Tax

You may have joined the Great Resignation, maybe temporarily or maybe for good.

Or your non-working status might have nothing to do with the Great Resignation. For instance, you could be a stay-at-home parent.

In any case, as a spouse with no tax-defined earned income, you might want to continue saving for retirement in a tax-favored fashion by making contributions to a traditional or Roth IRA.

An IRA set up to receive contributions by a non-working spouse is known as a spousal IRA.

The working spouse can make IRA contributions to it too.

Non-Working Spouse: Traditional Spousal IRA Contributions

For the 2022 tax year, you (the non-working spouse) can make a deductible contribution of up to $6,000, or up to $7,000 if you’ll be age 50 or older as of December 31, 2022, to a traditional spousal IRA set up in your name.

To make a traditional spousal IRA contribution, you must file a joint Form 1040, and you and your spouse must together have earned income—typically from your working spouse—at least equal to the sum of your contribution plus your spouse’s contribution, if any.

Note that taxable alimony received by you or your spouse under a pre-2019 divorce agreement counts as earned income for IRA contribution eligibility purposes.

Now It Gets Tricky

If your working spouse is covered by a tax-favored retirement plan, via a job or self-employment, the deductibility of your traditional spousal IRA contribution is phased out, for the 2022 tax year, between joint adjusted gross income (AGI) of $204,000 and $214,000.

Joint AGI is the sum of most taxable income items and gains, reduced by so-called above-the-line deductions. These include

• the deduction for contributions to a self-employed SEP, SIMPLE, or other self-employed retirement plan;
• the deduction for 50 percent of self-employment tax;
• the deduction for self-employed health insurance premiums;
• contributions to a health savings account (HSA);
• alimony payments required by a pre-2019 divorce agreement;
• the deduction for up to $250 of unreimbursed expenses for K-12 educators; and
• the deduction for moving expenses for eligible members of the Armed Forces.

If your working spouse is not covered by a tax-favored retirement plan, via a job or self-employment, you (the non-working spouse) can make a deductible traditional IRA contribution regardless of how high your joint AGI might be.

Working Spouse: Traditional IRA Contributions

If neither you nor your working spouse participate in a tax-favored retirement plan, via a job or self-employment, your working spouse can make a deductible contribution of up to $6,000 for the 2022 tax year to a traditional IRA set up in his or her name (regardless of your joint AGI level), or up to $7,000 if your working spouse will be 50 or older as of December 31, 2022.

You as a non-working spouse can make a deductible contribution to a traditional spousal IRA set up in your name, subject to the same limits.

But you and your spouse must together have enough earned income to at least match the combined amount of your contributions. All the requisite earned income can come from your working spouse. Once again, note that taxable alimony received by you or your spouse under a pre-2019 divorce agreement counts as earned income for IRA contribution eligibility purposes.

On the other hand, if your working spouse participates in a tax-favored retirement plan, his or her ability to make a deductible traditional IRA contribution for the 2022 tax year is phased out between joint AGI of $109,000 and $129,000.

If you have questions on your or your spouse’s ability to make IRA contributions, please call me on my direct line at 408-778-9651.

• By Leon Clinton
• August 23, 2022

The Fed is finally taking aggressive action to fight inflation, but will it work?

Where’s the stock market headed?

Who knows?
Real estate might be a good inflation hedge, but it’s a non-liquid asset and no sure thing.

Clearly, this is not a great environment for investors or retirement savers.

If you are thinking of investing conservatively but in a way that also offers some inflation protection, here’s an option to consider.

Treasury Inflation-Protected Securities

U.S. Treasury Inflation-Protected Securities (TIPS) are a special variety of Treasury bonds that are adjusted for inflation.

Specifically, in times of inflation, TIPS principal balances are adjusted upward twice a year, based on changes in the Consumer Price Index.

In contrast, significant inflation can punish the conservative investment strategy.

Okay, sounds interesting. How do TIPS work?

TIPS Basics

TIPS are sold at original issuance with terms to maturity of five, 10, and 30 years. They pay cash interest twice a year at a fixed rate that’s set at issuance.

Also, as we mentioned above, during times of inflation, TIPS principal balances are adjusted upward twice a year.

You receive the following if you hold a TIPS bond:

1. Cash interest payments twice a year at the stated fixed rate. Each semiannual payment equals half the stated rate times the inflation-adjusted principal balance at the time of the payment. So, cash interest payments go up with inflation because they are based on the increasing inflation-adjusted principal balance.
2. At the date of maturity, you receive the inflation-adjusted principal balance.

The Deflation Scenario

While deflation might seem highly unlikely at the moment, nothing is certain these days. Right?

During periods of deflation, TIPS principal balances are adjusted downward twice a year. The twice-yearly interest payments are also adjusted downward—because they are based on a declining adjusted principal balance. The stated fixed interest rate itself doesn’t change.

But even in the worst-case scenario of significant deflation during your ownership period, the results of owning a TIPS bond won’t be catastrophically bad, as long as you hold the bond to maturity. That’s because you’re guaranteed to receive at least the face value of the bond at maturity, even if the adjusted principal balance has fallen below that number. If the inflation-adjusted principal balance exceeds the face value, you’ll receive the larger inflation-adjusted number.

Best Way to Invest in TIPS

You can purchase TIPS upon original issue directly from the government, through the online TreasuryDirect program. If you invest this way, your principal is never at risk.

The TreasuryDirect option is available only for TIPS purchased for taxable accounts. You cannot use a tax-favored retirement account, such as an IRA, to buy TIPS upon original issue via TreasuryDirect.

If you buy a newly issued TIPS bond via TreasuryDirect, you’ll receive at least the face value of the bond if you hold it to maturity, even if there’s significant deflation. In other words, if you buy $100,000 of bonds via TreasuryDirect and hold them to maturity, then you receive no less than $100,000. Your principal is never at risk.

TIPS Tax Considerations

Cash interest payments from TIPS and non-cash increases in the principal of TIPS are subject to federal tax at ordinary income rates, but exempt from state and local income taxes.

TreasuryDirect reports the TIPS amounts subject to the federal income tax on two information forms:

• Form 1099-INT shows the sum of the semiannual cash interest payments made to you in a given year.
• Form 1099-OID shows the amount by which your TIPS principal amount increased or decreased due to inflation.

If you would like to discuss TIPS, please call me on my direct line at 408-778-9651.

• By Leon Clinton
• August 16, 2022

Here’s a question I received from one of my clients:

I will hire my 15-year-old daughter to work in my single-member LLC business, and I expect to pay her about $12,000 this year. Do I pay her through payroll checks and file a W-2?

My Answer

Yes. And W-2 payment is essential. If you pay her on a 1099, she will pay self-employment taxes.

When you pay her on a W-2, neither you nor your daughter pays any Social Security or Medicare taxes, and in most states, you also don’t pay any unemployment taxes.

Key point 1. Your single-member LLC is a “disregarded entity” for federal tax purposes. It’s taxed as a sole proprietorship (unless you elect corporate treatment). In this instance, you are the child’s parent, enabling “no Social Security or Medicare taxes” for both your child and your proprietorship.

Key point 2. Your daughter has a $12,950 standard deduction. This means she also pays zero tax on earned income up to that amount.

If you have questions on the hire-your-child strategy, please call me on my direct line at 408-778-9651.

• By Leon Clinton
• August 10, 2022