Monthly Archives: May 2012

When Distributions from Retirement Accounts Are Required

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Deductible contributions to IRAs and qualified plans are beneficial because they allow taxpayers to reduce their taxable income by the amount of the contributions.  The earnings within the retirement accounts are not subject to tax as long as the earnings remain in the retirement account.  However, the IRS doesn’t allow the party to last forever.  Eventually, taxpayers are subject to the minimum distribution rules that require taxpayers to withdraw funds from retirement plans and pay tax on the distributed amounts.  The rules discussed in this post apply to traditional IRAs and qualified plans.  These rules apply to Roth IRAs only after the owner’s death (i.e., the rules require beneficiaries of inherited Roth IRAs to receive minimum distributions; the original owners of Roth IRAs have no such requirement).

What Do the Minimum Required Distributions Rules Require?

Basically, these rules require the retirement account owner to distribute the balances in retirement accounts over her remaining life expectancy.  These rules require a minimum amount that must be distributed and taxed; the account owner is free to withdraw additional amounts from the retirement accounts.  Each year’s distribution is calculated independently.  No credit may be taken in the current year for prior year distributions that exceeded the required amount.

If an account owner withdraws less than the minimum required distribution, he is subject to a 50% penalty for the shortfall.

Example:  Terry’s minimum required distribution is $10,000.  She only withdraws $6,000.  She is subject to a 50% penalty on the $4,000 shortfall, which amounts to a $2,000 penalty.  Not good.

When Do Minimum Required Distributions Take Effect?

Minimum required distributions for IRAs are required starting April 1 of the year after the taxpayer reaches age 70½.  Generally, for participants of qualified plans, the minimum distribution rules take effect April 1 of the year following the year that the participant retires.  However, when the qualified plan participant owns more than 5% of the employer, the minimum required distributions are required in the year after the participant reaches age 70½ even if the participant isn’t retired.

An account owner reaches age 70½ six months after her 70th birthday.

Example:  John owns an IRA and turns 70 on January 16, 2012.  John therefore turns 70½ on July 16, 2012.  Minimum required distributions are required to be taken by April 1, 2013 (the year after he reaches age 70½).

The distribution required to be taken by April 1, 2013 is for 2012.  The distribution required for 2013 must be taken by December 31, 2013.  Therefore, if John waits until April 1, 2013 to take his first distribution, he will have to take two distributions during 2013 (one for 2012 and one for 2013).  The two distributions can bump John into a higher tax bracket, affect deductions and credits that are sensitive to income, and cause more of his Social Security income to be subject to tax.  John may be better off taking his 2012 distribution during 2012 rather than waiting until April 1, 2013.

How Is the Amount of the Minimum Required Distribution Calculated?

The simple answer is that the IRA trustee is required to report the minimum required distribution to IRA owners, or calculate it for them, by January 31 of the year the distribution is required.  However, it is the account owner’s responsibility to ensure that the calculated amount is correct.

The not so simple answer is that the minimum required distribution is calculated based on the account owner’s age at the end of the distribution year and based on the account balance at the end of the prior year.  Distributions are based on prior year balances because they are more readily determined than current year balances.

Example:  Jean turns 81 in 2012.  Her life expectancy is based on her age during 2012 (age 81).  Her life expectancy is 17.9 years.  She has two IRAs.  At December 31, 2011, IRA-1 has a balance of $100,000 and IRA-2 has a balance of $80,000.  Her minimum required distribution for 2012 for IRA-1 is $5,587 ($100,000 divided by 17.9) and her minimum required distribution for IRA-2 is $4,469 ($80,000 divided by 17.9).  The total required distributions of $10,056 can be withdrawn from one or both accounts.  

Only amounts that an individual owns as the IRA owner may be aggregated.  Amounts in IRAs that an individual holds as a beneficiary of the same decedent may be aggregated, but such amounts may not be aggregated with amounts held in IRAs that the individual holds as the IRA owner or as the beneficiary of another decedent.

For qualified plans, minimum required distributions must be calculated and distributed for each account–aggregation is not allowed for qualified plan accounts.

Buzzkill Disclaimer: This post contains general tax information that may or may not apply in your specific tax situation. Please consult a tax professional before relying on any information contained in this post.

Any tax advice contained in the body of this post was not intended or written to be used, and cannot be used, by the recipient for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code or applicable state or local tax law provisions. Any information contained in this post does not fall under the guidelines of IRS Circular 230.

Ugly Changes to Michigan Property Tax Credit

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The Michigan Homestead Property Tax Credit will be subject to new rules beginning in 2012.  This post will review the old rules, then explain how the new rules are different.

Review of Old Rules (Prior to 2012)

A Michigan resident who paid property tax or rent on a Michigan homestead could claim a refundable property tax credit against Michigan income tax.  A claimant must have been domiciled in Michigan for at least six months during the tax year and must occupy the dwelling.  The credit is based on property taxes that were billed (whether or not paid) for the taxable year.  For renters, 20% of rent paid is considered property taxes eligible for the credit.

For non-senior citizens, the credit is 60% of the amount by which the property tax for the year exceeds 3.5% of household income.  For senior citizens and certain disabled individuals, the 3.5% threshold is reduced for those with household income under $6,000.

Household income means all income received by all persons of a household in a tax year while members of a household.  Household income includes several items that are nontaxable such as child support, Social Security income, veterans’ disability benefits, etc.  Household income is reduced by business and rental losses.  Household income is also reduced by medical insurance premiums.  When Household income exceeds $82,650, the credit is no longer available.

The New Rules (effective January 1, 2012)

The property tax credit is now available only for homes with a taxable value of less than $135,000 (this is roughly equal to a home with a sales price of $270,000).

Household income is replaced by household resources.  The difference is that household resources is not reduced by business or rental losses.

Example:  Joan has $90,000 in wages during 2011 and has rental losses of $20,000.  Her household income is $70,000 ($90,000 in wages minus $20,000 in rental losses).  Since her household income during 2011 is less than the limit of $82,650 she is eligible for the property tax credit.  In 2012, her household resources are $90,000 (which is not reduced by her rental losses).  Since her household resources are over the household resources limit, she is NOT eligible for the property tax credit.

For non-seniors, the credit is 60% of the amount by which the property tax for the year exceeds 3.5% of household resources.

For seniors with household resources under $21,000, the credit is equal to 100% of the property tax for the year that exceed 3.5% of household resources.  The 100% amount is reduced by 4% for each $1,000 in additional household resources over $21,000 until $30,000 in household resources is reached.

Example:  John has household resources of $22,000.  His property tax credit is 96% of property taxes that exceed 3.5% of his household resources (100% minus [($22,000 minus $21,000) divided by 1,000 times 4%].

Senior claimants with household resources of $30,000 to $41,000  receive 60% of the credit.

For all claimants, there is a credit phaseout that begins at $41,000 of household resources.  The phaseout equals 10% for each $1,000 increase in household resources between $41,000 and $50,000.  At $50,000 of household resources, the credit is completely phased out.  This is a very significant decrease in the phaseout amount from 2011 ($82,650).

Example:  It is 2012.  Terry (who is not a senior citizen) has $45,000 in household resources.  He was billed $4,000 in property taxes.  Terry property tax credit is 60% of his property taxes in excess of 3.5% of his household resources.  His property tax credit before phaseout is $225 calculated as follows:

60% of property taxes of $4,000 =   $2,400

Less:  3% of household resources =   $1,575 ($45,000 times 3.5%)

Tentative property tax credit =          $    825 ($2,400 less $1,575)

Less: Phaseout =                                       $    412.50  The phaseout is 50% calculated as ([$45000-$40,000] divided by 1,000 times 10%)

Property Tax Credit =                            $    412.50 ($825 minus $412.50 phaseout)

Example:  Same facts as the last example except it is 2011.  Terry would be entitled to an $825 property tax credit.  Since his household income is less than $82,650, he still qualifies for the full property tax credit.

Buzzkill Disclaimer: This post contains general tax information that may or may not apply in your specific tax situation. Please consult a tax professional before relying on any information contained in this post.

Any tax advice contained in the body of this post was not intended or written to be used, and cannot be used, by the recipient for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code or applicable state or local tax law provisions. Any information contained in this post does not fall under the guidelines of IRS Circular 230.

 

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