By Stuart Armstrong
As the US Supreme Court addresses two cases related to same sex marriage with decisions likely to be announced by the end of June, the financial implications could be far reaching for LGBT couples. What financial planning strategies should LGBT couples be thinking about now, regardless of the results?
• Get your basic estate planning documents in place: wills, health care proxies, living wills, and durable powers of attorney. Doing this is a smart idea for just about everyone, not just gay couples. And consider revocable living trusts which can help the settling of one’s estate with greater privacy and speed. When you do have these documents in place, carry copies with you when you travel, especially to places where your marriage might not be recognized.
• Analyze your needs in the event of disability or premature death. Even if down the road Social Security and pension survivor benefits can ultimately be available to the survivor of a same sex couple, your needs may still go beyond what these survivor benefits might provide especially if you also have children to consider.
• Review your intentions for long-term care needs as to how you’d want to be taken care of and how you would pay for the care. This is especially true for those over 50 years old as they begin moving into the age ranges more likely to need care. Government programs remain very limited in covering long-term costs for most US citizens, so planning ahead can help a lot here. And consider long-term care insurance if it makes sense for you.
• Review, reflect, and refresh your financial planning strategies across all areas of concern including cash reserves allocation, debt management, education and retirement planning above and beyond the topics listed above. The stronger you are as a couple/family, the better prepared you are in the event of an unexpected emergency or opportunity. And the more the capable you are to give back charitably to causes that are important to you.
• Align yourselves with financial advisers, accountants, and attorneys who are in the know on the planning needs and sensitivities of LGBT families. Even if same sex marriage becomes the law of the land there may still be a desire to work with a professional who will be fully comfortable with working with an LGBT family and you may want to interview several to find one you feel is a good fit for you.
Stuart Armstrong is a financial planner with Centinel Financial Group of Needham Heights and serves on the Board of Directors of PridePlanners, a national organization that provides a range of assistance to advisors of all kinds who work with LGBT families.He can reached at www.stuartarmstrong.com.
The increase in and expansion of the Medicare tax commenced January 1, 2013. The increase in the Medicare tax, as required under healthcare reform, has two significant components. The first component is an increase in the Medicare tax rate by 0.9%. This increase will be imposed on wages and self-employment income in excess of $200,000 for single persons and in excess of $250,000 for married couples filing jointly. The second component applies a new 3.8% Medicare tax to “Net Investment Income” when modified adjusted gross income is in excess of the $200,000 and $250,000 threshold amounts for single and married couples, respectively. Previously Medicare taxes only applied to wages and self-employment income and never to investment income.
There are lots of discussions coming out of Washington about simplifying the tax code. While, this sounds wonderful, the realities are the opposite. Beginning January 1, 2013 the tax code became significantly more complicated with these new taxes. The federal tax code already required taxpayers to go through two layers of tax computation, the regular income tax and the Alternative Minimum Tax. Calculating the Medicare tax on net investment income is an entirely new calculation that will be required by taxpayers. The IRS's proposed regulations related to this new tax exceed 140 pages. Include state income tax regimes, and many taxpayers will now have to calculate their income tax obligation under four separate regimes to determine their annual income tax liability. This certainly does not sound simple to me.
Some thoughts on the increase in the Medicare tax rate to wages:
• The highest marginal Medicare tax rate will be 2.35%, or 3.8% for self-employed persons.
• For married couples, wages are combined to determine if the additional surcharge is applied. For example, if a husband makes $175,000 and a wife makes $100,000, the additional Medicare surcharge will apply to $25,000 of the wages.
• Employers are required to withhold the additional 0.9% from an employee’s payroll when said employee’s salary exceeds $200,000. The employer does not have to determine wages earned by the employee’s spouse or from other jobs that the employee may have. As such, the tax witholdings will not likely match the amount of tax due. This may require taxpayers to make estimated tax payments.
• There is no additional payroll tax being assessed against the employer. All of the additional Medicare taxes under the law are paid by the employee.
• The new Medicare tax will not be reduced by one-half for self-employed persons.
• The wage thresholds of $200,000 and $250,000 are not inflation adjusted. As such, this law will apply to more and more taxpayers over the years.
• The tax revenue generated by the tax will be sent to the general fund, not to the Medicare trust fund.
Some thoughts on the application of 3.8% Medicare tax that applies to net investment income:
• The tax applies to the lesser of the taxpayer's net investment income or the excess of the taxpayers modified adjusted gross income over the threshold of $200,000 and $250,000, respectively. As an example, if a taxpayer has wages of $300,000 and interest income of $10,000, the Medicare tax will apply to the $10,000 of investment income.
• Net investment income includes income from interest, dividends, royalties, rents , annuities, income from a business that is a passive activity.
• Gains from the sale of property are included in the calculation of net investment income, unless the property was held by the taxpayer in a business where he or she materially participated. As such, capital gains from a brokerage account will likely be subject to the Medicare tax, but capital gains from the sale of a small business that you owned would not be subject to the Medicare tax.
• One of the few exceptions to the Medicare tax on net investment income will be on S-Corporation income, where the taxpayer has “active” participation. It appears that the IRS is taking the position that these earnings will NOT be included in the calculation of net investment income. Consequently, they will escape both self-employment taxes as well as the Medicare tax on net investment income. (Note this is not the S corporation owners wages, but the profits / dividends allocated to the partner on the form K-1.)
• Tax free municipal bond interest will not be included in the calculation of net investment income. With the new maximum tax rate at 39.6% and the additional 3.8% Medicare charge on top of that, these instruments have even greater benefits to high income tax payers.
• Income from all types of traditional tax qualified retirement plans will not be included in the calculation of net investment income and thus not be subject to the tax.
As it currently stands, much of the regulations from the IRS are still in draft format. So the rule writing process is still fluid. Additionally, there will be positions taken by the IRS that will be challenged in the court systems.
Small business owners have many concerns, not least of which is retirement benefits for themselves and their employees. Many employers offer a 401(k) plan to their employees to help address retirement needs. While many small business owners take advantage of the deferred compensation available to them under the 401(k) plan, there are ways to increase the benefit and value of these plans.
While employee contributions are limited to $17,500 for 2013, the annual tax deferral limit is $51,000 ($56,500 for those over age 50). The tax deferral limit is the maximum amount that can be contributed to an individuals 401(k) account in a single year, it combines both the employee’s contribution as well as the employer’s contribution. As an example, a small business owner might contribute the full $17,500 deferral available to herself in a year under the 401(k) rules. In addition, the business makes a profit sharing contribution of $33,500 to the owners account, for a maximum contribution to the business owner of $51,000. This is obviously a tidy sum to receive.
For small business owners looking to maximize their savings and minimize their taxes, utilizing a profit sharing option in a 401(k) plan can be a very good decision. Here are some of the benefits for small business owners:
- Employee contributions to the plan are not taxed by the federal and most state governments until they are distributed (usually at retirement age).
- Employer profit sharing contributions are an allowable business deduction. Contributions to the plan are not taxed until they are distributed.
- The small business owner can defer up to $51,000 to his / her 401(k) account in a single year. Significantly more than if they just maximize the $17,500 employee contribution limit.
- Flexibility – The profit sharing contribution is discretionary and can vary by year. If the business has a difficult year, the profit sharing contribution can be reduced.
- Attract employees – A well designed and funded profit sharing plan can help attract great employees.
- Administration and costs are generally low.
There are several different types of profit sharing plans. The one I see the most is called a New Comparability Plan. A new comparability plan is a profit sharing plan that divides employees into groups. A simple division between groups might be an owner group and a non-owner group. Each group receives a profit sharing contribution match based on a percentage of compensation. However, the match percentage for each group does not have to be the same. As such, profit sharing contributions can be allocated significantly in favor of the small business owner.
As an example, the non-owner group might receive a contribution based on 1.5% of their salary and the owner group might receive a contribution based on 4.5% of their salary. If there is one employee in the non-owner group and their compensation is $40,000, the company will make a profit sharing contribution of $600 to the non-owner. If the owner’s compensation is $100,000, the company makes a profit sharing contribution of $4,500. So for a total cost of $5,100,which is fully tax deductible, the owner will receive $4,500 into her account. The goal for a small business owner might be to reach the annual tax deferral limit of $51,000 in a given year. Deferring this amount of income annually will save significant tax dollars and should create significant long term wealth for the small business owners.
There are some restrictions, including discrimination testing. However, most of these restrictions can be overcome by contributing 5% to the employees’ accounts, then the small business owner should be able to defer the full $51,000 for herself. Additionally, you will need to engage someone experienced in creating these types of plans, which has an administration cost. However, for many small business owners, the tax benefits can be substantial.