How are Series EE savings bonds taxed?
Savings bonds are purchased by many Americans, often as a way to help fund college or show their patriotism. Series EE bonds, which replaced Series E bonds, were first issued in 1980. From 2001 to 2011, they were designated as “Patriot Bonds” as a way for Americans “to express support for our nation’s anti-terrorism efforts,” according to the U.S. Treasury Department.
Perhaps you purchased some Series EE bonds many years ago and put them in a file cabinet or safe deposit box. Or maybe you bought them electronically and don’t think about them often. You may wonder: How is the interest you earn on EE bonds taxed? And if they reach final maturity, what steps do you need to take to ensure there’s no loss of interest or unanticipated tax consequences?
How interest accrues
Series EE bonds don’t pay interest currently. Instead, the accrued interest is reflected in the redemption value of the bond. The U.S. Treasury issues tables showing the redemption values.
The interest on EE bonds isn’t taxed as it accrues unless the owner elects to have it taxed annually. If an election is made, all previously accrued but untaxed interest is also reported in the election year. In most cases, this election isn’t made, so bond holders receive the benefits of tax deferral.
If the election to report the interest annually is made, it will apply to all bonds and for all future years. That is, the election cannot be made on a bond-by-bond or year-by-year basis. However, there’s a procedure under which the election can be canceled.
If the election isn’t made, all the accrued interest is finally taxed when the bond is redeemed or otherwise disposed of (unless it was exchanged for a Series HH bond).
Note: Interest on EE bonds isn’t subject to state income tax. And using the money for higher education may keep you from paying federal income tax on the interest.
Reaching final maturity
One of the main reasons for buying EE bonds is the fact that interest can build up without having to currently report or pay tax on it. Unfortunately, the law doesn’t allow for this tax-free buildup to continue indefinitely. When the bonds reach final maturity, they stop earning interest.
Series EE bonds issued in January 1994 reached final maturity after 30 years, in January 2024. That means that not only have they stopped earning interest, but all the accrued and as yet untaxed interest is taxable in 2024.
If you own EE bonds (paper or electronic), check the issue dates on your bonds. If they’re no longer earning interest, you probably want to redeem them and put the money into something more profitable. One option is Series I bonds, which feature an interest rate based on inflation. Contact us if you have any questions about savings bond taxation.
© 2024
Strategic planning for businesses needs to include innovation
When the leadership teams of many companies engage in strategic planning, they may be inclined to play it safe. And that’s understandable; sticking to strengths and slow, measured growth are often safe pathways to success.
But substantial growth — and, in some industries, just staying competitive — calls for innovation. That’s why, as your business looks to the future, be sure you’re creating an environment where you and your employees can innovate in ways big or small.
Encourage ideas
It’s sometimes assumed that innovation requires limitless resources or is solely the province of those in technical or research roles. But every department, from accounting to human resources, can come up with ways to work more efficiently or even devise a game-changing product or service concept.
Developing an innovative business culture typically calls for actively encouraging employees to come up with ideas and explore their feasibility without fear of making mistakes. As part of your strategic plan every year, challenge staff to identify problems, ask questions, and seek out solutions and answers. In addition, build and maintain a strong structure for innovation. Doing so includes:
- Establishing policies that promote research and development,
- Incorporating discussions about innovation into performance reviews,
- Allowing some or all employees to occasionally shift from their usual responsibilities to focus on innovative processes or new product or service ideas, and
- Allocating funds to innovation in the company budget.
Ideas can come from other sources, too. For example, what do your customers complain about or ask for? Customer feedback can be an excellent source of innovative concepts. Encourage employees to engage in conversations with customers about what new products or services they may be looking for, as well as about ways to improve your current ones.
Hold brainstorming sessions
Innovation is rarely a straight shot. Outrageous, seemingly unworkable ideas may be the genesis of concepts that ultimately prove both viable and profitable. Employees need to be confident they can propose ideas without fear of ridicule or adverse employment actions. One way to make this happen is through regularly scheduled strategic innovation brainstorming sessions. The goal of these meetings is to help staff get comfortable suggesting bold ideas without censoring themselves or harshly criticizing others. Make it clear to participants that there are no bad ideas.
Be sure to include employees from throughout the business. People tend to feel comfortable with co-workers they know well and work with regularly, but “echo chambers” may develop that limit the feasibility of ideas. Staff members from other departments are often able to provide different perspectives. They can help employees with ideas question their assumptions and view concepts from different angles. In other words, when pursuing prospective innovations, it’s helpful to assemble cross-functional teams that can cover more ground.
Find your next breakthrough
Waiting around for the next big breakthrough in your business or industry to fall in your lap is a huge gamble. By making room for innovation in your strategic planning, you’ll increase the likelihood that you’ll find it.
© 2024
Business website expenses: How they’re handled for tax purposes
Most businesses have websites today. Despite their widespread use, the IRS hasn’t issued formal guidance on when website costs can be deducted.
But there are established rules that generally apply to the deductibility of business expenses and provide business taxpayers launching a website with some guidance about proper treatment. In addition, businesses can turn to IRS guidance on software costs. Here are some answers to questions you may have.
What are the tax differences between hardware and software?
Let’s start with the hardware you may need to operate a website. The costs fall under the standard rules for depreciable equipment. Specifically, for 2024, once these assets are operating, you can deduct 60% of the cost in the first year they’re placed in service. This favorable treatment is allowed under the first-year bonus depreciation break.
Note: The bonus depreciation rate was 100% for property placed in service in 2022 and was reduced to 80% in 2023, 60% in 2024 and it will continue to decrease until it’s fully phased out in 2027 (unless Congress acts to extend or increase it).
Alternatively, you may be able to deduct all or most of these costs in the year the assets are placed in service under the Section 179 first-year depreciation deduction privilege. However, Sec. 179 deductions are subject to several limitations.
For tax years beginning in 2024, the maximum Sec. 179 deduction is $1.22 million, subject to a phaseout rule. Under the rule, the deduction is phased out if more than a specified amount ($3.05 million in 2024) of qualified property is placed in service during the year.
There’s also a taxable income limit. Under it, your Sec. 179 deduction can’t exceed your business taxable income. In other words, Sec. 179 deductions can’t create or increase an overall tax loss. However, any Sec. 179 deduction amount that you can’t immediately deduct is carried forward and can be deducted in later years (to the extent permitted by the applicable limits).
Similar rules apply to purchased off-the-shelf software. However, software license fees are treated differently from purchased software costs for tax purposes. Payments for leased or licensed software used for your website are currently deductible as ordinary and necessary business expenses.
Was the software developed internally?
If, instead of being purchased, the website is designed in-house by the taxpayer launching it (or designed by a contractor who isn’t at risk if the software doesn’t perform), bonus depreciation applies to the extent described above. If bonus depreciation doesn’t apply, the taxpayer can either:
- Deduct the development costs in the year paid or incurred, or
- Choose one of several alternative amortization periods over which to deduct the costs.
Generally, the only allowable treatment will be to amortize the costs over the five-year period beginning with the midpoint of the tax year in which the expenditures are paid or incurred.
If your website is primarily for advertising, you can currently deduct internal website software development costs as ordinary and necessary business expenses.
What if you pay a third party?
Some companies hire third parties to set up and run their websites. In general, payments to third parties are currently deductible as ordinary and necessary business expenses.
What about expenses before business begins?
Start-up expenses can include website development costs. Up to $5,000 of otherwise deductible expenses that are incurred before your business commences can generally be deducted in the year business commences. However, if your start-up expenses exceed $50,000, the $5,000 current deduction limit starts to be chipped away. Above this amount, you must capitalize some, or all, of your start-up expenses and amortize them over 60 months, starting with the month that business commences.
We can help
We can determine the appropriate tax treatment of website costs. Contact us if you want more information.
© 2024
The tax implications of disability income benefits
Many Americans receive disability income. Are you one of them, or will you soon be? If so, you may ask: Is the income taxed and if it is, how? It depends on the type of disability benefit and your overall income.
The key issue is: Who paid for the benefit? If the income is paid directly to you by your employer, it’s taxable to you just as your ordinary salary would be. (Taxable benefits are also subject to federal income tax withholding. However, depending on the employer’s disability plan, in some cases they aren’t subject to Social Security tax.)
Frequently, the payments aren’t made by an employer but by an insurance company under a policy providing disability coverage. In other cases, they’re made under an arrangement having the effect of accident or health insurance. In these cases, the tax treatment depends on who paid for the insurance coverage. If your employer paid for it, then the income is taxed to you just as if it was paid directly to you by the employer. On the other hand, if it’s a policy you paid for, the payments you receive under it aren’t taxable.
Even if your employer arranges for the coverage (in a policy made available to you at work), the benefits aren’t taxed to you if you (and not your employer) pay the premiums. For these purposes, if the premiums are paid by the employer but the amount paid is included as part of your taxable income from work, the premiums will be treated as paid by you. In these cases, the tax treatment of the benefits received depends on the tax treatment of the premiums paid.
Illustrative example
Let’s say your salary is $1,050 a week ($54,600 a year). Additionally, under a disability insurance arrangement made available to you by your employer, $15 a week ($780 annually) is paid on your behalf by your employer to an insurance company. You include $55,380 in income as your wages for the year ($54,600 paid to you plus $780 in disability insurance premiums). Under these circumstances, the insurance is treated as paid for by you. If you become disabled and receive benefits under the policy, the benefits aren’t taxable income to you.
Now assume that you include only $54,600 in income as your wages for the year because the amount paid for the insurance coverage qualifies as excludable under the rules for employer-provided health and accident plans. In this case, the insurance is treated as paid for by the employer. If you become disabled and receive benefits under the policy, the benefits are taxable income to you.
There are special rules if there is a permanent loss (or loss of the use) of a member or function of the body or a permanent disfigurement. In these cases, employer disability payments aren’t taxed, as long as they aren’t computed based on amount of time lost from work.
Social Security disability benefits
This discussion doesn’t cover the tax treatment of Social Security Disability Insurance (SSDI) benefits. They may be taxed to you under the rules that govern Social Security benefits. These rules make a portion of SSDI benefits taxable if your annual income exceeds $25,000 for individuals and $32,000 for married couples.
State rules may differ
If you receive disability benefits, your state may or not tax them. Consult with us to find out and to discuss this issue further.
When deciding how much disability coverage you need to protect yourself and your family, take the tax treatment into consideration. If you’re buying a private policy yourself, you only have to replace your “after tax” (take-home) income because your benefits won’t be taxed. On the other hand, if your employer is paying for the benefit, keep in mind that you’ll lose a percentage of it to taxes. If your current coverage is insufficient, you may want to supplement the employer benefit with a policy you take out on your own.
© 2024
Would an adoption assistance program suit your company?
There’s no one-size-fits-all benefits package for today’s businesses. The optimal combination of tax-friendly fringe benefits depends on various factors, including the size and demographics of your workforce. One option to consider, if you haven’t already, is an adoption assistance program.
Purpose and covered expenses
The purpose of adoption assistance programs is to provide participants with payments or reimbursements for qualified adoption expenses. Under the Internal Revenue Code, such programs must adhere to formal, written plan documents that specify the terms under which payments or reimbursements will be provided.
Adoption assistance programs are generally funded by employers. Because of the relatively limited number of potential participants, they’re often offered as a menu item in cafeteria plans.
To qualify for favorable tax treatment, program benefits must be provided, as mentioned, under a written plan document. In addition, all eligible employees must be notified about the program’s existence — even if they’re unlikely to be interested in participating. Businesses can’t set up programs to discriminate in favor of owners, officers or highly paid employees.
Qualified adoption expenses must be “reasonable and necessary” and meet other requirements. Some expenses typically covered under an adoption assistance program include:
- Adoption agency fees,
- Court costs,
- Attorneys’ fees,
- Travel costs (including meals and lodging), and
- Additional expenses incurred to adopt a foreign child.
Programs may set annual or lifetime limits on the dollar amount of benefits that participants can receive.
Tax and nontax advantages
Normally, taxpayers can claim a credit for qualified adoption expenses on their federal tax returns, up to a stated annual limit. Although the credit isn’t available for payments or reimbursements received through an employer’s adoption assistance program, qualified adoption expenses reimbursed through an eligible program are tax-free to employees up to the program’s stated limit.
Let’s back up. Under the Internal Revenue Code, an employee can exclude from tax up to a maximum of $16,810 in eligible adoption expenses in 2024. This amount is exempt from income tax withholding and “FICA” tax (payroll tax under the Federal Insurance Contributions Act). In 2024, FICA tax is 6.2% on the first $168,600 of wages along with a 1.45% Medicare tax. These rates also apply to the employer’s share of FICA tax. (Note: There’s no exclusion for federal unemployment tax under the Federal Unemployment Tax Act, commonly referred to as “FUTA.”)
However, you may establish your own annual limits on qualified adoption expense payments or reimbursements under the program (and in the plan document) that are less than the federal maximum exclusion amount — for instance $5,000 or $10,000. If you choose this option, a portion of the benefits that participants receive may be subject to taxes. Also, you’re responsible for reporting payment or reimbursement amounts to participating employees on their Forms W-2, “Wage and Tax Statement.”
Bear in mind that businesses can’t claim a tax credit for paying or reimbursing adoption expenses. However, as with other fringe benefits, companies generally can deduct expenses incurred to launch and administer the program.
There are also nontax advantages to adoption assistance programs. Many companies add them to their cafeteria plan menu to help attract a wider array of job candidates. Programs that make adoption more affordable can also increase staff loyalty and enhance your employer brand as a family-friendly business that respects work-life balance.
One option among many
Again, an adoption assistance program represents just one type of fringe benefit among many possibilities. But if it’s something that your employees would value — and that would likely draw quality job candidates in your industry — you should probably take a closer look. We can help you assess the costs, potential advantages and risks, and tax impact of any fringe benefit your business is considering.
© 2024
The possible tax landscape for businesses in the future
Get ready: The upcoming presidential and congressional elections may significantly alter the tax landscape for businesses in the United States. The reason has to do with a tax law that’s scheduled to expire in about 17 months and how politicians in Washington would like to handle it.
How we got here
The Tax Cuts and Jobs Act (TCJA), which generally took effect in 2018, made extensive changes to small business taxes. Many of its provisions are set to expire on December 31, 2025.
As we get closer to the law sunsetting, you may be concerned about the future federal tax bill of your business. The impact isn’t clear because the Democrats and Republicans have different views about how to approach the various provisions in the TCJA.
Corporate and pass-through business rates
The TCJA cut the maximum corporate tax rate from 35% to 21%. It also lowered rates for individual taxpayers involved in noncorporate pass-through entities, including S corporations and partnerships, as well as from sole proprietorships. The highest rate today is 37%, down from 39.6% before the TCJA became effective.
But while the individual rate cuts expire in 2025, the law made the corporate tax cut “permanent.” (In other words, there’s no scheduled expiration date. However, tax legislation could still raise or lower the corporate tax rate.)
In addition to lowering rates, the TCJA affects tax law in many other ways. For small business owners, one of the most significant changes is the potential expiration of the Section 199A qualified business income (QBI) deduction. This is the write-off for up to 20% of QBI from noncorporate entities.
Another of the expiring TCJA business provisions is the gradual phaseout of first-year bonus depreciation. Under the TCJA,100% bonus depreciation was available for qualified new and used property that was placed in service in calendar year 2022. It was reduced to 80% in 2023, 60% in 2024, 40% in 2025, 20% in 2026 and 0% in 2027.
Potential Outcomes
The outcome of the presidential election in three months, as well as the balance of power in Congress, will determine the TCJA’s future. Here are four potential outcomes:
- All of the TCJA provisions scheduled to expire will actually expire at the end of 2025.
- All of the TCJA provisions scheduled to expire will be extended past 2025 (or made permanent).
- Some TCJA provisions will be allowed to expire, while others will be extended (or made permanent).
- Some or all of the temporary TCJA provisions will expire — and new laws will be enacted that provide different tax breaks and/or different tax rates.
How your tax bill will be affected in 2026 will partially depend on which one of these outcomes actually happens and whether your tax bill went down or up when the TCJA became effective years ago. That was based on a number of factors including your business income, your filing status, where you live (the SALT limitation negatively affects taxpayers in certain states), and whether you have children or other dependents.
Your tax situation will also be affected by who wins the presidential election and who controls Congress because Democrats and Republicans have competing visions about how to proceed. Keep in mind that tax proposals can become law only if tax legislation passes both houses of Congress and is signed by the President (or there are enough votes in Congress to override a presidential veto).
Look to the future
As the TCJA provisions get closer to expiring, and the election gets settled, it’s important to know what might change and what tax-wise moves you can make if the law does change. We can answer any questions you have and you can count on us to keep you informed about the latest news.
© 2024
Do you owe estimated taxes? If so, when is the next one due?
Federal estimated tax payments are designed to ensure that certain individuals pay their fair share of taxes throughout the year. If you don’t have enough federal tax withheld from your paychecks and other payments, you may have to make estimated tax payments. This is the case if you receive interest, dividends, self-employment income, capital gains, a pension or other income that’s not covered by withholding.
Individuals must pay 25% of a “required annual payment” by April 15, June 15, September 15, and January 15 of the following year, to avoid an underpayment penalty. If one of those dates falls on a weekend or holiday, the payment is due on the next business day.
So the third installment for 2024 is due on Monday, September 16 because the 15th falls on a Sunday. Payments are made using Form 1040-ES.
The amount due
The required annual payment for most individuals is the lower of 90% of the tax shown on the current year’s return or 100% of the tax shown on the return for the previous year. However, if the adjusted gross income on your previous year’s return was more than $150,000 ($75,000 if you’re married filing separately), you must pay the lower of 90% of the tax shown on the current year’s return or 110% of the tax shown on the return for the previous year.
Most people who receive the bulk of their income in the form of wages satisfy these payment requirements through the tax withheld by their employers from their paychecks. Those who make estimated tax payments generally do so in four installments. After determining the required annual payment, divide that number by four and make four equal payments by the due dates.
But you may be able to use the annualized income method to make smaller payments. This method is useful to people whose income flow isn’t uniform over the year, perhaps because of a seasonal business. For example, if your income comes exclusively from a business operated in a resort area during June, July, and August, no estimated payment is required before September 15.
The underpayment penalty
If you don’t make the required payments, you may be subject to an underpayment penalty. The penalty equals the product of the interest rate charged by the IRS on deficiencies, times the amount of the underpayment for the period of the underpayment.
However, the underpayment penalty doesn’t apply to you if:
- The total tax shown on your return is less than $1,000 after subtracting withholding tax paid;
- You had no tax liability for the preceding year, you were a U.S. citizen or resident for that entire year, and that year was 12 months;
- For the fourth (January 15) installment, you file your return by that January 31 and pay your tax in full; or
- You’re a farmer or fisherman and pay your entire estimated tax by January 15, or pay your entire estimated tax and file your tax return by March 1.
In addition, the IRS may waive the penalty if the failure was due to casualty, disaster or other unusual circumstances and it would be inequitable to impose the penalty. The penalty can also be waived for reasonable cause during the first two years after you retire (and reach age 62) or become disabled.
We can help
Contact us if you need help figuring out your estimated tax payments or you have other questions about how the rules apply to you.
© 2024
Businesses should stay grounded when using cloud computing
For a couple decades or so now, companies have been urged to “get on the cloud” to avail themselves of copious data storage and a wide array of software. But some businesses are learning the hard way that the seemingly sweet deals offered by cloud services providers can turn sour as hoped-for cost savings fail to materialize and dollars left on the table evaporate into thin air.
Unclaimed discounts
One source of the trouble was revealed in a report entitled 2024 Effective Savings Rate Benchmarks and Insights, released earlier this year by cloud solution provider ProsperOps.
After analyzing $1.5 billion worth of Amazon Web Services (AWS) bills submitted to hundreds of organizations over a 12-month period, the report writers found that more than half of those organizations neglected to claim discounts baked into their cloud computing deals. As a result, the organizations paid full on-demand rates for “compute” services, such as data processing and computer memory, resulting in unnecessarily high costs.
The predicament reveals a key risk of cloud computing arrangements — particularly with major providers such as AWS, Microsoft Azure and Google Cloud: They’re complicated. Among the chief advantages of the cloud is that it’s scalable; companies can expand or diminish their computing services as their needs dictate. But with scalability, and other cloud functions, comes intense billing complexity that makes it difficult to control costs.
Best practices
So, what can your business do to ensure high cloud costs don’t rain on your parade? Here are a few best practices:
Know what you’re getting into. Just as you would for any other business contract, be sure you, your leadership team and your professional advisors thoroughly review and approve the terms of a cloud services agreement. Generally, the more predictable the pricing, the better.
Get familiar with your bill. Cloud computing invoices can be just as complex as the contracts, if not more so. Dedicate the time and resources to training yourself and other pertinent staff members to be able to read and understand your bill. If something seems inaccurate or difficult to understand, contact your provider for clarification.
Identify discounts … and claim them! If there’s one clear lesson from the aforementioned report, it’s that discounts matter and you should do everything in your power not to leave them on the table. Customers often have three types of savings “levers” to choose from: commitment-based discounts, volume-based discounts and enterprise discount programs.
Learn as much as you can about those offered by your provider. Then use carefully identified metrics to determine eligibility for discounts and claim them when you qualify. Many cloud computing platforms have built-in dashboards that enable you to visualize various metrics. Or you may be able to access a third-party dashboard via a web browser.
Review overall usage. At least once a year, take a broad look at precisely how you’re using the cloud. You may be able to scale down and save money. Also look for unused resources. If you’re paying for a service or certain type of software that you’re not using, ask your provider to discontinue it.
Find the savings
For many types of businesses, cloud computing has become a mission-critical resource. Whether this describes your company or you’re just using the cloud for efficiency and convenience, it likely represents a significant expense that you should manage carefully. Our firm can help you assess the costs — and identify the potential savings — of your current cloud computing arrangement or a prospective one.
© 2024
Understanding taxes on real estate gains
Let’s say you own real estate that has been held for more than one year and is sold for a taxable gain. Perhaps this gain comes from indirect ownership of real estate via a pass-through entity such as an LLC, partnership or S corporation. You may expect to pay Uncle Sam the standard 15% or 20% federal income tax rate that usually applies to long-term capital gains from assets held for more than one year.
However, some real estate gains can be taxed at higher rates due to depreciation deductions. Here’s a rundown of the federal income tax issues that might be involved in real estate gains.
Vacant land
The current maximum federal long-term capital gain tax rate for a sale of vacant land is 20%. The 20% rate only hits those with high incomes. Specifically, if you’re a single filer in 2024, the 20% rate kicks in when your taxable income, including any land sale gain and any other long-term capital gains, exceeds $518,900. For a married joint-filing couple, the 20% rate kicks in when taxable income exceeds $583,750. For a head of household, the 20% rate kicks when your taxable income exceeds $551,350. If your income is below the applicable threshold, you won’t owe more than 15% federal tax on a land sale gain. However, you may also owe the 3.8% net investment income tax (NIIT) on some or all of the gain.
Gains from depreciation
Gain attributable to real estate depreciation calculated using the applicable straight-line method is called unrecaptured Section 1250 gain. This category of gain generally is taxed at a flat 25% federal rate, unless the gain would be taxed at a lower rate if it was simply included in your taxable income with no special treatment. You may also owe the 3.8% NIIT on some or all of the unrecaptured Section 1250 gain.
Gains from depreciable qualified improvement property
Qualified improvement property (QIP) generally means any improvement to an interior portion of a nonresidential building that’s placed in service after the date the building is placed in service. However, QIP does not include expenditures for the enlargement of the building, elevators, escalators or the building’s internal structural framework.
You can claim first-year Section 179 deductions or first-year bonus depreciation for QIP. When you sell QIP for which first-year Section 179 deductions have been claimed, gain up to the amount of the Section 179 deductions will be high-taxed Section 1245 ordinary income recapture. In other words, the gain will be taxed at your regular rate rather than at lower long-term gain rates. You may also owe the 3.8% NIIT on some or all of the Section 1245 recapture gain.
What if you sell QIP for which first-year bonus depreciation has been claimed? In this case, gain up to the excess of the bonus depreciation deduction over depreciation calculated using the applicable straight-line method will be high-taxed Section 1250 ordinary income recapture. Once again, the gain will be taxed at your regular rate rather than at lower long-term gain rates, and you may also owe the 3.8% NIIT on some or all of the recapture gain.
Tax planning point: If you opt for straight-line depreciation for real property, including QIP (in other words, you don’t claim first-year Section 179 or first-year bonus depreciation deductions), there won’t be any Section 1245 ordinary income recapture. There also won’t be any Section 1250 ordinary income recapture. Instead, you’ll only have unrecaptured Section 1250 gain from the depreciation, and that gain will be taxed at a federal rate of no more than 25%. However, you may also owe the 3.8% NIIT on all or part of the gain.
Plenty to consider
As you can see, the federal income tax rules for gains from sales of real estate may be more complicated than you thought. Different tax rates can apply to different categories of gain. And you may also owe the 3.8% NIIT and possibly state income tax, too. We will handle the details when we prepare your tax return. Contact us with questions about your situation.
© 2024
New option for unused funds in a 529 college savings plan
With the high cost of college, many parents begin saving with 529 plans when their children are babies. Contributions to these plans aren’t tax deductible, but they grow tax deferred. Earnings used to pay qualified education expenses can be withdrawn tax-free. However, earnings used for other purposes may be subject to income tax plus a 10% penalty.
What if you have a substantial balance in a 529 plan but your child doesn’t need all the money for college? Perhaps your child decided not to attend college or received a scholarship. Or maybe you saved for private college, but your child attended a lower-priced state university.
What should you do with unused funds? One option is to pay the tax and penalties and spend the money on whatever you wish. But there are more tax-efficient options, including a new 529-to-Roth IRA transfer.
Nuts and bolts
Beginning in 2024, you can transfer unused funds in a 529 plan to a Roth IRA for the same beneficiary, without tax or penalties. These rollovers are subject to several rules and limits:
- Transfers have a lifetime maximum of $35,000 per beneficiary.
- The 529 plan must have existed for at least 15 years.
- The rollover must be through a direct trustee-to-trustee transfer.
- Transferred funds can’t include contributions made within the preceding five years or earnings on those contributions.
- Transfers are subject to the annual limits on contributions to Roth IRAs (without regard to income limits).
For example, let’s say you opened a 529 plan for your son after he was born in 2001. When your son graduated from college in 2023, there was $30,000 left in the account. In 2024, under the new option, you can begin transferring funds into your son’s Roth IRA. Since the 529 plan was opened at least 15 years ago (and no contributions were made in the last five years), the only restriction on rollover is the annual Roth IRA contribution limit. Assuming your son hasn’t made any other IRA contributions for 2024, you can roll over up to $7,000 (if your son has at least that much earned income for the year).
If your son’s earned income for 2024 is less than $7,000, the amount eligible for a rollover will be reduced. For example, if he takes an unpaid internship and earns $4,000 during the year from a part-time job, the most you can roll over for the year is $4,000.
A 529-to-Roth IRA rollover is an appealing option to avoid tax and penalties on unused funds, while helping the beneficiaries start saving for retirement. Roth IRAs are a great savings vehicle for young people because they’ll enjoy tax-free withdrawals decades later.
Other options
Roth IRA rollovers aren’t the only option for avoiding tax and penalties on unused 529 plan funds. You can also change a plan’s beneficiary to another family member. Or you can use 529 plans for continuing education, certain trade schools, or even up to $10,000 per year of elementary through high school tuition. In addition, you can withdraw funds tax-free to pay down student loan debt, up to $10,000 per beneficiary.
It’s not unusual for parents to end up with unused 529 funds. Contact us if you have questions about the most tax-wise way to handle them.
© 2024