Coronavirus RMD Relief: Ability To Waive Mandatory IRA Distributions In 2020
Congress passed the CARES Act in March 2020 which provides individuals with IRA, 401(k), and other employer sponsored retirement accounts, the option to waive their required minimum distribution (RMD) for the 2020 tax year.
Congress passed the CARES Act in March 2020 which provides individuals with IRA, 401(k), and other employer sponsored retirement accounts, the option to waive their required minimum distribution (RMD) for the 2020 tax year. This option is available to both individual over the age of 70½ and non-spouse beneficiaries of inherited IRA’s. In this article we will review:
The new RMD waiver rules
RMD’s for individuals age 70.5
RMD’s for beneficiaries of Inherited IRA’s
What happens if you already took your distribution for 2020?
Options for putting the RMD back into your IRA
Who Qualifies For The RMD Waiver?
Unlike other provisions in the CARES Act that require an individual to demonstrate that they have been impacted by the Coronavirus to gain access, the waiver of 2020 required minimum distributions is available to everyone. If you were age 70½ prior to December 31, 2019 or are the non-spouse beneficiary of an IRA, you are typically required to take a small distribution from your IRA each year, called an “RMD”, and pay tax on those distributions. However, for 2020, if you want to keep that money in your IRA in 2020 and avoid the tax hit associated with taking the distribution, you have the option to do so.
What If You Already Took Your RMD for 2020?
If you already received the RMD amount from your IRA for 2020, you may be able to return it to your IRA, and avoid the tax hit.
If the distribution came from your own personal IRA, not an inherited IRA, you will have two options:
OPTION 1: If the distribution happened within the last 60 days, you can simply return the money to your IRA. For this option, you are utilizing the 60-day rollover rule which allows you to take money out of an IRA, return it within 60 days, and avoid the tax liability. You are only allowed one 60-day rollover every 12 months.
OPTION 2: If the distribution took place more than 60 days ago, you will only be allowed to return it to your IRA if you qualify based on one of the four Coronavirus-Related Distribution criteria:
You, your spouse, or a dependent was diagnosed with the COVID-19
You are unable to work due to lack of childcare resulting from COVID-19
You own a business that has closed or is operating under reduced hours due to COVID-19
You have experienced adverse financial consequences as a result of being quarantined, furloughed, laid off, or having work hours reduced because of COVID-19
If you qualify under one of these items, then you will have 3-years from the date of the distribution to return the money back to your IRA and avoid the tax hit. However, while you have 3-years to return it to the IRA, if you don’t return the money to your IRA prior to December 31, 2020, you will have a tax liability in 2020 for all or a portion of that IRA distribution. It’s only when you actually return the money to your IRA that the tax liability is nullified. If you return it in a future tax year, you would have to go back and amend your 2020 tax return to recapture the taxes that were paid.
Inherited IRA – Non-spouse Beneficiary
However, if you are a non-spouse beneficiary of an IRA, the rules for returning the money to your IRA are different. If you are a non-spouse beneficiary of an IRA and you already received your RMD for 2020, you cannot return that money to your IRA to avoid the tax liability. Why is this? Beneficiaries are not eligible to make rollovers, so that disqualifies them from return the money to the IRA under the rollover rules in the CARES Act.
A Note To Our Greenbush Financial Clients
If you wish to waiver your RMD to 2020 or if have already received your RMD, and wish to process a rollover back into your IRA, 401(k), or employer sponsored plan, please contact us.
Michael Ruger
About Michael……...
Hi, I’m Michael Ruger. I’m the managing partner of Greenbush Financial Group and the creator of the nationally recognized Money Smart Board blog . I created the blog because there are a lot of events in life that require important financial decisions. The goal is to help our readers avoid big financial missteps, discover financial solutions that they were not aware of, and to optimize their financial future.
$5,000 Penalty Free Distribution From An IRA or 401(k) After The Birth Of A Child or Adoption
New parents have even more to be excited about in 2020. On December 19, 2019, Congress passed the SECURE Act, which now allows parents to withdraw up to $5,000 out of their IRA’s or 401(k) plans following the birth of their child
New parents have even more to be excited about! On December 19, 2019, Congress passed the SECURE Act, which now allows parents to withdraw up to $5,000 out of their IRA’s or 401(k) plans following the birth of their child without having to pay the 10% early withdrawal penalty. To take advantage of this new distribution option, parents will need to know:
Effective date of the change
Taxes on the distribution
Deadline to make the withdrawal
Is it $5,000 for each parent or a total per couple?
Do all 401(k) plans allow these types of distributions?
Is it a per child or is it a one-time event?
Can you repay the money to your retirement account at a future date?
How does it apply to adoptions?
This article will provide you with answers to these questions and also provide families with advanced tax strategies to reduce the tax impact of these distributions.
SECURE Act
The SECURE Act was passed in December 2019 and Section 113 of the Act added a new exception to the 10% early withdrawal penalty for taking distributions from retirement accounts called the “Qualified Birth or Adoption Distribution.”
Prior to the SECURE Act, if you were under the age of 59½ and you distributed pre-tax money from an IRA or 401(k) plan, in addition to having to pay ordinary income tax on the amount distributed, you were also hit with a 10% early withdrawal penalty from the IRS. The IRS prior to the SECURE Act did have a list of exceptions to the 10% penalty but having a child or adopting a child was not on that list. Now it is.
How It Works
After the birth of a child, a parent is allowed to distribute up to $5,000 out of either an IRA or a 401(k) plan. Notice the word “after”. You are not allowed to withdraw the money prior to the child being born. New parents have up to 12 months following the date of birth to process the distribution from their retirement accounts and avoid the 10% early withdrawal penalty.
Example: Jim and Sarah have their first child on May 5, 2025. To help with some of the additional costs of a larger family, Jim decides to withdraw $5,000 out of his rollover IRA. Jim’s window to process that distribution is between May 5, 2025 – May 4, 2026.
The Tax Hit
Assuming Jim is 30 years old, he would avoid having to pay the 10% early withdrawal penalty on the $5,000 but that $5,000 still represents taxable income to him in the year that the distribution takes place. If Jim and Sarah live in New York and make a combined income of $100,000, in 2025, that $5,000 would be subject to federal income tax of 22% and state income tax of 6.85%, resulting in a tax liability of $1,440.
Luckily under the current tax laws, there is a $2,000 federal tax credit for dependent children under the age of 17, which would more than offset the total 22% in fed tax liability ($1,100) created by the $5,000 distribution from the IRA. Essentially reducing the tax bill to $340 which is just the state tax portion.
TAX NOTE: While the $2,000 fed tax credit can be used to offset the federal tax liability in this example, if the IRA distribution was not taken, that $2,000 would have reduced Jim & Sarah’s existing tax liability dollar for dollar.
For more info on the “The Child Tax Credit” see our article: More Taxpayers Will Qualify For The Child Tax Credit
$5,000 Per Parent
But it gets better. The $5,000 limit is available to EACH parent meaning if both parents have a pre-tax IRA or 401(k) plan, they can each distribute up to $5,000 from their retirement accounts within 12 months following the birth of their child and avoid the 10% early withdrawal penalty.
ADVANCED TAX STRATEGY: If both parents are planning to distribute the full $5,000 out of their retirement accounts and they are in a medium to high tax bracket, it may make sense to split the two distributions between separate tax years.
Example: Scott and Linda have a child on October 3, 2025 and they both plan to take the full $5,000 out of their IRA accounts. If they are in a 24% federal tax bracket and they process both distributions prior to December 31, 2025, the full $10,000 would be taxable to them in 2025. This would create a $2,400 federal tax liability. Since this amount is over the $2,000 child tax credit, they will have to be prepared to pay the additional $400 federal income tax when they file their taxes, since it was not fully offset by the $2,000 tax credit.
In addition, by taking the full $10,000 in the same tax year, Scott and Linda also run the risk of making that income subject to a higher tax rate. If instead, Linda processes her distribution in November 2025 and Scott waits until January 2026 to process his $5,000 IRA distribution, it could result in a lower tax liability and less out of pocket expense come tax time.
Remember, you have 12 months following the date of birth to process the distribution and qualify for the 10% early withdrawal exemption.
$5,000 For Each Child
This 10% early withdrawal exemption is available for each child that is born. It does not have a lifetime limit.
Example: Building on the Scott and Linda example above, they have their first child October 2025, and both of them process a $5,000 distribution from their IRA’s avoiding the 10% penalty. They then have their second child in November 2026. Both Scott and Linda would be eligible to withdraw another $5,000 each out of their IRA or 401(k) within 12 months after the birth of their second child and again avoid having to pay the 10% early withdrawal penalty.
IRS Audit
One question that we have received is “Do I need to keep track of what I spend the money on in case I’m ever audited by the IRS?” The short answer is “No”. The new law does not require you to keep track of what the money was spent on. The birth of your child is the “qualifying event” which makes you eligible to distribute the $5,000 penalty free.
Not All 401(k) Plans Will Allow These Distributions
This 10% early withdrawal exception will apply to all pre-tax IRA accounts but it does not automatically apply to all 401(k), 403(b), or other types of qualified employer sponsored retirement plans.
While the SECURE Act “allows” these penalty-free distributions to be made, companies can decide whether or not they want to provide this special distribution option to their employees. For employers that have existing 401(k) or 403(b) plans, if they want to allow these penalty-free distributions to employees after the birth of a child, they will need to contact their third-party administrator and request that the plan be amended.
For companies that intend to add this distribution option to their plan, they may need to be patient with the timeline for the change. 401(k) providers will most likely need to update their distribution forms, tax codes on their 1099R forms, and update their recordkeeping system to accommodate this new type of distribution.
Ability To Repay The Distribution
The new law also offers parents the option to repay the amounts to their retirement account that were distributed due to a qualified birth or adoption. The repayment of the amounts previously distributed from the IRA or 401(k) would be in addition to the annual contribution limits. There is not a lot of clarity at this point as to how these “repayments” will work so we will have to wait for future guidance from the IRS on this feature.
Adoptions
The 10% early withdrawal exception also applies to adoptions. An individual is allowed to take a distribution from their retirement account up to $5,000 for any children under the age of 18 that is adopted. Similar to the timing rules of the birth of a child, the distribution must take place AFTER the adoption is finalized, but within 12 months following that date. Any money distributed from retirement accounts prior to the adoption date will be subject to the 10% penalty for individuals under the age of 59½.
About Michael……...
Hi, I’m Michael Ruger. I’m the managing partner of Greenbush Financial Group and the creator of the nationally recognized Money Smart Board blog . I created the blog because there are a lot of events in life that require important financial decisions. The goal is to help our readers avoid big financial missteps, discover financial solutions that they were not aware of, and to optimize their financial future.
Understanding Required Minimum Distributions & Advanced Tax Strategies For RMD's
A required minimum distribution (RMD) is the amount that the IRS requires you to take out of your retirement account each year when you hit a certain age or when you inherit a retirement account from someone else. It’s important to plan tax-wise for these distributions because they can substantially increase your tax liability in a given year;
Understanding Required Minimum Distributions & Advanced Tax Strategies For RMD’s
A required minimum distribution (RMD) is the amount that the IRS requires you to take out of your retirement account each year when you hit a certain age or when you inherit a retirement account from someone else. It’s important to plan tax-wise for these distributions because they can substantially increase your tax liability in a given year; consequentially, not distributing the correct amount from your retirement accounts will invite huge tax penalties from the IRS. Luckily, there are advanced tax strategies that can be implemented to help reduce the tax impact of these distributions, as well as special situations that exempt you from having to take an RMD.
Age 73 or 75
LAW CHANGE: There were changes to the RMD age when the SECURE Act was passed into law on December 19, 2019. Prior to the law change, you were required to start taking RMD’s in the calendar year that you turned age 70 1/2. For anyone turning age 70 1/2 after December 31, 2019, their RMD start age is now delayed to either age 73 or 75, depending on the individual’s date of birth.
The IRS has a special table called the “Uniform Lifetime Table”. There is one column for your age and another column titled “distribution period”. The way the table works is you find your age and then identify what your distribution period is. Below is the calculation step by step:
1) Determine your December 31 balance in your pre-tax retirement accounts for the previous year end
2) Find the distribution period on the IRS uniform lifetime table
3) Take your 12/31 balance and divide that by the distribution period
4) The previous step will result in the amount that you are required to take out of your retirement account by 12/31 of that year
Example: If you turn age 73 in March of 2025, you would be required to take your first RMD in that calendar year unless you elect the April 1st delay in the first year. After you find your age on the IRS uniform lifetime table, next to it, you will see a distribution period of 26.5. The balance in your traditional IRA account on December 31, 2024 was $400,000, so your RMD would be calculated as follows:
$400,000 / 26.5 = $15,094
Your required minimum distribution amount for the 2025 tax year is $15,094. The first RMD will represent about 3.8% of the account balance, and that percentage will increase by a small amount each year.
RMD Deadline
There are very important dates that you need to be aware of once you reach RMD start age. In most years, you have to make your required minimum distribution prior to December 31 of that tax year. However, there is an exception for the year that you turn age 73 or 75. In the year that you reach the RMD start date, you have the option of taking your first RMD either prior to December 31 or April 1 of the following year. The April 1 exception only applies to the year of your first RMD. Every year after that first year, you are required to take your distribution by December 31st.
Delay to April 1st
So why would someone want to delay their first required minimum distribution to April 1? Since the distribution results in additional taxable income, it’s about determining which tax year is more favorable to realize the additional income.
For example, you may have worked for part of the year that you turned age 73 so you’re showing earned income for the year. If you take the distribution from your IRA prior to 12/31 that represents more income that you have to pay tax on which is stacked up on top of your earned income. It may be better from a tax standpoint to take the distribution in the following January because the amount distributed from your retirement account will be taxed in a year when you have less income.
Very important rule:
If you decide to delay your first required minimum distribution past 12/31, you will be required to take two RMD‘s in that following year.
Example: I retire from my company in September 2024 and I also turned 73 that same year. If I elect to take my first RMD on February 1, 2025, prior to the April 1 deadline, I will then be required to take a second distribution from my IRA prior to December 31, 2025.
If you are already retired in the year that you turn age 73 and your income level is going to be relatively the same between the current year and the following year, it often makes sense to take your first RMD prior to December 31st, so are not required to take two RMD‘s the following year which can subject those distributions to a higher tax rate and create other negative tax events.
IRS Penalty
If you fail to distribute the required amount by the given deadline, the IRS will be kind enough to assess a 25% penalty on the amount that you should have taken for your required minimum distribution. If you were required to take a $12,000 distribution and you failed to do so by the applicable deadline, the IRS will hit you with a $3,000 penalty. If you make the distribution, but the amount is not sufficient enough to meet the required minimum distribution amount, they will assess the 25% penalty on the shortfall instead. Bottom line, don’t miss the deadline.
Exceptions If You Are Still Working
There is an exception to the RMD rule. If your only retirement asset is an employer sponsored retirement plan, such as a 401(k), 403(b), or 457, as long as you are still working for that employer, you are not required to take an RMD from that retirement account until after you have terminated from employment regardless of your age.
Example: You are age 73 and your only retirement asset is a 401(k) account with your current employer with a $100,000 balance; you will not be required to take an RMD from your 401(k) account in that year, even though you have reached your RMD start date.
In the year that you terminate employment, however, you will be required to take an RMD for that year. For this reason, be very careful if you’re working over the age of 73 / 75 and leave employment in late December. Your retirement plan provider will have a very narrow window of time to process your required minimum distribution prior to the December 31st deadline.
This employer sponsored retirement plan exception only applies to balances in your current employer’s retirement plan. You do not receive this exception for retirement plan balances with previous employers.
If you have retirement accounts such as IRA’s or other retirement plans outside of your current employer’s plan, you will still be required to take RMDs from those accounts, even though you are still working.
Advanced Tax Strategies
There are two advanced tax strategies that we use when individuals are age 73 or 75 and still working for a company that sponsors are qualified retirement plan.
It’s not uncommon for employees to have a retirement plan with their current employer, a rollover IRA, and some miscellaneous balance in retirement plans from former employers. Since you only have the exception to the RMD within your current employers plan, and most 401(k), 403(b), and 457 plans accept rollovers from IRAs and other qualified plans, it may be advantageous to complete rollovers of all those retirement accounts into your current employer’s plan so you can completely avoid the RMD requirement.
Strategy number two. If you are still working and you have access to an employer sponsored plan, you are usually able to make employee contributions pre-tax to the plan. If you are required to take a distribution from your IRA which results in taxable income, as long as you are not already maxing out your employee deferrals in your current employer’s plan, you can instruct payroll to increase your contributions to the plan to reduce your earned income by the amount of the required minimum distribution coming from your other retirement accounts.
Example: You are age 73 and working part time for an employer that gives you access to a 401(k) plan. Your 401(k) has a balance of $20,000 with that employer, but you also have a Rollover IRA with a balance of $200,000. In this case, you would not be required to take an RMD from your 401(k) balance, but you would be required to take an RMD from your IRA which would total approximately $7,500. Since the $7,500 will represent additional income to you in that tax year, you could turn around and instruct the payroll company to take 100% of your paychecks and put it pre-tax into your 401(k) account until you reach $7,500 which would wipe out the tax liability from the distribution that occurred from the IRA.
Or, if you have a spouse that still working and they have access to a qualified retirement plan, the same strategy can be implemented. Additionally, if you file a joint tax return, it doesn’t matter whose retirement plan it goes into because it’s all pre-tax at the end of the day.
5% or More Owner
Unfortunately, I have some bad news for business owners. If you are a 5% or more owner of the company, it does not matter whether or not you are still working for the company; you are required to take an RMD from the company’s employer-sponsored retirement plan regardless. The IRS is well aware that the owner of the business could decide to work for two hours a week just to avoid the required minimum distributions. Sorry entrepreneurs.
A Spouse That Is More Than 10 Years Younger
I mentioned above that the IRS has a uniform lifetime table for calculating the RMD amount. If your spouse is more than 10 years younger than you are, there is a special RMD table that you will need to use called the “joint life table” with a completely different set of distribution periods, so make sure you’re using the correct table when calculating the RMD amount.
Charitable contributions
There is also an advanced tax strategy that allows you to make contributions to charity directly from your IRA and you do not have to pay tax on those disbursements. The special charitable distributions from IRA’s are only allowed for individuals that are age 70.5 or older. If you regularly make contributions to a charity, church, or not for profit, or if you do not need the income from the RMD, this may be a great strategy to shelter what otherwise would have been more taxable income. There are a lot of special rules surrounding how these charitable contributions work. For more information on this strategy see the following article:
Lower Your Tax Bill By Directing Your Mandatory IRA Distributions To Charity
Roth IRA’s
You are not required to take RMD‘s from Roth IRA accounts at age 73 or 75, this is one of the biggest tax advantages of Roth IRAs.
Inherited IRA
When you inherit an IRA from someone else, those IRAs have their own set of required minimum distribution rules, which vary from the normal age 73/75 rules. The SECURE Act, which was passed in 2019, split non-spouse beneficiaries of IRAs into two categories. For individuals who inherited retirement accounts prior to December 31, 2019, they are still able to stretch the RMD over their lifetime, and the required minimum distributions must begin by December 31st of the year following the decedent's date of death. For individuals who inherited a retirement account after December 31, 2019, the New 10 Rule replaced the stretch option. For the full list of rules, deadlines, and tax strategies surrounding inherited IRAs, see the articles listed below:
About Michael……...
Hi, I’m Michael Ruger. I’m the managing partner of Greenbush Financial Group and the creator of the nationally recognized Money Smart Board blog . I created the blog because there are a lot of events in life that require important financial decisions. The goal is to help our readers avoid big financial missteps, discover financial solutions that they were not aware of, and to optimize their financial future.
Do I Have To Pay Tax On A House That I Inherited?
The tax rules are different depending on the type of assets that you inherit. If you inherit a house, you may or may not have a tax liability when you go to sell it. This will largely depend on whose name was on the deed when the house was passed to you. There are also special exceptions that come into play if the house is owned by a trust, or if it was gifted
Do I Have To Pay Tax On A House That I Inherited?
The tax rules are different depending on the type of assets that you inherit. If you inherit a house, you may or may not have a tax liability when you go to sell it. This will largely depend on whose name was on the deed when the house was passed to you. There are also special exceptions that come into play if the house is owned by a trust, or if it was gifted with the kids prior to their parents passing away. On the bright side, with some advanced planning, heirs can often times avoid having to pay tax on real estate assets when they pass to them as an inheritance.
Step-up In Basis
Many assets that are included in the decedent’s estate receive what’s called a step-up in basis. As with any asset that is not held in a retirement account, you must be able to identify the “cost basis”, or in other words, what you originally paid for it. Then when you eventually sell that asset, you don’t pay tax on the cost basis, but you pay tax on the gain.
Example: You buy a rental property for $200,000 and 10 years later you sell that rental property for $300,000. When you sell it, $200,000 is returned to you tax free and you pay long-term capital gains tax on the $100,000 gain.
Inheritance Example: Now let’s look at how the step-up works. Your parents bought their house 30 years ago for $100,000 and the house is now worth $300,000. When your parents pass away and you inherit the house, the house receives a step-up in basis to the fair market value of the house as of the date of death. This means that when you inherit the house, your cost basis will be $300,000 and not the $100,000 that they paid for it. Therefore, if you sell the house the next day for $300,000, you receive that money 100% tax-free due to the step-up in basis.
Appreciation After Date of Death
Let’s build on the example above. There are additional tax considerations if you inherit a house and continue to hold it as an investment and then sell it at a later date. While you receive the step-up in basis as of the date of death, the appreciation that occurs on that asset between the date of death and when you sell it is going to be taxable to you.
Example: Your parents passed away June 2019 and at that time their house is worth $300,000. The house receives the step-up in basis to $300,000. However, lets say this time you rent the house or don’t sell it until September 2020. When you sell the house in September 2020 for $350,000, you will receive the $300,000 tax-free due to the step-up in basis, but you’ll have to pay capital gains tax on the $50,000 gain that occurred between date of death and when you sold house.
Caution: Gifting The House To The Kids
In an effort to protect the house from the risk of a long-term event, sometimes individuals will gift their house to their kids while they are still alive. Some see this as a way to remove themselves from the ownership of their house to start the five-year Medicaid look back period, however, there is a tax disaster waiting for you with the strategy.
When you gift an asset to someone, they inherit your cost basis in that asset, so when you pass away, that asset does not receive a step-up in basis because you don’t own it and it’s not part of your estate.
Example: Your parents change the deed on the house to you and your siblings while they’re still alive to protect assets from a possible nursing home event. They bought the house 30 years ago for $100,000, and when they pass away it’s worth $300,000. Since they gifted the assets to the kids while they were still alive, the house does not receive a step-up in basis when they pass away, and the cost basis on the house when the kids sell it is $100,000; in other words, the kids will have to pay tax on the $200,000 gain in the property. Based on the long-term capital gains rates and possible state income tax, when the children sell the house, they may have a tax bill of $44,000 or more which could have been completely avoided with better advanced planning.
How To Avoid Paying Capital Gains Tax On Inherited Property
There are ways to both protect the house from a long-term event and still receive the step-up in basis when the current owners pass away. This process involves setting up an irrevocable trust to own the house which then protects the house from a long-term event as long as it’s held in the trust for at least five years.
Now, we do have to get technical for a second. When an asset is owned by an irrevocable trust, it is technically removed from your estate. Most assets that are not included in your estate when you pass do not receive a step-up in basis; however, if the estate attorney that drafts the trust document puts the correct language within the trust, it allows you to protect the assets from a long-term event and receive a step-up in basis when the owners of the house pass away.
For this reason, it’s very important to work with an attorney that is experienced in handling trusts and estates, not a generalist. It only takes a few missing sentences from that document that can make the difference between getting that asset tax free or having a huge tax bill when you go to sell the house.
Establishing this trust can sometimes cost between $3,000 and $6,000. But by paying this amount upfront and doing the advance planning, you could save your heirs 10 times that amount by avoiding a big tax bill when they inherit the house.
Making The House Your Primary
In the case that the house is gifted to the children prior to the parents passing away and the house is not awarded the step-up in basis, there is an advance tax planning strategy if the conditions are right to avoid the big tax bill. If one of the children would be interested in making their parent’s house their primary residence for two years, then they are then eligible for either the $250,000 or $500,000 capital gains exclusion.
According to current tax law, if the house you live in has been your primary residence for two of the previous five years, when you go to sell the house you are allowed to exclude $250,000 worth of gain for single filers and $500,000 worth of gain for married filing joint. This advanced tax strategy is more easily executed when there is a single heir and can get a little more complex when there are multiple heirs.
About Michael……...
Hi, I’m Michael Ruger. I’m the managing partner of Greenbush Financial Group and the creator of the nationally recognized Money Smart Board blog . I created the blog because there are a lot of events in life that require important financial decisions. The goal is to help our readers avoid big financial missteps, discover financial solutions that they were not aware of, and to optimize their financial future.
STAR Property Tax Credit: Make Sure You Know The New Income Limits
The STAR Credit is a great way to reduce your property taxes in New York. If you are over the age of 65, it gets even better with the Enhanced STAR Credit. But you have to know the income limits associated with the credit otherwise you could unexpectedly lose the credit which could cost you thousands of dollars in additional property taxes. They
The STAR Credit is a great way to reduce your property taxes in New York. If you are over the age of 65, it gets even better with the Enhanced STAR Credit. But you have to know the income limits associated with the credit otherwise you could unexpectedly lose the credit which could cost you thousands of dollars in additional property taxes. They made some big changes to the credit that a lot of homeowners are not aware of. In this article we will review:
The income limits for the STAR Credit
Eligibility requirements for the Enhanced STAR Credit
How much money the STAR credit saves you
The most common mistakes that people make that disqualify them from the credit
The changes that were made to the property tax credit
STAR Property Tax Exemption
Let’s start with the basics. STAR stands for School Tax Relief. It’s a partial exemption from school taxes for your primary residence. There are two different STAR programs:
Basic STAR
Enhanced STAR
You Have To Apply For The Credit
You have to apply for the credit to receive it. It’s not automatic. Also, if you turn 65 this year and you want to further reduce your property taxes, there is a special application process for the Enhanced STAR Credit which requires you to enroll in the annual Income Verification Program (IVP). We will cover this in more detail later on in the article.
How Does The STAR Credit Work
The STAR credit exempts a specified dollar amount from the assessed value of your house prior to the calculation of your school tax bill. Here are the current exemption amounts:
Basic STAR: $30,000
Enhanced STAR: $65,000
The actual dollar amount that you save in school taxes will vary based on where you live in New York State. But if you live in a $300,000 house, you qualify for Basic STAR, and your school taxes before the STAR’s credit are $7,000. It could save you around $700 per year in school taxes. If you qualify for the enhanced STAR, you can more than double that savings number. In a high property tax state like New York, every little bit helps.
Income Limits For The STAR Credit
Here is a table from NYS Department of Taxation and Finance that summarizes the eligibility requirements for the Basic STAR and Enhanced STAR credit:
Requirement #1: It must be your primary residence. The credit does not apply for rental properties or second homes.
Requirement #2: To qualify for the Enhanced STAR, one of the homeowners must be age 65
Requirement #3: The income limitations. We see fewer issues with the Basic STAR since the income limit is $500,000. We see a lot more issues with the Enhanced STAR credit with the income limit at $86,300. Mainly because when you add up social security, pension payments, and required minimum distributions from IRA’s, you have homeowners that flirt with that income limit on a year by year basis. Crossing the income line would drop you back into the Basic STAR program which will most likely result in an unfriendly property tax surprise.
Income Calculation
The eligibility for the 2019 STAR credit is actually based on your income from 2017. You can reference your 2017 federal and state tax returns against the table listed below:
Enhanced STAR Credit
Once you or your spouse turn age 65, you are then eligible to apply for the Enhanced STAR program.
Unlike the basic STAR program, the Enhanced STAR program required homeowners to file renewal applications with their local assessor each year to remain in the program. Under the new rules, new applicants are required to enroll in the Enhanced STAR Income Verification Process.
The application deadline is typically March 1st if you are filing at the county level but it can vary from county to county. You should contact your assessor to verify the application deadline in your area. The good news about enrolling in the Enhance STAR Income Verification Program is you only have to do it once. Once enrolled you will receive the Enhanced STAR credit each year as long as your income is below the required threshold.
Common Mistakes With The Enhanced STAR Credit
Since the income threshold for the Enhanced STAR program is much lower than the Basic STAR program this is where we see homeowners get into trouble. For most retirees, their income is relatively the same from year to year. However, there are frequently one-time events that occur that can push a retiree’s income higher for a given year. Not only do they end up with a large tax bill when they file their taxes but they also find out that they lost the Enhanced STAR Credit for that year. Double ouch!!
Here are the most common income events that retirees have to watch out for:
Capital gains and dividends from taxable investment accounts
Taking larger distributions from IRA’s or pre-tax retirement plans
Age 70 ½ - Required minimum distributions start from IRA’s
Receive an inheritance (some sources can be taxable)
Sell real estate or land other than the primary residence
Surrendering a life insurance policy
Part-time income
The year you turn on social security benefits
If you experience financial events that are expected to increase your taxable income for a given year, you should work closely with you financial advisor or accountant during those years because there may be ways to reduce your income to maintain the Enhanced STAR credit with some advanced planning.
Changes To The STAR Credit
New York made some significant changes to both the Basic STAR and the Enhanced STAR credit that not many homeowners are aware of. The amount of the credit did not change but the methods for applying for and receiving the credit did change.
If you were receiving the Basic STAR credit before and you have not moved since 2016, there is nothing that you have to do. Everything will continue to operate the same. However, if you move or if you are new homeowner, the STAR process will be different. Under the old method, you would simply see a deduction for your STAR credit on your school tax bill. Going forward, when you buy a new house, you will have to pay your full school tax bill, and then New York will mail you a physical check for your STAR credit. In order to receive your check in September, you must register for the Basic STAR program through the state Department of Taxation and Finance by July 1st.
After July 1st, you can still apply for the STAR credit, and the state will provide you with a check, but you may receive the check after September. The same manual check process is applicable with the Enhanced STAR program as well.
If you were receiving the Enhanced STAR and you have not moved, New York is allowing those homeowners to continue to file their renewal applications with their local assessor each year without having to enroll in the new Enhanced STAR Income Verification Program. However, if you move, you will have to enroll in the Income Verification Program in order to remain in the Enhanced STAR Program.
About Michael……...
Hi, I’m Michael Ruger. I’m the managing partner of Greenbush Financial Group and the creator of the nationally recognized Money Smart Board blog . I created the blog because there are a lot of events in life that require important financial decisions. The goal is to help our readers avoid big financial missteps, discover financial solutions that they were not aware of, and to optimize their financial future.
Why Do You Owe More In Taxes This Year?
“I thought there was a tax break. Last year I got a refund. This year, I owe money to the IRS. How did this happen and what do I need to change to fix this?.” As more and more people file their taxes for 2018, the situation described above seems to be the norm instead of the exception to the rule. Taxpayers are realizing that either their tax refund is lower, they owe money for the first time, o
“I thought there was a tax break. Last year I got a refund. This year, I owe money to the IRS. How did this happen and what do I need to change to fix this?”
As more and more people file their taxes for 2018, the situation described above seems to be the norm instead of the exception to the rule. Taxpayers are realizing that either their tax refund is lower, they owe money for the first time, or their tax bill is larger than it normally is. While this is a shock to many families and individuals, we saw this issue coming in February of 2018. We even wrote an article at that time titled “Warning To All Employees: Review The Tax Withholding In Your Paycheck Otherwise A Big Tax Bill May Be Waiting For You”.
Below we will highlight some of the catalysts of this issue and provide you with some strategies on how to better prepare for the coming tax year.
New Tax Withholding Tables
When tax reform was passed, the government issued new federal income tax withholding tables to your employer in February which provides them with the amount that they should withhold from your paycheck for tax purposes. Since the federal tax brackets dropped, so did the withholding tables. In February 2018, this seemed like a great thing because most taxpayers saw an increase in their take home pay. However, it simultaneously created a big tax problem for a lot of employees.
Gross Income vs. Taxable Income
There is a difference between your “gross income” and your “taxable income”. If your salary is $80,000 per year, that is your gross income. At tax time, you get to take deductions against your gross income, to reach your total “taxable income” which is a lower amount. Your taxable income is the amount that you actually have to pay taxes on.
For example, you have a married couple, husband has a W2 for $60,000 and his wife has a W2 for $70,000. Their combined gross income is $130,000. Let’s assume they take the standard deduction in 2018 which is a $24,000 deduction. Their total taxable income for 2018 is $106,000.
Impact of Tax Reform
While tax forms did bring lower federal income tax brackets, it also made a lot of changes to the deduction side of the equation. For those of us living in New York, California, and other high tax states, the biggest change was probably the $10,000 cap that they placed on property taxes and state income taxes. The other big change for taxpayers with children was the elimination of the personal exemption deduction which was replaced with a credit. The personal exemption change works for some taxpayers and against others. For more on this topic reference: More Taxpayers Will Qualify For The Child Tax Credit In 2018
For that married couple above that made $130,000 in 2018, under the new tax rules their total taxable income may be $106,000 but if they applied the old tax rules it may have only been $95,000. People are finding out that while the federal tax rates dropped, their total taxable income for the year increased because the higher standard deduction did not make up for all of the itemized deductions that were lost under the new tax rules.
To further aggravate that wound, at the beginning of 2018, the federal government instructed your employer to withhold less federal income tax from your paycheck which put some taxpayers further behind on their withholdings. If you were used to getting a refund when you filed your taxes, technically you may have already received it throughout the year in your paycheck but you just didn’t know it. There are of course taxpayers in the even more difficult camp that were banking on getting a refund only to find out that they actually owe money to the IRS.
How Do You Fix This?
If you unexpectedly owed money to the IRS this year or if you want to restore that refund that you typically receive when you file your taxes, you are going to have to change your tax withholding amount with your employer. You have to request a Form W-4 from your employer. I looks like this……
Form W-4
You can reduce the number of allowances that you are claiming on line 5 or you can instruct your employer to withhold an additional flat dollar amount each pay period on line 6.
There are also other options beside increasing your tax withholdings like increasing your contributions to your 401(k) account or contributing money to a Health Savings Account for your health expenses. These moves may assist you in reducing your taxable income which could lead to a lower tax liability.
Consult With Your Accountant
While I have highlighted the more common catalysts leading to this under withholding issue, there were a lot of changes made to the tax rules so there could have been other factors that led to your higher tax liability this year. Your gross income could have been higher, maybe you took a distribution from an IRA account, or you have realized gains from an investment that you sold during the year. You really have to work with your tax professional to identify what triggered the additional tax liability and determine what action should be taken to reduce your tax liability going forward.
About Michael……...
Hi, I’m Michael Ruger. I’m the managing partner of Greenbush Financial Group and the creator of the nationally recognized Money Smart Board blog . I created the blog because there are a lot of events in life that require important financial decisions. The goal is to help our readers avoid big financial missteps, discover financial solutions that they were not aware of, and to optimize their financial future
How To Change Your Residency To Another State For Tax Purposes
If you live in an unfriendly tax state such as New York or California, it’s not uncommon for your retirement plans to include a move to a more tax friendly state once your working years are over. Many southern states offer nicer weather, no income taxes, and lower property taxes. According to data from the US Census Bureau, more residents
If you live in an unfriendly tax state such as New York or California, it’s not uncommon for your retirement plans to include a move to a more tax friendly state once your working years are over. Many southern states offer nicer weather, no income taxes, and lower property taxes. According to data from the US Census Bureau, more residents left New York than any other state in the U.S. Between July 2017 and July 2018, New York lost 180,360 residents and gained only 131,726, resulting in a net loss of 48,560 residents. With 10,000 Baby Boomers turning 65 per day over the next few years, those numbers are expected to escalate as retirees continue to leave the state.
When we meet with clients to build their retirement projections, the one thing anchoring many people to their current state despite higher taxes is family. It’s not uncommon for retirees to have children and grandchildren living close by so they greatly favor the “snow bird” routine. They will often downsize their primary residence in New York and then purchase a condo or small house down in Florida so they can head south when the snow starts to fly.
The inevitable question that comes up during those meetings is “Since I have a house in Florida, how do I become a resident of Florida so I can pay less in taxes?” It’s not as easy as most people think. There are very strict rules that define where your state of domicile is for tax purposes. It’s not uncommon for states to initiate tax audit of residents that leave their state to claim domicile in another state and they split time travelling back and forth between the two states. Be aware, the state on the losing end of that equation will often do whatever it can to recoup that lost tax revenue. It’s one of those guilty until proven innocent type scenarios so taxpayers fleeing to more tax favorable states need to be well aware of the rules.
Residency vs Domicile
First, you have to understand the difference between “residency” and “domicile”. It may sound weird but you can actually be considered a “resident” of more than one state in a single tax year without an actual move taking place but for tax purposes each person only has one state of “domicile”.
Domicile is the most important. Think of domicile as your roots. If you owned 50 houses all around the world, for tax purposes, you have to identify via facts and circumstances which house is your home base. Domicile is important because regardless of where you work or earn income around the world, your state of domicile always has the right to tax all of your income regardless of where it was earned.
While each state recognizes that a taxpayer only has one state of domicile, each state has its own definition of who they considered to be a “resident” for tax purposes. If you are considered a resident of a particular state then that state has the right to tax you on any income that was earned in that state. But they are not allowed to tax income earned or received outside of their state like your state of domicile does.
States Set Their Own Residency Rules
To make the process even more fun, each state has their own criteria that defines who they considered to be a resident of their state. For example, in New York and New Jersey, they consider someone to be a resident if they maintain a home in that state for all or most of the year, and they spend at least half the year within the state (184 days). Other states use a 200 day threshold. If you happen to meet the residency requirement of more than one state in a single year, then two different states could consider you a resident and you would have to file a tax return for each state.
Domicile Is The Most Important
Your state of domicile impacts more that just your taxes. Your state of domicile dictates your asset protection rules, family law, estate laws, property tax breaks, etc. From an income tax standpoint, it’s the most powerful classification because they have right to tax your income no matter where it was earned. For example, your domicile state is New York but you worked for a multinational company and you spent a few months working in Ireland, a few months in New Jersey, and most of the year renting a house and working in Florida. You also have a rental property in Virginia and are co-owners of a business based out of Texas. Even though you did not spend a single day physically in New York during the year, they still have the right to tax all of your income that you earned throughout the year.
What Prevents Double Taxation?
So what prevents double taxation where they tax you in the state where the money is earned and then tax you again in your state of domicile? Fortunately, most states provide you with a credit for taxes paid to other states. For example, if my state of domicile is Colorado which has a 4% state income tax and I earned some wages in New York which has a 7% state income tax rate, when I file my state tax return in Colorado, I will not own any additional state taxes on those wages because Colorado provides me with a credit for the 7% tax that I already paid to New York.
It only hurts when you go the other way. Your state of domicile is New York and you earned wage in Colorado during the year. New York will credit you with the 4% in state tax that you paid to Colorado but you will still owe another 3% to New York State since they have the right to tax all of your income as your state of domicile.
Count The Number Of Days
Most people think that if they own two houses, one in New York and one in Florida, as long as they keep a log showing that they lived in Florida for more than half the year that they are free to claim Florida, the more tax favorable state, as their state of domicile. I have some bad news. It’s not that easy. The key in all of this is to take enough steps to prove that your new house is your home base. While the number of days that you spend living in the new house is a key factor, by itself, it’s usually not enough to win an audit.
That notebook or excel spreadsheet that you used to keep a paper trail of the number of days that you spent at each location, while it may be helpful, the state conducting the audit may just use the extra paper in your notebook to provide you with the long list of information that they are going to need to construct their own timeline. I’m not exaggerating when I say that they will request your credit card statement to see when and where you were spending money, freeway charges, cell phone records with GPS time and date stamps, dentist appointments, and other items that give them a clear picture of where you spent most of your time throughout the year. If you supposedly live in Florida but your dentist, doctors, country club, and newspaper subscriptions are all in New York, it’s going to be very difficult to win that audit. Remember the number of days that you spend in the state is just one factor.
Proving Your State of Domicile
There are a number of action items that you should take if it’s your intent to travel back and forth between two states during the year, and it’s your intent to claim domicile in the more favorable tax state. Here is the list of the action items that you should consider to prove domicile in your state of choice:
Register to vote and physically vote in that state
Register your car and/or boat
Establish gym memberships
Newspapers and magazine subscriptions
Update your estate document to comply with the domicile state laws
Use local doctors and dentists
File your taxes as a resident
Have mail forwarded from your “old house” to your “new house”
Part-time employment in that state
Join country clubs, social clubs, etc.
Host family gatherings in your state of domicile
Change your car insurance
Attend a house of worship in that state
Where your pets are located
Dog Saves Owner $400,000 In Taxes
Probably the most famous court case in this area of the law was the Petition of Gregory Blatt. New York was challenging Mr Blatt’s change of domicile from New York to Texas. While he had taken numerous steps to prove domicile in Texas at the end of the day it was his dog that saved him. The State of New York Division of Tax Appeals in February 2017 ruled that “his change in domicile to Dallas was complete once his dog was moved there”. Mans best friends saved him more than $400,000 in income tax that New York was after him for.
Audit Risk
When we discuss this topic people frequently ask “what are my chances of getting audited?” While some audits are completely random, from the conversations that we have had with accountants in this subject area, it would seem that the more you make, the higher the chances are of getting audited if you change your state of domicile. I guess that makes sense. If your Mr Blatt and you are paying New York State $100,000 per year in income taxes, they are probably going to miss that money when you leave enough to press you on the issue. But if all you have is a NYS pension, social security, and a few small distributions from an IRA, you might have been paying little to no income tax to New York State as it is, so the state has very little to gain by auditing you.
But one of the biggest “no no’s” is changing your state of domicile on January 1st. Yes, it makes your taxes easier because you file your taxes in your old state of domicile for last year and then you get to start fresh with your new state of domicile in the current year without having to file two state tax returns in a single year. However, it’s a beaming red audit flag. Who actually moves on New Year’s Eve? Not many people, so don’t celebrate your move by inviting a state tax audit from your old state of domicile
About Michael……...
Hi, I’m Michael Ruger. I’m the managing partner of Greenbush Financial Group and the creator of the nationally recognized Money Smart Board blog . I created the blog because there are a lot of events in life that require important financial decisions. The goal is to help our readers avoid big financial missteps, discover financial solutions that they were not aware of, and to optimize their financial future.
The Accountant Put The Owner’s Kids On Payroll And Bomb Shelled The 401(k) Plan
The higher $12,000 standard deduction for single filers has produced an incentive in some cases for business owners to put their kids on the payroll in an effort to shift income out of the owner’s high tax bracket into the children’s lower tax bracket. However, there was a non-Wojeski accountant that advised his clients not only to put his kids on the
Big Issue
The higher $15,000 standard deduction for single filers has produced an incentive in some cases for business owners to put their kids on the payroll in an effort to shift income out of the owner’s high tax bracket into the children’s lower tax bracket. However, there was a non-Wojeski accountant who advised his clients not only to put their kids on the payroll but also to have their children put all of that W2 compensation in the company’s 401(k) plan as a Roth deferral.
At first look it would seem to be a dynamite tax strategy but this strategy blew up when the company got their year end discrimination testing back for the 401(k) plan and all of the executives, including the owner, were forced to distribute their pre-tax deferrals from the plan due to failed discrimination testing. It created a huge unexpected tax liability for the owners and all of the executives, completely defeating the tax benefit of putting the kids on payroll. Not good!!
Why This Happened
If your client sponsors a 401(k) plan and they are not a “safe harbor plan”, then each year the plan is subject to “discrimination testing”. This discrimination testing is to ensure that the owners and “highly compensated employees” are not getting an unfair level of benefits in the 401(k) plan compared to the rest of the employees. They look at what each employee contributes to the plan as a percent of their total compensation for the year. For example, if you make $3,000 in employee deferrals and your W2 comp for the year is $60,000, your deferral percentage is 5%.
They run this calculation for each employee and then they separate the employees into two groups: “Highly Compensated Employees” (HCE) and “Non-Highly Compensation Employees” (NHCE). A highly compensated employee is any employee that in 2025:
is a 5% or more owner, or
Makes $160,000 or more in compensation
They put the employees in their two groups and take an average of each group. In most cases, the HCE’s average cannot be more than 2% higher than the NHCE average. If it is, then the HCE’s get pre-tax money kicked back to them out of the 401(k) plan that they have to pay tax on. It really ticks off the HCE’s when this happens because it’s an unexpected tax bill.
Little Known Attribution Rule
ATTRIBUTION RULE: Even though a child of an owner may not be a 5%+ owner or make more than $160,000 in compensation, they are automatically considered an HCE because they are related to the owner of the business. So in the case that I referred above, the accountant had the client pay the child $14,000 and defer $14,000 into the 401(k) plan as a Roth deferral making their deferral percentage 100% of compensation. That brought the average for the HCE way way up and caused the plan fail testing.
To make matters worse, when 401(k) refunds happen to the HCE’s they do not go back to the person that deferred the highest PERCENTAGE of pay, they go to the person that deferred the largest DOLLAR AMOUNT which was the owner and the other HCE’s that deferred over $18,000 in the plan each.
How To Avoid This Mistake
Before advising a client to put their children on payroll and having them defer that money into the 401(k) plan, ask them these questions:
Does your company sponsor a 401(k) plan?
If yes, is your plan a “safe harbor 401(k) plan?
If the company sponsors a 401(k) plan AND it’s a safe harbor plan, you are in the clear with using this strategy because there is no discrimination testing for the employee deferrals.
If the company sponsors a 401(k) plan AND it’s NOT a safe harbor plan, STOP!! The client should either consult with the TPA (third party administrator) of their 401(k) plan to determine how their kids deferring into the plan will impact testing or put the kids on payroll but make sure they don’t contribute to the plan.
Side note, if the company sponsors a Simple IRA, you don’t have to worry about this issue because Simple IRA’s do not have discrimination testing. The children can defer into the retirement plan without causing any issues for the rest of the HCE’s.
About Michael……...
Hi, I’m Michael Ruger. I’m the managing partner of Greenbush Financial Group and the creator of the nationally recognized Money Smart Board blog . I created the blog because there are a lot of events in life that require important financial decisions. The goal is to help our readers avoid big financial missteps, discover financial solutions that they were not aware of, and to optimize their financial future.
