Saving for Education: Understanding 529 Plans

 

Many parents are looking for ways to save for their child's education, and a 529 Plan is an excellent way to do so. Even better is that, thanks to the passage of tax reform legislation in 2017, 529 plans are now available to parents wishing to save for their child's K-12 education as well as college (two and four-year programs) or vocational school.

The SECURE Act of 2019 expanded the 529 Plan to include fees, books, supplies, and equipment for apprenticeship programs and repayment of principal and interest on student loan debt for the designated beneficiary or the beneficiary's sibling, up to a lifetime limit of $10,000.

You may open a Section 529 plan in any state, and there are no income restrictions for the individual opening the account. Contributions, however, must be in cash, and the total amount must not be more than is reasonably needed for higher education (as determined initially by the state). A minimum investment may be required to open the account, such as $25 or $50.

Each 529 Plan has a designated beneficiary (the future student) and an account owner. The account owner may be a parent or another person and typically is the principal contributor to the plan. The account owner is also entitled to choose (and change) the designated beneficiary.

Neither the account owner nor beneficiary may direct investments. Still, the state may allow the owner to select a type of investment fund (e.g., fixed-income securities) and change the investment annually as well as when the beneficiary is changed. The account owner decides who gets the funds (can pick and change the beneficiary) and is legally allowed to withdraw funds at any time, subject to tax and penalties (more about this topic below).

Unlike other tax breaks for higher education funding, such as the American Opportunity and Lifetime Learning Tax Credits, 529 plans aren’t limited to funding only tuition. Room, board, lab fees, books, and supplies can be purchased with funds from your 529 Savings Account. However, individual state programs could have a more narrow definition, so check with your particular state.

Tax-Free Distributions

Distributions from 529 plans are tax-free as long as they are used to pay qualified higher-education expenses for a designated beneficiary. Distributions are tax-free even if the student claims the American Opportunity Credit, Lifetime Learning Credit, or tax-free treatment for a Section 530 Coverdell Education Savings Account (ESA) distribution - provided the 529 plan distributions aren't covering the same specific expenses.

Qualified expenses include tuition, required fees, books, supplies, equipment, and special needs services. Room and board also qualify for someone who is at least a half-time student. Also, starting in 2018, qualified expenses include up to $10,000 in annual expenses for tuition in connection with enrollment or attendance at an elementary or secondary public, private, or religious school.

Qualified expenses also include computers and related equipment used by a student while enrolled at an eligible educational institution; however, software designed for sports, games, or hobbies does not qualify unless it is predominantly educational in nature.

Federal Tax Rules

Income Tax. Contributions made by the account owner or other contributor are not deductible for federal income tax purposes, but many states offer deductions or credits. Earnings on contributions grow tax-free while in the plan. Distributions for a purpose other than qualified education are taxed to the one receiving the distribution. In addition, the taxable portion of the distribution will incur a 10 percent penalty, comparable to the 10 percent penalty that applies to Coverdell ESAs. Also, the account owner may change the beneficiary designation from one to another in the same family. Funds in the account roll over tax-free for the benefit of the new beneficiary.

Gift Tax. For gift tax purposes, contributions are treated as completed gifts even though the account owner has the right to withdraw them - thus, they qualify for the up-to-$17,000 annual gift tax exclusion in 2023 ($16,000 in 2022). One contributing more than $17,000 may elect to treat the gift as made in equal installments over that year and the following four years so that up to $85,000 can be given tax-free in the first year.

Estate Tax. Funds in the account at the designated beneficiary's death are included in the beneficiary's estate - another odd result since those funds may not be available to pay the tax. Funds in the account at the account owner's death are not included in the owner's estate, except for a portion where the gift tax exclusion installment election is made for gifts over $17,000 ($16,000 in 2022). Here is an example: If the account owner made the election for a gift of $85,000 ($80,000 in 2022), a part of that gift is included in the estate if the owner dies within five years.

A Section 529 plan can be an especially attractive estate-planning move for grandparents. There are no income limits for contributing, and the account owner giving up to $85,000 ($80,000 in 2022) avoids gift tax and estate tax by living five years after the gift, yet has the power to change the beneficiary.

State Tax. State tax rules are all over the map. Some reflect the federal rules, and some are quite different. For an overview of each state's 529 plan, see: College Savings Plans Network (CSPN).

Looking Ahead

Starting in 2024, 529 college savings plans maintained for at least 15 years can be rolled over to a Roth IRA. Any contributions (and earnings on those contributions) to the 529 plan made within the last five years are not eligible. The rollover must be trustee to trustee, with a lifetime limit of $35,000 per account beneficiary. Rollovers are subject to Roth IRA annual contribution limits.

Seek Professional Guidance

Considering the differences among state plans, the complexity of federal and state tax laws, and the dollar amounts at stake, please call the office and speak to a tax and accounting professional before opening a 529 plan.

PAY YOURSELF FIRST!!

 

Automate a % of your income toward savings/investments.

If you only save/invest the leftover scraps, then don’t be surprised when you only have leftover scraps to retire on!!

What To Do if You Missed the Tax Deadline

 

Tuesday, April 18, 2023, was the deadline for most taxpayers to file their tax returns. If you haven't filed a 2022 tax return yet, it's not too late.

First, gather any information related to income and deductions for the tax years for which a return is required to be filed, then call the office. If you are owed money, the sooner you file, the sooner you will get your refund. If you owe taxes, file and pay as soon as you can, which will stop the interest and penalties you owe.

Some taxpayers filing after the deadline may qualify for penalty relief. Those charged a penalty may contact the IRS by calling the number on their notice and explaining why they couldn't file and pay on time.

For 2022 tax returns due April 18, 2023, some taxpayers automatically qualify for extra time to file and pay taxes due without penalties and interest, including:

• Some disaster victims. Individuals living or working in a federally declared disaster area have more time to file and pay what they owe.
• Taxpayers outside the United States. U.S. citizens and resident aliens who live and work outside the U.S. and Puerto Rico, including military members on duty who don't qualify for the combat zone extension, may qualify for a two-month filing and payment extension.
• Members of the military who served or are currently serving in a combat zone may qualify for an additional extension of at least 180 days to file and pay taxes.
• Support personnel in combat zones or a contingency operation in support of the Armed Forces may also qualify for a filing and payment extension of at least 180 days.

The military community can also file their taxes using MilTax, a free tax resource offered through the Department of Defense. Eligible taxpayers can use MilTax to file a federal tax return electronically and up to three state returns for free.

If You Don't File, You May Miss Out on a Refund

Every year, more than 1 million taxpayers choose not to file a return and miss out on receiving a refund due to potential refundable tax credits. The most common examples of these refundable credits are the Earned Income Tax Credit and Child Tax Credit. For example, the IRS estimates nearly 1.5 million people did not file a tax return for 2019 and missed out on an estimated average median refund of $893 (i.e., half of the refunds are more than $893, and half are less).

Taxpayers usually have three years to file and claim their tax refunds. If they don't file within three years, the money becomes the property of the U.S. Treasury. However, the three-year window for 2019 unfiled returns was postponed to July 17, 2023, due to the COVID-19 pandemic emergency.

How To Make a Payment

If you owe money but cannot pay the IRS in full, pay as much as possible when you file your tax return to minimize penalties and interest. The IRS will work with taxpayers suffering financial hardship. Taxpayers with a history of filing and paying on time often qualify for administrative penalty relief. A taxpayer usually qualifies if they have filed and paid promptly for the past three years and meet other requirements. However, if you continue to ignore your tax bill, the IRS may take collection action.

There are several ways to make a payment on your taxes: credit card, electronic funds transfer, check, money order, cashier's check, or cash. If you pay your federal taxes using a major credit card or debit card, there is no IRS fee for credit or debit card payments, but processing companies may charge a convenience or flat fee. It is important to review all your options. The interest rates on a loan or credit card could be lower than the combination of penalties and interest imposed by the Internal Revenue Code.

What To Do if You Can't Pay in Full

Taxpayers who cannot pay the full amount owed on a tax bill are encouraged to pay as much as possible. By paying as much as possible now, the interest and penalties owed will be less than if you pay nothing. Based on individual circumstances, a taxpayer could qualify for an extension of time to pay, an installment agreement, a temporary delay, or an offer in compromise. Don't hesitate to call if you have questions about these options.

Direct Pay. For individuals, IRS Direct Pay is a fast and free way to pay directly from your checking or savings account. Taxpayers who need more time to pay can set up either a short-term payment extension or a monthly payment plan.

Payment Plans. Most people can set up a monthly payment plan or installment agreement that gives taxpayers more time to pay. However, penalties and interest will continue to be charged on the unpaid portion of the debt throughout the duration of the installment agreement/payment plan. You should pay as much as possible before entering into an installment agreement.

Cash Payments. Individual taxpayers who do not have a bank account or credit card and need to pay their tax bill using cash can make a cash payment at participating PayNearMe Company payment locations (places like 7-Eleven). Individuals wishing to take advantage of this payment option should visit the IRS.gov payments page, select the cash option in the "Other Ways You Can Pay" section, and follow the instructions.

What Happens if You Don't File a Past Due Return

It's important to understand the ramifications of not filing a past-due return and the steps that the IRS will take. Taxpayers who continue not to file a required return and fail to respond to IRS requests for a return may be considered for various enforcement actions, including substantial penalties and fees.

Need Help Filing Your 2022 Tax Return?

If you haven't filed a tax return yet, don't delay. Call the office today to schedule an appointment as soon as possible.

Pay Off Your Debt...

 

"Yep, I want you to pay off debt as quickly as possible, but I want you to make sure you go about it in a wise way. Please don't take from any existing retirement investments. It may seem like that money is just sitting there waiting to be used, but what it's really doing is growing. If you withdraw it early, you'll owe a ton in taxes and fees, not to mention what that investment would have grown into.

You also need a $1,000 emergency fund set aside BEFORE you begin paying off debt. Keep that separate and use it only for true emergencies.

Also, don't use things like home equity lines of credit (HELOCs) or debt consolidation. Long story short, those only move the debt around and keep you in debt longer.

DO make a strict budget, and stick to it! Keep an emergency fund in place, find other sources of income, and sell things you don't need. Throw all of that extra money at the debt and use the debt snowball method to speed up the process. (If you're not sure what that is, just Google "Dave Ramsey Debt Snowball".)

Debt is a TRAP. Without a ton of payments, you can make your own decisions about what to do with your money. Without payments, you get to make your own decisions about what to do with your LIFE."  Dave Ramsey

A tax professionals observations from this tax season.

 

The following post was written by Keith Schroeder

I published this over on the FB page for my blog. It should prove of interest to folks here.

Some observations from this tax season.

When I started this experiment (the blog and hence any social media presence I have) it wasn't to fill in all that free time I wanted to fill. Instead, the goal was to show the world the view from my side of the desk. 

Every tax season is different in its own way. 

Last week a guy walks into the office and demands we take him on as a client. He was informed we are not taking new clients. He blows up saying, "You were taking new clients last week!"

Well. no. No we were not.

He persisted so I told him a short story before kicking him out. The story: You are filling the tank on your car. When it is full do you keep pumping more fuel, allowing it to spill on the ground, while saying, 'I was filling my tank 10 minutes ago so my tank is obligated to take more fuel now?' He got more angry so out the door he went. 

Moral of the story? Even if I were starving I would not have taken him on as a new client. Not everyone is a potential client.

Of course that is the normal part of tax season every year. Some "no's" are easier than others.

Here is the new twist for this tax season. (Well, not exactly new, but from a new source.)

Several local tax firms have closed their doors the past few years without new ones opening to replace them. That adds stress to the remaining crowd.

I closed my door to new clients for some time now, but did allow a few to sneak through if they were local. Two or three came from a larger accounting firm. The story was their fee was doubling, or nearly so. The firm sent them a letter informing them of this.

My first thought was they were cutting the size of the firm over staffing problems. But then the initial requests dried up. Hmmm?

Two or three of these returns snuck into my book. Then I realized what really happened. The firm sent the letter informing of the fee increase to PITA clients only. This became obvious when completing the return was followed by 8-10 calls over the remainder of tax season.

(I am well aware several clients are in this group/on this page. I am doing my best to be polite about the situation.)

There is a massive shortage of tax professionals/accountants and the shortage is getting worse by the day. It no longer takes a lot to become a PITA client. Time is at such a constraint that anything that  wastes that precious commodity needs to be eliminated or billed accordingly.

Mind you, the PITA client (only one sticks out) from the other firm did nothing egregious. It's just that the onslaught of follow-up questions were very basic. (Where do I send my balance due? It on the coupon we gave you. When is it due? It says on the coupon. Should I send it certified? Your call. Each question, and more, were from separate phone calls. They should have allowed electronic funds withdrawal.)

Lesson: Every tax pro I know works hard to be very nice. But every tax pro I know is sleep deprived this time of year. And they all have the same complaints. For example: missing documents are a scourge that saps precious personal time, time that could be used to sleep or pay attention to a significant other and the kids.

Don't accidently become a pain in the. . . 

And it is easy to do. It isn't your fault. It isn't the tax pros fault either. And yes, respect needs to work both ways.

Rules:

1.) It will take work finding a competent tax pro. Be polite and accept a decline from a tax firm. They want to say yes, but you don't want a firm that says yes too much.

2.) Think before calling the tax office. Some questions answer themselves. Tax pros no longer have the luxury of keeping slots of time open to hand hold during tax season.

3.) But, most tax pros are open to hand holding outside tax season. Consulting, too (for a fee (guy has to eat)).

4.) But! That doesn't mean the day after regular tax season closes. The sleep deprived are going to take a nap! For three days! And then check to see if they still have a family or if they left for fertile grounds elsewhere!

5.) More and more firms will downsize as the staffing shortage grows worse. Technology will not cover all the lost ground. 

6.) The best time to look for a tax pro is outside tax season with the promise (and one you keep) to bring ALL your tax docs in early. Then expect a long wait for completion, even an extension. (From my side of the desk: This allows for triage, where we can finish the maximum amount of work in a day, but not necessarily in the order received.) 

7.) Enough bullet points. You get the picture. Be nice to your tax pro. They only sleep 8 months of the year and that has a serious health cost for them. Show appreciation. Always understand, we care. There just is no way to deliver on all the demands made of us.

Thank you.

What to do if you owe taxes

 

1) Pay as much as you possibly can right now.

2) You can ask for (and often receive) an extension to pay.

3) "Financial hardship" delay: This is if paying your tax bill would demonstrably affect your ability to pay your other bills. Interest and penalties still accrue.

4) Installment payment plan: If you owe less than $50K in taxes, you should usually be able to get an installment payment plan of up to 72 months, simply by asking for it.

5) Negotiate: This is NOT something to try on your own. We can help, but the number of "Offers in Compromise" that get accepted each year is quite small and a knowledge of how the system works is important.

6) Using existing credit sources (credit card, HELOC, private loans): Some tax advisors would quickly recommend this, but I would NOT recommend you go this route. If you've exhausted the options above, do this instead:

7) Sell something you don't need anymore. Always a pretty good plan anyway.

How Jackson County Filers Can Prepare for an IRS Audit

 

First off – congratulations to the Kansas City Chiefs. From all accounts, it was a pretty epic game. And, of course, there are those commercials. Many great ones, but one quick note about one of, well, “professional interest” for me.

The TurboTax campaign (“Don’t do your taxes”).

You might not have seen them, but they are, in fact, BEAUTIFUL commercials (Intuit seems to have upped their design chops – which, when you’re a multi-billion, multinational conglomerate, should be table stakes).

But let me ask you this: does it give you confidence to entrust your (increasingly complex) taxes to a nameless, faceless “CPA” cheaply employed by Intuit to work for them? It’s almost a worse pitch than entrusting it to a software program.

They’ve figured out that a “software” solution isn’t ideal for something so sensitive and delicate as your taxes … but their new answer seems to involve you trusting THEM to pick somebody for you. And it would be someone who isn’t competent enough to establish their own practice, and needs help from Intuit to do so.

It’s a bit of a scary proposition, yes?

And speaking of scary … for many, almost nothing is scarier than getting an audit notice from the big bad IRS. 

Not scary for us here at Alliance Financial & Income Tax … but scary for normal Santa Cruz County folk. Truthfully, the total number of IRS audits has been on the low end of the spectrum the last ten years due to staffing and funding issues.

But… after Biden’s Inflation Reduction Act rolled out last summer, everyone’s been on high alert about increased enforcement measures (believe me, I heard from plenty of people worried about that) knowing that over half of the 80 billion dollar cash infusion to the IRS from said bill is allotted for that very thing. 

So, is the newer cashed-up, staffed-up IRS going to come after your tax dollars with an army of enforcers? Well, sort of – but also, not exactly. Enforcement funds will go to many things like new technologies and increased legal support for IRS investigations and new staff hiring doesn’t mean just agents. But, yes, audits will increase. 

Where those audits will focus has yet to be seen — Middle-class taxpayers? High-net worth individuals? Corporations? We’ll see…

But that’s why I’m talking today about preparing for an audit, to make sure you’re primed for whatever gets thrown your way and so you can be confident if that letter shows up in your mailbox.

Your first line of defense in the whole tax standing thing, is making sure things are done correctly the first time and getting it done on time. Though April is still a ways out, it’ll be here in a flash… which means you need to grab a time so we can get your tax filing signed, sealed, and submitted (and not by a randomly-selected drone). Let’s get something scheduled: 
https://www.afitonline.com/appointments

Alright, finally, let’s take a look at how to prepare for an audit…

How Jackson County Filers Can Prepare for an IRS Audit

“The lucky man is he who knows how much to leave to chance.” – C.S. Forester 

Some say IRS audits are on the rise for Jackson County residents; some say they’re rarer than ever. The Government Accountability Office, one of Uncle Sam’s agencies that keeps watch over the IRS, recently reported that audit rates dropped a lot in the past decade. 

But you might have heard (correctly) that the IRS got a big transfusion of funding last summer from Capitol Hill, and they’ve promised to use part of that money to beef up compliance — and for some people, that’s going to mean more audits. 

The potential of an IRS audit is never something to take lightly. 

Why me?

Good question. Don’t panic. 

An IRS audit can be random, picked by a computer. Other reasons include “significant inconsistencies” between your past tax returns and your most current one, miscalculated or weirdly high deductions, foreign accounts, or declaring a hobby as a business … to name a few. 

The government generally has three years to pull your tax return for an IRS audit. Most — not all — are done completely by mail. Most are wrapped up inside a year. 

Part of preparation is knowing as much as you can about what you’re getting into — and in this case, that starts with knowing how the IRS will and won’t contact you. 

They generally use mail first (not social media or email, and not the phone). If somebody calls threatening you with an IRS audit and quick action if you don’t comply, hang up and call us, the police, or the IRS itself. 

The IRS manages audits either by mail or through an in-person interview. In-person audits may be at an IRS office or at your home, place of business, or your tax preparer’s office. The IRS will give you contact info and instructions in the letter. 

You’ll likely need your paystubs, W-2s, receipts and bills, credit card and bank statements, canceled checks, loan papers, medical and insurance records, plus your previous returns and all their records. This is a partial list, and some digital records might be okay. (Check with us if you have questions.) If you have too many books or records to mail, you can ask for a face-to-face audit. 

Again, they’ll let you know what they want and give you time to assemble it. 

First steps

Numero uno: Do not ignore the letter. The IRS isn’t going to evaporate, and your problem with them isn’t, either. Read the notice. Read it again. Make certain you know what they want of you. 

Your best response depends on the type of audit. Mail-only audits, for instance, may mean you just need to collect the few items mentioned on the notice or pay/contest the amount owed. In-person audits may be tougher, requiring more documents and questions — an advocate experienced in tax (such as us) coming with you is also a great idea. 

Don’t reply to the notice unless the IRS asks you to. If the notice mentions a change or correction on one of your previous returns, compare what the IRS claims with your copy of the right return. Call the phone number on the top of the notice if you have questions, and when you call have a copy of your tax return and the notice with you and take down the name and information of the IRS agent you speak with. 

If you don’t agree with what the notice claims, mail a letter to the IRS. (We can help you write it.) The notice will have the address where to write. Use a tracking system such as USPS Priority or Certified Mail. Give the IRS a month to get back to you. 

KEEP COPIES OF EVERYTHING. 

If you have to meet the government face to face, bring these:

• a copy of your IRS audit letter;
• information and documents;
• a copy of the tax return in question and copies of your returns from two years before the return in question;
• a copy of the most recent year’s return (if it’s not the return being audited);
• a copy of any documentation you gave to your tax preparer;
• documents that show the results of any prior audits;
• and copies of any other IRS letters or notices you got for the tax year in question. 

Face to face, they’ll probably want to know about funny deductions or unreported income, as well as ask broader questions about your job, family, and life in general for an entire tax year. You may also get an Information Document Request. Respond to it by the deadline. 

If you don’t agree?

The IRS will eventually close the audit, sending you a written report of their findings and determination. You have 30 days to appeal. Don’t waste that time — as you’ve learned, take every interaction with the IRS very seriously. 

 

We’re always here, happy to be your advocate through every step of the process. 

Looking out for you, 

Mike Mead, EA, CTC