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Social Security tax update: How high can it go?

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Employees, self-employed individuals and employers all pay Social Security tax, and the amounts can get bigger every year. And yet, many people don’t fully understand the Social Security tax they pay.

If you’re an employee

If you’re an employee, your wages are hit with the 12.4% Social Security tax up to the annual wage ceiling. Half of the Social Security tax bill (6.2%) is withheld from your paychecks. The other half (also 6.2%) is paid by your employer, so you never actually see it. Unless you understand how the Social Security tax works and closely examine your pay statements, you may be blissfully unaware of the size of the tax. It’s potentially a lot!

The Social Security tax wage ceiling for 2024 is $168,600 (up from $160,200 for 2023). If your wages meet or exceed that ceiling, the Social Security tax for 2024 will be $20,906 (12.4% x $168,600). Half of that comes out of your paychecks and your employer pays the other half.

If you’re self employed

Self-employed individuals (sole proprietors, partners and LLC members) know all too well how hard the Social Security tax can hit. That’s because they must pay the entire Social Security tax bill out of their own pockets, based on their net self-employment income. For 2024, the Social Security tax ceiling for net self-employment income is $168,600 (same as the wage ceiling for employees). So, if your net self-employment income for 2024 is $168,600 or more, you’ll pay the maximum $20,906 Social Security tax.

Projected future ceilings 

The Social Security tax on your 2024 income is expensive enough, but it could get worse in future years — much worse, according to Social Security Administration (SSA) projections. That’s because the Social Security tax ceiling will continue to go up based on the inflation factor that’s used to determine the increases. In turn, maximum Social Security tax bills for higher earners will go up. The latest SSA projections for Social Security tax ceilings for the next nine years are:

  • $174,900 for 2025,
  • $181,800 for 2026,
  • $188,100 for 2027,
  • $195,900 for 2028,
  • $204,000 for 2029,
  • $213,600 for 2030,
  • $222,900 for 2031,
  • $232,500 for 2032 and
  • $242,700 for 2033.

These projected ceilings are not always accurate (they could be higher or lower). If the projected numbers pan out, the maximum Social Security tax on wages and net self-employment income in 2033 will be $30,095 (12.4% x $242,700).

Your future benefits

Despite what you pay in, you might receive more in Social Security benefits than you pay into the system. An Urban Institute report looked at some average situations. For example, a single man who earned average wages every year of his adult life and retired at age 65 in 2020 would have paid about $466,000 in Social Security and Medicare taxes. But he can expect to receive about $640,000 in benefits during retirement. Of course, there are many factors involved and each situation is unique. Plus, these calculations don’t account for the interest the Social Security tax dollars would have earned over the years.

Some people think the government has set up an account with their name on it to hold money to pay their future Social Security benefits. After all, that must be where those Social Security taxes on wages and self-employment income go. Sorry, but this is incorrect. There are no individual accounts — just a promise from the government.

Is the Social Security system financially solid? It’s on shaky ground. Congress has known that for years and has done nothing about it (although there have been many proposals on how to fix things). A Social Security Administration report states that “benefits are now expected to be payable in full on a timely basis until 2037, when the trust fund reserves are projected to become exhausted. At the point where the reserves are used up, continuing taxes are expected to be enough to pay 76% of scheduled benefits.”

The agency adds that “Congress will need to make changes to the scheduled benefits and revenue sources for the program in the future.” These changes could include a higher age to receive full benefits, additional Social Security tax hikes in the form of higher rates, some tax-law revision that effectively implements higher ceilings or a combination of these.

Stay tuned

The Social Security tax paid by many individuals will continue to go up. If you operate a small business, there may be some strategies than can potentially cut your Social Security tax bill. If you’re an employee, you need to take Social Security into account in your financial planning. Contact us for details.

© 2024

Figuring corporate estimated tax

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The next quarterly estimated tax payment deadline is June 17 for individuals and businesses, so it’s a good time to review the rules for computing corporate federal estimated payments. You want your business to pay the minimum amount of estimated tax without triggering the penalty for underpayment of estimated tax.

Four possible options

The required installment of estimated tax that a corporation must pay to avoid a penalty is the lowest amount determined under one of the following four methods:

  • Current year method. Under this option, a corporation can avoid the estimated tax underpayment penalty by paying 25% of the tax shown on the current tax year’s return (or, if no return is filed, 25% of the tax for the current year) by each of four installment due dates. The corporate due dates are generally April 15, June 15, September 15 and December 15. If a due date falls on a Saturday, Sunday or legal holiday, the payment is due the following business day.
  • Preceding year method. Under this option, a corporation can avoid the estimated tax underpayment penalty by paying 25% of the tax shown on the return for the preceding tax year by each of four installment due dates. (Note, however, that for 2022, certain corporations can only use the preceding year method to determine their first required installment payment. This restriction is placed on corporations with taxable income of $1 million or more in any of the last three tax years.) In addition, this method isn’t available to corporations with a tax return that was for less than 12 months or a corporation that didn’t file a preceding tax year return that showed some tax liability.
  • Annualized income method. Under this option, a corporation can avoid the estimated tax underpayment penalty if it pays its “annualized tax” in quarterly installments. The annualized tax is computed on the basis of the corporation’s taxable income for the months in the tax year ending before the due date of the installment and assumes income will be received at the same rate over the full year.
  • Seasonal income method. Under this option, corporations with recurring seasonal patterns of taxable income can annualize income by assuming income earned in the current year is earned in the same pattern as in preceding years. There’s a somewhat complicated mathematical test that corporations must pass in order to establish that they meet the threshold and therefore qualify to use this method. If you think your corporation might qualify for this method, don’t hesitate to ask for our assistance in determining if it does.

Also, note that a corporation can switch among the four methods during a given tax year.

We can examine whether your corporation’s tax bill can be reduced. If you’d like to discuss this matter further, contact us.

© 2024

House rich but cash poor? Consider a reverse mortgage strategy

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Are you an older taxpayer who owns a house that has appreciated greatly? At the same time, you may need income. Thankfully, there could be a solution with a tax-saving bonus. It involves taking out a reverse mortgage.

Reverse mortgage basics

With a reverse mortgage, the borrower doesn’t make payments to the lender to pay down the mortgage principal over time. Instead, the reverse happens. The lender makes payments to you and the mortgage principal gets bigger over time. Interest accrues on the reverse mortgage and is added to the loan balance. But you typically don’t have to repay anything until you permanently move out of the home or pass away.

You can receive reverse mortgage proceeds as a lump sum, in installments over a period of time or as line-of-credit withdrawals. So, with a reverse mortgage, you can stay in your home while converting some of the equity into much-needed cash. In contrast, if you sell your highly appreciated residence to raise cash, it could involve relocating and a big tax bill.

Most reverse mortgages are so-called home equity conversion mortgages, or HECMs, which are insured by the federal government. You must be at least 62 years old to be eligible. For 2024, the maximum amount you can borrow with an HECM is a whopping $1,141,825. However, the maximum you can actually borrow depends on the value of your home, your age and the amount of any existing mortgage debt against the property. Reverse mortgage interest rates can be fixed or variable depending on the deal. Interest rates can be higher than for regular home loans, but not a lot higher.

Basis step-up and reverse mortgage to the rescue

An unwelcome side effect of owning a highly appreciated home is that selling your property may trigger a taxable gain well in excess of the federal home sale gain exclusion tax break. The exclusion is up to $250,000 for unmarried individuals ($500,000 for married couples filing jointly). The tax bill from a really big gain can be painful, especially if you live in a state with a personal income tax. If you sell, you lose all the tax money.

Fortunately, taking out a reverse mortgage on your property instead of selling it can help you avoid this tax bill. Plus, you can raise needed cash and take advantage of the tax-saving basis “step-up” rule.

How the basis step-up works. The federal income tax basis of an appreciated capital gain asset owned by a person who dies, including a personal residence, is stepped up to fair market value (FMV) as of the date of the owner’s death.

If your home value stays about the same between your date of death and the date of sale by your heirs, there will be little or no taxable gain — because the sales proceeds will be fully offset (or nearly so) by the stepped-up basis.

The reverse mortgage angle. Holding on to a highly appreciated residence until death can save a ton of taxes thanks to the basis step-up rule. But if you need cash and a place to live, taking out a reverse mortgage may be the answer. The reason is payments to the lender don’t need to be made until you move out or pass away. At that time, the property can be sold and the reverse mortgage balance paid off from the sales proceeds. Any remaining proceeds can go to you or your estate. Meanwhile, you stay in your home.

Consider the options

If you need cash, it has to come from somewhere. If it comes from selling your highly appreciated home, the cost could be a big tax bill. Plus, you must move somewhere. In contrast, if you can raise the cash you need by taking out a reverse mortgage, the only costs are the fees and interest charges. If those are a fraction of the taxes that you could permanently avoid by staying in your home and benefitting from the basis step-up rule, a reverse mortgage may be a tax-smart solution.

© 2024

You may be entitled to tax breaks if caring for an elderly relative

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There are many rewards for taking care of an elderly relative. They may include feeling needed, making a difference in the person’s life and allowing the person to receive quality care. In addition, you could also be eligible for tax breaks. Here’s a rundown of four of them:

  1. Medical expenses. If the individual qualifies as your “medical dependent” and you itemize deductions on your tax return, you can include any medical expenses you incur for the person along with your own when determining your medical deduction. The test for determining whether an individual qualifies as your “medical dependent” is less stringent than that used to determine whether an individual is your “dependent,” which is discussed below. In general, an individual qualifies as a medical dependent if you provide over 50% of his or her support, including medical costs.

However, bear in mind that medical expenses are deductible only to the extent they exceed 7.5% of your adjusted gross income (AGI).

The costs of qualified long-term care services required by a chronically ill individual and eligible long-term care insurance premiums are included in the definition of deductible medical expenses. There’s an annual cap on the amount of premiums that can be deducted. The cap is based on age, and in 2024 goes from $470 for an individual age 40 or less to $5,880 for an individual over 70.

  1. Filing status. If you aren’t married, you may qualify for “head-of-household” status by virtue of the individual you’re caring for. You can claim this status if:
  • The person you’re caring for lives in your household,
  • You cover more than half the household costs,
  • The person qualifies as your “dependent,” and
  • The person is a relative.

If the person you’re caring for is your parent, the person doesn’t need to live with you, so long as you provide more than half of the person’s household costs and the person qualifies as your dependent. A head of household has a higher standard deduction and lower tax rates than a single filer.

There are requirements for determining whether your loved one is a “dependent.” Dependency exemptions are suspended (or disallowed) for 2018 through 2025. But even though the dependency exemption is currently suspended, the dependency tests still apply when it comes to determining whether a taxpayer is entitled to various other tax benefits, such as head-of-household filing status.

For an individual to qualify as your “dependent,” the following must be true for the tax year at issue:

  • You must provide more than 50% of the individual’s support costs,
  • The individual must either live with you or be related,
  • The individual must not have gross income in excess of an inflation-adjusted exemption amount,
  • The individual can’t file a joint return for the year, and
  • The individual must be a U.S. citizen or a resident of the U.S., Canada or Mexico.
  1. Dependent care credit. If the cared-for individual qualifies as your dependent, lives with you and physically or mentally can’t take care of him- or herself, you may qualify for the dependent care credit for costs you incur for the individual’s care to enable you and your spouse to go to work.
  2. Nonchild dependent credit. For 2018 through 2025, the Tax Cuts and Jobs Act (TCJA) established a $500 federal income tax credit for dependents who don’t qualify for the Child Tax Credit. A dependent parent can make you eligible for this $500 credit. However, your parent must pass the aforementioned gross income test to be classified as your dependent for purposes of this credit. You must also pay over half of your parent’s support.

The credit is phased out for taxpayers with adjusted gross income (AGI) above $200,000 ($400,000 for a married couple that files jointly). The credit is reduced by $50 for every $1,000 that your AGI exceeds the applicable threshold.

Contact us if you’d like to further discuss the tax aspects of financially supporting and caring for an elderly relative.

© 2024

A three-step strategy to save tax when selling appreciated vacant land

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Let’s say you own one or more vacant lots. The property has appreciated greatly and you’re ready to sell. Or maybe you have a parcel of appreciated land that you want to subdivide into lots, develop them and sell them off for a big profit. Either way, you’ll incur a tax bill.

For purposes of these examples, let’s assume that you own the vacant land directly as an individual or indirectly through a single-member LLC (SMLLC), a partnership or a multimember LLC that’s treated as a partnership for federal income tax purposes.

Here are a couple of scenarios and a strategy to consider.

Scenario 1: You simply sell vacant land that you’ve held for investment

If you’ve owned the land for more than one year and you’re not classified as a real estate dealer, any gain on sale will be a long-term capital gain (LTCG) eligible for lower federal income tax rates. The current maximum federal rate for LTCGs is 20%. You may also owe the 3.8% net investment income tax (NIIT) on all or part of your gain and maybe state income tax, too.

Scenario 2: You develop a parcel and sell improved lots

In this case, the federal income tax rules generally treat a land developer as a real estate dealer. If you’re classified as a dealer, the profit from developing and selling land is considered profit from selling inventory. That means the entire profit — including the portion from any pre-development appreciation in the value of the land — will be high-taxed ordinary income rather than lower-taxed LTCG. The maximum federal rate on ordinary income recognized by individual taxpayers is currently 37%. The 3.8% NIIT may also be owed and maybe state income tax, too. So, the total tax hit might approach 50% of the gain.

S corporation entity strategy to the rescue

Thankfully, there’s a strategy that allows favorable LTCG tax treatment for all the pre-development appreciation in the value of your land. However, any profit attributable to later subdividing, development and marketing activities will be high-taxed ordinary income because you’ll be treated as a dealer for that part of the process. But if you can manage to pay “only” the 23.8% maximum effective federal rate (20% + 3.8%), or maybe less, on the bulk of a large profit, that’s a win. Here’s a three-step plan to accomplish that tax-saving goal.

1. Establish an S corporation

If you’re the sole owner of the appreciated land, establish a new S corporation owned solely by you to function as the developer entity. If you own the land via a partnership, or via an LLC treated as a partnership for tax purposes, you and the other partners can form the S corporation and be issued stock in proportion to your partnership/LLC ownership percentages.

2. Sell the land to the S corporation

Next, sell the appreciated land to the S corporation for a price equal to the land’s pre-development fair market value. As long as the land has been held for investment and has been owned for more than one year, the sale will trigger a LTCG — equal to the pre-development appreciation — that won’t be taxed at more than the 23.8% maximum federal rate.

3. S corporation develops the land and sells it off

Next, the S corporation will subdivide and develop the property, market it and sell it off. The profit from these activities will be higher-taxed ordinary income passed through to the shareholder(s), including you. If the profit from development is big, you might pay the maximum 40.8% effective federal rate (37% + 3.8%) on that income. However, the part of your total profit that’s attributable to pre-development appreciation in the value of the land will be taxed at no more than the 23.8% maximum federal rate.

Seek professional help

The bottom line is if you’re simply selling appreciated vacant land that you’ve held for investment, the federal income tax results are straightforward. But if you’ll develop the land before selling, the S corporation developer entity strategy could be a big tax-saver in the right circumstances. However, it’s not a DIY project. Consult with us to avoid pitfalls.

© 2024

 

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