How to Gauge Benefits Tax

How-to-Gauge-Benefits-Tax

Some people who begin claiming Social Security benefits are surprised to find out they’re taxed by the federal government on the amounts they receive. If you’re wondering whether you’ll be taxed on your Social Security benefits, the answer is: It depends. Here’s what to know and how to gauge benefits tax.

The taxation of Social Security benefits depends on your other income. If your income is high enough, then between 50 percent and 85 percent of your benefits could be taxed. (This doesn’t mean you pay 85 percent of your benefits back to the federal government in taxes. It merely means that you’d include 85 percent of them in your income subject to your regular tax rates.)

Formulas and Fine Print

To determine how much of your benefits are taxed, first calculate your other income, including certain items otherwise excluded for tax purposes (for example, tax-exempt interest). Add to that the income of your spouse if you file a joint tax return. To this, add half of the Social Security benefits you and your spouse received during the year. The figure you come up with is your total income plus half of your benefits. Now apply the following rules:

  1. If your income plus half your benefits isn’t above $32,000 ($25,000 for single taxpayers), none of your benefits are taxed.
  2. If your income plus half your benefits exceeds $32,000 but isn’t more than $44,000, you will be taxed on one half of the excess over $32,000, or one half of the benefits, whichever is lower.

Here is an example to illustrate:

Let’s say you and your spouse have $20,000 in taxable dividends, $2,400 of tax-exempt interest, and combined Social Security benefits of $21,000. So, your income plus half your benefits is $32,900 ($20,000 + $2,400 + half of $21,000). You must include $450 of the benefits in gross income (½ [$32,900 − $32,000]).

(If your combined Social Security benefits were $5,000, and your income plus half your benefits were $40,000, you would include $2,500 of the benefits in income: ½ [$40,000 − $32,000] equals $4,000, but half the $5,000 of benefits [$2,500] is lower, and the lower figure is used.)

Note: If you aren’t paying tax on your Social Security benefits now because your income is below the floor, or you’re paying tax on only 50 percent of those benefits, an unplanned increase in your income can have a triple tax cost. You’ll have to pay tax on the additional income. You’ll have to pay tax on (or on more of) your Social Security benefits (since the higher your income the more of your Social Security benefits are taxed). And you may get pushed into a higher marginal tax bracket.

For example, this situation might arise if you receive a large distribution from an IRA during the year or if you have large capital gains. Careful planning might avoid this negative tax result. You might be able to spread the additional income over more than one year, or liquidate assets other than an IRA account, such as stock showing only a small gain or stock with gain that can be offset by a capital loss on other shares.

Stay Ahead of the Game

If you know your Social Security benefits will be taxed, you can voluntarily arrange to have the tax withheld from the payments by filing a Form W-4V. Otherwise, you may have to make quarterly estimated tax payments. Keep in mind that most states do not tax Social Security benefits, but 12 states do tax them. Contact the experienced professionals at Ramsay & Associates for assistance on how to gauge benefits tax or for more information on social security benefits.

About the author

Brady is the owner of Ramsay & Associates. He specializes in financial statement preparation and personal, fiduciary and corporate tax and accounting.

His professional experience includes seven years' experience for local and national CPA firms before joining Ramsay & Associates in 2006.

He has a Bachelor of Accounting degree from the University of Minnesota Duluth. He is a Certified Public Accountant, a member of the Minnesota Society of CPA's, an Eagle Scout, as well as an active volunteer in the community.

Is Now a Good Time for a Roth Conversion?

Is-Now-a-Good-Time-for-a-Roth-Conversion

The downturn in the stock market may have caused the value of your retirement account to decrease. But if you have a traditional IRA, this decline may provide a valuable opportunity: It may allow you to convert your traditional IRA to a Roth IRA at a lower tax cost. Keep reading to learn more.

Traditional vs. Roth: What Sets Them Apart?

Here’s what makes a traditional IRA different from a Roth IRA:

Traditional IRA. Contributions to a traditional IRA may be deductible, depending on your modified adjusted gross income (MAGI) and whether you (or your spouse) participate in a qualified retirement plan, such as a 401(k). Funds in the account can grow tax deferred.

On the downside, you generally must pay income tax on withdrawals. In addition, you’ll face a penalty if you withdraw funds before age 59½ — unless you qualify for a handful of exceptions — and you’ll face an even larger penalty if you don’t take your required minimum distributions (RMDs) after age 72.

Roth IRA. Roth IRA contributions are never deductible. But withdrawals — including earnings — are tax free as long as you’re age 59½ or older and the account has been open at least five years. In addition, you’re allowed to withdraw contributions at any time tax- and penalty-free. You also don’t have to begin taking RMDs after you reach age 72.

However, the ability to contribute to a Roth IRA is subject to limits based on your MAGI. Fortunately, no matter how high your income, you’re eligible to convert a traditional IRA to a Roth. The catch? You’ll have to pay income tax on the amount converted.

Minimize Your Tax Hit?

This is where the “benefit” of a stock market downturn comes in. If your traditional IRA has lost value, converting to a Roth now rather than later will minimize your tax hit. Plus, you’ll avoid tax on future appreciation when the market goes back up.

It’s important to think through the details before you convert. Here are some of the issues to consider when deciding whether to make a conversion:

Having enough money to pay the tax bill. If you don’t have the cash on hand to cover the taxes owed on the conversion, you may have to dip into your retirement funds. This will erode your nest egg. The more money you convert and the higher your tax bracket, the bigger the tax hit.

Your retirement plans. Your stage of life may also affect your decision. Typically, you wouldn’t convert a traditional IRA to a Roth IRA if you expect to retire soon and start drawing down on the account right away. Usually, the goal is to allow the funds to grow and compound over time without any tax erosion.

Keep in mind that converting a traditional IRA to a Roth isn’t an all-or-nothing deal. You can convert as much or as little of the money from your traditional IRA account as you like. So, you might decide to gradually convert your account to spread out the tax hit over several years.

Ask the Financial Planning Pros

So, is now a good time for a Roth conversion? It could be. There are also other issues that need to be considered before executing a Roth IRA conversion. If this sounds like something you’re interested in, contact the financial planning pros at Ramsay & Associates. We can answer your questions and discuss whether a conversion is right for you.

About the author

Brady is the owner of Ramsay & Associates. He specializes in financial statement preparation and personal, fiduciary and corporate tax and accounting.

His professional experience includes seven years' experience for local and national CPA firms before joining Ramsay & Associates in 2006.

He has a Bachelor of Accounting degree from the University of Minnesota Duluth. He is a Certified Public Accountant, a member of the Minnesota Society of CPA's, an Eagle Scout, as well as an active volunteer in the community.

Opportunities and Challenges: Valuation in the Age of COVID-19

Valuation and estate planning go hand in hand. After all, the tax implications of various estate planning strategies depend on the value of your assets at the time they’re transferred.

The COVID-19 pandemic has had a significant impact on the value of many business interests and other assets, which may create some attractive estate planning opportunities. It also presents unique challenges for valuation professionals. As a result, it’s more important than ever to involve experienced valuation experts in the estate planning process.

What are the opportunities?

With the value of many assets depressed (in many or most cases temporarily), now may be an ideal time to gift them, either directly to family members or to irrevocable trusts and other estate planning vehicles. Transferring assets while values are low also allows you to use as little of your gift and estate tax exemption as possible, maximizing the amount available for future gifts or bequests. As the economy fully recovers and assuming your asset values rebound, your beneficiaries should enjoy substantial growth outside your taxable estate.

What are the challenges?

The pandemic has created a situation that’s truly uncharted territory for the valuation profession. Unlike other economic crises in recent years, most of the damage to the economy resulted from business closures and restrictions and other measures designed to help contain the virus.

For business valuations, the current environment presents several challenges, including:

Known or knowable. A fair market valuation generally doesn’t consider “subsequent events” — that is, events that occur after, and weren’t “known or knowable” on the valuation date. Experts generally agree that the COVID-19 pandemic wasn’t known or knowable as of December 31, 2019. Yet for valuation dates after that, determining whether the pandemic was known or knowable and should be considered in valuing a business or other asset can be a formidable task.

Valuation approaches. Generally, valuators consider all three of the major valuation approaches: the income, market and asset approaches. The pandemic may affect the relative appropriateness of each approach and the amount of weight they should be assigned.

For example, market-based methods, which rely on data about actual transactions involving comparable businesses, may be less relevant today if the underlying transactions predate COVID-19 (although it may be possible to adjust to reflect the pandemic’s impact).

Many valuators are emphasizing income-based methods, such as the discounted cash flow (DCF) method, which involves projecting a business’s future cash flows over a defined period (such as five years) and discounting them to present value. The advantage of DCF is that it provides a great deal of flexibility to model a business’s expected financial performance based on current conditions as well as assumptions about its eventual return to “normal” over the next several years.

Regardless of the method or methods used, it’s important for valuators to consider a business’s available cash and expected cash needs to assess its viability as a going concern. These considerations will be critical in evaluating a business’s risk and the impact of that risk on value.

What’s it worth?

Depressed asset values can create attractive estate planning opportunities. While the pandemic has dropped the value of some assets, others haven’t been affected or have even increased in value. Contact us with questions regarding the valuation of your assets.

About the author

Brady is the owner of Ramsay & Associates. He specializes in financial statement preparation and personal, fiduciary and corporate tax and accounting.

His professional experience includes seven years' experience for local and national CPA firms before joining Ramsay & Associates in 2006.

He has a Bachelor of Accounting degree from the University of Minnesota Duluth. He is a Certified Public Accountant, a member of the Minnesota Society of CPA's, an Eagle Scout, as well as an active volunteer in the community.

Don’t Choose Your Executor Too Hastily

choosing-an-executor

Haste makes waste. Or, in the case of estate planning, it can lead to other problems and, possibly, financial loss. Notably, if you don’t take enough time to choose the best executor for your estate, this “wrong call” can cost your family.

Many responsibilities

You may think that there’s not much to the job, but an executor’s responsibilities are extensive. As your personal representative, he or she will be entrusted with several significant duties, including collecting, protecting and taking inventory of your estate’s assets; filing the estate’s tax return and paying its taxes; handling creditors’ claims and the estate’s claims against others; making investment decisions; distributing property to beneficiaries; and liquidating assets, if necessary.

Whom should you choose as executor? Usually, it comes down to a decision between a family member or close friend and a professional.

Your first thought might be to choose a family member or a trusted friend. But this may be a mistake for one of these reasons:

  • The person may be too grief-stricken to function effectively,
  • If the executor stands to gain from the will, there may be a conflict of interest — real or perceived — which can lead to will contests or other disputes by disgruntled family members,
  • The executor may lack the financial acumen needed for the position,
  • The executor may hire any necessary professionals, but they might not be the professionals you’d hire.

To avoid these risks, you might instead consider choosing an independent professional as executor, particularly if the professional is familiar with your financial affairs.

Form a team of executors

Finally, it’s common to appoint co-executors — one person who knows the family and understands its dynamics and an independent executor with the requisite expertise. Whether you decide to use co-executors or only one, be sure to designate at least one backup to serve in the event that your first choice is unable to do so. Contact us with questions about choosing an executor.

About the author

Brady is the owner of Ramsay & Associates. He specializes in financial statement preparation and personal, fiduciary and corporate tax and accounting.

His professional experience includes seven years' experience for local and national CPA firms before joining Ramsay & Associates in 2006.

He has a Bachelor of Accounting degree from the University of Minnesota Duluth. He is a Certified Public Accountant, a member of the Minnesota Society of CPA's, an Eagle Scout, as well as an active volunteer in the community.

The Tax Score of Winning

tax score of winning

Studies have found that more people are engaging in online gambling and sports betting since the pandemic began. And there are still more traditional ways to gamble and play the lottery. If you’re lucky enough to win, be aware that tax consequences go along with your good fortune.

Review the tax rules

Whether you win online or at a casino, a bingo hall, a fantasy sports event, or elsewhere, you must report 100% of your winnings as taxable income. They’re reported on the “Other income” line of your 1040 tax return. To measure your winnings on a particular wager, use the net gain. For example, if a $30 bet at the racetrack turns into a $110 win, you’ve won $80, not $110.

You must separately keep track of losses. They’re deductible, but only as itemized deductions. Therefore, if you don’t itemize and take the standard deduction, you can’t deduct gambling losses. In addition, gambling losses are only deductible up to the amount of gambling winnings. Therefore, you can use losses to “wipe out” gambling income but you can’t show a gambling tax loss.

Maintain good records of your losses during the year. Keep a diary in which you indicate the date, place, amount, and type of loss, as well as the names of anyone who was with you. Save all documentation, such as checks or credit slips.

Hitting a lottery jackpot

The odds of winning the lottery are slim. But if you don’t follow the tax rules after winning, the chances of hearing from the IRS are much higher.

Lottery winnings are taxable. This is the case for cash prizes and for the fair market value of any noncash prizes, such as a car or vacation. Depending on your other income and the amount of your winnings, your federal tax rate may be as high as 37%. You may also be subject to state income tax.

You report lottery winnings as income in the year, or years, you actually receive them. In the case of noncash prizes, this would be the year the prize is received. With cash, if you take the winnings in annual installments, you only report each year’s installment as income for that year.

If you win more than $5,000 in the lottery or certain types of gambling, 24 % must be withheld for federal tax purposes. You’ll receive a Form W-2G from the payer showing the amount paid to you and the federal tax withheld. (The payer also sends this information to the IRS.) If state tax withholding is withheld, that amount may also be shown on Form W-2G.

Since the federal tax rate can currently be up to 37%, which is well above the 24% withheld, the withholding may not be enough to cover your federal tax bill. Therefore, you may have to make estimated tax payments — and you may be assessed a penalty if you fail to do so. In addition, you may be required to make state and local estimated tax payments.

Talk with us

If you’re fortunate enough to win a sizable amount of money, there are other issues to consider, including estate planning. This article only covers the basic tax rules. Different rules apply to people who qualify as professional gamblers. Contact us with questions. We can help you minimize taxes and stay in compliance with all requirements.

About the author

Brady is the owner of Ramsay & Associates. He specializes in financial statement preparation and personal, fiduciary and corporate tax and accounting.

His professional experience includes seven years' experience for local and national CPA firms before joining Ramsay & Associates in 2006.

He has a Bachelor of Accounting degree from the University of Minnesota Duluth. He is a Certified Public Accountant, a member of the Minnesota Society of CPA's, an Eagle Scout, as well as an active volunteer in the community.