Understanding Pre-Tax Accounts

 When it comes to investment accounts, you basically have two different types: pre-tax accounts and after-tax accounts. If you’ve settled on a pre-tax account, as many people do, or are considering opening one, it’s important to understand how this type of account works so that you can determine if it’s the best fit for your investments.  

Pre-Tax Accounts Mean Deferred Taxes

Many people think that a pre-tax account means that the money is taxed before it’s put into your account, but it’s actually quite the opposite. Money is put into a pre-tax account before any taxes are assessed. The money then gets taxed later when you make a withdrawal

If your plan is to save money for retirement and you’re likely to be in a lower income bracket once you do retire, this makes sense. If you’re earning less, your taxation should be less as well. But, if you’re likely, for whatever reason, to be in a much higher income bracket when it comes time to make a withdrawal, then you could end up paying more in taxes, which is the opposite of what you want. Thus, it’s vital to take your future, or at least the most likely future you can envision, into consideration when determining whether or not this type of account is right for you.

There Are Limits

Something else to understand is that you can’t necessarily just put all the money you want into these accounts each year. Since your deposits lower your taxable income, there are limits on how many deposits you can make. However, these limits vary based on various factors, such as the type of account. Thus, it’s always smart to choose a plan that has limits you can live with and that work for your overall investment strategy.

Ultimately, pre-tax accounts do have a number of benefits and can be a great help to many people. But, to use them to their best advantage, you will need to do some careful planning on your part. Plus, you’ll need to choose the right plan at the right time. For this reason, it’s always best to work closely with a financial professional to ensure you choose the right type of investment for you, your life, and your future plans and financial goals.

Taxable Income Know How

Wages, bonuses, and tips are all considered taxable income, but the IRS has a broad definition of what income exactly means.

The IRS considers various payments and fees for services as taxable income, and it's best to become familiar with the list.   

§  

-Executor, trustee of estate administrator fees

§ Jury Duty wage

§  Board of Director fee

§  Security deposits from a tenant

§  Alimony you received for your ex-spouse after 2018

§  Award prizes and contest winnings

§  Freelance income

§  Severance Pay

§  Back pay

§  Strike Benefits

§  Freelance income

§  Interest and dividends

These are just a few of the items on a long list of taxable income.  There is also an equally long list of things where you don't' have to pay tax.

§  Accident or personal injury reward

§  Interest income from bonds issued in your state

§  Scholarships and grants

§  The money you receive as a gift.

§  Tax refund

§  The money you rolled from one retirement account to another.

Nontaxable income may not be as easy to identify as you might think and why it's essential to become educated and informed.  The tax laws are confusing and reason to enlist help in figuring it all out. You can look for more information on the IRS taxable and nontaxable income guides on www.irs.gov under Publication 525, or know that Lewis CPA accountants are here to answer all questions.

Fantasy Sports and Tax Laws

Winning big in this year's Fantasy Football league, it dawns on you that you may have to report the winnings to Uncle Sam, but you're not 100% sure.  Here's the 411 on what constitutes taxable income.  

To put it simply, if your winnings are at least $600, the organizers of those gaming websites like DraftKings are legally bound to report to the IRS.  They should send you and the IRS a 1099-MISC form.  There is also a form used called the 1099-K, that is used if you receive your winnings through PayPal.  1099 forms are the notification to the government that you have taxable winnings and, in turn, give you notice of what you must report on taxes.  Regardless of whether you receive 1099, you're responsible for reporting net profits on the federal and state tax returns.

If you forgo using 1099, you can report winnings on your 1040 as 'other income' and enter it on line 21 of the 1040 form.  If you can establish that playing fantasy sports if your profession, that it's a legit business, then you'd be able to report a net profit as business income.  You are also able to report losses, which makes this a great tax filing choice.  To claim fantasy sports as a business and not a hobby, the IRS requires a few founding characteristics.  Fantasy sports is more than just a hobby if you engage in it regularly, and you intend to earn a profit.  If an activity produces a profit two out of every five years, the IRS may consider it a business.

Fantasy sports can be considered a business, so make sure you're up to date on all the tax requirements, so you're sure to file appropriately.

Differences in Taxable and Non-Taxable Income

When it comes to income, there are basically two different types that you should be aware of: taxable income and non-taxable income. It is important for you to understand which type of income you should declare as taxable and which type you should declare as non-taxable. Making smart decisions in this regard can help you to reduce your tax liability.    

A good general rule of thumb to follow is that any income that increases your wealth is considered to be taxable income. Also, understand that most income does not fall under the non-taxable category. That doesn’t necessarily mean, however, that you have no non-taxable income, and assuming that and just declaring everything as taxable can end up hurting you in the long run.

What is Non-Taxable Income?

As mentioned, there honestly isn’t a ton that is non-taxable. However, some things that are typically going to be non-taxable include:

l  Inheritances

l  Healthcare benefits (in most cases)

l  Gifts

l  Cash rebates

l  Bequests

l  Welfare payments

l  Adoption reimbursements

l  Money from a life insurance policy in the case of a death (in some cases)

l  Money from a qualified scholarship that is not used for room and board

What is Taxable Income?

As mentioned, anything that increases your wealth or overall “value,” monetarily speaking, is considered to be taxable income.

This can include things such as:

l  Salaries

l  Childcare fees

l  Commissions

l  Stock options, as well as their interests and dividends

l  Unemployment compensation

l  Royalty payments

l  Strike pay

l  Income from rental properties

l  Alimony

l  Income from fringe benefits

Of course, as with all things, there are some “gray areas” when it come to what is taxable and what is not.

For this reason, it is wise to have a tax/financial professional who can assist you with fully understanding the difference between the two types of income and helping you to make the best possible financial decisions for yourself. While you can figure all of this out on your own, why not make it easier and get professional assistance?

Related articles

• A personal-finance columnist with 15 years of experience shares her 3 biggest money regrets (businessinsider.com)

About the Alternative Minimum Tax

The alternative minimum tax was originally enacted to ensure that high-income taxpayers pay at least a minimum amount of tax if they benefit from certain deductions and other tax preference items.

The AMT tax computation is a parallel system to the regular tax system with its own definitions of income and expenses, rules for income recognition and timing, and exemptions and tax rates. Although every taxpayer is subject to AMT rules, the additional tax is paid only if the tax computation under AMT rules is higher than the tax computed under regular rules.

Even though the AMT was originally targeted toward high-income taxpayers, factors, including inflation and treatment of certain tax credits, can sometimes push lower-income taxpayers into an AMT situation.

How AMT Works

Certain items called “adjustments and preferences” are added to federal gross income. Personal exemptions that reduce taxable income for regular tax purposes are not allowed for AMT purposes and are added back to taxable income. A separate AMT exemption amount is allowed, depending on the taxpayer’s filing status. After the AMT adjustments and preferences are added to income, and the AMT exemption amount is subtracted, an AMT tax rate of 26% to 28% is applied. If the resulting tax is greater than regular tax, the difference is added to regular tax on line 45, Form 1040.

Example #1: When computed under regular rules, John’s income tax is $4,700. When computed under AMT rules, the tax amount is $3,900. Since his tax computed under AMT rules is less than his tax computed under regular rules, John will not pay any additional amount for AMT.

Example #2: Assume the same facts as Example #1, except when computed under AMT rules, John’s tax amount is $5,100. Since his tax computed under AMT rules is higher than his tax computed under regular rules, John must pay the difference in additional tax. John must report additional AMT tax on line 45, Form 1040, in the amount of $400.

AMT Triggers

Items that commonly trigger AMT include high deductions for state income tax, dependent exemptions, exercise of incentive stock options, and large miscellaneous itemized deductions reported on Schedule A, Form 1040. Other AMT adjustments and preferences include:

•    Medical and dental expenses. A portion of these deductions may need to be added back for AMT purposes.

•    Taxes from Schedule A, Form 1040.

•    Certain mortgage interest deductions.

•    Tax refunds reported on Form 1040.

•    Certain investment interest expense.

•    Certain depletion expense.

•    Net operating losses.

•    Interest from specified private activity bonds.

•    A portion of gain from section 1202 small business stock.

•    Certain gains from dispositions of property.

•    Certain depreciation adjustments.

•    AMT loss limitations.

•    Certain circulation costs.

•    Long-term contracts.

•    Certain mining costs. 

•    Certain research and experimental costs.

•    Pre-1987 installment sale income.

•    Intangible drilling cost preferences.

AMT “Patch”

Because the original AMT law did not include a provision to index the exemption amount for inflation, over the years, a growing number of middle-income taxpayers have become subject to AMT. Historically, Congress limited the impact of the AMT by passing temporary legislation, often referred to as “patches,” to provide relief for millions of middle-income taxpayers who might otherwise be affected by AMT. Congress has patched the AMT every year for the past several years.

The “fiscal cliff” tax law that was passed on January 2, 2013, included a provision making the AMT patch permanent. Exemption amounts were retroactively increased for 2012 and will be indexed for inflation in future years. Under the new legislation, personal credits will also be allowed against the AMT on a permanent basis.

Related articles

• Alternative Minimum Tax: Common Questions (turbotax.intuit.com)