How Do Incentive Stock Options (ISOs) Impact Alternative Minimum Tax (AMT)?

How Do Incentive Stock Options (ISOs) Impact Alternative Minimum Tax (AMT)?

 

One of the most common areas where we see clients introduced to Alternative Minimum Tax is when Incentive Stock Options (ISOs) enter the financial picture.  To learn more about AMT and how it is calculated, so you can avoid a shock, check our blog post from last week.

ISOs can be a tremendous benefit to creating wealth, but they are often misunderstood and can pack a large surprise if not appropriately planned for.  Here are a few key terms to get us started:

  • Grant Date/Amount– Original date and number of shares awarded
  • Vesting Date– The date at which you are allowed to exercise your options
  • Exercise Price– Price paid for options, usually discounted from the current share price.
  • Bargain Element– Difference between exercise price and fair market value (FMV); drives potential AMT liability

ISO preferential tax treatment is attained when the shares are sold one year after exercise and two years after grant. When this criterion is met, the gains upon the sale will be considered long-term capital gains, as opposed to short-term gains which are taxed at current income rates.

 

Qualifying vs Disqualifying Disposition:

 

Qualifying Disposition
  • Exercise and sell one year after exercise and two years after grant – AMT liability in the year you exercise, and gains are considered long-term capital gains
  • Exercise and hold – AMT liability in the year you exercise but no additional immediate tax liability because the shares have yet to be sold

 

Disqualifying Disposition:
  • Exercise and sell within one calendar year – no AMT liability and gains are taxed as regular income
  • Exercise and sell within 12 months, across two calendar years – AMT liability in the year you exercise, and gains are taxed as regular income
  • Exercise and sell more than one year from exercise but less than two years from grant – AMT liability in the year you exercise, and gains are split between regular income rates for the bargain element and capital gains depending on holding period

 

The AMT tax liability mentioned in the scenarios above is determined based on the difference between the exercise price and the fair market value (FMV) of the shares on the date of exercise. AMT may result in a larger tax bill than a typical year without exercising options and thus will directly affect your household’s cash flow.  The good news is that when you end up paying AMT related exercising ISOs, you will likely receive an AMT tax credit, which can be used to offset your federal income tax bill in future years.  This is a great reason why involving a CPA to help keep track of all the moving pieces is highly recommended.

The 83(b) Election is an alternative approach to divesting company stock. If your company allows, you have 30 days from the grant date to notify the IRS and your company of the 83(b) election. This involves paying tax on the exercise price from the grant at regular income rates; there would be no AMT implication and depending on when you sell the shares, you would later realize short- or long-term capital gains. For shares which you expect to increase in value, this can provide a fantastic tax break. This is however considered a risky approach because the shares could lose value and you would have overpaid on taxes by making this election.

Please reach out to us if you would like to work through your specific situation.

 

 

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.

 

How-To Guide for Applying for a WA Cares Exemption

How-To Guide for Applying for a WA Cares Exemption

 

To learn more about the New Payroll Tax in Washington State check out our previous post

To start the process of applying for an exemption from the Washington Long-Term Care payroll tax (WA Cares), you will need an account with SecureAccess Washington (SAW). If you do not currently have an account, you will be asked to create a username and password for the site. You can get started here: https://secureaccess.wa.gov/

Note: Before creating an account, be sure to double check if you already have one as many Washingtonians use this site to also apply for fishing licenses, paid family and medical leave, professional licenses, and more.

A PDF of the instructions below can be downloaded here.

1. After creating an account, you will be directed to this page. Select “Add a New Service.”

2. From here, you will select the option for “I would like to browse a list of services by agency.”

3. Scroll down and select “Employment Security Department.”

4. Select Paid Family and Medical Leave (PFML) by clicking “Apply.”

 

4.5 If you are already registered for PFML, please skip to step 7.5.

5. By selecting the Paid Family and Medical Leave (PFML) option, this service is added to your SecureAccess account. From here, you can begin the process of applying for the Long-Term Care exemption. Click “Access Now.”

6. Click “Continue.”

7. From here, scroll down until you see “WA Cares Exemption” and click “Create an Account.”

7.5 If you have already registered for PFML in the past (see Step 4.5 above), you’ll need to complete a workaround to find the WA Cares Exemption application.

First, access the PFML service where you applied for benefits in the past. Look to the top right corner of the page and click “Add/Switch Account.”

          Then click “Create a New Account” under your name. Now proceed to step 7.

8. If you have not previously applied for PFML, you will be prompted to enter your personal information: Name, Social Security number, address, and phone number. Once this is done, you will select the link: “Apply for an Exemption.”

If you have applied for PFML before, you will need to review your personal information and make any necessary changes.

9. Complete the Attestation form. Input your age and check all of the boxes if you have signed up for an eligible private Long-Term Care Insurance policy or qualifying alternative.

10. You will be required to upload proof of identify, such as a photo of your driver’s license or passport.

11. You will see a screen that confirms your exemption application.

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 or legal or accounting advice, and nothing contained in these materials should be taken as such.

What Is Alternative Minimum Tax (AMT) And Does It Affect You?

What Is Alternative Minimum Tax (AMT) And Does It Affect You?

 

Alternative Minimum Tax (AMT) is not something everyone is exposed to, but when you are, it can often create confusion and add a layer of complexity to financial planning that many are not prepared for.  This article will help outline how AMT may affect your financial situation.

The Alternative Minimum Tax was created in the 1960s with the intention of preventing taxpayers with substantial income from utilizing various deductions in order to dodge the traditional federal income tax system. The AMT system runs parallel to federal income tax for individuals, trusts, and estates. Corporations were also once subject to AMT until this was repealed by the Tax Cuts and Jobs Act in 2017. AMT is calculated to determine if taxpayers are paying their “fair share” in a given tax year. For individuals, the AMT system recalculates income tax using fewer deductions and exemptions – for example the standard/itemized deduction – and then adds back specific tax preference items to an individual’s gross income. 

A few of the preference items that we often see that affect AMT are listed below. There are several other influencing factors which are less common, and for the sake of this article, have been left out. IRS Form 6251 has the full details.

  • Capital gains from exercise of stock options (i.e., Incentive Stock Options)
  • Qualifying exclusion for small business stock
  • Interest on private activity bonds
  • Deductions for accelerated depreciation

Once the Alternative Minimum Taxable Income (AMTI) is calculated, the annual AMT exemption is applied to determine what amount is subject to AMT rates. In 2021, the AMT exemption is $73,600 for single filers and $114,600 for married filing jointly. The exemption begins to phase out for single filers at $523,600 and at $1,047,200 for married filing jointly.

After determining the minimum tax base, the AMT tax rate of 26% is applied on the first $199,900 (as of 2021).  Amounts above this figure are then subject to the second and final AMT tax rate of 28% to determine your overall AMT liability. After all is said and done, you will owe the higher of the two, traditional tax liability or AMT liability.

One of the most common areas where we see clients introduced to AMT is when Incentive Stock Options (ISOs) enter the financial picture. ISOs are often awarded by companies in lieu of direct compensation (i.e., annual salary), as a way to incentivize an employee to help grow the value of the company. Please check our blog upcoming blog post for specific details regarding Incentive Stock Options and the impact of AMT.

The majority of taxpayers don’t encounter AMT, but when they do, it can be a complete surprise.  Here at Merriman, we take a comprehensive approach to fully understand your financial landscape. In most situations, it is wise to involve a CPA when facing the AMT due to the complexity and varying timelines that affect cash flow. Please reach out to Merriman if you would like to discuss your situation in greater detail.

Watch for our upcoming blog post which will go into further detail about Incentive Stock Options (ISOs).

 

 

 

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.

New Parents Guide to Securing Your Future and Supporting Your Loved Ones

New Parents Guide to Securing Your Future and Supporting Your Loved Ones

 

Making the decision to bring a child into the world and create a family of your own is a major life milestone to be celebrated. With this very exciting step can also come a lot of uncertainty and what-ifs about how to prepare for the coming months and years ahead. Without the proper planning or conversations about the future, it can all start to feel overwhelming or unmanageable. The good news is that whether you are planning to become parents soon or further down the road in your relationship, there are ways to start securing your financial future now to set yourself up for success wherever your life journey takes you.

 

Build an emergency fund

No matter what stage you’re in when it comes to your relationship or life in general, creating a sound financial foundation for yourself is a wise idea. Although your financial allocation might already be spread thin from paying off your loans, car payments, mortgage, rent, and other monthly bills, it’s important to have a plan for an emergency. Of course, you do need to stay on top of bills and scheduled payments; however, as new parents, it’s especially important to have a financial safety net should something unexpected happen.

This is also smart budgeting practice for individuals and their families. If it takes more than a month to set aside around $500, you might want to take a closer look at your spending habits. A reasonable goal is to have about six months’ worth of financial coverage to pay all your bills and expenses should you have no other source of income for a time. This might seem like a lot initially; however, after facing a worldwide pandemic, you can see how it would be beneficial to have an emergency fund to protect your family in the event of a crisis, job loss, or other outstanding circumstance.

 

Ensure healthcare coverage

Depending on your profession, it’s possible that you have healthcare coverage and benefits. If you are an entrepreneur, on the other hand, or work for yourself, it’s essential that you have the appropriate coverage for your situation. Talking with your spouse or partner in this case might be helpful to determine if you need separate or additional coverage for your family’s needs. There are various options available to get health insurance as an entrepreneur or if you are self-employed. Getting ready to start a family is a great time to ensure you have the appropriate coverage for the coming months.

 

Secure a life insurance policy

There are various ways to go about financial planning and investing in your future that will allow for less anxiety should you experience an unanticipated circumstance. It’s recommended that soon-to-be parents or new parents secure a life insurance policy as a way to protect your loved ones, allow for peace of mind in the present, and create financial assurance should you not be around to support your family.

Additionally, life insurance rates increase by about 8% annually, so it’s best to secure financial protection now if you think you’ll have dependents later. Ideally, the best time to shop for life insurance is before you become pregnant or in the earlier months of pregnancy since health complications can arise during pregnancy. But if this is not the case for you, there are still options to help you get affordable rates. Many people misunderstand how much life insurance they need and opt for whatever is available through their work or employer. Experts recommend a death benefit of at least 10–15x your annual income to prevent your family from being underinsured. Often with an employer or group policy, you will not be given this much coverage.

 

Get in the habit of budgeting

As mentioned, having a clear understanding of your financial situation is extremely critical if you are planning to become parents. Knowing where you stand in terms of monthly income versus expenditure plus additional investments will help you determine if you will need to cut back when the baby comes. Not only does a newborn require all your time and attention, but they also can be expensive. From clothes, food, and supplies to furniture, strollers, and doctor appointments, your finances will certainly be impacted.

Based on your relationship and situation, you and your significant other can decide on a budgeting method that works best for you. Getting into the habit of budgeting your finances before bringing a baby into the picture is a great idea if you are not used to accounting for all your expenses. If you are newer to budgeting for yourself or with your partner, it might be worthwhile to research some of the best budgeting methods as one style might be more naturally suited to your lifestyle. If you feel like budgeting is taking over your life or forcing you to change too much, you might be less likely to stick to it. Finding a sustainable way to manage your finances will help you get started and improve as time goes on without sacrificing more than you are willing to.

 

Work with a professional

If you are approaching a major life event such as starting a family and you don’t feel confident to organize or prepare your finances on your own, you are not alone. With so much to consider during a time of transition, finances are not something that you want to fall by the wayside. Consider hiring a financial advisor who can help set you up for success and provide you with reassurance that you are making all the right decisions for your situation. Should you decide to change jobs soon, you will want to evaluate your savings and retirement plans, all of which a financial planner can help you sort through.

 

Plan for retirement

If you do decide to meet with an advisor or professional to assist you in your financial planning process, they will be able to guide you through some of the opportunities available to you, including investing, savings, and retirement options. Most companies will have programs in place to allow for easy contribution into a 401k program or another type of retirement account. If you are an entrepreneur or work for yourself, once again, you will be responsible for setting up the appropriate accounts for future retirement savings. If you or your spouse wants to save for retirement as a stay-at-home parent, you’re going to want to factor in that you won’t have an income for a certain amount of time. Since everyone is unique in their wants and needs, you should discuss some of the finer details with your partner to determine the best path for your lifestyle and financial situation.

 

Create a college fund

It might feel far off to start planning for your child’s future education before they are even born, but doing so will make a major difference in your financial future if you intend to support them for this experience. Whether you plan to co-sign their loans, cover their expenses, or split the cost of college with them, it’s going to be a large financial investment and commitment. Depending on the school and program they attend, you might be stuck paying off college loans for years after graduation. By starting a college savings account before you have to take on the expenses of having a newborn, you can begin your financial journey ahead of time before life gets busy.

 

As new parents or parents-to-be, your list of priorities is sure to be extensive. With that being said, having a stable financial situation can allow you to celebrate exciting life events while navigating the challenges that come alongside them. By planning early and having conversations with your significant other about the months and years ahead, you can set yourself up for financial success and peace of mind, allowing you to enjoy these special milestones.

 

 

 

 

 

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.

Where To Start With Estate Settling

Where To Start With Estate Settling

 

Over the 25 years or so that I have been practicing and serving families, one of the crucial points that has surfaced time and again with clients is one that tends to occur after a spouse or family member has passed away, and they seek out our help. Quite understandably, most people have little or no experience in settling an estate and essentially do not know what needs to be done. There are a myriad of actions to be accomplished, each one of them important, and no one knows in what order tasks need to be completed, let alone how to weave through the legal dynamics. So what can we do to help?

About 10 years ago, I finally grew so frustrated with not being able to help several of my client families settle estate matters after a death that I decided I was going to solve the matter myself. I went back through all of my estate planning books to seek out as many action items as I could locate. In addition, I went through dozens of other legal and financial websites to gain as much knowledge as I could. The problem was not in locating information on estate settling but rather not to drown in the vastness of it. Ultimately, I realized that my task was to consolidate and distill as much information as possible into a short and clear format that we could share. The result was a composition of knowledge written in simple English that went through peer review multiple times to create a master end-of-life checklist.

The “Checklist: After a Death Occurs” was constructed to assist our clients and their families so they could understand most of the basic estate settling matters that must be pursued after a loved one has passed. The document is arranged in a priority-driven format, so from top to bottom, front to back, the most important estate marshalling activities are listed first. The current iteration is about six pages long and contains an additional short checklist at the end for a surviving spouse.

There is also a third checklist that we created in addition to these main two. The third list is a pre-mortem checklist for someone who is ailing or terminally ill, designed to assist family members with estate matter topics while the individual is still alive. We hope these tools will be useful to you and your family, and we would love to hear back if they help.

 

 

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.

How Do I Correct Excess Roth IRA Contributions?

How Do I Correct Excess Roth IRA Contributions?

 

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.