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Category: TAX : General

What is IRA?

IRA stands for Individual retirement Account. Mainly there are 7 types of IRA and these are.

• Traditional IRA.
• Roth IRA
• SEP IRA
• Non-Deductible IRA
• Spousal IRA
• Simple IRA
• Self-Directed IRA

Traditional IRA

The traditional IRA remains the most popular of the individual tax-advantaged retirement savings accounts. Key features include:

• An upfront tax break of up to $6,000 in 2020 and 2021, plus an extra $1,000 catch-up contribution if you're age 50 or older: Contributions may be deductible, thus lowering your taxable income for the year. It all depends on your current income plus whether you or your spouse has a workplace retirement plan.
• Investment earnings are not taxed as long as the money remains in the protection of the account.
• Withdrawals in retirement are taxed at your tax rate at that time.

Best for: Those who are in a higher tax bracket now than they think they’ll be in during retirement, as well as workers who do not have access to (or are not eligible to contribute to) a workplace-sponsored retirement plan. 

Roth IRA

The Roth IRA provides a nice tax-saving counterbalance to the traditional IRA. Key features:

• While contributions are not deductible — meaning there’s no upfront tax break — withdrawals in retirement are completely tax-free.
• The maximum annual contribution is $6,000 ($7,000 if age 50+). Eligibility to contribute to a Roth is based on your income, but if you earn too much to contribute, there’s a completely legal way to open one anyway via a backdoor Roth.
• Roth IRA withdrawal rules are more lenient, allowing tax- and penalty-free withdrawals of contributions at any time. Taxes and penalties apply to withdrawing earnings before retirement, with a few exceptions.

Best for: Savers who anticipate being in a higher tax bracket in retirement, to take advantage of those tax-free withdrawals. A Roth is also a better choice than a traditional IRA if you might need to access some of the money before retirement age, although we discourage dipping into retirement savings early. Interest piqued? Here’s a rundown of the best Roth IRA accounts.

SEP IRA

Simplified employee pension IRA. Even though it’s a type of traditional IRA, it is set up and funded for employees by an employer, who gets tax benefits for the effort. Within a SEP IRA, earnings grow tax-free and distributions in retirement are taxed. Other highlights:

• Annual contribution limits are much higher than what’s allowed in other tax-favored retirement accounts — the lesser of up to 25% of employee compensation or $57,000 in 2020 and $58,000 in 2021. (See this IRS.gov page for more information.)
• An employer must contribute equally (on a percentage basis of salary) to all employee accounts, including their own.
• Contribution size may vary year to year based on the business’s cash flow but must always be equal for all eligible workers.
• Employees are not allowed to contribute to the plan via salary deferral; must have worked for the employer in at least three of the last five years; and must have earned at least $600 in compensation during the year to be eligible.
• Sole proprietors (aka Employee No. 1 and only) can open a SEP IRA for themselves.
• Catch-up contributions for workers 50 and older are not allowed.

Best for: Small-business owners who want to avoid the startup and operating costs of a conventional retirement plan, as well as the ability to supersize their retirement stash and get a tax deduction on any contributions made for employees. Just be aware that if you’re both the employer and employee, it’s important to follow SEP IRA rules to avoid running afoul of the IRS.

Non-Deductible IRA

A traditional IRA may be tax deductible or may not be a tax deductible? If you (or your spouse) has a retirement plan at work and your income exceeds the IRA income limits, then you may not be able to deduct your traditional IRA contributions. But you can still put money into the IRA. The main things to know about a nondeductible IRA:

• Contributions are made with after-tax dollars and, as the name makes clear, are not deductible. But ...
• You still get the perk of tax-deferred growth on earnings within the account.
• Taxes in retirement are due on any earnings growth you withdraw, but not the principal, since the account was funded with already taxed dollars.

Best for: Those who don't qualify to contribute to a Roth IRA or a deductible IRA and later convert this to Roth via back door Roth IRA 

Spousal IRA

IRS rules state that a person must have earned income to be eligible to contribute to an IRA. But there’s a workaround for married taxpayers: If one half of the twosome isn’t working — or brings in a very low income — you still can both contribute to your own separate IRAs (either Roth or traditional).

• Couples must file a joint tax return and have taxable compensation to be eligible.
• Contribution limits are the same as for a traditional or Roth IRA: the nonworking spouse can contribute up to $6,000, or $7,000 for those 50 or older, in 2020 and 2021. The working spouse can contribute the same amount to his or her own IRA.
• The total amount contributed to both IRAs must be the lesser of your joint taxable income or double the annual IRA contribution limit (e.g., $12,000 for those under 50).
• The account can be funded with money from either spouse’s earnings but must be opened in the nonworking spouse’s name using his or her Social Security number.

Best for: Low-income or non working individuals married to someone who has earned income.

Simple IRA

The SIMPLE IRA (Savings Incentive Match Plan for Employees) is similar in many ways to an employer-sponsored 401(k). It primarily exists for small companies and the self-employed. Unlike the SEP IRA, employees are allowed to contribute to the account via salary deferral. Some plans even allow an employee to select the financial institution they want to use to hold their account. Tax-wise, SIMPLE IRA rules are much like those that apply to traditional IRAs. Other considerations:

• Contribution limits are lower than for 401(k)s — $13,500 versus $19,500 in 2020 and 2021.
• Employers are generally required to kick in up to a 3% matching contribution or a fixed contribution of 2% of each eligible employee’s compensation.
• To qualify to participate in a SIMPLE IRA, an employee must have earned at least $5,000 during any two years before the current calendar year and expect to receive at least that amount in the current year.
• Unlike the SEP, catch-up contributions are allowed: If you’re 50 or older, you can save an additional $3,000.
• Unlike most workplace plans, participants can roll the money from the account into a traditional IRA after two years of participation in the SIMPLE IRA plan.
• Early withdrawals from a SIMPLE IRA within the first two years of contributing to the account may be subject to a punishing 25% penalty (on top of regular income taxes).

Best for: Smaller companies with fewer than 100 employees. If you’re self-employed, you may be better off opening a SEP IRA for the higher contribution limits.

Self -Directed IRA

Self-directed IRAs (in the traditional and Roth flavors) are governed by the same eligibility and contribution rules as traditional and Roth IRAs except for one big difference: What goes in the account.

The other IRAs covered in this article typically limit investments in the account to common vehicles like stocks, bonds and mutual funds. In a self-directed IRA, you’re allowed to own assets such as real estate, hard assets like gold and privately held companies. Some must-knows:

• Setting one up requires a trustee or custodian who specializes in the less typical types of investments you’re interested in holding in the account.
• The IRS does not allow holding things like collectibles and life insurance in the account.
• There are many prohibited “self-dealing” transactions within a self-directed IRA (e.g., mowing the lawn or fixing the faucet in a rental property owned in the IRA) that the IRS deems equivalent to taking a distribution. These can trigger taxes and penalties on the entire account.

Best for: Experienced investors who want access to alternative investments such as real estate and nontraditional businesses. While there are benefits to using this type of account to save for retirement (mostly the potential for higher returns), do not pass go until understanding the risks of self-directed IRAs.

Traditional IRA vs. Roth IRA

Mainly for a salaried employee, there are two types of IRA (1) Traditional IRA and (2) Roth IRA. What are differences? Traditional IRA vs. Roth IRA, based on fact an example.

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Category: TAX : General

1. In gift tax, there are two threshold limit (1) Annual exclusion, (2) Lifetime exclusion.
2. For financial year 2020, the annual exclusion is $15,000. The taxpayer can make a gift up to $15,000 to a recipient without attracting the gift tax reporting requirement. The annual exclusion limit is $15,000 per recipient and per year. This means the taxpayer can make an N number of gifts to N number of recipients. Once the taxpayer gift is more than $15,000, then the taxpayer needs to file gift tax return Form 709. There are certain exclusions from gift tax.
3. The excess amount that is value of gift - $15,000 will be reduced from the lifetime exclusion (refer below chart).
4. Once the value of the gift exceeds the lifetime exclusion, then the taxpayer needs to pay tax as per gift tax slab (refer below chart).
5. The gift tax return is individual return that means, even though married couple filing a joint return, need to file two individual gift tax return.
6. The above concept holds good for federal tax, while a few states treat gift differently and tax. State gift tax is an addition to federal gift tax.
7. Contribution to a 529 college savings plan is also treated a gift. However, as of Financial Year 2020, the lump sum contribution to 529 plans can be spread over five years to calculate annual exclusion.
8. The gift tax filing date is 15^th of July of the subsequent year of the gift.

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Category: TAX : General

By now you must have a good idea on the Roth IRA. Mainly the benefits of Roth IRA are

1. Tax-Free Growth: The main benefit of a Roth IRA is that investments grow tax free within Roth. However, you do need to meet a few conditions to receive the investment growth income tax free. First, you need to have had a Roth IRA in existence for at least five years. Second, for a tax-free and penalty-free distribution of investment gains, one of the following conditions needs to be met: reach age 59.5, death, disability, or $10,000 of qualified first time home-buying expenses.
2. Access to Funds: The easy access you have to your own contributions to the Roth IRA. For instance, if you put $5,000 dollars into a Roth IRA, invest it in stocks, and the value grows to $10,000, you can still withdraw your initial investment of $5,000 at any time without paying income taxes or penalties. This is because Roth IRA withdrawals allow you to withdraw your contributions first before having to tap into any of the investment gains.
3. Lower Taxes in Retirement: Roth IRAs also offer great tax savings in retirement. Because Roth IRA withdrawals of both contributions and investment gains are income tax free. IRA distribution does not increase a retiree’s tax liability, tax rate, Medicare premiums, or Social Security taxes.
4. No RMDs: Roth IRA account balance is not subjected to required minimum distributions after the owner of the account reaches age 70.5. Most other retirement accounts, like the 401(k) and traditional IRAs, are subject to required minimum distributions. A Roth IRA means that seniors have more control over when they spend their money, and are not forced to take withdrawals. This also allows the money to remain invested and to continue to grow in a tax-free vehicle for a longer period of time.

However, Roth IRAs have a income restriction that restricts high income bracket to contribute to Roth IRA.

See here the income limit for Roth IRA contribution.

But there is a way to enjoy benefits of Roth IRA, called "Backdoor Roth IRA".

A backdoor Roth IRA is a convenient loophole that allows high-income individuals to enjoy all the tax benefits that a Roth IRA has to offer by converting Traditional IRA to Roth IRA.

Traditional IRA comes with deduction limit, while Roth IRA comes with contribution limit. Keep in mind, in any given year the combines contribution to all IRA should not exceed below limits.

With a backdoor Roth, you basically start with a traditional IRA, transfer it to a Roth IRA. In this case, taxpayers must pay tax on the deductible portion of the traditional IRA, then let investments grow tax-free and take advantage of tax-free withdrawals later. It’s that simple and it’s perfectly legal.

How to Create a Backdoor Roth IRA?

You might feel intimidated by the idea of making a backdoor Roth IRA, but the truth is that it's really not that difficult to put in place. Convert a traditional IRA to an IRA Roth in a few simple steps:

Phase 1: Invest in a traditional IRA.

As you are aware, there are no income restrictions for a traditional IRA, which means that anyone can open a traditional IRA to contribute to it. However, you can deduct for AGI up to certain limits.

Look up the deduction limit here.

If you want to open a transaction IRA with E-Trade click here.

Step 2: Convert the traditional IRA into a Roth IRA.

Once you have invested money into your traditional IRA, the next thing you need to do is convert these funds into a Roth IRA. This can be accomplished in three ways:

• Rollover: In this scenario, you will receive a check from your IRA provider and you must deposit this money into a Roth account within 60 days. Doing a backdoor Roth this way is risky, because if you forget to deposit that money for whatever reason, you’ll have to pay a withdrawal penalty on top of the taxes you owe. My recommendation would be to do one of the following transfers.
• Trustee-to-trustee transfer: If you have your traditional and Roth IRAs at different financial institutions (or want to open a new Roth account at a different institution), you can steer the institution that holds your traditional IRA to transfer the money to the Roth at the other institution.
• Same-trustee transfer: Have your IRAs with the same financial institution? Fantastic! Simply ask your financial institution to transfer money from your traditional IRA into your Roth account.

There are no restrictions on how much you can convert to a Roth IRA.  The transfer from the traditional IRA to the Roth IRA is considered a conversion, but not a contribution, therefore the contribution limit is not applicable.

Step 3: Pay the taxes you owe on the money you invested.

Since the contribution traditional IRA is tax deductible, the taxpayer need to pay tax on such conversion. Note that taxpayer need to pay only on the deductible portion of traditional IRA + income there on.

So if you put $6,000 into a traditional IRA and want to convert that into a Roth IRA, you’ll have to pay taxes on that $6,000. On top of that, you’ll have to pay taxes on whatever money your investments earned between the time you invested inside the traditional IRA and when you convert it to a Roth.

And heads up! The money you’re converting will probably count as income for the year and—depending on how much you earn and how much money you’re converting—that might bump you into a higher bracket for the year.

I can’t stress this enough: You should only do a backdoor Roth IRA if you have the cash on hand to pay the taxes you owe without taking money out of the traditional IRA itself. That would just undercut your future gains and that defeats the purpose of the conversion in the first place.

Step 4: Repeat the process every year and enjoy tax-free growth!

Repeat this process and benefit from the beauty of IRA Roth.

Transfer from one IRA to another IRA doesn’t attract penalty. Refer exception to early distribution.

Thanks, Surya Padhi. Contact Me, if you need more information.

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Category: TAX : General

Taxpayer sometimes worries that HSA might make their taxes excessively complicated.

There's no "one-size-fits-all" when it comes to taxes, but contributing to an HSA is not going to add much complexity to your tax situation. 

To start with, the reporting requirement of HAS covers four forms.

1. Form 5498-SA: 

   Form 5498-SA reports regular and rollover contributions on health savings accounts (HSAs), Archer Medical Savings Accounts (MSAs), and Medicare Advantage MSAs (MA MSAs) as well as the fair market value of an HSA, Archer MSA, or MA MSA at the end of 2019.

   Form 5498-SA is for informational purposes only; you do not need to file it with your tax return.7

   The W-2 you receive from your employer in January should match Form 5498-SA unless you made contributions outside of your employer or between January 1,2021, and April 15, 2021, for the 2020 tax year. Note: After-tax contributions will not appear on your W-2, but will be reflected on Form 5498-SA.

2. Form 1099-SA: Form 1099-SA is an IRS form issued by the HSA custodian to the HSA account beneficiary. This form provides withdrawal from the HSA account.
3. Form 8889: Form 8889, the taxpayer need to file along with Form 1040. This form comes with three parts. Part I is where the taxpayer reports contributions to the taxpayer’s HAS. Part II is where taxpayer report distributions (withdrawals) out of HAS. Part III is where the taxpayer will report Income and Additional Tax for Failure to Maintain HDHP Coverage. Form 8889 is a very simple form. Here are some of filing tips of the form 8889. Line 2 – Enter here the HSA contributions that the taxpayer made directly to an HSA (outside of your employer's payroll system). Line 9 – Enter taxpayer HSA contributions are deducted from taxpayer’s paycheck plus taxpayer’s employer contributes on behalf of taxpayers. Line 10 – Report here IRA to HAS rollover (The taxpayer can do this once in a lifetime. Line 14a: Enter here HAS distribution that taxpayers received from HAS. Line 15: Enter here qualified medical expenses paid by using HAS. Line 16: Line 14c – Line 15, taxable HAS distribution. Line 17: If the Taxpayer is under 65 and line 16 is greater than 0, then taxpayer need to pay a penalty, which is 20% of line 16. 

4. Form W-2

   Box 12 of your W-2 shows your HSA contributions made by pre-tax payroll deduction, if applicable, and by your employer (labeled “employer contributions” and marked with code "W”). Enter the amount from Box 12 on your W-2 on line 9 on Form 8889.

   If your HSA payroll deductions were taken pre-tax. they’re considered “employer contributions" and shown in Box 12 on your W-2. You cannot claim pre-tax payroll deductions as a deduction on line 13 on Form 8889.

   If you made any after-tax contributions to your HSA in 2020, enter this amount on line 2 on Form 8889. Note: After-tax contributions will not appear on your W-2. You may be able to claim a deduction for these contributions on line 13. See instructions for Form 8889 for more information.

5. Form 1040: Form 1040 is your tax return. This is a two-page form with many addenda. The contribution you mentioned in Form 8889 flow to Schedule 1 line # 12 and then sum of part II appear in  Form 1040 line # 10a.

Thanks, Surya Padhi. Contact Me,if you need more information.