Financial Frontlines®

This content is provided courtesy of USAA.

How did your tax return look?

If you got a big refund, think twice before celebrating. That only means you gave the government an interest-free loan during the year. On the other hand, if you ended up owing Uncle Sam a large amount, the IRS may have charged you interest and penalties for under-withholding. Fine-tune your withholding to make sure you’re closer to what you owe next time around.

Put Your Refund to Work

If you’re getting a tax refund, ask the IRS to deposit it directly into your checking or savings account.

Once the money is safely in your account, use it to make your financial future more secure:

• Pay down debt.
• Build your emergency fund.
• Consider an IRA.
• Save it for college.
• Repair or renovate your home.

Protect What Your Landlord Won’t

If you rent, your landlord’s insurance probably doesn’t cover your possessions, which means a fire or break-in could cost you dearly. You also may not be protected if a guest or visitor is injured in the house or apartment you’re renting. A renters policy can cover all those risks for a modest price.

The preceding discussion is not tax, legal or estate planning advice. Consult with your tax, legal or estate planning professional regarding your specific situation.

The Roth Thrift Savings Plan Option will soon be available. Most agencies and services can begin accepting elections for Roth (after-tax) contributions on or about May 07, 2012. Your question might be “should I invest in Roth?” The answer may come down to whether you want to pay Uncle Sam now, or pay him later.

There are two distinct types of contributory retirement savings in 401(k) type plans, like the TSP, or IRAs – traditional or Roth. Traditional plans allow you to delay the payment of income taxes (payroll taxes – FICA and Medicare – must still be paid) on your contribution to a qualified retirement account. Uncle Sam provides an incentive to save for retirement by allowing us to postpone the tax due on those funds until we receive them. The funds are deposited into your account before federal and state, if applicable, income taxes are imposed. The funds we contributed, plus the employer match, if any, and any growth within the fund will then be taxed at our marginal tax rate upon receipt.

We may begin a penalty-free withdrawal from these tax-advantaged accounts at age 59.5. Minimum distributions are required beginning at age 70.5. This tax deferment is significant. If you believe that your tax rate in retirement will be lower than it is now, then a traditional TSP may be for you. However, many military folks will be in higher tax brackets once they lose their tax exempt allowances and their ability to claim legal residence in an income tax exempt state. Making a Roth contribution while still serving may be a smart thing to do.

No one can predict with certainty what tax rates will do in the future, of course. Let’s just agree that there is pressure to increase taxes, and that pressure is unlikely to dissipate with so many Baby Boomers entering their retirement years. Uncle is going to want to collect the taxes he’s postponed for so long.

Our other choice is the “pay Uncle Sam now” election, or Roth. There is no immediate tax break with Roth TSP contributions. The break comes later. Since all contributions to a Roth TSP are made after-tax, later withdrawals, including all growth, are tax-exempt.

Many financial planners encourage their clients to set up a stream of taxable and tax-free dollars to use in retirement. Roth contributions are a great way to do this. If you’re currently serving military, you know that you already receive a significant tax break through your allowances, primarily BAH and BAS. Can you afford to pass up another break now to receive one later? Many of you can.

What other ways can you use to receive tax-free dollars in retirement? Roth IRAs are another investment you can make. But Roth IRA contributions begin to phase out for singles making $110,000 and for couples at $173,000, and are proscribed at $125,000 and $183,000 Modified Adjusted Gross Income, respectively. Sounds like a lot of money, but with a military pay and a working spouse, or military retired pay and a good second job, many retirees bump up against those limits. The Roth TSP or 401(k) contributions have no income limits.

A few cautions. Employer matches must be applied to a traditional 401(k). That’s not an issue for military folks, but someday it might be. It is a big part of the equation when you’re in a job with an employee match – those funds can’t go into a Roth 401(k).

If you open a Roth, or split your contributions between a traditional and Roth TSP, the annual contribution limits still apply ($17,000 in 2012, plus a $5,500 catch-up contribution if you’re age 50 or more). You don’t get another bite at the apple just because you opened another account. Any employer match you might receive does not count toward these contribution limits.

Uncle Sam has given you a choice. You can pay him now or later, so do your homework and make your decision.

Detailed information on the Roth TSP is available on the TSP website.

Cross-posted from the MOAA Message Center blog

ALERT FROM DFAS:

There are emails being sent to individuals, including military members, military retirees, and civilian employees, which appear to be sent by a DFAS employee. Although the email appears to come from a DFAS employee and displays a dot mil address it is actually from a non-government email account. This is an example of what’s called “spoofing.”

The emails indicate that individuals who are receiving disability compensation from the Department of Veterans Affairs (VA) may be able to obtain additional funds from the Internal Revenue Service (IRS). These emails are not issued by DFAS and will likely result in a financial loss if you comply with the suggestions in the email. Bottom line – do not send your personal information or copies of your tax returns and 1099s to the individual listed in the email.

The email indicates that individuals receiving VA disability compensation can receive additional funds from the IRS. The email states that such funds can be obtained by sending copies of your VA award letter, your income tax returns, your 1099-Rs, your RAS statements, and a copy of your DD 214, to a so-called retired Colonel at an address in Florida. Do NOT follow the suggestions in the email because you will be providing a significant amount of your personal information to a complete stranger, which could result in a financial loss to you.

The 1099-Rs that are issued by DFAS reflect only the taxable portion of a member’s retired pay. DFAS is not aware of any legal basis for the alleged additional funds that the IRS would supposedly pay over. By ignoring the email, you will avoid frustration, the release of personal information to a stranger, and the possibility of financial loss. If you have any questions or concerns about these or any other tax issues, you should contact a known, reputable tax consultant, tax attorney, or legal assistance officer for advice and assistance. Read our agency email policy that has been developed to protect customer privacy.

++++++++copy of text of scam email+++++++++++++

Sent: Thu, March 17, 2011 7:04:17 PM
Subject: FW: Income Tax

Sandra,

here you go!

I been informed that you can receive additional funds from IRS for SM who retired with 20 years of AFS, information required to receive this entitlement is as follows:

Copy of your VA award letter (note: if your VA rating has been increase within the last three years, you’ll need to send all
ratings).
Copies of your 1040′s for tax years: 08, 09 and 10
Any copy of your 1009R for year 08, 09 and 10
Copies of your RAS statements (Retired pay statements) for year 08, 09 and 10
Copy of your DD Form 214

This information should be mailed by Priority Mail to:
>
Willie Brooks
726 Mayflower Ave.
Ft. Walton Beach, FL 32547-3175
850-862-1673.

Mr. Brooks is a retired AF COL who worked for IRS and charges you 10% of what you receive. I have known of several within the AW2 program who has received from $8.000.00 to $19,000.00. See additional information concerning this matter.

Pass this on to any of your friends who has a VA rating and 20 or more years of AFS!

If you look at interest rates today, it sure makes a lot of sense to consider refinancing your home.  And, it may or may not be the right decision for you.  But, before you decide on whether you will refinance make sure you have considered the Alternative Minimum Tax (AMT).

Interest on mortgages or home equity loans against your principal residence are deductible when you calculate your taxes.  As long as the loan is secured by your home, you can deduct the interest.  A lot of people have used refinancing or home equity lines to pay down higher interest debt or to pay for such things as college for the kids.  Therein lies the problem.

When you calculate your tax liability under the AMT, you must add back any mortgage interest you deducted that was used for anything other than the acquisition, construction or improvement of your primary residence (the same holds true for a second home as well).  So if you refinance (or take out a home equity line) and “take out some equity” and then use the equity to pay for something other than improving, constructing or acquiring your principal residence the interest attributable to the other use of the funds is not deductible for calculating AMT.

Here is an example:

1. Primary Mortgage (used to acquire the house) interest = $20,000
2. Home Equity Line (used for college expenses) interest = $  3,000
3. Total Deductible interest for regular taxes                       = $ 23,000

AMT requires adding $3,000 to taxable income as the home equity line was NOT used for acquisition, construction or improvement of the primary residence.  If subject to AMT, the minimum tax rate is 26%.

Now…a refinance in and of itself may not trigger AMT, even if you use some of the proceeds for other purposes.  And remember that if the mortgage is used for construction, acquisition or improvement there is not an AMT concern.  However, if you use some of the proceeds for other purposes there are other items that when combined with the refinance could trigger the AMT (or the refinance might be enough by itself).  Some of the things to be wary of are:

1. Deductible Taxes (State Income, Personal Property, Real Estate)
2. Medical Expenses in excess of 7.5% and 10% of AGI
3. Miscellaneous Deductions
4. Private Activity Municipal Bonds

The AMT is complicated and it would be nice if Congress would make it go away.  But, until they do, you or your advisor will need to watch for “gotchas” like the potential AMT on a refinance.

Mention VA retroactive awards for disability compensation and the Strickland decision will make its way into the conversation. The Strickland court decision provides tax-free status to past taxable military retired pay due to the award of retroactive VA disability compensation.

We get numerous calls on this issue, and based on my discussions, there are some misunderstandings we need to clear up.  The most common is that the Strickland decision will convert taxable retired pay…amounts above and beyond the tax-free status provided by VA compensation and Combat-Related Special Compensation (CRSC)…to tax-free status.

First, let me start the discussion about members who do not qualify for concurrent receipt. You fall in two camps: 1) retirees with at least 20 years of service, are VA rated at 40% or less and whose disabilities are not combat-related, or, 2) retirees less than 20 years, with any VA rating but your disabilities are not combat-related. You represent two-thirds of the retiree/VA rated population. Bad news is you don’t qualify for concurrent receipt; good news is the Strickland decision probably does you the most good.

By the way, your group is a priority for MOAA as we fight for your concurrent receipt benefits up on the Hill.

We all know that military retired pay is taxable income and VA disability compensation is tax-free. When you qualify for VA disability compensation, you have to agree to waive your retired pay by the same amount you receive in VA compensation; aka the VA Waiver. With the VA Waiver, you trade away your taxable retired pay to receive tax-free VA compensation. This is the foundation of whether you qualify to file amended tax returns to receive a tax refund.

Consider your retired pay situation had your retired pay been docked by the VA Waiver during the VA retro award period. The VA Waiver amount would have docked your taxable pay and you wouldn’t have paid taxes on the amount of income that was docked. You can file an amended tax return for those years to seek a refund for the taxes you paid on the income you wouldn’t have received.

You have to determine what the VA Waiver amount would have been in those years by backing-up the Cost Of Living Adjustments (COLAs) and/or VA rating changes.

Next, for those of you who are eligible for concurrent receipt in the form of Concurrent Retirement and Disability Pay (CRDP) or CRSC, the retroactive tax-free status of retired pay is a little more complex.

Retirees eligible for concurrent receipt are: 1) retirees with 20 or more years of service, VA rating of 50% or greater, or, 2) retirees regardless of years of service and regardless of your VA rating whose disabilities are combat-related.

For you, your past retired pay, after the application of the VA retro award of disability compensation, may or may not have been impacted by a VA Waiver. As discussed above, this is all about the amount of tax you paid on income you wouldn’t have paid if the VA Waiver had applied in the past.

CRDP restores your retired pay by getting rid of the VA Waiver. In restoring your retired pay, the restored portion of pay is taxable; like regular retired pay since CRDP is regular retired pay. CRDP is being phased-in over the years. By 2014, there won’t be a VA Waiver for you CRDP eligibles**. During the phase-in, your VA Waiver amount is getting smaller each year. To determine what your tax refund would be for past years, you have to know what your actual VA Waiver amount was after the application of CRDP in those past years. In other words, you can’t claim a refund for the full amount of your VA compensation because your past pay wasn’t docked for the full amount of the VA compensation due to CRDP.

CRSC impacts retirees in a completely different way than the CRDP crowd. CRSC reimburses you for all or some of the amount of your VA Waiver. All CRSC recipients have a VA Waiver in their retired pay for the full amount of their VA compensation. Because the CRSC rating and payment is based only on the combat-related nature of your disabilities and not total disabilities as is a VA rating, it is possible that your CRSC amount is less than your VA compensation.

Because CRSC is tax-free and the amount will not be more than the VA Waiver amount, the amount of CRSC is not relevant to the amended tax return affected by the retro payment of VA compensation. CRSC payees will use the VA Waiver amount to determine their tax refund status over the retro period. It is the VA Waiver amount that docks the retired pay thereby making the past retired pay income waived by the VA Waiver amount eligible for tax-free status. Your situation is similar to the folks above who aren’t qualified for concurrent receipt.

Now that you know what you are looking for in past pays, I’ll provide a few details on how to file amended tax returns.

To change past taxable retired pay into tax-free pay, you have to file a separate amended tax return (IRS Form 1040X) for each tax filing year in involved. You are filing to get a tax refund for the income you paid taxes on that should have been tax-free had the VA Waiver amount been applied during the retro period.

Some details about how to apply for the tax refund were discussed in a recent article on this blog by Curt Sheldon, one of our guest authors. See Curt’s article for his practical insights at http://moaablogs.org/financial/2012/02/va-disability-benefits-retirement-pay-and-your-taxes/.

The tax code limits the time period to file amended tax returns due to the award of retroactive VA compensation to 4 years from the time of filing the taxes being amended. So a tax filing from 2008 can be amended in 2012. See IRS Publication 525 page 17 for more details (http://www.irs.gov/pub/irs-pdf/p525.pdf).

As Curt states in his article, the burden is on you to provide the background documents to make your case when you file the amended returns. Be sure to put yourself in the shoes of the IRS official reviewing your case. Assume you know nothing about VA disability compensation, military retired pay, or retroactive VA awards. Now what paperwork would you need to convince you the amended tax return is spot on?

Best wishes. When all else fails, consult an expert tax specialist.

** Technically there could be a VA Waiver amount if your retirement pay multiplier used a greater Service disability rating rather than your years of service retired pay multiplier.