Monthly Archives: June 2016
Increases Expected to Social Security Tax Base
Anyone who has received a paycheck knows that FICA takes a chunk out of their gross pay every payday, but many people don’t understand what FICA is (or what it stands for). FICA is the Federal Insurance Contributions Act and it imposes two taxes on employers, employees, and self-employed people. The first tax is Old Age, Survivors, and Disability Insurance (OASDI; commonly known as Social Security). The second tax is Hospital Insurance (HI; commonly known as Medicare).
How Much is the FICA Tax?
The total FICA rate for both taxes is 7.65%–6.2% for Social Security and 1.45% for Medicare.
For 2016, an employee will pay:
- 2% Social Security tax on the first $118,500 of wages (maximum tax is therefore $7,347 [6.2% of $118,500]) plus
- 45% Medicare tax on the first $200,000 of wages ($250,000 for joint returns; $125,000 for married taxpayers filing separately), plus
- 35% Medicare tax (regular 1.45% Medicare tax plus 0.9% additional Medicare tax) on all wages in excess of $200,000 (($250,000 for joint returns; $125,000 for married taxpayers filing separately)
The employer will match the employee’s 6.2% Social Security tax and the 1.45% Medicare tax (but not the 0.9% additional Medicare tax—this tax is just on the employee).
For 2016, a self-employed person will pay:
- 4% Social Security tax on the first $118,500 of self-employment income (maximum tax is therefore $14,694 [12.4% of $118,500]) plus
- 9% Medicare tax on the first $200,000 of self-employment income ($250,000 for joint returns; $125,000 for married taxpayers filing separately), plus
- 8% Medicare tax (regular 2.9% Medicare tax plus 0.9% additional Medicare tax) on all self-employment income in excess of $200,000 (($250,000 for joint returns; $125,000 for married taxpayers filing separately)
There is a maximum amount of income subject to Social Security tax, but there is no maximum amount for Medicare.
Projected Increases in Social Security Tax Base
The Social Security’s Office of the Chief Actuary (OCA) is projecting that the Social Security trust fund will become insolvent in 2034, and that the Disability Insurance trust fund will become insolvent in 2023. To shore up the programs’ solvency, it is expected that the Social Security taxable base will be increased. The OCA has provided the following estimated projection of the increase in the Social Security taxable base over the next few years:
- 2016 $118,500
- 2017 $126,000
- 2018 $129,900
- 2019 $135,900
- 2020 $142,500
These are just estimates—the actual increases to the taxable base are announced in October of the preceding year and are based on then-current economic conditions.
Basically, someone with at least $126,000 in wages will owe an additional $465 in taxes in 2017 because of the taxable base increase ($126,000 less $118,500 times 6.2%). A self-employed person with equal income will owe an additional $930 in self-employment tax.
To see how this applies to you, give us a call at 248-538-5331.
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.
How Terminations or Sales of Life Insurance Policies are Taxed
Life insurance proceeds on the death of an insured are generally income-tax free. Other forms of distributions from life insurance policies may or may not be taxable.
How a Termination/Surrender is Taxed
When a life insurance policy is terminated and the policyholder receives cash, the cash receipt will be taxable to the extent it exceeds the investment in the contract. The investment in the contract is the total amount of premiums or other consideration paid for the contract, less the aggregate amount of non-taxable proceeds received under the contract (e.g., as a loan or nontaxable dividend).
Example: Joan has paid $24,000 in premiums for a whole life policy. The current cash value is $30,000. Joan has not received any distributions from the policy. If Joan cancels her policy and receives the $30,000 cash value (assume no surrender fees), she has taxable income equal to the proceeds ($30,000) less her investment in the contract ($24,000). Thus, her taxable income is $6,000.
The next question is whether the $6,000 is taxed as capital gain (subject to a maximum 20% tax rate) or as ordinary income (subject to a maximum 39.6% tax rate). Unfortunately, when a life insurance policy is terminated, any income will be taxed as ordinary income.
How a Sale of a Policy is Taxed
In contrast to a termination or surrender of a life insurance policy, when a policy holder sells a life insurance policy, a portion of the income may qualify for capital gain treatment. The portion of the sales proceeds that exceeds the cash value can qualify for capital gain treatment.
Example 2: Same facts as above except that Joan finds a viatical settlement company to purchase her policy for $35,000. Joan’s total income is $11,000–the $35,000 sales proceeds less her $24,000 investment in the contract. The portion of her income that can be taxed as capital gain is $5,000 (the excess of the sales proceeds over the cash value). The remaining $6,000 of income is taxed at her ordinary income rate.
Tax-Free Sales if Policyholder is Terminally or Chronically Ill
An important exception to the taxability of a sale of a life insurance policy is when the policy is sold to a qualified viatical settlement provider and the policyholder is terminally or chronically ill. In this situation, the proceeds are tax free if the policyholder is terminally ill. If the policyholder is chronically ill, the proceeds are tax-free subject to certain limits.
Loans Can Cause a Problem
If there is an outstanding loan on the policy when the policy is terminated, the outstanding amount of the loan will be treated as cash proceeds (i.e., it will be taxable if it exceeds the investment in the contract).
Example: Jim has paid $24,000 in premiums. He has taken out a $20,000 policy loan. The cash value of the policy is $10,000. If Jim terminates the policy, his cash proceeds will be equal to his actual cash distribution ($10,000) plus his outstanding loan ($20,000). His total cash proceeds are $30,000. His taxable income will be his $30,000 proceeds less his $24,000 investment in the contract. He will have $6,000 of income taxed at his ordinary tax rate.
Exchanging Life Insurance Policies Can Be Tax-Free
When a policyholder needs a different level of coverage and/or wants to work with a different life insurance company, an exchange of life insurance policies can be tax-free if strict requirements are met. This is done under Section 1035, which is a provision of the U.S. tax code that gives a policyholder the ability to transfer funds from a life insurance, endowment or annuity to a policy of a similar type.
To see how this applies to you, give us a call at 248-538-5331.
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.
How to Borrow Money from a 401(k)
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One benefit of being a participant in a qualified retirement plan (e.g., 401(k) or profit sharing plan, but not a SIMPLE or SEP) is the ability to borrow money from the qualified plan. The loan process is usually quick, the funds can be borrowed for any reason, it won’t affect the participant’s credit rating, and can cost less than a bank loan. Additionally, the interest the participant pays on the loan is essentially paid back into the participant’s plan account (i.e., the participant is paying interest to herself).
It is important that the loan follow certain rules or the amount loaned will be treated as a taxable distribution and be subject to the 10% early withdrawal penalty.
The Maximum Loan Amount Requirement
The loan amount cannot exceed the lesser of:
- $50,000 or
- One-half of the present value of the participant’s nonforfeitable accrued benefit under the plan
If the plan meets certain requirements, a loan of up to $10,000 is allowed even if $10,000 is greater than ½ of the participant’s nonforfeitable accrued benefit.
A participant can have more than one outstanding loan at a time. However, any new loan, when added to the outstanding balance of all of the participant’s plan loans, cannot exceed the plan maximum amount.
The Term Requirement
The loan must generally be repaid within five years with substantially level amortization, with payments made not less frequently than quarterly, over the term of the loan. The five-year term requirement does not apply when the plan loan is used to buy a principal residence for the participant.
The level amortization is not required if the participant is on a leave of absence not lasting more than one year (longer, if for military service) and either (1) is not receiving pay or (2) is receiving pay at a lower rate than the required installments under the plan loan. Even though the level amortization requirement is avoided, the loan must still be repaid within the five years.
Documentation Requirement
The loan must be evidenced by a legally enforceable written agreement with terms that demonstrate compliance with the requirements for non-distribution treatment, specifying the amount and date of the loan, and the repayment schedule.
Is the Interest Deductible?
Probably not. There are three situations where interest is definitely not deductible. The first is where the loan is made to a key employee (a 5% owner of the company or an officer making more than $170,000 for 2016). The second situation is where the loan is secured by amounts attributable to the employee’s contribution amounts to the plan. The final situation is where the loan is used for education. Even if none of these three rules bar the interest deduction, the plan loan must meet specific statutory rules to be deductible (e.g., business loans, loans secured by a residence, etc.)
To see how this applies to you, give us a call at 248-538-5331.
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.
