Jul 05

As my regular readers will recall, I often pass Walden Pond, as I live a few towns away, and while writing at Walden Pond, Thoreau wrote, “Our life is frittered away by detail. Simplify, simplify, simplify! I say, let your affairs be as two or three, and not a hundred or a thousand; instead of a million count half a dozen, and keep your accounts on your thumb-nail.” Partially with this in mind, I like when a bit of proposed tax code aims to provide some level of simplification to our utterly incomprehensible too-long code.

The particular proposal I am looking at today offers to simplify the tax benefits for higher education. as the Ways and Means report states:

  • Under current law, there are 15 different tax benefits relating to education that often overlap with one an other.
  • The current-law education tax benefits are so complicated that they are ineffective because many taxpayers cannot determine the tax benefits for which they are eligible.
  • The IRS publication on tax benefits for education is almost 90 pages long.
  • Streamlining education tax benefits would enable taxpayers to understand better the tax benefits for which they qualify.
  • The provisions would help to simplify considerably the tax benefits relating to education.

The above puts in perspective just how difficult it is for the average parent to navigate their choices amongst the different benefits. The new proposal appears simple, a 100 percent tax credit for the first $2,000 of certain higher education expenses and a 25 percent tax credit for the next $2,000 of such expenses. So far, so good. A total $2500 gift from Uncle Sam to pay for your child’s college tab. Not so fast, a phase out for MAGI between $86,000 and $126,000 for joint filers and $43,000 and $63,000 for other filers. This is a tough one for me. For a Joint filer, that next $20K of income will kill $2K worth of the tax credit. In effect, a 10% extra phantom tax for the AGI between $86K and $106K for that couple. Many people with college age children are not far from retirement, and on my advice, they might be navigating to avoid the phantom tax that will hit retired couples on their social security income. The effect of this phaseout is that a couple will see a phantom 25% rate for income that should otherwise be taxed at 15%, the 15% bracket I suggest that pre-retirees “top off” by converting some money to their Roth IRA. I suppose that any credit such as this one should have a cap, an income level above which one doesn’t qualify. The real question is whether a joint AGI of $86K is the right level for the phaseout. My own opinion is no, I think $125K or higher is more appropriate. What do you think?

It doesn’t end there. The government gives and the government take away. This provision includes the repeal for the exclusion from United States savings bonds used to pay higher education tuition and fees. In other words, you followed the rules, you patriotically bought US savings bonds with the promise that the growth would not be taxed if these were used to fund higher education. Ouch. The estimate is that this will save $100M over 10 years, so only $10M per year or so. But save in this case means that people will be taxed when they weren’t expecting to pay tax on this money.

Other take-aways include the repeal of any student loan interest deduction, the repeal of deductions for qualified tuition, and the end of the Coverdell Education Savings Account (The account formerly known as the education IRA.)

That’s about it. It seems that simplification comes at a price, and anyone who thinks they understand today’s tax code enough to benefit from it had better keep up on changes that our congress may vote on. To miss these changes can be quite costly.

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Mar 17

The estate tax is a tricky beast. Just 15 years ago, Federal estate taxes kicked in at $650K of an estate’s value. This may seem like a large sum, but consider it included all that you leave behind. Your home, saving, retirement accounts, and perhaps the biggest item, life insurance. Biggest, because even if you are just starting out, newlyweds with no savings yet might easily decide to each have $1M life insurance policies. Just putting this number into perspective.

The exemption amount grew each year, up to $3.5M in 2009, and then the tax was repealed for 2010. As a Klingon might have said “This is a good year to die.” It might have been, expect the step up in basis was suspending that year so beneficiaries of those who passed in 2010 were in a unique position, having to research basis for their windfall. 2011 saw the return of the estate tax with a $5M exclusion, and a generous ‘second to die’ provision, in effect, allowing the spouse to pass along the $5M from the first spouse for a $10M total. In 2013, the exclusion was $5.25M.

Now, the 2015 proposed budget….. let me say this, in 2010 when congress was debating what to do, I suggested they pick a number, and offer a modest inflation rate, but stop the crazy swings up and down. They don’t listen. I am seeing a proposal to roll back the exclusion to the 2009 number of $3.5M, no inflation adjustment. It keeps the spouse portability, fortunately.

I see this as upsetting to those it impacts, but I’m sure that couples with $7M in gross assets including insurance, aren’t going to get much sympathy from my readers. If you fall near this number, it’s time to start gifting the $14K/yr to your loved ones.

This bit of new code could have been avoided. The budget could have simply frozen the number at 2014 levels $5.375M (I believe) and stop messing around. And for Pete’s sake, stop calling any code “permanent.” That’s just nonsense.

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Mar 15

I’m back with another proposed change to the tax code pulled from the 2015 Federal Budget.

The current law states that a surviving non-spouse beneficiary under a tax-favored employer retirement plan may roll over assets to an IRA only by means of a direct rollover and that a surviving non-spouse beneficiary under an IRA may move assets to a non-spousal inherited IRA only by means of a direct trustee-to-trustee transfer. This is in contrast to a spouse’s ability to use a 60-day rollover.

The Budget author acknowledges that this difference between how a spouse may treat an inherited IRA vs how a non-spouse is forced to treat it “serve little purpose and generate confusion among plan and IRA
administrators and beneficiaries.”

You might think I’d consider this minor, but it really isn’t. It’s the only bit of code I’ve seen that was written simply to avoid the confusion contained in the original tax code. No change in revenue to the government save for a loss of the penalties it would otherwise have received. I wont hold any hope for this to set a precedent for more cleaning up of our incomprehensible tax code, but it’s there, it’s a start, and a kudo to whoever wrote it.

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Mar 13

What? First I told you that the 2015 Federal Budget proposed RMDs for the Roth IRA, and now I’m saying no RMDs at all. Well, sort of.

The proposal eliminates the RMD from tax favored accounts (IRAs, 401(k)s etc.) if the prior year end balance was $100K or lower. To add a bit of complexity, it’s not a step function, it phases over $100K – $110K, so if your balance were exactly $105K, half the RMD calculated must be taken. More complex? Ok, the numbers will be indexed for inflation.

My assessment of the impact of this proposal? Needless. I look at any changes to the code and ask who it will help and who will it hurt. This will benefit the rare individual who has a sub-$100K IRA, but no need to withdraw any money. When you consider this, it’s an odd combination. I’m not going to lose sleep over this, only observe that the addition of more rules is counterproductive, and I’ll be on the lookout for the unintended consequence that will result – a well meaning retiree hoping to keep her IRA in tact, and passing it on to her kids, who are in the 28% tax bracket, while she might have just taken her RMDs out at 15%.

On a lighter note, I started this series mentioning the Budget and the Treasury’s General Explanations. Today, I discovered another document in the series, the 1438 page Appendix.  A warning, it’s 13.2MB, so be patient if you are going to download it. It gave a remarkably in depth overview of where the money is going. Kind of like your household budget if you add quite a few zeroes.

More to come….

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Mar 11

The budget is out. No, I’m not coming out with my personal budget. It’s a strange mix of stuff on both ends of the spectrum. And I think other people’s budgets are boring, do you really care that my daughter’s dance classes are a priority? I didn’t think so. I’m talking about the budget we should all be interested in, the U.S. Budget. It has something for everyone, and by that, I mean everyone will find something they don’t care for.

Budget2015In case you can’t sleep at night, Fiscal Year 2015 Budget of the U.S. Government can be downloaded right from the White House web site. If that’s not enough, the Treasury offers an even longer (297 pages vs 218) General Explanations of the Administration’s Fiscal Year 2015 Revenue Proposals. I’m still sifting through both documents, and hoping for a Cliff Notes version that will just list the potential changes to the tax code.

Over the next few articles, I plan to highlight what I’ve found, along with comments on the proposed changes. The first -

Harmonize MRD requirements for tax-favored retirement accounts. – this proposal add an RMD to the Roth IRA account. You might know that the Traditional IRA has a provision in which Required Minimum Distributions must be taken the year after one turns 70-1/2. I found it curious that when the Roth IRA was introduced in 1998, it offered a remarkable feature, no RMDs. This created an amazing opportunity for those wishing to leave a significant sum of money to their heirs, with no income tax bill. Note – the Roth inheritance can still trigger the estate tax, but as the funds are post tax, the beneficiary can withdraw money with no income tax due. This opportunity is scaled back by this proposal, as now the Roth IRA will have a post 70-1/2 RMD for those attaining age 70-1/2 after Dec 31, 2014.

My assessment of the impact of this proposal? Minimal effect. The RMD triggers no tax, nor does it pull in other money, such as Social Security benefits to be taxed (yet). If at 71, I take my withdrawals and invest in a stock fund, I need to deal with the dividends, but the capital gain can remain deferred until I pass. On my passing, my beneficiaries get a stepped up basis, so even if we are talking say, a million dollars, a 2% dividend is $20K, and the tax on it, $4000 maximum. Not a million per year, a cumulative million dollars no longer in the Roth, but taken out over more than a decade. The average taxpayer wont lose sleep over this one.

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