Category Archive: Blog

Upcoming Deadlines and Dates To Remember

April/May 2017 Upcoming Deadlines

April 18

Individuals. File a 2016 income tax return. If you want an automatic six-month extension of time to file the return, file Form 4868, Application for Automatic Extension of Time To File U.S. Individual Income Tax Return. Then, file Form 1040, 1040A, or 1040EZ by October 16.

If you are not paying your 2016 income tax through withholding (or will not pay in enough tax during the year that way), pay the first installment of your 2017 estimated tax. Use Form 1040-ES.

Employers. For Social Security, Medicare, withheld income tax, and nonpayroll withholding, deposit the tax for payments in March if the monthly rule applies.

Household employers. If you paid cash wages of $2,000 or more in 2016 to a household employee, file Schedule H (Form 1040) with your income tax return and report any household employment taxes. Report any federal unemployment (FUTA) tax on Schedule H if you paid total cash wages of $1,000 or more in any calendar quarter of 2015 or 2016 to household employees. Also, report any income tax you withheld for your household employees. 

Corporations. File a 2016 calendar year income tax return (Form 1120) and pay any tax due. If you want an automatic six-month extension of time to file the return, file Form 7004 and deposit what you estimate you owe.

Corporations. Deposit the first installment of estimated income tax for 2017.                                                                    

May 10    

Employers. For Social Security, Medicare, and withheld income tax, file Form 941 for the first quarter of 2017. This due date applies only if you deposited the tax for the quarter in full and on time.

May 15

Employers. For Social Security, Medicare, withheld income tax, and nonpayroll withholding, deposit the tax for payments in April if the monthly rule applies.

ESOPs as a Retirement Plan

Among the retirement plans that small businesses can offer to their workers are employee stock ownership plans (ESOPs). As the title indicates, an ESOP is a process for transferring ownership of the company to employees. How does that work as a retirement plan?

In some ways, an ESOP is similar to a profit-sharing plan (see the CPA Client Bulletin, January 2017), in which the company makes cash contributions. With a “vanilla” or unleveraged ESOP, the company funds the plan by contributing shares of its stock, or cash to buy those shares.

Uniquely among retirement plans, ESOPs can be leveraged. In one scenario, the ESOP borrows money from a financial institution or from another party, then uses the borrowed funds to purchase shares of the employer’s stock. Once the shares are in the plan, they are allocated to accounts of participating employees, generally all full-time workers over age 21. Assuming the company’s shares are not publicly traded, annual independent appraisals track the value of the company’s shares, which in turn determine the value of each participant’s ESOP holdings.

Current law calls for gradual vesting of all employer contributions over six years, or complete vesting at three years. When employees leave the company, at retirement or sooner, they receive their vested shares. The employer is required to buy back the shares, at the currently appraised price. Therefore, a long-time ESOP participant could retire with a substantial amount from the plan.

Advantages to owners

Why should business owners consider an ESOP? Some studies indicate that employees become motivated to excel when they become employee-owners. They know that good corporate results will boost the annually appraised value of their shares, and ultimately provide a bigger payout. Strong results will benefit major shareholders as well.

What’s more, ESOPs offer some exceptional tax benefits to the sponsoring company and its principals.

Example 1: A local bank lends money to an ESOP, which uses those dollars to buy common stock from ABC Corp, the ESOP sponsor. Going forward, ABC makes tax-deductible contributions to the ESOP, which uses that money to repay the bank loan. With such an arrangement, ABC effectively borrows money through the ESOP, then deducts the principal and interest payments made on the ESOP loan, rather than just the interest payments.

In addition to such tax advantages, an ESOP provides a way for business owners to sell their shares at appraised value, if there are no other obvious buyers. In some situations, the owners may be able to defer taxes on a profitable sale of shares to an ESOP, perhaps indefinitely.

Example 2: Alice Baker sells 50% of her Alice Baker Co. stock to her company’s ESOP for $2 million. Her basis in those shares is $200,000, giving her a taxable gain of $1.8 million. Alice reinvests the sale proceeds in qualified replacement property, which includes stock in other U.S. corporations. Alice can defer tax on that $1.8 million gain until she sells her qualified replacement property.

If her company is an S corporation, however, Alice won’t qualify for the tax deferral on the gain from the sale of her stock to the ESOP. However, ESOPs may offer other tax benefits to S corporations, such as tax exemption for any profits attributable to ESOP ownership.

ESOPs can be expensive

Business owners sponsoring ESOPs may realize advantages, but there are drawbacks as well. Payouts to departing employees, for share buybacks, can be a cash drain. The same is true for regulatory requirements, including annual appraisals. In addition, ESOP participants lack diversification in their retirement plans because the primary holding is the sponsoring company’s stock. Therefore, companies that sponsor ESOPs also may offer a retirement plan such as a 401(k), where employees can defer some of their salary (and the tax on that income) in order to acquire other investments.

If the idea of using an ESOP as a retirement plan appeals to you, HLB Gross Collins, P.C. can help you evaluate the costs and the potential benefits.

Deciding on a Vacation Home

Whether you live in the thawing North or in the always mild South, the onset of spring leads to thoughts of summer vacations. After all, next month will be May, which includes Memorial Day, often considered the unofficial beginning of weekend and week-long getaways.

At this time, you might be weighing the purchase of a second home specifically for vacations. Here are some of the issues to think about, so you can make a well-reasoned decision.

Extent of use

If you buy a vacation home, how often will you use it? A beach house or a lakefront cabin that’s, say, 50 miles from your primary residence may offer an opportunity for regular visits. On the other hand, if you live in Pennsylvania and buy a place in Maine, travel constraints may limit the amount of time you’ll spend at your vacation home.

In the same vein, buying a second home requires a certain investment, emotional as well as financial. Are you sure you’ll want to spend frequent vacations in the same place, year after year? You may be comfortable going away to your own home, where you’ll be assured of sleeping on your sheets and eating the food you’ve stored in your refrigerator. Some people will value the familiarity; however, others may prefer the excitement and adventure of seeing new places, when they take time off from their year-round routine.

Family circumstances also can play a role in deciding about a vacation home. You might envision a place where children and grandchildren come during summer vacations and school holidays. Such visits can be memorable.

In today’s world, though, youngsters often have other obligations and opportunities, from soccer practice to wilderness tours. Again, be realistic about how often you can expect “same time, next year” family gatherings.

Cost considerations

As is the case with any real estate purchase, you’ll want to buy a desirable vacation home at a reasonable price, one that’s not higher than comparable places in the area. Be aware that the cost of a vacation home goes well beyond the initial outlay. You’ll probably need to furnish the home, from bedding to bookcases. If you buy a place that’s fully or partially furnished, that likely will add to the purchase price—and you’ll be living with someone else’s taste.

If you own your primary residence, you’ll realize the other costs involved in owning a second home. They include property tax, homeowners insurance, utilities, maintenance, and possibly dues to a community association. You can compare those costs with the expense you’d incur by renting a house for annual vacations or going to hotels, when and where you decide to travel.

Of course, buying your own vacation home offers a chance to benefit from property appreciation. Long term, many people have enjoyed gains from real estate, and that’s certainly the case if you buy in the right area, at the right price. However, real estate markets are not easy to predict: some home prices have soared in recent years, whereas others have not recovered from the trauma of the 2008-2009 housing crisis. Profits from a vacation home purchase may result, but you can’t count on them.

Tax treatment

To modify the familiar saying, you shouldn’t let the tax tail wag the vacation home dog. Buy (or decide not to buy) a second home because of how you’ll use it and your cost-benefit outlook. Any tax savings you’ll enjoy from a purchase will be a pleasant byproduct. Downplaying the tax aspects is especially important now, with such uncertainty about future tax legislation. President Trump and the Republicans in Congress have said they want major changes, but as of this writing, we don’t know precisely what will be in any new tax law, or what the effective dates will be.

With that in mind, you should know the current tax treatment of second homes. Taxpayers who itemize deductions typically can include their costs for property tax and any mortgage interest. The tax exclusion for capital gains on a home sale (up to $250,000, or $500,000 on a joint return) does not apply to second homes. However, you can sell your primary residence and move into your vacation home for at least two years before selling the vacation home, but current tax law will limit you to counting only a portion of the home sale gain on the former vacation home when calculating the exclusion.

Different tax treatment may apply depending on if you rent your second home for less than or more than 15 days during the year. Again, the numbers may be changing, depending on what happens this year in Washington.

Dealing With an IRS Audit

IRS data indicate that fewer than 1% of all individual income tax returns are audited each year. That’s true, but some taxpayers are more vulnerable than others. For starters, the IRS is more likely to audit taxpayers who report high incomes because that’s where larger amounts of underpaid taxes might be found.

The latest numbers from the IRS reveal that about 1.5% of all taxpayers with income in the $200,000-$500,000 range are audited. With income from $500,000 to $1 million, the percentage increases to around 3.8%, while more than 8.4% of taxpayers with seven-figure incomes may face IRS questions.

In addition, certain taxpayers face more scrutiny because of how they earn their living. Self-employed individuals—generally, those who file Schedule C, Profit or Loss From a Business—may be audited more than other taxpayers. The same is true for professionals and business owners, who could see their business as well as their individual tax returns examined. The bottom line is that taxpayers with relatively high incomes as well as those who have control over their workplace bookkeeping can expect to face IRS queries at some point.

Triple threats

If you’re wondering how you should respond when you’re audited, the answer is straightforward: Call our office. We’ll let you know how to proceed, and offer assistance if professional help is warranted. Nevertheless, receiving correspondence from the IRS (or from your state’s tax authority) can be a stressful experience. The following summary of audit types may ease the pressure a bit, by spelling out what will be required:

  • Correspondence audit. These audits are the most common. Generally, they relate to a relatively minor discrepancy, such as faulty paperwork. You often can respond by mail to verify an item on your tax return and never have to meet anyone from the IRS.
  • Office audit. These examinations involve a visit to an IRS office, where you’ll meet with someone from the agency. In a typical situation, you’ll be informed of the issue involved and instructed to bring documents to support what you reported on your tax return. If you’ve deducted substantial charitable contributions, for example, you could be asked to bring cancelled checks, acknowledgment letters from the recipients, and other required materials.
  • Field audit. Here, the IRS will visit your home or office for the audit. These audits might be more far-reaching, or the examiner might want to check on something specific, such as home office deductions you’ve claimed.

Know your rights

For any type of audit, professional assistance can be valuable. Indeed, you’re entitled to have a CPA, an attorney, or an enrolled agent represent you at an office or a field audit. In such a situation, it may be possible for the audit to take place at your CPA’s office.

You also can receive help in requesting a postponement, if you need time to gather your records. If you must be present during the audit, you should answer all questions accurately, but there’s no need to volunteer any information that the IRS does not request. If an appeal of IRS findings seems warranted, your CPA can handle that as well.

Practice prudence

Avoiding an audit may be difficult if you’re self-employed, a business owner, or a highly-compensated employee. Probability may put you under the IRS spotlight someday.

Recognizing your vulnerability, take steps to minimize your financial exposure in case the IRS selects you for an audit. Report your income and your justifiable deductions accurately. Don’t overlook income reported on various 1099 Forms. In case of grey areas, discuss the matter thoroughly with the professional preparing your tax return and carefully consider extremely aggressive positions.

Keep in mind that the IRS communicates first by U.S. mail. If you receive an email purporting to be from the IRS, or a phone call demanding immediate payment, it’s a fake.

Audit Rights

  • Notices must include the amount (if any) of the tax, interest, and certain penalties you owe and must explain why you owe these amounts.
  • If the IRS fully or partially disallows a refund claim, it must explain the specific reasons why.
  • If the IRS proposes to assess tax against you, it must provide a letter with an explanation of the entire process from examination (audit) through collection, and explain that the Taxpayer Advocate Service may be able to assist you.
  • This IRS letter must tell you about a possible review by an independent Office of Appeals.
  • Help with Understanding Your IRS Notice or Letter is available online at

Holding Down Premiums for Medicare Part B

Medicare, the federal government’s health insurance program for people 65 and older, has four parts (see Trusted Advice, “ABCDs of Medicare”). Although Medicare offers good value to many seniors, high-income Medicare enrollees can pay over $5,000 a year for Part B, whereas high-income couples on Medicare can pay over $10,000 in annual premiums. For that money, high-income enrollees get the same Medicare coverage that most seniors get for about $1,300 a year, or $2,600 for couples.

Income-based premiums

Medicare Part B, which covers doctor visits and some other medical outlays, charges a monthly premium. Most enrollees have that premium deducted from their Social Security deposits, paying around $109 a month in that manner. (The “standard” amount, paid by some enrollees, is $134 a month in 2017, about $1,600 a year.) However, in 2017, seniors with certain levels of income will pay more, with premiums increasing as income tops certain thresholds.


Monthly payment in 2017
File individual tax returnFile joint tax returnFile married & separate tax return
above $85,000 up to $107,000above $170,000 up to $214,000Not applicable$187.50
above $107,000 up to $160,000above $214,000 up to $320,000Not applicable$267.90
above $160,000 up to $214,000above $320,000 up to $428,000above $85,000 and up to $129,000$348.30
above $214,000above $428,000above $129,000$428.60

For this purpose, “income” refers to modified adjusted gross income (MAGI), which equals the AGI reported on your tax return, plus any tax-exempt interest income. What’s more, there is a two-year lag between reported income and the resulting Part B premium.

Example 1: Carl and Donna Egan reported $210,000 of AGI on their 2015 tax return, which they filed in April 2016. The Egans also had $20,000 of tax-exempt interest in 2015. (The amount of tax-exempt interest is reported on federal income tax returns, even though that interest is not subject to federal income tax.) Thus, the Egans’ MAGI, for determining their Medicare Part B premium in 2017, is $230,000. With that MAGI, Carl and Donna will each have $267.90 a month deducted from their Social Security benefit, for a total of $535.80 a month, or $6,430 a year.

What’s more, the MAGI thresholds for these extra Part B premiums ($85,000, $107,000, etc.) are fixed until 2019, so they won’t increase for inflation, at least for a few years. At the same time, the extra Part B premium amounts can be increased, and have been rising rapidly. With identical MAGI in 2014, the Egans would each have paid $243.60 a month for Part B in 2016, so this year’s premium of $267.90 a month represents a 10% increase. The maximum Part B premium rose from $389.80 a month in 2016 to $428.60 a month in 2017. Even higher Part B premiums are likely in the future, as medical costs continue to rise.

Cliff notes

The Part B premiums are set by MAGI “cliffs”: Go over by $1, and you fall into a higher premium. The Egans, in our example, had 2015 MAGI of $230,000, $16,000 over the relevant threshold, yet, they are paying the same premiums as another couple with 2015 MAGI of $314,000—which was $100,000 over the same threshold of $214,000.

This system can be frustrating for Medicare enrollees who are just over a Part B MAGI threshold. The good news, though, is that some advance planning may enable seniors who are just over a Part B threshold to bring MAGI below that threshold, with relatively modest tax planning.

Example 2: Say the Egans once again would have $230,000 of MAGI for 2016, as reported on the tax return they are about to file for last year. If either Carl or Donna is eligible to make, say, a tax-deductible contribution to a SEP-IRA for 2016 or to recharacterize a Roth IRA conversion from 2016, it could be possible to fine tune the transaction, bringing MAGI for 2016 down to $213,000. They’d be under the $214,000 MAGI threshold and owe less for Part B in 2018.

Going forward, the Egans might spend time during 2017 on various tax-planning tactics. That could decrease the Part B premium they’ll owe in 2019, and ongoing tax planning could hold down future premiums. Possible strategies might include the timing of capital gains and Roth IRA conversions, for example.

Tax planning shouldn’t be driven solely by efforts to reduce Part B premiums. However, this issue should be included in overall tax planning by high-income Medicare enrollees and by people who soon will be in that situation. Reining in Part B premiums may become increasingly important in the coming years, due to expected financial strains on Medicare and federal efforts to raise more money from high-income taxpayers.

Paring Part B premiums

The examples of Carl and Donna Egan assume that they continue to have high incomes, even after they’re covered by Medicare. Conversely, some Medicare enrollees will report high income in 2017, then find themselves hard pressed to pay the resulting Part B premiums in 2019, due to changed circumstances.

Taxpayers whose income has fallen can appeal their elevated Part B premium to the Social Security Administration. Acceptable reasons for relief include retirement, in full or in part.

The ABCDs of Medicare

  • Part A covers hospital stays, some nursing care, hospice care, and some home care.
  • Part B covers doctors’ services and some medical supplies.
  • Part C, known as Medicare Advantage, includes plans from private companies that contract with Medicare to provide Part A and Part B benefits.
  • Part D adds prescription drug coverage from private companies. High-income seniors also pay more for Part D, so steps taken to reduce Part B premiums also might cut the cost of Part D.

Safe Harbor 401(k) Plans for Small Companies

Among employer-sponsored retirement plans, 401(k)s have become the standard. Some prospective employees assume that a job will come with a 401(k). Therefore, offering a 401(k) at your company may help you hire desired workers, and help you retain valued employees.

That said, there can be drawbacks to sponsoring a traditional 401(k). Such plans require annual testing to ensure that a 401(k) does not discriminate in favor of highly compensated employees, including owner-employees. Failing such a test may limit the amount that company principals and certain others may contribute to the plan, resulting in a reduced tax-deferred retirement fund for key individuals.

One solution is to offer a safe harbor 401(k) for your small business. A study released in late 2016 by Employee Fiduciary, a 401(k) provider for small businesses, found that 68% of the small firms responding to the survey use a safe harbor 401(k) plan design to avoid annual nondiscrimination testing. A safe harbor 401(k) allows sponsoring companies to avoid these tests, providing the business makes certain contributions to employees’ accounts. The mandatory employer contributions are always 100% vested.

Employer options

Employers have several ways to reach this safe harbor. Many companies prefer the “basic match” approach. Here, the company matches 100% of employee contributions to the 401(k), up to 3% of compensation, plus a 50% match on contributions up to 5% of pay. Thus, the maximum match is 4% of an employee’s compensation. (Some companies use an “enhanced match,” which might be 100% on the first 4% of pay.)

Alternatively, employers can shelter in a safe harbor with a “nonelective contribution.” Here, the company contributes 3% of compensation to each eligible employee’s 401(k) account, regardless of whether a worker is making elective deferrals.

Either way, the safe harbor contributions can be limited to employees earning less than $120,000 in 2017.

Considering the costs

Safe-harbor 401(k)s might not be a good fit for every small business. The required employer contributions may wind up being extremely expensive. Other efforts, such as employee education that increases contributions from non-highly compensated workers, may be a more cost-effective approach. Also, safe harbor 401(k)s have certain notice requirements. If you are interested in a safe harbor 401(k) for your company, HLB Gross Collins, P.C. can explain the notice requirements and provide an estimate of the cost involved, to help you make an informed decision.

Playing Defense as Stock Prices Soar


As of this writing, major U.S. stock market indexes are at or near record highs. This bullish run might continue…or it might end with a severe slide. Here are some strategies to consider.

Stay the course

Many investors will prefer to keep their current stock market positions. For nearly a century, every stock market reversal has been followed by a recovery. Even the severe shock of late 2008 through early 2009 has led to new peaks, less than a decade later.

What’s more, holding onto stocks and stock funds won’t trigger any tax on capital gains.

Move into cash

Investors who are truly nervous about pricey stocks can sell some or all of those holdings, then put the sales proceeds into vehicles that historically have been safe havens, such as bank accounts and money market funds. This would reduce or eliminate the risk of steep losses from a market crash. In both the 2000–2002 and the 2007–2009 bear markets, the S&P 500 Index of large-company stocks fell about 50%. After a loss of that magnitude, investors need a 100% rebound, just to regain their portfolio value.

However, cash equivalents have negligible yields right now, so investors would essentially be treading water in bank accounts and money funds. Timing the market has proven to be extremely difficult, so investors who go to cash risk missing out on future gains as well as possible losses. In addition, investors who sell appreciated equities held in taxable accounts will owe capital gains tax, which could be substantial.

Move into bonds

Aside from cash, bonds have long been considered a lower risk counterweight to stocks. According to Morningstar’s Ibbotson subsidiary, large-company U.S. stocks have suffered double-digit losses in five different calendar years since the 1970s. In 2008, that loss was 37%.

Long-term government bonds, on the other hand, have had fewer down years. The only year they lost more than 9% was 2009, when a drop of 15% was reported. That 2009 loss, though, came after a 26% gain in 2008, when stocks tanked. Therefore, Treasury bonds can be a useful hedge against stock market losses.

Yields on the 10-year Treasury are currently around 2.6%, so long-term Treasury bond funds may pay about 2%: not great, but more than the payout from cash equivalents. Intermediate-term Treasury funds will have lower yields but also less exposure to stock market volatility.

Investors in high tax states may have another reason to favor Treasury bonds and Treasury funds because the interest from these investments is exempt from state and local income tax. To benefit from the tax break, you must hold Treasuries in a taxable account.

Treasuries certainly can be held in a tax-deferred account such as a 401(k) or an IRA, and many investors do so. However, the state and local income tax break might be lost because withdrawals from tax-favored retirement plans may be fully taxable. (Some states offer tax exemption to distributions from retirement plans, often up to certain amounts.)

Individual circumstances

All of these strategies have advantages and drawbacks, so you should proceed with caution. Very generally, buy and hold strategies might appeal to workers who are some years from retirement. A market drop may turn out to be a buying opportunity, especially for those who are investing periodically through contributions to 401(k) and similar plans. On the other hand, trimming stocks might be prudent for people in or near retirement. Investment opportunities at low stock prices may be reduced, and a market skid can be particularly dangerous for retirees who are tapping their portfolio for spending money.

Treasury bond interest

  • Interest income from Treasury bills, notes, and bonds is subject to federal income tax.
  • That interest is exempt from state and local income taxes.
  • If you invest in a bond fund that holds only U.S. Treasuries, you will owe federal income tax on the interest income but no state or local income tax on that interest.
  • Although the bonds held in a bond fund pay interest, the fund will pay dividends to the fund’s investors. Those dividend payments will be taxed at the federal level as interest income, at ordinary income rates.

Defined Benefit Plans for Small Companies


Traditional defined benefit plans, structured to provide a lifelong pension, have become rare in the private sector. They’re still the norm for public sector employers; some large companies continue to offer plans.

Ironically, these plans might be a good fit for extremely small companies. A possible prospect could be a business or professional practice with one or two principals who are perhaps 5–10 years from retirement, with a few employees who are younger and modestly compensated.

Key difference

Most private sector retirement plans today are defined contribution plans. That is, the amounts that can be contributed to the plan are set by law, with a maximum of $60,000 (counting employee and employer inputs) in 2017, or $54,000 for those under age 50. The amount of the eventual retirement fund will depend on how much is contributed and how well the selected investments perform.

Defined benefit plans, as the name indicates, operate by setting a target benefit: the amount of a pension a given employee will receive in retirement. That benefit is determined by an employee’s age, compensation, and years of service with the company. Such plans might permit annual contributions well over $120,000 to the principal’s account, in certain circumstances. With few years to retirement, it will be necessary to build an adequate fund quickly, with large annual cash flows into the plan.

Those contributions can be tax-deductible for the employer and not taxable to the employee until money is received in retirement. Much smaller amounts might have to be contributed to the accounts of younger employees, who have many years to build up a retirement fund. What’s more, the money in the principal’s account eventually may be rolled over into an IRA, tax-free, for ongoing control over investment decisions and distributions.

Note: Even if your company already has a defined contribution plan such as a 401(k), it may be able to establish a defined benefit plan as well.

Proceed with care 

Before jumping into a defined benefit plan, business owners should consider the drawbacks. These plans can be extremely expensive to administer. You must hire an actuary or a third-party administrator to calculate how much to contribute annually. What’s more, your company must continue to make the required payments to the plan, even in a down year, and underfunding might trigger IRS penalties. Other rules and regulations apply to defined benefit plans.

In addition, some defined benefit plans may be structured so that employees who don’t work for a specified number of years forfeit their benefits. This can create incentives for the company’s principals to hire short-term workers. Hiring individuals who become long-term employees probably will be better for the firm, in terms of business results, but these workers eventually may be entitled to large payouts from the plan.

Overall, there is more to a small-company defined benefit plan than large tax-deductible contributions for business owners. If you think such a plan could work for you, HLB Gross Collins, P.C. can go over the numbers with you and explain the requirements that your company would face.

Long-term Care Coverage Combo Plans


If you or a loved one ever need help with daily living activities, you will discover that custodial care can be expensive. That’s true whether the care is provided at home, in an assisted living facility, or in a nursing home, and it’s especially true if care is needed for many years.

Long-term care (LTC) insurance is available, but insurance companies have learned that these costs can be steep. Premium increases for LTC insurance are in the news (for example, some press reports tell of cases where premiums have tripled in the last three years), and some insurance companies have dropped out of this business. Consumers face the prospect of paying thousands of dollars a year, every year, and never getting any benefit at all if it turns out that custodial care is not needed.

Sure things 

Some people might prefer another path to LTC coverage, such as a hybrid or “combo” product. These come in two varieties: a combination with a life insurance policy or with a deferred annuity. Here, a consumer buys a product that will deliver a death benefit (life insurance) or future cash flow (deferred annuity). With a combo product, the consumer can obtain a rider that will offer a payout if the covered individual needs LTC.

Example 1: Ted Moore has an insurance policy on his life, payable to his son Paul. Ted’s policy has an LTC rider. So, if Ted needs LTC, that insurance policy will provide a benefit to help pay those bills. Regardless if Ted needs care and collects an LTC benefit, his life insurance policy will pay a death benefit to Paul at the time of Ted’s death.

Generally, in this situation, Ted would receive an “accelerated death benefit” to pay for care. When someone receives such a payout, the amount of the lifetime benefit is subtracted from the death benefit that eventually will be paid to beneficiaries. Typically, a combo life insurance product would be some form of whole life or universal life, rather than term life insurance.

Example 2: Rita Smith decides to invest in a deferred annuity, attracted by that particular product’s features, which include guaranteed withdrawals. Like Ted in the previous example, she has an LTC rider for this annuity. In retirement, Rita can receive cash flow from the deferred annuity, and the LTC rider will provide money to pay for care, if needed. Depending on how Rita handles the annuity, there also may be a payout to beneficiaries she has named at the time of her death.

The common aspect of those two tactics is the absence of a “use it or lose it” drawback. With standalone LTC insurance, the money spent could wind up generating no return. With either life insurance or a deferred annuity, there will be a payout to someone at some point. The extra LTC coverage is another benefit that possibly will come in handy.

Acquiring LTC coverage in this manner usually avoids the threat of future premium increases. As another attraction, existing life insurance policies or annuities might be exchanged, tax-free, for a new contract that includes an LTC rider.

Added expense

The attractions of LTC combo products, however, come with negatives as well. The underlying problem here includes the potentially disastrous costs of LTC, and this problem can’t be escaped by switching from one type of insurance to another. There often is a cost to adding an LTC rider to an insurance policy or a deferred annuity. These combo products may require a substantial outlay, which must be paid upfront or within relatively few years.

In addition, tax advantages may be lost with combo products. With most standalone LTC insurance policies, certain amounts of your premium count as a medical expense, which can potentially be deducted. That’s not the case with a rider to a life insurance policy or to a deferred annuity.

As of 2017, people age 40 and younger can include LTC premiums up to $410 as a medical expense; that amount scales up as premium payers age, maxing out at $5,110 for those 70 and older. Those outlays are added to other medical expenses and the amount that exceeds 10% of adjusted gross income can be taken as an itemized deduction.

Putting needs first

Combo products vary widely, and so do individuals’ concerns on this issue. However, generally, people who only want LTC insurance might be best-served with standalone coverage, working with an insurance professional to hold down premiums. That said, if you are interested in life insurance such as whole life or universal life, it may be worth exploring the idea of adding LTC coverage, perhaps for an added fee. The same may be true if you are seriously considering a deferred annuity.

After Tax Dollars in Traditional IRAs


Workers under age 70½ can deduct contributions to a traditional IRA, as long as they are not covered by an employer’s retirement plan. The same is true for those workers’ spouses.

If these taxpayers are covered by an employer plan, they may or may not be able to deduct IRA contributions, depending on the taxpayer’s income. However, all eligible workers and spouses can make nondeductible contributions to a traditional IRA, regardless of income. Inside a traditional IRA, any investment earnings will be untaxed.

Dealing with distributions 

Problems can arise for people who hold nondeductible dollars in their IRAs when they take distributions. Unless they’re careful, they may pay tax twice on the same dollars.

Example 1: Marge Barnes has $100,000 in her traditional IRA on February 15, 2017. Over the years, she has made deductible and nondeductible contributions. Assume that $25,000 came from nondeductible contributions, $45,000 came from deductible contributions, and $30,000 came from investment earnings inside Marge’s IRA.

Now Marge wants to take a $20,000 distribution from her IRA. She might report $20,000 of taxable income from that distribution; indeed, Marge’s IRA custodian may report a $20,000 distribution to the IRS. However, Marge would be making a mistake, resulting in a tax overpayment.

Cream in the coffee 

To the IRS, a taxpayer’s IRA money must be stirred together to include pre-tax and after-tax dollars. Any distribution is considered to be proportionate. If Marge were to pay tax on a full $20,000 distribution, she would effectively be paying tax twice on the after-tax dollars included in this distribution.

Example 2: After hearing about this rule, Marge calculates that her $25,000 of after-tax money (her nondeductible contributions) was 25% of her $100,000 IRA on the date of the distribution. Thus, 25% of the $20,000 ($5,000) represented after-tax dollars, so Marge reports the $15,000 remainder of the distribution as a taxable withdrawal of pre-tax dollars. Again, this would be incorrect.

Year-end calculation 

Tax rules require an IRA’s after-tax contributions to be compared with the year-end IRA balance, plus distributions during the year, to calculate the ratio of pre-tax and after-tax dollars involved in a distribution.

Example 3: Assume that Marge’s IRA holds $90,000 on December 31, 2017. Her $100,000 IRA was reduced by the $20,000 distribution in February, but increased by subsequent contributions and investment earnings. Therefore, Marge’s IRA balance for this calculation is $110,000 (the $90,000 at year-end plus the $20,000 distribution). This assumes no other distributions in 2017.

Accordingly, Marge divides her $110,000 IRA balance into the $25,000 of after-tax money used in this example. The result¾22.7%¾is the portion of her distribution representing after-tax dollars. Of Marge’s $20,000 distribution, $4,540 (22.7%) is a tax-free return of after-tax dollars, and the balance ($15,460) is reported as taxable income. Marge reduces the after-tax dollars in her IRA by that $4,540, from $25,000 to $20,460, so the tax on future IRA distributions can be computed.

Form 8606

As you can see, paying the correct amount of tax on distributions from IRAs with after-tax dollars can be complicated. Without knowledge of the rules, an IRA owner may overpay tax by reporting already-taxed dollars as income. However, keeping track of after-tax and pre-tax dollars may not be simple, especially for taxpayers with multiple IRAs and multiple transactions during that year.

The best way to deal with this issue is to track pre-tax and after-tax IRA money by filing IRS Form 8606 with your federal income tax return each year that your IRA holds after-tax dollars. Our office can help prepare Form 8606 for you, when it’s indicated, and, thus, prevent this type of double taxation. 

Deducting IRA Contributions 

  • Single filers who are covered by a retirement plan at work cannot deduct traditional IRA contributions for 2016 with modified adjusted gross income (MAGI) of $71,000 or more in 2016 ($72,000 for 2017 IRAs).
  • On joint tax returns, covered workers are shut out from deductible IRA contributions with MAGI of $118,000 or more for 2016 ($119,000 for 2017).
  • A spouse who is not covered by a retirement plan at work and files jointly with a covered worker can deduct IRA contributions as long as joint MAGI is less than $194,000 for 2016 ($196,000 for 2017).
  • Other income limits apply to contributions to Roth IRAs in which contributions are never deductible, but future distributions may be tax-free.