Schaaf CPA Group LLC

You can exclude up to $500K of gain from the sale of your personal home if the home was the primary residence for you and your spouse and you lived in the home for 2 out of the 5 years before the sale.  We often see taxpayers move out of their primary residence and then rent the home for several years before deciding to sell.  If the taxpayer wants to take advantage of this $500K gain exclusion, then it is important to sell the home within 3 years of moving out so that the taxpayer doesn’t violate the “2 out of 5 years” rule.  So, the usual advice is to move out, rent the home for 2.5 years, and then sell the home within 3 years of moving out unless you want to keep the rental for a very long time (and don’t mind converting tax-free appreciation into taxable appreciation).

We routinely are asked to file tax returns for recently-deceased family members.  Often, the executor (normally the brother or sister of the decedent) can’t find all of the W-2s, 1099s, or other tax documents that we need or they might not even have a copy of the previous-year’s tax return for the decedent.  Our normal process is to have the executor sign a power of attorney so that we can ask the IRS for the decedent’s W-2s and 1099s and have the IRS provide us with a copy of the previous-year’s tax return.  This ensures that we “know what the IRS knows” and then can build upon that in order to make a complete tax filing for the decedent.

A provision of the tax code allows owners of small businesses to avoid paying tax on 20% of their small business profits.  This provision is called the Qualified Business Income Deduction (“QBID”).  This deduction is limited if the small business is a Specialized Services Trade or Business (“SSTB”).  An SSTB is a business in the fields of health, law, accounting, performing arts, consulting, athletics, financial services, brokerage services, or investing.  We often see service-based businesses erroneously classified as “consulting” businesses by other CPA firms.  This classification limits this valuable deduction.  The definition of “consulting” is not very broad and normally doesn’t describe the client’s business operations so we often amend the client’s tax returns to claim this valuable deduction.  If you think your QBID deduction is being limited because you were classified as a consulting SSTB (confusing…I know), then reach out to us so we can have a look.

We are often asked about Social Security claiming strategies. When should I claim Social Security? Should I wait? Should one spouse claim before the other? How does a pension affect Social Security?  This subject is deceivingly complex and we are not experts.  We will usually refer you to http://socialsecurityadvisors.com/appointment where you can make an appointment with advisors, we trust who focus on this one topic.

As we have posted, if a child works for your business then you should pay them as follows:

If under age 18, then pay the child from your Schedule C business (don’t pay them directly from your S Corp)

If age 18, then pay them directly from your S Corp or Schedule C (doesn’t matter which)

If age 19, then pay them from either your S Corp or Schedule C business, but see if you can get very cheap subsidized health insurance for them on healthcare.gov.  If the child earns more than 138% of the federal poverty level, and they are not your dependent, then you can take them off of your family health insurance plan and the child can get their own health insurance.  Since they don’t have much income, their health insurance will likely be better than yours and be almost completely subsidized by the Federal government.  Repeat each year until they graduate college and get a job.

As you likely know, an Indiana taxpayer can take advantage of the provision to get a 20% credit for funding an Indiana 529 plan.  The max credit per tax return is $1,500 on a $7,500 contribution.  If college is going to cost, say, $37,500/year, then you can withdraw that amount from your 529 each year without any consequence.  If you contribute $7,500 to the plan, you save $1,500 in tax.  If you give $7,500 to Grandpa and tell him to put that money in the 529 plan, then Grandpa gets $1,500 off of his Indiana taxes (and then you tell Grandpa to gift you the $1,500 of tax savings).  Repeat across every Indiana-taxpaying family member until you have contributed $3,7500 for the year (so 5 family members times $7,500).  You will receive 5 times $1,500 of tax credits.  We know this is an extreme example, but you get the point.

If you want to start a new business and only have money in your IRA/401K to fund it, then you might be tempted to use a “ROBS” strategy whereby you can use your IRA/401K funds to start the business.  The result of this decision is that your new business is “trapped” in a C Corp inside a 401K “forever”.  This results in the least-efficient form of taxation trapped a vehicle that forever produces income taxed at your highest tax rates for the life of your business.  Please see us before making this decision.  We can show you how to tax-efficiently avoid using this strategy so that you can end up with your business in a more-tax-efficient S Corp where you can take advantage of all of the tax advantages of an S Corporation:  shareholder wage, QBID, PTET, long-term capital gains rates on sale, no double taxation.

The amount you pay for Medicare is based on your income from 2 years ago (for example, your 2024 Medicare premiums are based on your 2022 tax return).  The more income you made in 2022, the more you pay in 2024 as Medicare premiums.  If you find that your income has gone down since filing the 2022 return AND you had a life-changing event (the most common life-changing event is retirement), then you can ask Social Security (who administers the Medicare surcharges) to base your 2024 premiums off of your lower expected current income.  Other common life-changing events are the marriage, divorce, or death of a spouse, a work reduction or stoppage, the loss of pension income, or the non-voluntary loss of an income-producing property.  So, for example, if you sold your business in 2022, which caused you to have large income in 2022, then retire and get a letter from Social Security telling you that you are going to pay more Medicare premiums in 2024, then tell Social Security that you retired and your income will be less in 2024 than it was in 2022 and they will base your 2024 premiums off of your expected 2024 income.

If you filed your tax-return late or owed tax to the IRS past the 4/15 payment deadline, you will be assessed a “Failure to File Penalty” or a “Failure to Pay Penalty”.  These penalties can be up to 25% of your unpaid tax.  The IRS has a first-time abatement program whereby if you have not had a similar penalty in the previous 3 years, they will automatically waive these penalties if you call and ask them.  In order to take advantage of this, prepare the tax return without the penalty, don’t pay the penalty, and wait for the notice from the IRS assessing the penalty and asking you to pay it.  Then call the IRS and see if the penalty can be waived.

The IRS generally wants you to pay your tax liability to them throughout the year and charges you 8% interest if you don’t. If you didn’t pay enough throughout the year and find yourself still owing money to the IRS at the end of the year, consider taking an IRA withdrawal by year-end and withholding all of it. You then can take money from your checking account and contribute that money back to your IRA as a rollover (if done so within 60 days of the withdrawal). Your cash flow will be the same as if you gave the money directly from your checking account to the IRS but by using this two-step process, you will avoid paying 8% interest to the IRS since the IRA withholding is deemed to have been paid equally throughout the year even though it was actually paid at year-end.

An early IRA withdrawal, typically before age 59 & 1/2, is subject to a 10% penalty tax on the taxable portion. There are several exceptions to this penalty. Reach out to your tax advisor with questions.

1. Medical expenses: medical expenses exceeding 7.5% of AGI are exempt
2. Higher Ed expenses: qualified educational expenses can be considered penalty-free withdrawals
3. First-time home purchase: withdrawals up to a $10K lifetime limit are available for home acquisition costs.
4. Substantially equal periodic payments: penalty-free withdrawals require adhering to specific conditions.
5. Disability: withdrawals due to disability are penalty-free under specific conditions
6. Long-term care: beginning in 2025, withdrawals for qualified long-term care are exempt
7. Birth or adoption: withdrawals are possibly penalty-free up to $5K for birth or adoption expenses
8. Emergency expenses: a new provision permits up to $1K annually for emergency expenses
9. Disaster recovery: withdrawals are exempt up to $22K for qualified disaster recovery
10. Military: active-duty reservists can withdraw penalty-free
11. Terminal illness: withdrawals are penalty-free for the terminally ill
12. After-death withdrawals: withdrawals are penalty-free after the death of the account owner
13. Health insurance premiums during unemployment: withdrawals can be penalty-free for health insurance payments made during unemployment.
14. IRS levies: if a withdrawal is to pay an IRS levy against the IRA account, it is exempt from penalties
15. Victim of domestic abuse: withdrawals up to $10K are penalty-free for domestic abuse victims

Indiana offers a credit of 20% of your contributions to a 529 account with a maximum credit of $1,500. If you have a child in college or private K-12, then contribute $7.5K to their Indiana College Choice 529 account, and then turn around and put that money back into your personal checking account. You don’t need to leave the 529 funds in the 529 to get the $1.5K Indiana tax
credit (i.e., save $1.5K of Indiana tax each year you do this). Contributions are now based on
an April 15^th deadline. Meaning you can contribute towards the prior year up until April 15^th of the following year as long as you apply the contribution to the prior year. To ensure you get the credit, you must have an Indiana 529 account. Indiana does cross reference the account contributions with your return and will deny the credit if the account isn’t an Indiana account.

Inherited IRAs are subject to Required Minimum Distributions (RMDs) according to the SECURE Act. Per the SECURE Act, RMDs would be required for each of the first nine years following the decedent’s death with the remaining balance to be withdrawn in the tenth year. However, the IRS will not begin penalizing missed RMDs until 2025 at the earliest. The IRS announced that penalties will not be imposed on taxpayers who fail to take the RMDs on IRAs and Roth IRAs inherited from decedents who passed away after 2019 through year end 2024. While RMDs may not be required for 2024, we recommend that you strategize with your CPA on the best way to distribute funds from these accounts before the end of the tenth year so you don’t end up with a large tax impact in year ten.

Remember these withdrawals would still be subject to ordinary income tax – we are solely avoiding the 10% penalty on early withdrawals (before 59 ½) with these exceptions.  Beginning in 2023, individuals with a terminal illness will be able to withdraw funds from their retirement plans or IRAs without penalty and there is no limit to this exception.  In 2024, victims of domestic abuse would be able to withdraw up to $10,000 from their retirement plan or IRAs penalty free.  Starting in 2026, individuals subject to long term care would be able to withdraw up to $2,500 penalty free from their retirement plan but not IRAs. 

Beginning in 2024, unused 529 accounts can be rolled over to a ROTH IRA in the beneficiary’s name.  The account must be open for at least 15 years and have no new contributions in the last five years.  These rollovers will be limited to the annual ROTH IRA contribution limits, currently $6,500.  There is also a lifetime limit of $35,000.  These rollovers will be tax and penalty free.