If your employer provides life insurance, you probably find it to be a desirable fringe benefit. However, if group term life insurance is part of your benefits package, and the coverage is higher than $50,000, there may be undesirable income tax implications.

You’re taxed on income you didn’t receive

The first $50,000 of group term life insurance coverage that your employer provides is excluded from taxable income and doesn’t add anything to your income tax bill. But the employer-paid cost of group term coverage in excess of $50,000 is taxable income to you. It’s included in the taxable wages reported on your Form W-2 — even though you never actually receive it. In other words, it’s “phantom income.”

What’s worse, the cost of group term insurance must be determined under a table prepared by the IRS even if the employer’s actual cost is less than the cost figured under the table. With these determinations, the amount of taxable phantom income attributed to an older employee is often higher than the premium the employee would pay for comparable coverage under an individual term policy. This tax trap gets worse as an employee gets older and as the amount of his or her compensation increases.

Look at your W-2

What should you do if you think the tax cost of employer-provided group term life insurance is higher than you’d like? First, you should establish if this is actually the case. If a specific dollar amount appears in Box 12 of your Form W-2 (with code “C”), that dollar amount represents your employer’s cost of providing you with group term life insurance coverage in excess of $50,000, less any amount you paid for the coverage. You’re responsible for federal, state and local taxes on the amount that appears in Box 12, and for the associated Social Security and Medicare taxes as well.

But keep in mind that the amount in Box 12 is already included as part of your total “Wages, tips and other compensation” in Box 1 of the W-2, and it’s the Box 1 amount that’s reported on your tax return.

What to do

If you decide that the tax cost is too high for the benefit you’re getting in return, find out whether your employer has a “carve-out” plan (a plan that carves out selected employees from group term coverage) or, if not, whether it would be willing to create one. There are different types of carve-out plans that employers can offer to their employees.

For example, the employer can continue to provide $50,000 of group term insurance (since there’s no tax cost for the first $50,000 of coverage). Then, the employer can provide the employee with an individual policy for the balance of the coverage. Alternatively, the employer can give the employee the amount the employer would have spent for the excess coverage as a cash bonus that the employee can use to pay the premiums on an individual policy.

If you have questions about group term coverage and how it affects your tax bill, contact us.

© 2023

Let’s say you own highly appreciated land that’s now ripe for development. If you subdivide it, develop the resulting parcels and sell them off for a hefty profit, it could trigger a large tax bill.

In this scenario, the tax rules generally treat you as a real estate dealer. That means your entire profit — including the portion from pre-development appreciation in the value of the land — will be treated as high-taxed ordinary income subject to a federal rate of up to 37%. You may also owe the 3.8% net investment income tax (NIIT) for a combined federal rate of up to 40.8%. And you may owe state income tax too.

It would be better if you could arrange to pay lower long-term capital gain (LTCG) tax rates on at least part of the profit. The current maximum federal income tax rate on LTCGs is 20% or 23.8% if you owe the NIIT.

Potential tax-saving solution

Thankfully, there’s a strategy that allows favorable LTCG tax treatment for all pre-development appreciation in the land value. You must have held the land for more than one year for investment (as opposed to holding it as a real estate dealer).

The portion of your profit attributable to subsequent subdividing, development and marketing activities will still be considered high-taxed ordinary income, because you’ll be considered a real estate dealer for that part of the process.

But if you can manage to pay a 20% or 23.8% federal income tax rate on a big chunk of your profit (the pre-development appreciation part), that’s something to celebrate.

Three-step strategy

Here’s the three-step strategy that could result in paying a smaller tax bill on your real estate development profits.

1. Establish an S corporation

If you individually own the appreciated land, you can establish an S corporation owned solely by you to function as the developer. If you own the land via a partnership, or via an LLC treated as a partnership for federal tax purposes, you and the other partners (LLC members) can form the S corp and receive corporate stock in proportion to your percentage partnership (LLC) interests.

2. Sell the land to the S corp

Sell the appreciated land to the S corp for a price equal to the land’s pre-development fair market value. If necessary, you can arrange a sale that involves only a little cash and a big installment note the S corp owes you. The business will pay off the note with cash generated by selling off parcels after development. The sale to the S corp will trigger a LTCG eligible for the 20% or 23.8% rate as long as you held the land for investment and owned it for over one year.

3. Develop the property and sell it off

The S corp will subdivide and develop the property, market it and sell it off. The profit from these activities will be higher-taxed ordinary income passed through to you as an S corp shareholder. If the profit is big, you’ll probably pay the maximum 37% federal rate (or 40.8% percent with the NIIT. However, the average tax rate on your total profit will be much lower, because a big part will be lower-taxed LTCG from pre-development appreciation.

Favorable treatment

Thanks to the tax treatment created by this S corp developer strategy, you can lock in favorable treatment for the land’s pre-development appreciation. That’s a huge tax-saving advantage if the land has gone up in value. Consult with us if you have questions or want more information.

© 2023

More than a million Americans live in nursing homes, according to various reports. If you have a parent entering one, you’re probably not thinking about taxes. But there may be tax consequences. Let’s take a look at five possible tax breaks.

1. Long-term medical care

The costs of qualified long-term care, including nursing home care, are deductible as medical expenses to the extent they, along with other medical expenses, exceed 7.5% of adjusted gross income (AGI).

Qualified long-term care services are necessary diagnostic, preventive, therapeutic, curing, treating, mitigating and rehabilitative services, and maintenance or personal-care services required by a chronically ill individual that are provided under care administered by a licensed healthcare practitioner.

To qualify as chronically ill, a physician or other licensed healthcare practitioner must certify an individual as unable to perform at least two activities of daily living (eating, toileting, transferring, bathing, dressing, and continence) for at least 90 days due to a loss of functional capacity or severe cognitive impairment.

2. Nursing home payments

Amounts paid to a nursing home are deductible as medical expenses if a person is staying at the facility principally for medical, rather than custodial care. If a person isn’t in the nursing home principally to receive medical care, only the portion of the fee that’s allocable to actual medical care qualifies as a deductible expense. But if the individual is chronically ill, all qualified long-term care services, including maintenance or personal care services, are deductible.

If your parent qualifies as your dependent, you can include any medical expenses you incur for your parent along with your own when determining your medical deduction.

3. Long-term care insurance

Premiums paid for a qualified long-term care insurance contract are deductible as medical expenses (subject to limitations explained below) to the extent they, along with other medical expenses, exceed the percentage-of-AGI threshold. A qualified long-term care insurance contract covers only qualified long-term care services, doesn’t pay costs covered by Medicare, is guaranteed renewable and doesn’t have a cash surrender value.

Qualified long-term care premiums are includible as medical expenses up to certain amounts. For individuals over 60 but not over 70 years old, the 2023 limit on deductible long-term care insurance premiums is $4,770, and for those over 70, the 2023 limit is $5,960.

4. The sale of your parent’s home

If your parent sells his or her home, up to $250,000 of the gain from the sale may be tax-free. In order to qualify for the $250,000 exclusion ($500,000 if married), the seller must generally have owned and used the home for at least two years out of the five years before the sale. However, there’s an exception to the two-out-of-five-year use test if the seller becomes physically or mentally unable to care for him or herself during the five-year period.

5. Head-of-household filing status

If you aren’t married and you meet certain dependency tests for your parent, you may qualify for head-of-household filing status, which has a higher standard deduction and lower tax rates than single filing status. You may be eligible to file as head of household even if the parent for whom you claim an exemption doesn’t live with you.

These are only some of the tax issues you may have to contend with if your parent moves into a nursing home. Contact us if you need more information or assistance.

© 2023

Recent reports have raised anew concerns about the impending insolvency of the Social Security program, absent congressional action. Social Security reform has long been considered a “third rail” of American politics and understandably so — the options for heading off insolvency will inevitably cause pain for significant segments of the population. Yet some in Congress have stepped forward with proposals that aim to tackle the problem.

The impending shortfall

Social Security currently provides benefits to more than 66 million recipients. The Congressional Budget Office (CBO) estimates that about 78 million people, or about 20% of the U.S. population, will receive benefits from the Old-Age and Survivors Insurance (OASI) Trust Fund in 2032.

The CBO and the trustees of the Social Security and Medicare trusts have both raised alarms about how soon Social Security will become “insolvent.” Insolvency in this context refers to the point at which the trust fund will be depleted, and payments would come solely from income generated by payroll tax and income tax on benefits.

The 2023 Trustees Report states that the OASI Trust Fund will be able to pay 100% of total scheduled benefits only until 2033, one year earlier than the trustees projected last year. The program would then be able to pay 77% of scheduled benefits.

The CBO’s forecast is even more dire. It predicts the OASI fund will be exhausted in 2032. As a result, it says, payable benefits would be 25% less than scheduled benefits.

The declining ratio of workers to beneficiaries is one reason for the trust fund’s shrinkage, and the retirement of Baby Boomers has only accelerated this trend. High interest rates and historic inflation also play a large role. Due to inflation, beneficiaries saw an 8.7% cost-of-living adjustment (COLA) in 2023, the largest such hike since 1981.

According to the Congressional Research Service, the trust fund’s depletion, whenever it occurs, would create a conflict between two federal laws. Beneficiaries would remain entitled to their full scheduled benefits under the Social Security Act. But the Antideficiency Act prohibits government spending in excess of available funds, so the Social Security Administration (SSA) would lack legal authority to pay full benefits on time.

Limited options

Congress has a limited arsenal of weapons for addressing the shortfall in the OASI fund. It generally can increase trust fund revenues or reduce benefits by taking various steps, such as:

Raising the retirement age. Retirees normally begin receiving benefits at age 66 or 67, depending on their year of birth (reduced early benefits are available at age 62). Various legislators and others have called for increasing the full retirement age. For example, some have suggested raising it to age 70 for people born in 1978 or later.

The American Academy of Actuaries (AAA) points out several potential problems with this approach, though. For example, raising the retirement age is essentially a cut in benefits, and jobs might not be available for people ages 67 to 69 who would have to keep working, particularly those who perform manual labor. A higher retirement age would disproportionately affect low-wage workers and those who have higher mortality rates. In addition, it would likely increase disability insurance costs and the costs for employer-provided insurance.

Increasing payroll tax. Workers and employers each pay 6.2% payroll taxes, for a total of 12.4% on the first $160,200 of wages in 2023. Payroll taxes could be boosted in two ways — increasing the tax rate and adjusting or eliminating the wage cap.

The AAA says that, of all the many proposals and bills for addressing the impending deficit, “raising the tax rate best preserves the current system structure.” The CBO says that trust fund balances would be sufficient to pay scheduled benefits through 2097 if the total payroll tax rate was increased immediately and permanently to 17.6% (before accounting for the effects of such changes on the economy).

Others have proposed applying the tax to greater amounts of wages. Some would apply the tax to earnings greater than a specific threshold (for example, $400,000), creating a “doughnut hole” of income not subject to the tax.

The AAA explains that, if the contribution base is increased but not the benefit base, the fund could raise revenue with no increase in benefits. The effect would be similar to increasing the tax rate, but the additional tax revenue would come only from workers with earnings in excess of the benefit base. In other words, this would negatively affect higher earners.

But the AAA says that even including the additional taxed earnings in the benefit formula would help. That’s because the additional earnings in the benefit formula would be at the high end of the earnings scale, where the benefit formula percentage is lowest. Moreover, while the additional tax revenue would begin immediately, the additional benefits would slowly phase in over time.

Changing benefits formulas. COLAs currently are based on changes to the Consumer Price Index for Urban Wage Earners and Clerical Workers. A different inflation index could be used to slow the annual increases. This would produce net benefit reductions as smaller benefit increases in early retirement years compound over time.

Other ideas include changing the primary formula for benefits for retirees or those for eligible spouses and dependents. For example, the basic Social Security benefit is called the primary insurance amount, based on average indexed monthly earnings (AIME) — generally, the average of a beneficiary’s highest earning years over a period of up to 35 years.

The number of averaging years included when calculating AIME could be increased, which would reduce the AIME for most workers. However, the AAA says this could have “especially adverse consequences” for workers who don’t have steady earnings, such as parents who leave the workforce to care for children.

Implementing means testing. Means testing generally refers to reducing or eliminating Social Security benefits for wealthy and/or high-income retirees whose current income or assets exceed a certain threshold. Supporters of means testing argue that the program shouldn’t benefit those who don’t have financial need.

Opponents contend that cutting or eliminating benefits for the wealthy would be unfair, as those individuals have contributed and been promised benefits just as others have. They also warn that it could undermine public support for Social Security, disincentivize work in later years and encourage consumption over saving.

Some recent proposals

Despite its third-rail status, several legislators on both sides of the aisle are working to confront the Social Security solvency crisis. For example, in February 2023, Sens. Bernie Sanders (I-VT) and Elizabeth Warren (D-MA), along with several Democratic colleagues, introduced the Social Security Expansion Act.

Among other things, it would apply the payroll tax to earnings above $250,000, without crediting the additional taxed earnings for benefit purposes. It also would impose a 12.4% tax on investment income and change the inflation index for COLAs. The SSA’s Office of the Chief Actuary estimates that enactment of the bill would extend the ability of the combined OASI and Disability Insurance program to pay scheduled benefits in full and on time for 75 years. In addition, the bill would add $2,400 to beneficiaries’ annual benefits.

Sens. Angus King (I-ME) and Bill Cassidy (R-LA) are heading a bipartisan coalition exploring other options. They’re reportedly discussing the creation of a so-called “sovereign wealth fund” separate from Social Security. The fund would invest $1.5 trillion or more in the U.S. economy and accrue returns over 70 years. If it fails to produce an 8% return, the maximum taxable income and the payroll tax rate would be increased to ensure solvency for 75 years. Cassidy says this approach would “solve 75% of the problem.”

A political conundrum

Both parties acknowledge the need for some type of action regarding Social Security. Generally, Democrats oppose cuts to benefits and Republicans oppose higher taxes. And the political climate isn’t favorable for reaching a compromise. We’ll follow the developments and keep you informed of any significant changes coming your way.

© 2023