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Monthly Archives: July 2019

Considering an investment in a Qualified Opportunity Fund?

A Qualified Opportunity Fund (QOF) is an economically distressed community where new investments, under certain conditions, may be eligible for preferential tax treatment.  These can be found via an internet search for state Qualified Opportunity Zones (QOZ). QOZ were added to the tax code by the Tax Cuts and Jobs Act on December 22, 2017. The Federal government created income tax incentives to enhance the taxpayer incentives to invest in QOZ which is meant to spur the economy and renovate these areas. So, let’s discuss the basics of a QOF. A QOF is a Corporation or a partnership which holds Qualified Opportunity property. The QOF would complete IRS Form 8996 to self-certify the QOF status. It is most beneficial to read the tax laws to understand the requirements.

The income tax benefits of these QOF are getting a lot of attention from wealthy investors. Why? Because the law allows a taxpayer to defer gain on capital gains and provides the ability to exclude the gain ultimately, based on the rules and regulations. The gain would have to be invested into a QOF within 180 days from the date of the sale. Based on the current rules, the gain would be shown gross on the taxpayer’s tax return and then the amount invested in the QOF would be shown as a loss. This method allows the IRS to review the transaction and see the investment into the QOF. Thus, the net of the transaction invested in the QOF would be taxable.

The tax benefits are:

  • Investors can defer tax on any prior capital gains invested in a QOF until the earlier of the date on which the investment in the QOF is sold or exchanged, or December 31, 2026.
  • If the investment is held for longer than 5 years, there is a 10% exclusion of the deferred gain.
  • If the investment is held for more than 7 years, the 10% exclusion becomes 15% of the deferred gain.
  • If the investment is held for at least 10 years, the investor is eligible for an increase in basis of the QOF investment equal to its fair market value on the date of the QOF investment is sold or exchanged. This is the tax benefit that everyone is talking about. This part of the law allows for 100% gain exclusion. However, if someone invests in 2019, how will they get to a 10-year hold? The tax law is set to expire on December 31, 2026, and 10 years from 2019 is 2029. This means most taxpayers are not planning on being able to fully benefit from the 100% exclusion unless the tax law is revised.

 

 

Here is an example to review the application of the law:

  1. A taxpayer sells 1,000 shares of ABC stock. The shares were purchased in 2009 for $300,000. The sale of the stock is for $700,000 which results in a capital gain of $500,000.
  2. The Federal income tax on the gain would be $119,000 (23.8% which includes 20% federal capital gains tax and 3.8% NIIT).
  3. If the taxpayer instead rolls the gain of $500,000 into a QOF within 180 days of the sale then the gain of $500,0000 is deferred until the earlier of the date of the QOF investment is sold or exchanged, or December 31, 2026.
  4. If the taxpayer holds the QOF investment for at least 5 years, then the basis of the original investment is increased by 10% of the deferred gain. The calculation is $500,000 multiplied by 10% = $50,000 is added to the basis.
  5. A sale after 5 years will reduce the original deferred gain of $500,000 to $450,000.
  6. If the taxpayer holds the QOF investment for another 2 years (total of 7 years), then the basis in the original investment is increased by an additional 5%. So, a sale after 7 years will reduce the original deferred capital gain of $500,000 to $425,000.
  7. If the investor holds the QOF investment for a total of 10 years, all appreciation on the investment in the Fund will be excluded from income tax entirely. Let’s assume the value of the original $300,000 investment has now appreciated to $1,000,000 at the 10-year mark. The gain of $700,000 will be exempt from any capital gains tax. Note that the taxpayer will have to pay the deferred capital gains tax as of December 31, 2026, even if their investment in the Fund continues. The amount included in taxable income should be added to the taxpayer’s basis in the fund.

Most taxpayers are focused on the 10-year full exemption of the tax. However, based on the expiration date, it doesn’t seem practical, since the taxpayer will not get a full tax exclusion unless the tax law is changed. Also, if a taxpayer is trying to implement any estate tax planning and they own a QOF investment, a deferred gain could be triggered if not done correctly. Also, most holdings of QOF’s in an estate will not be able to receive a step up. Please be careful with this and speak with your estate planner or tax advisor, as the law gets complicated here.

Plan for Estate tax NOW!

What will happen if a different president is elected?

Due to the Trump Administration, the estate tax exemption was increased as of 1/1/2018 – up to $10,000,000 per taxpayer.  This goes up annually and for 2019, the estate tax exemption is $11,400,000.   So, a married couple would get a combined total of $28,000,000.  Any estates above this amount are taxed at a Federal tax rate of 40%.  This is a LARGE amount, and one should seriously focus on utilizing the estate tax exemption before it changes.  The estate tax exemption amount is scheduled to expire at the end of 2025, after which it would be reduced to $5MM per taxpayer.

Consider that even though the estate tax exemption is high, it expires AND it could change.  There seems to be more and more conversation about increasing tax on the wealthy, but we also have the United States national debt to consider.  If political parties change in power, there could be a push to increase taxes on the wealthy and thus lower the estate tax exemption.  Recently, the IRS issued the following Proposed Regulation https://www.federalregister.gov/documents/2018/11/23/2018-25538/estate-and-gift-taxes-difference-in-the-basic-exclusion-amount, which explains that if a taxpayer uses the larger estate tax exemption rules and when they die the estate tax exemption is lower, the estate tax calculation will not claw back or recalculate to the lower estate tax at death.  Thus, we recommend that wealthy individuals review using the larger estate tax exemption while it is still law.

As always, income tax and estate tax can be very complex and individual taxpayers need to work with their tax adviser to customize an approach that will work for them.  There are many different strategies to consider, and each strategy should be reviewed in detail with the proper professionals.

Vertical Advisors is a boutique CPA, Accounting, and Business Advisory firm that focuses primarily on privately held businesses and their owners.

You may have to pay tax on Social Security benefits

During your working days, you pay Social Security tax in the form of withholding from your salary or self-employment tax. And when you start receiving Social Security benefits, you may be surprised to learn that some of the payments may be taxed.

If you’re getting close to retirement age, you may be wondering if your benefits are going to be taxed. And if so, how much will you have to pay? The answer depends on your other income. If you are taxed, between 50% and 85% of your payments will be hit with federal income tax. (There could also be state tax.)

Important: This doesn’t mean you pay 50% to 85% of your benefits back to the government in taxes. It means that you have to include 50% to 85% of them in your income subject to your regular tax rates.

Calculate provisional income

To determine how much of your benefits are taxed, you must calculate your provisional income. It starts with your adjusted gross income on your tax return. Then, you add certain amounts (for example, tax-exempt interest from municipal bonds). Add to that the income of your spouse, if you file jointly. To this, add half of the Social Security benefits you and your spouse received during the year. The figure you come up with is your provisional income. Now apply the following rules:

If you file a joint tax return and your provisional income, plus half your benefits, isn’t above $32,000 ($25,000 for single taxpayers), none of your Social Security benefits are taxed.
If your provisional income is between $32,001 and $44,000, and you file jointly with your spouse, you must report up to 50% of your Social Security benefits as income. For single taxpayers, if your provisional income is between $25,001 and $34,000, you must report up to 50% of your Social Security benefits as income.
If your provisional income is more than $44,000, and you file jointly, you must report up to 85% of your Social Security benefits as income on Form 1040. For single taxpayers, if your provisional income is more than $34,000, the general rule is that you must report up to 85% of your Social Security benefits as income.
Caution: If you aren’t paying tax on your Social Security benefits now because your income is below the floor, or you’re paying tax on only 50% of those benefits, an unplanned increase in your income can have a significant tax cost. You’ll have to pay tax on the additional income, you’ll also have to pay tax on (or on more of) your Social Security benefits, and you may get pushed into a higher tax bracket.

For example, this might happen if you receive a large retirement plan distribution during the year or you receive large capital gains. With careful planning, you might be able to avoid this tax result.

Avoid a large tax bill

If you know your Social Security benefits will be taxed, you may want to voluntarily arrange to have tax withheld from the payments by filing a Form W-4V with the IRS. Otherwise, you may have to make estimated tax payments.

Contact us to help you with the exact calculations on whether your Social Security will be taxed. We can also help you with tax planning to keep your taxes as low as possible during retirement.

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