Monday, December 5, 2016

Hardship Withdrawals and Loans from 401(k) Plans

Hardship Withdrawals and Loans from 401(k) Plans

Life doesn’t always go as smoothly as we have planned. Sometimes we are faced with an immediate financial need that has us eyeing our 401(k) retirement plan as a solution to that need. If you find yourself in this situation, you should be aware of the possible ways you may access this source of funds before you reach retirement.
Generally, distributions from a 401(k) plan while you're still employed and before you reach age 59½ are not permitted. However, an unusual financial obligation and an immediate need for cash, may permit you to take a distribution for financial hardship. IRS rules spell out what is an immediate and heavy financial need, which include funeral expenses for a family member. On the other hand, distributions to purchase a boat or a television do not qualify as an immediate and heavy financial need.

Limits on Hardship Withdrawals

Hardship withdrawals are limited to amounts attributable to elective contributions to the plan. Elective contributions are the amounts you have contributed to the 401(k) plan, not including employer matching or profit sharing contributions. This also includes the earnings attributable to your contributions. Hardship withdrawals are taxable distributions (except to the extent of Roth 401(k) contributions) and if you're under age 59½, you may be subject to a 10% addition to tax on premature distributions.

Consider the possible 10% early withdrawal penalty as well as ordinary income taxes when establishing the amount of tax to be withheld from the hardship withdrawal. Many times clients withhold for the 10% penalty thinking they have covered the taxes only to be surprised that they also owe income tax on the withdrawal.

Also, special rules apply to the withdrawal of any "after-tax" or voluntary contributions, other than Roth 401(k) contributions, that you may have made to your plan.

A Loan from the 401(k) Plan May Be a Better Alternative

Another way to get cash from your 401(k) plan is through a plan loan. If your plan provides for loans and certain conditions are met, you can borrow the funds tax-free. Loans must be repaid along with interest within a five-year term. The amount of any plan loan is generally limited to 50% of the value of your vested balance with a limit of $50,000. The five-year repayment requirement doesn't apply if the loan is for the purchase of a residence.

Unlike a taxable hardship distribution, a plan loan doesn't require that you establish an immediate and heavy financial need. Your ability to borrow from your 401(k) plan depends on requirements under the terms of the plan.

Another point to keep in mind is that a plan loan-unlike a hardship distribution-doesn't reduce the value of your 401(k) assets. Your account remains fully vested, subject, of course, to your obligation to repay the loan, with interest. If you are unable to repay the loan or leave employment before the loan is fully repaid, the unpaid balance will be considered as a withdrawal, subject to early withdrawal penalties (if under age 59½) and ordinary income taxes.


If you participate in your company's 401(k) plan, the value of your account balance may well be your most significant financial asset. While contributions to your 401(k) plan are intended for retirement savings, if you happen to be facing, or anticipate facing, major financial obligations, you should be aware of the possible ways you may access this source of funds while you're still working.

Before making a 401(k) hardship withdrawal or loan, consult a qualified tax advisor.

Monday, November 28, 2016

529 Education Savings Plans

529 Education Savings Plans

Do you have a child or grandchild who is going to attend college or trade school in the future? Are you concerned with how to pay for their education? If so, you are like many of us that desire our children or grandchildren to continue their education and are concerned with how to pay for it.

You have may have heard about qualified tuition programs, also known as 529 plans (named for the Internal Revenue Code section that provides for them). 529 plans allow prepayment of higher education costs on a tax-favored basis, by deferring or even completely eliminating the taxes on any earnings of the account. You can think of it as a Roth IRA for education.

Types of 529 Plans

There are two types of programs:

Prepaid plans allow you to buy tuition credits or certificates at present tuition rates, even though the beneficiary may not be starting college for some time. Prepaid plans were popular when first introduced, but have declined in availability; and
Savings plans that allow the account owner to make contributions and earn a return until the funds are withdrawn at a later date.

How 529 Plans Work

Contributions are not deductible for federal income taxes however, many states offer credits and deductions for contributions to state sponsored plans. Using a state sponsored plan doesn’t limit the beneficiary to attending school in that state. Most state plans offer great investment choices with low investment costs. The website publishes information on states offering credits and deductions for 529 contributions. 

The earnings on the account aren't taxed while the funds are in the program. Beneficiaries can be changed on the account and account owners can roll over the funds in the program to another plan for the same or a different beneficiary without income tax consequences.

Distributions from the program are tax-free up to the amount of the student's qualified higher education expenses. These include tuition, fees, books, supplies, and required equipment. Reasonable room and board is also a qualified expense if the student is enrolled at least half-time.

Distributions in excess of qualified expenses are taxed to the beneficiary to the extent that they represent earnings on the account. A 10% penalty tax is also imposed.

Eligible schools include colleges, universities, vocational schools, or other postsecondary schools eligible to participate in a student aid program of the Department of Education. This includes nearly all accredited public, nonprofit, and proprietary (for-profit) postsecondary institutions. A school should be able to tell you whether it qualifies.

Contributions made to the qualified tuition program are treated as gifts to the student, but the contributions qualify for the annual gift tax exclusion, which is currently $14,000. If your contributions in a year exceed the exclusion amount, you can elect to take the contributions into account ratably over a five-year period starting with the year of the contributions. Distributions from a qualified tuition program are not subject to gift tax, but a change in beneficiary or rollover to the account of a new beneficiary may be.


529 Plans are a great way to save for a child or grandchild’s education. These plans can yield tax savings since earnings are not taxed if used for qualified education expenses. Many states offer credits or deductions, so it may be beneficial to start a plan to use for paying current post-secondary education expenses. If you are considering how to pay for college expenses of a child or grandchild, consult a qualified tax professional.

Monday, November 21, 2016

Can I Deduct the Cost of Spouse Business Travel?

Can I Deduct the Cost of Spouse Business Travel?

Have you ever been enticed by professional education or a customer meeting in an exotic destination? Even thought about how nice it might be to bring your spouse along to make the trip more enjoyable? Wouldn’t it be even better if you could write-off that trip? Read on and learn how to maximize those travel costs.

Rules on Spousal Travel Costs

The IRS has some very restrictive rules for deducting a spouse's travel costs. First of all, to qualify, your spouse must be your employee. So unless your spouse is an employee, you can't deduct the travel costs of a spouse, even if his or her presence has a bona fide business purpose. This requirement prevents deductibility in most cases.

If your spouse is your employee and their presence on the trip serves a bona fide business purpose, you can deduct his or her travel costs. Make certain that the spouse’s presence is more than incidental and that it is necessary. For example, attending for customer goodwill isn’t considered necessary. Document the purpose of their travel to support the deduction. This is especially important when there is a vacation element to the trip, i.e., if your spouse will be spending time sightseeing, etc.

If your spouse's travel satisfies these tests, the normal deductions for business travel away from home can be claimed. These include the costs of transportation, meals, lodging, and incidental costs such as dry cleaning, phone calls, etc.

Deductible Costs When a Spouse’s Travel Doesn’t Qualify

If your spouse's travel doesn't satisfy the requirements, you may still be able to deduct a substantial portion of the trip's costs. The rules don't require you to allocate 50% of your travel costs to your spouse. You need only allocate to any additional costs you incur for your spouse. In many hotels the cost of a single room isn't that much lower than the cost of a double. If a single costs you $150 a night and a double costs you and your spouse $200, the disallowed portion of the cost allocable to your spouse would only be $50. And if you drive your own car or rent a car, the cost will be fully deductible even if your spouse is along. Of course, separate transportation, meals or other costs, incurred by your spouse wouldn't be deductible.

Discuss these rules with a qualified tax advisor before planning a business trip that includes your spouse. Hopefully, you can have a successful business trip while enjoying time with your spouse and getting to benefit from the tax deduction.


Monday, November 14, 2016

Installment Sales of Business Property

Installment Sales of Business Property

Entrepreneurs build businesses and hopefully reap the benefits of their hard work when they can ultimate sell the business.

When it comes to selling a business or business property, sellers may be confronted with the decision to carry the financing. During times when bank financing for buyers tightens up, seller financing a portion or all of the transaction may be the seller’s only option to complete a transaction. Aside from the seller’s risk associated with carrying the financing, there are tax implications that must be taken into consideration.

Taxable Gain versus Recovery of Basis

When a business or business property is sold, the gross proceeds can generally be broken into two categories, recovery of the seller’s basis with the remaining portion being treated as a taxable gain. In the case of seller financing, there is also be interest income that is received based on the terms of the installment agreement.

General Tax Benefits of an Installment Sales

Generally speaking, an installment sale allows the seller to take taxable gains over the period of the agreement. This most often leads to the seller being taxed at lower rates versus receiving the payment upfront and taxed at higher marginal rates in the year of the sale. Lump sum payments in the year of the sale can also subject the seller to addition taxes such as the net investment income tax and other “high earner” taxes. And there’s always the possibility of Alternative minimum tax that should be considered in the transaction.

Tax Reporting in an Installment Sale

When a seller receives payments from the buyer over time, sellers report the gain on the payments in the year received, rather than reporting the entire gain in the year of the sale. Thus, with each payment received, the seller recognizes a pro rata portion of the gain which is subject to tax. You must use the installment method unless you elect out of it. However, here are some things to be aware of:

Recapture of Depreciation

When using an installment note, any depreciation previously taken on real or business property and equipment must be recaptured in the year of the sale, regardless of the timing of the payments on the note. The portion of the gain related to depreciation recapture is recognized at the time of the sale even if you do not receive any cash at that time. Business owners are often surprised to find out they are taxed on the recapture of depreciation even though they did not collect a significant portion of the sales in the initial year.

Work with your advisor to ensure that the initial year of proceeds are adequate to cover any initial taxes resulting from the recapture of depreciation.

Avoid Constructive Receipts

A seller’s effort to mitigate risk in an installment sale can trigger recognition of the gain and defeat any benefit of taking the gains over the installment period. Receiving payment in an installment sale is not the only trigger for recognizing gains.

The buyer's debt cannot be payable on demand or readily tradable on an established securities market. In addition, the debt cannot be secured directly or indirectly by cash or a cash equivalent, such as a certificate of deposit or a treasury note. If this is the case, the IRS considers the seller to have constructively received payment on the installment note. However, the debt can be backed up by a third party guarantee or secured by a standby letter of credit.

Property Excluded from Installment Sales

The installment method cannot be used for all sales of business property. Sales of property by a dealer or sales of publicly traded property, such as stock or securities that are traded on an established securities market are excluded from installment sales. Thus, the installment method is not available to the extent the gain includes gain on your inventory or gain on publicly traded property.

Transfer of Installment Notes

Selling or discounting the installment note will trigger recognition of gains for the seller. Thus, the advantage of an installment sale is limited if you intend to transfer the note in the future. However, the transfer to a spouse or a transfer at death continue the deferral of the gain.

Plan Your Sale to Minimize Taxes

Often times sellers wait to consult with their tax advisors until the sale has be substantially negotiated. The process of selling a business has been likened to dancing with a bear. Once you are in step with the bear, it is very hard to change the dance. Work with your advisor in advance of negotiating a business sale to avoid any tax surprises and/or the possibility of having to renegotiate a deal.

Monday, November 7, 2016

Explaining College Savings Plan AR 529 Tax Deduction

We all know that college education costs have risen significantly over the past several years and the trend is expected to continue.  We also hope that our children or grandchildren will receive scholarships and financial aid to cover those costs.  Some of you may have even planned ahead by saving for college costs in excess of scholarships and financial aid.  Generally saving for college is done through a Section 529 plan which allows for tax free growth.
If your child or grandchild is ready to attend college and you have not funded a 529 plan, you can still benefit by establishing a state sponsored 529 account.  Taxpayers in Arkansas are allowed a deduction on their state tax return of up to $5,000 for individuals and $10,000 for married couples.  The savings on your Arkansas taxes for making this contribution can be as much as $700 for a married couple. As an Arkansas taxpayer, this opportunity is available even if the student attends an out of state school.
If you have established a 529 plan with a provider other than the state sponsored plan, you can still benefit. Rollovers from outside plans to the Arkansas sponsored plan qualify for the contribution deduction. Under this scenario, we recommend transferring not more than $10,000 per year to the state sponsored plan to maximize the state tax benefit. Please consult us before implementing this strategy, as rollovers from other state sponsored plans may have tax implications from those states.
You can establish the 529 plan for Arkansas on-line at We can assist you at establishing the 529 account at no charge. Once established, you contribute the funds needed to pay the qualified education costs and then use the 529 account to pay such costs.  Provide us with the contribution information when we file your taxes and we will take the appropriate deduction on your Arkansas tax return.
States Other Than Arkansas
Many states offer deductions for education savings accounts and some states even offer credits. Here’s a link to the Saving for College website that lists the plans for each state .
Consult a tax professional before establishing a 529 or other college savings plan. If you have questions about this potential tax savings strategy, please give us a call.

Monday, October 31, 2016

Taxation of Social Security Benefits

How are Social Security Benefits Taxed?

If you are approaching retirement you are probably wondering how your social security benefits will be taxed. Like most tax questions, the answer is depends on the taxpayer’s specific circumstances.

Depending on your income level, up to 85% of your social security benefits may be taxed. This doesn't mean you pay 85% of your benefits back to the government in taxes-merely that you would include 85% of the benefit in your income subject to your regular tax rates.

To determine how much of your benefits are taxed, you must first determine your other income, including certain items otherwise excluded for tax purposes (for example, tax-exempt interest). Add to that the income of your spouse, if you file jointly and half of the Social Security benefits you and your spouse received during the year. The figure you come up with is your total income plus half of your benefits. Now apply the following rules:
1.   If your income plus half your benefits is not above $32,000 [$25,000 for single taxpayers], none of your benefits are taxed.

2.   If your income plus half your benefits exceeds $32,000 but is below $44,000, you will be taxed on (1) one half of the excess over $32,000, or (2) one half of the benefits, whichever is lower.

For example (1): Sam and Catherine have $20,000 in taxable dividends, $2,400 of tax-exempt interest, and combined Social Security benefits of $21,000. Thus, their income plus half their benefits is $32,900 ($20,000 plus $2,400 plus 1/2 of $21,000). They must include $450 of the benefits in gross income (1/2 ($32,900 − $32,000)). (If their combined Social Security benefits were $5,000, and their income plus half their benefits were $40,000, they would include $2,500 of the benefits in income: 1/2 ($40,000 − $32,000) equals $4,000, but 1/2 the $5,000 of benefits ($2,500) is lower, and the lower figure is used.)

Single Taxpayers

The formula for single taxpayers is slightly different. Item 2 above is changed as follows when computing for a single taxpayer.

2.   If your income plus half your benefits exceeds $25,000 but is below $34,000, you will be taxed on (1) one half of the excess over $25,000, or (2) one half of the benefits, whichever is lower.

For example (1A): Sam has $20,000 in taxable dividends, $2,400 of tax-exempt interest, and Social Security benefits of $9,000. Thus, his income plus half his benefits is $26,900 ($20,000 plus $2,400 plus 1/2 of $9,000). He must include $950 of the benefits in gross income (1/2 ($26,900 − $25,000)). (If his Social Security benefits were $3,000, and his income plus half his benefits were $30,000, he would include $1,500 of the benefits in income: 1/2 ($30,000 − $25,000) equals $2,500, but 1/2 the $3,000 of benefits ($1,500) is lower, and the lower figure is used.)

When Your Income Plus ½ of Your Benefits Exceeds $44,000

When your income plus half your benefits exceeds $44,000 ($34,000 for single taxpayers), the computation in many cases grows far more complex. Generally, however, unless your income plus half your benefits is fairly close to $44,000 ($34,000 for single taxpayers), if you fall into this category, 85% of your Social Security benefits will be taxed.

Don’t Be Surprised With a Higher Tax Bill

If you aren't paying tax on your Social Security benefits now because your income is below the above floor, or are paying tax on only 50% of those benefits, an unplanned increase in your income can have a triple tax cost. You'll have to pay tax (of course) on the additional income, you'll also have to pay tax on more of your Social Security benefits (since the higher your income the more of your Social Security benefits that are taxed), and you may get pushed into a higher marginal tax bracket.

This situation might arise, for example, when you receive a large distribution from a retirement plan (such as an IRA) during the year or have large capital gains. Careful planning might be able to avoid this stiff tax result. For example, it may be possible to spread the additional income over more than one year, or liquidate assets other than an IRA account, such as stock showing only a small gain or stock whose gain can be offset by a capital loss on other shares. If you should need a large amount of cash for a specific purpose, contact your tax advisor before liquidating any assets to estimate what your additional tax cost will be.

We once had a client that took a large IRA distribution to pay medical bills. This client was surprised with the significant increase in taxes during that year resulting from the higher income level and the increase in the amount of his social security benefits that were taxed. It was even more difficult for the client to handle when he discovered that he was unable to itemize the most of the medical expenses that were paid with the IRA distribution due to the floor on medical expense deductions. A little planning in this situation could have saved our client taxes. Simply deferring the payment of the medical expenses until the following year would have allowed him to itemize most of the medical expenses.

If you know your social security benefits will be taxed, you can voluntarily arrange to have the tax withheld from the payments by filing a Form W-4V. Otherwise, you may have to make estimated tax payments.

Monday, October 24, 2016

Understanding the Home Office Deduction

Understanding the Home Office Deduction

  • Direct expenses include the costs of painting or repairing the home office, depreciation deductions for furniture and fixtures used in the home office, etc.
  • Indirect expenses of maintaining the home office include utility costs, depreciation, insurance, mortgage interest, real estate taxes, and casualty losses allocated based on the square footage.

Tests for Home Office Deductions

Home office expenses are deductible if you meet any of the three tests described below:

·         The management or administrative activities test is met if you use your home office for administrative or management activities of your business, and if you meet certain other requirements.

·         The relative importance test is met if your home office is the most important place where you conduct your business, in comparison with all the other locations where you conduct that business.

Place for Meeting Patients, Clients or Customers Test - You're entitled to home office deductions if you use your home office, exclusively and on a regular basis, to meet or deal with patients, clients, or customers. The patients, clients or customers must be physically present in the home office.

Separate Structures - You're entitled to home office deductions for a home office, used exclusively and on a regular basis for business, that's located in a separate unattached structure on the same property as your home—for example, an unattached garage, artist's studio, workshop, or office building.

Alternative Simplified Method – Some taxpayers may choose to forgo tracking home office expenses and choose the Simplified Method for computing the home office deduction. Under this method, the deduction equals $5 (for 2015) multiplied by the home’s square footage used for qualified business use (up to 300 square feet).

Employees Working From Home – Employees working from home may take a home office deduction on Schedule A subject to the 2% of AGI limit if they meet the tests above and the business use of the home is for the convenience of the employer.