P a g e 1 Article: Tax Savings for Empty-Nesters Author: Editor Date: April 2013 Source: Kiplinger Roll over an inherited 401(k), help your children earn a credit for retirement savings and rack up tax savings in the process. Empty-nesters should make these moves throughout the year to keep their bill low at tax time. Here are the areas where you should look for savings: WORK Give yourself a raise. If you got a big tax refund this year, it meant that you're having too much tax taken out of your paycheck every payday. So far this year, the average refund is nearly $2,800. Filing a new W-4 form with your employer (talk to your payroll office) will insure that you get more of your money when you earn it. If you're just average, you deserve about $225 a month extra. Go for a health tax break. Be aggressive if your employer offers a medical reimbursement account sometimes called a flex plan. These plans let you divert part of your salary to an account which you can then tap to pay medical bills. The advantage? You avoid both income and Social Security tax on the money, and that can save you 20% to 35% or more compared with spending after-tax money. Starting in 2013, the maximum you can contribute to a health care flex plan is $2,500. Use our handy calculator to figure out how much you can save. Stash cash in a self-employed retirement account. If you have your own business, you have several choices of tax-favored retirement accounts, including Keogh plans, Simplified Employee Pensions (SEPs) and individual 401(k)s. Contributions cut your tax bill now while earnings grow tax-deferred for your retirement. Don't be afraid of home-office rules. If you use part of your home regularly and exclusively for your business, you can qualify to deduct as home-office expenses some costs that are otherwise considered personal expenses, including part of your utility bills, insurance premiums and home maintenance costs. Some home-business operators steer away from these breaks for fear of an audit. But a new IRS rule that takes effect this year will make it easier to claim this tax break. Instead of calculating individual expenses, you can claim a standard deduction of $5 for every square foot of office space, up to 300 square feet.
P a g e 2 Switch to a Roth 401(k). If your employer offers the new breed of 401(k), seriously consider opting for it. Unlike the regular 401(k), you don't get a tax break when your money goes into a Roth, but younger workers are often in lower tax brackets... so the break isn't so impressive anyway. Also unlike a regular 401(k), money coming out of a Roth 401(k) in retirement will be tax-free at a time you may well be in a higher bracket. Pay back a 401(k) loan before leaving the job. Failing to do so means the loan amount will be considered a distribution that will be taxed in your top bracket and, if you're younger than 55, hit with a 10% penalty, too. Choose the right kind of business. Beyond choosing what business to go into, you also have to decide on the best form for your business: a sole proprietorship, a subchapter S corporation, a C-corp or a limited-liability company (LLC). Your choice will have a major impact on your taxes. HOME Save energy, save taxes. Congress extended a $500 tax credit for energy-efficient home improvements, such as new windows, doors and skylights, through 2013*. Be advised, though, that $500 is the lifetime maximum, so if you claimed $500 in energy-efficient credits before this year, you can t claim this credit. There are also restrictions on specific projects; for example, the maximum you can claim for new energy-efficient windows is $200. *NOT IN 2014 Think green. A separate tax credit is available for homeowners who install alternative energy equipment. It equals 30 percent of what a homeowner spends on qualifying property such as solar electric systems, solar hot water heaters, geothermal heat pumps, and wind turbines, including labor costs. There is no cap on this tax credit, which is available through 2016. Second homes can offer a vacation from taxes. If you're trying to figure whether you can afford a second home, remember that you'll get some help from the IRS. Mortgage interest on a loan to buy a second home is deductible just as it is for the mortgage on your principal residence. Interest on up to $1.1 million of first- and second-home debt can be deducted. Property taxes can be written off, too. Things get more complicated and perhaps more lucrative if you rent out the place part of the year to help cover the bills. Watch the calendar at your vacation home. If you hope to deduct losses attributable to renting the place during the year, be careful not to use the house too much yourself. As far as the IRS is concerned, "too much" is when personal use exceeds more than 14 days or more than 10% of the number of days the home is rented. Time you spend doing maintenance or repairs does not count as personal use, but time you let friends or relatives use the place for little or no rent does.
P a g e 3 Take advantage of tax-free rental income. You may not think of yourself as a landlord, but if you live in an area that hosts an even that draws a crowd (a Super Bowl, say, or the presidential inauguration), renting out your home temporarily could make you a bundle tax free while getting out of town when tourists overrun the place. A special provision in the law lets you rent a home for up to 14 days a year without having to report a dime of the money you receive as income. CHARITABLE CONTRIBUTIONS Tote up out-of-pocket costs of doing good. Keep track of what you spend while doing charitable work, from what you spend on stamps for a fundraiser, to the cost of ingredients for casseroles you make for the homeless, to the number of miles you drive your car for charity (worth 14 cents a mile). Add such costs with your cash contributions when figuring your charitable contribution deduction. Roll over an inherited 401(K). A recent change in the rules allows a beneficiary of a 401(k) plan to roll over the account into an IRA and stretch payouts (and the tax bill on them) over his or her lifetime. This can be a tremendous advantage over the old rules that generally required such accounts be cashed out, and all taxes paid, within five years. To qualify for this break, you must name a person or persons (not your estate) as your beneficiary. If your 401(k) goes through your estate, the old five-year rule applies. INVESTMENTS AND RETIREMENT SAVINGS Check the calendar before you sell. You must own an investment for more than one year for profit to qualify as a long-term gain and enjoy preferential tax rates. The "holding period" starts on the day after you buy a stock, mutual fund or other asset and ends on the day you sell it. Don't buy a tax bill. Before you invest in a mutual fund near the end of the year, check to see when the fund will distribute dividends. On that day, the value of shares will fall by the amount paid. Buy just before the payout and the dividend will effectively rebate part of your purchase price, but you'll owe tax on the amount. Buy after the payout, and you'll get a lower price, and no tax bill. Mine your portfolio for tax savings. Investors have significant control over their tax liability. As you near the end of the year, tote up gains and losses on sales to date and review your portfolio for paper gains and losses. If you have a net loss so far, you have an opportunity to take some profit tax free.
P a g e 4 Alternatively, a net profit on previous sales can be offset by realizing losses on sales before the end of the year.* (This strategy applies only to assets held in taxable accounts, not tax-deferred retirement accounts such as IRAs or 401(k) plans). *Doesn t help 2013 bill Consider tax-free bonds. It's easy to figure whether you'll come out ahead with taxable or taxfree bonds. Simply divide the tax-free yield by 1 minus your federal tax bracket to find the "taxable-equivalent yield." If you're in the 33% bracket, your divisor would be 0.67 (1-0.33). So, a tax-free bond paying 5% would be worth as much to you as a taxable bond paying 7.46% (5/0.67). Keep a running tally of your basis. For assets you buy, your "tax basis" is basically how much you have invested. It's the amount from which gain or loss is figured when you sell. If you use dividends to purchase additional shares, each purchase adds to your basis. If a stock splits or you receive a return-of-capital distribution, your basis changes. Only by carefully tracking your basis can you protect yourself from overpaying taxes on your profits when you sell. A new IRS rule requires financial services and brokerage firms to report to the IRS the cost basis for stocks purchased on or after January 1, 2011 and mutual funds purchased on or after January 2, 2012. They'll also provide you with this information, which should make it easier for you to avoid costly mistakes when you sell. For older shares, though, you'll still need to track your basis to avoid overpaying taxes on your profits. Beware of Uncle Sam's interest in your divorce. Watch the tax basis that is, the value from which gains or losses will be determined when property is sold when working toward an equitable property settlement. One $100,000 asset might be worth a lot more or a lot less than another, after the IRS gets its share. Remember: Alimony is deductible by the payer and taxable income to the recipient; a property settlement is neither deductible nor taxable. Help your children earn a credit for retirement savings. This credit can be as much as $1,000, based on up to 50% of the first $2,000 contributed to an IRA or company retirement plan. It's available only to low-income taxpayers, who are often the least able to afford such contributions. Parents can help, however, by giving an adult child (who can not be claimed as a dependent) the money to fund the retirement account contribution. The child not only saves on taxes but also saves for his or her retirement.
P a g e 5 Tax Savings for Empty-Nesters Article Summary Here are some tax moves empty-nesters can make throughout the year to lower their tax bill. If you got a big tax refund: o Too much is being withheld from your paycheck. o Filling out a new W-4 form at work gives the average person an extra $225/mo. Save 20-35% or more with flexible spending accounts. o For a Medical Reimbursement Account, or Health Care Flex Plan: The maximum is $2,500. Stashing money in here avoids both income and Social Security taxes. o Make sure you actually use it all or you forfeit the money; it doesn t roll over annually. If you re self-employed: o Save with tax-favored retirement accounts: Keogh Plans Simplified Employee Pensions (SEPs) Individual 401(k)s o Contributing cuts your income tax and your earnings grow tax-deferred. If you use an office at home: o Deduct a portion of your home-office expenses: Utilities Insurance Premiums Maintenance o If you re worried about getting audited, there s a new IRS rule that makes it easier. Standardized deduction of $5/ft 2 up to 300ft 2. If your employer offered Roth 401(k)s, consider converting to one. o Contributions don t lower this year s tax bill. o But your withdrawals and growth will be tax-free. o This is most beneficial if you re going to be in a higher tax bracket in the future. If you have a 401(k) loan: o Pay it back before you leave the job. o If you don t, the remainder will be taxed as a distribution. If you re younger than 55 you ll also get hit with a 10% penalty. If you always wanted to install alternative energy equipment: o There s a tax credit for that equaling 30% of the cost, including labor. o There is no cap and it is available through 2016. o Examples include solar electric systems, solar hot water heaters, geothermal heat pumps, and wind turbines. If congress reinstitutes the Mortgage tax break in 2014: o Mortgage interest on buying a second home will be deductible, just like your primary residence. o Interest on up to $1.1 million of both homes debt can be deducted. (Continued on the next page )
P a g e 6 If you rent a vacation home: o Make sure you or your friends and family don t stay there for more than 14 days or 10% of the time it s rented, even if you charge them a low rate. You ll be able to deduct losses from renting during the year. Time you spend there doing repairs doesn t count. If you rent your home for less than 14 days each year: o A special provision says you don t have to report it as income. o This counts if you let people rent your place for an event like the Super Bowl. If you do charitable work: o Keep track of your out-of-pocket costs: Stamps if you mail things Ingredients if you cook food Miles you drove for charity @ $0.14/mile o You can deduct these along with cash contributions. If you inherit a 401(k): o Roll it over and stretch the payouts and taxes over your lifetime. The old rule makes you cash out the account within 5 years. o Name a person as a beneficiary, not your estate, or the old rule applies. If you re an investor: o Make sure you own an investment for more than 1 year for profit to qualify as a long-term gain and taxed less. The clock starts the day after you buy it and includes the day you sell it. o If you re buying a mutual fund near the end of the year, watch out for distributions. Buy just before the payout and you ll owe taxes on the dividend. Buy just after the payout and the price will be lower and you avoid those taxes. o Take advantage of tax-loss harvesting. o Consider tax-free bonds. If you re in the 33% bracket, one of these paying 5% is worth a taxable bond paying 7.46%. Tax-Free Yield (1 Tax Bracket) o Protect yourself from overpaying taxes on profits when you sell. Keep track of your tax basis, which is what you ve invested. Buying additional shared with dividends adds to your basis. Stock splits and return-of-capital distributions affect your basis as well. If you re getting divorced: o Watch your tax basis when working on an equitable property settlement. o Property settlements are neither deductible nor taxable. o Alimony is deductible by the payer and taxable as income for the recipient. If you have an adult child you do not claim as a dependent: o Fund his or her retirement contribution. o He or she gets a tax credit for 50% up to $2,000 o The credit is only available to low-income tax payers.