Frequently Asked Questions
Over 500 every day financial questions answered.
Frequently Asked Questions
Small Business: FAQs
Less than one-third of family businesses survive the transition from first to second generation ownership. Of those that do, about half do not survive the transition from second to third generation ownership. At any given time, 40 percent of U.S. businesses are facing the transfer of ownership issue. Founders are trying to decide what to do with their businesses; however, the options are few.
The following is a list of options to consider:
- Close the doors.
- Sell to an outsider or employee.
- Retain ownership but hire outside management.
- Retain family ownership and management control.
There are four basic reasons why family firms fail to transfer the business successfully:
- Lack of viability of the business.
- Lack of planning.
- Little desire on the owner’s part to transfer the firm.
- Reluctance of offspring to join the firm.
The primary cause for failure is the lack of planning. With the right succession plans in place, the business, in most cases, will remain healthy.
Transferring the family business requires the family to make a determined effort to do the following:
- Create a business strategic plan.
- Create a family strategic plan.
- Prepare an Estate Plan.
- Prepare a Succession Plan, including arranging for successor training and setting a retirement date.
These are the four plans that make up the transition process. By implementing them, you will virtually ensure the successful transfer of your business within the family hierarchy.
Q: What is a business strategic plan?
A: A business strategic plan defines goals, objectives, and targets for a company and outlines its resources will be allocated in order to achieve them. When a strategic business plan is in place, it allows each generation an opportunity to chart a course for the firm. Setting business goals as a family will ensure that everyone has a clear picture of the company’s future. A strategic plan is long-term in nature and focuses on where you want the business to be at some future date.
Q: What is a family strategic plan?
A: The family strategic plan establishes policies for the family’s role in the business and is needed to maintain a healthy, viable business. For example, it should include the creed or mission statement that spells out your family’s values and basic policies for the business, and it may include an entry and exit policy that outlines the criteria for working in the business. The plan should consider which family members desire to have a part in management of the business versus those who desire a more passive role.
Q: What is an estate plan?
A: An estate plan is a written document that outlines the disposal of one’s estate and includes such things as a will, trust, power of attorney, and a living will. An estate plan is critical for the family and the business because, without it, you will pay higher estate taxes than necessary, allocating less of the estate to your heirs. The estate plan should be used in conjunction with the succession plan to see that the family business is transferred in a tax effective manner.
Q: What is a succession plan?
A: A succession plan identifies key individuals who will be groomed to take over the business when the time comes. It also outlines how succession will occur and how to know when the successor is ready. Having a succession plan in place goes a long way toward easing the founding or current generation’s concerns about transferring the firm.
Before starting out, list your reasons for wanting to go into business. Some of the most common reasons for starting a business include wanting to be self-employed, wanting financial and creative independence, and wanting to maximize your skills and knowledge.
When determining what business is “right for you,” consider what you like to do with your time, what technical skills you have, recommendations from others, and whether any of your hobbies or interests are marketable. You must also decide what kind of time commitment you’re willing to make to running a business.
Then you should do research to identify the niche your business will fill. Your research should address such questions as what services or products you plan to sell, whether your idea fits a genuine need, what competition exists, and how you can gain a competitive advantage. Most importantly, can you create a demand for your business?
The following outline of a typical business plan can serve as a guide that you can adapt to your specific business:
- Financial Management
- Concluding Statement
Q: What should be included in the introduction to my business plan?
A: The introductory section of your business plan should give a detailed description of the business and its goals, discuss its ownership and legal structure, list the skills and experience you bring to the business, and identify the competitive advantage your business possesses.
Q: What should be included in the marketing section of my business plan?
A: In the marketing section, you should discuss what products/services your business offers and the customer demand for them. Furthermore, this section should identify your market and discuss its size and locations. Finally, you should explain various advertising, marketing, and pricing strategies you plan to utilize.
Q: What should be included in the financial management section of my business plan?
A: In this section, explain the source and amount of initial equity capital. Also, develop a monthly operating budget for the first year as well as an expected return on investment, or ROI, and monthly cash flow for the first year. Next, provide projected income statements and balance sheets for a two-year period, and discuss your break-even point. Explain your personal balance sheet and method of compensation. Discuss who will maintain your accounting records and how they will be kept. Finally, provide “what if” statements that address alternative approaches to any problem that may develop.
Q: What should be included in the operations section of my business plan?
A: This section explains how the business will be managed on a day-to-day basis. It should cover hiring and personnel procedures, insurance, lease or rent agreements. It should also account for the equipment necessary to produce your products or services and for production and delivery of products and services.
Q: What should be included in the concluding statement of my business plan?
A: In the ending summary statement, summarize your business goals and objectives and express your commitment to the success of your business. Also, be specific as to how you plan to achieve your goals.
To succeed, your business must be based on something greater than a desire to be your own boss: an honest assessment of your own personality, an understanding of what’s involved, and a lot of hard work.
You have to be willing to plan ahead and then make improvements and adjustments along the road. Overall, it is important that you establish a professional environment in your home; you should even set up a separate office in your home, if possible.
A home-based business is subject to many of the same laws and regulations affecting other businesses. Be sure to consult an attorney and your state department of labor to find out which laws and regulations will affect your business. For instance, be aware of your city’s zoning regulations. Also, certain products may not be produced in the home.
Most states outlaw home production of fireworks, drugs, poisons, explosives, sanitary or medical products, and toys. Some states also prohibit home-based businesses from making food, drink, or clothing.
In terms of registration and accounting requirements, you may need a work certificate or a license from the state, a sales tax number, a separate business telephone, and a separate business bank account.
Finally, if your business has employees, you are responsible for withholding income and social security taxes, and for complying with minimum wage and employee health and safety laws.
Failure to properly plan cash flow is one of the leading causes of small business failures. Experience has shown that many small business owners lack an understanding of basic accounting principles. Knowing the basics will help you better manage your cash flow.
A business’s monetary supply can exist either as cash on hand or in a business checking account available to meet expenses. A sufficient cash flow covers your business by meeting obligations (i.e., paying bills), serving as a cushion in case of emergencies, and providing investment capital.
The Operating Cycle
The operating cycle is the system through which cash flows, from the purchase of inventory through the collection of accounts receivable. It measures the flow of assets into cash. For example, your operating cycle may begin with both cash and inventory on hand. Typically, additional inventory is purchased on account to guarantee that you will not deplete your stock as sales are made. Your sales will consist of cash sales and accounts receivable – credit sales. Accounts receivable are usually paid 30 days after the original purchase date. This applies to both the inventory you purchase and the products you sell. When you make payment for inventory, both cash and accounts payable are reduced. Thirty days after the sale of your inventory, receivables are usually collected, which increases your cash. Now your cash has completed its flow through the operating cycle and is ready to begin again
Cash-flow analysis should show whether your daily operations generate enough cash to meet your obligations, and how major outflows of cash to pay your obligations relate to major inflows of cash from sales. As a result, you can tell if inflows and outflows from your operation combine to result in a positive cash flow or in a net drain. Any significant changes over time will also appear.
A monthly cash-flow projection helps to identify and eliminate deficiencies or surpluses in cash and to compare actual figures to past months. When cash-flow deficiencies are found, business financial plans must be altered to provide more cash. When excess cash is revealed, it might indicate excessive borrowing or idle money that could be invested. The objective is to develop a plan that will provide a well-balanced cash flow.
To achieve a positive cash flow, you must have a sound plan. Your business can increase cash reserves in a number of ways:
- Collecting receivables: Actively manage accounts receivable and quickly collect overdue accounts. Revenues are lost when a firm’s collection policies are not aggressive.
- Tightening credit requirements: As credit and terms become more stringent, more customers must pay cash for their purchases, thereby increasing the cash on hand and reducing the bad-debt expense. While tightening credit is helpful in the short run, it may not be advantageous in the long run. Looser credit allows more customers the opportunity to purchase your products or services.
- Manipulating price of products: Many small businesses fail to make a profit because they erroneously price their products or services. Before setting your prices, you must understand your product’s market, distribution costs, and competition. Monitor all factors that affect pricing on a regular basis and adjust as necessary.
- Taking out short-term loans: Loans from various financial institutions are often necessary for covering short-term cash-flow problems. Revolving credit lines and equity loans are common types of credit used in this situation.
- Increasing your sales: Increased sales would appear to increase cash flow. However, if large portions of your sales are made on credit, when sales increase, your accounts receivable increase, not your cash. Meanwhile, inventory is depleted and must be replaced. Because receivables usually will not be collected until 30 days after sales, a substantial increase in sales can quickly deplete your firm’s cash reserves.
You should always keep enough cash on hand to cover expenses and as an added cushion for security. Excess cash should be invested in an accessible, interest-bearing, low-risk account, such as a savings account, short-term certificate of deposit or Treasury bill.
Choosing a Professional: FAQs
For certain legally complex or time-consuming disputes or problems, there is no doubt that a lawyer is necessary. For example, if you want a will prepared, or a more complex business deal handled, you will need to hire a lawyer. And, if a court case is involved (other than a simple, routine matter), you’ll almost always need a lawyer.
When deciding whether to hire an attorney, consider the following:
- Does the matter involve a complex legal issue or is it likely to go to court? Is a large amount of money, property, or time involved? These factors indicate that you need to hire a lawyer.
- Is there a form or self-help book available that you can use instead of hiring a lawyer? You may be able to solve certain problems with only minimal assistance.
- Are there any non-lawyer legal resources available to assist you?
Unlike more complex transactions, some transactions can be handled without a lawyer. For instance, a living will can often be prepared with the help of organizations such as the American Association of Retired Persons (AARP). Non-profits that deal with retired and elderly persons may also be able to provide you with the necessary paperwork to create a living will in your state, as well as additional information and/or assistance in completing the form properly.
Many disputes can be resolved by writing letters or negotiating with the other party on your own, or by using arbitration or mediation. Legal self-help manuals and seminars can provide you with the tools to handle a portion of, or the entire, dispute.
Tip: Consider hiring an attorney to review papers or provide advice, rather than fully representing you.
Negotiating on your own. Negotiating on your own behalf is often the best way to solve minor disputes. Visit your local library or search online for resources that explain the best way to negotiate a dispute.
Tip: Before starting the negotiation process, it’s usually a good idea to familiarize yourself with legal issues that might come up by calling a legal hot-line or consulting other sources of information.
Mediation or arbitration. Dispute resolution centers have been established in every state. Most specialize in helping to resolve problems in the areas of consumer complaints, landlord/tenant disputes, and disagreements between neighbors or family members.
During the mediation process, a neutral person assists the two sides in discussing their differences and helps them possibly reach an agreement. In an arbitration setting, the neutral third party conducts a more formal process and makes a decision (usually written) after listening to both sides.
If both parties agree to it, using a dispute resolution center or a private mediation center is a lower-cost alternative to bringing a lawsuit to court or hiring an attorney to represent you during a negotiation process.
Small claims court. Small claims court may be appropriate if you have a monetary claim for damages within the limits set by your state (usually $1,000 to $5,000). These courts are more informal and involve less paperwork than regular courts. If you file in small claims court, be prepared to act as your own attorney, gathering necessary evidence, researching the law, and presenting your story in court.
The first step is to compile a list of names. Ask relatives, friends, clergy, social workers, or your doctor for recommendations. State bar associations usually have lawyer referral lists organized by specialty. Martindale-Hubbell also has a comprehensive lawyer referral service. For specific groups such as persons with disabilities, older persons, or victims of domestic violence consult a community lawyer referral services. The court and your banker may also be good referral sources. Finally, don’t forget the yellow pages of the telephone book, which often lists lawyers according to their specialties.
Tip: If you use a referral service, ask how attorneys are chosen to be listed with that particular service. Many services make referrals to all lawyers who are members (regardless of type and level of experience) of a particular organization.
Tip: Be aware that many bar associations have committees that conduct training or public service work in various areas of specialty. An attorney serving on one of these committees could have the expertise you are looking for.
After developing a list of potential lawyers, interview them initially by telephone to narrow down the list and then arrange face-to-face interviews.
Before committing yourself to a consultation, ask potential candidates the following questions:
- Do you provide a free consultation for the initial interview?
- How long have you been in practice?
- What percentage of your cases is similar to my type of legal problem? (A lawyer with experience in handling cases like yours will be more efficient).
- Can you provide me with any references, such as trust officers in banks, other attorneys, or clients?
- Do you represent any clients or special-interest groups that might cause a conflict of interest?
- What type of fee arrangement do you require? Are the fees negotiable?
- What information should I bring with me to the initial consultation?
Follow up your phone calls by scheduling interviews with at least two of the attorneys. Don’t feel embarrassed about selecting only the best candidates or canceling appointments with some of the attorneys after you complete your initial phone calls.
Next, interview the candidates. Come prepared with a brief summary of your immediate case (including dates and facts) as well as a list of general questions for the attorney. The purpose of the interview is twofold: (1) to decide if the attorney has the necessary experience and is available to take your case; and, (2) to decide if you are comfortable with the fee arrangement and, most importantly, comfortable working with the attorney.
The market rate for any given legal service varies by locality. A “fair” fee is what seems fair to you, based on your knowledge of going rates. Whether you are comfortable with a fee is likely to be based on the following factors:
- How much you can afford
- Whether the case is routine or requires special expertise
- The range of attorney rates for this type of case in your area
- How much work can you can do on the case yourself
The most common types of fee arrangements used by lawyers are listed below.
Flat fee. The lawyer will charge you a specific total fee for your case. A flat fee is usually offered only if your case is relatively simple or routine.
Note: While lawyers will not set a flat fee for litigation, they can usually give you a good estimate of the costs at each stage.
Tip: Ask if photocopying, typing, and other out-of-pocket expenses are covered by this flat fee.
Hourly rate. Attorneys charge by the hour (or portion of an hour). For instance, if your attorney’s fee is $100 per hour, and he or she works ten hours, the cost will be $1,000. Some attorneys charge a higher rate for court work and less per hour for research or case preparation. And, as a rule, large law firms usually charge more than small law firms and attorneys in urban areas often charge more per hour than attorneys practicing in rural areas.
Tip: If you agree to an hourly rate, be sure to find out how much experience your attorney has had with your type of case. A less experienced attorney will usually require more time to research your case, although he or she may charge a lower hourly rate.
Tip: Ask what is included in the hourly rate. If other staff such as secretaries, messengers, paralegals, and law clerks will be working on your case, find out how their time will be charged to you? Ask about costs and out-of-pocket expenses, which are usually billed in addition to the hourly rate.
Contingency fee. Under this arrangement, the attorney’s fee is based on a percentage of what you are awarded in the case. If you lose the case, the attorney does not get a fee, although you will still have to pay expenses. A one-third fee is common.
Tip: Ask whether the lawyer will calculate the fee before or after the expenses. This can make a substantial difference, since calculating the percentage of the attorney’s fee after the expenses have been deducted increases the amount of money you receive.
It is important to remember that a lawyer’s fees are often negotiable, but your lawyer is unlikely to invite you to bargain over fees! Here are some tips for saving ensuring the cost-effectiveness of legal fees.
Comparison shop for flat fees on simple cases.
Ask about the billing method for hourly rates. A written agreement specifying the fee arrangement and the work involved is the best way to be clear about the total cost of the case.
Choose a lawyer with the appropriate qualifications. Most legal work is relatively routine in nature and often has more to do with knowing which form to fill out and which county clerk will process it most quickly.
Offer to perform some of the work.
Hire the attorney to act as a go-between. Some lawyers are open to negotiating a lower fee if you are only looking for their legal expertise to write a letter to the other side to settle.
Hire the attorney to act as your pro se coach. If you want to represent yourself in court (called “appearing pro se”), hire your attorney to act as a pro se coach who will review documents and letters that you prepare and sign.
Choose a lawyer who specializes in what you need.
Prepare for meetings with your attorney. The more work you do to prepare, the less time your attorney needs to spend (and charge you) for finding the information.
Answer your attorney’s questions fully. If your attorney knows all the facts as early as possible in the case, it will save time and money that might be spent later on further investigations or misdirected case development.
If the situation changes, tell your attorney as soon as possible. You don’t want your attorney heading in the wrong direction on a case.
Maximize contact with your attorney. Consolidate your questions or information-giving into a single call. Unless you have a specific reason for doing so, pass on information in writing or to other office staff rather than speaking directly with the attorney.
Examine your bill. Request that your attorney bill you on a regular basis. Even if you have agreed on a contingency fee and will not actually pay the expenses until the case is settled, you should periodically examine the expenses. Question any items that you do not understand or that are not covered in your fee agreement.
Employee Benefits: FAQs
The employer must pay in whole or in part for certain legally mandated benefits and insurance coverage, including Social Security, unemployment insurance, and workers’ compensation. Funding for the Social Security program comes from mandatory contributions from employers, employees and self-employed persons into an insurance fund that provides income during retirement years.
Full retirement benefits normally become available at age 66 for people born after 1943, and age 67 for those born in 1960 or later. Other aspects of Social Security deal with survivor, dependent and disability benefits, Medicare, Supplemental Security Income (SSI) and Medicaid. Unemployment insurance benefits are payable under the laws of individual states from the Federal-State Unemployment Compensation Program.
Workers’ compensation provides benefits to workers disabled by occupational illness or injury. Each state mandates coverage and provides benefits. In most states, private insurance or an employer self-insurance arrangement provides the coverage. Some states mandate short-term disability benefits as well.
A comprehensive benefit plan might include the following elements health insurance, disability insurance, life insurance, a retirement plan, flexible compensation, and sick, personal, and vacation leave. A benefit plan might also include bonuses, service awards, reimbursement of employee educational expenses and perquisites appropriate to employee responsibility.
As an employer, before you implement any benefit plan, it’s important to decide what you’re willing to pay for this coverage. You may also want to seek employee input on what benefits interest them. For instance, is a good medical plan more important than a retirement plan? Furthermore, you must decide whether it is more important to protect your employees from economic hardship now or in the future. Finally, you must decide if you want to administer the plan or have the insurance carrier do it.
Today, most health insurance falls under what is called “managed care” in which you pay monthly premiums, as well as co-pays and deductibles. The four main types of health insurance are briefly described below. For more information contact your plan administrator.
In addition, due to the passage of the Affordable Care Act of 2010, which was upheld by the Supreme Court in July 2012, starting in 2014 states may opt to create a “healthcare exchange” that enable individuals and small businesses to compare health plans, get answers to questions, find out if they are eligible for tax credits for private insurance or health programs like the Children’s Health Insurance Program (CHIP), and enroll in a health plan that meets their needs.
Health maintenance organizations (HMOs) provide health care for their members through a network of hospitals and physicians. Comprehensive benefits typically include preventive care, such as physical examinations, well baby care and immunizations, and stop-smoking and weight control programs. The choice of primary care providers is limited to one physician within a network; however, there is frequently a wide choice for the primary care physician.
A preferred provider organization (PPO) is a network of physicians and/or hospitals that contracts with a health insurer or employer to provide health care to employees at predetermined discounted rates. PPOs offer a broad choice of health care providers.
Point of Service (POS) health care plans are similar to HMOs in that you choose a primary-care doctor from the plan’s network, but you must have a referral in order to see in-network specialists. You can also see out of network providers as long as you get a referral first.
Another option to consider is a high-deductible health insurance combined with a health-savings account (HSA) or a health reimbursement arrangement (HRA). By law, the two must be linked.
HSAs should not be confused with FSAs (Flexible Spending Accounts). Money that you set aside in a health savings account or a health reimbursement arrangement to pay for certain medical expenses is tax-free. HSAs must be linked to a high-deductible health insurance plan, and HRAs often are. (For preventive care, such as cancer screenings, you might not have to pay the deductible first.) Typically, a special debit type card is used for the HSA or HRA account to keep track of expenses and payments.
A disability plan provides income replacement for the employee who cannot work due to illness or accident. These plans are either short term or long term and are distinct from workers’ compensation because they pay benefits for non-work-related illness or injury.
Short-term disability (STD) is usually defined as an employee’s inability to perform the duties of his or her normal occupation. Benefits may begin on the first or the eighth day of disability and are usually paid for a maximum of 26 weeks. The employee’s salary determines the benefit level, ranging from 60 to 80 percent of pay.
Long-term disability (LTD) benefits usually begin after short-term benefits conclude. LTD benefits continue for the length of the disability or until normal retirement. Again, benefit levels are a percentage of the employee’s pay, usually between 60 and 80 percent. Social Security disability frequently offsets employer-provided LTD benefits. Thus, if an employee qualifies for Social Security disability benefits, these are deducted from benefits paid by the employer.
Traditionally, life insurance pays death benefits to beneficiaries of employees who die during their working years. Most employers purchase a group life policy for their employees. Typically an employee is provided with life insurance coverage that is at least equal to their yearly salary. For example, an employee who makes $50,000 per year would receive $50,000 of coverage. The employer is responsible for the premium but may require employees to pay part of the premium cost.
With self-insurance, the business predetermines and then pays a portion or all of the medical expenses of employees in a manner similar to that of traditional healthcare providers. Funding comes through the establishment of a trust or a simple reserve account and a self-insured employer assumes the risk for paying the health care claim costs for its employees.
As with other health care plans, the employee generally pays a portion of the cost of premiums. Catastrophic coverage is usually provided through a “stop-loss” policy, a type of coinsurance purchased by the company. The plan may be administered directly by the company or through an administrative services contract. Businesses with self-insured health plans are not subject to taxes, benefit requirements, profit limits, or other provisions of the Affordable Care Act.
The idea behind cafeteria plans is that amounts which would otherwise be taken as taxable salary are applied, usually tax-free, for needed services like health or child care. Besides saving employee income and social security taxes, salary diverted to cafeteria plan benefits isn’t subject to social security tax on the employer. With a cafeteria plan, employees can choose from several levels of supplemental coverage or different benefit packages. These can be selected to help employees achieve personal goals or meet differing needs, such as health coverage (family, dental, vision), retirement income (401(k) plans) or specialized services (dependent care, adoption assistance, legal services – legal services amounts are taxable).
Complete and accurate financial record keeping is crucial to your business success. Good records provide the financial data that helps you operate more efficiently. Accurate and complete records enable you to identify all your business assets, liabilities, income, and expenses. That information helps you pinpoint both the strong and weak phases of your business operations.
Moreover, good records are essential for the preparation of current financial statements, such as the income statement (profit and loss) and cash-flow projection. These statements, in turn, are critical for maintaining good relations with your banker. Finally, good records help you avoid underpaying or overpaying your taxes. In addition, good records are essential during an Internal Revenue Service audit, if you hope to answer questions accurately and to the satisfaction of the IRS.
To assure your success, your financial records should show how much income you are generating now and project how much income you can expect to generate in the future. They should inform you of the amount of cash tied up in accounts receivable. Records also need to indicate what you owe for merchandise, rent, utilities, and equipment, as well as such expenses as payroll, payroll taxes, advertising, equipment and facilities maintenance, and benefit plans for yourself and employees. Records will tell you how much cash is on hand and how much is tied up in inventory. They should reveal which of your product lines, departments, or services are making a profit, as well as your gross and net profit.
The Basic Recordkeeping System
A basic record-keeping system needs a basic journal to record transactions, accounts receivable records, accounts payable records, payroll records, petty cash records, and inventory records.
An accountant can develop the entire system most suitable for your business needs and train you in maintaining these records on a regular basis. These records will form the basis of your financial statements and tax returns.
You must have a clear understanding of your firm’s long- and short-range goals, the advantages and disadvantages of all of the alternatives to a computer and, specifically, what you want to accomplish with a computer. Compare the best manual (non-computerized) system you can develop with the computer system you hope to get. It may be possible to improve your existing manual system enough to accomplish your goals. In any event, one cannot automate a business without first creating and improving manual systems.
Business Applications Performed by Computers
A computer’s multiple capabilities can solve many business problems from keeping transaction records and preparing statements and reports to maintaining customer and lead lists, creating brochures, and paying your staff. A complete computer system can organize and store many similarly structured pieces of information, perform complicated mathematical computations quickly and accurately, print information quickly and accurately, facilitate communications among individuals, departments, and branches, and link the office to many sources of data available through larger networks. Computers can also streamline such manual business operations as accounts receivable, advertising, inventory, payroll, and planning. With all of these operations, the computer increases efficiency, reduces errors, and cuts costs.
Computer Business Applications
Computers also can perform more complicated operations, such as financial modeling programs that prepare and analyze financial statements and spreadsheet and accounting programs that compile statistics, plot trends and markets and do market analysis, modeling, graphs, and forms. Various word processing programs produce typewritten documents and provide text-editing functions while desktop publishing programs enable you to create good quality print materials on your computer. Critical path analysis programs divide large projects into smaller, more easily managed segments or steps.
To computerize your business you need to choose the best programs for your business, select the right equipment, and then implement the various applications associated with the software. In addition, application software is composed of programs that make the computer perform particular functions, such as payroll check writing, accounts receivable, posting or inventory reporting and are normally purchased separately from the computer hardware. QuickBooks is a good example of this type of software.
To determine your requirements, prepare a list of all functions in your business. in which speed and accuracy are needed for handling volumes of information. These are called applications.
For each of these applications make a list of all reports that are currently produced. You should also include any pre-printed forms such as checks, billing statements or vouchers. If such forms don’t exist, develop a good idea of what you want – a hand-drawn version will help. For each report list the frequency with which it is to be generated, who will generate it and the number of copies needed. In addition to printed matter, make a list of information that you want to display on the computer video screen (CRT).
For all files you are keeping manually or expect to computerize list, identify how you retrieve a particular entry. Do you use account numbers or are they organized alphabetically by name? What other methods would you like to use to retrieve a particular entry? Zip code? Product purchased? Indeed, the more detailed you are, the better your chance of finding programs compatible with your business.
When implementing computer applications for your business, problems are inevitable, but proper planning can help you avoid some and mitigate the effects of others. First, explain to each affected employee how the computer will change his or her position. Set target dates for key phases of the implementation, especially the last date for format changes. Be sure the location for your new computer meets the system’s requirements for temperature, humidity, and electrical power. Prepare a prioritized list of applications to be converted from manual to computer systems, and then train, or have the vendors train, everyone who will be using the system.
After installation, each application on the conversion list should be entered and run parallel with the preexisting, corresponding manual system until you have verified that the new system works.
If you will have confidential information in your system, you will want safeguards to keep unauthorized users from stealing, modifying or destroying the data. You can simply lock up the equipment, or you can install user identification and password software.
The best and cheapest insurance against lost data is to back up information on each diskette regularly. Copies should be kept in a safe place away from the business site. Also, it is useful to have and test a disaster recovery plan and to identify all data, programs, and documents needed for essential tasks during recovery from a disaster.
Finally, be sure to employ more than one person who can operate the system, and ensure that all systems are continually monitored.
Travel and Entertainment: FAQs
Generally not. Usually, you can only deduct costs of meals when you’re away from home overnight. Even so, the deduction is allowed only to the extent of 50 percent of the cost of meals and related tips. For tax years 2021 and 2022, the deduction is allowed at 100 percent.
Also, because business-related entertainment expenses were eliminated under tax reform, starting in 2018, the deduction for meals at entertainment events is deductible (at 50%) only when costs for meals are itemized separately from entertainment costs.
Under tax reform, miscellaneous itemized deductions subject to the 2-percent floor were eliminated for tax years 2018-2025. However, prior to tax reform (i.e., for tax years prior to 2018), the following applied:
It depends. If you give your employer a detailed expense accounting, return any excess reimbursement, and meet other requirements, you don’t have to report the reimbursement and you don’t deduct the expenses. This means that any deduction limits are imposed on your boss, not you, and the 2-percent limit on miscellaneous itemized deductions won’t affect your travel, entertainment and meals costs.
Prior to tax reform (i.e., for tax years before 2018), the deduction for business entertainment and business meals could not exceed 50 percent of the cost. Note that due to the coronavirus pandemic, business-related meals purchased from a restaurant (eat-in or take-out) are deductible at 100 percent. There are no dollar limits. Expenses must be “ordinary and necessary” (meaning appropriate and helpful) and not “lavish or extravagant,” but this doesn’t bar deluxe accommodations, travel or meals. Additionally, there were additional special limitations on skyboxes and luxury water travel.
Starting in 2018 and continuing through tax year 2025, no deduction is allowed for business entertainment. Tax reform also eliminated deductions for expenses relating to sporting events such as those for skybox expenses (previously 50%), tickets to sporting events (previously 50%), and transportation to and from sporting events (previously 50%).
Yes. Living expenses at the temporary work site are away from home travel expenses. An assignment is temporary if it’s expected to last no more than a year. If it’s expected to last more than a year, the new area is your tax home, so you can’t deduct expenses there as away from home travel.
A wide range of expenses can be deducted while traveling away from home.
Here are the main ones:
- Transportation fares, or actual costs (or a standard per mile rate) of using your own vehicle. Also, transportation costs of getting around in the work area-to and from hotels, restaurants, offices, terminals, etc.
- Lodging and meals (subject to the 50 percent limit on meals; 100 percent in 2021 and 2022)
- Phone, fax, laundry, baggage handling
- Tips related to the above
The following travel expenses cannot be deducted:
- Costs of commuting between your residence and a work site, but it’s a deductible business trip if your residence is your business headquarters.
- Travel as education
- Job hunting in a new field or looking for a new business site
Prior to 2018 and the passage of the TCJA, the following generally applied:
- There should be a business discussion before, during, and after the meals and entertainment.
- The deduction for entertainment and meals is limited to 50 percent of the cost. In 2021 and 2022 restaurant meals are deductible at 100 percent.
- There were further limitations for club dues, entertainment facilities, and skyboxes.
- Spouses of business associates and your own spouse could be included in the entertainment in settings where spouse attendance is customary.
After tax reform, and starting in 2018, the rules changed and the entertainment expense deduction was eliminated entirely with the exception of certain activities such as office holiday parties, which remain 100% deductible. For example, the deduction for business entertainment expenses is eliminated but meals remain deductible at 50 percent (100 percent in 2021 and 2022). In addition, the following now applies:
Entertainment-related Meals. Prior to tax reform expenses for meals purchased during entertainment activities such as meals included at a sporting event were deductible at 50%. Starting in 2018; however, the deduction is eliminated unless the costs of meals are invoiced separately.
Sporting Events. Tax reform eliminated all deductions relating to sporting events including deductions for sky box expenses (previously 50%), tickets to sporting events (previously 50%), tickets to qualified charitable events (previously 100%), and transportation to and from sporting events (previously 50%).
Club Memberships. While there was never a deduction for club dues, business owners were able to take a 50% deduction for expenses incurred at a business, recreational, or social club as long as it was related to their trade or business. Under tax reform, however, that deduction has been eliminated.
If you’re an employee who is reimbursed for expenses you’ll need to file an expense report for your employer, which is a written accounting of your expense while on travel. If you received a cash advance, you’ll also need to return to the employer any amounts in excess of your expenses.
Some per diem arrangements and mileage allowances called “accountable plans” take the place of detailed accounting to the employer, if time, place and business purpose are established.
For tax years 2018 through 2025, miscellaneous itemized deductions (Form 1040, Schedule A) have been eliminated due to tax reform (Tax Cuts and Jobs Act of 2017). Prior to tax reform (i.e., tax years prior to 2018), the following held true:Where expenses aren’t fully reimbursed by your employer or excess reimbursements aren’t returned, detailed substantiation to IRS is required and, if you’re an employee, your deductions are subject to the 2-percent floor on miscellaneous itemized deductions. In addition, your expense records should be “contemporaneous,” that is, recorded close to the time expenses are incurred.
Marketing and Pricing: FAQs
Market research is the most critical element of successful business planning because it provides the basic data that will determine if and where you can successfully sell your product or service and how much to charge. It is a process that involves scrutinizing your competition and your customer base, and interviewing potential suppliers.
There are a number of benefits to conducting market research such as helping you create primary and alternative sales approaches to a given market, making profit projections from a more accurate base, organizing marketing activities, developing critical short/mid-term sales goals, and establishing the market’s profit boundaries, but first, you must define your goals and organize the collection/analysis process.
Your research questions should revolve around the demographic data of your customers such as age, location, and income (what they can afford). Your research should also address larger questions such as what type of demand there is for your product, how you might generate demand. In addition, you will want to find out how many competitors provide the same service or product and whether you can you effectively compete with regard to price, quality, and delivery.
You also might want to ask yourself whether you can price the product or service so as to assure a profit. Finally, it is helpful to understand the general economy of your service or product area and the areas within your market that are declining or growing.
Every component of a service or product has a different, specific cost. Many small firms fail to analyze each component of their commodity’s total cost, therefore failing to price profitably. Once this analysis is done, prices can be set to maximize profits and eliminate any unprofitable service. Cost components include material, labor and overhead costs.
Material Costs. These are the costs of all materials found in the final product.
Labor Costs. Labor costs are the costs of the work that goes into the manufacturing of a product. The direct labor costs are derived by multiplying the cost of labor per hour by the number of person-hours needed to complete the job. Remember to use not only the hourly wage but also the dollar value of fringe benefits. These include social security, workers’ compensation, unemployment compensation, insurance, retirement benefits, etc.
Overhead Costs. Overhead costs are any costs that are not readily identifiable with a particular product. These costs include indirect materials, such as supplies, heat, and light, depreciation, taxes, rent, advertising, transportation, and insurance. Overhead costs also cover indirect labor costs, such as clerical, legal and janitorial services. Be sure to include shipping, handling, and/or storage as well as other cost components.
Part of the overhead costs must be allocated to each service performed or product produced. The overhead rate can be expressed as a percentage or an hourly rate. It is important to adjust your overhead costs annually. Charges must be revised to reflect inflation and higher benefit rates. It’s best to project the costs semiannually, including increased executive salaries and other projected costs.
Business Forms of Organization: FAQs
Corporations, limited liability companies (LLCs), limited partnerships, and limited liability partnerships (LLPs) are the three most common business entities that limit liability. General partnerships and sole proprietorships don’t limit owners’ liability. Limited partnerships limit the liability of some partners (limited partners) and not others (general partners).
Double taxation of corporations results in a significant tax burden on corporate income. Often referred to as the “corporate double tax,” it occurs when a business corporation (or an entity treated for tax purposes as a business corporation) pays a federal tax on its income, and tax is also paid by its owners in the form of individual income tax on capital gains and dividends when they collect corporate profits.
Double taxation occurs even if the corporation retains its after-tax earnings (as opposed to distributing them as dividends) because the value of the stock increases to reflect an increase in assets held by the corporation. Shareholders that decide to sell their stock will realize a capital gain and pay tax on that gain.
The tax on the corporation is called an “entity level tax” and an entity so taxed is called a “C-corporation” (C-corp). The double tax can be avoided one of two ways:
- By electing to be an S-corp. While this doesn’t change its nature under state business law, but in most cases eliminates federal tax at the corporate level.
- By postponing profits distributions to corporate owners, the second tax (on the owners) can be postponed.
It depends. Generally speaking, the “pass-through” type of entity saves tax overall by eliminating tax at the entity level. pass-through entity owners are taxed directly on their share of entity profits. Another pass-through advantage is that owners can take tax deductions for startup or operating losses, against their income from investments or other businesses.
You have much control over whether the entity you choose is treated as a pass-through entity for federal tax purposes (see below), but the leading pass-through forms are general partnerships, limited partnerships, LLPs, LLCs, S-corps, and sole proprietorships.
If your business is in the form of a partnership (any type) or limited liability company, you may choose whether your business is treated for tax purposes as a corporation or a partnership (or, if you’re the only one in the LLC, as a corporation or disregarded for tax purposes). Tax and business advisors call this choice the “check-the-box” system. If it’s actually incorporated, or you choose to have it treated as a corporation, you may qualify to have it treated as a pass-through by electing S-corp status.
Your choice under check-the-box is binding. That is, if you choose one entity (say, corporation) in one year and another (say, partnership) the next year, you must pay tax as if you sold last year’s entity and put the proceeds into this year’s.
S-corps (usually) and all of the following, assuming that you don’t choose to have them treated as corporations: LLCs; LLPs; and limited partnerships, for the limited partners. For sole owners, the choice is limited to S-corps or, in states that allow single-owners, LLCs.
LLCs combine limited liability with pass-through tax treatment. They can offer benefits unavailable from S-corps, their nearest rival (for businesses other than professional practices). The key benefits:
- A way to allocate certain tax benefits disproportionately among owners.
- Opportunity for greater loss deductions.
- Avoiding or reducing tax when a new owner joins the business or when distributions are made to owners in business liquidation.
State law varies when it comes to allowing single-owner LLCs; some states allow it and some states don’t. Where it is allowed, the owner can choose under check-the-box rules to have the LLC disregarded for tax purposes (without losing LLC limited liability), and pay tax directly on LLC income.
In states where single member LLCs aren’t allowed S-corps are a good alternative, and they can also postpone tax, as compared to LLCs, where the business is to be bought out by a corporate giant.
Limitation of liability, especially malpractice liability, is a major concern. No entity will protect you against liability for your own malpractice. But LLCs, Professional Limited Liability Companies (PLLCs), and LLPs, where available for professional practices, will protect you against liability for malpractice of co-owner professionals in the firm, and maybe (depending on state law) for other debts. Professional Corporations (PCs) may not protect against liability for a co-owner’s malpractice, depending on state law.
The tax rules governing those in LLCs, PLLCs, and LLPs are about the same, and somewhat more liberal than those for PCs.
This is a critical decision that should be studied carefully with professional guidance, but briefly stated:
- There’s no tax on a change from C-corp to S-corp or vice versa.
- There is no tax on a change from LLC, partnership or sole proprietorship to a C or S-corp.
- There is no tax on a change from a proprietorship or partnership to LLC or vice versa.
- There is a tax on a change from C or S-corp to an LLC, partnership or sole proprietorship.
Keep in mind the difference between state business law and state tax law. The tax status you choose for your entity under the federal check-the-box system doesn’t make it that entity for state business law purposes. So, for example, choosing corporate tax treatment for a partnership won’t bring corporate limited liability.
There is a trend for states to treat the entity chosen under federal check-the-box as the entity recognized for state tax purposes, but this is optional with the state.
State law may accept pass-through status for an entity (such as an S-corp or an LLC) and still impose a tax of some kind on the entity.
A corporation is a legal entity that exists separately from its owners. Creation of a corporation occurs when properly completed articles of incorporation are filed with the correct state authority, and all fees are paid.
All corporations start as “C” corporations and are required to pay income tax on taxable income generated by the corporation. A C-corporation becomes an S-corporation by completing and filing federal form 2553 with the IRS. An S-corporation’s net income or loss is “passed-through” to the shareholders and are included in their personal tax returns. Because income is NOT taxed at the corporate level, there is no double taxation as with C-corporations. Subchapter S-corporations, as they are also called, are restricted to having no more than 100 shareholders.
An attorney is not a legal requirement for incorporating a business in any state except South Carolina, where a signature by a South Carolina attorney licensed to practice in the state is required on articles of incorporation. In every other state, you can prepare and file the articles of incorporation yourself. However, if you are unsure of what steps your business should take and you don’t have the time to research the matter yourself, a consultation with a good corporate attorney is often well worth the money you spend.
We will request your two top name choices. We will check these as part of your order. If neither of these is available, we will contact you for other name choices.
First, we recommend that you spend some time coming up with a name for your corporation. Although each state has different rules concerning the naming of your corporation, the most common rule is that it must not be deceptively similar to another already formed company. The corporate name must include a suffix. Some examples are “Incorporated”, “Inc.”, “Company”, and “Corp.” However, your state may have different suffix requirements.
The primary advantage of incorporating is to limit your liability to the assets of the corporation only. Usually, shareholders are not liable for the debts or obligations of the corporation. So if your corporation defaults on a loan, unless you haven’t personally signed for it, your personal assets won’t be in jeopardy. This is not the case with a sole proprietorship or partnership. Corporations also offer many tax advantages that are not available to sole proprietors.
Some other advantages include:
- A corporation’s life is unlimited and is not dependent upon its members. If an owner dies or wishes to sell their interest, the corporation will continue to exist and do business.
- Retirement funds and qualified retirement plans (like 401k) may be set up more easily with a corporation.
- Ownership of a corporation is easily transferable.
- Capital can be raised more easily through the sale of stock.
- A corporation possesses centralized management.
Most every state requires that a corporation has a registered agent. That agent must have a physical location in the formation state. The registered agent can typically be any person (usually a resident of the state) or any properly registered company who is available during normal business hours to receive official state documents or service of process (lawsuit).
Most states allow for one person to act as shareholder, director, and all officer roles.
We provide a default of 200 shares, although you can choose any amount you want on all orders. Your par value is not requested on all orders, and is usually expressed as “No Par Value” or some dollar amount per share such as “$1.00” or “$0.10.” Some states require that you do not issue your stock for less than the par value. Some states also base their fees on the number of shares authorized, multiplied by the par value.
Your corporation is required to have an Employer Identification Number (EIN) also known as your Federal Tax Identification Number so that the IRS can track payroll and income taxes paid by the corporation. But, like a social security number, an EIN is used for most everything the business does. Your bank will require an EIN to open your corporate bank account.
We provide two EIN services:
- Basic EIN Service – We prepare and email your SS4 (EIN application) & easy one-page instructions for obtaining your EIN. You need only review, sign and fax or call in the information to the IRS to get your EIN.
- Full EIN Service – We actually obtain your company’s EIN for you.
You must have your initial shareholder(s) meeting to elect your director(s), if your director(s) haven’t been designated in the articles. Then, you must have your initial organizational meeting of your directors. At this meeting, you will need to elect your officers, adopt your company’s bylaws, and issue your stock (among other actions).
Once you have decided on a name, order your corporation online. Once we receive your paid order, we verify the availability of your name choices, draft your articles, file them with the state and send you all appropriate documents after they have been filed.
Limited Liability Companies: FAQs
You should consider forming an LLC (limited liability company) if you are concerned about personal exposure to lawsuits arising from your business. For example, if you decide to open a store-front business that deals directly with the public, you may worry that your commercial liability insurance won’t fully protect your personal assets from potential slip-and-fall lawsuits or claims by your suppliers for unpaid bills. Running your business as an LLC may help you sleep better because it instantly gives you personal protection against these and other potential claims against your business.
Not all businesses can operate as LLCs, however. Businesses in the banking, trust, and insurance industry, for example, are typically prohibited from forming LLCs.
While the S-corporation’s special tax status eliminates double taxation, it lacks the flexibility of an LLC in allocating income to the owners.
An LLC may offer several classes of membership interests while an S-corporation may only have one class of stock.
Any number of individuals or entities may own interests in an LLC. However, ownership interest in an S-corporation is limited to no more than 100 shareholders. Also, S-corporations cannot be owned by C-corporations, other S-corporations, many trusts, LLCs, partnerships, or nonresident aliens. Also, LLCs are allowed to have subsidiaries without restriction.
An LLC operating agreement allows you to structure your financial and working relationships with your co-owners in a way that suits your business. In your operating agreement, you and your co-owners establish each owner’s percentage of ownership in the LLC, his or her share of profits (or losses), his or her rights and responsibilities, and what will happen to the business if one of you leaves.
Although most states’ LLC laws don’t require a written operating agreement, you shouldn’t consider starting business without one. Here’s why an operating agreement is necessary:
- It helps to ensure that courts will respect your personal liability protection by showing that you have been conscientious about organizing your LLC.
- It sets out rules that govern how profits will be split up, how major business decisions will be made, and the procedures for handling the departure and addition of members.
- It helps to avert misunderstandings between the owners over finances and management.
- It keeps your LLC from being governed by the default rules in your state’s LLC laws, which might not be to your benefit.
While LLC owners enjoy limited personal liability for many of their business transactions, it is important to realize that this protection is not absolute. This drawback is not unique to LLCs, however — the same exceptions apply to corporations. An LLC owner can be held personally liable if he or she:
- personally and directly injures someone
- personally guarantees a bank loan or a business debt on which the LLC defaults
- fails to deposit taxes withheld from employees’ wages
- intentionally does something fraudulent, illegal, or clearly wrong-headed that causes harm to the company or to someone else, or
- treats the LLC as an extension of his or her personal affairs, rather than as a separate legal entity.
This last exception is the most important. In some circumstances, a court might say that the LLC doesn’t really exist and find that its owners are really doing business as individuals, who are personally liable for their acts. To keep this from happening, make sure you and your co-owners:
- Act fairly and legally. Do not conceal or misrepresent material facts or the state of your finances to vendors, creditors, or other outsiders.
- Fund your LLC adequately. Invest enough cash into the business so that your LLC can meet foreseeable expenses and liabilities.
- Keep LLC and personal business separate. Get a federal employer identification number, open up a business-only checking account, and keep your personal finances out of your LLC accounting books.
- Create an operating agreement. Having a formal written operating agreement lends credibility to your LLC’s separate existence.
A good liability insurance policy can shield your personal assets when limited liability protection does not. For instance, if you are a massage therapist and you accidentally injure a client’s back; your liability insurance policy should cover you. Insurance can also protect your personal assets in the event that your limited liability status is ignored by a court.
In addition to protecting your personal assets in such situations, insurance can protect your corporate assets from lawsuits and claims. Be aware, however, that commercial insurance usually does not protect personal or corporate assets from unpaid business debts, whether or not they’re personally guaranteed.
Although a corporation’s failure to hold shareholder or director meetings may subject the corporation to alter ego liability, this is not the case for LLCs in many states. In California for example, an LLC’s failure to hold meetings of members or managers is not usually considered grounds for imposing the alter ego doctrine where the LLC’s Articles of Organization or Operating Agreement do not expressly require such meetings.
Frequently Asked Questions
Buying or Leasing Your Next Car: FAQs
Will you save money leasing instead of buying? It depends on four things: (1) how good a deal you can strike with the dealership, (2) how many miles you put on a car, (3) how much wear and tear you put on a car, and (4) what the car will be used for.
To decide whether to lease or buy, compare the costs and other factors involved with both leasing and buying. Consider the following factors:
- Your initial costs
- Your ongoing costs
- Your final costs and option rights
- Whether you will be able to deduct any of the costs of the car because it will be used in a business
- Whether having an ownership interest in the car is of overriding importance
First, decide on the size and type of car you want, and then decide what options you want (e.g., automatic, air conditioning, anti-lock brakes).
Second, find out what the car dealer is paying for the car(s) you’re interested in. This is known as the dealer invoice cost. this is important because the difference between the invoice price and the sticker price is the amount that can be negotiated.
There are two different ways to go about getting this information. The first (and best) way is to use an auto pricing service provided by a consumer group or an auto magazine such as Consumer Reports New Car Price Service. This service gives you a complete run-down of the invoice price and the sticker price, adjusted for various options, as well as any rebates or factory incentives. And it tells you how to use the information in negotiating your new car’s price. In addition, using an auto pricing service provides you with the most up-to-date information. The second way is to use pricing guides found on the Internet, such as Edmund’s New Car Prices.
If you have a car to trade-in, you’ll want to find out what it’s worth, too. You can do this by looking up your used car in the N.A.D.A Official Used Car Guide, available online (www.nadaguides.com) or at the library.
The next step is to begin negotiating with car dealers. Now that you know the invoice price, use that information to bargain for the lowest possible markup over the dealer’s cost.
Generally, $300 to $500 over the dealer’s cost is a reasonable mark-up, unless the car you want is either hard to get or an extremely popular, exotic or sporty model.
Resist any attempts by dealerships to sell you undercoating, rust-proofing, or other extras. Depending on the repair history of your model, however, you might want to invest in the extended warranty.
Remember that you are not only shopping for a car; you are choosing a dealer, with whom you will have a long-term relationship as you’ll bring your car in for servicing. So if you don’t like the dealership, go elsewhere.
As far as timing of purchase, the last Saturday of September, October, or December is generally a good time to get a good bargain on a car because sales managers are scrambling to meet their quotas for month and year-end.
Find out about financing alternatives before you begin shopping for a car. If you know what banks are charging, you will be prepared when the dealer talks about financing.
Here are some of the main points you’ll want to get across during your negotiations:
- You know the exact model you want, and which options you want.
- You are comparison shopping, and will obtain price quotes from other dealers.
- You will not discuss financing or trade-ins until the dealer has made you an offer (do not mention a trade-in until you have finished negotiating the price of your car).
- You know how much the car cost the dealer.
Finally, even if you get what sounds like a good price, go to other dealers to get quotes.
Similar to a loan, the monthly lease payment depends on the lease terms, the initial “purchase price” of the vehicle, and the interest rate. Unlike a loan, another important factor is the “lease-end” or “residual” value. This is the expected value of the car at the end of the lease term.
In a lease you are effectively paying for the difference between initial purchase price and residual value. You should negotiate the best possible (i.e. lowest) purchase price because this will lower your cost of leasing. If it is a closed-end lease and you do not intend to purchase the car at the end of the lease term, you should also try to negotiate a higher residual value.
If you walk into a dealership and ask to lease a car, they will often try to base the lease on the Manufacturer’s Suggested Retail Price (MSRP). You would never pay this sticker price to purchase a car for cash, so you should not do so in a lease situation.
The first step is to negotiate the lowest possible price on the vehicle and then negotiate the lease terms. For example, assume a Lexus sedan has an MSRP of $36,955 (and the lease provides for a term of 36 months, an implicit interest rate of 6.67% and a residual value of $25,895). Based upon this MSRP, the monthly lease payment would be $481.50, excluding sales/use tax, licenses, etc.
The invoice (dealer) cost on the same vehicle is $32,469. If you negotiated a price between MSRP and invoice, say $34,750; the lease payment would be reduced to $416.00.
There are two types of lease arrangements: closed-end (“walk-away”) and open-end (finance). Here’s how they work:
Closed-End: The Dealer Bears the Risk of Depreciated Value
When a closed-end lease is up, you bring the car back to the dealership and “walk away.” You must return the car with only normal wear and tear and with less than the mileage limit specified in your lease. Since the dealer is bearing the risk that the value of the car at the end of the lease will go down, your monthly payment is higher than with an open-end lease.
Open-End: You Bear the Risk of Depreciated Value
With the open-end lease the customer bears the risk that the car will have a certain value (called the “estimated residual value”) at the end of the lease. The monthly payment is lower because of this risk.
When you return the car at the end of the lease, the dealer will have the car appraised. If the car’s appraised value is at least equal to the estimated residual value in the agreement, you won’t need to pay anything at the end of the lease term. Under some contracts, you can even receive a refund if the appraised value is higher than the residual value stated in the contract. If the appraised value is lower than the residual value, however, you may have to pay all or part of the difference.
In deciding whether to lease or buy, find out what your total initial costs will be. This is part of the total dollar amount you will arrive at to compare with the cost of buying.
“Initial costs” are the down payment you must come up with when you lease a car. They include the security deposit, the first and last lease payments, the “capitalized cost reductions,” the sales taxes, title fees, license fees, and insurance. With a lease, the initial costs usually total less than the down payment needed to buy a car. Further, all initial costs are subject to negotiation during your bargaining with the dealer.
The Federal Consumer Leasing Act requires the Lessor to disclose all up-front, continuing and final costs in a standard, easy-to-read format.
Here is a list of questions you may want to ask the dealer before you enter into a car lease (you’ll know some of the answers):
- What kinds of leases are available and what are the differences? We explained the two main types of leases earlier, but dealers may have variations.
- What are the initial costs of leasing the vehicle?
- Are there any ongoing costs associated with leasing?
- Does a trade-in decrease initial or ongoing costs?
- What happens if I exceed the mileage specified in my lease?
- How will my mileage allowance be enforced if I take an early termination or a purchase option?
- Can I sublease if I fall behind in my payments or want to stop leasing?
- What happens if I want to terminate my lease before the agreement is up?
Look for a “premature termination” clause, which provides for termination prior to the end of the lease term.
- What are my options at the end of my lease?
- What costs and charges can I expect to pay at the end of the lease?
The Lessor is allowed to keep the security deposit if you owe money at the end of your lease or if you missed a monthly payment. The security deposit can also be used by the dealer to cover damage to the car or mileage in excess of the limit specified in the lease. If you do not owe any money on the lease at the end of the term, then your security deposit is returned to you.
The Consumer Leasing Act (CLA) limits how much the dealer can collect at the end of the lease period. The CLA says dealers cannot collect more than three times the average monthly payment. However, the dealer can collect a higher amount in the following circumstances:
- The vehicle has unreasonable wear and tear, or miles greater than specified in the lease
- You agreed to pay a greater amount than specified in the original contract; or
- The Lessor wins a lawsuit asking for a greater amount.
The dealer also has the option of selling the car at the end of the lease term. If the car is sold for less than the residual value stated in your leasing contract, you could be obligated to pay as much as three monthly payments to make up the difference.
Although dealers will generally not risk the goodwill of their customers and sell leased cars for less than the residual value just to move the car quickly, you may want to negotiate to include the right to approve the final sales price of the leased vehicle as part of your lease agreement.
Here are a few other things you should know:
- If you stay under the mileage limit, you don’t get a refund.
- If you buy a car at the end of a closed-end lease and you go over your mileage allowance, you probably won’t have to pay for excess mileage.
The Consumer Leasing Act requires dealers to disclose the total number of payments, the amount of each payment, the total amount of all payments, and the due date or schedule of payments. There is usually a penalty for late payment, which the Lessor must also disclose to you.
Maintenance is part of the lease and specifies whether the dealer assumes the maintenance expenses or the customer (you) assumes these expenses. If the dealer is to provide repair and maintenance, you will have to bring the car to the dealership in accordance with the manufacturer’s suggested schedule in order to keep the warranty coverage. Even if you have to pay for repair and scheduled maintenance, you usually have to observe the manufacturer’s scheduled maintenance in order not to jeopardize warranty coverage.
Final costs include:
Excess mileage charges
Mileage limitations usually occur with a closed-end lease. If you have gone over the allowable mileage at the end of your lease, you will have to pay a fee.
Consider carefully whether the mileage allowance is enough. Make some calculations of the miles you have driven per week, month, and year to find out whether the mileage allowance is sufficient.
Be aware that the low-mileage lease deals currently popular in certain areas offer mileage limits that are insufficient for many people. If you think you need more than the allowable mileage, negotiate a larger mileage allowance in your lease.
If you buy a car at the end of a closed-end lease and you go over your mileage allowance, you probably won’t have to pay for excess mileage.
If you stay under the mileage limit, you don’t get a refund.
With an open-end lease, although there is no penalty, if you exceed the mileage limit the appraisal value at the end of the lease term will usually be lower.
These cover any payments or security deposits that the dealer does not receive from you and legal fees and costs the dealer incurs to repossess the car.
Excessive wear and tear charges
You’ll have to pay charges for excessive wear and tear when you return the car at the end of the lease unless the contract reads otherwise. The dealer must tell you in writing the specific definition of excessive wear and tear. Generally, it means anything beyond normal usage (mechanical or physical).
These are the costs of cleaning the car, giving it a tune-up, and doing final maintenance. If the agreement does not state otherwise, the dealer may pass these costs on to you.
Your lease may include the option to purchase the car at the end of the lease term. This option is usually found in open-end rather than closed-end leases. The dealer must tell you the estimated residual value of the car and the formula that will be used to determine your purchase price at the end of the lease.
If you think you might want to buy the car, be sure the purchase option is in your lease before you sign it; otherwise you’ll have to renegotiate later, at which time you may have less bargaining power.
If you terminate your lease after, say, 36 months on a 48-month lease, you will have to pay an extra charge, based on the difference between the residual value of the car at that time and the estimated residual value at the end of the lease term (stated in the contract). The difference between these two may be great. In most lease agreements, you must keep the car at least 12 months. Before you sign the contract the dealer must tell you whether you can terminate early and what the cost is.
This is similar to a down payment. The dealer may ask you to put a certain amount of money down before leasing. The amount of the capitalized cost reduction varies with the business custom prevalent in the geographic area and the credit rating of the customer. The larger the down payment is, the smaller the monthly payment under the lease is; however, most people who want to lease instead of buy don’t want to put down a large down payment, which is one of the major advantages of leasing.
Trading in your old car can reduce your down payment and/or your monthly payments.
Getting Married: FAQs
When it comes to legal rights and being married vs. unmarried, there are several major issues to consider. Specifically, unmarried couples do not automatically:
- Inherit each others’ property. Married couples who do not have a will have their state intestacy laws to back them up; the surviving spouse will inherit at least a fraction of the deceased spouse’s property under the law.
- Have the right to speak for each other in a medical crisis. If your life partner loses consciousness or capacity, someone will have to make the decision whether to go ahead with a medical procedure. That person should be you. But unless you have taken care of some legal paperwork, you may not have the right to do so.
- Have the right to manage each others’ finances in a crisis. A husband and wife who have jointly owned assets will generally be affected less by this problem than an unmarried couple.
The following steps are particularly important for couples who are not married:
Prepare a will. If both partners make out wills, the chances are that the intentions expressed in the wills will be followed after one partner dies. If there are no wills, the unmarried surviving partner will probably be left high and dry.
Consider owning property jointly. Joint ownership of property with right of survivorship is a way of ensuring that property will pass to the other joint owner on one joint owner’s death. Real property and personal property can be put into this form of ownership.
Prepare a durable power of attorney. Should you become incapacitated, the durable power of attorney will allow your partner to sign papers and checks for you and take care of other financial matters on his or her behalf.
Prepare a health care proxy. The health care proxy (sometimes called a “medical power of attorney”) allows your partner to speak on your behalf when it comes to making decisions about medical care, should you become incapacitated.
Prepare a living will. A living will is the best way to let the medical community know what your wishes are regarding artificial feeding and other life-prolonging measures.
The purpose of life insurance is to provide a source of income for your children, dependents, or whoever you choose as a beneficiary, in case of your death. Therefore, married couples typically need more life insurance than their single counterparts. If you have a spouse, child, parent, or some other individual who depends on your income, then you probably need life insurance. Here are some typical families that need life insurance:
Families or single parents with young children or other dependents. The younger your children, the more insurance you need. If both spouses earn income, then both spouses should be insured, with insurance amounts proportionate to salary amounts. If the family cannot afford to ensure both wage earners, the primary wage earner should be insured first, and the secondary wage earner should be insured later on. A less expensive term policy might be used to fill an insurance gap. If one spouse does not work outside the home, insurance should be purchased to cover the absence of the services being provided by that spouse (child care, housekeeping, and bookkeeping). However, if funds are limited, insurance on the non-wage earner should be secondary to insurance on the life of the wage earner.
Adults with no children or other dependents. If your spouse could live comfortably without your income, then you will need less insurance than the people in situation (1). However, you will still need some life insurance. At a minimum, you will want to provide for burial expenses, for paying off whatever debts you have incurred, and for providing an orderly transition for the surviving spouse. If your spouse would undergo financial hardship without your income, or if you do not have adequate savings, you may need to purchase more insurance. The amount will depend on your salary level and that of your spouse, on the amount of savings you have, and on the amount of debt you both have.
Single adults with no dependents. You will need only enough insurance to cover burial expenses and debts, unless you want to use insurance for estate planning purposes.
Children. Children generally need only enough life insurance to pay burial expenses and medical debts. In some cases, a life insurance policy might be used as a long-term savings vehicle.
You should notify all organizations with which you previously corresponded with your maiden name. The following is good list to start with:
- The Social Security Administration
- Driver’s license bureau
- Auto license bureau
- Passport office
- Voter’s registration office
- School alumni offices
- Investment and bank accounts
- Insurance agents
- Retirement accounts
- Credit cards and loans
- Club memberships
- Post Office
Absolutely. Your will should be updated often, especially when such a significant life event occurs. Otherwise, your spouse and other intended beneficiaries may not get what you intended upon your death.
Once you are married you are entitled to file a joint income tax return. While this simplifies the filing process, you may find your tax bill either higher or lower than if each of you had remained single. Where it’s higher it’s because when you file jointly more of your income is taxed in the higher tax brackets. This is frequently referred to as the “marriage tax penalty.” Tax law changes in the form of marriage penalty relief were made permanent by the American Taxpayer Relief Act of 2012, and remained in place under the Tax Cuts and Jobs Act of 2017 with the exception of married taxpayers in the highest tax bracket.
You cannot avoid the marriage penalty by filing separate returns after you’re married. In fact filing as “married filing separately” can actually increase your taxes. Consult your tax advisor if you have questions about the best filing status for your situation.
Under a joint IRS and U.S. Department of the Treasury ruling issued in 2013, same-sex couples, legally married in jurisdictions that recognize their marriages, are treated as married for federal tax purposes, including income and gift and estate taxes. The ruling applies regardless of whether the couple lives in a jurisdiction that recognizes same-sex marriage or a jurisdiction that does not recognize same-sex marriage.
In addition, the ruling applies to all federal tax provisions where marriage is a factor, including filing status, claiming personal and dependency exemptions, taking the standard deduction, employee benefits, contributing to an IRA and claiming the earned income tax credit or child tax credit.
Any same-sex marriage legally entered into in one of the 50 states, the District of Columbia, a U.S. territory or a foreign country is covered by the ruling. However, the ruling does not apply to registered domestic partnerships, civil unions or similar formal relationships recognized under state law.
There are several ways of owning property after marriage, but keep in mind that they may vary from state to state. Here are the most common:
Sole Tenancy. Ownership by one individual. At death the property passes according to your will.
Joint Tenancy, with right of survivorship. Equal ownership by two or more people. At death, property passes to the joint owner’s. This is an effective way of avoiding probate.
Tenancy in Common. Joint ownership of property without the right of survivorship. At death your share of the property passes according to your will.
Tenancy by the Entirety. Similar to Joint Tenancy, with right of survivorship. This is only available for spouses and prevents one spouse from disposing of the property without the others permission. Community Property. In some states, referred to as community property states, married people own property, assets, and income jointly; that is, there is equal ownership of property acquired during a marriage. Community property states are AZ, CA, ID, LA, NV, NM, TX, WA, and WI.
Getting Divorced: FAQs
If you are considering divorce, it’s vital to plan for the dissolution of the financial partnership in your marriage. This means dividing the financial assets and liabilities you have accumulated during the years of marriage. Further, if children are involved, the future support given to the custodial parent must be planned for. The time you take to prepare and plan for eventualities will pay off later on.
Here is what you can do:
1. Make a list of all of your assets, joint or separate, including:
- The current balance in all bank accounts
- The value of any brokerage accounts
- The value of investments, including any IRAs
- Your residence(s)
- Your autos
- Your valuable antiques, jewelry, luxury items, collections, and furnishings
2. Make sure you have copies of the past two or three years’ tax returns. These will come in handy later.
3. Inventory your financial debts and obligations. This helps you to prepare in two ways:
- It will provide you with preliminary information for an eventual division of the property.
- It will help you to plan how the debts incurred in the marriage are to be paid off. Although the best way of dealing with joint debt, such as credit card debt, is to get it all paid off before the divorce, often this is not possible. Having a list of your debts will help you to come to some agreement as to how they will be paid off.
4. Make sure you know the exact amounts of salary and other income earned by both yourself and your spouse.
5. Find any papers relating to insurance-life, health, auto, and homeowner’s, as well as pension and other retirement benefits.
6. List all debts you both owe, separately or jointly. Include auto loans, mortgage, credit card debt, and any other liabilities.
If you are a spouse who has not worked outside the home lately, be sure to open a separate bank account in your own name and apply for a credit card in your own name. This will help you to establish credit after the divorce.
It is important to immediately cancel all joint accounts once you know you are going to obtain a divorce. Creditors have the right to seek payment from either party on a joint credit card or other credit account, no matter which party actually incurred the bill. If you allow your name to remain on joint accounts with your ex-spouse, you are also responsible for the bills.
Your divorce agreement may specify which one of you pays the bills. As far as the creditor is concerned, however, both you and your spouse remain responsible if the joint accounts remain open. The creditor will try to collect the bill from whoever it thinks may be able to pay, and at the same time report the late payments to the credit bureaus under both names. Your credit history could be damaged because of the cosigner’s irresponsibility.
Some credit contracts require that you immediately pay the outstanding balance in full if you close an account. If so, try to get the creditor to have the balance transferred to separate accounts.
If your spouse’s poor credit hurts your credit record, you may be able to separate yourself from your spouse’s information on your credit report. The Equal Credit Opportunity Act requires a creditor to take into account any information showing that the credit history being considered does not reflect your own.
If for instance, you can show that accounts you shared with your spouse were opened by him or her before your marriage and that he or she paid the bills, you may be able to convince the creditor that the harmful information relates to your spouse’s credit record, not yours. In practice, it is difficult to prove that the credit history under consideration doesn’t reflect your own, and you may have to be persistent.
If a woman divorces and changes her name on an account, lenders may review her application or credit file to see whether her qualifications alone meet their credit standards. They may ask her to reapply, but generally the account remains open.
Maintaining credit in your own name avoids this inconvenience. It can also make it easier to preserve your own, separate, credit history. Furthermore, should you need credit in an emergency, it will be available.
Do not use only your husband’s name, for example, Mrs. John Wilson for credit purposes.
Check your credit report if you haven’t done so recently. Make sure the accounts you share are being reported in your name as well as your spouse’s. If not, and you want to use your spouse’s credit history to build your own, write to the creditor and request the account be reported in both names. If there is any inaccurate or incomplete information in your file write to the credit bureau and ask them to correct it. The credit bureau must confirm the data within a reasonable time period, and let you know when they have corrected the mistake.
If you have been sharing your husband’s accounts, building a credit history in your name should be fairly easy. Contact a major credit bureau and request a copy of your file, then contact the issuers of the cards you share with your husband and ask them to report the accounts in your name as well.
The best way to plan for the legal issues that must be faced in a divorce such as child custody, division of property, and alimony or support payments, is to come to an agreement with your spouse. If you can do this, the time and money you will have to expend in coming up with a legal solution — either one worked out between the two attorneys or one worked out by a court — will be drastically reduced.
Here are some general tips for handling the legal aspects of a divorce:
- Get your own attorney if there are significant issues dealing with assets, child custody, or alimony.
- There are several ways to find a good matrimonial attorney including referrals from other professionals, referrals from trusted friends, or lists obtained from the American Academy of Matrimonial Lawyers.
- Make sure the divorce decree or agreement covers all types of insurance coverage-life, health, and auto.
- Be sure to change the beneficiaries on life insurance policies, IRA accounts, 401(k) plans, other retirement accounts, and pension plans.
- Don’t forget to update your will.
Those who have trouble arriving at an equitable agreement, but do not require the services of an attorney, might consider the use of a divorce mediator. This type of professional advertises in the section of the classifieds titled “Divorce Assistance”, or “Lawyer Alternatives.”
The laws governing the division of property between ex-spouses vary from state to state. You should also be aware that matrimonial judges have a great deal of latitude in applying those laws as well.
Here is a list of items you should be sure to take care of, regardless of whether you are represented by an attorney:
- Gain an understanding of how your state’s laws on property division work.
- If you owned property separately during the marriage, be sure you have the papers to prove that it’s been kept separate.
- Be ready to document any non-financial contributions to the marriage, e.g., your support of a spouse while he or she attended school or your non-financial contributions to his or her financial success.
- If you need alimony or child support, be ready to document your need for it.
If you have not worked outside the home during the marriage consider having the divorce decree provide for money for you to be trained or educated.
After divorce each individual will file their own tax return. However, there are several areas where transactions between former spouses can result in tax consequences. The most common areas are:
Child support is not deductible by the payer and is not taxable to the recipient. A payment is considered to be child support if it is specifically designated as such in a divorce or separation agreement or if it is reduced by the occurrence of a contingency related to the child (such as attaining a certain age).
Alimony is a payment made pursuant to a divorce decree other than child support or designated as something in the instrument as other than alimony. Similar treatment is accorded separate maintenance payments made pursuant to a separation agreement. In order to qualify, payments must also cease upon the death of the recipient and must not be front-loaded.
Starting in 2019, alimony as well as separate maintenance payments were repealed by the Tax Cuts and Jobs Act of 2017 and are no longer deductible by the payer spouse.
For tax year 2018 and those years preceding it, alimony is deductible by the payer and is taxable to the recipient.
Property settlements are not taxable events when pursuant to divorce or separation. Transfers of assets between spouses in this event do not result in taxable income, deductions, gains or losses. The cost basis of the property carries over to the recipient spouse. Be careful in a divorce, your spouse may give you an equal share of property based upon fair market value, but with the lower basis. This can result in a higher taxable gain upon a sale of the asset.
Generally, when these plans are split up there is no taxable event if pursuant to a qualified domestic relations order or other court order in the case of an IRA. This is true, however, only if the assets remain in a retirement account or IRA. Once funds are distributed they will be taxed to the recipient. At the time of division, the payer does not receive a deduction and the recipient does not have taxable income.
Generally, no; however, fees paid specifically for income or estate tax advice pursuant to a divorce may be deductible. Also, fees made to determine the amount of alimony or to collect alimony can be deducted. These deductions would be miscellaneous itemized deductions subject to the two percent limitation.
For tax years 2018 through 2025, miscellaneous itemized deductions (Form 1040, Schedule A) have been eliminated due to tax reform (Tax Cuts and Jobs Act of 2017).
Generally, the custodial parent is entitled to the deduction. However, this is often negotiated in the divorce settlement. If the parents agree in writing, the non-custodial parent can take the deduction.
For tax years 2018 through 2025, the personal exemption as well as dependent exemptions is eliminated due to tax reform (Tax Cuts and Jobs Act of 2017). However, the dependent exemption deduction for noncustodial parents still exists for 2018-2025 (that is, it was not repealed) but is reduced to $0.
Death of a Loved One: FAQs
Here is a list of the papers that you will probably need:
- Certified copies of the death certificate (at least 10). You can purchase them through the funeral director or directly from the County Health Department.
- Copies of all insurance policies, which may be located in the deceased’s safe deposit box or among his or her personal belongings.
- Social Security numbers of the deceased, the spouse, and any dependent children.
- Military discharge papers, if the deceased was a veteran. If you cannot find a copy, write to The Department of Defense, National Personnel Record Center, 1 Archives Drive, St. Louis, MO 63138.
- Marriage Certificate, if the spouse of the deceased will be applying for benefits. Copies of marriage certificates are available at the Office of the County Clerk where the marriage license was issued.
- Birth Certificates of dependent children. Copies are available at either the State or the County Public Health offices where the child was born.
- The Will, which may be with the deceased’s lawyer.
- A complete list of all property including real estate, stocks, bonds, savings accounts and personal property of the deceased.
If the death is not unexpected, you should try to gather these papers in advance (other than the death certificate, of course) to lessen the strain at the time of death.
You should check with your financial advisor as to how you should handle the following assets of the deceased, but some general rules of thumb include:
- Insurance Policies. You may need to change the beneficiaries of policies held by the spouse of the deceased. Moreover, if the spouse does not have any dependents, it might be wise to reduce the amount of life insurance coverage. Auto and home insurance may also need revision.
- Automobiles. Check with your State DMV to see if the title of the deceased’s car needs to be changed.
- Bank Accounts. If the deceased and his or her spouse had a joint bank account, title will automatically pass to the surviving spouse. Notify the bank to change its records to reflect this change in ownership. If a bank account was held only in the name of the deceased, that asset will have to go through probate (unless it’s a trust account).
- Stocks and Bonds. To change title to stocks or bonds, check with the deceased’s broker.
- Safe Deposit Box. In most states, you will need a court order to open a safe deposit box that is rented only the name of the deceased.
In most states, only the will and other materials pertaining to the death can be removed before the will has been probated.
- Credit Cards. Any credit cards exclusively in the name of the deceased should be canceled (and any payments due should be paid by the estate). As to credit cards in the names of both the deceased and his or her spouse, the surviving spouse should notify the credit card companies of the death and ask that the card should be reissued in the survivor’s name only.
You should update your own will if it provides that any of your property will pass to the deceased upon your death.
The best way to avoid overpaying for a funeral is to plan ahead. Further, it pays to know about the “Funeral Rule,” the regulation of the Federal Trade Commission (FTC) concerning funeral industry practices. The Funeral Rule provides that:
- The funeral provider must give you, over the phone, price and other readily available information that reasonably answers your questions.
- The funeral provider must give you (1) a general price list, (2) a disclosure of your important legal rights and (3) information about embalming, caskets for cremation, and required purchases.
- The funeral provider must disclose in writing any service fees for paying for goods or services on your behalf (such as flowers, obituary notices, pallbearers, and clergy honoraria). While some funeral providers charge you only their cost for these items, others add a service fee to their cost. The funeral provider must also inform you of any refunds, discounts, or rebates from the supplier of any such item.
- The funeral provider must disclose in writing your right to buy, and make available to you, an unfinished wood box (a type of casket) or an alternative container for a direct cremation.
- You do not have to purchase unwanted goods or services or pay any fees as a condition to obtaining those products and services you do want. In addition to the fee for the services of the funeral director and staff, you need pay only for those goods and services selected by you or required by state law.
- The funeral provider must give you an itemized statement of the total cost of the funeral goods and services you selected; this statement must disclose any legal, cemetery, or crematory requirements for you to purchase any specific funeral goods or services.
- The funeral provider is prohibited from telling you that a particular funeral item or service can indefinitely preserve the body of the deceased in the grave or claiming that funeral goods such as caskets or vaults will keep out water, dirt, or other gravesite substances.
If you have a problem concerning funeral matters, and cannot resolve it with the funeral director, contact your federal, state, or local consumer protection agencies, the Funeral Consumers Alliance, or the International Conference of Funeral Examining Boards.
The deceased is considered covered by Social Security if he or she paid into Social Security for at least 40 quarters. Check with your local Social Security office or call 800-772-1213 to determine if the deceased was eligible. If the deceased was eligible, there are two types of possible benefits.
One-Time Death Benefit
Social Security pays a death benefit toward burial expenses. Complete the necessary form at your local Social Security office, or ask the funeral director to complete the application and apply the payment directly to the funeral bill. This payment is made only to eligible spouses or to a child entitled to survivors benefits.
Survivors Benefits for a Spouse or Children.
If the spouse is age 60 or older, he or she will be eligible for benefits. The amount of the benefit received before age 65 will be less than the benefit due at age 65 or over. Disabled widows age 50 or older are eligible for benefits. The spouse of the deceased who is under the age of 60 but who cares for dependent children under the age of 16 or cares for disabled children may be eligible for benefits. The children of the deceased who are under the age 18 or are disabled may also be entitled to benefits.
Probate is the legal process of paying the deceased’s debts and distributing the estate to the rightful heirs. This process usually entails:
- The appointment of an individual by the court to act as “personal representative” or “executor” of the estate. This person is often named in the will. If there is no will, the court appoints a personal representative, usually the spouse.
- Proving that the will is valid.
- Informing creditors, heirs, and beneficiaries that the will is probated.
- Disposing of the estate by the personal representative in accordance with the will or state law.
The spouse or personal representative named in the will must file a petition with the court after the death. There is a fee for the probate process.
Depending on the size and complexity of the probable assets, probating a will may require legal assistance.
Assets that are jointly owned by the deceased and someone else are not subject to probate. Proceeds from a life insurance policy or Individual Retirement Account (IRA) that are paid directly to a beneficiary are also not subject to probate.
Here is a summary of the various taxes that may have to be paid on the death of a family member:
Federal Estate Tax. Amounts passing to a surviving spouse, and amounts passing to charity, are generally exempt from estate tax. Estate tax is generally only due on estates which, after reduction for what goes to spouse and charity, exceed the unified credit exemption equivalent, which in 2021 is $11,700,000 ($11,580,000 in 2020).
Contact the IRS for a Form 706, United States Estate (and Generation-Skipping Transfer) Tax Return, if you need to file an estate tax return. A federal estate tax return must be filed and taxes paid within nine months of the date of death absent extension.
State Estate and Inheritance Taxes. State laws vary. Many states impose estate taxes, which may apply in addition to federal estate taxes, or may apply even when federal estate taxes don’t. Some states impose inheritance taxes on individuals who receive inheritances, rather than on the estate.
Income Taxes. The federal and state income taxes of the deceased are due for the year of death. The taxes are due on the normal filing date of the following year unless an extension is requested. The spouse of the deceased may file a joint federal income tax return for the year of death. A spouse with a dependent child may file jointly for two additional years. IRS Publication 559, Survivors, Executors, and Administrators, may be helpful.
The disclaimer or generation-skipping transfer tax is a way for you to refuse all or part of property that would otherwise pass to you, via will, intestacy laws, or by operation of law. An effective disclaimer passes the property to the next beneficiary in line.
The fact that the property is treated as if it had passed directly from the decedent to the next-in-line beneficiary may save thousands of dollars in estate taxes. The provision for a disclaimer in a will and the wise use of a disclaimer allows intra-family asset shifting and income shifting for maximal use of the estate tax marital deduction, the unified credit, and the lower income tax brackets.
Disclaimers can also be used to provide for financial contingencies. For example, you can disclaim an interest if someone else is in need of the funds.
Yes, the surviving spouse can elect to file a joint return provided they did not remarry prior to the end of the tax year.
Generally, no. Proceeds of life insurance policies are not taxable income unless the recipient paid for the right to receive them. For example, if you purchased a policy as an investment.
Generally, yes. This is known as income in respect of a decedent. Since the deceased has not paid income tax on the distribution, the tax is owed by the recipient. If the value of the account was included in the decedent’s estate tax return, you may be entitled to a deduction for a portion of the estate taxes paid.
Assets held jointly with right of survivorship will transfer by law to the joint holder. Insurance policies or retirement accounts with a designated beneficiary will go to that beneficiary. Assets owned solely by the decedent will transfer according to state law. This is known as intestacy. These laws vary by state, but generally, give preference to the spouse and children.
Other Situations: FAQs
First, go to the seller of the item. Second, contact the relevant consumer agency. Finally, if neither of these results in satisfaction, you can file a lawsuit or use arbitration.
Contacting the Seller
Before you take your complaint to the store or other entity that sold you the service or product:
- Gather any evidence you may need, such as the receipt, a canceled check, photographs showing the problem, a warranty, a contract, or a bill of sale.
- Figure out what your goal is. Do you want the product replaced? Do you want your money back? Do you merely want an apology?
- Call the store or service provider and ask to make an appointment with the manager, customer service representative, or another appropriate person. Meet face to face with that individual and explain as succinctly as possible the nature of the problem and what you want to be done about it. If you talk on the phone, follow up with a letter, and make notes of the dates of your calls and to whom you spoke.
If the product is covered by a warranty, it’s usually better to follow up with the manufacturer instead of the merchant.
- If this doesn’t produce results, take your problem to a higher authority. This might be a supervisor or a corporate president. You should put your complaint in writing at this point if you haven’t already done so. Your letter should include your name, address, phone numbers, and account number (if relevant). If a product is involved, include the date and place of purchase, and the model and serial number. Briefly, state the problem with the product or service, and write about what you have done so far to resolve it. Finally, tell the letter recipient what you want done, and give him or her a deadline. Include copies of relevant documents (not originals), and keep a copy of your letter. Keep copies of anything you receive from the company.
Contacting an Agency
If you still haven’t achieved the result you wanted, look in the phone book for a consumer complaint agency, such as the state, county, or city consumer protection office, or the Better Business Bureau.
Or, you might want to go the trade association route. Some industry trade associations offer help in mediating disputes concerning their members.
If your complaint involves a bank, you might wish to contact the appropriate state banking regulator. Similarly, you might want to contact the state insurance regulator if an insurer is involved, the securities regulator for a securities problem, or the public utility commission for utility-related problems.
If the problem involves a state-licensed trade (e.g., a general contractor or a plumber), call the state licensing department.
If you bought a “lemon” used car, investigate your state’s lemon laws by contacting your state consumer protection agency.
If the problem involves mail order or mail fraud, contact your area postal inspector, who can be found in the U.S. government section of the phone book.
There may also be a local television news program hotline for resolving consumer complaints.
Call the agency first to find out what procedures it wants you to follow.
Filing a Lawsuit
When all else fails, you might want to file a court case–either a small claims case, if the amount of money involved is small enough (generally, under $5,000)–or a regular lawsuit. More often than not, simply contacting an attorney and having him or her write a letter to the merchant or service provider indicating that you intend to file a lawsuit will get you the result you are seeking. If a small claims case is involved, you generally won’t need to hire an attorney, but if the case doesn’t qualify for small claims, you’ll probably need to hire an attorney.
There are many ways to reduce your bank fees. Here are a few of them:
- Are there fees associated with your checking account? If so, then call your bank and find out what you can do to get free checking and free ATM usage. For example, you might need to keep a minimum balance in the account and use only ATMs at your own bank. You may want to ditch banks altogether and join a credit union, which typically charges less for banking services.
- Don’t keep too much money in a low-interest savings account. Find out how much money you’ll need access to in an emergency (generally three to six months’ worth of expenses) and keep only that amount in your savings account. The rest of your funds should be invested in the stocks and mutual funds or in the high-interest rate CD (Certificate of Deposit) you can find (check out Bankrate.com).
- If you still write checks don’t order them through your bank. Many check printers charge less for check orders than the printers used by banks.
Here are some ways to save on insurance of all types:
- Shop around for a life insurance policy. It pays to check prices on life insurance policies periodically because rates change frequently. Also, if you’ve quit smoking, you may be entitled to better rates after a few years.
- Take a look at your life insurance needs to see whether you even need a policy or are paying for too much coverage.
- Insure your home and autos with the same insurer. You may be able to get a break by doing this.
- Shop for auto insurance to try to get a lower rate.
- Install smoke detectors, burglar alarms, and sprinkler systems to save on homeowner’s insurance. Don’t forget to ask your insurance agent about other cost saving measures.
- Get rid of private mortgage insurance. Once you have enough equity in the home, ask your lender to cancel your private mortgage insurance.
Here are some thoughts to keep in mind when trying to cut utility costs:
- Your utility company or state may have a program that subsidizes making your home more energy-efficient. If not, there’s plenty of information out there about making your home more energy efficient such as caulking your windows and making sure your insulation’s “R” factor is correct for your location.
- Install CFLs (compact fluorescent lights) or LEDs (light-emitting diodes) instead of incandescent bulbs to save energy and money.
- Keep the thermostat at the lowest temperature comfortable in winter and the highest temperature comfortable in summer.
Consider the following options to help you reduce the cost of your mortgage:
- Paying down your mortgage. For most people, paying down a mortgage is an effective way of saving and increasing net worth. Decide that you will pay $100 or $200 per month-or more-in mortgage principal, and do it faithfully.
- Refinancing your mortgage. You may be able to save money by refinancing your mortgage., but you need to go through the calculations and see whether the reduction in your monthly payments would be worth the costs involved with refinancing. The general rule is that a reduction of at least two points will make it worthwhile to refinance if you intend to stay in the house for at least five years.
Today’s cost-cutting competition among land-line and mobile phone service providers offers a few opportunities for savings on your phone bills, such as:
- Shopping around to make sure you’re paying as little as possible for long-distance and mobile phone charges. Take the time to investigate which service provider will save you the most and switch if it is a better deal.
- Consider getting rid of your land-line phone altogether.
- Use e-mail or Skype to correspond with relatives and friends.
Frequently Asked Questions
Tax Saving Strategies: FAQs
For tax years 2018 through 2025 interest on home equity loans is only deductible when the loan is used to buy, build or substantially improve the taxpayer’s home that secures the loan. Prior to 2018, many homeowners took out home equity loans. Unlike other consumer-related interest expenses (e.g., car loans and credit cards) interest on a home equity loan was deductible on your tax return.
You may be able to take an immediate Section 179 expense deduction of up to $1,050,000 for 2021 ($1,040,000 in 2020), for equipment purchased for use in your business, instead of writing it off over many years. There is a phaseout limit of $2,620,000 in 2021 ($2,590,000 in 2020). Additionally, self-employed individuals can deduct 100 percent of their health insurance premiums. You may also be able to establish a Keogh, SEP, or SIMPLE IRA plan and deduct your contributions (investments).
You sometimes may benefit from filing separately instead of jointly. Consider filing separately if you meet the following criteria:
- One spouse has large medical expenses, miscellaneous itemized deductions, or casualty losses.
- The spouses’ incomes are about equal.
Separate filing may benefit such couples because the adjusted gross income “floors” for taking the listed deductions will be computed separately.
In 2021 (as in 2020), medical and dental expenses are deductible to the extent they exceed 7.5 percent of your adjusted gross income or AGI. If your employer offers a Flexible Spending Account (FSA), Health Savings Account, or cafeteria plan, these plans permit you to redirect a portion of your salary to pay these types of expenses with pre-tax dollars.
If you’re planning to make a charitable gift, it generally makes more sense to give appreciated long-term capital assets to the charity, instead of selling the assets and giving the charity the after-tax proceeds. Donating the assets instead of the cash avoids capital gains tax on the sale, and you can obtain a tax deduction for the full fair-market value of the property.
If you also have an investment on which you have an accumulated loss, it may be advantageous to sell it prior to year-end. Capital gains losses are deductible up to the amount of your capital gains plus $3,00 ($1,500 for married filing separately). If you are planning on selling an investment on which you have an accumulated gain, it may be best to wait until after the end of the year to defer payment of the taxes for another year (subject to estimated tax requirements).
For growth stocks you hold for the long term, you pay no tax on the appreciation until you sell them. No capital gains tax is imposed on appreciation at your death.
Interest on state or local bonds (“municipals”) is generally exempt from federal income tax and from tax by the issuing state or locality. For that reason, interest paid on such bonds is somewhat less than that paid on commercial bonds of comparable quality. However, for individuals in higher brackets, the interest from municipals will often be greater than from higher paying commercial bonds after reduction for taxes.
For high-income taxpayers, who live in high-income-tax states, investing in Treasury bills, bonds, and notes can pay off in tax savings. The interest on Treasuries is exempt from state and local income tax.
Consider setting up and contributing as much as possible to a retirement plan. These are allowed even for a sideline or moonlighting business. Several types of plans are available: the Keogh plan, the SEP, and the SIMPLE IRA plan.
Through the use of tax-deferred retirement accounts you can invest some of the money you would have otherwise paid in taxes to increase the amount of your retirement fund. Many employers offer plans where you can elect to defer a portion of your salary and contribute it to a tax-deferred retirement account. For most companies, these are referred to as 401(k) plans. For many other employers, such as universities, a similar plan called a 403(b) is available.
Some employers match a portion of employee contributions to such plans. If this is available, you should structure your contributions to receive the maximum employer matching contribution.
If you are due a bonus at year-end, you may be able to defer receipt of these funds until January. This can defer the payment of taxes (other than the portion withheld) for another year. If you’re self-employed, defer sending invoices or bills to clients or customers until after the new year begins. Here, too, you can defer some of the tax, subject to estimated tax requirements.
You can achieve the same effect of short-term income deferral by accelerating deductions, for example, paying a state estimated tax installment in December instead of at the following January due date.
Most individuals are in a higher tax bracket in their working years than during retirement. Deferring income until retirement may result in paying taxes on that income at a lower rate. Deferral can also work in the short term if you expect to be in a lower bracket in the following year or if you can take advantage of lower long-term capital gains rates by holding an asset a little longer.
Recordkeeping For Your Taxes: FAQs
Keep detailed records of your income, expenses, and other information you report on your tax return. A good set of records can help you save money when you do your taxes and will be your trusty ally in case you are audited.
There are several types of records that you should keep. Most experts believe it’s wise to keep most types of records for at least seven years, and some you should keep indefinitely.
Keep records of all your current year income and deductible expenses. These are the records that an auditor will ask for if the IRS selects you for an audit.
Here’s a list of the kinds of tax records and receipts to keep that relate to your current year income and deductions:
- Income (wages, interest/dividends, etc.)
- Exemptions (cost of support)
- Medical expenses
- Charitable contributions
- Child care
- Business expenses
- Professional and union dues
- Uniforms and job supplies
- Education, if it is deductible for income taxes
- Automobile, if you use your automobile for deductible activities, such as business or charity
- Travel, if you travel for business and are able to deduct the costs on your tax return
While you’re storing your current year’s income and expense records, be sure to keep your bank account and loan records too, even though you don’t report them on your tax return. If the IRS believes you’ve underreported your taxable income because your lifestyle appears to be more comfortable than your taxable income would allow, having these loan and bank records may be just the thing to save you.
Keep the records of your current year’s income and expenses for as long as you may be called upon to prove the income or deduction if you’re audited.
For federal tax purposes, this is generally three years from the date you file your return (or the date it’s due, if that’s later), or two years from the date you actually pay the tax that’s due, if the date you pay the tax is later than the due date. IRS requirements for record keeping are as follows:
- You owe additional tax and situations (2), (3), and (4), below, do not apply to you; keep records for 3 years.
- You do not report income that you should report, and it is more than 25 percent of the gross income shown on your return; keep records for 6 years.
- You file a fraudulent return; keep records indefinitely.
- You do not file a return; keep records indefinitely.
- You file a claim for credit or refund* after you file your return; keep records for 3 years from the date you filed your original return or 2 years from the date you paid the tax, whichever is later.
- You file a claim for a loss from worthless securities or bad debt deduction; keep records for 7 years.
- Keep all employment tax records for at least 4 years after the date that the tax becomes due or is paid, whichever is later.
Yes, keep your old tax returns.
One of the benefits of keeping your tax returns from year to year is that you can look at last year’s return while preparing this year’s. It’s a handy reference and reminds you of deductions you may have forgotten.
Another reason to keep your old tax returns is that there may be information in an old return that you need later.
Audits and your old tax returns
Here’s a reason to keep your old returns that may surprise you. If the IRS calls you in for an audit, the examiner will more than likely ask you to bring your tax returns for the last few years. You’d think the IRS would have them handy, but that’s not the way it works. More than likely, your old returns are stored in a computer, in a storage area, or on microfilm somewhere. Usually, your IRS auditor has just a report detailing the reason the computer picked your return for the audit. So having your old returns allows you to easily comply with your auditor’s request.
How long should I keep my old tax returns?
You may want to keep your old returns forever, especially if they contain information such as the tax basis of your house. Probably, though, keeping them for the previous three or four years is sufficient.
If you throw out an old return that you find you need, you can get a copy of your most recent returns (usually the last six years) from the IRS. Ask the IRS to send you Form 4506, Request for Copy or Transcript of Tax Form. When you complete the form, send it, with the required small fee, to the IRS Service Center where you filed your return.
You need to keep some other types of tax records and receipts because they tell you how much you paid for something that you may later sell.
Keep the following types of records:
- Records of capital assets, such as coin and antique collections, jewelry, stocks, and bonds.
- Records regarding the purchase and improvements to your home.
- Records regarding the purchase, maintenance, and improvements to your rental or investment property.
How long should I keep these records? You need to keep these records as long as you own the item so you can prove the cost you use to figure your gain or loss when you sell the item.
There are other records you should keep, even though they don’t appear to have any use for your tax returns. Here are a few examples:
- Insurance policies, to show whether you were to be reimbursed in case you suffer a casualty or theft loss, have medical expenses, or have certain business losses.
- Records of major purchases, in case you suffer a casualty or theft loss, contribute something of value to a charity or sell it.
- Family records, such as marriage licenses, birth certificates, adoption papers, divorce agreements, in case you need to prove change in filing status or dependency exemption claims.
- Certain records that give a history of your health and any medical procedures, in case you need to prove that a certain medical expense was necessary.
- These categories are the most universal and should cover most of your recordkeeping needs. Everyone’s needs are unique, however, and there may be other records that are important to you. Skimming through our Tax Library Index might highlight other categories that apply to you.
Unless you own or operate your own business, partnership, or S corporation, recordkeeping does not have to be fancy.
Your recordkeeping system can be as casual as storing receipts in a box until the end of the year, then transferring the records, along with a copy of the tax return you file, to an envelope or file folder for longer storage.
To make it easy on yourself, you might want to separate your records and receipts into categories, and file them in labeled envelopes or folders. It’s also helpful to keep each year’s records separate and clearly labeled.
If you have your own business, or if you’re a partner in a partnership or an S corporation shareholder, you might find it valuable to hire a bookkeeper or accountant.
Do you contribute to charity?
If you donate to a charity, you must have receipts to prove your donation.
Starting in 2007, contributions in cash or by check aren’t deductible at all unless substantiated by one of the following:
- A bank record that shows the name of the qualified organization, the date of the contribution, and the amount of the contribution. Bank records may include: a canceled check, a bank or credit union statement or a credit card statement.
- A receipt (or letter or other written communication) from the qualified organization showing the name of the organization, the date of the contribution, and the amount of the contribution.
- Payroll deduction records. The payroll records must include a pay stub, Form W-2 or other document furnished by the employer that shows the date and the amount of the contribution, and a pledge card or other document prepared by or for the qualified organization that shows the name of the organization.
Besides deducting your cash and non-cash charitable donations, you can also deduct your mileage to and from charity work. If you deduct mileage for your charitable efforts, keep detailed records of how you figured your deduction.
Are you employed by someone else?
If you work for someone else and spend your own money on company business, keep good records of your business expense receipts. You will need these records to either get a reimbursement from your employer or to prove business-related deductions that you take on your taxes.
Do you have income from tips?
If you make tips from your job, the hand of the IRS reaches here too, and if you are ever audited, the IRS will be interested in records of how much you made in tips.
Do you own property?
If you own property, be particularly careful to keep receipts or some other proof of all your expenses, especially for repairs and improvements.
Do you hire domestic workers?
It’s important to keep accurate information about who works for you, including nannies and housekeepers, when and where they worked for you, and how much you paid them for the work.
Do you have a business?
If you have a business, you must keep very careful records of all your business expenses, including vehicle mileage, entertainment expenses, and travel expenses.
If you have a business, just because you have cash in your pocket doesn’t mean you’re in the black on the books. Keeping up-to-date records of all transactions and costs will not only help you tax wise, it will tell you if your business is actually profitable.
Do you travel for your business?
If you travel for business, keep good receipts and logs of all your travel expenses, including those for meals and entertainment. You will need this information whether you work for yourself or for someone else.
Tax Benefits of Higher Education: FAQs
A wide variety of tax relief is available, but you’ll need to choose which credit or deduction to claim or which savings plan to use based on your individual tax situation. You also can’t use two different kinds of relief for the same item. For instance, you can’t take the higher education credit and tuition fees deduction for the same student for the same year. You also can’t take the American Opportunity Tax Credit and the Lifetime Learning Credit for the same student for the same year. There may also be limits based on adjusted gross income.
Two tax credits are available for education costs – the American Opportunity Tax Credit and the Lifetime Learning Credit. These credits are available only to taxpayers with adjusted gross income below specified amounts, see Income Phase-Outs, below. Both credits were made permanent by the Protecting Americans from Tax Hikes Act of 2015 (PATH).
How Do These Credits Work?
The amount of the credit you can claim is either, $0, $2,000, or $4,000 and depends on (1) how much you pay for qualified tuition and other expenses for students and (2) your adjusted gross income (AGI) for the year.
You must report on Form 8863 the eligible student’s name and Social Security number on your return to claim the credit. You subtract the credits from your federal income tax. If the credit reduces your tax below zero, you cannot receive the excess as a refund. If you receive a refund of education costs for which you claimed a credit in a later year, you may have to repay (“recapture”) the credit.
If you file married-filing separately, you cannot claim these credits.
Which costs are eligible? Qualifying tuition and related expenses refer to tuition and fees, and course materials required for enrollment or attendance at an eligible education institution. They now include books, supplies, and equipment needed for a course of study whether or not the materials must be purchased from the educational institution as a condition of enrollment or attendance.
“Related” expenses do not include room and board, student activities, athletics (other than courses that are part of a degree program), insurance, equipment, transportation, or any personal, living, or family expenses. Student-activity fees are included in qualified education expenses only if the fees must be paid to the institution as a condition of enrollment or attendance. For expenses paid with borrowed funds, count the expenses when they are paid, not when borrowings are repaid.
If you pay qualified expenses for a school semester that begins in the first three months of the following year, you can use the prepaid amount in figuring your credit.
You pay $1,500 of tuition in December 2021 for the winter 2021-2022 semester, which begins in January 2022. You can use the $1,500 in figuring your 2021 credit. If you paid in January instead, you would take the credit on your 2022 return.
As future year-end tax planning, this rule gives you a choice of the year to take the credit for academic periods beginning in the first 3 months of the year; pay by December and take the credit this year; pay in January or later and take the credit next year.
Eligible students. You, your spouse, or an eligible dependent (someone for whom you can claim a dependency exemption, including children under age 24 who are full-time students) can be an eligible student for whom the credit can apply. If you claim the student as a dependent, qualifying expenses paid by the student are treated as paid by you, and for your credit purposes are added to expenses you paid. A person claimed as another person’s dependent can’t claim the credit. The student must be enrolled at an eligible education institution (any accredited public, non-profit or private post-secondary institution eligible to participate in student Department of Education aid programs) for at least one academic period (semester, trimester, etc.) during the year.
No “double-dipping.” The tax law says that you can’t claim both a credit and a deduction for the same higher education costs. It also says that if you pay education costs with a tax-free scholarship, Pell grant, or employer-provided educational assistance, you cannot claim a credit for those amounts.
Income limits. To claim the American Opportunity Tax Credit, for example, your modified adjusted gross income (MAGI) must not exceed $90,000 ($180,000 for joint filers). To claim the Lifetime Learning Credit, MAGI must not exceed $69,000 ($138,000 for joint filers). “Modified AGI” generally means your adjusted gross income. The “modifications” only come into play if you have income earned abroad.
The American Opportunity Tax Credit
The American Opportunity Tax Credit (AOTC) was made permanent starting with tax-year 2015. The maximum credit, available only for the first four years of post-secondary education, is $2,500. You can claim the credit for each eligible student you have for which the credit requirements are met.
Special qualification rules. In addition to being an eligible student, he or she:
- Must be enrolled in a program leading to a degree, certificate, or other recognized credential;
- Must be taking at least half of a normal full-time load of courses, for at least one semester or trimester beginning in the year for which the credit is claimed; and
- May not have any drug-related felony convictions.
Amount of credit. The maximum amount of the AOTC is $2,500. Generally, 40 percent of the AOTC is now a refundable credit for most taxpayers, which means that you can receive up to $1,000 even if you owe no taxes.
The Lifetime Learning Credit
You may be able to claim a Lifetime Learning Credit of up to $2,000 (20 percent of the first $10,000 of qualified expense) for eligible students (subject to reduction based on your AGI). Only one Lifetime Learning Credit can be taken per tax return, regardless of the number of students in the family.
- The credit can help pay for undergraduate, graduate and professional degree courses, including courses to improve job skills.
- For courses taken to acquire or improve job skills, there are no requirements as to course loads, so that even one or two courses can qualify.
- The number of years for which this credit can be claimed is not limited.
Choosing the Credit. You can’t claim both credits for the same person in the same year. But you can claim one credit for one or more family members and the other credit for expenses for one or more others in the same year – for example, an American Opportunity Tax Credit for your child and a Lifetime Learning Credit for yourself.
Electing Not to Take the Credit. There are situations in which the credit is not allowed, or not fully available, if some other education tax benefit is claimed – where the higher education expense deduction is claimed for the same student, see below, or where credit and tax exemption (under a Section 529 or 530 program) are claimed for the same expense. In that case, the taxpayer – or, more likely, the taxpayer’s tax adviser – will determine which tax rule offers the greater benefit and if it’s not the credit, elect not to take the credit.
For an academic period (quarter, semester, etc.) beginning in the first 3 months of a calendar year, you can pick which year to pay the expense and take the credit. That is, pay in December 2021 and take the credit in 2021 or pay in, say, February 2022 and take the credit in 2022.
Your family may be able to save tax by foregoing the education credit and taking an available exemption for program distributions instead.
Sometimes. Examples are for relief provided for Coverdell Education Savings Accounts (Section 530 programs), for Qualified Tuition Programs (Section 529), for withdrawals from traditional and Roth IRAs, and for student loans.
An education IRA differs from other IRAs in the following ways:
- No more than $2,000 a year can be contributed to any beneficiary of a single 530 account in any year and contributors are subject to income limits. Modified AGI cannot exceed $110,000 ($220,000 joint filers).
- Contributions aren’t deductible and excess contributions are subject to penalty.
- Withdrawals are tax-free to the extent used for qualified education expenses.
- Contributions can’t be made after the student reaches age 18, and the account generally must distribute all funds by the student’s age 30.
A 530 account may be used for primary and secondary education, including paying for room and board of children in private schools, and for computers and related materials whether or not away from home.
There can be a number of Section 530 accounts for any student. Various family members, such as grandparents, aunts, and uncles, and siblings–and persons outside the family–can contribute to separate accounts for a student.
The original student beneficiary for the Section 530 account can be changed to another family member, such as a sibling – for example, where the original beneficiary wins a scholarship or drops out.
Funds can be rolled over tax-free from one family member’s Section 530 account to another’s for example, to avoid distribution when the first family member reaches age 30.
The education tax credit (where applicable) can be waived in favor of tax-free treatment for Section 530 account distributions.
Also called Section 529 plans, these college savings plans have been established by almost every state and some private colleges. You invest now to cover future college or vocational school expenses, by contributing to a savings account or buying tuition credits redeemable in the future. Investments grow tax-free, and distributions to pay college expenses can also be tax-free. You may choose any state’s plan, regardless of where you live. Starting in 2018, funds from 529 plans can be used for up to $10,000 of qualified expenses related to K-12 education as well.
Even if a QTP is used to finance a student’s education, the student or the student’s parents still may be eligible to claim the American Opportunity Tax Credit or the Lifetime Learning Credit.
Section 530 plans limit investment to $2,000 a year per student; 529 plans allow a much larger investment. Section 530 plans allow a wide choice of investments; 529 investment choices are limited and conservative. Section 530 is a single nationwide program, whereas each 529 program is different. Both are available for higher education as well as primary and secondary education.
Yes. The 10 percent penalty on withdrawal under age 59-1/2 won’t apply, but ordinary income tax will apply to at least some of the withdrawal.
Yes, generally under the same terms as traditional IRAs. Also, ordinary income tax is somewhat less likely or may be smaller in amount, than with traditional IRAs.
You can choose to take a tax deduction rather than the college tuition tax credits noted above. A tax deduction is usually taken if income is too high for the tax credits. The tax deduction reduces your amount of income. The tax credits reduce the amount of tax you pay.
A $4,000 above the line deduction for qualified tuition expenses was extended through tax-year 2020, but repealed for 2021 and beyond under the Consolidated Appropriations Act (CAA). In 2020, the deduction was allowed if taxpayer’s (modified) adjusted gross income is $80,000 or less ($160,000 or less on a joint return).
A business expense deduction is also allowed without dollar limit, for education that serves the taxpayer’s business, including employment. The deduction is also allowed for student loan interest; however, a taxpayer may not take more than one deduction for the same item.
If it’s not part of a degree or certificate program, and not work-related, the limited deduction (up to $4,000 for qualified tuition and fees) was your only option; however, please note that this deduction expired at the end of 2020 and was repealed for tax years 2021 and beyond. It is possible that in some instances, a sideline interest might qualify for exclusion if paid for under an employer-provided education assistance program.
Since personal interest is generally non-deductible, deductions must meet several tests:
- You must be the person liable on the debt and the loan must be for education only (not an open line of credit).
- Your income can’t exceed $170,000 on a joint return or $85,000 for single filers. Married couples filing separately cannot take the deduction.
- You can’t deduct if you’re claimed as a dependent.
- Deduction ceiling is $2,500 (starting in tax year 2013).
For tax years prior to 2018, you could deduct interest form a home equity loan used to pay educational and other non-home improvement-related expenses, not as student loan interest. In this case, there was no income ceiling on your deduction, and certain other student loan limits didn’t apply. However, for tax years 2018 through 2025, taxpayers are no longer able to deduct interest on home equity loans taken out for non-home-related purposes.
Usually you’re taxed on the unpaid loan balance, but the tax can be waived if the debt is canceled if you worked:
- For a certain period of time,
- In certain professions, and
- For any broad class of employers.
Tax reform legislation passed in 2017 further stipulated that student loan debt forgiveness due to death or permanent and total disability is excluded from income.
Interest on redemption of Series EE bonds is tax-exempt if you redeem them in a year you have qualified education expenses. Exemption depends on the amount of your income in the year you redeem the bond.
For tax years prior to 2018, the answer was, yes, if it’s to maintain or improve skills in your present job, but no, if it was to meet minimum requirements of that job, or to qualify to enter a new business. Furthermore, employee’s deductions were subject to the two percent floor on miscellaneous itemized deductions. However, under the Tax Cuts and Jobs Act of 2017 (“tax reform”), for tax years 2018 through 2025, employee business-related deductions (including education expenses) are disallowed. That is, there are no miscellaneous deductions on Schedule A as there were previously. Self-employed individuals are still able to deduct qualifying educational expenses on Schedule C.
Maybe not. Starting in 2013, up to $5,250 can be tax-free. Exemption can apply to graduate level courses.