Changing Jobs? Don’t Forget About Your 401(K)

One of the most important questions you face when changing jobs is what to do with the money in your 401(k) plan. Making the wrong move could cost you thousands of dollars or more in taxes, penalties and lower returns.

Consequences of Cashing Out

Let’s say you work five years at your current job. For most of those years, you’ve had the company take a set percentage of your pretax salary and put it into your employer’s plan. Now that you’re leaving, what should you do?

The first rule of thumb is to leave it alone. Resist the temptation to cash out. The worst thing you can do when leaving a job is to withdraw the money and put it in your bank account. Here’s why:

If you decide to have your distribution paid to you, the plan administrator will withhold 20 percent of your total for federal income taxes. So if you had $100,000 in your account, you’re already down to $80,000.

Furthermore, if you’re younger than 59 1/2, you’ll generally face a 10 percent penalty for early withdrawal come tax time. Now you’re down another 10 percent from the top line to $70,000.

There is an exception to the 10 percent early withdrawal tax penalty for 401(k) plans if you separate from service during or after the year you reach age 55 (age 50 for public safety employees of a state, or political subdivision of a state, in a governmental defined benefit plan). IRAs, SEPs, SIMPLE IRAs, and SARSEPs do not qualify for the exception.

In addition, because distributions are taxed as ordinary income, at the end of the year, you’ll have to pay the difference between your tax bracket and the 20 percent already taken out. For example, if you’re in the 32 percent tax bracket, you’ll still owe 12 percent, or $12,000, which lowers the amount of your cash distribution to $58,000. (If your tax bracket is less than 20%, you may qualify for a refund, depending on your overall tax liability for the year compared to what was withheld or paid in estimated taxes for the year.)

But that’s not all. You also have to pay any applicable state and local taxes. Between taxes and penalties, you could end up with little over half of what you saved, short-changing your retirement savings significantly. Finally, you will miss out on any future tax-deferred growth those assets would have produced had they remained in the retirement plan.

What Are the Alternatives?

If your new job offers a retirement plan, the easiest course of action is to roll your account into the new plan. A “rollover” is relatively painless to do. Contact the 401(k) plan administrator at your previous job, who should have all the necessary forms.

The best way to roll funds over from an old 401(k) plan to a new one is to use a direct transfer. With the direct transfer, you never receive a check, you avoid all the taxes and penalties mentioned above, and your savings will continue to grow tax-deferred.

Many employers require that you work a minimum length of time before you can participate in their 401(k) plan. If that is the case with your new employer, one solution is to keep your money in your former employer’s 401(k) plan until you are eligible for the new one. Then you can roll it over into the new plan. Most plans let former employees leave assets in their old plan for several months or longer.

If you’re not happy with the fund choices your new employer offers, you might opt for a rollover IRA instead of your company’s plan. You can then choose from hundreds of funds and have more control over your money. But again, to avoid the withholding hassle, use direct rollovers.

60-Day Rollover Period

If you have your former employer make the distribution check out to you, the Internal Revenue Service considers this a cash distribution. The check you get will have 20 percent taken out automatically from your vested amount for federal income tax.

 

But don’t panic. You have 60 days to roll over the lump sum (including the 20 percent) to your new employer’s plan or into a rollover IRA. Then you won’t owe the additional taxes or the 10 percent early withdrawal penalty and, depending on your overall tax liability for the year, you might receive a refund of some or all of the 20% withheld. But keep in mind that in your rollover you will have to make up for the withheld 20% with funds from another source. Otherwise, the withheld amount will be treated as a distribution and subject to any applicable taxes and penalties.

Leave It Alone

If your vested account balance in your 401(k) is more than $5,000, you can usually leave it with your former employer’s retirement plan. Your balance will keep growing tax-deferred.

However, if you can’t leave the money in your former employer’s 401(k) and your new job doesn’t have a 401(k), your best bet is a direct rollover into an IRA. The same applies if you’ve decided to go into business for yourself. You can still continue to enjoy tax-deferred growth.

Questions about IRA rollovers? Help is just a phone call away.

Reporting Foreign Income on Your Federal Tax Return

By law, U.S. citizens and resident aliens living abroad must file a U.S. income tax return and report any worldwide income. Some key tax benefits, such as the foreign earned income exclusion, are only available to those who file U.S. returns. As such, if you are living or working outside the United States and Puerto Rico, you generally must file and pay your tax the same way as people living in the U.S. This includes people with dual citizenship. Here’s what taxpayers need to know about reporting foreign income:

Reporting Worldwide Income

Federal law also requires U.S. citizens and resident aliens to report any worldwide income, including income from foreign trusts and foreign bank and securities accounts. In most cases, affected taxpayers need to file Schedule B (Form 1040), Interest and Ordinary Dividends, with their tax returns. Part III of Schedule B asks about the existence of foreign accounts, such as bank and securities accounts, and usually requires U.S. citizens to report the country in which each account is located.

Some taxpayers may need to file additional forms with the Treasury Department:

Form 8938. Generally, U.S. citizens, resident aliens, and certain nonresident aliens must report specified foreign financial assets on Form 8938, Statement of Specified Foreign Financial Assets if the aggregate value of those assets exceeds certain thresholds. FATCA (Form 8938) is submitted on the tax due date (including extensions, if any) of your income tax return.

FBAR. Taxpayers with foreign accounts whose aggregate value exceeded $10,000 at any time during 2022 (or in 2023 for next year’s filing returns) must file a Treasury Department FinCEN Form 114 (formerly TD F 90-22.1), Report of Foreign Bank and Financial Accounts (“FBAR”). FBAR is not a tax form but is due to the Treasury Department by April 18, 2023, and must be filed electronically through the BSA E-Filing System website. It may be extended to October 16.

Foreign Earned Income Exclusion

Many Americans who live and work abroad qualify for the foreign earned income exclusion when they file their tax return. This means taxpayers who qualify will not pay taxes on up to $112,000 of their wages and other foreign earned income they received in 2022 ($120,000 in 2023).

Credits and Deductions

Taxpayers may also be able to take either a credit or a deduction for income taxes paid to a foreign country. This benefit reduces the taxes these taxpayers pay in situations where both the U.S. and another country tax the same income.

An income tax filing requirement applies even if a taxpayer qualifies for tax benefits such as the Foreign Earned Income Exclusion or the Foreign Tax Credit, which reduce or eliminate U.S. tax liability. These tax benefits are available only if an eligible taxpayer files a U.S. income tax return.

Automatic Extension

U.S. citizens and resident aliens whose tax home and abode are outside the U.S. and Puerto Rico on April 18, 2023, qualify for an automatic two-month extension (until June 15) to file their 2022 federal income tax returns. The extension of time to file also applies to those serving in the military outside the U.S. Taxpayers must attach a statement to their returns explaining why they qualify for the extension.

Additional Extension of Time to File

U.S. citizens and resident aliens living abroad may be granted a filing extension of up to six months (October 16, 2023) by filing Form 4868, Application for Automatic Extension of Time to File U.S. Individual Income Tax Return prior to the due date of the tax return (April 18, 2023). However, a taxpayer filing an extension must pay any tax due by the original date or be subject to late payment penalties and interest.

If you’re a taxpayer or resident alien living abroad that needs help with tax filing issues, IRS notices, and tax bills, or have questions about foreign earned income and offshore financial assets in a bank or brokerage account, don’t hesitate to call.

Five Overlooked Tax Breaks for Individuals

Are you confused about which credits and deductions you can claim on your 2022 tax return? You’re not alone. With tax law becoming more complicated every year, it’s hard to remember which tax breaks are available in any given year. With that in mind, here are five tax breaks you might not want to overlook.

  1. State Sales and Income Taxes

The IRS allows for a deduction of either state income tax paid or state sales tax paid, whichever is greater. As an individual, your deduction of state and local income, sales, and property taxes is limited to a combined total deduction of $10,000 ($5,000 if married filing separately). If you bought a big ticket item like a car or boat in 2022, deducting the sales tax might be more advantageous, but don’t forget to figure out any state income taxes withheld from your paycheck, just in case. If you’re self-employed, you can include the state income paid from your estimated payments. In addition, if you paid state tax when filing your 2021 tax return in 2022, you can include that amount in the state tax deduction on your 2022 federal tax return this year.

  1. Child and Dependent Care Tax Credit

Most parents realize that there is a tax credit for daycare when their child is young, but they might not realize that once a child starts school, the same credit can be used for before and after school care, as well as day camps during school vacations. The child and dependent care tax credit can also be taken by anyone who pays a home health aide to care for a spouse or other dependent such as an elderly parent who is physically or mentally unable to care for him or herself. The credit is worth a maximum of $1,050 or 35% of $3,000 of eligible expenses per dependent. For two or more qualifying children, the credit can be up to $6,000.

  1. Student Loan Interest Paid by Parents

Typically, a taxpayer can only deduct interest on mortgages and student loans if they are liable for the debt; however, if a parent pays back their child’s student loans, the IRS treats the money as if the child paid it. As long as the child is not claimed as a dependent, they can deduct up to $2,500 in student loan interest paid by the parent. The deduction can be claimed even if the child does not itemize.

  1. Medical Expenses

Most people know medical expenses are deductible if they are more than 7.5% of AGI for tax year 2022. They often don’t realize which medical expenses can be deducted, such as medical miles driven to and from appointments and travel (airline fares or hotel rooms) for out-of-town medical treatment. For 2022, these amounts are 22 cents per mile from July 1-December 31, 2022, and 18 cents per mile from January 1-June 30, 2022. For tax year 2023, the rate is 22 cents per medical mile driven.

Other deductible medical expenses that taxpayers might not be aware of include: health insurance premiums, prescription drugs, co-pays, and dental premiums and treatment. Long-term care insurance (deductible dollar amounts vary depending on age) is also deductible, as are prescription glasses and contacts, counseling, therapy, hearing aids and batteries, dentures, oxygen, walkers, and wheelchairs.

Self-employed individuals. If you’re self-employed, you can deduct the amount of your entire health insurance premium, and if you pay health insurance premiums for an adult child under age 27, you may be able to deduct them as well. Self-employed individuals aged 65 or older can also deduct the amounts paid for medicare premiums as long as they do not have a regular job covered under their (or their spouse’s) employer’s health care plan.

  1. Bad Debt

If you’ve loaned money to a friend but were never repaid, you may qualify for a non-business bad debt tax deduction of up to $3,000 annually. To qualify, however, the debt must be totally worthless in that there is no reasonable expectation of payment. Non-business bad debt is deducted as a short-term capital loss, subject to the capital loss limitations. You may take the deduction only in the year the debt becomes worthless. You do not have to wait until a debt is due to determine whether it is worthless. Any amount you are not able to deduct can be carried forward to reduce future tax liability.

If you think you qualify for these tax breaks but aren’t sure, help is just a phone call away.

Taxable vs. Nontaxable Income

Are you wondering if there’s a hard and fast rule about what income is taxable and what income is not? The quick answer is that all income is taxable unless the law specifically excludes it. But as you might have guessed, there’s more to it than that.

Taxable income includes any money you receive, such as wages, tips, and unemployment compensation. It can also include noncash income from property or services. For example, both parties in a barter exchange must include the fair market value of goods or services received as income on their tax return.

Nontaxable Income

Here are some types of income that are usually not taxable:

  • Gifts and inheritances
  • Child support payments
  • Welfare benefits
  • Damage awards for physical injury or sickness
  • Cash rebates from a dealer or manufacturer for an item you buy
  • Reimbursements for qualified adoption expenses

In addition, some types of income are not taxable except under certain conditions, including:

  • Life insurance proceeds paid to you are usually not taxable. But if you redeem a life insurance policy for cash, any amount that is more than the cost of the policy is taxable.
  • Income from a qualified scholarship is normally not taxable; that is, amounts you use for certain costs, such as tuition and required books, are not taxable. However, amounts used for room and board are taxable.
  • If you received a state or local income tax refund, the amount might be taxable. You should have received a 2022 Form 1099-G from the agency that made the payment to you. If you didn’t get it by mail, the agency might have provided the form electronically. Contact them to find out how to get the form. Be sure to report any taxable refund you received even if you did not receive Form 1099-G.

Important Reminders About Tip Income

If you get tips from customers, you must pay federal income tax on any tips you receive. The value of noncash tips, such as tickets, passes, or other items of value, are also subject to income tax. You must include the total of all tips you received during the year on your income tax return, such as tips received directly from customers, tips added to credit cards, and your share of tips received under a tip-splitting agreement with other employees.

Bartering Income is Taxable

Bartering is trading one product or service for another. Small businesses sometimes barter to get products or services they need. For example, a plumber might trade plumbing work with a dentist for dental services. Typically, there is no cash exchange; however, if you barter, the value of products or services from bartering is considered taxable income by the IRS.

Barter and trade dollars are the same as real dollars for tax purposes and must be reported on a tax return. Both parties must report as income the fair market value of the product or service they get. The tax rules may vary based on the type of bartering. Barterers may owe income taxes, self-employment taxes, employment taxes, or excise taxes on their bartering income. How you report bartering on a tax return also varies. For example, if you are in a trade or business, you normally report it on Form 1040, Schedule C, Profit or Loss from Business.

Questions?

Don’t hesitate to call if you have any questions about taxable and nontaxable income. Contact the ThomasRoss Group www.thomasrossfinancialgroup.com

Small Business Taxpayers: The Year in Review

Here’s what business owners need to know about tax provisions for 2022:

Standard Mileage Rates

Due to inflation, there were two standard mileage rates in 2022: 62.5 cents per business mile driven (July 1-December 31, 2022) and 58.5 per business mile driven (January 1-June 30, 2022).

Health Care Tax Credit for Small Businesses

Small business employers who pay at least half the premiums for single health insurance coverage for their employees may be eligible for the Small Business Health Care Tax Credit as long as they employ fewer than the equivalent of 25 full-time workers and average annual wages do not exceed $50,000. This amount is adjusted annually for inflation (e.g., for 2021 returns it was $56,000).

In 2022, the tax credit is worth up to 50 percent of your contribution toward employees’ premium costs (up to 35 percent for tax-exempt employers).

Section 179 Expensing and Depreciation

for 2022, the Section 179 expense deduction increased to a maximum deduction of $1.08 million of the first $2.70 million of qualifying equipment placed in service during the current tax year. The deduction is indexed to inflation for tax years after 2018 and enhanced to include improvements to nonresidential qualified real property such as roofs, fire protection, alarm systems and security systems, and heating, ventilation, and air- conditioning systems.

Businesses are allowed to immediately deduct 100% of the cost of eligible property placed in service after September 27, 2017, and before January 1, 2023, after which it will be phased downward over a four-year period: 80% in 2023, 60% in 2024, 40% in 2025, and 20% in 2026. The standard business depreciation amount is 26 cents per mile (same as 2021).

Work Opportunity Tax Credit (WOTC)

Extended through 2025 (The Consolidated Appropriations Act, 2021), the Work Opportunity Tax Credit can be used by employers who hire long-term unemployed individuals (unemployed for 27 weeks or more). It is generally equal to 40 percent of the first $6,000 of wages paid to a new hire. Please call if you have any questions about the Work Opportunity Tax Credit.

SIMPLE IRA Plan Contributions

Contribution limits for SIMPLE IRA plans increased to $14,000 for persons under age 50 and $17,000 for persons aged 50 or older in 2022. The maximum compensation used to determine contributions is $305,000.

Please contact the office if you would like more information about these and other tax deductions and credits to which you are entitled.