Simply Junior

Have you ever completed your tax return to find out that you owe the federal government thousands of dollars? If so, I expect it was because you raided your pension or retirement plan. If you haven’t learned this painful lesson yet, you should read this article so that you don’t end up owing the IRS thousands.

“NEVER TAKE MONEY OUT OF YOUR RETIREMENT PLAN!” read the sign that hung in the tax accountant’s office. I knew this was an overstatement, but understood why the accountant had such a sign in his office. Too many times did I, as a tax accountant myself, have to console crying or angry clients after explaining to them that they owed the government thousands of dollars because they withdrew money from their retirement or pension plan. The worst part is that these people that withdrew were often already facing immense financial problems – job losses, foreclosures, and bankruptcies.

If you take money out of your pension or retirement plan, you will first find out that the law requires retirement plan administrators to withhold 20 percent of your money for the federal government. Most people are upset by this news and believe withholding this amount will cover their tax bill. After all, it is a lot of money. What’s important for you to know is that it’s only the beginning.

Most taxpayers still need to worry about more federal and state taxes due. If you’re in the 28 percent tax bracket, you’ll owe the federal government another 8 percent of the amount you withdraw. Worse yet, if you’re under 591/2 years of age, you’ll most likely be penalized another 10 percent. In addition, most states will tax you 5 to 10 percent.

How will this affect your tax bill? If you withdraw $20,000, the plan administer will withhold 20 percent, leaving you with $16,000. By April 15 you’ll realize that you owe another $3,600 to the federal government and $1,500 to the state. So by taking out $20,000 of retirement savings, you end up with only $10,900. Now you’re probably beginning to understand why that tax accountant hung the sign “NEVER TAKE MONEY OUT OF YOUR RETIREMENT PLAN!”

Sure, there are exceptions. There are a number of ways to avoid the 10 percent penalty – using the retirement proceeds for tuition, medical costs, or to buy your first time home (up to $10,000). Some states don’t have an income tax. And, of course, these penalties and taxes don’t apply to ROTH Individual Retirement Accounts.

What’s important to remember is that your tax advisor will be able to explain to you the financial consequences that specifically pertain to your situation. He or she may even be able to suggest alternatives, such as taking a loan out against your retirement plan. Remember, contributing to a retirement account is a wise choice, just don’t make the very unwise choice by liquidating your account before speaking to a tax professional.

The Roth 401(k) plan is becoming a more popular retirement plan option offered by employers. This has become the foundation for many people’s retirement plan. Unlike a traditional 401(k) plan where contributions are made pre-taxed, contributions to a Roth 401(k) plan are made after tax. The benefit, however, is that if the account is open five years and the taxpayer is over age 59½, then all of the distributions are income-tax free.

For 2010, the maximum contribution to a Roth 401(k) plan is $16,500. For taxpayers over the age of 50, an additional $5,500 is allowed as a “catch up” contribution. This amount can be put into a 401(k) plan, a Roth 401(k) plan or any combination of the two.

Why would participating in a Roth 401(k) plan make sense for you?

* If you thought your income tax bracket was going to be higher in retirement.
* Younger people will have many years of tax-free growth and can accumulate a significant amount of money.

There is a phase out for Roth IRA’s based on your Adjusted Gross Income. In 2011 it is as follows:

* Single: $107,000-$122,000
* Married Filing Joint: $169,000-$179,000

What if your employer doesn’t offer a Roth 401(k) plan?

Have a conversation with them and see if they would be willing to adopt this plan. There may be some administrative costs, so not all employers will want to participate. If your employer offers a match, first of all, be grateful. The match, however, will need to be made to the 401(k) plan and not the Roth 401(k) plan.

Action Item: Find out if your employer offers a Roth 401(k) plan. If so, review the items above to determine if this retirement plan makes sense in your situation.

A last-ditch effort on the part of liberal Democrats in the House to send the big tax cut extension bill back to the Senate has failed. With last night’s favorable vote, an AMT Patch for 2010 and 2011 has now been passed by Congress, included as a part of “The Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010.” The bill now goes to President Obama, who is expected to sign it into law as soon as he receives it.

What the Patch actually does

As has been mentioned in previous articles, “the Patch” simply is an adjustment to the AMT exemption amount that individuals are allowed as a deduction in computing their Alternative Minimum Taxable Income. The new law sets the 2010 exemption levels at $72,450 for married couples filing jointly and $47,450 for single individuals. Without this adjustment, the exemption amounts would have reverted to their much smaller equivalents from ten years ago, with the unfortunate result that 28 million new taxpayers would have been pulled into the AMT for the first time.

Effect on those already in the AMT

While the Patch primarily is designed to keep the 28 million new taxpayers from getting caught in the amt, there also is a significant benefit to the four million individuals already there. This benefit is the avoidance of as much as additional AMT of nearly $8,000 for married folks and nearly $4,000 for singles, had the exemption levels fallen back to their levels a decade ago.

Taxpayers by level of income who benefit from the Patch

The IRS Statistics of Income report for 2008, just recently released, shows that the majority of AMT payers – 62% – fall within the $200-500,000 income range. Taxpayers making between $100-200,000 comprise 22% of AMT payers while those in the $50-100,000 range make up another 5%. Without the Patch, the number of folks at these levels and below filing the Form 6251, Alternative Minimum Tax – Individuals, would have grown dramatically.

Different types of taxpayers who benefit from the Patch

With respect to what types of taxpayers are affected by the Patch, the entire spectrum is included. This includes employees receiving regular paychecks, self-employed individuals running their own businesses, and investors as well as retirees. There are so many different ways of becoming ensnared in the AMT that its tentacles reach out and pull in every single category of individual taxpayer.

AMT planning between now and year-end

With only two weeks left in the year, much still can be done to lower an individual’s 2010 Alternative Minimum Tax liability. The key to doing this is the fact that individuals are cash method taxpayers, and, therefore, income that can be pushed to 2011 will not be taxed this year (and vice-versa), and checks that can be written by December 31 become eligible deductions in 2010 (and, again, vice versa). These types of changes will directly affect the calculation of an individual’s AMT liability.

As an example, the biggest single item pushing people into the AMT is the itemized deduction for state and local taxes. This includes income taxes as well as real estate taxes, and it represents an AMT item that affects nearly 95 percent of all individuals who are stuck in the AMT. The simple act of whether and to what extent an individual pays these state and local taxes by December 31, or waits until January 1, can represent a significant savings opportunity.

Don’t wait any longer – with the Patch now enacted, there’s no excuse for anyone not to be doing year-end AMT planning right now!

Tax Day 2011 Extension

Normally, all previous years’ taxes are to be postmarked no later than midnight on April 15th of the following year of any given year. Meaning, that your taxes due for 2010 must be paid and filed by April 15th 2011, correct? Well, normally, yes; but not this year. The only time that this normally fluctuates is if and when April 15th falls on a weekend. April 15, 2011 will be on a Friday – so what gives? For the millions of American, like me, who wait until the last possible minute (my mantra – procrastinate later) this is welcome, but puzzling news. While we procrastinators and last minute filers rarely reason long enough to ask why, it is important to know the correct date, and to realize how it may or may not have an effect on other dates relevant to Tax Day 2011 such as automatic extension dates.

Extension to Pay NOT an Option

It is imperative to state and remind that although the IRS grants “automatic” extensions allowing taxpayers to file their final forms sixty days later, the extension and any estimated owed taxes are still due on tax day, which for 2011 means that your forms and payment (normally done on a Form 1040 V) must be postmarked at or before midnight, Monday April 18, 2011. Tax Day 2011 Extended Due to Emancipation Day Recognition What holiday? So by now, most of us Americans are racking our brains and scratching our heads trying to figure out what holiday in April is nationally celebrated. Tax Day 2011 has been extended due to remembrance, recognition and celebration of Emancipation Day, a Washington D.C. holiday, not a nationally recognized holiday.

Emancipation Day had been recognized previously by (Washington D.C.) mayoral proclamation and now by being officially designated as an officially recognized public holiday of the District of Columbia. The holiday commemorates the “first freed” by the U.S. federal government when President Lincoln signed the Compensated Emancipated Act nine months prior to his issuance of the infamous Emancipation Proclamation.

As a result of the public holiday in Washington D.C. the Department of Treasury, the governing body overseeing the Internal Revenue Service, has extended Tax Day 2011 until Monday, April 18, 2011. Careful Calendar Markings Required Emancipation Day does not equate to Tax Amnesty Day. Just because Tax Day 2011 is not April 18th versus the 15th does not automatically adjust other dates by 3 days. Keep these dates in mind:

Overseas Exception Due Date: June 15, 2011, the 15th falls on a regularly scheduled business day and hence the deadline will not be extended without approval.

Automatic Approval Extensions Due Date: June 15, 2011 (remember – estimated payments must still be sent in via IRS Form 1040V with the request for extension; it is better to over estimate as you may still be held liable for penalties for underpayment.)

Approved Filing 1040 Extensions Due Date: October 15, 2011

The extension of Tax Day 2011 will give some the necessary additional weekend and time to prepare and file the required forms and payments, but hopefully it will allow all to reflect on the reason – Emancipation Day, commemorating the freeing of those held in servitude in the federal capitol.

Many employers will offer a 401(k) to their employees. A 401(k) plan offers many advantages to employees. The biggest advantage is tax-deferred investing. These accounts are not taxed until distributions are made.

For 2011, an employee can contribute up to $16,500 into a 401(k) plan. Taxpayers over age 50 are allowed to contribute another $5,500 as a “catch up” contribution for a total of $22,000. This catch up provision was implemented because Congress did not think people were saving enough for retirement. Imagine that-for once they got it right.

Why should you contribute to your 401(k) plan?

* You are on your own with your retirement. That’s right, Long gone are the days when someone would go and work for an employer for 30 years and then retire. They would be eligible for a pension and get their social security benefits. Now most companies no longer offer a pension plan.

* Although some employers have eliminated their pension plan, many will still offer a company match. If your employer offers a match, participate in the 401(k) plan at least up to the amount the company is going to match.

What is another big benefit to a 401(k) plan? Having the money taken out of your paycheck automatically. This is huge. Remember, you can’t spend money you don’t have.

Do you want to have financial piece of mind in retirement? Put the most you can into your 401(k) plan because you’re going to need it.

Action Item: Employees should be participating in their employer 401(k) plan. This should be at least up to the amount of the employer match. For employees that aren’t covered by a pension plan, the 401(k) plan will likely be the foundation of their retirement plan.

Thomas F. Scanlon, CPA, CFP ®