Before you start tapping into your retirement savings, you may want to read this first:
If you are under age 59½ and plan to withdraw money from a qualified retirement account, you will likely pay both income tax and a 10% early-distribution tax on any previously un-taxed money that you take out. Withdrawals you make from a SIMPLE IRA before age 59½ and those you make during the 2-year rollover restriction period after establishing the SIMPLE IRA may be subject to a 25% additional early-distribution tax instead of the normal 10%. The 2-year period is measured from the first day that contributions are deposited. These penalties are just what you’d pay on your federal return; your state may also charge an early-withdrawal penalty in addition to the regular state income tax.
The following exceptions may help you avoid the penalty:
- Withdrawals from any retirement plan to pay medical expenses—Amounts withdrawn to pay unreimbursed medical expenses are exempt from penalty if they would be deductible on Schedule A during the year and if they exceed 10% of your adjusted gross income. This is true even if you do not
- IRA withdrawals annuitized over your lifetime—To qualify, the withdrawals must continue unchanged for a minimum of 5 years, including after you reach age 59½.
- Employer retirement plan withdrawals—To qualify, you must be separated from service and be age 55 or older in that year (the lower limit is age 50 for qualified public-service employees such as police officers and firefighters) or elect to receive the money in substantially equal periodic payments after your separation from service.
- Withdrawals from any retirement plan as a result of a disability—You are considered disabled if you can furnish proof that you cannot perform any substantial gainful activities because of a physical or mental condition. A physician must certify your condition.
- IRA withdrawals by unemployed individuals to pay medical insurance premiums—The amount that is exempt from penalty cannot be more than the amount you paid during the year for medical insurance for yourself, your spouse, and your dependents. You also must have received unemployment compensation for at least 12 weeks during the year.
- IRA withdrawals to pay higher education expenses—Withdrawals made during the year for qualified higher education expenses for yourself, your spouse, or your children or grandchildren are exempt from the early-withdrawal penalty.
- IRA withdrawals to buy, build, or rebuild a first home—Generally, you are considered a first-time homebuyer for this exception if you had no present interest in a main home during the 2-year period leading up to the date the home was acquired, and the distribution must be used to buy, build, or rebuild that home. If you are married, your spouse must also meet this no-ownership requirement. This exception applies only to the first $10,000 of withdrawals used for this purpose. If married, you and your spouse can each withdraw up to $10,000 penalty-free from your respective IRA accounts.
You should be aware that the information provided above is an overview of the penalty exceptions and that conditions other than those listed above may need to be met before qualifying for a particular exception. You are encouraged to contact this office before tapping your retirement funds for uses other than retirement. Distributions are most often subject to both normal taxes and other penalties, which can take a significant bite out of the distribution. However, with carefully planned distributions, both the taxes and the penalties can be minimized. Please call Dagley & Co. for assistance.
Are you a parent? Did you know there are a significant number of tax benefits available to you? Whether you’re single, divorced or married, there are many deductions, exemptions and credits that can help put a dent in your tax liability.
Exemptions – Regardless of filing status, you receive a $4,050 income exemption for each of your qualifying children whom you claim as a dependent on your tax return. In the case of divorced or separated parents, the exemption is allowed to the custodial parent unless the custodial parent releases the exemption to the non-custodial parent. If you are the custodial parent, you can release the exemption on a year-by-year basis or for multiple years if you wish to do so. However, being unable to foresee the future means it is generally wiser to release the exemption annually. The exemption amount gradually decreases to zero once a certain income threshold is reached; this phase out generally applies to higher income taxpayers.
Child Tax Credit – If you have dependent children, you are also entitled to a nonrefundable tax credit of $1,000 for each child under the age of 17 at the close of the year. The term “nonrefundable” means the credit can only be used to offset any tax liability you may have, and the balance of the credit is lost. If you are not filing jointly with the child’s other parent and have released the exemption to that parent, then you will not qualify for the child tax credit for that child. In addition, this credit also phases out for higher income taxpayers. For lower income parents, a portion of the child tax credit, which is normally nonrefundable, can become refundable.
Earned Income Tax Credit – The earned income credit benefits lower income parents based upon your earned income, filing status (either married filing jointly or unmarried) and the number of qualifying children you have up to three. The credit for 2017 can be as much as $6,318, and better yet, the amount not used to offset your tax liability is fully refundable. This credit is phased out for higher income filers, and those with investment income of more than $3,450 for 2017 aren’t eligible.
Head of Household Filing Status – The tax code provides a special filing status – head of household – for unmarried and separated taxpayers. The benefit of head of household filing status is that it provides lower tax rates and a higher standard deduction than the single status ($9,350 as opposed to $6,350 for a single individual in 2017). If you are an unmarried parent and you pay more than one-half the cost of the household for yourself and your child, you qualify for this filing status. Even if you are married, if you lived apart from your spouse the last six months of the year and pay more than one-half the cost of the household for yourself and your child, you qualify for this filing status.
Childcare – Many parents who work or are looking for work must arrange for care of their children. If this is your situation, and your children requiring care are under 13 years of age, you may qualify for a nonrefundable tax credit that can reduce your federal income taxes.
The childcare credit is an income-based percentage of up to $3,000 of qualifying care expenses for one child and up to $6,000 of qualifying care expenses for two or more children. The allowable expenses are also limited to your earned income, and if you are married, both you and your spouse must work and the limit is based upon the earned income of the spouse with the lower earnings. The credit percentages range from a maximum of 35% if your adjusted gross income (AGI) is $15,000 or less to 20% for an AGI of over $43,000.
If your employer provides dependent care benefits under a qualified plan that pays your child care provider either directly or by reimbursing you for the expenses, or your employer provides a day care facility, you may be able to exclude these benefits from your income. Of course, the same expenses aren’t eligible for both tax-free income and the child care credit.
Education Savings Plans – The tax code provides two plans to save for your children’s future education. The first is the Coverdell Education Savings Account, which allows non-deductible contributions of up to $2,000 per year. The earnings on these accounts are tax-free provided the amounts withdrawn from the accounts are used to pay qualified expenses for kindergarten and above. Coverdell contributions will phase out for higher income taxpayers beginning at an AGI of $190,000 for married taxpayers filing jointly and half that amount for other taxpayers.
A second plan, called a Qualified Tuition Plan (sometimes referred to as a Sec 529 plan), allows individuals to gift large sums of money for a family member’s college education while continuing to maintain control of the funds. The earnings from these accounts grow tax-deferred and are tax-free if used to pay for college tuition and related expenses.
Contributions to these plans are not limited to the child’s parents and can be made by virtually anyone, although if not the parents, then typically it is the grandparents who fund the accounts.
Education Credits – If you are a parent with a child or children in college, don’t overlook the American Opportunity Tax Credit (AOTC). It provides a tax credit equal to 100% of the first $2,000 of qualified tuition and related expenses and 25% of the next $2,000 for each child who was enrolled at least half time. Better yet, 40% of the credit is refundable. This credit is good for the first four years of post-secondary education.
There is a second education credit called the Lifetime Learning Credit (LLC) that provides a nonrefundable tax credit equal to 20% of up to $10,000 of qualified tuition and related expenses. Unlike the AOTC, which is allowed per student, the LLC is calculated on a per-family basis with a maximum credit of $2,000 but is not limited to the first four years of post-secondary education.
You don’t even have to pay the expenses to get the credits. The credits are allowed to the person claiming the exemption for the child. So if the child’s grandparent, uncle, aunt or even an ex-spouse or the child’s other parent pays the tuition, you still get the credit as long you claim the child as your dependent.
Student Loan Interest – Generally, personal interest you pay, other than certain mortgage interest, isn’t deductible on your tax return. However, there is a special deduction, up to $2,500 per year, allowed for interest paid on a student loan (also known as an education loan) used for higher education. You don’t have to itemize deductions to take advantage of this deduction, but you must have paid the interest on a loan taken out for your own or your spouse’s education or that of a dependent. So if you were legally obligated to pay the loan for one of your children who was your dependent when the loan was taken out, you may be able to claim this deduction, even if the child is no longer your dependent.
The student must have been enrolled at least half-time, and the loan must have been taken out solely to pay qualified higher education expenses. The lender can’t be a related person. This deduction phases out if your AGI is more than $65,000 ($130,000 if filing a joint return) and isn’t allowed if you use the married filing separate status.
Child’s Medical Expenses – If you itemize deductions, the unreimbursed medical expenses you pay for your dependents are counted for figuring your total medical expenses. This is true for both parents even if they do not file together as long as one of them is able to claim the child as a dependent.
If you have questions related to any of these benefits, please give Dagley & Co. a call.
2017 green light alert! Congress has approved the 21st Century Cures Act, a provision allowing small employers to reimburse their employees for medical expenses under a health reimbursement arrangement (without being liable for the draconian, $100 per day penalty for violating the Affordable Care Act’s rules).
Background: Stand-alone HRAs do not meet two key requirements of the ACA, as they:
- Limit the dollar amount of the insured person’s annual benefits and
- Fail to provide certain preventive-care services without requiring cost-sharing.
As a result, under the IRS’ interpretation of the ACA, employers are subject to a $100 per day (maximum $36,500 per year) excise tax penalty per employee.
New Law: Effective January 1, 2017, under the 21st Century Cures Act, qualified small employers that have an average of fewer than 50 full-time employees (including full-time-equivalent employees) and that maintain a qualified small-employer HRA will be exempt from the penalty. Under this act, a qualified small employer is one that:
- Employs an average of fewer than 50 full-time employees (including full-time-equivalent employees) and does not offer a group health plan to its employees. The number of full-time-equivalent employees is determined by adding up all the hours that part-time employees worked in a given month and dividing by 120.
- Provides the HRA on the same terms to all eligible employees. Eligible employees all those except:
- Those who have not completed 90 days of service,
- Those who have not attained the age of 25,
- Part-time workers (generally those working an average of less than 30 hours per week),
- Seasonal workers (generally those employed for 6 months or fewer during the year),
- Those covered by a collective bargaining unit, and
- Certain nonresident aliens.
- Entirely funds the HRA (i.e., no salary-reduction contribution is made to the HRA).
- Only reimburses the employees after being provided with proof of their medical expenses.
- Limits reimbursements to $4,950 ($10,000 where the plan includes family members) per year. Amounts are subject to inflation adjustments for years after 2016.
Any medical-expense reimbursements that an employee receives from a qualifying HRA are excluded from that employee’s income.
If you have questions regarding this new topic effective January 1, 2017, please give Dagley & Co. a call at 202-417-6640.
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Employment legal actions in monetary settlements and damage awards have complex and sometimes discriminatory tax laws. The actual taxation of the award is primarily based on the following factors: the nature of the legal action, whether a settlement occurred before trial, and how the legal costs were handled.
Nature of the Legal Action – Generally, all monetary awards as the result of an employment-related legal action are fully taxable, with one exception. Under the exception, the tax code allows an exclusion from gross income for damages received due to a personal physical injury or a physical sickness. Consequently, when a lawsuit is based on a physical injury or sickness, all damages (other than punitive damages, which are always taxable) flowing from that suit are treated as payments received due to a physical injury or sickness, and are therefore excluded from income. This is true whether or not the recipient of the damages is the injured party.
Here are some commonly encountered situations and their taxability: Wrongful Death – Wrongful death is considered physical injury or physical sickness for purposes of the income exclusion. In addition, punitive damages are excludable where state law provides that only punitive damages can be awarded in wrongful death suits. Emotional Distress – Emotional distress isn’t considered physical injury or physical sickness for purposes of the income exclusion. However, the exclusion from gross income does apply to the amount of damages received for emotional distress that is attributable to a physical injury, but not in excess of the amount paid for medical care related to emotional distress. Previously Deducted Medical Expenses – Even though awards for physical injury or physical sickness are excludable, if any part of the award received is compensation for medical expenses deducted in a prior year, that portion of the award must be included as income, up to the amount of the deduction taken. Employment Discrimination – No exclusion is allowed for damages received in a suit involving employment discrimination or an injury to reputation that is accompanied by a claim of emotional distress. However, the exclusion would apply to a claim of emotional distress related to a physical injury or physical sickness. Age Discrimination - The law doesn’t consider back pay or liquidated damages received under the Age Discrimination in Employment Act (ADEA) to be compensation for personal injuries; therefore, these payments are includable in income. But see the special treatment of attorney fees below. Punitive Damages – Punitive damages are made as a punishment for unlawful conduct and are always taxable; they cannot be excluded from income as damages received due to personal physical injury or physical sickness, except as noted above for wrongful death. Unpaid or Disputed Employment Earnings – Back pay, severance pay, overtime pay, etc., are all treated as W-2 type income and are both taxable and subject to payroll FICA withholding. Interest – Interest that may be included in an award, even one for personal injury or sickness, is not excludable and must be included in gross income.
Settlements – In legal actions, the plaintiff may frequently sue for both excludable and non-excludable damages. For example, an employee is injured on the job and sues for back vacation pay of $10,000 and damages for personal injury in the amount of $90,000 (a total of $100,000). If the suit is settled for $50,000 without a stipulation of how the settlement is applied, the settlement will need to be allocated in the same manner as the original suit. In this example, the settlement would be allocated $5,000 for back vacation pay (taxable) and $45,000 for personal injury (excludable).
Legal Costs – Generally, legal costs associated with employment-related legal actions can only be deducted as a miscellaneous itemized deduction on the employee’s Schedule A itemized deductions. When all or some of the monetary award is excludable, the fees are prorated between the taxable and excludable award, and only the portion allocated to the taxable portion is deductible.
This is where significant tax problems are encountered because miscellaneous itemized deductions must be reduced by 2% of the employee-taxpayer’s adjusted gross income (AGI), and the gross monetary award received is included in the employee’s AGI, making it abnormally high. On top of that, miscellaneous itemized deductions are not even allowed for purposes of the alternative minimum tax (AMT), which is very frequently triggered in situations of this nature. This would result in the taxpayer having to include the entire monetary award in income and not being able to deduct much, if any, of the legal costs. The taxpayer, in effect, is paying taxes on just about the entire, or in some cases the total, amount, including what the attorney got.
There is a very limited exception that allows attorney fees to be deducted above-the-line (without itemizing), thus eliminating the 2% reduction and the AMT issues. However, it only applies in connection with a claim of unlawful discrimination, certain claims against the federal government, or a private cause of action under the Medicare Secondary Payer statute.
So, before you rush out and spend any of the award money you received, you had better drop by the office and see what the government’s share is, because it could be substantial. In addition, with some careful analysis, it may be possible to take actions that will reduce the tax.
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This Thanksgiving, you may want to toast to good health and wealth – but sadly for some, 2014 may have been spent in and out of treatments, therapy, doctors and hospitals. The silver lining is that your medical expenses may be tax deductible, particularly if the bills ran high.
Beginning is 2013, the only medical expenses that you can deduct are those in excess of 10% of your adjusted gross income (AGI), up from the previous 7.5% AGI limitation. The limitation remains at 7.5% for taxpayers age 65 and over through 2016, unless they are subject to the alternative minimum tax, in which case it is 10% for them as well. For joint return filers not subject to the AMT, if either spouse is age 65 or older, the 7.5% of AGI limitation applies to their joint medical expenses.
If you don’t itemize your medical deductions or are nowhere near exceeding the AGI limitation, you need not concern yourself with this deduction. On the other hand, if you do itemize and think you might meet the AGI limitation, then it may be worth your time to summarize your medical expenses for the year. Use the following checklist to help you accumulate your deductible medical expenses. The list is by no means all-inclusive, and some of the deductions listed may have additional restrictions not included here:
• Artificial Limb
• Artificial Teeth
• Birth Control Pills
• Braille Books and Magazines
• Abortion, Legal
• Alcoholism Treatment
• Christian Science Practitioner
• Contact Lenses
• Dental Treatment
• Drug Addiction Treatment
• Drugs (Prescription)
• Fertility Enhancement
• Guide Dog
• Hearing Aids
• Hospital Services
• Impairment-Related Expenses
• Insurance Premiums
• Laboratory Fees
• Laser Eye Surgery
• Lead-based Paint Removal
• Learning Disability Treatment
• Medicare B & D Premiums
• Medical Services
• Medicines, Prescribed
• Mentally Retarded, Special Home for
• Nursing Home
• Nursing Services
• Organ Donors
• Psychiatric Care
• Special Schools and Education
• Stop Smoking Programs
• Weight-loss Program
• Wig (Cancer Patient)
If you have questions related to your medical tax deductions please contact Dagley & Co.