Cordasco's 5 Things You Need To Know

Few things can derail your estate plan as quickly as unanticipated long-term care (LTC) expenses. Most people will need some form of LTC — such as a nursing home or an assisted living facility stay — at some point in their lives. And the cost of this care is steep.

Contrary to popular belief, LTC expenses generally aren’t covered by traditional health insurance policies, Social Security or Medicare. So, to help ensure that LTC expenses don’t deplete savings or other assets meant to go to your heirs, have a plan for funding them. Here are some of your options.

Self-funding

If your nest egg is large enough, it may be possible to pay for LTC expenses out-of-pocket as (or if) they’re incurred. An advantage of this approach is that you’ll avoid the high cost of LTC insurance premiums. In addition, if you’re fortunate enough to avoid the need for LTC, you’ll enjoy a savings windfall that you can use for yourself or your family. The risk, of course, is that your LTC expenses will be significantly larger than anticipated, eroding the funds available to your heirs.

Any type of asset or investment can be used to self-fund LTC expenses, including savings accounts, pension or other retirement funds, stocks, bonds, mutual funds, or annuities. Another option is to tap the equity in your home by selling it, taking out a home equity loan or line of credit, or obtaining a reverse mortgage.

Two vehicles that are particularly effective for funding LTC expenses are Roth IRAs and Health Savings Accounts (HSAs). Roth IRAs aren’t subject to minimum distribution requirements, so you can let the funds grow tax-free until they’re needed. And an HSA, coupled with a high-deductible health insurance plan, allows you to invest pretax dollars that can be withdrawn tax-free to pay for qualified unreimbursed medical expenses, including LTC. Unused funds may be carried over from year to year, making an HSA a powerful savings vehicle.

LTC insurance

LTC insurance policies — which are expensive — cover LTC services that traditional health insurance policies typically don’t cover. Determining when to purchase such a policy can be a challenge. The younger you are, the lower the premiums, but you’ll be paying for insurance coverage during a time that you’re not likely to need it.

Although the right time for you to buy coverage depends on your health, family medical history and other factors, many people purchase these policies in their early to mid-60s. Keep in mind that once you reach your mid-70s, LTC coverage may no longer be available to you or may be prohibitively expensive.

Hybrid insurance

Hybrid policies combine LTC coverage with traditional life insurance. Often, these take the form of a permanent life insurance policy with an LTC rider that provides for tax-free accelerated death benefits in the event of certain diagnoses or medical conditions.

These policies can have advantages over stand-alone LTC policies, such as less stringent underwriting requirements and guaranteed premiums that won’t increase over time. The downside, of course, is that to the extent you use the LTC benefits, the death benefit available to your heirs will be reduced.

Potential tax breaks

If you buy LTC insurance, you may be able to deduct a portion of the premiums on your tax return. And if you need LTC, you may be able to deduct some of the costs. If you have questions regarding LTC funding or the tax implications, please don’t hesitate to contact us.

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When creating or revising your estate plan, it’s important to take into account all of your loved ones. Because each family has its own unique set of circumstances, there are a variety of trusts and other vehicles available to specifically address most families’ estate planning objectives.

Special needs trusts (SNTs), also called “supplemental needs trusts,” benefit children or other family members with disabilities that require extended-term care or that prevent them from being able to support themselves. This trust type can provide peace of mind that your loved one’s quality of life will be enhanced without disqualifying him or her for Medicaid or Supplemental Security Income (SSI) benefits.

Preserve government benefits

An SNT may preserve your loved one’s access to government benefits that cover health care and other basic needs. Medicaid and SSI pay for basic medical care, food, clothing and shelter. However, to qualify for these benefits, a person’s resources must be limited to no more than $2,000 in “countable assets.” Important note: If your family member with special needs owns more than $2,000 in countable assets, thus making him or her ineligible for government assistance, an SNT is useless.

Generally, every asset is countable with a few exceptions. The exceptions include a principal residence, regardless of value (but if the recipient is in a nursing home or similar facility, he or she must intend and be expected to return to the home); a car; a small amount of life insurance; burial plots or prepaid burial contracts; and furniture, clothing, jewelry and certain other personal belongings.

An SNT is an irrevocable trust designed to supplement, rather than replace, government assistance. To preserve eligibility for government benefits, the beneficiary can’t have access to the funds, and the trust must be prohibited from providing for the beneficiary’s “support.” That means it can’t be used to pay for medical care, food, clothing, shelter or anything else covered by Medicaid or SSI.

Pay for supplemental expenses

With those limitations in mind, an SNT can be used to pay for virtually anything government benefits don’t cover, such as unreimbursed medical expenses, education and training, transportation (including wheelchair-accessible vehicles), insurance, computers, and modifications to the beneficiary’s home. It can also pay for “quality-of-life” needs, such as travel, entertainment, recreation and hobbies.

Keep in mind that the trust must not pay any money directly to the beneficiary. Rather, the funds should be distributed directly — on behalf of the beneficiary — to the third parties that provide goods and services to him or her.

Consider the trust’s language

To ensure that an SNT doesn’t disqualify the beneficiary from government benefits, it should prohibit distributions directly to the beneficiary and prohibit the trustee from paying for any support items covered by Medicaid or SSI. Some SNTs specify the types of supplemental expenses the trust should pay; others give the trustee sole discretion over nonsupport items.

Alert family and friends

After creating or revising your estate plan, discuss your intentions with your family. This is especially important if your plan includes an SNT. To ensure an SNT’s terms aren’t broken, family members and friends who want to make gifts or donations must do so directly to the trust and not to the loved one with special needs. Contact us with any questions regarding an SNT.

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If your small business is strapped for cash (or likes to save money), you may find it beneficial to barter or trade for goods and services. Bartering isn’t new — it’s the oldest form of trade — but the internet has made it easier to engage in with other businesses.

However, if your business begins bartering, be aware that the fair market value of goods that you receive in these types of transactions is taxable income. And if you exchange services with another business, the transaction results in taxable income for both parties.

Fair market value

Here are some examples of an exchange of services:

• A computer consultant agrees to offer tech support to an advertising agency in exchange for free advertising.
• An electrical contractor does repair work for a dentist in exchange for dental services.

In these cases, both parties are taxed on the fair market value of the services received. This is the amount they would normally charge for the same services. If the parties agree to the value of the services in advance, that will be considered the fair market value unless there’s contrary evidence.

In addition, if services are exchanged for property, income is realized. For example:

• If a construction firm does work for a retail business in exchange for unsold inventory, it will have income equal to the fair market value of the inventory.
• If an architectural firm does work for a corporation in exchange for shares of the corporation’s stock, it will have income equal to the fair market value of the stock.

Joining a club

Many businesses join barter clubs that facilitate barter exchanges. These clubs generally use a system of “credit units,” which are awarded to members who provide goods and services. The credits can be redeemed for goods and services from other members.

In general, bartering is taxable in the year it occurs. But if you participate in a barter club, you may be taxed on the value of credit units at the time they’re added to your account, even if you don’t redeem them for actual goods and services until a later year. For example, let’s say that you earn 2,500 credit units one year, and that each unit is redeemable for $2 in goods and services. In that year, you’ll have $5,000 of income. You won’t pay additional tax if you redeem the units the next year, since you’ve already been taxed on that income.

If you join a barter club, you’ll be asked to provide your Social Security number or Employer Identification Number. You’ll also be asked to certify that you aren’t subject to backup withholding. Unless you make this certification, the club is required to withhold tax from your bartering income at a 24% rate.

Tax reporting

By January 31 of each year, a barter club will send participants a Form 1099-B, “Proceeds from Broker and Barter Exchange Transactions,” which shows the value of cash, property, services and credits that you received from exchanges during the previous year. This information will also be reported to the IRS.

Exchanging without exchanging money

By bartering, you can trade away excess inventory or provide services during slow times, all while hanging on to your cash. You may also find yourself bartering when a customer doesn’t have the money on hand to complete a transaction. As long as you’re aware of the federal and state tax consequences, these transactions can benefit all parties involved. Contact us if you need assistance or would like more information.

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Some people mistakenly believe that Social Security benefits are always free from federal income tax. Unfortunately, that’s often not the case. In fact, depending on how much overall income you have, up to 85% of your benefits could be hit with federal income tax.

While the truth about the federal income tax bite on Social Security benefits may be painful, it’s better to understand it. Here are the rules.

Calculate provisional income

The amount of Social Security benefits that must be reported as taxable income on your tax return depends on your “provisional income.” To arrive at provisional income, start with your adjusted gross income (AGI), which is the number that appears on Page 1, Line 11 of Form 1040. Then, subtract your Social Security benefits to arrive at your adjusted AGI for this purpose.

Next, take that adjusted AGI number and add the following:

1. 50% of Social Security benefits,
2. Any tax-free municipal bond interest income,
3. Any tax-free interest on U.S. Savings Bonds used to pay college expenses,
4. Any tax-free adoption assistance payments from your employer,
5. Any deduction for student loan interest, and
6. Any tax-free foreign earned income and housing allowances, and certain tax-free income from Puerto Rico or U.S. possessions.

The result is your provisional income.

Find your tax scenario

Once you know your provisional income, you can determine which of the following three scenarios you fall under.

Scenario 1: All benefits are tax-free

If your provisional income is $32,000 or less, and you file a joint return with your spouse, your Social Security benefits will be federal-income-tax-free. But you might owe state income tax.

If your provisional income is $25,000 or less, and you don’t file jointly, the general rule is that Social Security benefits are totally federal-income-tax-free. However, if you’re married and file separately from your spouse who lived with you at any time during the year, you must report up to 85% of your Social Security benefits as income unless your provisional income is zero or a negative number, which is unlikely.

Having federal-income-tax-free benefits is nice, but, as you can see, this favorable outcome is only allowed when provisional income is quite low.

Scenario 2: Up to 50% of your benefits are taxed

If your provisional income is between $32,001 and $44,000, and you file jointly with your spouse, up to 50% of your Social Security benefits must be reported as income on Form 1040.

If your provisional income is between $25,001 and $34,000, and you don’t file a joint return, up to 50% of your benefits must be reported as income.

Scenario 3: Up to 85% of your benefits are taxed

If your provisional income is above $44,000, and you file jointly with your spouse, you must report up to 85% of your Social Security benefits as income on Form 1040.

If your provisional income is above $34,000, and you don’t file a joint return, the general rule is that you must report up to 85% of your Social Security benefits as income.

As mentioned earlier, you also must report up to 85% of your benefits if you’re married and file separately from your spouse who lived with you at any time during the year — unless your provisional income is zero or a negative number.

Turn to us

This is only a very simplified explanation of how Social Security benefits are taxed. With the necessary information, we can precisely calculate the federal income tax, if any, on your Social Security benefits.

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Unemployment has been holding steady recently at 3.7%. But there are still some people losing their jobs — particularly in certain industries including technology and media. If you’re laid off or terminated from employment, taxes are likely the last thing on your mind. However, there are tax implications due to your altered employment circumstances.

Depending on your situation, the tax aspects can be complex and require you to make decisions that may affect your tax bill for this year and for years to come. Be aware of these three areas.

1. Unemployment and payments from your former employer

Many people are surprised to find out that federal unemployment compensation is taxable. (Some states exempt unemployment comp from state tax.) In addition, payments from a former employer for any accumulated vacation or sick time are taxable. Although severance pay is also taxable and subject to federal income tax withholding, some elements of a severance package may get special treatment. For example:

• If you sell stock acquired by way of an incentive stock option (ISO), part or all of your gain may be taxed at lower long-term capital gain rates rather than at ordinary income tax rates, depending on whether you meet a special dual holding period.
• If you received — or will receive — what’s commonly referred to as a “golden parachute payment,” you may be subject to an excise tax equal to 20% of the portion of the payment that’s treated as an “excess parachute payment” under very complex rules, along with the excess parachute payment also being subject to ordinary income tax.
• The value of job placement assistance you receive from your former employer usually is tax-free. However, the assistance is taxable if you had a choice between receiving cash or outplacement help.

2. Health insurance costs

Under the COBRA rules, employers that offer group health coverage generally must provide continuation coverage to most terminated employees and their families. While the cost of COBRA coverage is usually expensive, the amount of any premium you pay for insurance that covers medical care is an eligible medical expense for tax purposes. That means it’s deductible if you itemize deductions and if your total medical expenses exceed 7.5% of your adjusted gross income.

If your former employer pays some of your medical coverage for a period of time after termination, you won’t be taxed on the value of the benefit.

3. Retirement plan balance

Employees whose employment is terminated may need tax planning help to determine the best option for amounts they’ve accumulated in retirement plans sponsored by former employers, such as a 401(k) plan. In many cases, a direct, tax-free rollover to an IRA is the best move. You may also choose to leave the account in your previous employer’s 401(k) plan (although the employer may elect to distribute the funds to you). Or, if you get a new job, you may want to transfer the money in the account with your former employer to your new employer’s 401(k) plan.

If you’re under age 59½, and make withdrawals from your former company’s plan or IRA to supplement missing income, you may owe an additional 10% penalty tax unless you qualify for an exception.

If a distribution from the retirement plan includes employer securities in a lump sum, the distribution is taxed under the lump-sum rules, except that “net unrealized appreciation” in the value of the stock isn’t taxed until the securities are sold or otherwise disposed of in a later transaction.

Further, any loans you’ve taken out from your former employer’s retirement plan, such as a 401(k)-plan loan, may be required to be repaid immediately, or within a specified period. If they aren’t, they may be treated as if the loan is in default. If the balance of the loan isn’t repaid within the required period, it will typically be treated as a taxable deemed distribution.

If you need assistance, contact us. We can help you navigate the best path forward during this transition period.

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