Personal Banking E-Newsletter - March 2013

Smart Ways to Spend Your Tax Refund

Despite the late start to this year’s tax season, refund checks are already rolling in. About 75% of taxpayers are expected to receive refunds this year, according to estimates from the Internal Revenue Service, with the average check coming out to about $3,000. And as this winter windfall arrives, Americans wrestle with competing desires to spend, save, or invest the cash.

Many people say they are being responsible with their refunds: 42% plan to use the money to pay down debt and cover bills and 25% plan to save it, according to a 2012 survey by TurboTax. Others are splurging: 15% of taxpayers plan to treat themselves to a vacation or shopping. But advisers say that even if you’ve done everything right—you have an emergency fund, no debt and are maxing out your retirement account contributions—you might want to reconsider spending the refund on a 70-inch TV or a cruise. Here are some of their suggestions.

Rebalance your portfolio
With the stock market hovering near five-year highs, advisers normally would recommend investors rebalance their portfolios by selling stocks and using the proceeds to buy bonds or whatever assets they need to get back to their target allocations. But some investors might be able to rebalance without selling their stocks — if they use their refund money to build up their exposure in those areas, says Steve Billimack, managing director at the HighTower Chicago Advisory Group. “And it’s a very tax efficient way to do it because they’re not selling anything to rebalance,” says Billimack. (Investors typically need to pay taxes when they sell assets that have risen in value.)

Prepay your bills
Even if you’re not living paycheck to paycheck and could afford to spend your refund on a new iPad without falling behind on your bills, there may be better uses for the cash. Though it’s not nearly as exciting, one can use the money to pay off future bills, says Jon Beyrer, a financial planner in San Diego with Blankinship & Foster. “Why not use this money to put yourself ahead of the game?” says Beyrer. Prepay six months of car insurance bills or car loan payments. Write the phone company a large check, or save the money for the home insurance bill you know is coming up in a few months, he says. But don’t forget to check monthly statements to be sure you aren’t paying for something you didn’t request, experts say.

Make home improvements
“If you’re going to spend it, take a look at your house,” says Mike Blehar, managing director and principal at Fort Pitt Capital Group. “What have you been putting off?” If your furnace is on its last leg, now may be your chance to replace it, he says. Have you wanted to install new windows? Using the money on your home could lift your property value and prevent future damage, advisers say. People who make energy-efficient improvements might also qualify for a residential energy tax credits expiring at the end of this year, says Blehar. To get the maximum credit of $500, taxpayers need to make $5,000 in qualifying improvements to their stoves, heating or air conditioning systems, insulation, roofs, water heaters and windows and doors.

Buy a car
If the list of needed car repairs is piling up, some advisers say it might be best to put your check toward a new ride. A $3,000 refund can cover the typical 10% down payment needed on a $30,000 loan for a new car and the 20% down payment needed on a $15,000 used car.


6 Ways to Avoid an Audit

While the government has cracked down in recent years on wealthy Americans stashing millions in offshore accounts, tax pros say it isn’t just the high rollers who might merit a double take from the IRS.

The total number of audits conducted over the mail for people earning more than $200,000 increased by 13% in 2012 from the year before, to 109,318, according to the IRS. Some taxpayers can get flagged for an audit if they make mistakes that cause the agency to question whether they’re reporting all of their income — from forgetting to report even small amounts of income to paying taxes for your babysitter.

To be sure, you can typically stay in the clear if you report your income honestly and maintain proper documentation, tax pros say. And overall, the probability of being audited is still low — the IRS audited less than 1% of taxpayers last year. Still, there are a few steps taxpayers can take to help keep their chances to a bare minimum.

Don’t boast on Twitter
In addition to scouring public records like motor vehicle and employment documents to confirm if a taxpayer has moved to another state or landed a promotion, the taxman also uses more modern tools to help them find tax dodgers: Facebook and Twitter. For several years, state tax officials have used social media accounts to track down people’s whereabouts and to look for signs that some people are lying about how much they make. For the most part, however, the IRS says audit decisions are based on the information a taxpayer uses on the tax return, not on postings on social media sites. And tax agents are not allowed to deceive people or use fake profiles to obtain information. But details uncovered on business websites, for instance, are not off limits. Authorities may go after a taxpayer who claims they’re struggling financially in order to reduce taxes owed, but then boasts online that business is booming, experts say. 

List all of your income
Not reporting all the income listed on 1099 forms, says Robert Wood, a tax attorney in San Francisco, invites an audit from the IRS. The IRS has matching software that can help it catch any income that was reported under your Social Security number but that wasn’t listed on your tax return. That includes investment income, payments for freelance work, and interest earned on a bank account. “They will match it no matter how small it is,” says Wood. Being flagged for underreported income could open the door for the IRS to scrutinize other parts of your return, including deductions and credits claimed, says Bill Smith, managing director of CBIZ MHM’s National Tax Office, a consulting firm that helps individuals and businesses with their taxes. You could also be charged late-payment penalties on any taxes owed, says Smith.

Don’t mix business with pleasure
The IRS keeps a close eye on income and deductions reported by self-employed taxpayers since much of the tax gap — the difference between the amount of tax owed and what’s actually paid — is due to misreporting on the Schedule C, the tax form self-employed workers use to report income. If you are self-employed and going to claim business deductions for travel expenses, keep a log of trips made to visit clients so that you can distinguish personal travel costs from those incurred for work. And while the IRS recently introduced a simpler method for claiming the home-office deduction, taxpayers still need to show that the space is used exclusively and often for work, in accordance with IRS rules. “You can’t have a family room that doubles as your office,” says Benson Goldstein, senior technical manager on the tax staff for the American Institute of Certified Public Accountants.

Be careful when claiming a hobby loss
The recent tax court ruling against former NFL linebacker Bill Romanowski affirming that he and his wife owe $4.75 million in back taxes from deductions related to horse-breeding expenses brings attention to a key requirement many taxpayers may forget when they try to claim losses on a hobby: Taxpayers need to show they’re going into the hobby with the intention of making a profit. If they keep striking out, they should show that they are changing their methods to improve their chances of making money, or at least show that the activity has made a profit in the past, according to IRS rules. “Your behavior has to be in line with somebody who is trying to make a go of it,” says Anthony Parent, a tax resolution attorney with IRS Medic. Otherwise, the IRS may suspect you’re investing in the hobby solely with the purpose of creating a loss that could be used to deduct taxes owed, he says.

Pay your nanny or babysitter taxes
People hired to do work around the house, such as nannies, babysitters, and gardeners, need to be reported properly to the IRS, and families may need to pay Social Security and Medicare taxes and withhold the worker’s share of those taxes just like any other employer, experts say. The rules apply to any one household worker paid at least $1,800 this year. Parents, children, spouses and employees under the age of 18 don’t count. Not doing so could lead to thousands of dollars in back taxes and penalties, and families could be charged with tax evasion, says Stephanie Breedlove, a partner at Breedlove and Associates, a firm that helps families handle payroll taxes and labor law. Families have a greater chance of being audited if they incorrectly list a household worker on the payroll of a small business they own, says Breedlove. While that may seem like a simpler way to pay the appropriate taxes for the worker, taxpayers could be exaggerating the number of small-business credits and deductions they’re entitled to, says Breedlove.

Double check your math
The IRS caught more than 6 million math errors on tax returns in 2010, according to the most recent data available. Taxpayers commonly make mistakes on how big their deductions are, how much they owe and how large their refunds should be, tax pros say. Filing electronically may help people catch some of these errors, but experts say taxpayers should pause to make sure they’re claiming the appropriate amount of deductions. The IRS may flag your return if the deductions you claim seem out of line for your income, says Goldstein. It also helps to use exact numbers, since rounding may give the IRS reason to request more documentation, experts say.


Five Biggest Mistakes Not to Make on Beneficiary Forms

For many retirees, individual retirement accounts are their single largest asset, a financial war chest meant to supplement their income during their lifetime and provide for their heirs once they're gone.

Yet, all too often IRA owners commit costly errors on their beneficiary form that negate their best intentions, leaving loved ones out in the cold.

From failing to update their document after a divorce, to forgetting to name a beneficiary, such financial fumbles can force future generations to surrender too much to Uncle Sam -- or worse, deny them their rightful inheritance.

"It happens more often than you'd think," says Certified Financial Planner professional Joel Larsen, a principal with Navion Financial Advisors in Davis, Calif. "Otherwise capable and intelligent people don't always do proper estate planning because they don't want to address their own mortality."

Outdated Forms
Perhaps the most common mistake when it comes to designating an IRA beneficiary is forgetting to update your beneficiary form after you divorce or remarry, or when the person you intended to pass your assets to passes away before you.

Your beneficiary form should be reviewed and updated after every life event, says Neil Brown, CFP professional and CPA with Burkett Financial Services in West Columbia, S.C. Updating your will is not enough.

"The IRA beneficiary form overrides your will," says Brown.

Indeed, if you get remarried and change your will, but forget to amend your IRA, the person named on your IRA beneficiary form (most likely your ex) would be legally entitled to your assets when you die -- and, thus, able to pass that money along to any children he or she had from other marriages.

"Retirees can very easily leave their IRA to someone not within their wishes, or leave it to someone within their wishes, but with very negative tax consequences," says Brown, noting many of his clients have insisted that their beneficiary forms are "taken care of" only to discover on closer inspection that their ex-spouse was still named as sole beneficiary.

Naming Your Estate
This is the biggest blunder of all. Those who name their estate as their IRA beneficiary, or who inadvertently do so by failing to select a beneficiary, deprive their heirs of a significant growth opportunity.

Normally, nonspouse beneficiaries who inherit a traditional IRA can choose between two options: Either liquidate and pay taxes on those assets within five years of the owner's death, or "stretch" their required minimum distributions out over their lifetime.

"Too many people do not understand the significance of a beneficiary form and leave them blank or name their estate," says Brown. "This is a complete mistake because it limits the beneficiaries' ability to stretch the IRA after the owner's death. It speeds up the income taxes on the distributions as well and can amount to hundreds of thousands of lost growth potential."

Another negative to not naming an IRA beneficiary: The probate court would consider that asset to be part of your estate after you die, and thus it would be subject to any creditors.

If that's not enough, your IRA would also not be distributable to your heirs until the probate process concludes, which can take more than a year. Do your family a favor and be sure you've named an actual person as your beneficiary, not your estate.

No Financial Controls
Another IRA no-no is naming your child as sole beneficiary without establishing controls, especially if he/she lacks financial sophistication. After you die, the money in your account belongs to your beneficiary. She can spend it however she likes -- on a college education, a down payment on a house, or at a tattoo parlor in Tennessee.

So Much for Tax-Deferred Growth. If a loss of control concerns you, you might consider naming a trust as beneficiary instead, says Brown. A trust enables you to stipulate how much your beneficiaries will receive and how often.

"If you are going to leave it to someone who you fear is going to just blow it, a trust gives you control provisions," says Brown, noting such documents must be handled by an estate lawyer to avoid future legal entanglement. "The language might stipulate that the income can only be distributed out for health, education, support or maintenance purposes."

That said, trusts can be pricey to maintain, with many corporate and bank trustees charging 1% to 2% of the IRA's value per year.

Estate attorney Bill Dendy, president of Elite Financial Management in Dallas, advises clients to check first with the custodian or insurance company to see if they offer "restrictive beneficiary endorsements" on their IRA or annuity products.

Such endorsements provide "earnings only" to beneficiaries on an annual basis, which preserves the principal.

"This is simple and low-cost compared to a trust," says Dendy.

Forgetting to Name a Guardian
Parents who wish to leave their IRA to an underage child also frequently forget to select a guardian, with potentially disastrous effects.

If you die before your child reaches adulthood, the court will appoint a guardian for you to oversee those assets until he or she reaches the age of majority. It might not be the person you would choose.

"Naming a minor child is a problem," says Larsen. "If you are divorced, guess who the courts will name? The estranged spouse." When choosing a minor child as a beneficiary, he notes, consider how you want that money controlled and select your own trustee or guardian.

The Form is MIA
You did everything right: named a beneficiary, kept your forms current and created a trust to rein in reckless spending. But you didn't tell your loved ones where to find the paperwork. Even the most bulletproof beneficiary form won't help your heirs if they can't track it down after you pass away.

And don't assume that your bank or brokerage firm has a copy. Amid the flurry of mergers and acquisitions in the financial services industry, there's no guarantee they'll be able to produce the document when it matters most. Better to retain your own record, says Larsen.

Without an IRA beneficiary form, the courts have no choice but to subject your heirs to the faster payout schedule, causing them to miss out on the tax-deferred stretch IRA.

Get a copy of your beneficiary form from your IRA custodian, keep it in a secure location (fireproof safe at home, deposit box at the bank or scanned file) and tell your beneficiaries where it is.

This is also a good time to review your wishes for the account -- explaining to your children and grandchildren how you'd like their inheritance used, and the benefits of stretching out their distributions versus liquidating the account, says Brown.

To prevent other unforeseen mishaps, have your IRA beneficiary form reviewed by a professional to be sure it reflects your wishes and adheres to federal and state law. If you live in a community property state, for example, you can't name someone other than your spouse as a primary beneficiary without obtaining a notarized release from the spouse.

"So often people don't go back and look at their financial paperwork," says Larsen. "Financial planning is not an event. It's a process."


Eight Tax Breaks for Homeowners

Taxes are due April 15, which means it’s time to start gathering your W2s, 1099s, child care receipts and bank statements.

But before you sit down with your accountant, it’s important for you to know that merely owning a home could mean you qualify for tax breaks. In most cases, you need to itemize your taxes in order to take advantage of these deductions. Yes, it makes the tax-filing process seem impenetrable, but the benefits may outweigh the complications.

Here are a few of the tax breaks you’ll want to investigate:

Mortgage interest paid at settlement
Take a look at your closing statement; one item that’s generally listed there is home mortgage interest. On a mortgage of up to $1 million, you can deduct the interest that you pay at settlement if you itemize your deductions on Schedule A (Form 1040). This amount should be included in the mortgage interest statement provided by your lender.

Did you pay points in order to obtain your home mortgage? These fees are included on the income tax deductions list and can be deducted as long as they are associated with the purchase of a home. If you refinanced your home, these points are still deductible, but it must be done over the life of the mortgage.

Property taxes
As long as they are based on the assessed value of the real property, you can deduct your state and local property taxes. However, if your money is being held in escrow for the purpose of paying property taxes, you cannot claim this deduction until the money is actually taken out of escrow and paid. If you do this, check your Form 1098 for the amount you may deduct. Be aware that if you receive a partial refund of your property tax, the amount of the deduction you can claim will be reduced.

Selling costs
If you sold a home in the past year, you may be able to reduce your income tax by the amount of your selling costs. These costs can include things such as repairs, title insurance, advertising expenses and broker’s fees. The IRS only allows the deduction of repair costs associated with selling if the repairs were made within 90 days of the sale. It’s also crucial that the repairs were made with the intent of improving your home’s marketability. Selling costs are deducted from your gain on the sale.

Home office
If you use a portion of your home exclusively for the purpose of an office for your small business, you may be able to claim a deduction on your taxes for costs related to insurance, repairs and depreciation. You may only claim this deduction if the space within your home is used exclusively and regularly as either your principal place of business or a place where you meet and deal with customers or patients. You may also be able to take advantage of this deduction if a portion of your home routinely is used for storing items (product samples, inventory, etc.) used in your business.

In tax year 2010 (the most recent year for which figures are available) nearly 3.4 million taxpayers claimed the home office deduction.

Mortgage insurance premiums
You may be able to deduct the premiums paid for private mortgage insurance for your principal residence and for a non-rental second home.

The deduction begins to phase out once your adjusted gross income reaches $100,000 ($50,000 for married filing separately). In general, you can deduct the premiums paid for the current tax year only. A qualified tax adviser can provide information about rules for mortgage insurance provided by the Federal Housing Administration, Department of Veterans Affairs and Rural Housing Service.

Home improvement loan interest
If you’ve taken out a loan to make improvements on your home, you may be able to deduct the interest on this loan. Qualifying loans are those taken out to add “capital improvements” to your home, meaning the improvement must increase your home’s value, adapt it to new uses or extend its life. New carpeting or painting are not considered capital improvements, while adding a garage, installing a water heater or building a deck are all examples of capital improvements.

Construction loan interest
If you take out a construction loan to build a home, you may qualify to deduct the interest. The IRS only allows a deduction for mortgage interest if the loan relates to a “qualified” home, which means it must either be your principal residence or a vacation home that you will use for personal purposes. You can only use this deduction for the first 24 months of the loan, even if the actual construction takes longer.

Tax codes can be confusing. You may want to consult the IRS website for information concerning deductions and credits. Additionally, consider meeting with a professional to ensure you’re not missing any deductions for which you’re eligible.


The Benefits of an IRA

Have you forgotten your IRA? If you don't have one, should it be part of your overall investment plan? Here are some compelling reasons why this vehicle can help you plan for your future.

  1. Tax deferral: Traditional IRAs allow your investment earnings to grow tax deferred until withdrawn, typically at retirement. For 2012, the maximum contribution is $5,000, but for those aged 50 and over, the limit is $6,000.

  2. Deductibility: If you are a single taxpayer who doesn't participate in an employer-sponsored plan and you earn less than an amount set each year by the IRS, you can deduct your contributions to a traditional IRA off your income taxes. Note that Roth IRA contributions are not deductible.

  3. Investment flexibility: IRAs typically give investors access to a wider range of investment options than workplace-sponsored plans such as a 401(k). Depending on the financial institution you use to open your account, you can invest in a broad array of mutual funds, ETFs, individual stocks and bonds, CDs, annuities, even commodities and real estate.

  4. Convertibility: Traditional IRA holders can convert to a Roth IRA to enjoy some of the additional benefits listed below. But before you decide make a switch, be sure to investigate the tax consequences of such a move.

  5. Portability: If you have assets in an employer-sponsored plan and you leave your job, you can easily roll over those assets into an IRA. Rolling over your assets can make sense particularly if you change jobs frequently and don't want to devote too much time to coordinating and tracking your accounts.

Additional Benefits of Roth IRAs

  • Qualified tax-free withdrawals: Since Roth IRAs are funded with after-tax dollars, your withdrawals are tax free, as long as you have held the account for at least five years and are over age 59 1/2.

  • No RMDs: Unlike traditional IRAs, Roth IRAs are not subject to required minimum distributions (RMDs) once the accountholder reaches age 70 1/2.

Contact your financial professional to discuss a strategy for your IRA or to see if investing in an IRA makes sense for you. Withdrawals made prior to age 59 ½ are subject to 10% IRS penalty tax. (In the case of a Roth, it must be held five years as well.) Gains from tax-deferred investments are taxable as ordinary income upon withdrawal.

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