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And … Other Financial Planning Topics of Import
By Lon Jefferies MBA CFP®
In 2014, the federal tax brackets are 10%, 15%, 25%, 28%, 33%, 35%, and 39.6%. For a taxpayer who is married and files jointly, regardless of how much the household makes, the first $18,150 of income after accounting for deductions and exemptions will only be taxed at the 10% rate.
Similarly, any income the household makes that is more than $18,150 but less than $73,800 is taxed at the 15% rate. At that point, the next $75,050 is taxed at 25%, and so on.
Consequently, not all income a household makes during the course of the year is taxed at the same rate. A marginal tax bracket is the tax rate that applies to the last dollar the household made.
It is crucial for all taxpayers to know their marginal tax rate. This information can help a client identify which type of investment accounts fits their situation best, how to structure an investment portfolio, and how to determine the value of certain deductions when filing their tax return.
Roth or Traditional Retirement Accounts
Contributions to traditional retirement accounts like IRAs and 401(k)s allow taxpayers to avoid recognizing income earned during the tax year and push the need to acknowledge the revenue into a future year. This is valuable because many people are in a higher tax bracket during their working years than they are during retirement. For instance, for a person who is currently in the 25% marginal tax bracket, it may be advantageous to delay recognizing the income until the investor retires and has less income, causing him to be in only the 15% marginal tax bracket. Doing this would enable the taxpayer to pay taxes at only 15% as opposed to 25%.
Alternatively, a Roth IRA or Roth 401(k) allows an investor to pay taxes on contributed income during the year it was earned but the money then grows tax-free. Consequently, a Roth retirement account is great for someone who believes they may be in a higher marginal tax bracket in the future. For example, a young employee in the early stages of his career who is in the 15% tax bracket but believes he may be in the 25% or 28% bracket in the future would benefit from paying all taxes on the income at his current rate of 15% and then getting tax-free investment growth. This would prevent the investor from having to pay the higher future tax rate of 25% or 28% on the invested dollars.
Knowing your marginal tax bracket can help you determine if you would favor paying taxes on your invested dollars at your current tax rate or if you believe you may benefit from pushing the need to recognize the income into a future tax year. This is a critical decision when planning for retirement and it can’t accurately be made without knowing your marginal tax rate.
Capital Gains Rate
A long term capital gains tax rate is the rate that applies to the growth of any asset held for longer than a year that is not within a tax-advantaged account. If you buy stock outside a tax-advantaged account, or purchase investment property, any growth in the value of the investment will be taxed as capital gains when sold.
An investor’s capital gains tax rate is determined by the investor’s marginal tax rate. For most taxpayers the long term capital gains tax rate is 15%. However, if a taxpayer is in the 10% or 15% marginal tax bracket, the long term capital gains tax rate is an amazing 0%! Additionally, many taxpayers in either the 35% or 39.6% tax bracket may end up paying capital gains at a rate of 20%.
Clearly, knowing your marginal tax bracket will help you analyze the appeal of making investments outside of tax-advantaged accounts. People who qualify for the 0% capital gains tax should actively search for ways to take advantage of this benefit.
Additionally, knowing your marginal tax rate can help you determine the best time to recognize long-term capital gains. If your marginal tax rate will be 25% in 2014 — leading to a capital gains tax rate of 15% — but you believe your marginal rate will be 15% in 2015 — leading to a capital gains tax rate of 0% — it would save you money and lower your tax bill to defer recognizing long-term capitals gains until next year.
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Annuities
Annuities are promoted as a way for invested dollars to obtain tax-deferred growth. However, when money is withdrawn from an annuity it is taxed at the investor’s marginal tax rate as opposed to his long term capital gains tax rate. Knowing your marginal tax bracket can help determine whether an annuity adds any value to your portfolio, or whether it could actually be detrimental.
Suppose an investor is in the 15% marginal tax bracket. If this person invests in an annuity, he will avoid paying taxes on any of the investment’s growth until the funds are withdrawn from the annuity. However, at that point the investment’s growth will be taxed at the taxpayer’s marginal income tax bracket of 15%. Alternatively, if this same investor utilized a taxable investment account rather than an annuity, the investment’s growth would be taxed at the investor’s capital gains tax rate of 0% when sold. In this case, investing in an annuity actually created a tax bill for this investor!
Clearly, knowing your marginal tax rate and your resulting capital gains tax rate can help you determine the best type of investment accounts for your personal situation.
Itemized Deductions
The value of your itemized deductions is essentially determined by your marginal tax bracket. For a simplified example, consider a taxpayer who could generate an additional $10,000 of deductions. Doing so would mean the individual would pay taxes on $10,000 of income less than he would without the deduction. If the individual is in the 15% tax bracket, generating the deduction would lower the person’s tax bill by $1,500 dollars ($10,000 x 15%). However, if the individual is in the 25% tax bracket, the same deduction would lower the person’s tax bill by $2,500 ($10,000 x 25%).
Consequently, knowing your marginal tax bracket can help determine when large itemized deductions should be taken. If you would like to donate funds to your favorite charitable institution, knowing which year you will be in the highest marginal tax bracket can help you determine the best time to make the contribution.
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Marginal Tax Rates Change
Many people’s income is relatively constant year-after-year. For these people, there may not be much fluctuation in their marginal tax bracket. However, any time you have a significant increase or decrease in income recognized during a year, your marginal tax rate may change. Whenever possible, it is best to anticipate how your current marginal tax rate might compare to your future marginal tax rate.This is another strong factor that can impact all the key financial decisions effected by your marginal tax rate.
Conclusion
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Filed under: Accounting, Financial Planning, Insurance Matters, Taxation | Tagged: Annuities and Insurance, Capital Gains Rate, Financial Planning, Itemized Deductions, Lon Jefferies, marginal tax rates, tax accounting, tax rates |
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Tax scam victimizes hundreds of physicians
The IRS, Secret Service and other agencies are investigating the theft of names, addresses and Social Security numbers pinched from a national database.
http://www.medicalpracticeinsider.com/best-practices/tax-scam-victimizes-hundreds-physicians-nationwide
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Employers in 7 states and the Virgin Islands will face higher FUTA rates for 2014
The U.S. Department of Labor (DOL) has released a schedule that shows the states that, because they have had an outstanding federal unemployment insurance (UI) loan for at least two years, are subject to federal unemployment tax (FUTA) credit reduction on 2014 federal Form 940, Employer’s Annual Federal Unemployment (FUTA) Tax Return .
Employers pay FUTA tax at a rate of 6.0% on the first $7,000 of covered wages paid to each employee during a calendar year, regardless of when those wages were earned. This tax may be offset by credits of up to 5.4% (known as the “normal credit” and “additional credit”) against their FUTA tax liability for amounts paid to a state UI fund by January 31 of the subsequent year. The net FUTA tax rate for most employers is therefore 0.6% (i.e., 6.0% – 5.4%).
Under Title XII of the Social Security Act, states with financial difficulties can borrow funds from the federal government to pay UI benefits. If a state defaults on its repayment of the loan, the amount of state UI tax credits that employers in the state may claim is reduced. Employers in credit reduction states pay FUTA tax at a 0.3% rate higher than other employers, beginning with the second consecutive January 1 in which the loan is not repaid by November 10 of that year. For each succeeding year in which there is a balance, the credit is further reduced by an additional 0.3%.
2014 FUTA credit reduction states. The following seven states and the Virgin Islands are FUTA credit reduction states for the 2014 tax year because they did not repay their outstanding federal UI loans by Nov. 10, 2014: California, Connecticut, Indiana, Kentucky, New York, North Carolina, and Ohio. In 2013, there were 13 states (and the Virgin Islands) that were credit reduction states.
1.2% credit reduction. Employers in California, Kentucky, New York, North Carolina, Ohio, and the Virgin Islands are subject to a 1.2% credit reduction on their 2014 FUTA tax return (maximum $84 increase per employee) because of their state’s failure to repay its outstanding federal loans for five consecutive years.
1.5% credit reduction. Indiana employers are subject to a 1.5% credit reduction on their 2014 FUTA tax returns (maximum $105 increase per employee) because of Indiana’s failure to repay its outstanding federal loans for six consecutive years.
Connecticut. Connecticut employers are subject to a 1.7% credit reduction on their 2014 FUTA tax returns (maximum $119 increase per employee). Included in the 1.7% is a 1.2% credit reduction because of Connecticut’s failure to repay its outstanding federal loans for five consecutive years. There is also a 0.5% Benefit Cost Ratio (BCR) add-on. The BCR add-on (see 20 CFR 606.20 and 20 CFR 606.21) applies beginning with the third or fourth consecutive year in which the federal loan has not been repaid and state unemployment insurance rates do not meet minimum federal levels. In addition, states may be subject to the BCR add-on beginning with the fifth year in which a federal loan balance still exists. The Connecticut 0.5% BCR add-on is in effect because this was the fifth year in which a federal loan balance still existed.
Former credit reduction states. Arkansas, Delaware, Georgia, Missouri, New Jersey, Rhode Island, and Wisconsin repaid their outstanding federal UI loans. As a result, the net 2014 FUTA tax rate for employers in these states will be 0.6% (i.e., the rate for employers that are not in credit reduction states). The additional tax for Georgia will now be eliminated for 2014.
South Carolina. South Carolina has received approval from the DOL to avoid being a FUTA credit reduction state for the 2014 tax year.
BCR add-on waivers. California, Indiana, New York, North Carolina, Ohio, South Carolina, and the Virgin Islands applied for, and received, waivers from the BCR add-on credit reduction.
Connecticut did not apply for a waiver from the BCR add-on credit reduction.
Bobby Whirley, CPA
[Managing Partner]
Whirley & Associates, LLC + ProActive Advisory
2500 Northwinds Parkway
Suite 190
Alpharetta, GA 30009
770.932.1919
770.932.1192 (fax)
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