Clearing Up Common Myths about Life Insurance Proceeds

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"The foundation of life insurance is the recognition of the value of a human life & the possibility of indemnification for the loss of that value." In translation, it means someone pays a premium to an insurance company for someone else to receive a a sum of money on his/ her death. The contract can also include a terminal or critical illness. Some life insurance contracts are only for a specified term. 

Many people know that having life insurance is important, however are not so sure about the proceeds that are distributed and the tax consequences of such distribution. This post seeks to clear up some of those common myths. 

The question, "Are life insurance proceeds taxable?", elicits the favorite answer of accountants worldwide, "It depends!". So what's the scoop? For federal income tax purposes, the proceeds are not taxable when received due to death of the insured. In fact, hey, they don't even get a mention on the federal income tax return! That's easy, you say?

How about the interest that has accrued on the policy? 
Like any other interest, this accrued interest is also reported. So if a beneficiary gets a check for $52,500 for the proceeds & the death benefit was $50,000 and $2,500 was interest, you report the $2,500 on Schedule B of your tax return. 

What if I receive death benefits in a lump-sum versus in installments?
That doesn't change the taxability. The benefits are not reported as income or you would not pay tax on any benefits paid due to death of the insured. The only exception to this is if the insurance proceeds are paid to you on death of a spouse, who died before October 23, 1986 and the benefits are received in installments-you can exclude $1,000 of the interest included in installments. 

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Is the right to receive life insurance proceeds a good planning tool?
Yes, it is & is used a lot in estate, trust & business planning. A life insurance policy can also be considered an asset. If the ownership is passed or sold to another party, for cash or any other kind of consideration, the proceeds paid to the beneficiary is considered taxable income to the beneficiary. 

Can this "asset" be useful to the owner of the policy as well?
Many use this as an investment device to pay for college or retirement. Income grows in the policy tax-deferred. Generally, if the policy is cashed in (or surrendered) during the lifetime of the policy holder, the proceeds are subject to tax if they are more than the investment in the policy. 

How is Investment in the policy calculated? 
The Investment = Total Premiums Paid In - Payouts in Cash from the Insurance Company. This is reported by the company to the policy holder on Form 1099-R, & it is reported on lines 16a and 16b of Form 1040. 

If a loan is taken out on a life insurance policy-if allowed under the terms of policy- the amount of the loan is not taxable. The interest paid is not tax deductible as well since the loan is a personal expense. 

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Sometimes benefits are paid out before death & the proceeds are excluded from income. These are called accelerated death benefits. These are fully excluded only if the insured has been certified by a qualified physician  as having an illness or physical condition that is expected to result in death within 24 months from the date of the certification. There are other definitions for chronically ill people who can exclude the proceeds from tax. There are certain restrictions that apply, the details for your policy should be examined. 

What does all this break down to?
Life insurance proceeds are taxable only in certain cases. However since life insurance premium is considered a personal expense, it is not deductible on your federal taxes. There are some costs that can be excluded from employer-provided insurance policies. The type of the policy, the ownership & the method by which the policy was purchased determines if the life insurance is taxable. 

Making this determination and planning for various ways in which your taxes will be affected needs consultation with a tax professional. 

Bibliography: Pub 554: Tax Guide for Seniors; The Life Insurance Buyers Guide from the NAIC. 

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As always, read my disclaimer here. Please consult a qualified tax professional for your unique tax needs. More of my contact information is on my website, www.mntaxsolutionsllc.com.

  

Streamlined Procedure And Foreign Bank Account Regs For Non-Resident US Citizens

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It all started with the announcement of the FATCA going into effect, then the new streamlined compliance procedures were announced in 2012 to go into effect on September 1st, 2012. More on FBAR Filing Requirements in my posts here and here. 

They were implemented in recognition that some U.S. taxpayers living abroad had failed to timely file U.S. federal income tax returns or FBARs, Form TD F 90-22.1. These delinquent taxpayers may have recently become aware of their filing obligations and now seek to come into compliance with the law. 

The new procedures are for non-residents including but not limited to dual citizens who have not filed U.S. income tax and other related information returns. 

As the Internal Revenue Service (IRS) envisioned it, this procedure is designed for those taxpayers who are considered a "low compliance risk". Having said that, the IRS still is the one to decide the intensity of the review and that will vary according to the level of risk presented by the submission. 

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• For those presenting a low compliance risk, the review will be expedited and no penalties will be asserted or follow-up actions will be pursued. 
• For those submissions that present a higher compliance risk, as determined by the IRS, the taxpayers will not be eligible for the streamlined process. Not only so, they will also be subject to a thorough review and sometimes full examination. The examination may then include more than 3 years of tax returns. 

Eligibility:  This procedure is available for: 

1. Non-resident U.S. taxpayers who have resided outside of the U.S since January 1st, 2009. 
2. These taxpayers must not have filed a U.S. tax return during this period. 
3. Amended tax returns submitted through this program will be considered "high risk" except in certain cases where the amended return was filed to submit a Form 8891. 
4. The taxpayers must have a valid Taxpayer Identification Number (TIN) or a Social Security Number (SSN). Those who do not have a TIN & are eligible for one may apply for it along with the submission made through this program. 

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The Procedure:  The actual process of submission goes like this: 

• The taxpayers will be required to file delinquent tax returns.
• With appropriate informational returns like Forms 3520 or Form 5471 for the past 3 years.
• Or to file delinquent FBARs (TD F 90-22.1) for the past 6 years. 
• Any applicable tax & interest has to be paid along with the  delinquent returns filed. 
• The submissions must include any income deferrals elected by the taxpayer where permitted by a relevant treaty.  

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How the IRS determines Compliance Risk:  The level of compliance risk is based on the returns filed & the additional information provided as per the responses to the Questionnaire which is an integral part of a submission. 

• Those returns which are "simple" and carry very little or no U.S. tax will have low compliance risk. Or if the submitted returns and application show less than $1,500 in tax due in each of the years filed, will be treated as low risk. 
• The risk level may rise if any of the following are present: refunds claimed on returns filed; tax returns not filed in country of residence; taxpayer is under audit or investigation; FBAR penalties previously assessed against taxpayer etc. (Complete list provided on irs.gov under instructions for the procedure) 

Other Considerations:   Please note that the above information is only to jump start your streamlined process & is not exhaustive. Taxpayers considering going down this route are advised that there is a risk of prosecution if the IRS & the Dept of Justice warrant it. In such cases, taxpayers should consult with their legal advisers and explore other means of disclosure such as the Offshore Voluntary Disclosure Program (OVDP). More about OVDP in my post here.  Readers should also note that those taxpayers who are ineligible to use the OVDP cannot use this streamlined procedure as well. 

Bibliography: irs.gov; Instructions for Streamlined Filing Compliance; IRS Fact Sheet FS-2011-13; IRM 4.26.16; Form TD F 90-22.1; Notice 2011-55

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As always, read my disclaimer here. Please consult a qualified tax professional for your unique tax needs. More of my contact information is on my website, www.mntaxsolutionsllc.com.

Small Business Payroll: Mistakes & How To Avoid Them

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Payroll Compliance is a challenge that many small businesses struggle with. Payroll done by business owners themselves mean that they need to have the know-how to comply with the Internal Revenue Service (IRS)'s strict rules regarding accurate reporting & deposits. Moreover, federal, state & local tax regulations change & many times without notice. Small business owners need to follow such changes keenly as well. 

Having a professional as a trusted guide & advisor helps small business owners (SBO) navigate these dangerous waters. It also saves them time and costly errors. Errors which are due to late filing or deposit of taxes increase the risk of steep penalties & scrutiny from the IRS. 

Mistakes & How to Avoid Them: 

• Misclassifying Employees: It is very important to correctly classify a worker-either as an independent contractor or as an employee. More on how that determination is made, is on my post here. This is a rampant problem and therefore the Government has enacted an Employee Misclassification Initiative. Misclassified employees are often denied access to critical benefits and protections and it also generates substantial losses to the Treasury and the Social Security and Medicare funds, as well as to state unemployment insurance and workers compensation funds.

        To Avoid: The SBO should learn the government definitions & the rules & regulations regarding worker classification. 

• Late Deposit of Taxes & Forms: There are due dates stipulated for depositing taxes & for filing the required forms by the IRS. Failure to meet these due dates may result in failure-to-deposit penalties upto 10% based on the total payroll amount & a 5% failure-to-file penalty. 

        To Avoid: The SBO should start preparing for payroll taxes early and keep a watchful eye on 

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the timeline. 

• Incorrect Forms Filed: Correct forms are necessary so that over or underpayment of taxes can be avoided. Correct forms also help with year-end reconciliation so the employees get correct W-2s. The business owners should also that the forms are signed before submission. 

To Avoid: The SBO should first verify the version of the forms being filed & make sure they are the most recent. They should double-check their figures. 

• Submitting Incorrect Amounts: The business owner will incur a penalty from 2 up to 10 percent if the wrong payroll amount is deposited. The penalties start accruing from the due date of the taxes. They can only be avoided if the failure is due to a reasonable cause and not willful neglect. There can be a one-time abatement sought. 

To Avoid: The SBO should make sure the math on the form is right if being done by hand. The numbers should be placed on the correct line numbers. Everything should be double-checked. 

Personally I urge all small business owners to hire a professional to do this job. Having a copy of the Publication 15 (Circular E)  is a must. 

Bibliography: IRS Pub 15 Circular E ; sba.gov-10 Step Guide to Setting Up Payroll; 

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As always, read my disclaimer here. Please consult a qualified tax professional for your unique tax needs. 

More of my contact information is on my website, www.mntaxsolutionsllc.com. 

Final Regs On The 3.8% Net Investment Income Tax

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The Accounting community was waiting for this eagerly, to see which of their recommendations had been adopted. On November 26th, 2013, the Department Of the Treasury issued final regulations governing the Net Investment Income Tax (NIIT). 

If you remember, the 3.8% tax took effect from January 1st, 2013. We talked about this in my post here and here.  It applies to individuals, estates & trusts who have Net Investment Income and Modified Adjusted Gross Income above the following threshold amounts:

• Married Filing Jointly & Qualifying Widower with Dependent Child- $250,000
• Single & Head of Household with Qualifying Person - $200,000
• Married Filing Separately- $125,000

Some Salient Points in the Final Regs & What May Affect You?

The final regulations usually follow proposed regulations but with changes adopted in answer to the recommendations provided. Comments which had been made were for the following: 

1. Calculation of net investment income;
2. Treatment of several special types of trusts;

   

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3. Interaction between various aspects of the Sec. 469 passive activity rules with the calculation of net investment income;
4. The method of gain calculation regarding a sale of an interest in a partnership or S corporation; and
5. Multiple areas where the proposed regulations could be simplified.

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• The general structure of calculating NIIT have been retained as in the proposed regulations. 
• The Internal Revenue Service (IRS) did not address the income & expenses excludible from NIIT. 
• The IRS rejected calls for providing special relief for estimated taxes with regard to NIIT even though many investors do not know till the end of the year if their pass-through investment will generate NIIT. 
• The IRS clarified that the foreign tax credit may not be used to offset NIIT. 
• The IRC 1411 final regs follow the proposed regs & provide that foreign trusts & estates are not subject to NIIT. However, this rule does not exempt U.S. beneficiaries from the application of NIIT to distributions from foreign income. 
• The IRS has issued guidance on capital loss carry-forwards against NIIT. 
• Certain net operating losses will be allowed against NIIT, the propsed regs had expressly disallowed these. 
• The IRS has deemed real estate professionals to be conducting "trade or business" thus removing their rental income from net investment income if certain requirements are met. 
• The final regs did not provide further clarification regarding the term "trade or business". 
• Regrouping of activities under Reg. Section 1.469-4 may not be elected if taxpayers do not have both net investment income & MAGI in excess of the applicable thresholds. However with the final regs, if a taxpayer has to amend his 2013 or 2014 tax return that causes him to exceed this threshold, he may then elect to regroup. 
• The special treatment of sale of S corp or partnership interests have been completely overhauled. Please read more here in this excellent article on forbes.com. 

  

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The final regulations are effective Dec. 2, upon their publication in the Federal Register, and generally apply to tax years beginning after Dec. 31, 2013. 

For tax years beginning before Jan. 1, 2014, taxpayers can rely on the proposed regulations or on the final regulations, but if a taxpayer takes a position in a tax year beginning before Jan. 1, 2014, that is inconsistent with the final regulations, and that position affects the treatment of one or more items in a tax year beginning after Dec. 31, 2013, then the taxpayer must make reasonable adjustments to ensure that the taxpayer’s tax liability under Sec. 1411 is not "inappropriately distorted" in tax years beginning after Dec. 31, 2013.

Bibliography: T.D. 9644; REG-130843-13; Journal Of Accountancy; Thomson Reuters-Resources; irs.gov

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As always, read my disclaimer here. Please consult a qualified tax professional for your unique tax needs. 

More of my contact information is on my website, www.mntaxsolutionsllc.com.