Divorce Tax Tips

Divorce Tax Tips
Undergoing the throes of divorce can be pretty traumatic.  There are many issues that must be handled. When it comes to tax and financial matters, there are numerous important areas that, if handled properly, can lead to a successful–and less financially damaging conclusion.  There are 7 main issues that impact divorce and they are outlined in this text.  Here are a number of tips on certain steps to take to make things go better.

1. Alimony
This is one of the most common issues in divorce.  Basically, a qualified alimony payment is deductible by the payor and taxable to the recipient.  In order for the payment to qualify it must be unallocated–that is, not specified as support for children.  It must be an actual payment for items directly on the financial behalf of the ex-spouse; and the payments must end at death or re-marriage of the ex-spouse.  Some third party payments (as part of the decree), may be allowed as alimony.  Some examples are: medical expenses, life insurance, and certain payments for jointly owned residences. 

Child support payments should not be "sneaked" in as alimony.  If alimony payments are tied in to age or events in the children's lives, this could be grounds for denial as alimony by the IRS.

Further, alimony shouldn't be a disguised property settlement.  As such, there are parameters on the terms of payment, and the amount the alimony can vary from year to year.  If payments fall by more than $15,000 in year two or year three, prior alimony payments may be ruled invalid as to deductibility, under current IRS tax rules.

2. Children
The two areas of concern here are child support payments, and who gets to claim the children as dependents for tax purposes.  Basically, child support payments are not deductible by the payor, nor income to the recipient.  Further, if the payor becomes delinquent in making child support payments, any alimony payments being made may be disqualified as a deduction until child support payments are current.

Regarding the dependency question: Who gets to claim the kids for tax purposes?  It is generally determined by the primary custodial parent; with whom did the child live the majority of the year?  This is the person who usually gets to claim the deduction.  There is an exception if the non-custodial parent has a written statement from the custodial parent waiving the right to claim the dependency exemption.

3. Property Settlements
This is a tax-planning area that requires careful thought, and some attention to detail.  The overriding issue is the IRS rule that, for all divorces after July 18, 1984, any transfer of property is no longer subject to income tax liability by the transferor.  But, the basis of the property being transferred is treated like a gift; the recipient takes over the property with the same basis as the payor– not the fair market value at date of transfer.  This can result in major tax consequences if it is not handled properly.

For instance, if the couple had a stock that was worth $80,000 at transfer date, but only cost $10,000, the recipient would have a potential capital gain of $70,000.  If they also had a bank account with $80,000 in it, there would be no capital gain problem.  So the nature of the asset, and its appreciated value become important issues–and important bargaining tools in a divorce.

If property is in joint names when sold instead of being transferred to one spouse, any gain on the sale will normally be taxed 50/50.  This is true even if the divorce decree specifies that one party is to receive more than the other.  However, if the property has been transferred prior to sale, the entire gain is taxable to the seller, even if all the proceeds go to the other spouse.  This is an area that frequently is misinterpreted by attorneys, so care must be taken to get good tax advice prior to any agreements to avoid potential inequities.

These same rules apply to a primary residence, with further complications due to special wrinkles in the tax codes involving sales of primary residences.  According to present tax laws, if you sell a primary residence that has appreciated, you can exempt up to $250,000 as a single filer, and up to $500,000 as joint filers.  Thus, a possible planning opportunity exists here if the house has potential capital gains in excess of $250,000 , and both names are on the property.  It may make sense to sell it before divorce instead of transferring title to one spouse and then selling it.  An extra $250,000 in capital gains may be exempt. 

4. Estate Planning, Beneficiary Adjustments
When divorce occurs, this can have a major impact on any prior estate planning techniques (such as trusts, title ownership), so it must be immediately reviewed.  Similarly, Wills must be reviewed and altered.  If there are any life insurance policies, pension or profit- sharing plans, IRA's, Keogh's, or SEP's, these must be reviewed to see if beneficiary names need to be changed.  Otherwise, money may end up going to the wrong people.

If the overall taxable estate exceeds $5,000,000 (indexed for inflation), all the previous estate-planning techniques that the couple used prior to divorce may have to be revised.  This should be considered and changed as soon as possible after divorce.

Similar care should be taken to review health insurance plans, home and auto insurance, living wills, and any durable powers of attorney to see if names and directions need to be changed.

5. IRA'S & Pensions
Many divorce settlements require a division of IRA or other pension/profit sharing savings.  How this is handled can make a huge difference in taxes and penalties.  Basically, if done properly using IRS Code Section 408(d), an interest in an IRA or pension can be given to an ex-spouse without tax consequence to the payor.  However, if not done properly, it could be taxable to the payor, and if the payor is under age 59½ there could also be a 10% penalty.  The proper way to do this is with a Qualified Domestic Relations Order.  What this does is to accept the ex-spouse as an alternate payee so the distributions go directly to the ex-spouse instead of the plan participant.  In effect, it passes the tax and penalty burden to the ex-spouse.  If the ex-spouse rolls the money into an IRA, the tax burden can be shielded by the ex-spouse as well.

6. Timing Issue
The IRS rule on divorce and marriage is simple.  You are considered married or divorced for the entire tax year, no matter when the event occurred during that year.  Thus, if you are divorced on the last day of the year, your tax return gets filed as if you were divorced for the entire year.  This can have serious tax consequences since tax rates vary for Married Filing Joint vs. Single vs. Married Filing Separately, and according to one's separate taxable income.

So a divorcing couple should do a "pro-forma" tax return using joint vs. single filing to properly plan for the best time to finalize the divorce.  This is especially true if the divorce is pending during the last few months, weeks, or days of a given tax year.  Timing can be everything here!

7. Adjust Your Withholdings
Many people forget to do this after divorce.  You should reconsider how to file your W-4 form at work or your estimated tax vouchers if you pay any of your taxes directly to the taxing authority.  Since your filing status has changed, this can have a marked impact on your tax liability, your allowable deductions and exemptions (especially if your income exceeds certain levels).  A quick call to your tax accountant is in order here.

Tips Regarding Divorce
Here are a few tips that could save you thousands of dollars:

1. Get a lawyer who specializes in divorce if you expect a nasty fight.  If you use your "pal" or a generalist you could get "financially slaughtered" in the divorce.

2. Legal fees in divorce are usually not deductible unless they involve alimony issues, or tax advice.  Additionally, legal fees related to property settlement can be added to the basis of the property, hence ultimately deductible.  However, the lawyer must separately state the amount of legal fees paid for these items.  Work out the deal with the lawyer before you pay the bill to maximize your possible tax deductions here.  Some lawyers may not be as cooperative in this area once they have been paid.

3. Try to reach general agreements with your spouse on property splits and issues related to children before going to Divorce Court.  Consider using a Divorce Mediator before having your attorneys "duke it out" in court at your expense.  It can save a great deal of money.

4. Make copies of all financial and tax records for each spouse so after divorce you can each set up your own tax files.  This is especially true for property that will not be sold on or before divorce.

5. If estimated taxes have been paid prior to divorce, and if a tax refund or tax liability is expected upon filing, decide on the split before divorce.

6. If you will be divorcing and you have no credit card in your own name, try to get one prior to divorce.

7. If one of the spouses has been filing as a sole proprietor and/or any potentially damaging tax issues may exist on any joint returns previously filed during the marriage, work out a settlement of possible damages to the innocent spouse.  Keep in mind that the IRS position on a joint return is that either spouse can be held liable for the taxes owed by the other even after divorce, unless the "innocent souse " doctrine can be proven.

8. Close out all joint checking accounts, bank accounts, and credit cards as soon as possible.

9. Remember that any outstanding debts jointly signed for can be chargeable to either spouse, so account for this potential disaster in the divorce settlement.

Conclusion
While contemplating divorce can be a sad matter, one is no longer in the minority.  Statistics show that over 50% of all marriages now end in divorce.  The important thing to remember is to cut your losses.  But do it the smart way.  Careful planning ahead of time with the appropriate advisors can save a fortune in taxes – and further grief.

Reference: Practice Enhancers, Able & Co.

Tax Rates & Brackets

Tax Rates & Brackets 
"What's my tax bracket?" is a very important –and commonly asked– question.  First, it lets you know how much tax you must pay the government, and second, it affects how much after-tax savings certain deductions can generate, as well as how much after-tax return certain investments generate, under current rules.
In actual fact, there are two important tax rates for everyone:
• Marginal Tax Rate and 
• Effective Tax Rate (sometimes called "Overall Tax Rate").

Marginal Tax Rate
This rate is very important for tax planning purposes.  In effect, it is the tax rate you pay on the last dollar of net taxable income, hence the term "marginal."  Under our current tax laws, there are several tax brackets; the more money you make, the higher the tax for that portion –or bracket– of money.  For instance, a single individual with a taxable income of $400,000 would pay federal tax as follows:  10% on first $8,500, 15% on the first $26,000, 25% on the next $49,100, 28% on the next $90,800, 33% on the next $204,750 and 35% on the remaining $20,850, based on the 2012 tax rate schedules.

Thus, in this example,  the marginal rate would be 35%, and the taxpayer would pay 35 cents on every extra dollar earned above the $379,150 level already being taxed.  It also means this taxpayer would save 35 cents on every extra dollar of tax deductions at this level.  Examples of these allowable federal deductions are such items as interest expense, donations, taxes, medical, and miscellaneous business expenses, to name a few.  Taxpayers who also have deductions in such areas as rental property, capital losses, retirement plan deductions, and businesses of their own follow the same pattern.

Finally, this marginal rate is important in evaluating the true return on different types of investments.  By analyzing the gross income from the investment vs. the actual, after-tax yield, a "common denominator" can be found among various investments.  So, if the taxpayer in the example we used made an extra investment that yielded 10%, the actual, after-tax yield on this from a marginal tax rate standpoint would be 10% less the 35% tax, or 6.5%.

Let's use dollars to make the conceptualization easier.  Assume you make an investment that costs $10,000 and returns $1,000 (10%) in taxable income.  If your marginal tax rate is 35%, then $350 must be paid in taxes, leaving $650, or 6.5%.

Again, the same type of analysis applies to state taxes paid on a marginal basis.  This becomes especially important from an after-tax analysis in comparing taxable vs tax-free investments such as municipal bonds, or U.S. obligations such as treasuries.

In fact, the state marginal tax rate can be defined even more technically when you assume that state income taxes will be deductible on the federal tax return.  In this case, the state taxes are actually less because of the federal tax savings due to their deductibility.  As an example, if your state marginal tax rate were 4%, and your federal marginal tax rate were 35%, than the actual state, after-federal-tax marginal rate would be 3.65% which is the 4% less the federal tax savings of 35 cents on the dollar of deductions.

As you can see, the higher your income, the higher the marginal tax rate, and the more important this after-tax analysis becomes when it concerns your deductions, or your investments.

Effective Tax Rate (sometimes called "Overall Tax Rate")
This is exactly as it sounds; it's an average figure based on the total amount of tax you pay divided by your gross taxable income.  Thus, if you paid $5,000 in federal taxes, and your gross taxable income was $33,400 as a married filer, your Effective Tax Rate ("Overall Tax Rate") would be 15%.  In effect, you paid 15% of your gross taxable income to the federal government.  So, everything else being equal, you could budget that amount as your reserve for federal taxes.

The same type of analysis applies for state income taxes paid.  If your state tax amounted to $1,000 in the above example, your state Effective Tax Rate ("Overall Tax Rate") would be 3% before allowance for federal deductibility of these state taxes.

The effective tax rate is often a more accurate representation of a taxpayer's tax liability than its marginal tax rate.   Two companies that are in the same marginal tax bracket, for example, may end up with different effective tax rates depending on their earnings.  This occurs particularly with a progressive, or tiered, tax system, where different levels of income are taxed at different rates. Your effective tax rate is the rate you actually pay on all of your taxable income. You find your annual effective rate by dividing total tax you paid in the year by your taxable income for the year.  Your effective rate will always be lower than your marginal tax rate, which is the rate you pay on the income that falls into the highest tax bracket you reach.

For example, if you file your federal tax return as a single taxpayer, had taxable income of $75,000, and paid $12, 510 in federal income taxes, your federal marginal tax rate would be 28% but your effective rate would be 16.7%. That lower rate reflects the fact that you paid tax on portions of your income at the 10%, 15%, and 25% rates, as well as the final portion at 28%.  

Under progressive tax systems, one pays different rates for different amounts in income.  For example, one may pay 10% for the first $10,000 of income and 25% for all additional income.  In practice this means that one would pay somewhere between 10% and 25%. One calculates the effective tax rate simply by taking the total tax liability, dividing by one's taxable income and multiplying by 100.

Suppose one makes $20,000 in a year and is taxed under the above system. This person pays $1,000 (10%) of the first $10,000 and $2,500 (25%) of the second $10,000. The total tax liability is $3,500, which when divided by the $20,000 of income and multiplied 100, is found to have an effective tax rate of 17.5%.

Reference: Practice Enhancers, Able & Co.,  Farlex Financial Dictionary, Dictionary of Financial Terms

Social Security - An Overview

Social Security - An Overview
Primer on the Social Security System
This is to provide an overview of the Social Security system:  How you qualify; what benefits are available; taxability; and a look at medicare, disability, and SSI. 

Here are some interesting statistics:  As of 1997, there were 53 million people collecting Social Security;  33 million were on Medicare; and 94% of all employees of record are paying social security and medicare tax from their income earned.  
• At the end of 2011, 55,404,480 people (all recipients - retired workers and dependents, survivors, disabled workers and dependents) collected Social Security 
• 48 million people were served by Medicare in 2011  
• 10,000—The number of baby boomers who, starting on January 1, 2011, will turn 65 every day for the next 19 years  
• 79 million—The number of people who will enroll in Medicare by 2030, nearly doubling the total number of people served by the program in 2000  
• 70 years—The average life expectancy when Medicare was established almost 50 years ago.  Today, life expectancy is approaching 80 years of age.  In 1965, President Lyndon B. Johnson signs Medicare, a health insurance program for elderly Americans, into law. At the bill-signing ceremony, which took place at the Truman Library in Independence, Missouri, former President Harry S. Truman was enrolled as Medicare's first beneficiary and received the first Medicare card. Johnson wanted to recognize Truman, who, in 1945, had become the first president to propose national health insurance, an initiative that was opposed at the time by Congress.

How You Earn Social Security Credits
The Social Security system is basically funded through a tax on earnings whether you work for someone else, or for yourself. This tax is comprised of two components:  The Social Security portion is 6.20%, and the Medicare portion is the remaining 1.45%  Further, this tax is charged to both employee, and employer (for self-employed people, a similar treatment is used in which the self-employed is also considered the employer, hence paying nearly both sides).

The Social Security portion is "capped" out in that this tax stops once the earnings reach $110,100 for 2012.  However, the Medicare portion is not "capped."  You pay it no matter how much you earn.

How Your Retirement Benefits Are Calculated
In effect, you pay into Social Security just like a pension.  For the average retiree, how much one gets in Social Security benefits depends on your highest average earnings, the length of time worked, amount contributed into Social Security, the age when one retires, and how many years one contributed Social Security payments.  Social Security benefits are based on your lifetime earnings. Your actual earnings are adjusted or “indexed” to account for changes in average wages since the year the earnings were received. Then Social Security calculates your average indexed monthly earnings during the 35 years in which you earned the most.  A formula is applied to these earnings to arrive at your basic benefit, or “primary insurance amount” (PIA). This is how much you would receive at your full retirement age — 65 or older, depending on your date of birth.

For most retirees, a certain number of quarters of coverage paid into the Social Security are required to get the maximum benefits.  For people who reach age 62 from 1991 or later, they normally need 40 quarters–or ten years–of coverage.  For maximum benefits, the more of these 40 quarters in which the retiree had contributed the maximum into Social Security, the better it is, everything else being equal.  So, the more you pay into Social Security, the higher on the benefit chart you will be.

Note:  You can get a very good estimate of how much Social Security you qualify for from the Social Security Administration.  It is planning to automatically send this to you on a periodic basis. If you do not get it, you can request it. To do this, call Social Security (800-772-1213) and request a "Personal Earnings and Benefits Estimate Statement" form.  You will get back in the mail in a few weeks a form which shows your earnings to date on an annual basis, and estimates of the monthly benefit you will receive at various allowable retirement ages.

This report shows a record of your earnings history.  Errors can – and do – occur.  It's your responsibility to spot these errors and notify Social Security within a reasonable amount of time.  Otherwise, you could get less benefits than you deserve.  A good rule of thumb:  Get this report every three years or so to check the earnings figures while they are still fresh in your mind.

Applying For Social Security Benefits
For most people considering collecting Social Security retirement, there is a choice of ages:  62 or 65 depending on whether one wants full benefits at 65, or reduced benefits at the earlier age of 62.  However, beginning in year 2000, the full benefit age will begin rising, until it reaches age 67 by year 2027.

How much your full benefit is reduced by taking the earlier 62 age retirement depends on a number of factors, but as a guide, you can figure your monthly benefits will be reduced by 20% if you retire at 62, 14% at 63, and 7% at 64.

Conversely, if you do not start taking benefits at 65, but wait, the monthly check you will eventually receive from Social Security will be increased on an average of 3% for each year you are eligible to get Social Security, but elect not to take it and continue working instead. This calculated credit will begin to rise over the next 15 years or so until it eventually becomes 8% instead of 3%.

You can get some very good estimates from the Social Security Administration as to the specific amounts you will receive at retirement when you get close to the two age choices to help you decide.  Some other factors to consider in determining which age to choose:  Will you be receiving any other types of pensions?  Do you have other sources of retirement such as savings?  Will your spouse continue to work?  Will you continue to work, full or part-time?

Remember, once you elect early, reduced benefits at 62, there is no going back.  So review it carefully.  The trade-off is getting earlier benefits, although reduced amounts.

Once you start receiving Social Security benefits you will receive a fixed amount each month.  This may increase periodically since Social Security has a form of "inflation adjustor" built in.  A formula is used to determine how much to increase your benefit if the official cost of living increases and/or the average wage rate increases.   

How To Apply For Benefits
Applying for benefits is fairly easy.  You should start the process two months in advance so your checks will start arriving on your first retirement month and you have no "gaps" in your income stream. However, if you are a little late in applying, you will get all the benefits to which you are entitled from the first month you are entitled–you just may have to wait longer to get them.

The process involves filling out a few simple forms and verifying such information as your age, Social Security number, recent past earnings statements, marriage/divorce papers, and recent tax return.  It usually involves only one relatively quick interview with a social security administrator, and in many cases, can be done through the mail or on-line Applying for Retirement? - Social Security.

If you have been working for yourself, then it can be a little more complicated, but not necessarily so.  Sometimes you need to provide a little "proof" that you are really retiring from your business.  Are you selling it?  Turning it over to other family members?  Closing it down?  All they are trying to do is make sure you are really retiring, not playing some game.

Taxability And Earning Limitations
Once you start collecting Social Security benefits there are two possible limiting factors that involve future income and earnings.

The first issue relates to benefit recipients who continue to work after signing up for Social Security benefits.  Even though you are receiving these retirement benefits, you can still earn a certain amount of money without it affecting your benefits.  However, beyond a certain amount,  you may have to start giving back some of the benefits.

In 2012, people under age 65 (under full retirement age) collecting these benefits can earn up to $14,640 per year without giving back any of their Social Security.  Beyond this amount, they must refund $1 for every $2 they make above this annual exemption amount.

In 2012, people from age 65 to 69 (year of full retirement age) can earn up to $38,880 per year without giving back any retirement benefits.  Beyond this amount, they must refund $1 for every $3 they earn.

People age 70 or higher (full retirement age) can earn any amount without giving back any of their Social Security benefits.

This calculation is performed on a monthly basis for the first year in which you retire, to account for the transitional year in which you may have earned more than these amounts prior to the month you retire.

The second issue deals with whether or not your Social Security benefits are subject to federal income tax. The answer is:  It depends!

In general terms, a portion of your benefits (up to 85% of them) may be subject to federal (and state) income taxes if your total adjusted income exceeds certain levels (2012 rules):  $34,000 for a single individual, and $44,000 for a married couple.

As you can see, these two issues, how much one can earn after collecting Social Security, and how much tax one may have to pay on the Social Security received, can have a major impact on when one should apply for these benefits.  This is where some financial planning ahead of time may be quite beneficial!

Medicare
Medicare relates to the health insurance portion paid by the federal government for those who are 65 or older, people with kidney failure, or those categorized as disabled.

Part A
There are two components.  First ("Part A") is the hospital insurance part which assists in paying various inpatient hospital, nursing home, hospice, or home health care costs.  There are various deductibles and limitations on reimbursements depending upon the number of days of required care.

Part B
The second component is the "Part B" or Medical Insurance portion.  After a deductible, this program pays up to 80% of allowable medical costs associated with physician-related services such as visits, tests, therapy, and home health care, to name a few.

Note the term "allowable."  Basically, that means Medicare medical insurance will pay for what are considered "ordinary, necessary, and customary" fees–which may be lower than your doctor is charging.  Unless your caregiver is "accepting assignment (that is, taking only what Medicare will pay)," you must pay the differential.  In addition, there are various medical-type costs Medicare generally doesn't cover, such as eyeglasses, normal custodial care, most drugs, and various dental costs, to name a few.

This is why many people buy private "Medigap" policies after they become eligible for Medicare.  Since Medicare doesn't necessarily cover 100% of all costs, the Medigap policy is designed to "pick up" the bulk of the unpaid part.

There is a choice of these policies available varying in cost and coverage from a very basic to a very comprehensive plan to help you cover the charges that Medicare won't pay.

Part D
Medicare offers prescription drug coverage (Part D) to everyone with Medicare. If you decide not to join a Medicare Prescription Drug Plan when you're first eligible, and you don't have other creditable prescription drug coverage, or you don't get Extra Help, you'll likely pay a late enrollment penalty.

To get Medicare drug coverage, you must join a plan run by an insurance company or other private company approved by Medicare. Each plan can vary in cost and drugs covered.  Drug coverage (Part D) | Medicare

Medicaid
Medicaid is a government funded program to assist in paying various medical bills for eligible low income people of any age.  The requirements vary somewhat but they are based on certain monthly income and poverty level requirements.

Since this is primarily a state-responsible program assisted by the federal government, requirements can vary from state to state.  Normally, anyone qualifying for Supplemental Social Security Income will also be eligible to receive Medicaid.

Social Security Disability Benefits
For those who qualify as disabled under the Social Security Administration guidelines, a monthly disability check may be available.  In fact, as of last year's statistics, there were over 3.4 million recipients of this program.

In addition to a disability check, qualifiers can receive Medicare coverage as well after a 24 month "waiting" period.  Those disability persons with certain kidney problems may get the Medicare coverage without this waiting period.

Similar to receiving Social Security benefits, in order to qualify for a disability benefit, one must have earned enough work credits based on the age at which the disability is recognized by the Social Security Administration.  For people age 31 or older as of the present year, they need to have at least 5 years of these credits during the past 10 years.  However, disability due to blindness has an easier formula to reach this 5 year credit qualifier.

People who qualify as disabled earlier than age 31 may require less work credits and work credit years.  Conversely, the formula increases with the recipient's age, until at age 62 or older it requires a full 10 years of work credits to get the maximum disability check.

"Disability" as far as the Social Security Administration is concerned can be a far more stringent definition than with private concerns.  In a nutshell, to receive a disability check from the government, two tests must be met:

1.  You have a physical or mental condition that stops you from performing ANY substantial work.  This condition will last at least 12 months, or will lead to death.

2.  To prove your disability you will have to show medical evidence from a qualified source regarding these qualifying tests.  In addition, the Social Security Administration can (and frequently does) require a "second opinion" from medical sources they recommend.  Your disability is reviewed periodically – every four years or so on average – to see to it your condition has not improved enough to suspend the disability benefits.

What main conditions may qualify a person to seek Social Security Disability?  The general categories are as follows:

• Blindness in which your CORRECTED vision is no more than 20/200.
• Pulmonary diseases, and other "progressive diseases.
• Certain arthritic conditions.
• Brain abnormalities, and certain mental illness.
• Cancer that cannot be controlled.
• Kidney problems, certain digestive illnesses.
• Loss of speaking ability, loss of limb functions.
• Certain Aids-related illnesses.

Applying for Disability:  Like Social Security, you need to apply for disability with a written application.  It is a detailed statement of your condition with required back-up.

The claim will be reviewed, and it averages 3 months for this processing in most cases.  Your disability checks are paid on the sixth month of the recognized disability date–unless you are under 22, in which case there may be no "deductible" period.

The amount of disability payment depends upon your qualifying work credit formula.  Generally speaking, the amount of  benefit is similar to the one a worker retiring at 65 would receive from Social Security. The notable exception here concerns disability due to blindness.  In this case, the qualifying work credit formula is much more lenient to get maximum benefits.

Can you work once you receive Social Security disability benefits?  For most people, the answer is NO.  However, there are exceptions involving part-time work, especially for those who are blind.  Your Social Security benefits administrator makes a decision in each case on an individual basis.

Conclusion
Social Security, Medicare, Medicaid, and Disability benefits are important mainstays to millions of Americans.  Sadly for many, these benefits represent the main source of financial survival.  It is sad because these benefits rarely cover all the normal financial requirements to live a secure, comfortable life.

However, it is far better than many other countries.  If there is any "moral" to the Social Security System, it is that one should realize early on that Social Security should be considered a supplemental plan, not a retirement plan–and save accordingly.

Reference: Practice Enhancers, Able & Co., ssa.gov, medicare.gov

Steps When Leaving a Company

Steps When Leaving a Company
Financial Issues When Leaving a Company
There are often many financial choices to make when leaving a company, especially if you are contemplating a retirement or "early retirement" situation.  Frequently there are trade-offs that must be made, and you are only given a short time, a "window of opportunity" to make choices before they are made for you.

The choices for this type of termination incentive involve present and future benefits which require tax and financial planning decisions.  Thus, the purpose here is to give you a general look at the most commonly-offered choices you may be asked to make.

Continued Medical Benefits
While today's law requires your company to allow you to pay for continued medical insurance for a period of 18 months after separation (COBRA provision), a frequent "bribe" to induce you to leave the company involves allowing you to stay in the plan until you are eligible for Medicare (age 65 currently).  Another inducement provides that the company will pay all or a portion of your medical coverage until age 65, or until your death.

We all know how expensive medical coverage can be, especially as one grows older.  This benefit can end up being a very valuable option.  However, if you have a spouse who is also covered under a family plan, you may not need this option, so you can trade it off for another one instead.

Pension/Profit Sharing Payouts
This is a very important issue.  If you are "Vested," that is you have rights to accumulated pension/profit sharing/savings plan monies, you may be given a choice on how to get the funds.

In addition, the company may offer to "accelerate" your pension calculation to give you more money than that to which you ordinarily would be entitled.  As an example, if you normally would be given full benefits at age 65, but are being "retired" at age 55, the company may alter the age/service requirements to allow you full retirement benefits.  This is an attractive inducement. 

A growing trend in companies is to allow a "lump sum" payout instead of annuitizing the payout over a projected life span.  This may be an important negotiating point for you.  The tax treatments will vary according to how it is handled.  If it is annuitized over your life, or over the joint life of you and your spouse (which is the most common method), you will receive a periodic check.  The taxable portion is the annuitized amount of company contributions, and "pre-tax" contributions you have made plus all accumulated earnings within the plan.  You pay tax in the year you receive the payments, so if you will be receiving monthly checks, you will pay tax each year.

For a lump sum payout, you get just that–one lump sum and you pay tax in the year it is received.  However, you have several options here to reduce or defer the taxes.  If it is a qualified singular payout from a qualified plan, and if you meet certain criteria, you may be eligible for special lump sum averaging in which the tax is calculated using a special averaging method.  The tax savings here compared to paying regular tax on the lump sum can be enormous.

You may be eligible to "roll over" this lump sum into a special IRA and pay no tax until you start withdrawing it from the IRA.  At that point, you would pay tax based on your ordinary income tax rates at the time of withdrawal.

Which way should you go?  Take a monthly annuitized check?  Take a lump sum and pay regular tax?  Take a lump sum and do special averaging?  Take a lump sum and roll it into an IRA?  Each of these issues requires some serious calculations of both your present tax bracket, your expected future tax bracket, your present needs for the cash, and possible estate tax considerations as well.  There is no easy one-shot answer.  It may require careful analysis and some "what if" scenarios.

Statistics show that approximately half of the people elect lump sum.  If you were planning to start your own business, for instance, you may elect to take a lump sum because you may need the cash for the business.  Also, if you think you could invest the money at better yields than you would be getting with an annuitization calculation or monthly pension check, a lump sum is attractive.

These decisions may be the most important of all the early retirement choices.  They also may be the most complicated because they involve making detailed projections about such items as future tax brackets and tax laws, future cash needs, and rates of returns on investments.  If the amount of money in question is considerable, you may need a coordinated effort among your tax adviser, a lawyer, a financial planner, a broker, and an estate planner.  In this area, proper planning can make a tremendous overall difference in your after-tax analysis.

Life & Disability Insurance
If you are being covered by company-paid life and disability insurance, this is a good negotiating area, especially if you are over 45 or not in excellent health.  If you have to re-apply for coverages on your own, it could be much more expensive, or even impossible to get.  Although most company plans in this area will not allow for continuance after separation, you may wish to negotiate for the extra dollars it will cost you to implement similar plans on your own.

Extra Severance or Cash Incentives
This is a common company offer to get you to leave on a date most suitable to them.  Extra lump sum pay is given based on the years you have been with the company.  A popular variation is an extra week's pay for every year of service.  This is a totally taxable payout, so you may want to try to time the payout most favorably according to your tax bracket (Regular and Social Security) for the current year vs the following year.  How the tax will be withheld is also important.  Is it being taxed at your regular rate, or is it being "flat" taxed?  It's important to get good tax advice here!

Social Security Supplemental Pay
For people who will be near retirement age, but not eligible for maximum Social Security benefits yet, a possible offer is to "make you whole." The calculation is the difference between what you will get from Social Security now, and what you would get at maximum retirement age.  You get this in a monthly check from the company.  Unlike Social Security, however, this company check will be fully taxable, so a good negotiating ploy here is to ask for an extra check to cover the added-tax you will be paying.  This is called negotiating for a "Gross-up" allowance.

Release of any Non-Compete Clauses
For workers who have signed a company non-compete clause(can apply to managers, technical workers, software applications, designers, etc.), a good "fringe" is to have this eliminated so you can find another job in your field immediately and/or in your same general work area.  Since non-compete clauses are not very common in most fields, many termination incentive packages do not account for this automatically.  You should bring this up if you fall under such a clause.

Use of Company Facilities after Separation
This can be a very valuable, "tax-free" fringe to have.  You would get the use of their facilities and/or so-called outplacement services in order to help you find another job.  You are provided with an office, support help (typing, copying, etc.), free use of company phones, postage, and mailing services.  In looking for a job, these items can add up to thousands of dollars, so don't ignore this possible option.

Becoming a Temporary "Subcontractor"
Sometimes a company will release you as an employee, but retain you for a temporary basis as an Independent Contractor.  This gets you off their pension and benefits roles, and passes the full tax burden onto you.

While this may be an excellent way for you to get more money from the company, and possibly new and extra tax write-offs (since you may qualify as a self-employed taxpayer), there is a big caveat here.  If you are contemplating a lump sum payout of your pension/profit sharing monies, and if you are eligible for special "lump sum" averaging, the continuance as an Independent may jeopardize your rights to this tax saving method under certain IRS rules.

In effect, in their eyes you haven't truly left the job, so you become ineligible for the special averaging.  You must be very careful in this regard.  You may need good tax advice, and maybe some good legal advice as well.

Timing Considerations
Basically, this involves timing the receipt of various taxable incentives according to the most favorable tax bracket.  If you expect to be in a much lower tax bracket the year following your separation, you might want to try to defer some of the taxable package into the next year.  This could be a sizable savings in taxes.

For instance, if you are planning to go into your own business, and don't expect to have much taxable income for the following year, you would try to defer some of the company payouts into that year to reduce your tax liabilities.

As was mentioned earlier, if you are eligible for extra sub-contractor work from your company, the timing of when you will do this, and when you will get paid can have significant tax savings, especially as it applies to Social Security and Medicare taxes.

Collecting unemployment has timing considerations also since each state has its own interpretation of "severance" pay as it relates to when you can collect your unemployment.  A similar issue develops for those who will be applying for Social Security, since the amount of outside earnings you can make directly affect how much Social Security you can collect until you reach age 70.

Conclusion
As you can see, there may be numerous choices and decisions to be made when you leave a company. With all the downsizing that is going on throughout the country, the probabilities of needing to consider these issues is much higher for a worker than in years past.

Further, since a lot of these choices fall under the "non-qualified" sections of IRS codes on benefits and fringes, it means you may have room to negotiate.  But you must first be aware of your choices before you can make suggestions.  Hopefully, this little synopsis gives you room for present – and future – possibilities in this regard.

Reference: Practice Enhancers, Able & Co.

Sale of Personal Residence

Sale of Personal Residence
Tax effects of selling a residence
The main issue is: the potential capital gains you will realize, and how much tax you may owe.  

When selling your primary residence, a portion of the gain realized on the sale (or perhaps all the gain) may be excluded from federal tax, if you meet certain current year IRS qualifying tests. 

This exemption of gain works as follows: 

1) The house sold must be your primary, qualifying residence for at least two years out of a five year period to get the full benefit.

2) The amount of gain that can be excluded from tax is up to $250,000 for a single filer, and up to $500,000 for joint  filers. 

3) This exclusion may be used once every two years.  In effect, if you sell one house and use the exclusion, you can buy another residence and start all over again.  This means you could conceivably buy and sell residences perpetually and  avoid all the capital gains taxes. 

How is the gain that is eligible for this exclusion calculated?  Basically, it is the residence sale price, less qualified closing costs (like real estate commissions, legal fees, etc.), less the original cost of the residence and all improvements put into it.  This gives you the net gain which is then compared to the $250,000 (or $500,000) exclusion amount.  If the calculated gain is less than the IRS allowance, there is no tax to pay.  If the gain is more, you pay tax on the differential amount. 

Note the two major differences between this new law (under IRC §312) and the old laws (under IRC §121 and §1034).  First, you no longer have to replace a residence with another.  There is no "buying up" option.  Second, there is no provision for any "once in a lifetime exclusion of gain" based on any age qualifications.  Rather, you are eligible for the $250,000/$500,000 exclusion on each qualifying residence you sell - as many times as it occurs in your lifetime.

Reference: Practice Enhancers, Able & Co.

Mortgage Qualifying Methodology

Qualifying for a Mortgage 
Mortgage Calculator
Owning a home, and incurring a mortgage is usually one of the most important financial aspects of a person's life.  It has significant impact on one's tax picture since mortgage interest and property taxes may be deductible; it has a tremendous impact on one psychologically since a house represents a form of freedom and life style choice; and, it has a major impact on one's sense of financial security since a house has historically been the largest piece of one's investment portfolio at retirement.  In effect, for the average homeowner, paying off a mortgage is a forced savings plan toward retirement.

Mortgage Qualifying Methodology
Mortgages come in two main forms:  conventional, "Fannie Mae" types and privately-funded types.  "Fannie Mae" loans are the type most people get through banks, and they are handled through the Federal National Mortgage Association.  These are mortgages that must meet certain financial criteria in order to "conform" so that they have a secondary market.  Believe it or not, most banks do not keep the mortgages they give out.  Rather, they  sell them off to a secondary market, and only serve as a type of "frontman."

By the way, this is where the mortgage-qualifying rules come into play.  In order to be able to sell off these mortgages, banks must conform to "Fannie Mae" rules as to what portion of your total income the mortgage debt can be.  These are the so-called standard "28/33" or "28/36" ratio tests, depending on how much you put down for a downpayment.  If you put down less than 10% you must meet the 28/33 test.  Otherwise, you can qualify with the 28/36 test.

This means the monthly mortgage payment, plus monthly property taxes, plus monthly house insurance may not exceed 28% of gross monthly income.   The second ratio refers to the fact that total long term debt from all sources may not exceed 33% (or 36% with the larger downpayment) of gross monthly income.  Long term debt is generally defined as any debts with more than 10 monthly payments still outstanding.

There are variations to this rule depending on whether you have a fixed or variable mortgage.  Variable mortgages usually must meet the 28/36 test based on the maximum rate increase permitted after the first adjustment period, which is usually the end of the first year.  Thus, a 6% variable (or adjustable rate) mortgage with a maximum 2 point increase each year would require using an 8% calculation rate for qualification.  However, for most people variable loans are easier to mathematically qualify for than fixed.

Private, or non-conventional mortgages–such as those issued by mortgage companies–do not have to follow these rules.  Since these companies are "Carrying their own paper" they can make their own rules.  However, you will find that many of them still use a variation on the "Fannie Mae" rules.

Keep in mind that the "Fannie Mae" guidelines have some leeway.  If you are putting down more than 20%, or in the case of a refinance your house equity is more than 20%, the 28% ratio can go higher. Or if you have other real property with less than normal debt it can be in your favor.  Again in the case of a refinance, if your previous mortgage payment has been a higher ratio, then a refinance may be allowed for a higher amount as well. Certain mortgages that are accompanied by PMI(Private Mortgage Insurance) allow for higher ratios as well.  Finally, there are various federal and state mortgage programs (mostly for first time home buyers and veterans) that allow these ratios to be expanded.

Points
"Points" are a euphemism for fees charged by the lender for the use of their assets.  They are called by various terms depending on the institution and the geographical regions: "loan origination fees," "points," or "loan discount fees", are several terms used.

These points are a percentage of the amount financed.  Thus, 2 points means you will pay 2% extra up front on the mortgage amount.  If points are paid on a purchase of a primary residence, they can be deducted on your tax return in the year paid.  To qualify, you must pay for these separately from your mortgage.  If they are "added on" to the mortgage balance, then you may have to deduct these over the life of the mortgage.  Similarly, points paid on a refinancing, or points paid for a property other than a personal residence must normally be deducted over the life of the loan (this is called amortization of points).

Usually when you go for a mortgage, you are given choices in which the more points you pay, the lower the interest rate that you will pay on the loan.  Which way you should go depends on the length of time you know you will keep the loan.   The longer the period, the more you should consider paying more points for a lower fixed mortgage rate. If you are certain as to how long you will keep the loan, deciding which option is a basic financial "numbers crunching" exercise that can be done quite readily.

Tips on "Iffy" Qualifiers
If you don't qualify for a certain-size conventional mortgage, you may try stacking the deck in your favor with ways to enhance your credit worthiness.  A co-signer can make the difference.  Adding another investor can also swing the deal.  Relatives can participate in various ways.  Convincing the seller to take back a second mortgage is an option to reduce the amount of downpayment you will need to do the deal.  Using a variable rate mortgage can sometimes reduce the monthly qualifying numbers.  Making a qualified loan from your retirement plan can sometimes help.  Finally, going to mortgage companies that don't use "Fannie Mae" rules can swing the deal, although you probably will pay a higher interest rate.

Mortgages and Your Taxes
A big benefit to having a mortgage is that the current tax laws favor home ownership.  You are allowed to deduct your mortgage interest and property taxes if you itemize your deductions. This can save taxes which means your actual after-tax mortgage payment is  lower so your true cost of ownership is actually less than you may think.  As an example, let's assume the monthly interest and taxes you pay on your mortgage is $1,000.  Further, let's assume you are in the 28% marginal tax bracket such that for every extra dollar of deductions you save 28 cents.  Thus, on your $1,000 per month payment, you may save $280 in income taxes.  So your true, after-tax cost of this payment is really $720. In effect, your mortgage payment is being subsidized by Uncle Sam.

In fact, you can take into account this tax savings throughout the year instead of waiting until tax time by adjusting your W-4 form at work, and/or adjusting your estimated tax payments if you are filing such.  In this way, your net take home pay can be increased in anticipation of the extra deductions on your mortgage.

Reference: Practice Enhancers, Able & Co.

Non-Cash Donations

Donations other than Cash
Enclosed please find a guide sheet link (based on "Goodwill/ Salvation Army-type estimates") as to the approximate fair market value of various items you may have donated to charities.  It lists a relatively conservative high and low dollar amount you may wish to use as a guide for taking an itemized deduction under the charitable donations section.

What exactly is "Fair Market Value?"  In effect, it is the re-sale value of the item, or what a given buyer would pay for the item in its given state.  This value is based on such issues as its physical condition, its age, and if it has any antique value.

Thus, the difference between the high and low fair market value figures represents the difference in condition of the item donated:

Items that are in good to excellent condition may qualify for the higher figure; while those in fair to poor condition would list at the lower figure.

These donations can add up to a significant itemized deduction, so you should keep this as a handy reference for current and future donations.

IRS Recordkeeping Requirements
In the event of an audit, the IRS can require various types of proof in order for you to qualify for this type of donation.  According to IRS 
Publication 526, Charitable Contributions, you should be prepared to provide 
the following:

• A detailed list of the items donated, and their condition.
• Name and address of organization to which you made the donation.
• Proof of receipt of the items from the charitable organization.

Usually, you provide a list of all items when you make the donation, and the organization will stamp and date this list so you can use it for your tax return.

Any single item you are donating that has a fair market value of $500 or more requires further detail.  You must also state how the item was acquired (bought, inherited, etc.), when it was acquired, how much it originally cost, and the method you used to determine fair market value. Any item with a claimed value of more than $5,000 requires an appraisal that the IRS would deem acceptable.

A Tip To Reduce Your Chance Of An Audit In This Area
If you will be claiming significant deductions for donations other than cash, a copy of the detailed list of items, along with proof of receipt from the charity can go a long way toward heading off an IRS inquiry here, along with any required appraisals. The list does not have to be typed or computerized.  A legible, handwritten, itemized list will do nicely.

GUIDELINES

• You don't have to send in your list of donated items with your return. Simply keep the information with your personal tax records and put the total contribution amount on line 17 of your Schedule A.

• Be sure to get, again for your personal records, a receipt from the charity of your donated goods. The nonprofit won't put a dollar value on this receipt, but it will help you prove that you did indeed donate the property if the IRS later asks.

• If you do make a single noncash gift worth between $250 and $500 (for example, you donate a vehicle), you will need that receipt or a written acknowledgment of your gift from the qualified charitable organization.

• If the total of all your contributed property comes to more than $500, you have to file IRS Form 8283 with your tax return. 

Men's clothing work sheet
	Average price per item low and high		Number of items x price = donation amount
Shirt	$3.00	$14.40	_____ x _____ = _____
Slacks	$6.00	$14.40	_____ x _____ = _____
Sweater	$3.00	$14.40	_____ x _____ = _____
Overcoat	$18.00	$72.00	_____ x _____ = _____
Belt or necktie	$3.60	$9.60	_____ x _____ = _____
Suit	$18.00	$72.00	_____ x _____ = _____
Jacket	$9.00	$30.00	_____ x _____ = _____
Shoes	$4.20	$30.00	_____ x _____ = _____
Total of all donated items:	_____ x _____ = _____

Women's clothing work sheet
	Average price per item low and high		Number of items x price = donation amount
Blouse	$3.00	$14.40	_____ x _____ = _____
Slacks	$4.00	$14.40	_____ x _____ = _____
Sweater	$3.00	$18.00	_____ x _____ = _____
Overcoat	$12.00	$48.00	_____ x _____ = _____
Handbag	$2.40	$24.00	_____ x _____ = _____
Suit	$18.00	$72.00	_____ x _____ = _____
Jacket	$7.20	$30.00	_____ x _____ = _____
Shoes	$2.40	$30.00	_____ x _____ = _____
Total of all donated items:	_____ x _____ = _____

Children's clothing work sheet
	Average price per item low and high		Number of items x price = donation amount
Blouse	$2.40	$9.60	_____ x _____ = _____
Shirt	$2.40	$7.20	_____ x _____ = _____
Dress	$4.20	$14.40	_____ x _____ = _____
Slacks	$2.40	$9.60	_____ x _____ = _____
Jeans	$4.20	$14.40	_____ x _____ = _____
Coat	$5.40	$24.00	_____ x _____ = _____
Sweater	$3.00	$9.60	_____ x _____ = _____
Shoes	$3.00	$10.50	_____ x _____ = _____
Total of all donated items:	_____ x _____ = _____

Household goods work sheet
	Average price per item low and high		Number of items x price = donation amount
Towels	$0.60	$4.80	_____ x _____ = _____
Sheets and pillows	$2.40	$9.60	_____ x _____ = _____
Blanket	$3.00	$9.60	_____ x _____ = _____
Bicycle	$18.00	$78.00	_____ x _____ = _____
Floor lamp	$9.00	$48.00	_____ x _____ = _____
Sofa	$42.00	$240.00	_____ x _____ = _____
Throw rug	$1.80	$14.40	_____ x _____ = _____
Color TV	$90.00	$270.00	_____ x _____ = _____
Kitchen table	$30.00	$72.00	_____ x _____ = _____
Bedroom (double) complete	$60.00	$204.00	_____ x _____ = _____
Total of all donated items:	_____ x _____ = _____

Here are a few handy websites to help you evaluate your noncash items:

• Salvation Army evaluation guides
• Valuation Guide for Goodwill Donors - Goodwill Industries ...
• Usedprice.com contains Blue Book valuations for different categories of noncash donations from television sets and computers to guns, musical instruments, power tools and more. 

Reference: Practice Enhancers, Able & Co., Bankrate