The tax code contains a not-so-secret secret: the tax break for “net unrealized appreciation,” which can help you save tax dollars when you have employer stock in your retirement plan. Here’s how the break works.
Normally, you can accumulate assets in a qualified retirement plan at work, such as a 401(k) plan, without paying any current tax until you take withdrawals from the plan. At that point, distributions are taxed at ordinary income tax rates, which can be as high as 39.6%. The result: you could face a hefty tax bill when you retire and begin taking distributions.
However, if your account consists in total or in part of your employer’s stock, and you take a lump-sum distribution in the form of stock instead of a cash payout, you can defer part of the federal income tax. In that situation, your cost basis in the stock is taxed at ordinary rates at the time of distribution (you may also owe a penalty). Tax on the difference between your basis in the stock and the value at the date of the distribution — the net unrealized appreciation — is deferred until you sell the stock.
Here’s an example. Say you’re holding 20,000 shares of company stock in your 401(k). You bought the stock at an average price of $10 a share, so your basis is $200,000. Currently, the stock is valued at $50 a share, for a total of $1 million. You expect to be in the 39.6% bracket in retirement.
If you roll your retirement account into an IRA to defer tax and take distributions from the IRA when you retire, those distributions are taxable at your ordinary tax rate. But if you take an immediate lump-sum distribution from your retirement account in the form of company stock, in the current year you’ll pay income tax on your cost basis of $200,000. The net unrealized appreciation is not taxed until you sell the stock. At that point, you’ll use long-term capital gain rates to calculate the tax on the appreciation (including any additional appreciation from the date of the distribution). The potential saving is the difference between your ordinary tax rate and the generally lower capital gain rate. Be aware the 3.8% net investment income tax may apply.
To qualify for this tax break, the stock distribution must come from a qualified retirement plan, be due to death, attaining age 59½, or separation from service, and be made in a single tax year. Because the rules can be complex, we urge you to contact us for an explanation of your options.
Are you transferring money between retirement accounts? Be aware of the rollover rules, which govern the tax treatment of retirement plan distributions.
The key to rollovers is timing. The funds you withdraw must be deposited in another account within 60 days of receipt. If you miss the deadline, the payout is treated as a distribution that is taxable at ordinary income rates, which can reach as high as 39.6%.
Another caution: When you receive a qualified retirement plan distribution, income tax will be withheld, even if you intend to roll over the funds to an IRA within 60 days. But to avoid penalties, you have to roll over the entire distribution, meaning you’ll need to replace the withheld amount with other funds. You can’t get a refund of the tax withheld from the original distribution until you file your income tax return.
What if you roll over the net amount instead of replacing the withholding with other funds? You could be hit with a 10% penalty tax for withdrawals from a retirement plan prior to age 59½, unless you qualify for an exception.
Fortunately, tax rules offer a simple alternative to rollovers known as a “trustee-to-trustee transfer.” The term means instead of you taking possession of the money, your plan administrator transfers your distribution directly to your new IRA trustee or custodian. This kind of transfer eliminates the need for withholding, as well as the need to keep a close eye on the calendar.
Contact Carl Heinemann, your Chattanooga CPA, if you have questions about your retirement accounts. We’ll help you steer the right course.
As the year-end holidays approach, it may be time to empty out your health flexible spending account (FSA). Here’s an overview of the tax rules for these accounts.
- The tax savings. If your employer offers a health FSA as a fringe benefit, you can fund your account through pre-tax contributions. That means you save on both income and payroll taxes. Withdrawals made during the course of the year are exempt from tax as long as the money is used to pay for qualified expenses.
- Contributions. Annual contributions to your health FSA are limited. The limit for 2016 is $2,550. For 2017, the limit will be $2,600.
- Qualified expenses. The list of qualified expenses ranges from prescription drugs to wheelchairs and generally mirrors those that would be deductible as itemized medical costs on your personal federal income tax return.
- Why you might need to empty your account. Under the basic “use it or lose it rule,” funds remaining in your account at year-end are forfeited. To avoid that outcome, you might want to schedule routine doctor and dentist visits, such as a medical exam or dental cleaning, in December. However, your employer can extend the deadline by authorizing a grace period of up to 2½ months after the close of the year. Alternatively, your employer could allow you to carry over up to $500 to 2017.
For more tax planning advice, give Carl Heinemann, your Chattanooga CPA, a call.
The IRS isn’t giving up its job as the nation’s tax collection agency, but it is farming out some of the work. Starting this spring, four private contractors will begin helping collect delinquent tax accounts. The outsourcing was authorized by a law passed last summer, but this isn’t the first time outsiders have been called on to collect back taxes. The tactic was tried twice before.
This time, turning debt over to private collectors will be limited to situations when the IRS hasn’t been able to collect due to a lack of resources or inability to locate the delinquent taxpayer. The IRS can also turn over the debt when more than one-third of the statute of limitations has expired and no IRS employee has been assigned to collect the debt, and when the tax bill has been assigned for collection, but more than a year has passed without any action.
Private collectors won’t be used in certain cases, such as when an offer-in-compromise or an installment agreement is pending or active. Innocent spouse cases won’t be turned over either, nor those involving deceased taxpayers, taxpayers who are under age 18, or who are victims of identity theft.
And what about identity theft and scam concerns? Private collection agencies must identify themselves as contractors of the IRS. In addition, employees of the collection agencies are required to follow fair debt collection laws, be courteous, and respect taxpayer rights. Finally, those who owe back taxes will still make payments to the Treasury Department, not to the private contractors.
If you need assistance getting caught up with back returns, please contact our office.
You approach the cash register at a local clothing store and place your selections on the counter. Before ringing up your purchase, a friendly sales associate asks, “Would you like to apply for a store credit card? Apply now and you’ll receive a 10% discount on your purchase.” Should you accept the offer?
Before you sign on the dotted line, take time to consider the pros and cons. Some store credit cards are issued on a “closed loop,” meaning the card is only good at the sponsoring retailer. Other store cards are considered “open loop” or “co-branded.” Such cards carry the MasterCard, Visa, American Express, or Discover logo, indicating that the network issuer stands behind the card. Approval for co-branded cards is generally harder to get, but the cards can be used at a wide variety of retailers.
If you’re trying to build credit, store-branded credit cards may help you achieve your goal. Stores frequently offer low credit limits on branded cards and you may get approval even if your credit score is not stellar. But consider another factor. A major component of your credit score is the credit utilization or debt-to-credit ratio. If you have a Visa card with a $3,000 credit limit and you charge $300, that ratio equals 10%. Charge the same amount on your store credit card and the card may be maxed out, possibly damaging your credit score.
Although store-branded credit cards typically do not charge an annual fee, retailers make money by charging high interest rates. For example, rates for America’s largest retailers often exceed 20%. In contrast, credit cards issued by the major networks may range between 13% and 15%.
Is it ever a good idea to apply for a store-branded credit card? Perhaps. If you regularly shop at a particular store and expect to take advantage of discounts for items you typically buy, a store-branded card may make sense. Higher interest rates may be irrelevant if you’re in the habit of paying off your credit cards in full every month. But before you apply, take a hard look at your spending habits and be sure to read the fine print.
If you have questions about sound financial management, contact Carl Heinemann, your Chattanooga CPA.
As the owner of a fledgling business, you may dream of customers lining up at your door, ever-increasing orders flowing from your website, and sales going through the roof. But when sales skyrocket, you may get distracted and begin to confuse short-term surges in revenue with long-term profitability. Although sales growth is one factor that distinguishes a vibrant company from peers, rapidly increasing sales can capsize a business that isn’t adequately prepared. If your company is entering a phase of brisk and perhaps unexpected growth, be aware of the risks.
- Staff struggles. As the demand for products and services grows, you may ask existing employees to work harder and longer. Some may begin to feel dissatisfied and stressed, which can result in escalating turnover. If remaining employees are asked to take up the slack for former colleagues, quality may suffer. Although hiring more staff is one solution, it’s crucial to hire carefully. Be sure the employees you bring onboard have the right mix of skills and experience. Through careful interviewing and research, find employees who fit your company culture and can work well with your existing team. Adding more people doesn’t automatically translate into more productive operations.
- Customers first. When sales climb sharply, take care to not neglect existing customers. Otherwise, the customer service reputation that built your company may deteriorate. Don’t give the people who have remained loyal to your company a reason to leave.
- Accounting matters. If you’re managing a small company, a pad of paper and a simple spreadsheet may suffice to keep tabs on income, expenses, and profit. As the company grows, however, accounting transactions tend to become more complex. Installing a robust accounting system and seeking professional advice can keep your business on track during periods of rapid growth.
- Stay focused. When revenues increase sharply, concentrate on your core values and mission. Keep current strategies in sync with your overall vision. Review your organizational structure, marketing plans, and supplier relationships regularly to avoid the trap of crisis management. Keep your banker in the loop to ensure that cash flows remain stable.
If your business is growing faster than expected, give Carl Heinemann, your Chattanooga CPA, a call. We’re here to help.