Strategies to Manage Taxes in Retirement

One way to potentially lower taxes in retirement is to start taking distributions from tax-deferred accounts before it’s required. Again, once you reach age 59½, you can withdraw funds from those accounts without paying the 10% early-withdrawal penalty. The withdrawals are still taxed as ordinary income, but over time they reduce the size of tax-deferred accounts, and thus the size of your RMDs. Another reason to access those funds before 70½ is that it could help you delay taking your Social Security benefit, which increases in size the later you take it, up to age 70.

That said, it’s important to look at your tax situation at age 59½ before taking early withdrawals. For the many Americans who will still be working at that age, withdrawing too much could push them into a higher tax bracket. Taking Social Security benefits could also push you into a higher tax bracket, but keeping RMDs low means less income would be subject to the higher tax rate.

One of the most popular and appealing strategies for reducing the potential tax consequences of RMDs is converting a traditional IRA or 401(k) plan into a Roth IRA before the age of 70½. Roth IRAs are funded with after-tax dollars and thus are exempt from RMDs during the owner’s lifetime — and when the funds are withdrawn, both the principal and earnings are tax-free. It’s worth noting that the act of converting to a Roth IRA is a taxable event and the five-year rule still applies.

A Roth conversion may make sense when you’re certain you’ll be in a higher bracket when you eventually withdraw the money, which is often the case once RMDs and Social Security are factored in. It may also be a good option when you don’t need the money, aren’t concerned about paying income taxes and would like to leave an income-tax-free Roth IRA to your heirs.

Lastly, if you make a full or partial conversion to a Roth IRA, you may be able to reduce the resulting tax burden via charitable giving during the same year as the conversion — though the donation can’t be funded from your retirement accounts.

There’s a lot to consider as you plan for how to manage your tax obligation in retirement. Consulting with a financial professional, and particularly a tax adviser, can help ensure your choices are most advantageous for your situation.

Catherine Golladay is senior vice president for 401(k) participant services and administration with Schwab Retirement Plan Services.

The information contained herein is proprietary to Schwab Retirement Plan Services Inc. (SRPS) and is for informational purposes only. None of the information constitutes a recommendation by SRPS. The information is not intended to provide tax, legal, or investment advice; please consult with your accountant or investment adviser for how this applies to your specific situation. SRPS does not guarantee the suitability or potential value of any particular investment or information source. Certain information provided herein may be subject to change.

BEAT Could Eat into Income Tax Savings

Tax legislation generally includes promises to simplify the process of computing taxes. But in the process of transforming legislation into law, those good intentions often are overshadowed by new complexities.

The Tax Cuts and Jobs Act of 2017 is no exception, especially for U.S. multinational corporations. Although most corporations herald their much lower 21% tax rate under the TCJA, it comes with a price.

The law’s Base Erosion Anti-Abuse Tax (BEAT) is designed to discourage companies from steering revenue to lower-tax countries overseas by reducing the incentive to shift profits to foreign-related parties.

Previously, corporations shipped $300 billion of profits annually to lower-tax countries. The Congressional Budget Office estimates that BEAT and other measures will instead add $65 million annually to the federal government’s coffers.

BEAT’s intricacies, of which there are many, haven’t been sorted out entirely, because the IRS has yet to issue final guidelines. But corporations with more than $500 million in U.S.-sourced revenue who make deductible payments to foreign-related entities are vulnerable. It amounts to an alternative minimum tax (AMT).

The BEAT calculation itself is fairly straightforward. It’s computed from Modified Taxable Income (MTI), which equals the corporation’s regular taxable income, with certain foreign-related payments added back.

The BEAT is the excess of 10% of MTI over the company’s regular liability, minus certain tax credits. (There will be an initial 5% phase-in rate for the 2018 tax year, then the 10% will apply through 2025, after which it will rise to 12.5%.) Like-kind payments may be aggregated in the calculation.

As befits tax legislation, details related to the BEAT calculation are more complex.

To begin, corporations must have U.S.-generated revenue of $500 million for the prior three years, subject to some deductions. Unlike the repealed AMT regime, there is no future credit for any BEAT that the taxpayer incurs. Thus, it is a lost cost.

BEAT affects both U.S. and non-U.S. corporations (controlled and consolidated groups), except for regulated investment company (RIC), REIT, and S corporations. The “foreign” entity criterion is satisfied by determining ownership of at least 25% of the taxpayer’s stock and/or other tests to determine relationship or control.

Banks will not receive the benefits of the historic rehabilitation tax credit and the new markets tax credits, and their rate is 1% higher; rates for registered securities dealers and affiliates can be 2% to 3%. BEAT may be considered an additional tax in determining a bank’s effective tax rate, which could reduce regulatory capital. And there is no netting of BEAT payments.

But calculating payments is more involved. Accruals of interest, rents, royalties, trademarks, and certain fees for services are included (though it’s unclear whether deemed/allocated interest expense for foreign banks under Treasury regulations Section 1.882-5 will be considered a BEAT payment).

Payments made in the ordinary conduct of business are excluded, such as cost of goods sold (COGS) and labor, plus qualifying derivative instruments, and other eligible service payments. (This should be addressed specifically in the proposed regulations due out for comment later this year; check IRS website for schedule dates.)

Although BEAT applies to foreign corporations with effectively connected income (ECI), it does not appear to exempt payments to foreign-related entities that treat such payments as ECI. Also, low taxable income due to net operating losses or large credits against regular tax may trigger BEAT.

Tax-filing with Free File – Pros and Cons

If you’re doing your own business taxes, you need a good tax software program. Whether you want to maximize your credits and deductions, or avoid penalties and audits, you need to be sure you’re partnering with a great company. Incomplete forms and inaccuracies are unforgivable when it comes to taxation, so it’s important to select software that’s going to do the job right the first time.

IRS Free File Software

Might be good for you: If you want a variety of options to choose from. IRS Free File Software allows you to prepare and e-file your taxes for free through certain brand-name software.

May not be the best: If your adjusted gross income in 2017 was more than $66,000, you cannot use IRS Free File Software to file your 2017 taxes.

Pros

Works with multiple free brand-name software programs. The IRS website lists a dozen free-file software providers.

Help choosing a provider. By answering some basic life questions such as your income, age and state of residence, the Free File Software Lookup Tool can help you choose a Free File Software provider for your tax situation.

Cons

There’s an income limit. You can’t use IRS Free File to file your 2017 tax return if your AGI exceeded $66,000 in 2017.

You may not qualify for all the business automation software available. Each software provider may have its own eligibility requirements, and you may be restricted based on your age, state of residence and/or military status.

You may have to pay to file your state taxes. Some companies will allow you to also file a state return for free, while others will charge. You’ll need to review each company’s offering to find out if a state return is included in the free e-filing service.

So, What is unique about Free File?

Completely free taxation platform. Free File allows taxpayers to choose their preferred company to prepare and efile tax returns for free. It is also combined with direct deposits to enable users to obtain refunds in a shorter period of time.

Free fillable forms. The Free File Fillable Forms offers taxpayers a convenient way to fill IRS forms electronically. It is an excellent option for taxpayers used to preparing and filing income taxes on their own.

Tax breaks. Free File features a question-and-answer format which is instrumental in helping eligible taxpayers to find tax breaks. Some of the possible tax breaks reserved for taxpayers could consist of credits like the earned income tax credit and more.

Easy online extensions. If for any reason you fail to finish your tax return by the deadline, you can request a six-month extension using the Free File. However, the extension to file your returns will not mean an extension of the time to pay.

IRS partnership. This service is, in fact, a result of the partnership between the International Revenue Service (IRS) and the Free File Alliance, a union of the leading private sector tax preparation institutions.