Day: May 29, 2019

Tax Guy: How to avoid painful tax issues when settling a loved one’s estate

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A loved one who was “financially comfortable” has passed away. What happens now tax-wise? Good question, especially if you’re the one responsible for taking care of financial matters. This column is the first installment of a three-part series covering the most important tax-related considerations when a loved one departs.

The role of the executor

When a loved one (the decedent) passes away, someone must tackle the job of handling the resulting tax issues. That person may be identified in the decedent’s will as the executor of the decedent’s estate. If there’s no will, the probate court will appoint an administrator. Either way, let’s just call that person the executor to keep it simple. That person may be you. If so, not so simple for you. So please pay close attention.

The executor’s job is to identify the estate’s assets, pay off its debts, and distribute the remainder to the rightful heirs and beneficiaries.

The executor is also responsible for filing any necessary tax returns and arranging to pay any taxes. So let’s start covering those bases.

Filing the final Form 1040

If the decedent was unmarried, the final Form 1040 covers the period from January 1 though through the date of death. The final return is prepared in the usual fashion. It is due on the standard date: 4/15/20 for someone who dies in 2019. The return can be extended for six months, to October 15 (adjusted for weekends and holidays) of the year after the year of the decedent’s death.

Side note: How to handle final medical expenses for taxes

Pay special attention to the decedent’s medical expenses. If large uninsured medical expenses were incurred in the year of death, the executor must make a potentially important choice about how they are treated for federal tax purposes. Along with any medical expenses paid before death, the executor can choose to deduct accrued (as-yet-unpaid) medical expenses on the decedent’s final Form 1040 to the extent they exceed 7.5% of adjusted gross income (AGI) for 2018 or 10% of AGI for 2019, assuming the decedent’s final Form 1040 claims itemized deductions.

To take advantage of this special rule, the medical expenses must be paid out of the decedent’s estate during the one-year period beginning with the day after the date of death. This special rule is an exception to the general rule that expenses of a cash-basis taxpayer must be paid in cash before they can be deducted. Final medical expenses can easily exceed the percent-of-AGI threshold, especially when death occurs early in the year before much income has been earned.

Alternatively, in the relatively unlikely event that the estate is subject to the federal estate tax, the executor can choose to deduct accrued medical expenses on the estate’s federal estate tax return rather than on the decedent’s final Form 1040. When no federal estate tax is owed, this is obviously not an option. The federal estate tax exemption for someone who died in 2018 is $11.18 million. It is $11.4 million for someone who dies in 2019.

Key Point: When federal estate tax is owed, deducting accrued medical expenses on the federal estate tax return is usually the tax-smart option. That is because the estate tax rate is 40% while the decedent’s final federal income tax rate could be as low as 10%. Also, the full amount of accrued medical expenses can be deducted on the estate tax return (not just the excess over the percent-of-AGI threshold).

Surviving spouse can usually file joint return for year of death

When there is a surviving spouse who remains unmarried as of the end of the year that includes the decedent’s date of death, the final Form 1040 can be a joint return filed as if the decedent were still alive. This final joint return includes the decedent’s income and deductions up to the time of death plus the surviving spouse’s income and deductions for the entire year. Filing a joint return is usually beneficial, because it allows the surviving spouse to take advantage of the more taxpayer-friendly rates and rules that apply to married joint-filing couples.

If the surviving spouse remarries on or before December 31 of the year that includes the decedent’s date of death, married filing separate status must be used for the decedent’s final Form 1040.

Surviving spouse may be able to use joint return rates for two more years

The tax-rate advantage of joint filer status is extended to a qualified widow or widower for the two tax years following the year that includes the decedent’s date of death.

To be a qualified widow/widower for the year, the surviving spouse must be unmarried as of the end of that year. The surviving spouse must also pay more than half the cost of maintaining a home that is the principal home for the entire year of a child of the surviving spouse (including a step-child) who qualifies as a dependent of the surviving spouse. Finally, the surviving spouse must have been eligible to file a joint return with the decedent for the tax year that includes the decedent’s date of death.

New Law Impact: The Tax Cuts and Jobs Act suspended dependent exemption deductions for 2018-2025. However, for purposes of various provisions that make reference to persons for whom dependent exemption deductions are allowed (such as the aforementioned eligibility rule for qualified widow/widower status), the dependent exemption is still deemed to exist for 2018-2025. It just equals $0 for those years. Strange but true!

If decedent had revocable trust

To avoid probate, many individuals and married couples of means set up revocable trusts to hold valuable assets including real property and financial accounts. These revocable trusts are often called living trusts or family trusts. For tax purposes, these trusts are so-called grantor trusts. As long as the trust remains in revocable status, it is a grantor trust and its existence is disregarded for federal tax purposes. Therefore, the grantor or grantors are treated as still personally owning the trust’s assets for tax purposes, and tax returns of the grantor(s) are prepared accordingly.

Unmarried individual’s trust

When an unmarried individual passes away, his or her grantor trust becomes irrevocable. As such, the trust is now treated as a separate taxpayer that is subject to the federal income tax rules for trusts. This is an unfavorable development, because the tax rates on undistributed trust income quickly climb to the maximum 37% rate for ordinary income and short-term capital gains and the maximum 20% rate for long-term capital gains (LTCGs) and qualified dividends. (See the section above about medical bills.) If the 3.8% net investment income tax also applies, the marginal federal rate on a trust’s undistributed investment income and gains can be as high as 40.8%/23.8%. Ouch!

Married couple’s trust

For married couples, grantor trusts typically continue to exist as such when the first spouse passes away. In that case, the trust’s existence continues to be disregarded for federal tax purposes, and the surviving spouse’s tax returns are prepared without regard to the trust. However, when the surviving spouse passes away, the trust becomes an irrevocable trust. As such, it is treated as a separate taxpayer with the unfavorable federal income tax consequences mentioned above.

Tax planning goal with trusts

To avoid the unfavorable federal income tax rates for trusts, it’s generally a good idea to get the income and gains out of the trust by either distributing them to the trust beneficiaries or by winding up the trust.

The bottom line

When an unmarried individual passes away, the important federal income tax considerations explained here can apply.

When a married individual passes away, the surviving spouse can often step into relatively favorable federal income tax rules. However, important timing considerations may apply.

In either scenario, you as the person responsible for handling tax matters may want to hire a professional to prepare returns and help you identify and implement tax-saving strategies for the future. Honestly, you probably need all the help you can get.

The 2019 federal income tax rate brackets for trusts are as follows.

Rate brackets for ordinary income

10% tax bracket                $0 – $2,600 
Beginning of 24% bracket           $2,601
Beginning of 35% bracket             9,301
Beginning of 37% bracket          $12,751

Rate brackets for LTCGs and dividends

0% tax bracket                 $ 0 – $2,650 
Beginning of 15% bracket            $ 2,651 
Beginning of 20% bracket         $12,951

The office grump, who gripes about wages, could be doing his employers a favor

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The office grump may be doing the whole company a favor.

When disgruntled employees have a chance to gripe about pay and conditions, they skip work and leave for other jobs at lower rates, according to new research. As garment workers absorbed news that a minimum wage increase was less than expected, the study — distributed by the National Bureau of Economic Research — found the quit rate was 20% lower for employees who participated in a randomly-assigned worker satisfaction survey.

‘The act of communicating dissatisfaction regarding the employment relationship is in itself valuable, at least in the short term.’

—‘Expectations, Wage Hikes, and Worker Voice: Evidence from a field experiment’

“The act of communicating dissatisfaction regarding the employment relationship is in itself valuable, at least in the short term,” wrote researchers from the University of Michigan, Boston College and the University of Hawaii at Manoa. Survey participants also showed up for work more often, they noted.

The research focused on a 2016 minimum-wage increase by the government. The wage increase was about three times smaller than what workers anticipated. After the increase, researchers surveyed a test group about their satisfaction with their job, their bosses and their work environment.

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On a five-point scale, workers gave less than a 3 to wage satisfaction, but gave around a 4 to workplace conditions. The quit rates were noticeably lower for the workers who were most disappointed in the low wage hike, according to the study distributed by the National Bureau of Economic Research.

While many aggrieved workers are advocating for fair treatment, there can be some contexts where constant complaining about small, day to day issues can just be a drag.

In the U.S. where employees arguably have more choices in a strong economy, managers might do well to read the study. There have been several protests and strikes this month — even as strikes have become increasingly infrequent in past years.

Last week, hundreds of McDonald’s MCD, -0.56%  workers walked off the job during breakfast and morning hours at chains in more than 10 cities to push for a $15 hour minimum wage and improved work conditions.

A McDonald’s spokeswoman told MarketWatch average pay at corporate-owned restaurants starts at $10 and wages at franchisee-owned restaurants is “likely similar. Separately, McDonald’s recognizes the rights under the law of individual employees to choose to join — or choose not to join — labor organizations.”

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Earlier this month, Uber UBER, -1.35%  and Lyft LYFT, -0.37% drivers — considered independent contractors by the company — went on strike to protest worker conditions and pay. The strike, which lasted between several hours and a day depending on location, happened days ahead of Uber’s IPO. Both companies told MarketWatch they treat their drivers fairly and listen to their concerns.

Unemployment rates are at the lowest point in the U.S. since 1969, so American workers might feel like they have options that don’t include sticking around.

But the latest study might have its limits when applied to the U.S. labor force. Many U.S. companies already have their workers fill out anonymous surveys on satisfaction. Likewise, not all worker complaints are the same. While many aggrieved workers are advocating for fair treatment, there can be some contexts where constant complaining about small, day to day issues can just be a drag.

Finally, merely relying on surveys to hear out workers might not be the best management strategy right now. Unemployment rates are at the lowest point since 1969, so workers might feel like they have options that don’t include sticking around.

Robert Sutton, professor of organizational behavior at Stanford Graduate School of Business, said the latest findings fit with other research that’s long established the benefits when company management hears out workers and treats workers well.

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A 1990 study compared theft rates at two plants going through pay cuts — one with a brief explanation of the pay cut and the other with a detailed explanation. There were higher employee theft rates among employees who received a detailed explanation.

Sutton said treating workers with genuine respect went a long way. And even if worker respect wasn’t a management priority for some companies, this tight job market might force them to fake it all the same. “The harder it is to hire the people you want,” the more companies and leaders will show they care — “even if they don’t,” he said.

More From MarketWatch What you need to know about buying a vacation home for retirement

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It’s been a goal for decades — a vacation home — and now it’s time to realize that goal. And while you should absolutely seize this opportunity, there are a lot of details to figure out before buying a vacation home during retirement. Here’s what you need to know about owning a vacation home from start to finish.

Paying for a vacation home

The first question anyone should ask before buying a vacation home is, “Can I afford it?” Your vacation home may be smaller than your primary residence, but if it’s in a desirable destination it could be more expensive.

If you need to pull money from retirement savings to afford a vacation home, think twice. But if your primary residence is paid off and you have a substantial down payment for a second home, a vacation property may be within your budget.

Your cost for a vacation home includes more than the purchase price. You want to account for additional expenses in your calculations, including:

  • Taxes: In addition to property taxes, you’ll pay higher taxes on the sale of a second home. Second homes aren’t eligible for the capital gains exemption.
  • Homeowner’s insurance: This may be higher if the vacation home has a pool, waterfront, or is in a flood zone. You need additional coverage if you plan to use the property as a rental.
  • Property management: If your home is vacant for long periods or you rent it out, you may want a property management agency to oversee maintenance, marketing and other logistics for you.
  • Moving expenses: While it’s a one-time cost, moving is costly, especially interstate moving. Compare the cost of moving furniture against buying new furnishings where your vacation home is located. For the items, you intend to move, use a moving cost calculator to understand what you can expect to spend.
Renting out your vacation home

Many vacation homeowners use their property as a short-term rental to offset the costs of ownership. Renting out your vacation home can be a smart call, but don’t underestimate the time and money involved. Unless you live nearby, you want to hire professionals to manage the property for you, including a:

  • Property manager to market the unit, handle tenant relations and coordinate maintenance.
  • Cleaning service to deep clean the unit before renting it out and between renters and your own return.
  • Landscaping company to maintain the exterior of the property.

It’s also important to be realistic about how renting a second home affects your own use of the property. You may not be able to use your vacation home during the most popular travel weekends if your goal is to maximize rental income. Know your priorities and whether you want to use your second home as an investment or just subsidize the mortgage payment. How frequently you rent your second home also affects your tax obligation.

Security for a second home

Whether you rent out your second home or leave it vacant, you need extra security to protect against vandalism and burglary. Vacation homes are susceptible to criminal activity; if burglars notice your home frequently sits empty, they’ll consider it an easy target for property crime.

You might like: The sharing economy is coming for your retirement

Home security deters crime and protects you if something does happen. A monitored security system is best because it notifies authorities automatically if a break-in is detected. Self-monitored systems require you to react and call for help instead.

Upfront costs and monitoring subscription fees vary widely for home security systems, so research home security systems and set a realistic budget based on your security needs. Keep in mind that a strong security system may get you a cheaper rate on homeowners insurance.

These are other security features to consider for your vacation home:

  • Smart keypad locks: Smart keypad locks are especially convenient for short-term rentals because you can change the code between tenants. And vacation homeowners appreciate the ability to let maintenance workers and cleaning staff with the click of a button.
  • Smart smoke detectors: Traditional smoke detectors aren’t helpful if no one’s home. But smart smoke detectors send push notifications to your phone, so you or your local property manager can call the fire department in the event of a fire.
  • Smart leak detector: If your vacation home is in a flood-prone area or has aging plumbing, buying a leak detector is a small price to pay for peace of mind. These devices alert you when water is detected, so you can take action before serious damage occurs.
Maintaining a vacation home

What about when something goes wrong? It’s easy to keep up on maintenance when you live in a home and notice every strange noise, but problems in a second home easily go undetected. And the longer a problem sits, the bigger it can grow.

Also read: 9 ways the housing market may find itself in the middle of a perfect storm

Proactive maintenance is necessary to prevent your vacation home from turning into a money pit. Start with listing your home’s major systems and when they’re due for service. Then, prepare for minor repairs by screening handymen now—before you need one. That way you know exactly who to call when something goes wrong and can trust that you’re getting a fair price. You can find handymen—as well as cleaning services and landscapers—at online sites, such as Home Advisor and Angie’s List.

If you can’t get your eyes on your vacation home on a regular basis, hire someone else to manage maintenance. Many property management agencies include inspections and maintenance coordination in their service plans. Before taking a hands-off approach to second home maintenance, double-check your contract. If you think maintenance is covered and it’s not, you could be in for an expensive surprise.

Owning a vacation home in retirement can be an amazing reward after decades of hard work. But if you do it wrong, it can also be a major burden. Before investing in a vacation home, make sure you understand what you’re signing up for, from the mortgage payments to the maintenance. As long as you’re prepared for the realities of owning a second residence, buying a vacation home could be the best choice you ever make.

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NerdWallet: If you’ve never sold a home before, prepare yourself for these costs

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This article is reprinted by permission from NerdWallet.

As a first-time home seller, you know how much you owe on the mortgage, and you’ve got a good idea of your home’s market value. But then come all of the closing costs you’re responsible for.

Unlike buyers, sellers are usually on the hook for real-estate agent commissions and title insurance. All told, closing costs for a seller can amount to roughly 6%–10% of the sale price, according to

Real-estate agent commissions

Let’s start with the most significant closing cost the seller typically pays, other than paying off their current mortgage: the real-estate agent commissions.

It’s common for the seller to pay the commission for both the seller’s and the buyer’s agents. That’s usually a 6% hit to your bottom line — 3% of the home’s selling price to the agent on either side of the transaction.

On a $250,000 home sale, that would amount to $15,000.

And it doesn’t help to have just one agent involved in the sales process. A single real-estate agent will expect to get the full 6% commission.

Of course, you can negotiate fees when you hire an agent, but it’s too late to make any deals when you’re sitting around the closing table handing out big checks.

The title insurance policy

Among the other closing costs that a seller could expect to pay is the lender’s title insurance policy, says Tyler Lee, CEO of Bay National Title in Clearwater, Florida.

Also read: The $17,000 ‘sweet spot’ you should know about before you sell your home

Before a sale, a title search is conducted to verify ownership. A title policy protects the lender (and the new home buyer if they opt to buy a policy of their own) against unexpected ownership claims that may arise against the property. While not common, an ownership claim can trigger legal disputes — and the fees that come with them.

Closing costs a seller pays

All the closing costs that are often the seller’s responsibility include:

  • A property or deed transfer tax.
  • Recording fees.
  • Any outstanding liens or judgments against the property.
  • Repairs required following a home inspection.
  • Real-estate agent commissions.
  • Title insurance.

There are additional closing costs that are split between the buyer and seller, too, including property taxes and any homeowner association dues.

Read and understand your purchase contract

Closing costs, and whether the buyer or seller pays them, vary widely from state to state — and even between counties in some parts of the nation.

Which party pays what fee may be negotiable, but many filing and recording fees or transfer taxes are determined by the state or local jurisdiction.

And as for knowing for sure what’s going to be your financial responsibility when calculating your closing costs, there’s only one definitive guide: the purchase contract.

“Read the contract and make sure you understand what you’re paying for,” Lee says. “That’s the key.”

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Hal M. Bundrick, CFP is a writer at NerdWallet. Email: Twitter: @halmbundrick.