Don t Forget Your Retirement! Gifting Money or Property Can Have Serious Tax Consequences. Eldercare Can Be a Medical Deduction

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1 Tax & Business Issues Newsletter Spring Fall Don t Forget Your Retirement! Even though retirement may be years away, and it may not be the most pressing issue on your mind these days, don t forget your retirement contributions, especially with generous government incentives involved. Gifting Money or Property Can Have Serious Tax Consequences Gift and inheritance taxes were created long ago to prevent an individual s assets from being passed on to future generations free of tax. Reverse Mortgages: A Cash Flow Solution for Seniors Some retirees are faced with mounting debt and inadequate income. What options do these seniors have, especially if they have a mortgage on their home and their retirement income is too low to cover the mortgage payments and have enough left over for some enjoyment in their golden years? Eldercare Can Be a Medical Deduction With people living longer, many find themselves becoming the care provider for elderly parents, spouses, and others who can no longer live independently. When this happens, questions come up regarding the tax ramifications associated with the cost of nursing homes or in-home care. Avoiding IRS Underpayment Penalties Congress considers our tax system a pay-as-you-go system. To facilitate that concept, the government has provided several means of assisting taxpayers in meeting the pay-as-you-go requirement. Are Charity Auction Purchases Deductible Contributions? It is common practice for charities to hold auction events where attendees bid on and purchase items. Attendees often wonder whether the money spent on the items purchased constitutes a charitable donation. Connect With Us Upcoming Events We have many educational events planned for the coming months. Nonprofit Resources Visit our new website for nonprofit news, resources, webcasts and more!

2 Don t Forget Your Retirement! Even though retirement may be years away, and it may not be the most pressing issue on your mind these days, don t forget your retirement contributions, especially with generous government incentives involved. There are a variety of retirement plans available to small businesses and small tax-exempt organizations that allow the employer and employee a tax-favored way to save for retirement. For a business, contributions made for the owner-employee and for other employees can be tax-deductible. Most of the same plans a business can use are available for tax-exempt employers. For all employers and employees, the earnings on the contributions grow tax-free until the money is distributed from the plan. Here are some retirement plan options: Simplified Employee Pension Plan (SEP) - This plan was designed to avoid the complications of a qualified plan. Contributions to the plan are held in the beneficiaries IRA accounts; hence, the title simplified. Deductible contributions for 2015 are limited to the lesser of 25% of the participant s compensation (up to $265,000) or $53,000. A SEP can be established and funded after the close of the year. Qualified Plan (Keogh) - Generally, the rules surrounding a Keogh are more complex. This type of plan may include a discretionary contribution profitsharing plan or a mandatory contribution money purchase plan, or a combination of these. SEP plans are favored over Keogh plans by most self-employed individuals. For 2015, deductible contributions are limited to the lesser of 25% of the participant s compensation (up to $265,000) or $53,000. These plans must be established before the end of the tax year, but contributions can be made afterwards. Savings Incentive Match Plan for Employees (SIMPLE Plan) - Under this plan, the business owner takes a deduction, and employees receive a salary deferral. For 2015, the contribution limit is $12,500 (per employer or employee), with an additional catch-up contribution limit of $3,000 for participants aged 50 or older. The employer can match the contribution up to 3% of compensation, or make a non-elective contribution of 2% of compensation. Individual 401(k) Plan - The individual 401(k) plan is similar to the traditional 401(k) plan, with added benefits for the small business owner. For 2015, the owner can contribute and deduct up to 25% of compensation plus an additional $18,000 salary deferral, up to a $53,000 maximum ($59,000 for those who are age 50 and over). For employees, the contribution and salary deferral limit is $18,000, with an additional $6,000 catch-up contribution available to those aged 50 or over. Employers can match employee contributions. Elective Deferral 403(b) Plan - Tax-exempt organizations may allow employees to participate in a 403(b) plan that only has elective deferrals and avoid compliance requirements with the Employee Retirement Income Security Act of 1974 (ERISA), even if they are not churches. This does not allow employer contributions and there are other limitations on employer involvement. An employee s contributions are not taxed. The contribution and salary deferral limit is $18,000, with an additional $6,000 catch-up contribution available to those aged 50 or over. If you do establish a new qualified pension plan for your business, you may be entitled to the small employer pension startup credit. The credit is equal to 50% of administrative and retirement-related education expenses for the plan for each of the first three plan years, with a maximum credit of $500 for each year. Plan-related expenses in excess of the amount of the credit claimed are generally deductible as ordinary expenses of the business. The first credit year is the tax year that includes the date the plan becomes effective, or, electively, the preceding tax year. Examples of qualifying expenses include the costs related to changing the employer s payroll system, consulting fees, and set-up fees for investment vehicles. Gifting Money or Property Can Have Serious Tax Consequences Gift and inheritance taxes were created long ago to prevent an individual s assets from being passed on to future generations free of tax. Congress has frequently tinkered with these taxes, and currently the gift and inheritance taxes are unified with a top tax rate of 40%. However, the law does provide the following two exclusions from the tax: Lifetime exclusion - For 2015, $5.43 million per person is excluded from gift and inheritance tax. This amount is annually adjusted for inflation and applies separately to each spouse of a married couple. When one of the couple dies and does not use the entire exclusion amount, the unused portion of the exclusion can be passed on to the surviving spouse by filing an estate tax return for the decedent, even if one is otherwise not required. Annual exclusion - The exclusion amount is periodically adjusted for inflation. For 2015 the Tax & Business Issues Newsletter Fall

3 annual gift exclusion is $14,000 per recipient. Thus, an individual can give up to $14,000 to as many recipients as he or she would like without creating a requirement to file a gift tax return. The $14,000 applies to each individual giver, so each spouse of a married couple can give $14,000, for a total per couple of $28,000 to any one person. If a person gives more than $14,000 for the year to any single individual, then a gift tax return is required, and the excess of the gifts over $14,000 reduces the lifetime exclusion. Once the annual limit and the lifetime limit have been exceeded, the excess becomes taxable. Gifts can take the form of cash or property. When property is given, the dollar value placed on the gift for gift tax purposes is the property s fair market value (FMV) at the time of the gift. However, the gift recipient assumes the giver s tax basis in the property, which means that if the giver s property had built-in gains, the recipient becomes responsible for those gains when the recipient subsequently disposes of the property in a taxable event. Example: Earl gives his son, Jack, stock worth $14,000 that originally cost Earl $5,000. Later, Jack sells the stock for $16,000. Jack s taxable gain from selling the stock will be $11,000 ($16,000 - $5,000). However, if Jack had inherited the stock from his father, Jack s basis would have been the FMV of the stock at the date of his father s death instead of what Earl had paid for the stock. Assuming the FMV was $14,000 at the time of Earl s death and Jack subsequently sold the stock for $16,000, he would only have a taxable gain of $2,000 ($16,000 - $14,000). This example points to a mistake often made by elderly taxpayers. They will frequently sign over their assets, most commonly their home, to their heirs while they are still alive rather than waiting and allowing the heirs to inherit the property. By doing this, they create a large tax liability for the heirs, since the basis of the gift is the giver s basis. Thus the heirs become responsible for the giver s built-in gain rather than inheriting the property with the basis equal to the FMV at the time of the decedent s death. Example: Mary signs over her home worth $500,000 to her son, John. Mary originally paid $100,000 for the home. If John immediately sells the home for $500,000 after Mary s passing, he will have a taxable gain of $400,000. However, if John had inherited the property after Mary s passing, his basis would be the FMV at date of death, or $500,000, and if he sold it for $500,000, he would have no taxable gain at all. Additional Exclusions For Gift Tax In addition, certain medical and education expenses are also excludable over and above the $14,000 annual exclusion cap. Tuition Expenses - Tuition expenses paid directly to the qualifying educational institution are permitted without gift tax consequences. For example, a grandparent who wants to help out a college-bound grandchild can pay the student s tuition directly to the college. Even if the amount is over $14,000, no gift tax reporting is required, and the grandparent s annual gift exclusion with respect to the child and his or her lifetime exclusion are not affected. Medical Expenses - Medical expenses paid directly to the qualifying medical institution or individual providing the care, or to the insurance company providing the medical coverage, are also exempt from the gift tax and don t affect the gift tax exclusions. The payments cannot go through the hands of the individual who incurred the medical expenses, but must go directly to the medical provider or insurance company. As you can see, gifting can be complicated and requires advance planning to take full advantage of tax benefits. Reverse Mortgages: A Cash Flow Solution for Seniors Some retirees are faced with mounting debt and inadequate income. What options do these seniors have, especially if they have a mortgage on their home and their retirement income is too low to cover the mortgage payments and have enough left over for some enjoyment in their golden years? One option you see promoted on television is the reverse mortgage, which allows homeowners to borrow against the equity they have built up in their home over the years. The loan is not due until the homeowner passes away or moves out of the home. If the homeowner dies, the heirs can pay off the debt by selling the house, and any remaining equity goes to them. If at that time the loan balance is equal to or more than the value of the home, the repayment amount is limited to the home s worth. In order to be eligible for this loan, the borrower must be at least 62 years of age and have equity in the home. The reverse mortgage must be a first trust deed. Thus any existing loans would have to be paid off with separate funds or with the proceeds from the reverse mortgage. The amount that can be borrowed is based upon age: the older the borrower, the greater the amount that can be borrowed and the lower the interest rate. The loan amount will also depend on the value of the home, interest rates, and the amount of equity built up. Tax & Business Issues Newsletter Fall

4 The borrower has the option of taking the loan as a lump sum, a line of credit, or as fixed monthly payments. In addition, the money can generally be used for any purpose, without restrictions imposed. Homeowners considering reverse mortgages often wonder when the interest will be deductible. When determining whether reverse mortgage interest is deductible, when it is deductible, and by whom, consider these factors: 1. Interest (regardless of type) is not deductible until paid. A reverse mortgage loan is not required to be repaid as long as the borrower lives in the home. Therefore, the interest on a reverse mortgage is not deductible by anyone until the loan is paid off. 2. Generally, reverse mortgages are classified as equity loans and the deductible interest would be limited to the interest accrued on the first $100,000 of debt. There are exceptions where the reverse mortgage paid off an existing acquisition debt loan. Equity debt interest is not deductible by taxpayers subject to the alternative minimum tax (AMT). So who deducts the interest when the loan is paid off? Debtor - If the debtor pays off the loan while still living, the debtor is the one who deducts the sum of the interest they would have been entitled to deduct each year had it been paid, subject to the limitations discussed in 1 & 2 above. Estate - If the estate pays off the mortgage after the debtor has passed away, the estate would deduct the interest on its income tax return. The amount deductible would be the sum of the interest the debtor would have been entitled to deduct each year had they paid it, subject to the limitations discussed in 1 & 2 above. Beneficiary - If the beneficiary, or beneficiaries, who inherit the home pay off the mortgage, the interest would be deductible as an itemized deduction on their personal 1040 income tax return(s). The amount deductible would be the sum of the interest the debtor would have been entitled to deduct each year had they paid it, subject to the limitations discussed in 1 & 2 above. Reverse mortgages have brought financial security to many seniors. If you are a senior who is struggling with your finances, carefully explore your options, including the possibility of a reverse mortgage. Keep in mind, however, that some reverse mortgages may be more expensive than traditional home loans, and the upfront costs can be high, especially if you don t plan to be in your home for a long time or only need to borrow a small amount. Eldercare Can Be a Medical Deduction With people living longer, many find themselves becoming the care provider for elderly parents, spouses, and others who can no longer live independently. When this happens, questions come up regarding the tax ramifications associated with the cost of nursing homes or in-home care. Generally, the entire cost of nursing homes, homes for the aged, and assisted living facilities are deductible as a medical expense, if the primary reason for the individual being there is for medical care or the individual is incapable of self-care. This would include the entire cost of meals and lodging at the facility. On the other hand, if the individual is in the facility primarily for personal reasons, only the expenses directly related to medical care would be deductible and the meals and lodging would not be a deductible medical expense. As an alternative to nursing homes, many elderly individuals or their care providers are hiring day help or live-in employees to provide the needed care at home. When this is the case, the services provided by the employees must be allocated between household chores and deductible nursing services. To be deductible, the nursing services need not be provided by a nurse so long as they are the same services that would normally be provided by a nurse, such as administering medication, bathing, feeding, and dressing. If the employee also provides general housekeeping services, the portion of the employee s pay attributable to household chores would not be a deductible medical expense. Household employees, like other employees, are subject to Social Security and Medicare taxes, and it is the responsibility of the employer to withhold the employee s share of these taxes and to pay the employer s payroll taxes. Special rules for household employees greatly simplify these payroll withholding and reporting requirements and allow the federal payroll taxes to be paid annually in conjunction with the employer s individual 1040 tax return. Federal income tax withholding is not required unless both the employer and the household employee agree to withhold income tax. However, the employer is still required to issue a W-2 to the employee and file the form with the federal government. A federal employer ID number (FEIN) and a state ID number must be obtained for reporting purposes. Most states have special provisions for reporting and paying state payroll taxes on an annual basis that are similar to the federal reporting requirements. The employer s portion of the employment taxes (Social Security, Medicare, and federal and state unemployment taxes) that relate to the employer s deductible medical expenses are also allowed as a medical expense. Tax & Business Issues Newsletter Fall

5 Avoiding IRS Underpayment Penalties Congress considers our tax system a pay-as-you-go system. To facilitate that concept, the government has provided several means of assisting taxpayers in meeting the pay-as-you-go requirement. These include: Payroll withholding for employers; Pension withholding for retirees; and Estimated tax payments for self-employed individuals and those with other sources of income not covered by withholding. When a taxpayer fails to prepay a safe harbor (minimum) amount, he or she can be subject to the underpayment penalty. This nondeductible interest penalty is higher than what might be earned from a bank and is computed on a quarter-by-quarter basis. Federal law and most states have safe harbor rules. There are two federal safe harbor amounts that apply when the payments are made evenly throughout the year. 1. The first safe harbor is based on the tax owed in the current year. If your payments equal or exceed 90% of your current year s tax liability, you can escape a penalty. 2. The second safe harbor -- and the one taxpayers rely on most often -- is based on your tax in the immediately preceding tax year. If your current year s payments equal or exceed 100% of the amount of your prior year s tax, you can escape a penalty. If your prior year s adjusted gross income was more than $150,000 ($75,000 if you file married separate status), then your payments for the current year must be 110% of the prior year s tax to meet the safe harbor amount. Where most taxpayers get into trouble is when their income goes up or their withholding goes down for the current year versus the prior year. Examples are having a substantial increase in income, such as when investments are cashed in, thereby increasing income but without any corresponding withholding or estimated payments. Another common situation is when a taxpayer retires and his payroll income is replaced with pension and Social Security income without adequate withholding. Taxpayers who don t recognize these types of situations often find themselves substantially underpaid and subject to the underpayment penalty when tax time comes around. Ministers have some unique concerns. Minister payroll practices can vary substantially and be very different from other employees. New ministers, or ministers switching between employers, may be unaware of the need to consider estimated tax issues or how their new employer handles minister payroll. Salary may be withheld at the normal rate for income tax, but without allowing for their SECA tax liability. Actual housing expenses may be substantially less than the amount of the designated housing allowance. Failure to consider these issues can result in significant underpayment of tax. The bottom line: 100% (or 110% for upper-income taxpayers) of your prior year s total tax is the only true safe harbor because it is based on the prior year s tax (a known amount). In contrast, 90% of the current year s tax is a variable based on the income for the current year, and that amount often isn t determined until it is too late to adjust the prepayment amounts. If you have a substantial increase in income, we recommend that you contact your CPA about adjusting your withholding or estimated tax payments to avoid a penalty. Are Charity Auction Purchases Deductible Contributions? It is common practice for charities to hold auction events where attendees bid on and purchase items. Attendees often wonder whether the money spent on the items purchased constitutes a charitable donation. The answer to that question is that some, but not all, of what is paid for the item may be deductible. If you purchase items at a charity auction, you may claim a charitable contribution deduction for the excess of the purchase price paid for the item, over its fair market value. You must be able to show, however, that you knew that the value of the item was less than the amount you paid for it. For example, a charity may give every auction attendee a catalog that provides a good faith estimate of the items available for bidding. Assuming you have no reason to doubt the accuracy of the published estimate, if you pay Tax & Business Issues Newsletter Fall

6 more than the published value, the difference between the amount you paid and the published value may constitute a charitable contribution deduction. In addition, if you provide goods for charities to sell at an auction, you may wonder if you are entitled to claim a fair market value charitable deduction for your contribution of appreciated property that will later be sold. Under these circumstances, the law limits your charitable deduction to your tax basis in the contributed property and does not permit you to claim a fair market value charitable deduction for the contribution. Specifically, the Treasury Regulations (Sec 170) provide that if a donor contributes tangible personal property to a charity that is put to an unrelated use, the donor s contribution is limited to the donor s tax basis in the contributed property. The term unrelated use means a use that is unrelated to the charity s exempt purposes or function. The sale of an item is considered unrelated, even if the sale raises money for the charity to use in its programs. Atlanta Chicago Dallas Indianapolis San Diego Boston Colorado Springs Denver Los Angeles San Francisco Charlotte Columbia Grand Rapids New York Tax Division CapinCrouse LLP capincrouse.com