Taxes in retirement
First realize that you are now in charge. If you worked for w-2 wages, your employer took care if of your withholding. Now, it is your responsibility. Our tax system is a pay as you go kind of thing, so IRS is going to penalize you if you owe too much at the end of the year. To address this issue you should either have whoever is paying you a retirement income to withhold as your former employer did, or you can do what is called a quarterly estimate. That is when you send a check to Uncle Sam every quarter. Either method works, but you are the one responsible for figuring out how much should be withheld. Individual states vary on this pay-as-you-go system, with some allowing you to pay it all at the end of the year without any penalty.

Retirement income can compound your tax issues. Money coming out of a retirement account is going to be taxable at ordinary rates, which is your marginal rate as we previously discussed. This causes two things to happen. First, it will probably make your SS income more taxable. Second, it will make you hesitant to use your funds. You could go on that cruise you always wanted to take, but if you take out an extra $10,000 for the trip, you will probably need to take out another $3,000 to pay the generated taxes which then creates tax on $13,000. Once you hit the 85% figure with SS it can't get any worse, but it is taxed.

What is a possible solution? This one requires planning years ahead. We suggest, once you have maximized your company retirement matching requirement, which means that you contribute enough to your 401k to receive maximum matching funds. Then we suggest you open a regular after tax account and make contributions to it instead of additional amounts into your 401k. This approach allows you to access moneys later without creating too much extra tax. Consider it to be a pay-now-not-later approach to income tax. In our experience, we have found that clients who have sufficient sheltered retirement accounts to cover basic living expenses and a substantial after tax account to do special things with, such as travel, a new vehicle, or other significant items have experienced a wonderful and tax controlled retirement.

Estate Taxes - Gift Taxes
This topic is filled with misunderstanding. How gift tax and estates relate and when tax is paid on gifts and by whom is one of our most often asked questions. We will start with a discussion of the basics and proceed to details later.

We have lived with a $10,000 gift tax limit for years but now the annual gift tax exclusion has been raised to $12,000. This means that you may gift $12,000 to anyone of your choosing each year with no tax impact on you or the person you are gifting to. It is like giving Christmas presents but with an $12,000 limit. You may give this $12,000 gift to as many different people as you wish each year with no tax impact on anyone. Your spouse may do the same thing. As an example, mom and dad would each gift $22,000 to son and daughter-in-law for a total giving of $44,000. This may all occur with no tax to anyone and no reporting requirements.

The gift(s) may be personal or real property with a fair-market-value (FMV) that meets the exclusion limits. If the gift has a current value of $12,000 and a cost to the donor, of half that value, the donee, has a basis in the gift equal to the parents basis. This means that when the kids sell the asset, their cost is considered to be the same as the cost of it to mom and dad. The kids then may be facing a gain on the sale. Cost basis to the kids $5,500, sale price $12,000 taxable gain on the sale $5,500. If the gift is property, mom and dad's holding period goes with the asset, so the gain would probably be Long Term Capital Gain.

Gift tax and estate or inheritance tax all tie together in the sense that it is an attempt by the Government to place a tax on the movement of wealth from one generation to another. This kind of tax bears no relationship to Income Tax which we already have the opportunity to pay. Keeping the concept that the Government is taxing only large sums in mind may make this system a little easier to understand as we work through it.

That $12,000 exclusion applies to every year and is always free even if your gift to one person far exceeds that amount. If mom and dad gift a property to a child worth a FMV of $100,000, here is an example of how it works.

Title is passed and a Form 709 is to be filed. This is the gift tax return and may or may not require a check be attached to pay towards estate taxes. Most likely, no tax payment will be needed; it is more likely to be what is called an information filing only. The numbers would work as follows: When a $100,000 gift was made, the $24,000 exclusion from both parents was deducted, leaving a potential taxable gift of $74,000. A return is filed to report the above transaction. The IRS then files this Form 709 among thousands of others until the Form 706 Estate Tax Return is filed. The Form 709 is then pulled out via the SSN and the $74,000 is added to the amounts on the Form 706 to determine the total amount of money subject to estate tax. Then, the estate tax, if any, is computed on the total. In case you have made these gifts before and you are already at the estate tax level, then tax may be owed with your gift tax form. Note that the vast majority of us will not need to file a form 706 because we don't own enough assets to require one. Also note that I managed the estate tax attorneys and I in that job at least reviewed every single Form 706 filed.

One more important consideration before we move to the mundane. You must remember that when moving assets other than cash, which is always at face value, the gift is measured at current FMV and real estate and stocks carry with them the basis of the donor. If however, the asset moves with the death of the owner, the basis is stepped up to FMV. So, if the asset moves to the beneficiaries via the will, the basis is FMV which means the donees can sell with a cost basis equal to what it was worth on the day the person died. This could be make a huge tax difference.

The central issue of this tax, which as we said is basically unrelated to Income Tax, is to keep the value of your estate to something less than the excludable amount. Our difficulty is in dealing with this amount as it changes. At the moment, it is $1,500,000 for 2005 and $2,000,000 for 2006. Without Congressional action, this amount will revert back to $1,000,000 in 2011 It is financially best to die in 2010 as there are no estate taxes in that year as the law now reads. If you are close, keep on top of this issue.

As we discussed in other topics, life insurance owned by the deceased is included in the estate as are Living Trusts. Anything which is under the control of the deceased at death will be included in the estate. The bad scenario is where one spouse dies leaving everything to the surviving spouse and ownership is often transferred directly to the survivor under the rule of law and without probate. This transaction is simple at the time, but resulting in the loss of that exclusion of possibly millions. Then when grandma dies, she only gets her exclusion and grandpa's exclusion is lost. As discussed under Trusts, in the Asset Protection Topic, there are tools to help control this issue.

When moving a single asset to the next generation, reorganizing ownership into shares with a corporation or partnership will allow for a single asset to be moved a little at a time over several years. See Asset Protection. One thing to look out for is what one taxpayer learned the hard way. Grandma and Pa moved the ranch into a C Corporations so they could move shares into kids' ownership. Problem was that the ranch always ran at a loss. They needed to know that you can not move losses out of a C Corporation to the share holders.

If you are gifting to a qualified charity, the amounts may be unlimited, but the income tax deduction allowed is limited, so you should learn those limits.

Estate planning beyond what is covered here is complex and should be addressed with professional assistance.