Smart Moves to Make with Your Tax Refund

Whether you’re working with a robust tax refund, a work bonus, or an inheritance of some kind, here’s a list of positive moves to make with that windfall.

Evaluate Your Debt

There’s “bad” debt and “good” debt. Good debt is an investment that will grow in value or generate long-term income, such as student loans or home equity loans. Bad debt is anything that quickly loses value, doesn’t generate income, and/or has a high interest rate, such as credit cards and cash advance loans. Whenever you come into extra funds, it’s recommended to pay down or pay off bad debt as a top priority.

Consider Your Emergency Fund

Your rainy-day fund should be stocked with at least three months’ worth of living expenses. If yours isn’t there yet, think about boosting it with your refund. If you are a business owner or your income fluctuates, consider shooting for six months’ worth of living expenses.

Fund Your 401(k)

This is a good time to open or boost contributions to your 401(k) or individual retirement account. The 401(k) contribution limit for 2020 is $19,500 for those under age 50, and taxpayers over age 50 are allowed an additional “catch-up” contribution of $6,500.

Open a Roth IRA

If you’re married filing jointly and have a combined adjusted growth income of less than $196,000, you can contribute up to $6,000 to a Roth IRA. The adjusted growth income cap for single filers is $124,000. This is meant to be a long-term money management move, but if you need to withdraw sooner, you can do so tax-free and penalty-fee, though you may owe taxes and penalties on any earnings (not regular contributions) you withdraw.

Invest in Stocks

Assuming you’ve paid off debt, built up your emergency savings fund to three to six months’ worth of living expenses, and boosted your retirement fund, you could think about consulting a financial professional to build a stock portfolio that aligns with your financial goals and personal risk tolerance. Or, if you’re stock market savvy, you can open a brokerage account on your own and start investing in a stock you believe has the potential for growth.

Additional money moves you could make with your refund (again, assuming debt, emergency savings, and retirement funds are taken care of) include making home improvements; opening up a savings account for something big, like saving for a down payment on a house; or donating to charity.

How Could New FICO Scoring Affect You?

A new scoring model from Fair Isaac Corp., the company behind the FICO score, is set to be implemented later this year by Equifax and other major credit bureaus. The popular score is commonly used by lenders to determine your eligibility and interest rate for certain loans. Read on to find out if it could affect you.

Consumers in Debt

The new model, FICO 10, will start incorporating consumers’ debt levels into its tabulation, which could cause a decrease in score for some overextended consumers, particularly those who have both personal loans and rising debt. This change is speculated to create greater divide to scores in the 600s. If your score is in the 600s and you’re making payments on time and hacking away at debt, your score could increase. On the other hand, if you’re struggling to pay off debt and missing payments, your score could go down.

Combat Credit Card Spending

FICO 10 will give more consideration to how consumers have changed their payment history in the previous two years, benefitting individuals who are making progress in paying off debt and judging more harshly those who show increasing financial strain. Currently, credit card utilization, which is the percent of your available credit lines you’re using, accounts for 30% of your score, but it could become even more important in FICO 10. The goal is to keep your utilization as low as possible, so be sure to pay balances in full each month or at least keep the balances low. One option to paying off credit card debt is to consolidate it by taking out a personal loan, but this only works if you use that loan to pay off debt while refraining from piling new debt on your credit cards.

Create a Monthly Budget

Because delinquent payments will carry greater weight in the new model, it’s crucial to pay bills on time, so if missing payments is a habit or even an occasional slip-up, you’ll want to be more mindful of this. The best way to keep up with payments is to create a monthly budget. This will not only help with keeping payments at the forefront of your mind (and on your calendar), but you’ll have a better overall picture of your finances and whether or not you’re overspending. Also consider enrolling in autopay, with your loan or credit card payments automatically taken from your bank account at the same time each month.

Though banks and lenders decide which credit model they’ll use, Fair Isaac claims that FICO is used in 90% of all lending decisions, so take the next few months to make changes that will start cutting away at high interest rate debt and provide better overall financial wellness.

Taxes You Could Face in Retirement

As an American worker, relinquishing part of your income to taxes is standard practice, but once you move out of the workforce, much of your retirement income is subject to taxes as well. Below are some possible taxes you could face in retirement.

Social Security Taxes

If you have income in addition to Social Security, you will likely lose a portion of your benefits to federal taxes. To determine if your Social Security benefit will be taxable, you need to determine your provisional income. This is your income outside of Social Security—including pension payments, traditional 401(k) and IRA withdrawals, and income from a part-time job—plus half of your yearly benefits. If your provisional income totals more than $25,000 for individuals and $32,000 for couples, 50% of your Social Security benefit will be taxable. If your provisional income exceeds $34,000 for individuals and $44,000 for couples, up to 85% of your Social Security benefit will be subject to tax.

Retirement Plan Penalties

A common tax deduction tactic among workers is to deposit money in an IRA shortly before filing taxes in order to defer paying income tax on the new contributions, but this is not an option after age 70 ½. Additionally, if you miss a required distribution from your retirement accounts after age 70 ½, you will incur a 50% penalty, which is added to the income tax due on retirement account distributions. However, Roth IRAs don’t have distribution requirements in retirement, and workers older than 70 ½ might be able to delay 401(k) distributions.

Taxes on Pension Income

With the possible exception of military or disability pension, you should expect to pay taxes on pension income. However, if you contributed after-tax dollars to your pension, you won’t be required to pay tax on that part of the contribution.

Taxes on Investment Sales

If you intend to sell some investments in retirement, expect to report that sale on your tax return as a short-term or long-term capital gain or loss. Long-term gains are generally taxed at a lower rate than other types of income, but you must hold the investment for at least a year and a day in order to qualify for long-term gains. Interest income and dividends will also continue to be taxed as they were before retirement.

What to Do If You Owe Taxes to the IRS

What happens when you file your taxes and discover that you owe money to the IRS? What are your options? What about when the amount owed is greater than you can afford at the moment? Luckily, there are several options for both scenarios.

Before we get into the different options for making payments to the IRS, remember that your payment has to be received by the IRS no later than the April 15th tax deadline, or be prepared for IRS-issued tax penalties and interest. This deadline applies to those who filed for a tax extension as well.

Below are the different payment options available to pay the IRS.

Automatic Withdraw

If you have the funds available when you file, you can have them automatically withdrawn from your bank account when you e-file and choose the e-pay option. This is available whether you use tax preparation software or an accounting professional to do your taxes.

Direct Pay

The IRS has a “Direct Pay” service through its website, where you can pay from your checking or savings account at no cost. In order to track your payment, use the “Look Up a Payment” tool on the website or enable email notifications.

Credit or Debit

The IRS provides three third-party payment processors on its website through which you can pay your balance using a credit or debit card either online or by phone. They do charge a small service fee, which may be tax-deductible, and your credit card company may charge a fee as well.

Check or Money Order

Make checks payable to the United States Treasury and include your social security number or employer identification number, phone number, related tax form or notice number, and the tax year in the memo field. Send your check with a Form 1040-V, which is a payment voucher found on the IRS website, but don’t paperclip or staple your check to the voucher. You’ll find the correct mailing address for your check on page two of Form 1040-V.

Pay in Person

If you want to be absolutely sure that your payment is getting to the IRS on time, you can pay in person at your local IRS Taxpayer Assistance Center, which can be located on the IRS website. You will need to schedule an appointment before you go.

Wire Service

Check with your bank to see if they offer same-day wire transfer payable to the IRS. Be sure to ask about cut-off times and fees for this service.

What if you don’t have the full amount now? Luckily, the IRS offers two installment plans – a short-term plan and a long-term plan – which you can apply for online with the Installment Agreement Request (Form 9465). Which plan you qualify for depends on how much you owe and your specific tax situation. There is an application fee, and once approved the IRS can void the agreement if you don’t stay on schedule with payments.

Another option is to request a temporary delay from the IRS. You might have to fill out a Collection Information Statement and provide transparent information on your personal finances, and penalties and interest will factor in until the amount is paid in full.

Finally, you can offer to settle for a smaller amount than what’s owed, but the IRS encourages taxpayers to consider all other options before submitting an offer to settle. If you decide to go this route, you will need to be current on your tax filings and not involved in an open bankruptcy proceeding. To determine if you qualify, the IRS will take into account your income, expenses, ability to pay, and asset equity.

Clarifying the 199A Deduction

The Internal Revenue Service (IRS) recently released a new document clarifying the new rules related to section 199A. If you’re unfamiliar with 199A, this section is a part of the tax code that references a new deduction of up to 20 percent of qualified domestic business income (QBI) for pass-through entities such as sole-proprietorships, partnerships, S-corporations, trusts, or estates.  This section is extremely intricate, but the newly released regulations have cleared up many of the questions raised by the original legislation.

Like many of the other provisions of the Tax Cuts and Jobs Act (TCJA), the rules for 199A are effective for the tax year 2018. This particular deduction will go away unless further action is taken, expiring in 2025. This particular deduction allows business entities to take up to a 20% deduction of QBI. Qualifying for this particular deduction can be tricky as it is only for pass-through entities. Other information about your business (what kind of work you do, wages paid, etc.) may also preclude you from some or all of the deduction.

In order to be deemed a section 162 business that would qualify for the 199A deduction, you must be involved hands-on with the activity of your business on a consistent basis. Typically, if you think you’re running the business, you are most likely involved enough to be qualified. In regards to rental property, this gets a little more complicated. Under Revenue Procedure 2019-7, the IRS claims that rental property is a qualified business if 250 hours or more of rental services are provided for the year and separate books and records are kept for each rental. However, you can’t qualify and lose the deduction if you use the rental for yourself more than two weeks of the year. Matters get even more complicated when the IRS requires you to handle each business (even if operating under the same legal entity) separately with the ability to calculate a QBI for each individual business.

Furthermore, you must know the business owner’s taxable income. If the business owner’s income falls above the thresholds listed below, the next matter is determining whether the business is a specified service trade or business (SSTB).

Business Owner’s Income Thresholds

  • Single
  • 2018: $157,500 – $207,500
  • 2019: $160,700 – $210,700
  • Married Filing Jointly
  • 2018: $315,000 – $415,000
  • 2019: $321,450 – $421,450

Many questions around the 199A deduction that remain unanswered. In the foreseeable future, the 199A deduction will require professional attention as we adapt to the new tax laws. According to the IRS, 95 percent of business owners fall below the threshold amounts and don’t need to worry about the limitations of the deduction. As always, it is crucial to work with tax professionals, such as MKR CPAs, to ensure that your business isn’t missing out on important deductions and properly filing for your business’ needs.

AICPA Extends Comment Deadlines

Two committees of the American Institute of CPAs (AICPA) – the Professional Ethics Executive Committee (PEEC) and the Accounting and Review Services Committee (ARSC) – have extended deadlines on exposure drafts of proposed revisions of existing requirements for nonattest services and of requirements for compilation services.

Requirements of Nonattest Services
The PEEC has agreed to extend the deadline from August 30, 2012, to November 30, 2012, for comments on an exposure draft dated June 29, 2012, of proposed revisions to Interpretation 101-3, “Nonattest Services.”

The committee is proposing that financial statement preparation and cash-to-accrual conversions performed by a CPA member for a client should be considered nonattest services and subject to the revised requirements.

Under the proposed revisions, the preparer is no longer required to perform a compilation with respect to those statements unless engaged to do so.
The exposure draft also considers the cumulative effect that providing multiple nonattest services can have on independence.

“We have extended the deadline because we want to give people additional time to understand the impact of these changes,” said Ellen Goria, senior technical manager of AICPA’s Professional Ethics Division. “We expect the major impact to be experienced by individuals who are preparing financial statements for attest clients. Their systems and processes may need to be modified so that they can be in compliance. We will be providing additional documents to explain this further,” she said.

Requirements for Compilation Services
The ARSC has extended its deadline for comment on proposed revisions to Statements on Standards for Accounting and Review Services (SSARS) to November 30, 2012. The proposed revised SSARS are AR section 70, Association with Unaudited Financial Statements, and AR section 80, Compilation of Financial Statements (Revised).

Existing SSARS require the accountant to perform a compilation engagement whenever the accountant prepares and presents financial statements to a client or third parties. Proposed revisions to SSARS would remove the preparation of financial statements from the attest function, the exposure draft says.

The AICPA stated in its announcement that the proposed SSARS would also “revise the objective of the compilation engagement and provide requirements and guidance when an accountant is associated with financial statements that were not subjected to a compilation, review, or audit engagement.”

The Exposure Draft, Association with Unaudited Financial Statements, includes the following requirements if an accountant is requested to be associated with unaudited financial statements.

The accountant should:

  • Read the unaudited financial statements.
  • Consider whether the unaudited financial statements appear free from material inconsistencies with other knowledge or information of which the accountant may be aware.
  • If after performing the procedures in paragraphs 6a and 6b, the accountant decides to permit the use of the accountant’s name in a report, document, or written communication containing the statements, the accountant should request that the entity clearly indicate that the financial statements were not compiled, reviewed, or audited.

The proposed SSARS also addresses the accountant’s responsibilities when engaged to compile financial statements. The proposed revisions state that the objectives of a compilation engagement provide definitions and enumerate specific requirements that apply to compilation engagements.

The ARSC stated in its exposure draft that it “is supportive of proposed revisions of Interpretation 101-3 because it is in harmony with how the 2011 edition of Government Auditing Standards (the Yellow Book) treats the preparation of financial statements. The proposed clarification would also be consistent with the views of many practitioners who believe that the preparation of financial statements is a responsibility of management and an essential part of an entity’s system of internal control.”