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income tax

How Can I reduce Capital Gains Taxes?

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Consider Transferring Highly Appreciated Assets to a Parent

If property is held by someone at their death, the “basis” in the property used by the seller to determine taxable gain on its sale is re-set to the fair market value at the date of death.

Income and capital gains tax rates have increased over the last 10 years, and during that time the exemption to avoid estate tax has increased dramatically. This combination (which did not generally exist before now) creates a tremendous opportunity to reduce income tax on property sales. There are many ways to do this. One simple technique is to transfer a highly appreciated asset to a parent. When Mom or Dad passes away, the basis in the asset is increased to its fair market value at the date of death (even though there is no estate tax), which can eliminate income tax on the gain on a sale thereafter, or permit much greater depreciation deductions when re-acquired by the owner.

So for example, if basis is stepped up by $1,000,000, then the tax on sale of the asset will be reduced, which tax savings could easily be $300,000. Note this is an after-tax savings!

There are related issues that should be addressed to protect the asset, account for timing and further enhance the tax benefits.

Can I Deduct Nursing Home Expenses?

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My mother is in a nursing home. Can she still deduct this expense?

Yes. For 2018, in certain instances nursing home expenses are allowable as medical expenses.

  • If you or someone who was your spouse or your dependent, either when the service was provided or when you paid them, is in a nursing home primarily for medical care, then the entire Long Term Carecost including meals and lodging is deductible as a medical expense.
  • If the individual is in the home mainly for personal reasons, then only the cost of the actual medical care is deductible as a medical expense, not the cost of the meals and lodging.

To determine if your mother qualifies as your dependent for this purpose, refer to Whose Medical Expenses Can You Include and Nursing Home in Publication 502Medical and Dental Expenses.

  • Deduct medical expenses on Schedule A (Form 1040)Itemized Deductions.
  • The total of all allowable medical expenses must be reduced by 7.5% of your adjusted gross income.

This write-off is only available to filers who itemize. People who qualify for it can deduct insurance premiums paid with after-tax dollars, plus many costs not always covered by health insurance—such as for long-term care, prostheses, a wig after chemotherapy and more.

Income Tax And Medicaid

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Q: My mother has been in a nursing home for the last eight years. She is enrolled in the Medicaid long-term care program, so her Social Security and pension checks are turned over to the nursing home each month. She receives a personal-needs allowance of $50.

Her adjusted gross income is $45,000, but when she takes allowable deductions and exemptions, including the deduction for itemized medical expenses, she has no federal income tax liability. However, after filing her state personal income tax return, she owes Rhode Island $1,170. How can she pay this tax bill when her net income is $50 a month?

A: Your question spans three different, but related, issues: federal income tax, state income tax and Medical Assistance (Medicaid) long-term care. Looking at each issue in order will help answer your question.

Internal Revenue Service rules require that a single person age 65 or older must file a federal tax return for 2013 if his/her gross income exceeds $11,500. Adjusted gross income is total gross income minus specific reductions, such as alimony payments made to a former spouse, contributions to certain retirement accounts or interest derived from certain types of bonds.

Taxable income is adjusted gross income minus itemized deductions and personal exemptions. The IRS allows a tax deduction for qualified medical expenses that exceed 10 percent of adjusted gross income. There is a temporary exemption, from Jan. 1, 2013 through Dec. 31, 2016, for individuals who turned 65, or whose spouse turned 65 during the tax year, that sets the qualified medical expense deduction threshold at 7.5 percent of adjusted gross income.

The IRS allows the deduction for nursing home expenses, including meals and lodging, if the primary reason for being in a nursing home is for medical care. If the person is in a nursing home for personal care, the IRS allows a deduction only for the cost of the medical care.

In your mother’s case, her total deductions, including medical expenses and personal exemption, probably resulted in no federal income tax liability. For more information about medical expenses and other deductions, contact the IRS at (800) 829-1040, or go to irs.gov.

In 2011, Rhode Island changed its personal income tax structure. When the state income tax became effective in 1971, it was a “piggyback” based system; state personal income tax was a percentage of your federal income tax. Generally, you received credit for deductions and exemptions reported on your federal income tax return.

Most likely, if you didn’t have a federal income tax liability, you had no state income tax liability. According to the Rhode Island Division of Taxation, one of the changes that took effect for 2011 and after eliminated the option to itemize deductions, including the medical expense deduction.

The new law effectively reduced the top marginal tax rate; broadened the lower-rate income brackets; reduced the number of tax brackets; introduced a single, uniform set of tax brackets; eliminated the state alternative minimum tax; and expanded the standard deduction. The Division of Taxation declared that these changes benefited more than 60 percent of Rhode Island taxpayers, mostly in lower income brackets.

As you saw, however, eliminating itemized deductions, such as medical expenses, created a new reality; it’s possible to owe no federal income tax and still have a state personal income tax liability. That’s why your mother owes $1,170 in state income tax. (For more information on state personal income taxes, call the Division of Taxation at (401) 574-8829, or go to tax.ri.gov.)

Here’s the good news. The state administration realized that these changes could affect Medicaid long-term care clients who were using most of their income to pay for nursing home care. In other words, you might not be able to pay state personal income taxes and contribute to the cost of nursing home care. The Executive Office of Health and Human Services has developed a process that allows Medicaid long-term care clients, such as your mother, to decrease the amount they contribute to their care by the amount of the state income tax liability. Based on information provided by that agency, here’s an outline of the process:

The state tax liability must be directly related to the change in law regarding the deduction of medical expenses. The tax liability must be paid first. You will have to send the following documentation to your mother’s long-term care caseworker at the Department of Human Services field office:

A letter indicating that the state tax liability is a direct result of the inability to deduct medical expenses.

A signed and dated copy of her R.I. 1040 tax return that shows the tax owed.

A copy of the check or proof of electronic transfer that paid the tax liability.

A copy of the bank statement showing that the check was cashed, if applicable.

If necessary, submit a copy of Power of Attorney Form 2848.

The caseworker will review the documentation. If all the information is acceptable, your mother’s patient liability to the nursing home will be decreased in the amount equal to the tax liability payment. For instance, let’s say that your mother has a patient liability of $2,100 each month that she pays the nursing home directly. She has a state income tax liability of $1,170 that she pays in April. If the only funds she has to pay her taxes are the same funds she uses to pay the nursing home, she would pay the state $1,170 for the tax bill owed and the difference of $930 ($2,100 minus $1,170) to the nursing home for the April bill. The state will then reimburse the nursing home for the unpaid patient liability of $1,170 that she paid in state personal income tax.RI State House

 

 

This is a shared article written by Larry Grimaldi is the chief of program development at the Rhode Island Department of Human Services, Division of Elderly Affairs and published in the Providence Journal on September 22, 2014. CLICK HERE to see the original article.

Estate Plans With Income Tax Strategies

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Today, you generally do not need to be concerned about federal estate taxes unless your net worth approaches $5 million (about $10 million if you are married). For 2016, the federal estate tax exemption is $5.45million per taxpayer and the exemption is scheduled to be annually adjusted for inflation. The exemption is the amount, reduced by any taxable gifts you made during life, which can pass tax-free to your heirs upon your death.

As the higher, inflation-indexed estate tax exemption was permanently signed into law, the top ordinary income and long-term capital gains rates increased approximately five percentage points each, to 39.6% and 20%, respectively. In 2013, the 3.8% net investment income tax went into effect for higher-income taxpayers and at thresholds lower than those triggering the top income tax rates.

So, for higher-income taxpayers and people with higher-income heirs, income taxes are important to plan for. However, even middle-bracket taxpayers should factor income taxes into their estate planning to minimize tax liability for themselves and their heirs. After all, why pay, say, even a 15% federal tax on a capital gain if, with careful planning, your family could avoid incurring any federal taxes on that gain?estate-tax-return.ashx_

Two Valuable Income Tax Strategies
Several income-tax-saving strategies can be incorporated into an estate plan. However, the following are two of the most valuable that most taxpayers can take advantage of:

  1. Hold on to appreciated assets — unless you have loved ones eligible for the 0% rate. Inherited assets receive a step-up in basis to their fair market value on the owner’s date of death. The recipient can then sell the appreciated assets shortly after receiving them and owe little, if any, income tax on the sale. So, if estate taxes are not a concern, holding on to both assets that have already appreciated and assets that you expect to appreciate significantly in the future can be beneficial. However, if you would like to dispose of an appreciated asset and you have loved ones in the 10% or 15% bracket for ordinary-income taxes who thus are eligible for the 0% rate on long-term capital gains, consider gifting it to the loved one to sell. This might require a gift tax return to be filed.
  2. Make charitable donations during life. If you are charitably inclined, consider maximizing your lifetime donations rather than waiting to make large charitable bequests at your death. Properly substantiated lifetime gifts to qualified charities generally provide an income tax deduction (and reduce the value of your estate), while charitable bequests provide only an estate tax deduction, which you will not need if your estate is below the exemption amount.

Before making significant charitable gifts, be sure to consider your cash flow needs and the legacy you want to leave. Also, keep in mind that your annual income tax deduction for charitable donations is limited to a percentage of your adjusted gross income (AGI) — 50%, 30% or 20%, depending on the type of gift and charity. Contributions exceeding the applicable AGI limit can be carried forward for up to five years.

Stay AlertIRSbuilding_0
As you consider — and perhaps implement — these income-tax-savings strategies for your estate plan, you also need to keep an eye on two things: 1) Your net worth, and 2) Congress. If you have a financial windfall or simply enjoy a steady increase in compensation or investment performance, your estate could be boosted to a size where federal estate taxes become a concern. And, while the high, inflation-adjusted estate tax exemption has no expiration date, Congress could pass legislation to reduce it at any time.

Medicaid Planning Issues

Obviously, the above items do not work in the context of Medicaid Planning. Gifting of assets, holding onto appreciated assets work for estate planning strategies and tax strategies – but not for Medicaid Planning strategies. While an Irrevocable Income Only Grantor trust does allow for tax basis planning opportunities, charitable gifting during lifetime and within 5 years of applying for Medicaid will be a disqualifying transfer of assets.

Whatever happens, be ready to revisit your estate plan and, if necessary, alter your strategies based on changing circumstances. Be sure to consult with appropriate financial, tax and legal professionals. Want to discuss your plans?  Contact us to schedule an appointment.

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