Scott Christensen

Supreme Court Upholds Washington State Capital Gains Tax – What You Need To Know

by Scott Christensen | Mar 30, 2023 | Advisors, Ask Merriman, News, Scott Christensen, Tech Focus, Wealth Protection

Supreme Court Upholds Washington State Capital Gains Tax – What You Need To Know

On March 24, 2023, the Washington State Supreme Court ruled in favor of a state capital gains tax, which was originally passed in 2021 to take effect starting January 1, 2022. In light of the court’s ruling, the state will continue as planned and collect the tax due for tax year 2022. The due date corresponds with the federal tax return filing deadline (which lands on April 18th this year), leaving just a few short weeks to file a return and pay the tax. With the clouds of uncertainty dispersed, it’s important for Washington residents to understand what is at play.

Who pays the tax?

Individuals with realized long-term capital gains above $250,000 are now required to file a Washington state capital gains tax return. A 7% tax on gains above this threshold will apply. The $250,000 annual standard deduction applies to spouses or domestic partners whether they file joint or separate returns (it is not $250,000 per person rather $250,000 per household). Income from work, pensions, social security, etc. are not included in this tax. It applies to the sale of intangible or tangible property such as stocks and bonds (including mutual funds, ETF’s, and other pooled investments), art, and other collectables. There are, of course, important exemptions to be aware of – we are talking about taxes after all! These include among others:

Sale of real estate, regardless of whether it’s a residential or commercial property. The property can be owned by a business, individual, or trust. It doesn’t matter how long the seller owned the property or whether the seller was renting the property.
The gain on the sale of a private entity, to the extent that gain is directly attributable to real estate owned by the entity.
Gains in retirement accounts, including 401(k)s, deferred-compensation plans, IRAs, Roth IRAs, employee-defined contribution plans, employee-defined benefit plans, and similar retirement savings accounts.

In addition to the exemptions outlined above, there are specific deductions that apply to the taxable capital gain income in Washington. Beyond the $250,000 standard deduction already mentioned, the following deductions also apply:

Long-term gains on the sale of qualified family-owned small businesses
A charitable deduction up to $100,000 for qualifying charitable gifts in excess of $250,000. The catch is that the charities need to be directed or managed in the state of Washington, which makes it unlikely for donor-advised funds to qualify for the deduction. Since the deduction is capped at $100,000 annually, to qualify for a full deduction one would need to have made qualified charitable contributions of $350,000.

The Revised Code of Washington defines the specifics for applying each of the family-owned small business and charitable deductions. Please don’t hesitate to reach out to us if you have questions.

For general examples of how the tax is calculated, please see our previous article on the topic. We also include a specific example for the charitable gift deduction below.

Charitable Deduction Example:

Sarah had $300,000 of long-term capital gains subject to the Washington state capital gains tax. She owes a tax of 7% on $50,000 (the excess above the $250,000 standard deduction). If Sarah contributed $50,000 to a charity directed or managed in the state, she would still owe tax on the full amount since the minimum charitable contribution is $250,000. Since the $50,000 charitable contribution is below the minimum, it would not reduce the $50,000 taxable income.

If Sarah had instead contributed $300,000 to a qualified charity directed or managed in Washington, she would qualify for a $50,000 charitable deduction which would eliminate her taxable realized gains subject to Washington state capital gains tax.

How do I pay the tax?

The Washington state capital gains tax return is filed separate from your federal tax return, but because your federal income tax return is required to be attached to your Washington state capital gains tax return, it’s necessary to first complete your federal return. Then you will submit the Washington state capital gains tax return electronically using the Washington Department of Revenue website. This video tutorial walks through the process of filing the return and paying the tax.

An extension can be granted to those who file an extension for their federal income tax return, but payments must still be made by April 18, 2023 or penalties will apply.

What you need to know when filing

When completing the capital gain tax return, you will be asked whether the gain is allocated to Washington. Only gains allocated to Washington apply when calculating the tax. So what is and is not allocated to Washington? It depends where the sale or exchange occurred, regardless of where it was purchased. You could have purchased a stock years ago while living in a different state, but if you sell the stock while you reside in Washington, it is allocated to Washington.
For tangible property, such as art or collectibles, there are a few more rules to determine whether it is allocated to Washington. A FAQ can be found on the DOR website that covers tangible property, cryptocurrency, business owners, and mutual fund distributions.
Since this is a tax only on realized long-term capital gains (property held for more than one year), property that is sold within a year is not included in the Washington state capital gains tax. This means there may be a difference between what is reported on your federal return and the state return since both short-term and long-term capital gains are netted together at the federal level, but only long-term gains are considered at the state level. Capital loss carryovers can be used but are limited to the amount used in determining the federal net long term capital gain.
For those receiving restricted stock units (RSU’s), vested shares sold within one year will not be considered in the Washington state capital gains tax. Only shares held for longer than a year after vest are considered long-term and potentially subject to the tax.

Conclusion

It’s more important than ever to be aware of how much capital gains income is being realized. It will likely make sense to diversify from a concentrated stock position over time where possible, to not incur an extra 7% tax. In cases where cash is needed, we can help analyze other options such as using short-term borrowing tools like a home equity line of credit or margin on your brokerage account. With a payoff plan in place, these tools may present a lower interest cost than the capital gains tax that would otherwise be paid. For those subject to the tax this year, your CPA should be able to help fill out your Washington state capital gains tax return. If you have questions determining how this impacts you, we’re happy to help.

Disclosure: All opinions expressed in this article are for general informational purposes and constitute the judgment of the author(s) as of the date of the report. These opinions are subject to change without notice and are not intended to provide specific advice or recommendations for any individual or on any specific security. The material has been gathered from sources believed to be reliable, however Merriman cannot guarantee the accuracy or completeness of such information, and certain information presented here may have been condensed or summarized from its original source. Merriman does not provide tax, legal or accounting advice, and nothing contained in these materials should be taken as such.

How Do I Correct Excess Roth IRA Contributions?

by Scott Christensen | Sep 14, 2021 | Advisors, Goal Planning, Preparing for Retirement, Retirement Savings, Scott Christensen, Tech Focus, Wealth Enhancement

Co-written by: Scott Christensen & Katherine Li

Contributing to a Roth IRA is a great way to receive tax benefits for retirement savers. If you already do or are planning to take advantage of this tax savings vehicle, it is important to familiarize yourself with the rules that govern these accounts. The IRS has put in place strict limits regarding the amount that individuals can contribute to their Roth IRAs, as well as income limits for determining who qualifies.

If you are a single tax filer, you must have Modified Adjusted Growth Income (MAGI) under $140,000 in order to contribute to your Roth IRA. The amount you can contribute to your Roth IRA begins to phase out starting at a MAGI of $125,000; if your MAGI is greater than $140,000, you can no longer contribute to the Roth IRA. For those who file as married filing jointly, your MAGI must be under $208,000 in order to contribute. The phaseout range in this case applies to those with a MAGI between $198,000 and $208,000. The maximum IRA contribution in either case is $6,000 for those under 50 and $7,000 for those 50 and older.

As a result of these strict limits, it is easy for taxpayers to overcontribute. So what happens when taxpayers contribute in excess of their contribution limit?

For every year that your excess contribution goes uncorrected, you must pay a 6% excise tax on the excess contribution. In order to avoid the 6% tax penalty, you must remove the excess contributions in addition to any earnings or losses on that excess contribution by the tax filing deadline in April. To determine your earnings on your excess contribution, you can use the net attributable income (NIA) formula.

Net income = Excess contribution x (Adjusted closing balance – Adjusted opening balance) / Adjusted opening balance

Note: If you find that you have losses on your excess contribution, you can subtract that loss from the amount of your excess contribution that you have to withdraw.

Reasons for Overcontribution

You’ve contributed more than the annual amount allowed.
- Remember that the $6,000 and $7,000 dollar maximum applies to the combined total that you can contribute to your Traditional and Roth IRAs.
You’ve contributed more than your earned income.
Your income was too high to contribute to a Roth IRA.
- Unfortunately, single tax filers who make $140,000 or more and those who are married filing jointly who make $208,000 or more are unable to contribute to a Roth IRA.
Required minimum distributions (RMDs) are rolled over.
- RMDs cannot be rolled over to a Roth IRA.
  - If it is rolled over to a Roth IRA, the amount will be treated as an excess contribution.

Removal of Excess Prior to Tax Filing Deadline

If you find that you have overcontributed prior to filing your tax return and prior to the tax filing deadline, you can remove your excess contributions before the tax filing deadline (typically April 15) and avoid the 6% excise tax. However, your earnings from your excess contribution will be taxed as ordinary income. Additionally, those who are under 59 and a half will have to pay a 10% tax for early withdrawal on earnings from excess contributions.

Keep in mind that it is your earnings that are subject to an ordinary income and early withdrawal tax, not the amount of your excess contribution.

If you find that you have overcontributed after filing your tax return, you can still avoid the 6% excise tax if you are able to remove your excess contribution and earnings and file an amended tax return by the October extended deadline (typically October 15).

Recharacterization

Recharacterization involves transferring your excess contribution and any earnings from your Roth IRA to a Traditional IRA. In order to avoid the 6% excise tax, you would have to complete this transfer process within the same tax year. It is also important to note that you can’t contribute more than your total allowable maximum contribution. Thus, you must make sure that you can still contribute more to your Traditional IRA prior to proceeding with recharacterization.

Apply the Excess Contribution to Next Year

You can offset your excess contribution by lowering the amount of your contribution the following year by the excess amount. For example, say that you contributed $7,000 to your Roth IRA when the maximum amount that you could contribute was $6,000. The next year, you can offset this excess amount of $1,000 by limiting your contribution to $5,000. You are, however, still subject to the 6% excise tax due to the fact that you were unable to correct the excess amount by the tax filing deadline, but you won’t have to deal with withdrawals.

Withdraw the Excess the Next Year

If you choose to withdraw the excess the following year, you will only have to remove the amount of your excess contribution, not any earnings. However, you will be subject to a 6% excise tax for each year that your excess remains in the IRA.

These rules can be confusing to navigate which is why we recommend involving your tax accountant or trusted advisor in these situations. We are happy to connect you with a Merriman advisor to discuss your situation.

Sources:

https://www08.wellsfargomedia.com/assets/pdf/personal/goals-retirement/taxes-and-retirement-planning/correct-excess-IRA-contributions.pdf

https://www.nerdwallet.com/article/investing/excess-contribution-to-ira

https://investor.vanguard.com/ira/excess-contribution

https://www.fool.com/retirement/plans/roth-ira/excess-contribution/

Disclosure: The material is presented solely for information purposes and has been gathered from sources believed to be reliable, however Merriman cannot guarantee the accuracy or completeness of such information, and certain information presented here may have been condensed or summarized from its original source. Merriman does not provide tax, legal or accounting advice, and nothing contained in these materials should be relied upon as such. Advisory services are only offered to clients or prospective clients where Merriman and its representatives are properly licensed or exempt from licensure. No advice may be rendered by Merriman unless a client service agreement is in place.

Think Twice Before Moving Into Your Rental To Avoid Taxes

by Geoffrey Curran | Dec 23, 2020 | Geoff Curran, Jeff Barnett, Property & Casualty Insurance, Scott Christensen, Tech Focus, Wealth Preservation

Updated 12/23/2020 by Geoff Curran, Jeff Barnett, & Scott Christensen

National real estate prices have been on the rise since 2014, and many investors who jumped into the rental industry since the Great Recession have substantial gains in property values (S&P Dow Jones Indices, 2019). You might be considering selling your rental to lock in profits and enjoy the fruits of your well-timed investment, but realizing those gains could come at a cost. You could owe capital gains tax in addition to potential depreciation recapture on the profits from your rental sale.

One strategy for paying less tax is to move back into your rental and use the property as a primary residence before selling. Living in your rental full-time for at least two years prior to selling can help you take advantage of the gain exclusion of $500,000 ($250,000 if single), which can wipe out all or most of your gain on the property. Sounds easy, right?

Let’s take a look at some of the moving pieces for determining the taxes when you sell your rental. Factors like depreciation recapture, qualified vs. non-qualified use and adjusted cost basis could make you think twice before moving back into your rental to avoid taxes.

Depreciation Recapture

One of the benefits of having a rental is the ability to claim depreciation on the property, which allows you to offset rental income that would otherwise be taxed as ordinary income. The depreciation you take reduces your basis in the property, potentially resulting in more capital gains when you ultimately sell. If you sell the property for a gain, the amount up to the depreciation you took is taxed at the maximum recapture rate of 25%. Any remaining gains are taxed at the lower long-term capital gains rate. Moving back into your rental to claim the primary residence gain exclusion does not allow you to exclude your depreciation recapture, so you might still owe a hefty tax bill after moving back, depending on how much depreciation was deducted. (IRS, 2019).

When the Property Sells for a Loss

Keep in mind that if you sell your home for a loss, whether it’s currently a rental or is now your primary residence, you aren’t subject to depreciation recapture or other gains taxes. However, due to depreciation decreasing your cost basis in the property each year until it reaches zero, it’s more common that sales of former rental homes result in gains. (more…)

Making Sense of the WEP and GPO

by Scott Christensen | Dec 8, 2020 | Advisors, After you retire, Preparing for Retirement, Retirement Savings, Scott Christensen, Wealth Protection

Do you have a federal or local government pension? Don’t let the WEP or GPO surprise you. The Windfall Elimination Provision and Government Pension Offset, often called the WEP and GPO, are two rules that can leave you scratching your head. Not only do many people find these rules confusing, but they are also often completely overlooked, which may result in a big surprise when filing for Social Security benefits. Unfortunately, this is not one of those good surprises.

What are the WEP and GPO?

The WEP reduces a worker’s own Social Security benefit while the GPO reduces spousal and survivor benefits received from another’s work record, such as a spouse.

Who is affected?

The WEP and GPO affect individuals who qualify for a pension from non-covered (did not pay Social Security tax) employment. These are typically your federal and local government workers, such as teachers, police officers, and firefighters. Whether these jobs are non-covered will depend on the state/employer. Overseas employees may also fit under this category.

For the WEP to apply, the individual must have an additional job with covered earnings (did pay Social Security tax) that qualifies them for Social Security benefits. Thus, the WEP applies to those who have a mix of covered and non-covered employment. Specifically, they qualify for Social Security benefits and receive a non-covered pension. The GPO applies when an individual with a non-covered pension receives a spousal or survivor benefit. Are you scratching your head yet?

WEP example:

Dan works as a public school teacher in California, one of 15 states where teachers do not pay Social Security tax. He qualifies for a pension through the California State Teachers’ Retirement System (CalSTRS). To make extra money for his household, Dan works an additional job during the summer, where he does pay Social Security tax. By the end of his career, he has worked enough summers to qualify for a Social Security benefit. The WEP will reduce Dan’s benefit since he has both a non-covered pension from his career as a teacher and qualifies for Social Security benefits from his summer job.

How will the WEP affect my benefit?

Understanding the details of the WEP is quite complicated. To simplify, the WEP tweaks the Social Security benefit formula, resulting in a reduction of the worker’s Primary Insurance Amount (PIA). The PIA is the benefit amount one would receive at full retirement age. The amount reduced depends on the number of years with “substantial earnings” in covered employment. The Social Security Administration provides the WEP Chart as a reference to understand the potential benefit reductions based on the number of years of substantial earnings. The maximum monthly reduction is capped at $480 in 2020. The amount reduced stays constant for the first 20 years of substantial earnings before decreasing incrementally per year until it is completely eliminated upon reaching 30 years of substantial earnings.

This offers an incredible planning opportunity for those who have already accumulated a number of years of substantial earnings. If you are thinking of retiring and have accumulated 20 years of covered work, it could make a lot of sense to work for ten more years to eliminate the WEP completely. Remember, you only need to have substantial earnings, so part-time work would count as long as you make what is deemed “substantial” in that year. For someone subject to the full WEP reduction and assuming a 20-year retirement, it could be worth more than $100,000.

It is important to note that the reduction is limited to one-half of an individual’s non-covered pension. This primarily comes into play when the majority of an individual’s earnings are in covered employment but have a small non-covered pension. For example, if you had a pension of $600 per month and your Social Security benefit was $1,200 per month, your benefit will not be reduced by more than $300 (half of your pension income).

How will the GPO affect my benefit?

This rule is more straightforward to understand than the WEP. The GPO will reduce an individual’s spousal or survivor benefit by two-thirds of their non-covered pension benefit.

GPO example:

Sarah qualified for a pension of $2,100 per month from a government job. Her husband, Drew, worked as an engineer for a large corporation. Drew applied for his Social Security benefit at his full retirement age and receives $2,600 per month. Sarah applies for a spousal benefit once she reaches full retirement age. This benefit would generally be $1,300 (50% of her spouse’s); however, the benefit is reduced by two-thirds of her non-covered pension. In this case, she would not receive anything since two-thirds of her pension ($1,400) is greater than what her spousal benefit would be.

Let’s say Drew passed away unexpectedly. Sarah would normally qualify for a survivor benefit equal to Drew’s entire benefit of $2,600. Because of the GPO, she will only receive $1,200 since the benefit would first be reduced by two-thirds of her pension ($2,600 – $1,400).

Keep in mind the GPO only applies to the individual’s own non-covered work. If a surviving spouse is a beneficiary of a non-covered pension, their Social Security benefits will not be reduced.

Conclusion

These rules are tricky to navigate and important to understand for those affected. What makes it worse is that your Social Security statement will not reflect the reduction in benefits from the WEP and GPO. This means it requires work and effort on your part to figure out! The Social Security Administration has provided an online WEP and GPO calculator to help with this. It will ask for a birthdate, non-covered pension benefit amounts, and other relevant information to calculate your new benefit factoring in the rule. If you have a family member or friend with a non-covered pension, they may be subject to these two rules. Please forward this on to them or anyone else who may find it useful.

Maximizing Credit Card Rewards for Your Next Getaway

by Scott Christensen | Jun 18, 2019 | Goal Planning, Jeff Barnett, Scott Christensen, Wealth Enhancement

By: Scott Christensen & Jeff Barnett

With summer upon us and your thoughts wandering to visions of paradise, have you questioned how to save money on expensive trips? Major travel expenses like airline tickets, hotel nights and rental cars can push trip costs into the thousands. Travel credit cards are an excellent way to save money while traveling and improve your entire vacation experience. However, no single card is perfect for every traveler. Let’s review the factors that set some cards apart and how to find the best card for your travel plans this summer. So what kinds of rewards can you earn with top travel credit cards?

Understanding Rewards

Unlike cash back credit cards, travel card bounties typically come in the flavor of rewards points or miles. You will earn points or miles for every dollar spent, and some cards offer additional rewards for spending in specific categories like hotel accommodations or restaurants. To choose the best card for you, it’s important to know your major spending categories. For example, a card may offer 3x points for travel and dining, as well as 1 point per dollar spent on everything else. Unless you spend a considerable amount on travel and dining, a different card that offers 2x points on all purchases might help you earn more rewards.

One example we can look at to illustrate rewards differences is if you spend $4,000 per month on a credit card and are also planning a $5,000 trip this year. You could earn 3x points on $5,000 of travel spending and 1x points on $48,000 of monthly spending for a total of 63,000 points that year. However, earning 2x points on your entire budget with a different card nets you 106,000 points. That’s over two-thirds more rewards for using another card!

Types of Travel Cards

Now that you know how to earn rewards, the next step is examining types of travel credit cards. Travel credit cards feature two main categories of rewards options—co-branded versus generic.

Co-branded cards bear the name of specific airlines, hotels or rewards programs and often have strict rules for redeeming points. For example, you may be limited to redeeming rewards with the card issuer or their program partners. While co-branded cards are less flexible for where you can spend rewards, they often come with other perks. Some cards allow you to get priority boarding, avoid baggage fees, earn double points on brand purchases or have annual discounted hotel stays.

Extra perks can help you feel like a movie star on your next trip, but rewards on other spending like groceries are often less with co-branded cards. If a co-branded card sounds appealing, we recommend checking out how to use multiple cards across all your spending to maximize rewards. Aligning your purchases with credit cards that offer the best reward for each spending category can help you earn more bonuses. Whether you’re using a travel card to earn 3x miles on your next ticket to Maui or buying groceries with a 2% cash back card, researching the best card for each of your major spending categories pays off.

Compared to co-branded travel credit cards, generic cards offer more flexibility and are not tied to a specific travel company. Generic cards may be used for any airline, hotel or cruise without requirements for redeeming your rewards with a specific brand. This is a great option for people who aren’t committed to a single frequent flier program, loyal to any particular airline, or always stay at the same resort. With a generic card, you can choose travel options that fit your itinerary, even when surprises pop up (like missing the last boat for the night and being stuck staying in the hotel across from the dock, don’t ask how we know). If a generic card fits your style, check out whether your card of choice offers valuable perks like trip cancellation or rental car insurance coverage. Co-branded cards are not the only plastic with awesome perks.

Evaluating Card Benefits

Once you narrow down your travel card options, evaluating other benefits like sign-up bonuses, low annual fees and higher value rewards can help you make the best choice.

Sign-up bonuses can be worth hundreds of dollars and may be the deciding factor between two cards.
Annual Fees offset rewards. You will need to assess if your spending level justifies the potential benefits from higher fee credit cards.
Point Valuations determine how much you get from your reward points. A point on one card or a specific reward option might not be as valuable as rewards offered by another card or different redemption choice.

When you’re thinking of backpacking through Yosemite or hiking up to Machu Picchu, travel credit cards are a great way to save money on your next trip. Credit cards are valuable tools, but it’s also important to use credit wisely and be wary of carrying a high-interest balance. We recommend reaching out to a Merriman advisor if you have questions about credit, spending, or other ways to enhance your finances. We are here to help and offer guidance throughout your financial journey.