Track your IRA basis

 

What's your definition of basis? When it comes to your taxes, you might think of the amount you paid for an asset, such as your home or a security, less certain adjustments. But you may also have basis in your traditional IRA — and tracking that basis can save you tax dollars.
You get basis in a traditional IRA when you make contributions that are not deductible on your federal income tax return. Later — the save-you-money part — when you take distributions or convert your traditional IRA to a Roth, the basis reduces the amount you report as taxable income.
Does that mean you can withdraw or convert only your basis and owe no tax at all? Unfortunately, no. The reason is a pro-rata rule. It works like this: You figure the taxable portion of distributions by dividing your basis by the total year-end balance of all your IRAs. Each distribution is partly taxable and partly tax-free.
Knowing your basis can help heirs, too. When your beneficiaries inherit your IRA, they also inherit your basis.
Track your nondeductible contributions on IRS Form 8606. The form does not need to be filed every year, so be sure to keep a copy of the latest one.
If you need help constructing IRA basis from prior years, please give us a call at (949) 453-1521. $$

 

Check out Coverdell ESAs for college savings

You're probably familiar with 529 college savings plans. Named for Section 529 of the Internal Revenue Code, they're also known as qualified tuition programs, and they offer tax benefits when you save for college expenses.

But are you aware of a lesser known cousin, established under Section 530 of the code? It's called a Coverdell Education Savings Account and it's been available since 1998.

The general idea of Coverdell accounts is similar to 529 plans — providing tax incentives to encourage you to set money aside for education. However, one big difference between the two is this: Amounts you contribute to a Coverdell can be used to pay for educational costs from kindergarten through college.

Generally, you can establish a Coverdell for an under-age-18 child — yours or someone else's. Once the Coverdell is set up, you can make contributions of as much as $2,000 each year. That maximum is reduced when you're married filing jointly and your modified adjusted gross income reaches $190,000 ($95,000 when you're single).

Anyone, including trusts and corporations, can contribute to the account until the child turns 18. There are no age restrictions when the Coverdell is established for someone with special needs.

While your contribution is not tax-deductible, earnings within the account are tax-free as long as you use them for educational expenses or qualify for an exception. In addition, you can make a tax-free transfer of the account balance to another eligible beneficiary, to a different custodian, or to a 529 plan.

Qualified distributions from a Coverdell are tax-free when you use the money to pay for costs such as tuition, room and board, books, and computers.

Please call us at (949) 453-1521 for information about other rules that apply to Coverdell accounts. We'll be happy to help you decide whether establishing one makes sense for you$$

A tax credit is available for adoptions

Together you make a family.

Is this the year you'll become an adoptive parent? In addition to the benefits of family togetherness, you might also qualify for a special break on your income tax return. The federal credit for qualified adoption expenses became permanent in January.

As you know, tax credits save you money by reducing the amount you owe dollar-for-dollar. In the case of the adoption credit, you may be able to save up to $12,970 on your 2013 federal income tax return for expenses you pay during the process of adopting a child.

Be aware the credit is subject to a phase-out — that is, the amount you can claim is reduced once your 2013 modified adjusted gross income (MAGI) reaches $194,580. No credit is available when your MAGI is $234,580 or more.

In general, the credit is based on total out-of-pocket expenses including adoption fees, amounts you paid your attorney, court costs, and your meals and lodging while away from home. However, when you adopt a special needs child and qualify for the credit, you can claim the full $12,970, regardless of how much you spent during the adoption process. In addition, you may also be able to exclude from income certain adoption benefits provided by your employer.

The credit is typically available for both foreign and U.S. adoptions. For domestic adoptions, you can claim it even if your attempt to adopt was unsuccessful.

Other tax breaks are available for new parents. Please call us at (949) 453-1521 if you would like details$$

Happy 4th of July!

Many tax planning questions arise after Supreme Court's DOMA decision

On June 26, the U.S. Supreme Court held that Section 3 of the federal Defense of Marriage Act (DOMA) is unconstitutional (E.S. Windsor, SCt., June 26, 2013). Immediately after the decision, President Obama directed all federal agencies, including the IRS, to revise their regulations to reflect the Court's order. How the IRS will revise its tax regulations - and when - remains to be seen; but in the meantime, the Court's decision opens a number of planning tax opportunities for same-sex couples.

Background

The Supreme Court agreed in 2012 to hear an appeal of a federal estate tax case. Due to DOMA, the surviving spouse of a same-sex married couple was ineligible for the federal unlimited marital deduction under Code Sec. 2056(a). The survivor sued for a refund of estate taxes. A federal district court and the Second Circuit Court of Appeals found unconstitutional Section 3 of DOMA, which defines marriage for federal purposes as only a legal union between one man and one woman as husband and wife.

Supreme Court's decision

In a 5 to 4 decision, the Supreme Court held that Section 3 of DOMA is unconstitutional as a deprivation of the equal liberty of persons that is protected by the Fifth Amendment. Writing for the five-justice majority, Justice Anthony Kennedy said that "DOMA rejects the long-established precept that the incidents, benefits, and obligations of marriage are uniform for all married couples within each State, though they may vary, subject to constitutional guarantees, from one State to the next." Kennedy explained that "by creating two contradictory marriage regimes within the same State, DOMA forces same-sex couples to live as married for the purpose of state law but unmarried for the purpose of federal law, thus diminishing the stability and predictability of basic personal relations the State has found it proper to acknowledge and protect."

Chief Justice John Roberts, who would have upheld DOMA, cautioned that "the Supreme Court did not decide if states could continue to utilize the traditional definition of marriage." Roberts noted that the majority held that the decision and its holding "are confined to those lawful marriages-referring to same-sex marriages that a State has already recognized."

Tax planning

The Supreme Court's decision impacts countless provisions in the Tax Code, covering all life events, such as marriage, employment, retirement and death. The affect on the Tax Code cannot be overstated. It is expected that the IRS will move quickly to clarify how the decision impacts many of the more far-reaching provisions, such as filing status and employee benefits. Other provisions, especially the complex estate and gift tax provisions, will likely require more time from the IRS to issue guidance.

For federal tax purposes, only married individuals can file their returns as married filing jointly or married filing separately. Because of DOMA, the IRS limited these married filing statuses to opposite-sex married couples. The IRS is expected to issue guidance. Same-sex couples who filed separate returns may want to explore the benefits of filing amended returns (as married filing jointly), if applicable. Our office will keep you posted of developments.

Among the other provisions in the Tax Code affected by the Supreme Court's decision are:

• Adoption benefits
• Child tax credit
• Education tax credits and deductions
• Estate tax marital deduction
• Estate tax portability between spouses
• Gifts made by spouses
• Retirement plans

Looking ahead

Will the federal government look to where the same-sex couple was married (state of celebration) or where the same-sex couple reside (state of residence) for purposes of federal benefits? The Supreme Court did not rule on Section 2 of DOMA, which provides that no state is required to recognize a same-sex marriage performed in another state. At the time of the Supreme Court's decision, 12 states and the District of Columbia recognize same-sex marriage.

In some cases, the rules for marital status are determined by federal regulations, which can be changed without action by Congress. In other cases, the rules are set by statute, which would require Congressional action. Sometimes, a federal agency follows one rule for some purposes but another rule for other purposes. Generally, the IRS has used place of domicile for determining marital status. Our office will keep you posted of developments.

If you have any questions about the Supreme Court's decision and its impact on tax planning, please contact our office at (949) 453-1521 $$