Understanding Capital Gains, New IRS Mileage Rates & What the IRS Will Never Do
YOUR FINANCIAL ADVISOR Although Congress continues to pass large economic bills (the CARES Act and the Inflation Reduction Act were each about 800 pages long), no single bill can account for every unique situation. Worse, the federal tax code is crazily long. At over 2,500 pages, it is 5x the length of the Grapes of Wrath, written by John Steinbeck. So, before you go down a path that might not be in your best interest long-term, make sure you consult with your financial advisor to determine how any new tax changes and any proposed tax changes might impact you and your family.
A lack of knowledge leaves individual retirees dumping thousands of dollars out of their own pockets.
The graph below says it all. The age at which most people claim Social Security (green line) is opposite to the age at which they should claim Social Security (purple line). According to The Retirement Solution Hiding in Plain Sight: How Much Retirees Would Gain by Improving Social Security Decisions, “retirees will collectively lose $3.4 trillion in potential income that they could spend during their retirement because they claimed Social Security at a financially sub optimal time, or an average of $111,000 per household.”
Figure 1: Optimal vs. Actual Social Security Claim Ages
This comprehensive study observed 2,024 households, considering each household’s outside resources, spending, health, and longevity to determine how much income and wealth they would have if they had taken Social Security at the various ages of eligibility.
Although later claiming typically caused wealth to drop during a person’s 60s as they drew down their personal retirement accounts, this wealth drop was more than made up for by the late 70s, when Social Security income was higher.
In order to isolate the effect of claiming age, the study did not consider the effect of working longer. But in real life, a person who decides to maximize benefits by claiming at 70 might choose to work a few years longer, and this would mitigate some or all of the wealth drop in their 60s. This appears to be the first study of its kind to consider the impact of claiming age on not just the Social Security income, but other assets and income as well, as optimal Social Security claimingcan lead to higher account balances, which in turn generate more income. Only 4% of retirees make the optimal claiming decision.
The study found that a claiming age of 62–64 is optimal for only about 8% of adults (primarily those with short life expectancies or low-earning spouses)—yet about 79% of eligible adults in the sample claimed at those ages. A claiming age of 70 is optimal for 71% of primary wage earners—yet only 4% of the adults in the sample claimed at that age.
Among those at the highest wealth levels, 99% make suboptimal claiming decisions. Yes, you read that right. Ninety-nine percent of higher-wealth households make suboptimal claiming decisions. While it’s true that wealthy individuals can afford to leave Social Security benefits on the table, what’s troubling is that they are not getting good advice from their financial advisors.
Here at Boston Harbor Group, we pride ourselves for making this matter a very important one when elaborating the financial strategies for our clients. We show our clients calculator reports and different scenarios to reveal their personalized and optimal claiming time.
For retirees, financially suboptimal decisions add up to a loss of $2.1 trillion in wealth and a loss of $3.4 trillion in income. In its conclusion the report mentions a few ways to deal with this, including:
Make early claiming an exception, reserved for those who have a demonstrable need to claim benefits before full retirement age.
Change the way we refer to early or delayed claiming, labeling a claiming age of 62 as the “minimum benefit age” and 70 as the “maximum benefit age.”
Remove the disincentives wealth management firms have for delivering optimal claiming advice (i.e., the near-term drop in assets) by providing “cover” for executives to make the right financial decision for their clients and the right long-term decision for their shareholders.
Provide SSA with more resources, perhaps in partnership with third-party fiduciaries, to help households determine their optimal claiming age. “That limited investment could help recapture some of the $5.5 trillion lost in wealth and income to retirees and the U.S. economy because of the struggles retirees currently face making the right decision.”
MORE NONRETIRED AMERICAN EXPECT COMFORTABLE RETIREMENT
Meanwhile, a recent Gallup poll found that 57% of nonretired Americans now expect that they will live comfortably in retirement, a six-point increase in positivity since last year and the highest reading since 2004.
Only 33% of nonretirees see Social Security as a major source of income in retirement (compared to 57% of retirees). Eighteen percent of nonretirees aren’t counting on it at all. Instead, nonretirees tend to focus on 401(k)s, IRAs and other retirement savings accounts as being a major source of income. They also are planning on having multiple sources of income in retirement, including part-time work, home equity, and rent and royalties.
Distributions taken before an IRA owner reaches age 59½ are subject to a 10% early distribution penalty, unless an exception applies. For those who claim exceptions, it’s vital to maintain documented proof, as the IRS may deny the claim for exception in the absence of sufficient documentation. And that can be costly.
According to the National Center for Education Statistics (NCES), the average cost of college for an academic year can be over $39,000. Faced with the high costs of student loans and challenges with getting scholarships and grants, some individuals choose to take distributions from their retirement accounts to help defray higher education expenses. If those distributions are made before the account owner reaches age 59½, any tax deferred amount would not only be subject to income tax, but also an additional 10% tax (early distribution penalty). However, the penalty is waived if the IRA owner qualifies for an exception.
Individuals who plan to claim the higher education expenses exception must ensure that they have documented proof that the amount was in fact used to cover such expenses, so as to ensure that the IRS does not deny any claims for the exception.
Background
Generally, distributions from IRAs are subject to ordinary income tax. If the distribution occurs while the IRA owner is under age 59½, an additional tax of 10% (early distribution penalty) applies to any taxable amount, unless an exception applies. One of the exceptions to the early distribution penalty applies to amounts used to cover qualified higher education expenses.
Qualified higher education expenses
Amounts used to pay for tuition, fees, books, supplies, and equipment required for the enrollment or attendance of a designated beneficiary at an eligible educational institution
Expenses for special needs services in the case of a special needs beneficiary which are incurred in connection with enrollment or attendance
Expenses for the purchase of computer or peripheral equipment, computer software, or Internet access and related services, if such equipment, software, or services are to be used primarily by the beneficiary during any of the years the beneficiary is enrolled at an eligible educational institution
Room and board included for students who are at least half-time
Some caveats and exceptions apply. You should consult with your tax professionals, to identify amounts for which you can claim as qualified higher education expenses.
For this purpose, an eligible educational institution is generally any accredited college, university, vocational school, or other postsecondary educational institution; eligible to participate in a student aid program administered by the U.S. Department of Education.
An educational institution should be able to tell interested parties whether it meets the requirements to be considered an eligible educational institution.
A new PLR confirms: When multiple beneficiaries inherit an IRA, each beneficiary is independently responsible for any income taxes and/or penalties assessed on their share of the inheritance. Proper accounting must be done to ensure accurate accountability of individual responsibility.
Beneficiaries who inherit IRAs are responsible for paying any income taxes owed on tax deferred amounts that they distribute from the inherited IRAs. If there are multiple beneficiaries of one IRA, each beneficiary is independently and separately responsible for any income taxes owed on his or her share. Taxes are usually assessed on amounts that are distributed, for the year in which the distributions occur. This includes required minimum distributions (RMD).
Inherited IRAs are subject to RMD rules, and failure to take RMDs by the applicable deadline would result in the offending beneficiary owing the IRS a 50% excess accumulation penalty on the RMD shortfall. If an IRA is inherited by multiple beneficiaries, individual beneficiaries are separately responsible for any excess accumulation penalty owed because of any RMD shortfall for his or her inherited share.
Taxation status of moving inherited IRAs to beneficiaries
Generally, when a beneficiary inherits amounts held in an IRA, that amount is moved to an inherited IRA, using the trustee-to-trustee transfer method. The inherited IRA is required to be properly titled in accordance with IRS requirements, which state that inherited IRAs must be registered in the name of the decedent for the benefit of the beneficiary, and the transfer is nonreportable and nontaxable.
Separate RMD requirements for multiple beneficiaries
If an IRA is inherited by multiple beneficiaries, RMD requirements and excess accumulation penalties apply separately to each beneficiary, based on the beneficiary’s separate share of the inherited IRA. Each separate share is determined at the time of the IRA owner’s death, adjusted for gains and losses on a pro-rata basis until the transfers occur. Once the transfers are completed, gains and losses for each inherited IRA is based on the performance of the investments for each of those separate IRAs.
Even though tax return are not due until April 15th, we recommend filing tax returns as soon as possible to get ahead of potential fraudulent filings submitted on your beheld. Traditionally, tax advisors wait to file close to the deadline if a payment is due, but it may behoove you to file early, regardless of whether there is a payment due, to help prevent fraudsters from filing before you.
2. Be vigilant about suspicious emails ,phone calls and text messages.
Email scams may claim to be from the IRS or others in the tax industry, including tax software companies. These emails may ask the recipient to update or provide important information via a link to a website that appears to be an official IRS website but is actually fake. In addition, some of these websites may contain malware.
The IRS urges anyone who believes they may have received a fraudulent tax email not to click any links in the email and to forward the email to phishing@irs.gov.
Tax scams that happen via telephone call or text message often have common characteristics that you can look out for to identify a fake, including:
Fake names and IRS badge numbers. Look out for common names and surnames.
Scammers may know the last four digits of your Social Security number.
The IRS toll-free telephone number can be spoofed on caller ID.
Telephone scammers may follow up with an email containing a link to a fraudulent website that is often malware-infected.
Background noise that sounds like a call center.
Scammers may threaten victims with jail time or driver’s license revocation, then hang up and call back claiming to be the local police or DMV while also spoofing the numbers of these departments on caller ID.
Foreign language use and claims that the call is from a foreign embassy investigating tax nonpayment.
3. Verify Schedule K-1 and W-2 Form Requests
Be sure to password-encrypt K-1, W-2, 1099 and copies of tax documents when sending them via email and do not distribute the password via email. We recommend that you use password-protected portals for transferring such documents.
4. Use a shredder
“Dumpster diving” is more common than most believe. We strongly recommend that you use a modern, crosscut shredder to dispose of sensitive documents that contain personal data, including any disposed tax forms.
5. Validate charities
Fraudulent charities have become common, and attackers use breached email boxes to send support requests for these charities to victims. Before providing a credit card or payment to a charity, validate whether the charity is legitimate.
6. Raise Awareness
Share this information with family, friends, staff and colleagues. Knowledge is the best weapon against scammers. If you or someone you know has been the victim of identity theft or a fraudulent wire transaction, reach out to your local police department and/or the FBI for assistance.
The Tax Cuts and Jobs Act of 2017 is only the latest in a long and controversial history of taxation in the U.S. As you can imagine, no one has ever been gleeful about handing over money to the government. And so the debates continue to rage. As you celebrate the end of another tax season, here is a lighthearted look at this quintessential government function.
Taxes have caused a ruckus in North America longer than the United States itself has existed. They date to the colonial era, when Britain imposed tariffs on various goods as a way to raise revenue for the imperial power. While the actual rates were low, most colonists rebelled against the idea that Britain had the right to impose taxes on Americans when they were not represented in Parliament—the infamous “taxation without representation” that sparked a revolution. Famously, in 1773 the Sons of Liberty protested the Tea Act of 1773 by destroying an entire shipment of tea by throwing it overboard, in what came to be known as the Boston Tea Party.
This was but one in a series of incidents that eventually led to the American Revolution, and eventual formation of the United States of America in 1776. However, even democratic governments need funding, so taxes continued. Tariffs on goods continued to be the main source of state and federal revenue until the early 20 century. And people continued to be upset about it.
The first tax on a domestic product (distilled spirits) was imposed in 1791 to recoup losses from the Revolutionary War. Distilled spirits were a crucial source of income for certain rural farmers, because they were easier to transport than grain. Resentment came to a head in the 1794 Whiskey Rebellion, which required an army of 13,000 to suppress the insurgents. Income taxes got their start in 1861 as an effort to pay for the Civil War. However, constitutionality was in question and the law was repealed 10 years later. It was not until 1913 that the 16 Amendment passed, stating that “The Congress shall have power to lay and collect taxes on incomes, from whatever source derived, without apportionment among the several States, and without regard to any census or enumeration.”
The income tax of 1913 levied a 1% tax on net personal incomes above $3,000, with a 6% surtax on incomes above $500,000. By 1918, the top rate of the income tax was increased to 77% (on income over $1,000,000)—this time to finance World War I. The top marginal tax rate was reduced to 58% in 1922, to 25% in 1925, and finally to 24% in 1929. In 1932, the top marginal tax rate was increased to 63% during the Great Depression and then it steadily decreased. Taxes as we know them continued to develop throughout the 20 century. Reagan’s tax act in 1981 was considered historic for lowering all individual tax brackets by 25%. However, Clinton’s act of 1993 saw taxes raise again. Then, in 2001 George W. Bush reduced tax rates but continued to increase tax credits. And, as you know, in 2017 Trump signed an act eliminating many itemized deductions but increasing the standard deduction, and adjusting tax brackets. How many pages is the tax code, really? A quick Google search will find several articles stating that the tax code stands at a whopping 70,000 pages.
Explaining the bloat, The Washington Examiner writes: Amazingly, in the first 26 years of the federal income tax, the tax code only grew from 400 to 504 pages. Even through President Franklin Roosevelt’s New Deal, the tax code was well under 1,000 pages. Changes during World War II made the length of the tax code balloon to 8,200 pages. Most of the growth in the tax code came in the past 30 years, growing from 26,300 pages in 1984 to nearly three times that length today. If the tax code continues to grow at the same pace it did over the last century, it will pass 100,000 pages in 2050. However, tax attorney Andrew Grossman dismisses this number as a myth. The figure traces back to the Tax Foundation, which cites the pages in the CCH Standard Federal Tax Reporter. What this actually means requires explanation for the average Joe.
The Reporter contains not just the actual tax code, but a compilation of resources for tax lawyers and accountants, including legislative history, Treasury regulations, editorial comments, and court cases on relevant topics. So there is in fact no way to reduce the 70,000 page count, no matter what any politician says. As soon as you make any changes to the tax code, they will be added to the Reporter, in addition to more case studies and commentaries. So how long is the actual tax code itself? According to Vox, the last page of the 2016 version of the Internal Revenue Code numbered 4,132 pages. But the page numbers jump from 527 to 1,001 (no one seems to know why) and the code includes all past tax statutes, not just current laws. They conclude that the current code is only around 2,600 pages. Still a little heavy for bedtime reading. I’m being taxed on what?! As we close, here are some strange but true state taxes that you probably didn’t even realize you were paying, courtesy of efile. New York City places a special tax on prepared foods, so sliced bagels are taxed once as food and again as prepared food, thus creating a sliced bagel tax.
In 2005, Tennessee began requiring drug dealers to anonymously pay taxes on any illegal substances they sold. States like Iowa, Pennsylvania, and New Jersey exempt pumpkins from a sales tax, but only if they will be eaten and not carved. In California, fresh fruit bought through a vending machine is subject to a 33% tax! In Texas, Christmas tree decoration services are subject to a tax only if the decorator provides the decorations and ornaments. In addition, there is a tax on holiday-themed pictures that are meant to be placed on windows. In the state of Kansas, untethered hot air balloon rides are exempt from sales tax because they are considered a legitimate form or air transportation. Tethered hot air balloon rides, on the other hand, are considered to be an amusement ride and therefore are subject to sales tax.
