Retirement plans

Saving for retirement should be an important financial goal for everyone, no matter their age or income. Everyone has dreams for retirement, whether it is soaking up the sun on a beach somewhere or traveling the country in an RV, and saving for retirement is the key to making those dreams come true. One struggle that people face, especially younger workers, is that retirement is so far away that it's hard to acknowledge the benefit of saving for retirement now, which is why it helps to view a retirement account as both a savings account and a tax reduction tool. In the world of retirement plans, there are a variety of options available for everyone, whether you are an employer, employee, or self-employed.

401(k) plan

This is probably the most common retirement vehicle out there. The 401(k) plan is typically offered by employers, and allows employees to contribute a portion of their wages to an account. The contributions are "pre-tax" meaning that they go in before payroll and income taxes are calculated. The employee usually can direct the investment of the funds within the account, either by buying individual investments or selecting an allocation between mutual funds / ETFs offered within the plan. Employers also have the option (but not the obligation) to make profit-sharing or matching contributions (i.e. free money). The catch is that employee contributions are limited to $17,500 for 2013, and catch-up contributions of $5,500 for employees 50 years old and over.

Individual retirement account (IRA)

The traditional IRA is a useful product for many reasons, but does not carry the same tax deduction characteristics as other retirement accounts. An IRA can be opened by anyone at a participating institution and contributions can be made at any time during the year up to a maximum of $5,500 or taxable compensation for the year. The catch to an IRA is that distributions are almost always taxable, but contributions are not always tax deductible.  In other words, the contributions have the potential to be taxed twice.  For example, for a married filing joint taxpayer that is covered by a retirement plan at work with AGI in excess of $115,000 gets no deduction.  Limits can be found on the IRS website  here.

Roth IRA

The Roth has grown in popularity in recent years due to its tax deferral attributes. The Roth functions almost entirely the opposite as a traditional IRA in that contributions are made "after-tax" i.e. they are still included in your taxable income, but the distributions in future years are not taxable. This is a great resource for someone with the ability to make contributions and still pay the taxes currently such as a young worker with a higher level of disposable income. There are two catches to a Roth, 1) the contribution limit is the maximum of $5,500 or taxable compensation for one year (2013) and 2) taxpayer's with AGI in excess of $188,000 MFJ / $10,000 MFS / $127,000 S cannot make a contribution to a Roth.

All of the options above are also available to self-employed individuals depending on the income level of the business and whether or not it has employees.

The 401(k) and IRA plans can be useful tools in reducing taxable income.  By making higher contributions to a 401(k) plan, an employee's W-2 taxable income will decrease.  Also, if a taxpayer's income is in a certain range, IRA contributions can also help reduce taxable income.  Contributions to a Roth IRA have a different benefit.  Although current contributions are not deductible, distributions from the plan in the future are not taxable, meaning that a taxpayer can experience years of tax free growth for their retirement.

Bonus

One of the better moves made by Congress at the end of 2012 was to extend the 50% bonus depreciation allowance to 2013. This is a great resource for businesses, but is often confused with its less beneficial counterpart, the Section 179 depreciation allowance. Bonus depreciation allows a business to expense 50% of the original cost (depreciable basis) of a qualified asset in the year of acquisition. The taxpayer can then take normal depreciation on the remaining 50%, beginning in the first year. For example, if a business buys a $5,000 piece of equipment, they can expense $2,500 in the first year plus the normal depreciation on the remaining $2,500. This is why it's called "bonus" depreciation - because you get your normal depreciation, plus a "bonus" of 50%.

Bonus depreciation has benefits that make it more useful than Section 179 in some cases. There is no income limitation, which means a business is eligible to take advantage of bonus depreciation no matter their level of income (or even loss). As a matter of fact, bonus is considered to be automatic, and the taxpayer actually has to elect not to take it. Bonus is also elected by "class life" instead of by specific asset.

Bonus can be helpful because, unlike Section 179, it can be used to reduce taxable income below zero. Using bonus to create a loss can be an especially helpful planning tool for 2013. With the 50% special bonus depreciation allowance slated to go away in 2014, a taxpayer can take advantage of the special allowance in 2013 by making as many planned PP&E acquisitions as possible. By utilizing bonus depreciation, the taxpayer can push their company into a loss for 2013, and the net operating loss (NOL) can be carried forward to 2014 (and future years) and used to offset ordinary income.

In some cases, electing out of bonus is a better decision for a business. For businesses that do not turn over PPE very often and count on depreciation each year to keep their taxable income down, bonus might not be ideal. It will provide a 50% write-off in year one, but the depreciation expense in each subsequent year will be significantly lower. Also, some states (such as my state of Arkansas) do not conform to the same rules as the IRS, which can create a Federal to State difference in depreciation. Although this is not a reason in itself to elect out of bonus, it does require the taxpayer to keep a record of the Fed to State difference in future years.

Thanks to my colleague for suggesting this topic. Have something you want to hear about? Email me.

Haircuts

How often do you get a haircut?  On average, I get a haircut every two weeks.  If I don't get a haircut regularly, I start to look funny.  Although the frequency with which you visit the barber or hair salon is at your discretion, if you are a high-income taxpayer, you might be getting an extra haircut in 2013 that you didn't know about. As a part of the new tax laws implemented at the end of 2012, the IRS will be giving high-income taxpayers their own haircut through the provisions known as PEP and Pease.  This refers to the phaseout of personal exemptions (PEP) and certain itemized deductions (Pease) when adjusted gross income (AGI) reaches a certain amount.  The AGI limit is different based on your filing status, which can be Single (S), Head of Household (HOH), or Married Filing Jointly (MFJ).

Personal exemptions

Personal exemptions are allowed to reduce adjusted gross income (AGI) in arriving at taxable income.  Taxpayers typically receive one exemption for themselves, their spouse, and dependents.  For instance, if you are a married taxpayer with two dependent children, you are allowed four personal exemptions.

The personal exemption amount for 2013 has been set at $3,900.  However, the exemption amount will begin to phase out when AGI reaches $250,000 (S) / $275,000 (HOH) / $300,000 (MFJ) and phases out completely at $372,500 (S) / $397,500 (HOH) / $422,500 (MFJ).  The exemption is reduced by 2% for every $2,500 over the AGI limit.

Example: Bonnie and Clyde are married taxpayers with three children.  Their AGI is $330,000 and their personal exemption amount is $19,500.  Their AGI exceeds the limit by $30,000 and therefore their personal exemptions are reduced by $4,680 ($30,000 / $2,500 x 2% x $19,500).

Itemized deductions

Itemized deductions consist of specific expense items that are permitted to be deducted on an individual tax return, the most common of which are medical expenses, state taxes paid, charitable contributions, and mortgage interest.

Itemized deductions will be limited when AGI reaches $250,000 (S) / $275,000 (HOH) / $300,000 (MFJ).  When these limits are reached, itemized deductions will be reduced by an amount equal to the lesser of 1) 3% of AGI or 2) 80% of certain itemized deductions.  All itemized deductions are subject to the 80% calculation except for qualified medical expenses, interest expense, and casualty/theft losses.

Example: Bob is a single, unmarried doctor.  His AGI is $285,000 and he has total itemized deductions of $50,000.  Of these deductions, $10,000 is interest expense.  His itemized deductions are therefore reduced by $8,550, which is the lesser of 3% of his AGI ($285,000 x 3% = $8,550) and 80% of certain itemized deductions (($50,000 total itemized deductions - $10,000 interest expense) x 80% = $32,000).

Conclusion

If you are a high-income taxpayer, you will most likely be affected by one or both of these provisions.  There are still 3 months left in the year, which is plenty of time to consult a tax professional on ways to reduce the impact of the PEP and Pease on your individual situation.  This will ensure that the only haircut you have to worry about is the one you get every two weeks.

Charity

An area that can be considered as one of the most hotly contested on a tax return is charitable contributions. Charitable contributions can be made to qualified organizations in either monetary or non-monetary form. This could be as simple as putting a check in the offering plate at church on Sunday morning, or more complex, such as a charitable remainder trust. Following are some things to keep in mind as you select a charity to contribute to, how to determine what to contribute, and your recordkeeping responsibilities to justify your deduction. Type of charity

When donating to a charity, it's important to know what kind of charity it is. Most charities that you will contribute to are qualified non-profit organizations under the proper Internal Revenue Code section, such as 501(c)(3). Large national/international charities like the American Cancer Society or the United Way, and the majority of organized churches, fall under this category. But there are other types of organizations, like private operating foundations, that do not fall in the same category. Knowing the kind of charity you're giving to is important because contributions are limited to a certain level of your adjusted gross income (AGI). The deduction for contributions to qualified organizations are typically limited to 50% of AGI, whereas contributions to private operating foundations can be limited to 30% or 20% of AGI.

Cash is king

When contributing to a charity, cash is king for two reasons. First, this is the easiest way for you to keep up with your contribution; you write the check, and the charity will send you a receipt saying that you contributed $xx, and that no goods or services were received in exchange for the contribution. Second, cash is the best asset for them to support their programs. With cash they can buy supplies and pay their employees, as opposed to if you contributed a car, which they would have to maintain or sell.

What do I keep?

As mentioned above, when making a contribution to a qualified charity, they should issue you a receipt. You should keep these with your tax documents to support your deduction if you are ever audited by the IRS. Charities that receive non-cash contributions are getting pretty good about issuing receipts as well, such as Goodwill or Habitat ReStore.

There are some contributions that, regardless of what kind of paperwork you come up with, are not deductible. For example, payments to individuals and support of political organizations are usually not deductible.

Benefits of a paid preparer

The United States of America is a great country.  We have many freedoms, a democratic government, and as a population we have to opportunity to chase the American dream and live our lives as we please.  But those benefits come with a price.  As I like to say, "America is the greatest country club in the world, and the membership fees are the taxes that we pay." For most Americans, getting together tax information, figuring out how to report it to the IRS, and filing a tax return can be a cumbersome and stressful process.  To alleviate some of this stress, consider hiring a paid tax preparer.  There are many benefits to engaging a paid preparer to do your taxes.

We know the rules

The tax code is complicated.  Without a full knowledge of the code, you are likely to report income incorrectly or miss deductions.  CPAs know the code and know how to report your information.  They also know the differences between Federal tax code and states in which you might have to file.  They can also help if you get a nasty letter from the IRS and amend previous tax returns if necessary.

We can help you through life changes

Whether you just bought a house or had a child, got divorced or had a death in the family, CPAs know how to guide you through life changes.  They can make sure that you report your situation transparently and accurately, and also explain to you what it all means.

We keep you up to date

Not a day goes by when I don't read something or see something on the news and think "wow, that really might affect my client."  We worry about your taxes so you don't have to, and we keep you up to date on the changing landscape to help you plan during the year.

It's important to find a tax preparer that you trust, that understands your business and family, and that takes a genuine interest in your situation.  Don't be afraid to be honest with your preparer, especially about deadlines and fees.  Instead of stressing about your taxes, let a CPA help and rest easy knowing you are taken care of.