As Disney’s live-action The Lion King plays in theaters all around the world, we are reminded of the fable’s signature song, “The Circle of Life.” Taxes are certainly a part of our lives at the beginning and at the end of life. Contemplating this truism, I thought I’d share six (6) tax considerations for those who have welcomed a newborn in 2019, as well as six (6) tax considerations for those who may have regrettably lost a loved one.
The Circle of Life Starts with Birth…
- Obtain a Social Security Number ASAP
Apply for a Social Security card and birth certificate simultaneously for your new bundle of joy while at the hospital. It is much easier than having to apply later with the Social Security Administration. With a Social Security number, you can now start certain tax-free savings plans in the child’s name and name them as beneficiaries on certain insurance, IRA and 401(k) accounts.
- Qualifying for the Child Tax Credit
No matter what day of the year your child is born (even if born on New Year's Eve), you will be eligible for a full $2,000 tax credit provided your modified adjusted gross income is less than $400,000 for married couples filing jointly or $200,000 for other filers. Beyond these levels of income, the credit begins to phase-out.
- Re-visit your Paycheck Withholding
If one parent will stop working after having a child, consider reducing the income tax withholding from the working spouse's paycheck to see an increase in net take-home pay throughout the year, rather than waiting for an income tax refund in April.
- Start Saving for College with a Section 529 Plan
As we know, time flies and children grow up fast. Contributing now to a 529 plan is a great way to save for your baby's future college costs. And, beginning in 2018, 529 plans can be used for elementary and secondary school expenses of up to $10,000. All contributions to these plans grow tax-free and payouts are tax-free if the money is used to pay for qualifying education expenses. Although contributions to a 529 plan are not deductible on your federal taxes, many states, including Pennsylvania, allow residents to claim a state income tax deduction.
- Child Care Credit
If you pay for child care to allow both you and your spouse to work, the Child Care Credit may be available depending on your income and how much you pay for child care. The credit can be between 20% to 35% for child-care expenses of up to $3,000 for the care of one child and up to $6,000 for the care of two or more children. A dependent child must be 12 or younger when the child care is provided. Qualifying care expenses can include after-school care and non-sleep-over summer camp fees.
- Child Care Reimbursement Account
Child Care Reimbursement Accounts allow workers to contribute up to $5,000 a year of their salary into an account that can pay for child-care bills. Check if you employer provides this benefit. Contributions to a Child Care Reimbursement Account are tax free and avoid federal income, Social Security and Medicare taxes. Similar to flexible savings accounts for medical expenses, a drawback with Child Care Reimbursement Accounts is that you must "use or lose" the funds prior to year-end. However, if your expenses are consistent from year to year, a Child Care Reimbursement Account would benefit you more than the Child Care Credit. You cannot use a Child Care Reimbursement Account and the Child Care Credit for the same expenses.
…And Ends at Death
- Filing a Final Income Tax Return
A surviving spouse can file a joint tax return with the decedent for the year of death and can sign it as the surviving spouse. If a person other than a surviving spouse has been appointed by a court, that executor or personal representative must sign the return and attach a copy of the certificate that shows the official appointment.
If there is a refund on the decedent’s return, and the person claiming the refund is not the surviving spouse, you may have to file Form 1310, Statement of Personal Claiming Refund Due a Deceased Taxpayer, to obtain the refund.
- Allocation of Final Year Income and Medical Deductions
The decedent's tax year ends on the date of death, so only income received through that date is reportable on their final Form 1040. Analysis may be necessary because Forms 1099 may inadvertently report interest and dividend income for the full year, and sales of securities whose tax basis has not been adjusted to date-of-death values. Medical expenses paid before death, and within one year after death, can be claimed either as an itemized deduction on the final Form 1040 or as a debt on the federal estate tax return, depending upon which option provides the greatest tax benefit.
- Expiration of Certain Tax Attributes
Unfortunately, upon an individual’s passing, any capital loss carryover, charitable contribution carryover, and investment interest expense carryover, that is attributable to them are lost and are not transferred to their estate, their surviving spouse, or other beneficiaries. With proper planning, a surviving spouse could have one last opportunity with filing a joint return with the decedent to utilize some of these carryovers before they expire.
- Federal Estate Tax
For 2019, many people will owe no federal estate tax upon their passing. This is because the federal estate tax exemption was increased to $11.4 million. Any estate valued at less than the exemption amount will owe no estate tax; however, The Tax Warriors® at Drucker & Scaccetti recommend Form 706, United States Estate (and Generation-Skipping Transfer Tax) Return be filed (even though not required) to elect portability of a deceased spouse's unused federal estate tax exemption. For estates over $11.4 million or more, Form 706 must be filed.
- State Estate Tax
If a deceased person lived in, or owned real estate in, Connecticut, District of Columbia, Hawaii, Illinois, Maine, Maryland, Massachusetts, Minnesota, New York, Oregon, Rhode Island, Vermont, or Washington, a state estate tax return filing may be required as well as a possible state estate tax obligation. Because the estate tax laws at the state level change often, it is important for your estate professionals to know of each state's tax exemption amounts and estate tax rates.
- State Inheritance Tax
Six states, including Pennsylvania, have an inheritance tax. While an estate tax is based on the overall value of a deceased person's estate, an inheritance tax is based upon who will receive the deceased person’s property. Luckily, all the states with an inheritance tax exempt assets passed onto charities and surviving spouses.
In Pennsylvania, the tax rates for transfers to direct descendants (lineal heirs) is 4.5%, 12% for transfers to siblings, and 15% for transfers to other heirs. Property owned jointly between spouses is exempt from Pennsylvania inheritance tax, while property inherited from a child aged 21 or younger by a parent is taxed at 0%. The rate of Pennsylvania inheritance tax upon transferring property to or for a child aged 21 or younger from a parent who dies after December 31, 2019, is also taxed at 0%
When we talk about taxes, we often relate them to income alone, but Uncle Sam has his hand in our birth and death, often at times before and after our income-earning years. The good news is proper planning for both ends of the circle of life can be done and is essential to mitigating tax exposure. Trusts and estate planning strategies can benefit family members after the passing of a loved one, as well as get a newborn off to a good start in life and Hakuna Matata!
The Tax Warriors at Drucker & Scaccetti have decades of specialized experience in helping clients plan for the inevitable and uncertainties of the circle of life. It’s not always easy or comfortable to have these conversations but talking about it and proper planning can save lots of headaches and uncertainty down the road. Call on us to help with all your strategic tax planning needs.