May 2000
In This Issue
Do You Know. . .
Who said, The greater part of our happiness or misery depends on our
dispositions, and not on our circumstances.
Answer: Martha Washington
For many, the cost of a college education looms as one of the largest
financial burdens they will incur in their lives. Over the past 20 years,
college tuition costs have increased almost 400%. Recently, however, help has
arrived through federal legislation, which has created new types of programs and
IRAs that make it easier to save for a higher education. To successfully use
these programs and accounts, you must realize their investment, tax, retirement,
and estate planning implications and incorporate them into your financial
planning.
State tuition programs
Qualified state tuition programs (QSTP's) are a very popular way to save for
college. These programs, also known as Ò529 plans after the IRC section that
authorizes them, are offered by 34 states. State tuition programs are popular
because they are available for children of any age and families of any income
level and are an effective way to save for future college costs.
Types of plans. States have a lot of discretion in crafting the tuition
programs, so features vary greatly; however, they generally fall into two
categories: prepaid tuition plans and savings plans.
Prepaid tuition plans. These state-operated trusts provide residents of the
state with a good way to hedge against tuition inflation. Under these plans,
states offer contracts where they agree to pay future tuition at in-state public
institutions at prices pegged to current tuition levels.
Savings plans. Tuition savings plans are very similar to mutual funds,
except they are sponsored by a state. The contributor's account is intended to
grow over time and thus keep up with or surpass the increasing costs of college.
The risk is if the investments made with the account money don't keep pace with
the tuition increases. Many savings plans lower the risk by managing the
investments more conservatively as the designated beneficiary approaches college
age. Most state programs are savings plans that offer more flexibility, and more
and more states are opening their programs to both residents and nonresidents.
Tax consequences of QSTP's. Contributions to a QSTP are not deductible, but
the earnings are taxed only on withdrawal. The withdrawal is divided into two
parts: the initial investment and the earnings. The initial investment portion
is nontaxable, and the earnings are taxable. The QSTP computes the taxable
portion of any withdrawals made during the year under the annuity taxation rules
found in IRC section 72 and reports it to the IRS as ordinary income on Form
1099-G.
Another advantage of QSTP's is that earnings are taxed at the income tax
rate of the beneficiary of the account (i.e., the child) and not the owner of
the account (the parent). This is usually a lower income tax bracket; most
college students are in the zero or 15% bracket. This rule is true as long as
the funds withdrawn are used to pay for a qualified higher education expense.
These consist of tuition, fees, required books, supplies, equipment, and some
room and board expenses, at an eligible educational institution. Generally, this
includes any accredited postsecondary educational institution in the United
States, undergraduate or graduate.
If the funds are withdrawn and not used for a qualified higher education
expense (called a nonqualified withdrawal), then the earnings are taxed to the
distributee (usually the parent) and not the beneficiary, so any savings due to
the student's lower tax bracket are lost. In addition, nonqualified withdrawals
are subject to penalties, which may equal at least 10% of the earnings of a
nonqualified withdrawal, not the entire withdrawal.
Rollover options. Another advantage of QSTP's is the ability to change the
designated beneficiary to another member of the family at any time. QSTP's also
allow you to make a withdrawal and re-contribute it to a QSTP account for another
family member beneficiary. If the re-contribution is done within 60 days, it is
treated as a tax-free rollover. The definition of family members includes
parents, grandparents, children, and grandchildren, but does not include
cousins.
Contribution limits. Section 529 does not impose contribution limits; it
requires only that a QSTP have adequate safeguards to prevent contributions that
exceed what the beneficiary may need for qualified higher education expenses.
The proposed regulations provide a safe-harbor limit; the limit is determined by
actuarial estimates and takes into account all tuition, fees, and other
qualifying expenses that a beneficiary would have for five years of
undergraduate enrollment at a qualifying institution with the highest cost. A
qualifying institution in this case is one allowed under the specific state
program. Some programs limit the total amount that can be contributed to the
account, while other programs have annual contribution limits.
When determining whether to contribute to a QSTP, remember that it is the
state program and not the account owner that determines how the funds are
invested.
Estate and gift tax considerations. For some, the best feature of QSTP's is
the estate and gift tax treatment they receive. Generally, under estate tax
rules, if the decedent names a beneficiary to certain assets but retains control
over the assets, the assets will be included in the decedent's estate. However,
a QSTP account can be controlled by the owner, while the value of the account is
shifted from the owner's estate to the beneficiary and will not be included in
the owner's estate. This feature can be a helpful estate planning tool. A
grandparent who would like to fund a grandchild's college education, but does
not want the child to have full control of unused funds, can use a QSTP.
QSTP's also get favorable gift tax treatment. A contribution to a QSTP
qualifies for the $10,000 annual gift and generation-skipping transfer tax
exclusion. An added plus: Donors can use a special election that allows them to
treat a QSTP contribution as if it had been made over five years. This allows a
donor to contribute up to $50,000 in year one to a beneficiary's account
(subject to state limits), have it treated as if he or she had made five $10,000
contributions over five years, and qualify for the annual exclusion.
Other options
QSTP's are only one way to save for higher education costs; other options
include Education IRAs and Roth IRAs.
Education IRAs. These IRAs must be created exclusively to pay the qualified
higher education expenses of a named beneficiary, such as a child or grandchild.
Generally, the earnings on the funds in the IRA won't be taxed until a
distribution from the IRA is made, and distributions from the IRA won't be
included in gross income. The annual contribution is limited to $500 per
beneficiary, and can't be made after
the beneficiary reaches 18. And you can't contribute to an Education IRA in the
same year in which you contribute to a qualified state tuition program on behalf
of the same beneficiary. Eligibility for Education IRAs phases out for single
taxpayers with modified AGI's between $95,000-$110,000 and between
$150,000-$160,000 for joint returns.
Note: You can claim only one of the following for each student in any given
year: the Hope Scholarship credit, the Lifetime Learning credit, and the
exemption for the Education IRA earnings withdrawal.
Roth IRAs. Roth IRAs are a great way to save for college, because
withdrawals used to pay education expenses are excluded from the 10% excise tax
on early distributions. Roth IRAs are also good because the withdrawals are
first considered a nontaxable return of investment. This helps those who would
like to use part of the Roth IRA to pay for college and let the earnings remain
in the account to continue to grow for retirement. Another plus: The
distributions at retirement are tax-free. The disadvantages to Roth IRAs are
that the annual contributions are limited to $2,000, the contributor must have
earned income, and eligibility is phased out for individuals with AGI's over
$95,000 and for married couples with AGI's over $150,000.
Conclusion
Paying for college can be a daunting financial task, but the burden can be
eased with some careful planning early on. Using one of the QSTP's or IRA
accounts can make saving for higher education easy and effective by letting
parents or grandparents put aside money each year for higher education and reap
certain tax benefits while doing so.
Resumania is a term coined by Robert Half, founder of
Accountemps, to
describe the bloopers that appear in resume's, job applications, and cover
letters. Below are some of the blunders, demonstrating the importance of careful
preparation at every stage of the job search process.
Worked party-time as an office assistant.
I am entirely thorough in my work; no detail gets by me.
Thank you for meeting me for an interview.
Computer illiterate.
My qualifications are above reproach.
You have nothing to loose by calling me for an interview.
Outside activities: A bell ringer for the Salvation Army.
More is sometimes less
At times, applicants give too much information on their resume's or
applications; below are some examples:
Reason for leaving: I did not have enough idle time.
Willing to relocate to residence in upscale neighborhood on waterfront with
easy access to mass transit.
Prefer to work alone in maximum privacy.
Reason for leaving: Sick and tired of being a human punching bag for my
boss.
Under IRC section 152(e), the custodial parent, as a result of a divorce, is
generally entitled to take the dependency exemptions for the children. This
applies as long as both parents provide more than half the children's support
and the children live with either or both parents for more than six months each
year.
However, the non-custodial parent may claim a child if the custodial parent
agrees not to claim that child as a dependent for a particular year, and signs
Form 8332, Release of Claim to Exemption for Child of Divorced or Separated
Parents. The non-custodial parent then attaches the signed form to his or her tax
return.
On Form 8332, the custodial parent can choose to release a claim for the
deduction in the current year, specified future years, or all future years. The
custodial parent need sign the form only once, but the non-custodial parent must
attach it to his or her return every year. However, problems can arise because
the form contains no cancellation date, and there is no way to nullify the form.
For example, a custodial parent may waive the exemption for specified future
years because the non-custodial parent is providing child support. But if the non-custodial
parent stops making child support payments, yet continues to claim
the exemption, it can be very difficult for the custodial parent to void the
release.
According to IRS legal memorandum no. 200007031, the only way a custodial
parent can void Form 8332 and claim the child on his or her own tax return is to
get the non-custodial parent to forgo claiming that child as a dependent. If the
two former spouses cannot agree and both claim the same child, then the IRS
steps in and calls for an audit.
To avoid such situations, custodial parents should agree to the release of
the deduction on an annual basis and not for the long term.
Many types of items can be donated to charitable organizations; most of
them, such as used articles and clothing, have little value, but can be counted
as part of your charitable deduction if you itemize. However, other types of
items, such as paintings, antiques, and coins, have significant value and not
only provide the donor with a current deduction, but can also save the donor
capital gains taxes that would have been paid if the property had been sold.
Deduction amount. The amount of the deduction depends on how the property
will be used by the charity. If the property is to be used by the organization
(e.g., a painting donated to a museum), the deduction is the fair market value (FMV)
of the property. If the property is to be immediately sold by the organization,
then the deduction is limited to FMV or the cost, whichever is less. Property
donations of assets with values over $5,000 must be appraised by qualified
appraisers to ensure the assets are not overvalued.
Reporting requirements. For each contribution of property over $5,000
(except publicly traded securities), an appraisal summary is needed (section B
of Form 8283). The summary should be signed by someone at the charitable
organization to acknowledge receipt of the property.
Even if you think you will never make such a significant charitable
contribution, you may still have to comply with reporting requirements. If the
total non-cash charitable contributions of property are valued over $500 (e.g.,
you donated several pieces of used furniture in the same year), certain
reporting requirements need to be met. The donor must file IRS Form 8283, non-cash
Charitable Contributions. Information required by the form includes the
name and address of the charity and the FMV of the donated property.
The appraisal. If the contributed property is valued over $5,000, then an
appraisal should be done. The appraisal should include the following: a detailed
description, including physical condition and a photograph; FMV on the date of
transfer; the date or expected date of the contribution and the date the
property is valued; the appraiser's name, address, telephone number, and
taxpayer identification number (TIN); the appraiser's qualifications; and the
method used to determine the FMV.
Even if an appraisal is submitted, the IRS may decide to make its own
determination of value through an IRS appraiser, the IRS Art Advisory Board, or
independent dealers and appraisers.
Penalties. If the FMV is overstated, penalties of 20% to 40% of the tax
underpayment may apply. The 20% penalty applies if the underpayment is more than
$5,000 and the deduction amount was between 200% and 400% of the actual value of
the donated property. The 40% penalty applies if the deduction amount was 400%
or more of the actual value and the tax underpayment is more than $5,000.
May 1
Employers. For Social Security, Medicare, and withheld income tax, file Form
941 for the first quarter of 2000. Deposit any un-deposited tax. (If the total is
less than $1,000 and not a shortfall, you can pay it with the return.) If you
deposited the tax for the quarter in full and on time, you have until May 10 to
file the return. For federal unemployment tax, deposit the tax owed through
March, if more than $100.
May 10
Employees who work for tips. If you received $20 or more in tips during
April, report them to your employer. Use Form 4070.
Employers. File Form 941 for the first quarter of 2000. This due date
applies only if you deposited the tax for the quarter in full and on time.
May 15
Employers. For Social Security, Medicare, withheld income tax, and non-payroll
withholding, deposit the tax for payments in April if the monthly
rule applies.
June 15
Individuals. Make a payment of your 2000 estimated tax if you are not paying
your income tax for the year through withholding (or will not pay in enough tax
that way). Use Form 1040-ES. This is the second installment date for estimated
tax in 2000.
Corporations. Deposit the second installment of estimated income tax for
2000.
Employers. For Social Security, Medicare, withheld income tax, and non-payroll
withholding, deposit the tax for payments in May if the monthly rule
applies.
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