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Secure Your Business Partnership with a Buy-Sell Agreement
Secure Your Business Partnership with a Buy-Sell Agreement 150 150 smolinlupinco

Buying a business with co-owners or already sharing the reins? A buy-sell agreement isn’t just a smart move–it’s essential. It gives you a more flexible ownership stake, prevents unwanted changes in ownership, and avoids potential IRS complications. 

The basics

There are two main types of buy-sell agreements: cross-purchase and redemption agreements (also known as liquidation agreements).

  • Cross-purchase agreements. This contract between co-owners specifies what happens if one co-owner leaves due to a trigger event, like death or disability. In these cases, the remaining co-owners are required to purchase the departing owner’s interest in the business.
  • Redemption agreements. This is a contract between the business and co-owners which outlines that if one co-owner leaves, the business itself buys their stake.

Triggering events

Co-owners work together to outline what triggering events to include in the buy-sell agreement. Common triggers like death, disability, or reaching retirement age are standard but you can also opt to include other scenarios like divorce.

Valuation and payment terms

Make sure your agreement includes a solid method for valuing ownership stakes. This could be a set price per share, an appraised fair market value, or a formula based on earnings or cash flow. It should also spell out how amounts will be paid out–whether a lump sum or installments–to withdrawing co-owners or their heirs upon a triggering event.

Using life insurance to fund the agreement

The death of a co-owner is a common triggering event, and life insurance is often used to fund buy-sell agreements. 

In a basic cross-purchase agreement between two co-owners, each buys a life insurance policy on the other. If one co-owner dies, the survivor uses the payout to buy the deceased co-owner’s share from the estate, surviving spouse or another heir (s). These insurance proceeds are tax-free as long as the surviving co-owner is the original purchaser of the policy.

Things get complicated when there are more than two co-owners because each co-owner must have life insurance policies on all the other co-owners. In this scenario, the best decision is often to use a trust or partnership to buy and maintain one policy on each co-owner. 

That way, if a co-owner dies, the trust or partnership collects the death benefit tax-free and distributes it to the remaining owners to fund the buyout.

In a redemption agreement, the business buys policies on the co-owners and uses the proceeds to buy out the deceased’s share.

Be sure to specify in your agreement what to do if insurance money does not cover the cost of buying out a co-owner. By clearly outlining that co-owners are allowed to buy out the rest over time, you can ensure some breathing room to come up with the needed cash instead of having to fulfill your buyout obligation right away.

Create certainty for heirs 

If you’re like many business owners, your business is likely a big chunk of your estate’s value. A buy-sell agreement ensures that your heirs can sell your share under the terms you approved. It also locks in the price for estate tax purposes, helping you avoid IRS scrutiny. 

A well-drafted buy-sell agreement protects you, your heirs, your co-owners, and their families. But remember, buy-sell agreements can be tricky to handle on your own.

Reach out to your Smolin advisor to set up a robust agreement that protects the interests of everyone involved.

Your Need-to-Know Tax Guide for Inherited IRAs
Your Need-to-Know Tax Guide for Inherited IRAs 850 500 smolinlupinco

A 2019 change to tax law ended the “stretch IRAs” strategy for most inherited IRAs. This means that beneficiaries now have 10 years to withdraw all of the funds. Since then, there’s been a lot of confusion about required minimum distributions (RMDs).

Thankfully, the IRS has now issued final regulations clarifying the “10-year rule” for inherited IRAs and defined contribution plans, like 401(k)s. In a nutshell, the final regulations largely align with proposed rules released in 2022.

The SECURE Act and 10-Year Rule

Under the Setting Every Community Up for Retirement Enhancement (SECURE) Act of 2019, most heirs except surviving spouses must withdraw the entire balance within 10 years of the original account owner’s death. In 2022, the IRS proposed regulations to clarify the rule. It outlines that beneficiaries must take their taxable RMDs over the course of the 10-year period after the account owner dies. 

They are not permitted to wait until the end of 10 years to take a lump-sum distribution. This annual RMD requirement significantly limits beneficiaries’ tax planning flexibility and, depending on their situations, could push them into higher tax brackets during those years.

Confused beneficiaries reached out to the IRS trying to determine when they needed to start taking RMDs on recently inherited accounts. The uncertainty posed risks for both beneficiaries and the defined contribution plans. 

This is because beneficiaries could have been assessed a tax penalty on amounts that should have been distributed but weren’t. And the plans could have been disqualified for non-compliance.

In response, the IRS waived penalties for taxpayers subject to the 10-year rule who missed 2021 and 2022 RMDs due to the death of the account owner in 2020 or 2021, respectively. 

The waiver guidance also stated that the IRS would issue final regulations no earlier than 2023. When 2023 rolled around, the IRS extended the waiver relief to excuse 2023 missed RMDs if the participant died in 2020, 2021 or 2022.

As of April 2024, the IRS again extended the relief, this time for RMDs in 2024. If certain requirements are met, beneficiaries won’t be assessed a penalty on missed RMDs for these years, and plans will be safe from disqualification based solely on the missed RMDs.

2024 final regulations

The final regulations require certain beneficiaries to take annual RMDs from inherited IRAs or defined contribution plans within ten years following the account owner’s death. These regulations will take effect in 2025.

If the deceased hadn’t begun taking their RMDs before their death, beneficiaries have more flexibility. They can take annual RMDS or wait until the end of the 10-year period and take a lump-sum distribution. Ultimately, the IRS eliminated the requirement to take annual distribution, allowing beneficiaries greater tax planning flexibility. 

For instance, if Ken inherited an IRA in 2021 from his father, who had already begun taking RMDs, under the IRS-issued waivers, Ken doesn’t need to take RMDs for 2022 through 2024. Under the final regulations, he must take annual RMDs for 2025 to 2030, with the account fully distributed by the end of 2031.

If Ken’s father had not started taking RMDs, Ken could have waited until the end of 2031 to take a lump-sum distribution. As long as the account is fully liquidated by the end of 2031, Ken remains in compliance with the rules.

Contact us with questions

If you’ve inherited an IRA or defined contribution plan in 2020 or later, it’s understandable to feel confused about the RMD rules. Reach out to your Smolin advisor for help understanding these regulations and developing a personalized tax-saving strategy.

Tax Implications of Disability Income
Tax Implications of Disability Income 850 500 smolinlupinco

If you are one of the many Americans who rely on disability benefits, you might be wondering how that income is taxed. The short answer is it depends on the type of disability income you receive and your overall earnings.

Taxable Disability Income

The key factor is who paid for the benefit. When the income is paid to you directly from your employer, it’s taxable like your ordinary salary and subject to federal income tax withholding. Depending on your employer’s disability plan, Social Security taxes may not apply. 

Often, disability income isn’t paid by your employer but rather from an insurance policy that provides the disability coverage. Depending on whether the insurance is paid for by you or by your employer, the tax treatment varies. If your employer paid, the income is taxed the same as if it was paid directly to you by the employer as above. But if you paid for the policy, payments received are usually tax-free.

Even if the insurance is offered through your employer, as long as you pay the premiums instead of them, the benefits are not taxed. However, if your employer pays the premiums and includes that amount as part of your taxable income, your benefits may also be taxable. Ultimately, tax treatment of benefits received depends on tax treatment of paid premiums.

Illustrative example

Scenario 1: 

If your salary is $1,050 a week ($54,600 a year) and your employer pays $15 a week ($780 annually) for disability insurance premiums, your annual taxable income would be $55,380. This total includes your salary of $54,600 plus $780 in disability insurance premiums. 

The insurance premiums are considered paid by you so any disability benefits received under that policy are tax-free.

Scenario 2:

If the disability insurance premiums are paid for by your employer and not included in your annual wages of $54,600, the amount paid is excludable under the rules for employer-provided health and accident plans.

The insurance premiums are considered paid for by your employer and any benefits you receive under the policy, are taxable income as ordinary income.

If there is permanent loss of a body part or function, special tax rules apply. In such cases, employer-paid disability might be tax-free, as long as they aren’t based on time lost from work.

Social Security disability benefits 

Social Security Disability Insurance (SSDI) benefits have their own tax rules. Payments are generally not subject to tax as long as your annual income falls under a certain threshold. 

For individuals if your annual income exceeds $25,000, a portion of your SSDI benefits are taxable. The threshold for married couples is $32,000. 

State Tax Implications

Though federal law treats disability payments as taxable income as outlined above, state tax laws vary. It’s wise to seek out professional support to determine if disability payments are taxed or exempt in your state. 

As you determine your disability coverage needs, remember to consider the tax implications. If you purchase a private policy yourself, the benefits are generally tax free since you are using your after-tax dollars to pay the premium. 

On the other hand, if your employer pays for the benefit, you will lose a portion of the benefits to taxes. Plan ahead and look at all your options. If you think your current coverage will be insufficient to support you should the unthinkable happen, you might consider supplementing any employer benefits with an individual.

Reach out to your Smolin advisor to discuss your disability coverage and how drawing benefits might impact your personal tax situation.

Cash or Accrual Accounting: Which is Right for Your Business?
Cash or Accrual Accounting: Which is Right for Your Business? 850 500 smolinlupinco

Your business can choose between cash or accrual accounting for tax purposes. While the cash method can provide certain tax advantages to those that qualify, the accrual method might be a better fit for some businesses. 

To maximize tax savings, you need to weigh both methods before deciding on one for your business. 

Small business tax benefits

Small businesses, as defined by the tax code, generally enjoy the flexibility of using either cash or accrual accounting. Various hybrid approaches are also allowed for some businesses. 

Before the Tax Cuts and Jobs Act (TCJA), the gross receipts threshold to classify as a small business was $1 million to $10 million depending on factors like business structure, industry, and if inventory significantly contributed to business income.

The TCJA established a single gross receipts threshold and increased it to $25 million (adjusted for inflation), expanding small business status benefits to more companies. In 2024, a small business is defined as having average gross receipts of less than $30 million for the preceding three-year period, up from $29 million in 2023.

Small businesses also benefit from simplified inventory accounting and exemptions from the uniform capitalization rules and business interest deduction limit.  S corporations, partnerships without C corporation partners, and farming businesses and certain personal service corporations may still use the cash accounting method, regardless of their gross receipts. 

Regardless of size though, tax shelters are ineligible for the cash accounting.

Potential advantages

Since cash-basis businesses recognize income when it’s received and deduct expenses when they’re paid, they have more control over their tax liability. This includes deferring income by delaying invoices or shifting deductions forward by accelerating expense payments.

Accrual-basis businesses, on the other hand, recognize income when earned and expenses are deducted as they’re incurred, regardless of cash flow. This limits their flexibility to time income and deductions for tax purposes.

The cash method can improve cash flow since income is taxed in the year it’s received. This helps businesses make their tax payment using incoming funds. 

If a company’s accrued income is lower than accrued expenses though, the accrual method can actually result in a lower tax liability than the cash method. The accrual method also allows for a business to deduct year-end bonuses paid in the first 2½ months of the following tax year and tax deferral on some advance payments.

Considerations when switching methods

If you’re considering a switch from one method to the other, it’s important to consider the administrative costs involved. If your business follows the U.S. Generally Accepted Accounting Principles (GAAP), you’ll need to maintain separate books for financial and tax reporting purposes. You may also be required to get IRS approval before changing accounting methods for tax purposes. 

Reach out to your Smolin advisor to learn which method is best for your business.

Six Tax Issues to Consider During a Divorce
Six Tax Issues to Consider During a Divorce 850 500 smolinlupinco

Divorce is a complex legal process, both financially and emotionally. Taxes are likely the farthest thing from your mind. But, you need to keep in mind the tax implications and consider seeking professional assistance to minimize your tax bill and navigate the separation process more smoothly. 

Here are six issues to keep top of mind as you move through the divorce process.

1. Planning to sell the marital home 

When a divorcing couple chooses to sell their home, they can possibly avoid paying tax on up to $500,000 of gain if they owned the home and lived there for two of the previous five years. If the living situation is such that one spouse continues living in the home while the other moves out, as long as they both remain owners, they might be able to avoid gains on future sale of the home for up to $250,000 each. In this instance, there may need to be special wording in the divorce decree or separation agreement to protect this exclusion for the spouse who moves out.

If the couple doesn’t meet strict two-year ownership and use requirements to qualify for the full $250,000 or $500,000 home sale exclusion, they might still be eligible for a reduced exclusion due to unforeseen circumstances.

2. Dividing retirement assets

Pension benefits often represent a significant portion of a couple’s marital assets. To ensure fair division of property, a “qualified domestic relations order” or QDRO is typically necessary. A QDRO is a legal document that outlines how pension benefits will be split between divorcing parties and whether one former spouse has the right to share in the benefits.

Without a QDRO, the spouse who earned the benefits remains solely responsible for associated taxes, even though they’re paid to the other spouse. A QDRO essentially transfers a portion of the pension benefits to the non-earning spouse along with the tax liability for their share. 

3. Determining your filing status

If you’re still legally married as of December 31st, you still need to file taxes as married jointly or married separately, even if you are in the process of getting divorced. However, if you’ve finalized your divorce by year-end, you could potentially qualify for “head of household” status if you meet certain requirements, such as having dependent children reside with you for more than half the year. 

4. Understanding alimony and spousal support 

The Tax Cuts and Jobs Act of 2017 made significant changes to the way alimony and spousal support are treated regarding taxes. For divorce or separation agreements executed after December 31, 2018, alimony and support payments are no longer deductible by the payer and are not taxable income for the recipient. This means alimony and spousal support are now treated similarly to child support payments for tax purposes. 

It’s important to note that divorce or separation agreements executed before 2019 generally still follow the old tax rules, where alimony is deductible for the payer and taxable for the recipient.

5. Claiming dependents

Unlike alimony, regardless of when the divorce or separation agreement was executed, child support payments are neither tax-deductible for the payer nor taxable income for the recipient. 

Determining which parent claims the child as a dependent or tax purposes often depends on standing custody agreements. Generally the custodial parent —the one the child lives with the majority of the year—can claim the child as a dependent; however, there are a few exceptions.

For instance, if the non-custodial parent provides more than half of the child’s support, they may be able to claim the child. It’s essential to coordinate with your ex-spouse to determine who will claim the child and thus access any related tax breaks.

6. Dividing business assets 

Divorcing couples who own a business together face unique tax challenges. The transfer of business interests in connection with divorce, can trigger significant tax implications.  For instance, if one spouse owns shares of an S corporation, transferring the shares could result in loss of valuable tax deductions such as forfeiting suspended losses ie. when losses are carried over into future tax years rather than being deducted for the year they’re incurred. 

Similarly, transferring a partnership interest can lead to even more complex tax issues  involving partnership debt, capital accounts, and valuation of the business. 

Seeking professional guidance

These are just some of the tax-related issues you may face when getting a divorce. You may need to adjust your tax withholding to reflect your new filing status. Be sure to also notify the IRS of any address or name changes. You likely also need to re-evaluate your estate plans to align with your new circumstances.

Proper planning is essential to ensure a fair division of assets while minimizing your tax liability. Our skilled team of Smolin advisors can help you navigate the complex financial issues involved with your divorce.

Does a FAST Fit into Your Estate Plan?
Does a FAST Fit into Your Estate Plan? 850 500 smolinlupinco

Traditional estate planning often focuses on minimizing gift and estate taxes while protecting your assets from creditors or lawsuits. While these are important considerations, many people also hope to create a lasting legacy for their family.

Dovetailing with the “technical” goals of your estate plan, such “aspirational” goals might include preparing your children or grandchildren to manage wealth responsibly, promoting shared family values and encouraging charitable giving. A Family Advancement Sustainability Trust (FAST) is one way to ensure your estate plan meets your objectives while informing your advisors and family of your intentions. 

FAST funding options

A well-structured estate plan can protect your assets while aligning with your family values and goals. Establishing a FAST can bridge the gap between those objectives.

A FAST typically requires minimal up-front funding, instead being primarily funded with life insurance or a properly structured irrevocable life insurance trust (ILIT) upon the grantor’s death. This lets you maximize the impact of your trust without depleting your current assets. 

4 decision-making entities

FASTs are typically created in states that 1) allow perpetual, or “dynasty,” trusts to benefit future generations, and 2) have directed trust statutes, making it possible to appoint an advisor or committee, making it possible for family members and trusted advisors to participate in the governance and management of the trust.

To ensure effective management and decision-making, a FAST often includes four key roles:

  1. An administrative trustee oversees day-to-day operations and administrative tasks but doesn’t handle investment or distribution decisions.
  2. An investment committee typically consists of family members and an independent, professional investment advisor who collaboratively manage the trust’s investment portfolio.
  3. A distribution committee which determines how trust funds are used to support the family and helps ensure that funds are spent in a way that achieves the trust’s goals.
  4. A trust protector committee essentially takes over the role of the grantor after death and makes decisions on matters such as the appointment or removal of trustees or committee members and amendments to the trust document for tax planning or other purposes.

Bridging the leadership gap

In many families, the death of the older generation creates a leadership vacuum and leads to succession challenges. A FAST can be particularly beneficial for families looking to help avoid a gap in leadership and establish a leadership structure that can provide resources and support for younger generations.

Consult with a Smolin advisor to discuss if including a FAST in your estate plan is the right choice for your family.

Could Borrowing From Your Corporation Equal Lower Rates, Bigger Risks?
Could Borrowing From Your Corporation Equal Lower Rates, Bigger Risks? 850 500 smolinlupinco

Did you know that you can borrow funds from your own closely held corporation at rates much lower than those charged by a bank? This strategy can be advantageous in some aspects but careful planning is crucial to avoid certain risks.  

The Basics

Interest rates have risen sharply over the last couple of years, making this strategy more attractive. Rather than pay a higher interest rate on a bank loan, shareholders can opt to take loans from their corporations. 

This option—with its lower interest rates—is available thanks to the IRS’s Applicable Federal Rates (AFRs) which are typically more budget-friendly than rates offered by banks. If the charged interest falls short of the AFRs, adverse tax results can be triggered.

This borrowed money can be used for a variety of personal expenses, from helping your child with college tuition to tackling home improvement projects or paying off high-interest credit card debt. 

Two Traps to Avoid

1. Not creating a genuine loan 

The IRS needs to see a clear-cut borrower-lender relationship. If your loan structure is sloppy, the IRS could reclassify the proceeds as additional compensation, which would result in an income tax bill for you and payroll tax for you and your corporation. However, the business would still be able to deduct the amount treated as compensation as well as the corporation’s share of related payroll taxes.

On the other hand, the IRS can claim that you received a taxable dividend if your company is a C corporation, triggering taxable income for you with no offsetting deduction for your business.

It’s best to create a formal written loan agreement to establish your promise of repayment to the corporation either as a fixed amount under an installment schedule or on demand by the corporation. Be sure to document the terms of the loan in your corporate minutes as well.

2. Not charging sufficient interest

To avoid getting caught in the IRS’s “below-market loan rules” make sure you’re charging an interest rate that meets or exceeds the AFR for your loan term. One exception to the below-market loan rules is if aggregate loans from corporation to shareholder equal $10,000 or less.

Current AFRs

The IRS publishes AFRs monthly based on current market conditions. For loans made in July 2024, the AFRs are:

  • 4.95% for short-term loans of up to three years,
  • 4.40% for mid-term loans of more than three years but not more than nine years, and
  • 4.52% for long-term loans of over nine years.

These rates assume monthly compounding of interest. However, the specific AFR depends on whether it’s a demand loan or a term loan. Here’s the key difference: 

  • Demand loans allow your corporation to request repayment in full at any time with proper notice.
  • Term loans have a fixed repayment schedule and interest rate set at the loan’s origination based on the AFR for the chosen term (short, mid, or long). This type of loan offers stability and predictability to both the borrower and the corporation.

Corporate Borrowing in Action

Imagine you borrow $100,000 from your corporation to be repaid in installments over 10 years. Right now, in July 2024, the long-term AFR is 4.52% compounded monthly over the term. To avoid tax issues, your corporation would charge you this rate and report the interest income.

On the other hand, if the loan document states that the borrowed amount is a demand loan, the AFR is based on a blended average of monthly short-term AFRs for the year. If rates go up, you need to pay more interest to avoid below-market loan rules. And, if rates go down, you pay a lower interest rate.

From a tax perspective, term loans for more than nine years are because they lock in current AFRs. If interest rates drop, you can repay the loan early and secure a new loan at the lower rate.

Avoid adverse consequences

Shareholder loans are complex, especially in situations where the loan charges below-AFR interest, the shareholder stops making payments, or your corporation has more than one shareholder. Contact a Smolin advisor for guidance on how to proceed in your unique circumstance.

Maximize Giving and Minimize Taxes with the Power of Qualified Charitable Distributions
Maximize Giving and Minimize Taxes with the Power of Qualified Charitable Distributions 850 500 smolinlupinco

Are you a philanthropic person nearing or past retirement age and facing required minimum distributions (RMDs) from your traditional IRA? There is a smart strategy that allows you to support the causes you care about while reducing your tax burden: Qualified Charitable Distributions (QCDs).

Here’s how it works:

Once you reach age 70½, you can make a cash donation to an IRS-approved charity out of your IRA. This method of transferring assets to charity leverages the QCD provision so you can direct up to $105,000 of their distributions to charity in 2024 (or $210,000 for married couples). 

By making QCDs, the money given to charity counts toward your RMDs but won’t increase adjusted gross income (AGI) or generate a tax bill.

There are several important reasons to keep your donation amount out of your AGI. When distributions are taken directly out of traditional IRAs, federal income tax of up to 37% (in 2024) and possible state income taxes must be paid. A QCD avoids these taxes. 

Here are some other potential benefits:

  1. You might qualify for other tax breaks. A lower AGI can reduce the threshold for itemizers who deduct medical expenses, which are only deductible to the extent they exceed 7.5% of AGI.
  2. You can skip potential taxes on your Social Security benefits and investment income, avoiding the 3.8% net investment income tax.
  3. It might help you bypass a high-income surcharge for Medicare Part B and Part D premiums that are triggered when AGI falls above a certain level.

Note: You can’t claim a charitable contribution deduction for a QCD that is not included in your income. Also, remember that the age after which you must begin taking RMDs is now 73, but the age you can start making QCDs is 70½.

To benefit from a qualified charitable distribution for 2024, you must arrange for the payment from your IRA to go directly to a qualified charity before December 31, 2024. 

QCDs are truly a win-win. You can use them to fulfill all or part of your RMD for the year. 

Think of it as a double-duty approach, supporting a cause you care about while meeting your IRA withdrawal needs. For example, if your 2024 RMDs are $20,000 and you make a $10,000 QCD, you only need to withdraw another $10,000 to satisfy your requirement.QCDs aren’t right for everyone, though. Depending on your unique situation, additional rules and limits may apply. Contact a Smolin advisor to discuss whether this strategy makes sense for you.

Decoding Corporate Estimated Tax: Which Method is Best for You?
Decoding Corporate Estimated Tax: Which Method is Best for You? 850 500 smolinlupinco

With the next quarterly estimated tax payment deadline coming up on September 16, it’s the perfect time to brush up on the rules for computing your corporate federal estimated payments. Ideally, your business can pay the minimum amount of estimated tax without triggering any penalties for underpayment. 

But how do you determine that amount? To avoid penalties, corporations must pay estimated tax installments equal to the lowest amount calculated using one of these four methods: 

Current Year Method

Pay 25% of the tax shown on the current tax year’s return (or, if no return is filed, 25% of the tax for the current year) by each of four corporate installment due dates –  generally April 15, June 15, September 15 and December 15. If a due date falls on a Saturday, Sunday or legal holiday, the payment is due the following business day.

Preceding Year Method 

Pay 25% of the tax shown on the return for the preceding tax year by each of four installment due dates. For 2022, corporations with taxable income of $1 million or more in any of the last three tax years can only use the preceding year method to determine their first required installment payment. Additionally, this method is not available to corporations whose last tax return covered less than a full year (i.e. new corporations) or corporations without a tax return from the previous year showing some tax liability.

Annualized Income Method

Under this option, a corporation can avoid the estimated tax underpayment penalty if it pays its “annualized tax” in quarterly installments. The annualized method estimates tax based on the corporation’s taxable income for the months leading up to the installment due date. It also assumes income will stay consistent throughout the year.

Seasonal Income Method

Corporations with recurring seasonal patterns of taxable income can annualize income by assuming income earned in the current year is earned in the same pattern as in preceding years. There’s a somewhat complicated mathematical test corporations must pass to establish that they meet the threshold to qualify to use this method.

If you think your corporation might qualify, reach out to your Smolin Advisor for assistance making that determination.If you find yourself needing to adjust estimated tax payments, corporations are able to switch between the four methods during the given tax year. Let the Smolin team help you determine the best method for your corporation.

Tax Breaks for Family Caregivers: Are You Eligible?
Tax Breaks for Family Caregivers: Are You Eligible? 850 500 smolinlupinco

Caring for an elderly relative is a privilege that offers many rewards: a deeper bond with your loved one, the knowledge that you are making an impact, and the peace of mind knowing they are in good hands. There are also potential tax benefits that can help lighten the load of caregiving. 

1. Medical expenses. When you provide over 50% of your loved one’s support, including medical expenses, they qualify as your “medical dependent” on your tax return. This allows you to include their qualified medical expenses along with your own when you itemize, which can potentially lower your income. The test for determining whether an individual qualifies as your “medical dependent” is less stringent than that used to determine “dependents,” which is covered in more detail below. 

In order to claim medical expense deductions, the total costs must exceed 7.5% of your adjusted gross income (AGI). 

Deductible medical expenses include costs for qualified long-term care services required by a chronically ill individual. Eligible long-term care insurance premiums can also be deducted; however, there is an annual cap on the amount. The cap is based on age, and in 2024 goes from $470 for an individual aged 40 or less to $5,880 for an individual over 70.

2. Filing status. You may qualify for “head-of-household” status by virtue of the individual you’re caring for if you are not married and:

  • The person you’re caring for lives in your household,
  • You cover more than half the household costs,
  • The person qualifies as your “dependent,” and
  • The person is a relative.

If you are caring for your parent, they do not need to live with you. As long as you provide more than half of their household costs and they qualify as your dependent, you can claim head of household status which has a higher standard deduction and lower tax rates than a single filer.

While dependency exemptions are currently on hold for 2018 through 2025, the rules for determining who qualifies as a dependent still apply when determining eligibility for other tax benefits, like head-of-household filing status.

The following must be true for the tax year you are filing in order for for an individual to qualify as your “dependent”:

  • You provide more than 50% of their support costs,
  • They must either live with you or be related,
  • They must not have gross income in excess of an inflation-adjusted exemption amount,
  • They can’t file a joint return for the year, and
  • They are a U.S. citizen or a resident of the U.S., Canada or Mexico.

3. Dependent care credit. In cases where your loved one qualifies as your dependent, lives with you and is physically or mentally unable to take care of themselves, you may qualify for the dependent care credit. This credit is designed to account for costs incurred for their care necessary while you and your spouse go to work.

4. Nonchild dependent credit. For 2018 through 2025, the Tax Cuts and Jobs Act (TCJA) created a credit of up to $500 dependents who don’t qualify for the Child Tax Credit. This could apply to a dependent parent; however, they must pass the aforementioned gross income test to be classified as your dependent. You must also pay over half of your parent’s support.

If your adjusted gross income (AGI) is above $200,000 ($400,000 for a married couple filing jointly), this credit is reduced by $50 for every $1,000 that your AGI exceeds the threshold.

Contact your Smolin Advisor to explore the tax implications of financially supporting and caring for an elderly relative.

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