-out: Single: $166,565 MFJ:

$333,134$333,134 Itemized deduction phase-out: Itemized deduction phase-out: Single: $166,565 MFJ: Single: $166,565 MFJ:

$333,134$333,134 Filing requirement (Single): under 65: $15,152 65+: $ Filing requirement (Single): under 65: $15,152 65+: $

20,25220,252 Filing requirement (MFJ): under 65: $30,305 65+: Filing requirement (MFJ): under 65: $30,305 65+:

$35,405 $40,505$35,405 $40,505

Tax Tips for Investors & Tax Tips for Investors & RetireesRetirees©©

This presentation is for educational purposes only; it is not individual tax or investment advice. The presentation includes tax issues and alternatives that This presentation is for educational purposes only; it is not individual tax or investment advice. The presentation includes tax issues and alternatives that individuals may wish to explore in more detail. Because of time constraints, this is only a quick summary. The slides are designed to be explained during individuals may wish to explore in more detail. Because of time constraints, this is only a quick summary. The slides are designed to be explained during the presentation. Use of slide copies without the oral presentation is not recommended. New and pending legislation may modify the information shown the presentation. Use of slide copies without the oral presentation is not recommended. New and pending legislation may modify the information shown on the slides. Attendees should consult with their personal financial advisor to determine whether any of the issues presented are appropriate to their own on the slides. Attendees should consult with their personal financial advisor to determine whether any of the issues presented are appropriate to their own situation. situation. Use of these materials in any other manner or context is neither recommended nor authorized by the author. These materials may not be copied Use of these materials in any other manner or context is neither recommended nor authorized by the author. These materials may not be copied without written authorization by the author.without written authorization by the author.

© 2012 Herbert D. Farrington© 2012 Herbert D. Farrington

Herb Farrington, EA, CFPHerb Farrington, EA, CFP®® Cell: (714) 904-5825Cell: (714) [email protected]@msn.com

Misc. Tax Provisions 2011 Misc. Tax Provisions 2011 (1)(1)

Adoption Tax CreditAdoption Tax Credit Adoptions finalized in 2011Adoptions finalized in 2011 Refundable Credit of up to $13,360 Refundable Credit of up to $13,360

American Opportunity CreditAmerican Opportunity Credit College students or parents claiming students as dependentsCollege students or parents claiming students as dependents First 4 years of college onlyFirst 4 years of college only Up to $2500 total credit, $1000 refundableUp to $2500 total credit, $1000 refundable Also allowed for AMT purposesAlso allowed for AMT purposes Expires 12/31/2012Expires 12/31/2012

Non-business Energy Property CreditNon-business Energy Property Credit Qualifying improvements to your home are eligible.Qualifying improvements to your home are eligible. Based on 10% of costBased on 10% of cost Up to $2500, non-refundableUp to $2500, non-refundable Improvements must be installed by 12/31/2011Improvements must be installed by 12/31/2011


Alternative Motor Vehicle CreditsAlternative Motor Vehicle Credits For qualified fuel cell motor vehicles for 2011 – 2014.For qualified fuel cell motor vehicles for 2011 – 2014. For 2011 only, credits are available for vehiclesFor 2011 only, credits are available for vehicles 2011 only: cars converted into qualified plug-in electric drive car2011 only: cars converted into qualified plug-in electric drive car Beginning 2011: Beginning 2011: NoNo credit for purchasing hybrid, advanced lean- credit for purchasing hybrid, advanced lean-

burn technology, or alternative fuel motor vehiclesburn technology, or alternative fuel motor vehicles

Roth Contributions for Governmental 457(b) PlanRoth Contributions for Governmental 457(b) Plan State and local governments plans can allow Roth contributions.State and local governments plans can allow Roth contributions. Government employees should determine if their plan allows Government employees should determine if their plan allows

this and whether appropriate for them.this and whether appropriate for them.

Partial Annuitization of Non-qualified AnnuityPartial Annuitization of Non-qualified Annuity Allows taxpayers to elect to receive a portion of theirAllows taxpayers to elect to receive a portion of their

nonqualified annuities as annuity payments while allowing thenonqualified annuities as annuity payments while allowing theremainder to accumulate as tax-deferred income.remainder to accumulate as tax-deferred income.

Life insurance contracts and other nonqualifiedLife insurance contracts and other nonqualifiedannuities may be eligible.annuities may be eligible.


Payroll Tax Holiday: 2011 - 2012Payroll Tax Holiday: 2011 - 2012 Employees pay 4.2% instead of 6.2% in Social Security taxes Employees pay 4.2% instead of 6.2% in Social Security taxes

on wages up to $106,800.on wages up to $106,800. Self-employed individuals pay 13.3% instead of 15.3%.Self-employed individuals pay 13.3% instead of 15.3%.

Increase and Expansion of Section 179 Increase and Expansion of Section 179 DeductionDeduction

May expense up to $250,000 of the cost of qualified real May expense up to $250,000 of the cost of qualified real property expenditures.property expenditures.

May expense up to $500,000 of the cost of qualified tangible May expense up to $500,000 of the cost of qualified tangible personal property expenditures.personal property expenditures.

In 2011 only, may purchase property that qualifiesIn 2011 only, may purchase property that qualifies

Bonus Depreciation Qualified property placed in Bonus Depreciation Qualified property placed in service in 2011 can be expensed at 100%.service in 2011 can be expensed at 100%.

““Obamacare” TaxesObamacare” Taxes

U.S. Constitution, First Amendment:U.S. Constitution, First Amendment:

““Congress shall make no law respecting an establishment Congress shall make no law respecting an establishment of religion, or prohibiting the free exercise thereof ”of religion, or prohibiting the free exercise thereof ”

Anti-Gigolo / Anti-Floozy TrustsAnti-Gigolo / Anti-Floozy Trusts

What if:What if:

Your surviving Your surviving spouse marries spouse marries someone with little someone with little or no assets?or no assets?

You have children You have children from a prior from a prior marriage?marriage?

Anti-Gigolo / Anti-Floozy TrustsAnti-Gigolo / Anti-Floozy Trusts

Qualified Terminable Interest Property Qualified Terminable Interest Property Trust (QTIP)Trust (QTIP) Income paid to surviving spouseIncome paid to surviving spouse Surviving spouse can also receive principal if Surviving spouse can also receive principal if

needed for medical care, maintenance, & support needed for medical care, maintenance, & support (trustee determines)(trustee determines)

Decedent pre-determines disposition of remaining Decedent pre-determines disposition of remaining trust principal after death of surviving spousetrust principal after death of surviving spouse

Property allocated to QTIP qualifies for unlimited Property allocated to QTIP qualifies for unlimited marital deduction for estate taxesmarital deduction for estate taxes

Remaining QTIP principal included in surviving Remaining QTIP principal included in surviving spouse’s estatespouse’s estate

Disclaimer can add flexibility at death of first Disclaimer can add flexibility at death of first spouse so that maximum estate tax exemptions spouse so that maximum estate tax exemptions can be utilizedcan be utilized

Don’t like Required Minimum Don’t like Required Minimum Distributions ?Distributions ?

Direct Charitable Contribution StrategyDirect Charitable Contribution Strategy Tax-efficient strategy for those who make charitable Tax-efficient strategy for those who make charitable

contributionscontributions Funds flow directly from your IRA custodian to the charityFunds flow directly from your IRA custodian to the charity Can be the full amount or a partial amount of your RMDCan be the full amount or a partial amount of your RMD The RMD-contribution is not be taxableThe RMD-contribution is not be taxable The RMD-contribution is not deductibleThe RMD-contribution is not deductible What’s the advantage?What’s the advantage?

This avoids putting you into a higher tax bracketThis avoids putting you into a higher tax bracket This avoids reductions in deductions and creditsThis avoids reductions in deductions and credits

This strategy is This strategy is available through 2011available through 2011, those age 70 ½ +, those age 70 ½ + Maximum contribution: $100,000Maximum contribution: $100,000

Gifts and Gift TaxesGifts and Gift Taxes

2011 - 20122011 - 2012 Annual exclusionAnnual exclusion: $13,000: $13,000

$13,000 allowed per recipient$13,000 allowed per recipient Husband & wife can give $26,000 to one personHusband & wife can give $26,000 to one person Does Does notnot count against lifetime exclusion amount count against lifetime exclusion amount Does Does not not require a gift tax returnrequire a gift tax return If annual gift over $13,000: a gift tax return (Form If annual gift over $13,000: a gift tax return (Form

706) 706) is requiredis required IRS has a current campaign to find gifts over IRS has a current campaign to find gifts over

$13,000$13,000 IRS is making inquiries to State of California about IRS is making inquiries to State of California about

real estate transfers to family membersreal estate transfers to family members Lifetime exclusionLifetime exclusion: $5 million ($5.12 million in 2012): $5 million ($5.12 million in 2012)

Married couple can exclude up to $10 millionMarried couple can exclude up to $10 million Gifts over $13,000 count against lifetime exclusionGifts over $13,000 count against lifetime exclusion

2013 & After (without new legislation)2013 & After (without new legislation) Annual exclusion: $13,000Annual exclusion: $13,000 Lifetime exclusion: $1,000,000Lifetime exclusion: $1,000,000

Gift TipsGift Tips

Large estates (more than Lifetime Exclusion Large estates (more than Lifetime Exclusion amount)amount)

Consider giving $13,000 each year, per recipientConsider giving $13,000 each year, per recipient If you are married and/or have several children, you can If you are married and/or have several children, you can

gift much more than $13,000 per yeargift much more than $13,000 per year You can give more than $13,000 per recipient per year, You can give more than $13,000 per recipient per year,

but you must file a gift tax return, Form 706but you must file a gift tax return, Form 706 Such gifts count against Lifetime Exclusion amountSuch gifts count against Lifetime Exclusion amount However, future appreciation is out of your estateHowever, future appreciation is out of your estate

Warning: Don’t wait too longWarning: Don’t wait too long Gifts within 3 years of death may be included in estateGifts within 3 years of death may be included in estate

Consider cash gifts instead of propertyConsider cash gifts instead of property Gifts of property that have appreciated in value are Gifts of property that have appreciated in value are

generally generally notnot a good idea a good idea Recipient gets your basis with a giftRecipient gets your basis with a gift If inherited, recipient gets FMV on date of deathIf inherited, recipient gets FMV on date of death

GeneralGeneral Most get a greater joy in gifting while still livingMost get a greater joy in gifting while still living

Gift Tips - continuedGift Tips - continued

Large Estates – many complex options available, Large Estates – many complex options available, one:one:

Charitable Remainder TrustCharitable Remainder Trust Do you have property that has gone up in value but you Do you have property that has gone up in value but you

are afraid to sell it because of “capital gains tax” ?are afraid to sell it because of “capital gains tax” ? Rental real estate or a business that is a hassle to Rental real estate or a business that is a hassle to

manage, especially now that you are getting older ?manage, especially now that you are getting older ?

1.1. Gift property to a large, valid, reliable charityGift property to a large, valid, reliable charity2.2. Get a charitable deduction for full market value of giftGet a charitable deduction for full market value of gift

Potentially can use and carryover for many yearsPotentially can use and carryover for many years3.3. Do not pay capital gains tax on appreciationDo not pay capital gains tax on appreciation4.4. Get a lifetime stream of income from charity’s Get a lifetime stream of income from charity’s

investment of gift proceeds, that can be tax-sheltered investment of gift proceeds, that can be tax-sheltered by the charitable deductionby the charitable deduction

5.5. After death of both spouses, charity retains remaining After death of both spouses, charity retains remaining assetsassets

IRS AuditsIRS AuditsChances of Being AuditedChances of Being Audited

Overall rate in 2010: 1.11%Overall rate in 2010: 1.11% Income $200,000 - $1,000,000: 2%+Income $200,000 - $1,000,000: 2%+ Business income $25,000: 2%+Business income $25,000: 2%+ Earned Income Credit claimed: 2%+Earned Income Credit claimed: 2%+ Income over $1 million: 8.36%Income over $1 million: 8.36%

Some Audit “Red Flags”Some Audit “Red Flags” Failure to report income reported on Forms W-2 or 1099Failure to report income reported on Forms W-2 or 1099 Home buyer credit claimedHome buyer credit claimed Large amount of charitable deductions for level of incomeLarge amount of charitable deductions for level of income Home office deduction claimedHome office deduction claimed Business meals, travel, or entertainment claimedBusiness meals, travel, or entertainment claimed Claiming 100% business use of autoClaiming 100% business use of auto Claiming a loss on activity that is usually a hobbyClaiming a loss on activity that is usually a hobby Having a cash intensive businessHaving a cash intensive business Taking a larger than average deduction for level of incomeTaking a larger than average deduction for level of income

From Kiplinger’s Tax Letter June 2011

Tax Planning Tip - ContinuedTax Planning Tip - Continued

If your Taxable Income is under $69,000 (MFJ) and If your Taxable Income is under $69,000 (MFJ) and you own some stock that has risen in value:you own some stock that has risen in value:

1.1. But you would like to sell it and buy another stock, use the But you would like to sell it and buy another stock, use the “tax-free” opportunity described previously.“tax-free” opportunity described previously. Then you’ll have the stock you really want and won’t Then you’ll have the stock you really want and won’t

have to pay any federal income tax on the trade.have to pay any federal income tax on the trade.

2.2. And you want to keep the stock, use the “tax-free” And you want to keep the stock, use the “tax-free” opportunity described previously.opportunity described previously. Then re-buy the stock. You will now have a higher cost Then re-buy the stock. You will now have a higher cost

basis, so if you sell it in the future, you will have a lower basis, so if you sell it in the future, you will have a lower taxable gain. Remember capital gain tax rates are taxable gain. Remember capital gain tax rates are scheduled to rise in 2013. scheduled to rise in 2013.

Tax Planning Tip: Mutual FundsTax Planning Tip: Mutual Funds

Be careful about buying a mutual fund late in the Be careful about buying a mutual fund late in the yearyear

Mutual funds make distributions in December and they Mutual funds make distributions in December and they are taxable.are taxable.

The price of mutual funds tends to rise in November and The price of mutual funds tends to rise in November and December, in anticipation of the distribution.December, in anticipation of the distribution.

After the distribution, the price of the mutual fund drops in After the distribution, the price of the mutual fund drops in proportion to the distribution paid.proportion to the distribution paid.

Buying late in the year can result in you paying for a Buying late in the year can result in you paying for a taxable distribution that you don’t get full value for.taxable distribution that you don’t get full value for.

Required Minimum DistributionsRequired Minimum Distributions20112011

Calculate by using:Calculate by using: IRS’ Uniform Lifetime Table for age at end of current yearIRS’ Uniform Lifetime Table for age at end of current year IRA market value as of end of prior yearIRA market value as of end of prior year Example:Example:

Age 72 as of Dec. 31, 2011Age 72 as of Dec. 31, 2011 IRS factor is 25.6IRS factor is 25.6 IRA market value as of Dec. 31, 20IRA market value as of Dec. 31, 201010 = $100,000 = $100,000 ** $100,000 divided by 25.6 = $3907 $100,000 divided by 25.6 = $3907

** Whether market value is now $50,000 or $150,000 Whether market value is now $50,000 or $150,000

Required Minimum DistributionsRequired Minimum DistributionsOther Retirement AccountsOther Retirement Accounts

Inherited IRAs, 401(k), 457, 403(b) plansInherited IRAs, 401(k), 457, 403(b) plans Same rules for IRAsSame rules for IRAs Exception for those still workingException for those still working

Except 5%+ ownersExcept 5%+ owners

Roth IRAs, Roth Accounts in employer plansRoth IRAs, Roth Accounts in employer plans NoNo RMDs during your lifetime RMDs during your lifetime Your heirs can make withdrawals over Your heirs can make withdrawals over theirtheir lifetime lifetime

Tax Tips for Retirees San Diego CRA Chapter February 14, 2012 Herb Farrington, EA, CFP ® Cell:...

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