Many businesses continually make expenditures to improve and maintain business property. However, it is not always clear whether the amount incurred to repair or refurbish that business property is a capital expense or an incidental repair. Proper classification is critical because, for federal tax purposes, capital expenditures (see below) must be added to the property’s tax basis and recovered (expensed) through depreciation over a period of years. If the property is not subject to depreciation, capitalized costs are only recovered when the property is sold. Incidental repairs are not considered capital expenditures and can be deducted as incurred, providing a more immediate tax benefit.
Capital expenditures include (1) costs of permanent improvements or betterments to increase the value of the property or (2) amounts expended in restoring property. In addition, capital expenditures include amounts paid or incurred to add value to or prolong the useful life of property or adapt property to a new or different use. Capital expenditures also include the cost of title defense or perfection, architects’ fees, and purchase commissions.
Incidental repairs are deductible currently as ordinary and necessary business expenses. These costs do not materially add to the value of property or appreciably prolong its life. Rather, they keep the property in an ordinarily efficient operating condition.Costs of acquiring property generally are capitalized as part of the property’s basis. However, expenses for repairs immediately after the property is acquired might be either capitalized or deducted. These repairs can be deducted if the expense would ordinarily qualify for deduction as a repair. If, however, the repairs are required as a condition of the purchase, their cost is capitalized.
It is often difficult to determine the proper classification for capital and repair expenditures. So, please contact us concerning capital expenditure classification matters or any other tax compliance or planning issue.
Tuesday, February 8, 2011
Converting a Residence to Rental Property
For various reasons, including the generally depressed real estate market, homeowners may consider converting their personal residence to rental property. The process for making this decision should include an analysis of economic factors, such as the homeowners’ marginal tax rate and the potential loss of the ability to exclude up to $250,000 ($500,000, if married) of gain from the sale of their principal residence for federal income tax purposes.
Other economic factors to consider include the expected growth rate for rental property in the area, length of time the house will be rented before being sold, cash flow from renting, effect of passive activity rules (which limit and defer tax deductions), and expected rate of return available on other investments. Generally, the economic advantage of converting a personal residence to a rental rather than selling it is increased as the growth rate of the rental property increases and the rate of return on alternative investments decreases. But, each situation should be thoroughly analyzed given its particular facts and circumstances.
If selling a personal residence would result in a nondeductible loss, the homeowner can seriously consider converting the residence to a rental property. Tax savings opportunities generally are limited for residential rental conversions, primarily because of the passive activity loss rules. Converting a personal residence into rental property may allow the homeowner to eventually recognize a loss for tax purposes on the property’s subsequent sale if the property continues to decline in value, but provide cash flow in the interim.
The fact that a residence is rented at the time of the sale does not automatically preclude gain attributable to such use to be excluded under the gain exclusion rules. Instead, the exclusion of gain depends on whether the homeowner meets the ownership and use requirements and the one-sale-in-two-years test at the time of the sale. In all cases, however, gain exclusion cannot be claimed to the extent of depreciation adjustments attributable to periods after May 6, 1997.
The decision to convert a residence to rental or investment property is complex, and the ramifications of this decision are far-reaching. Please contact us to thoroughly explore the numerous tax and economic issues related to such a conversion.
Other economic factors to consider include the expected growth rate for rental property in the area, length of time the house will be rented before being sold, cash flow from renting, effect of passive activity rules (which limit and defer tax deductions), and expected rate of return available on other investments. Generally, the economic advantage of converting a personal residence to a rental rather than selling it is increased as the growth rate of the rental property increases and the rate of return on alternative investments decreases. But, each situation should be thoroughly analyzed given its particular facts and circumstances.
If selling a personal residence would result in a nondeductible loss, the homeowner can seriously consider converting the residence to a rental property. Tax savings opportunities generally are limited for residential rental conversions, primarily because of the passive activity loss rules. Converting a personal residence into rental property may allow the homeowner to eventually recognize a loss for tax purposes on the property’s subsequent sale if the property continues to decline in value, but provide cash flow in the interim.
The fact that a residence is rented at the time of the sale does not automatically preclude gain attributable to such use to be excluded under the gain exclusion rules. Instead, the exclusion of gain depends on whether the homeowner meets the ownership and use requirements and the one-sale-in-two-years test at the time of the sale. In all cases, however, gain exclusion cannot be claimed to the extent of depreciation adjustments attributable to periods after May 6, 1997.
The decision to convert a residence to rental or investment property is complex, and the ramifications of this decision are far-reaching. Please contact us to thoroughly explore the numerous tax and economic issues related to such a conversion.
Retirement Plan Review
Your retirement plan savings (that is, qualified plans and IRAs) are important to your financial well-being for several reasons. Right now, you can accumulate income without currently paying tax, and the power of compounding pretax dollars makes a retirement plan one of the most powerful investment vehicles available. When you reach retirement age, the assets in your retirement plan(s) may be a significant portion of your overall savings. Therefore, it is important that you do everything you can to get the most out of one of the best investment opportunities you have. So, listed below is information to consider when conducting a review of your retirement plans.
Generally, when you begin to withdraw funds from your retirement plans, you will be subject to tax on the distributions. If you made after-tax contributions to your plan, a portion of each distribution will be tax-free. Also, special rules apply to Roth IRAs. If distributions begin prematurely (before age 59 1/2) you may be hit with a 10% penalty tax, but exceptions are available. When you reach age 70 1/2 (or in some cases, retire) you must start withdrawing a minimum amount from your traditional IRAs and qualified plans each year. Severe penalties can result if required minimum distributions are not made on a timely basis. However, distributions from Roth IRAs are not required during your lifetime. At the time of your death, the beneficiary designation in effect at the date of death will determine not only who gets the retirement plan assets, but also how quickly your account must be paid out to your beneficiary (and, therefore, how quickly the benefits of tax deferral are lost). So, beneficiary designation adjustments may be necessary as family and beneficiary conditions change (e.g., divorce).
Your retirement plan savings may be critical for you and your dependents’ future well-being. With proper planning, you can maximize tax-deferred earnings, avoid penalty taxes, choose a desired beneficiary, and minimize the amount your heirs are required to withdraw (and pay taxes on) after your death.
Please contact us to assist with your retirement plan checkup and ensure you are doing everything you can to get the most out of your retirement savings.
Generally, when you begin to withdraw funds from your retirement plans, you will be subject to tax on the distributions. If you made after-tax contributions to your plan, a portion of each distribution will be tax-free. Also, special rules apply to Roth IRAs. If distributions begin prematurely (before age 59 1/2) you may be hit with a 10% penalty tax, but exceptions are available. When you reach age 70 1/2 (or in some cases, retire) you must start withdrawing a minimum amount from your traditional IRAs and qualified plans each year. Severe penalties can result if required minimum distributions are not made on a timely basis. However, distributions from Roth IRAs are not required during your lifetime. At the time of your death, the beneficiary designation in effect at the date of death will determine not only who gets the retirement plan assets, but also how quickly your account must be paid out to your beneficiary (and, therefore, how quickly the benefits of tax deferral are lost). So, beneficiary designation adjustments may be necessary as family and beneficiary conditions change (e.g., divorce).
Your retirement plan savings may be critical for you and your dependents’ future well-being. With proper planning, you can maximize tax-deferred earnings, avoid penalty taxes, choose a desired beneficiary, and minimize the amount your heirs are required to withdraw (and pay taxes on) after your death.
Please contact us to assist with your retirement plan checkup and ensure you are doing everything you can to get the most out of your retirement savings.
Tuesday, November 30, 2010
Small Business Jobs Act
The President recently signed the Small Business Jobs Act of 2010 (2010 Small Business Act), which includes a number of provisions to spur business activity and create jobs. Listed below are some of the more important provisions of the 2010 Small Business Act. Please contact us if you have questions about these or other provisions of this recent legislation.
Section 179 First-year Depreciation Deductions Doubled for 2010 and 2011
The Section 179 deduction privilege allows many small and medium-sized businesses to immediately write off most or all of the cost of qualifying new and used assets in the first year instead of having to depreciate the cost over a number of years. The 2010 Small Business Act increases the maximum annual Section 179 deduction to $500,000 for eligible assets placed in service in tax years beginning in 2010 and 2011 (up from the $250,000 maximum that applied for tax years beginning in 2009). Most types of depreciable personal property (including computers, equipment, and furniture) and most purchased software qualify. For the first time, some types of real estate improvement costs also qualify (see the following topic).
However, larger businesses can lose all or part of the Section 179 deduction allowance due to an unfavorable phase-out rule. Under that rule, the allowance is reduced dollar for dollar by the cost of qualifying assets placed in service during the year (those that would otherwise be eligible for the Section 179 privilege) in excess of the applicable threshold. For tax years beginning in 2010 and 2011, the new law greatly increases the phase-out threshold to the quite-generous level of $2 million (way up from the $800,000 threshold for tax years beginning in 2009). Thanks to this change, far fewer businesses will be tripped up by the phase-out rule in 2010 and 2011.
Caution: Watch out if your business already has or is close to a tax loss for the year before considering any Section 179 deduction. You cannot claim a Section 179 write-off that would create or increase an overall business tax loss for the year.
Some Real Property Improvement Costs Now Qualify for Section 179
Until now, real property improvement costs were ineligible for the Section 179 deduction privilege. That is no longer true. For tax years beginning in 2010 and 2011, up to $250,000 of qualified improvement costs for (a) interiors of leased nonresidential buildings, (b) restaurant buildings, (c) and interiors of retail buildings can be deducted immediately under the Section 179 deduction provision. However, the $250,000 Section 179 allowance for real estate improvements is part of the overall $500,000 allowance. Again, watch out if your business already has or is close to tax loss for the year before considering any Section 179 deduction. You cannot claim a Section 179 write-off that would create or increase an overall business tax loss for the year.
50% First-year Bonus Depreciation Retroactively Reinstated
The 2010 Small Business Act retroactively reinstates the 50% first-year bonus depreciation provision for one year to cover qualifying new (not used) personal property assets and purchased software placed in service by December 31, 2010. Before this retroactive change, the bonus depreciation provision had expired on December 31, 2009. It is now back for eligible assets placed in service by the end of this year.
Unlike the Section 179 deduction, bonus depreciation is available to even the largest businesses. However, small and medium-sized businesses that can take advantage of both the Section 179 deduction and bonus depreciation are the biggest winners.
Bigger First-year Depreciation Deductions for New Autos and Light Trucks
If your business buys a new (not used) passenger auto or light truck during 2010 that is subject to the dreaded luxury auto depreciation limitations, the reinstated 50% bonus depreciation write-off increases the maximum first-year depreciation deduction by $8,000 for vehicles placed in service by December 31, 2010. Most passenger vehicles qualify except for big SUVs, pickups, and vans. For new cars, bonus depreciation raises to the maximum first-year depreciation write-off for 2010 to $11,060 (assuming 100% business use). For new light trucks, the maximum first-year depreciation deduction for 2010 is raised to $11,160 (assuming 100% business use).
Business Start-up Cost Deduction Rule Liberalized for 2010
For tax years beginning in 2010, the 2010 Small Business Act increases the maximum deduction that can be claimed for start-up costs to $10,000 (up from $5,000) in the year when a new business commences operations. However, the $10,000 deduction allowance is phased out once cumulative start-up costs exceed $60,000. Start-up costs that cannot be deducted in the year business commences can be amortized (written-off) over 180 months, starting with the month business commences.
General Business Credits
Before the 2010 Small Business Act, most general business credits could be used to offset regular income taxes but not AMT. Also, general business credits that could not be used in the current year (unused credits) could be carried back one year or forward 20 years. The 2010 Small Business Act creates an exception that allows general business credits that arise in tax years beginning in 2010 to offset AMT for 2010. Also, unused general business credits from 2010 can be carried back five years or forward 20 years. However, these exceptions are only available to eligible small businesses with average annual gross receipts for the preceding three tax years of $50 million or less.
For more info and questions regarding the Small Business Act and legislation, please call Charles to set an appointment.
Email: Charles@annetahim.com
Section 179 First-year Depreciation Deductions Doubled for 2010 and 2011
The Section 179 deduction privilege allows many small and medium-sized businesses to immediately write off most or all of the cost of qualifying new and used assets in the first year instead of having to depreciate the cost over a number of years. The 2010 Small Business Act increases the maximum annual Section 179 deduction to $500,000 for eligible assets placed in service in tax years beginning in 2010 and 2011 (up from the $250,000 maximum that applied for tax years beginning in 2009). Most types of depreciable personal property (including computers, equipment, and furniture) and most purchased software qualify. For the first time, some types of real estate improvement costs also qualify (see the following topic).
However, larger businesses can lose all or part of the Section 179 deduction allowance due to an unfavorable phase-out rule. Under that rule, the allowance is reduced dollar for dollar by the cost of qualifying assets placed in service during the year (those that would otherwise be eligible for the Section 179 privilege) in excess of the applicable threshold. For tax years beginning in 2010 and 2011, the new law greatly increases the phase-out threshold to the quite-generous level of $2 million (way up from the $800,000 threshold for tax years beginning in 2009). Thanks to this change, far fewer businesses will be tripped up by the phase-out rule in 2010 and 2011.
Caution: Watch out if your business already has or is close to a tax loss for the year before considering any Section 179 deduction. You cannot claim a Section 179 write-off that would create or increase an overall business tax loss for the year.
Some Real Property Improvement Costs Now Qualify for Section 179
Until now, real property improvement costs were ineligible for the Section 179 deduction privilege. That is no longer true. For tax years beginning in 2010 and 2011, up to $250,000 of qualified improvement costs for (a) interiors of leased nonresidential buildings, (b) restaurant buildings, (c) and interiors of retail buildings can be deducted immediately under the Section 179 deduction provision. However, the $250,000 Section 179 allowance for real estate improvements is part of the overall $500,000 allowance. Again, watch out if your business already has or is close to tax loss for the year before considering any Section 179 deduction. You cannot claim a Section 179 write-off that would create or increase an overall business tax loss for the year.
50% First-year Bonus Depreciation Retroactively Reinstated
The 2010 Small Business Act retroactively reinstates the 50% first-year bonus depreciation provision for one year to cover qualifying new (not used) personal property assets and purchased software placed in service by December 31, 2010. Before this retroactive change, the bonus depreciation provision had expired on December 31, 2009. It is now back for eligible assets placed in service by the end of this year.
Unlike the Section 179 deduction, bonus depreciation is available to even the largest businesses. However, small and medium-sized businesses that can take advantage of both the Section 179 deduction and bonus depreciation are the biggest winners.
Bigger First-year Depreciation Deductions for New Autos and Light Trucks
If your business buys a new (not used) passenger auto or light truck during 2010 that is subject to the dreaded luxury auto depreciation limitations, the reinstated 50% bonus depreciation write-off increases the maximum first-year depreciation deduction by $8,000 for vehicles placed in service by December 31, 2010. Most passenger vehicles qualify except for big SUVs, pickups, and vans. For new cars, bonus depreciation raises to the maximum first-year depreciation write-off for 2010 to $11,060 (assuming 100% business use). For new light trucks, the maximum first-year depreciation deduction for 2010 is raised to $11,160 (assuming 100% business use).
Business Start-up Cost Deduction Rule Liberalized for 2010
For tax years beginning in 2010, the 2010 Small Business Act increases the maximum deduction that can be claimed for start-up costs to $10,000 (up from $5,000) in the year when a new business commences operations. However, the $10,000 deduction allowance is phased out once cumulative start-up costs exceed $60,000. Start-up costs that cannot be deducted in the year business commences can be amortized (written-off) over 180 months, starting with the month business commences.
General Business Credits
Before the 2010 Small Business Act, most general business credits could be used to offset regular income taxes but not AMT. Also, general business credits that could not be used in the current year (unused credits) could be carried back one year or forward 20 years. The 2010 Small Business Act creates an exception that allows general business credits that arise in tax years beginning in 2010 to offset AMT for 2010. Also, unused general business credits from 2010 can be carried back five years or forward 20 years. However, these exceptions are only available to eligible small businesses with average annual gross receipts for the preceding three tax years of $50 million or less.
For more info and questions regarding the Small Business Act and legislation, please call Charles to set an appointment.
Email: Charles@annetahim.com
Borrowing from your Retirement Plans
If you are unable (or prefer not) to borrow from a bank or other outside source, your qualified retirement plan may be a good option. IRS guidelines permit a limited amount of borrowing from corporate qualified retirement plans, including 401(k) plans. In general, borrowings are limited to 50% of the participant’s account balance up to a maximum of $50,000 and must be repaid within five years (unless the loan proceeds are used to purchase a principal residence). Hardship withdrawals (different from a loan, which must be repaid to the plan) from 401(k) plans are also permissible in certain circumstances. However, hardship withdrawals are taxable and subject to a 10% penalty if made before age 59½.
Tax law generally prohibits borrowing from IRAs. However, a distribution from an IRA followed by a redeposit of the funds into the same account or another IRA within 60 days of receipt of the funds will qualify as a tax-free rollover transaction. Once you have made such a tax-free rollover, you must wait at least one year from the date of receipt of the amount withdrawn from that particular IRA before becoming eligible to participate in another similar transaction. This once-per-year rule is applied individually to each IRA. Therefore, a person who has more than one IRA may make a rollover once per year on each account. Your use of the funds for the 60-day rollover period is, in effect, a short-term loan. It is recommended that you not implement this strategy without careful planning.
Example: Borrowing from an IRA.
Sue needs $8,000 to pay her income taxes on April 15th. Her only liquid asset is her IRA account with a balance of $63,000. However, she expects to receive an accident settlement of $20,000 around May 15th. Sue can take an $8,000 distribution from her IRA account and use these funds to pay her taxes due April 15th. If she redeposits the funds within 60 days, there are no tax consequences. She can use a portion of her settlement or other available funds for the redeposit to her IRA. If Sue does not receive her insurance settlement within 60 days and has no other source from which to repay the $8,000 distribution, severe tax consequences can result. The distribution becomes taxable and is subject to the 10% penalty if Sue is under age 59½.
Please contact us if you have questions about the tax ramifications of borrowing from retirement accounts.
Tax law generally prohibits borrowing from IRAs. However, a distribution from an IRA followed by a redeposit of the funds into the same account or another IRA within 60 days of receipt of the funds will qualify as a tax-free rollover transaction. Once you have made such a tax-free rollover, you must wait at least one year from the date of receipt of the amount withdrawn from that particular IRA before becoming eligible to participate in another similar transaction. This once-per-year rule is applied individually to each IRA. Therefore, a person who has more than one IRA may make a rollover once per year on each account. Your use of the funds for the 60-day rollover period is, in effect, a short-term loan. It is recommended that you not implement this strategy without careful planning.
Example: Borrowing from an IRA.
Sue needs $8,000 to pay her income taxes on April 15th. Her only liquid asset is her IRA account with a balance of $63,000. However, she expects to receive an accident settlement of $20,000 around May 15th. Sue can take an $8,000 distribution from her IRA account and use these funds to pay her taxes due April 15th. If she redeposits the funds within 60 days, there are no tax consequences. She can use a portion of her settlement or other available funds for the redeposit to her IRA. If Sue does not receive her insurance settlement within 60 days and has no other source from which to repay the $8,000 distribution, severe tax consequences can result. The distribution becomes taxable and is subject to the 10% penalty if Sue is under age 59½.
Please contact us if you have questions about the tax ramifications of borrowing from retirement accounts.
Monday, October 25, 2010
Maximizing Tax Savings from Outright Charitable Gifts
A taxpayer can use either cash or property to make a charitable gift. That choice can affect the taxpayer’s overall tax consequences resulting from the gift. For example, a charitably inclined taxpayer may derive greater tax benefits from gifting property to charity rather than selling the property and gifting the proceeds. In addition, consideration should be given to gifting property with unrealized appreciation to maximize the economic benefit from disposing of the property.
Cash contributions are deductible in the year paid. A contribution generally is considered made at the time of delivery. Thus, contributions paid by check are considered made on the date of delivery or mailing (assuming the check subsequently clears in due course).
Contributions charged to a bank credit card are deductible in the year the charge is incurred, even though paid in a later year. However, interest paid on the credit card balance is not considered a charitable contribution. Charitable contributions made by credit card may be useful for a taxpayer who anticipates a greater benefit from the contribution in the current year, yet needs to defer payment until the next year.
Promissory notes given to charity generally do not constitute a charitable contribution until paid.
Transferring cash is the simplest way to make a tax-deductible donation. Unlike property, the value of a cash donation is not subject to IRS challenge. Costs associated with transferring title to property are avoided. Also, property donations by individuals may be more limited under the percentage-of-AGI limitations than cash donations. Finally, cash is generally a suitable gift for any recipient. Property donations may not always be exactly what the recipient organization needs. In fact, some property donations may cause the donee to incur costs trying to sell them or adapt them to a specific use.
The price for simplicity is giving up cash, which is not possible for all donors. A donor may prefer to donate property that is not producing current income, since he or she suffers no loss of income. A property donation may also be attractive to an owner of illiquid property or low tax basis property.
Please contact us if you have questions concerning charitable deductions and for additional tax-saving guidance.
Cash contributions are deductible in the year paid. A contribution generally is considered made at the time of delivery. Thus, contributions paid by check are considered made on the date of delivery or mailing (assuming the check subsequently clears in due course).
Contributions charged to a bank credit card are deductible in the year the charge is incurred, even though paid in a later year. However, interest paid on the credit card balance is not considered a charitable contribution. Charitable contributions made by credit card may be useful for a taxpayer who anticipates a greater benefit from the contribution in the current year, yet needs to defer payment until the next year.
Promissory notes given to charity generally do not constitute a charitable contribution until paid.
Transferring cash is the simplest way to make a tax-deductible donation. Unlike property, the value of a cash donation is not subject to IRS challenge. Costs associated with transferring title to property are avoided. Also, property donations by individuals may be more limited under the percentage-of-AGI limitations than cash donations. Finally, cash is generally a suitable gift for any recipient. Property donations may not always be exactly what the recipient organization needs. In fact, some property donations may cause the donee to incur costs trying to sell them or adapt them to a specific use.
The price for simplicity is giving up cash, which is not possible for all donors. A donor may prefer to donate property that is not producing current income, since he or she suffers no loss of income. A property donation may also be attractive to an owner of illiquid property or low tax basis property.
Please contact us if you have questions concerning charitable deductions and for additional tax-saving guidance.
529 Plans — College Savings for Your Children
Many parents and grandparents are using 529 Plans to fund their children’s and grandchildren’s education. However, 529 Plans are somewhat confusing because they are subject to Internal Revenue Code qualification requirements, but are operated by the various states or educational institutions under varying policies defined by them. 529 Plans established by the states come in two basic formats: (a) prepaid tuition plans and (b) savings plans. (Eligible educational institutions can only establish prepaid tuition plans; these institutions cannot set up savings plans.) Every state offers at least one 529 Plan.
A prepaid tuition plan is best thought of as a way to lock in the price of covered educational services at today’s prices, thus insuring against college cost inflation. The tax benefits are a nice bonus. In contrast, a savings plan is best thought of as a tax-advantaged way to build up a college fund. Savings plans do not lock in the cost of covered educational services. The federal tax advantages for both types of plans are identical. Each type of plan generally allows both one-time (lump sum) and periodic contributions. Since each state plan is unique, each one must be analyzed in terms of the student’s needs.
Many factors should be considered before opening a 529 Plan account. For many individuals, especially those whose children or grandchildren are years away from college, the savings plans generally will be the better choice. However, the volatility of the stock market, including years of negative returns, has renewed interest in prepaid tuition programs. Prepaid plans might be appropriate in certain circumstances, particularly for those with low risk tolerance or those who want to be guaranteed a certain amount of education credits or units. Whichever route is taken, it is important to review all of the program details, including investment options, fees, and state income tax consequences.
When a state income tax applies, individuals typically should look at their own state program first, as the state income tax consequences might make it more favorable than others. However, many individuals may find that out-of-state programs better meet their needs and objectives. Some families choose to open both a prepaid plan for the cost certainty and a savings plan for the growth potential.
Prepaid tuition plans allow individuals (generally parents) to prepay the education costs of a designated beneficiary (generally their child) at specified institutions and thereby lock in the price. The prepayments are invested by the 529 Plan. In effect, the investment return is guaranteed to keep pace with inflation in the cost of the covered educational services—nothing more; nothing less. Even if the plan’s conservative investments post inadequate returns, there is no obligation to make further payments. However, if the 529 Plan earns more than enough to finance the cost of the covered educational services, the plan gets to keep the excess. In either case, once college time arrives, the covered costs of the designated beneficiary will be paid for by the 529 Plan.
Unlike prepaid tuition plans, 529 savings plans make no promises that contributions will cover a given amount of future college education. As their name implies, savings plans simply provide tax-favored savings accounts for higher education expenses.
The bad news is that savings plans are not a surefire hedge against college cost inflation. The good news is that these plans allow upside potential. If the savings plan’s investment return exceeds the rate of inflation for college costs, less money is needed to fund the account. Basically, the account owner decides how much to contribute to the savings plan, chooses among the plan’s investment options, and then monitors performance. At college time, the account is drawn down to pay some or all of the designated beneficiary’s eligible expenses.
When determining the impact 529 Plans have on a student’s financial aid offer, it is important to recognize that how the 529 Plan is owned (titled) can impact the financial aid computations in two ways. First, it may be an asset that can be assessed in the financial aid computation. Second, withdrawals from the 529 Plan may be treated as a resource that has a direct impact on the student’s financial need (as an outside scholarship would).
Qualified distributions from state-sponsored 529 Plans and institutional programs are completely tax-free. Qualified distributions are distributions for qualified higher education expenses, including tuition, fees, books, supplies, and equipment required for enrollment or attendance at an eligible educational institution. A beneficiary with special needs can also include the expenses of special needs services as qualified expenses.
Finally, 529 Plans may be particularly attractive to higher income parents and grandparents because there are no AGI-based limitations on who can contribute to these plans. In addition, the federal income and estate tax aspects generally are favorable with 529 Plans.
A prepaid tuition plan is best thought of as a way to lock in the price of covered educational services at today’s prices, thus insuring against college cost inflation. The tax benefits are a nice bonus. In contrast, a savings plan is best thought of as a tax-advantaged way to build up a college fund. Savings plans do not lock in the cost of covered educational services. The federal tax advantages for both types of plans are identical. Each type of plan generally allows both one-time (lump sum) and periodic contributions. Since each state plan is unique, each one must be analyzed in terms of the student’s needs.
Many factors should be considered before opening a 529 Plan account. For many individuals, especially those whose children or grandchildren are years away from college, the savings plans generally will be the better choice. However, the volatility of the stock market, including years of negative returns, has renewed interest in prepaid tuition programs. Prepaid plans might be appropriate in certain circumstances, particularly for those with low risk tolerance or those who want to be guaranteed a certain amount of education credits or units. Whichever route is taken, it is important to review all of the program details, including investment options, fees, and state income tax consequences.
When a state income tax applies, individuals typically should look at their own state program first, as the state income tax consequences might make it more favorable than others. However, many individuals may find that out-of-state programs better meet their needs and objectives. Some families choose to open both a prepaid plan for the cost certainty and a savings plan for the growth potential.
Prepaid tuition plans allow individuals (generally parents) to prepay the education costs of a designated beneficiary (generally their child) at specified institutions and thereby lock in the price. The prepayments are invested by the 529 Plan. In effect, the investment return is guaranteed to keep pace with inflation in the cost of the covered educational services—nothing more; nothing less. Even if the plan’s conservative investments post inadequate returns, there is no obligation to make further payments. However, if the 529 Plan earns more than enough to finance the cost of the covered educational services, the plan gets to keep the excess. In either case, once college time arrives, the covered costs of the designated beneficiary will be paid for by the 529 Plan.
Unlike prepaid tuition plans, 529 savings plans make no promises that contributions will cover a given amount of future college education. As their name implies, savings plans simply provide tax-favored savings accounts for higher education expenses.
The bad news is that savings plans are not a surefire hedge against college cost inflation. The good news is that these plans allow upside potential. If the savings plan’s investment return exceeds the rate of inflation for college costs, less money is needed to fund the account. Basically, the account owner decides how much to contribute to the savings plan, chooses among the plan’s investment options, and then monitors performance. At college time, the account is drawn down to pay some or all of the designated beneficiary’s eligible expenses.
When determining the impact 529 Plans have on a student’s financial aid offer, it is important to recognize that how the 529 Plan is owned (titled) can impact the financial aid computations in two ways. First, it may be an asset that can be assessed in the financial aid computation. Second, withdrawals from the 529 Plan may be treated as a resource that has a direct impact on the student’s financial need (as an outside scholarship would).
Qualified distributions from state-sponsored 529 Plans and institutional programs are completely tax-free. Qualified distributions are distributions for qualified higher education expenses, including tuition, fees, books, supplies, and equipment required for enrollment or attendance at an eligible educational institution. A beneficiary with special needs can also include the expenses of special needs services as qualified expenses.
Finally, 529 Plans may be particularly attractive to higher income parents and grandparents because there are no AGI-based limitations on who can contribute to these plans. In addition, the federal income and estate tax aspects generally are favorable with 529 Plans.
Subscribe to:
Posts (Atom)