Taxes

Individual Retirement Accounts (IRAs) are designed to help you save for retirement, and they come with a set of rules and regulations to encourage long-term savings. While it’s generally not recommended to dip into your IRA before retirement, there are certain circumstances where you can borrow from your IRA without incurring penalties or taxes. However, it’s crucial to understand the rules and potential consequences of doing so. In this article, we’ll explore the rules for borrowing from your IRA.

Types of IRAs

Before we delve into the rules for borrowing from your IRA, it’s essential to understand the two main types of IRAs: Traditional IRAs and Roth IRAs. The rules for borrowing from these accounts differ significantly.

1. Traditional IRA:

Contributions: You may make tax-deductible contributions to a Traditional IRA, which can reduce your taxable income in the year you make the contribution.

Distributions: Distributions from a Traditional IRA are generally taxed as ordinary income. You must start taking required minimum distributions (RMDs) after reaching the age of 72.

2. Roth IRA:

Contributions: Roth IRAs accept after-tax contributions. This means you don’t get a tax deduction when you contribute, but qualified distributions in retirement are tax-free.

Distributions: Contributions to a Roth IRA can be withdrawn at any time without taxes or penalties. Earnings, however, may be subject to penalties and taxes if withdrawn before age 59½.

Now, let’s look at the specific rules for borrowing from both types of IRAs.

Borrowing from a Traditional IRA

Traditional IRAs have strict rules regarding borrowing money, and taking funds from your Traditional IRA may result in taxes and penalties. Here are the key points to consider:

1. Early Withdrawal Penalty: If you withdraw funds from your Traditional IRA before you reach age 59½, you will typically face a 10% early withdrawal penalty. Additionally, the distribution is subject to income tax.

2. Exceptions: There are specific exceptions to the early withdrawal penalty, such as using the funds for qualified education expenses, first-time home purchases, certain medical expenses, or to cover substantial unreimbursed medical insurance premiums if you’re unemployed.

3. Required Minimum Distributions (RMDs): Starting at age 72, you are required to take minimum distributions from your Traditional IRA. Failing to do so can result in hefty penalties.

Borrowing from a Roth IRA

Roth IRAs have more flexibility when it comes to accessing your contributions, but the rules for earnings are stricter:

1. Contributions: You can withdraw your Roth IRA contributions at any time without incurring taxes or penalties. This is because you’ve already paid taxes on these funds.

2. Earnings: If you withdraw earnings from your Roth IRA before age 59½, the distribution may be subject to income tax and a 10% early withdrawal penalty, unless an exception applies.

3. Exceptions: Similar to Traditional IRAs, there are exceptions to the early withdrawal penalty for Roth IRAs, including qualified first-time home purchases and certain medical expenses.

It’s essential to note that borrowing from your retirement accounts should be a last resort. When you take money out of your IRA, you’re not only potentially subject to taxes and penalties, but you’re also depleting your retirement savings. It’s generally recommended to explore other financial options, such as emergency funds, low-interest loans, or budget adjustments, before considering an IRA withdrawal.

IRAs are intended for retirement savings, and there are rules in place to encourage responsible use. While there are exceptions to these rules, it’s vital to consult with a financial advisor or tax professional before making any decisions about borrowing from your IRA. Your financial future is at stake, and making informed choices is key to a comfortable retirement.

What is Beneficial Ownership Information Reporting?

Beneficial Ownership Information (BOI) reporting is a federal requirement by the Corporate Transparency Act (CTA). BOI reports include information about all the company’s beneficial owners.

Who is considered a Beneficial Owner?

A beneficial owner is any individual who, directly or indirectly, exercises substantial control over a reporting company or owns or controls at least 25 percent of the company’s ownership interests.

What is the Corporate Transparency Act?

The Corporate Transparency Act (CTA) is a United States federal law that aims to increase transparency in corporate ownership. The law requires that individuals considered beneficial company owners in the U.S. provide the Financial Crimes Enforcement Network (FinCEN) with specific information.

For individuals, that includes:

• their full name
• date of birth
• current residential address
• a federally issued identification number from a driver’s license or passport

For companies, that includes:

• legal entity name or DBA name
• business address
• state jurisdiction of formation of registration
• IRS TIN

Any changes to the above reporting information must be updated with the FinCEN within 30 days of the change.

What is considered a Reporting Company?

Companies required to report a BOI are referred to as reporting companies. There are two types of reporting companies: domestic and foreign. They are defined as follows:

1. Domestic reporting companies are corporations, limited liability companies (LLC), and other entities created by filing a document with a secretary of state or similar office in the U.S.
2. Foreign reporting companies are entities (including corporations and LLCs) formed under a foreign country’s law and registered to do business in the U.S. by filing a document with a secretary of state or similar office.

There are 23 types of entities that are exempt from the reporting requirements. Those entities can be found on the FinCEN website.

What is the Reporting Process?

The reporting process takes place via an online portal on the FinCEN’s website. Filing begins January 1, 2024, with an initial filing window of one year (i.e., initial BOI reporting can be done from January 1, 2024, through January 1, 2025). The FinCEN will not accept BOI reporting before January 1, 2024. There is no fee for submitting this information.

New entities established after December 31, 2023, must report within 90 days of establishment.

Hefty civil ($500/day) and criminal penalties (up to $10,000) can be imposed on companies that fail to file a complete report.

To be sure that you and your firm comply with BOI reporting requirements, check with your trusted tax accountant or CPA.

As a business owner, you should familiarize yourself with your federal, state, and local tax requirements. Understanding what your obligations are will assist you in filing returns and paying taxes accurately and on time. Whatever taxes you are required to pay, you have to be very aware that there are deadlines for remitting them and any delays on your part could result in penalties. Here are some tips that can help you avoid tax trouble with the IRS.

Employment Taxes

The IRS requires employers to withhold federal income tax and FICA (Social Security and Medicare) taxes from their employees’ wages. The IRS also wants you to remit these employment taxes, along with your company’s FICA contributions, to them in a timely manner. Failing to remit these taxes can lead to serious penalties for noncompliance. This is one issue you absolutely must stay on top of.

Remember, sole proprietors, general partners, and, usually, members of limited liability companies do not have Social Security and Medicare taxes withheld like employees do. Instead, they must pay self-employment taxes, which typically cover Social Security and Medicare.

Estimated Taxes

You must generally make quarterly estimated tax payments to cover self-employment taxes and income tax on income that is not subject to withholding. If you do not make required estimated payments on time, you may owe the IRS an underpayment penalty.

Misclassifying Workers

Employees and independent contractors are treated differently for income tax withholding and employment tax purposes. Generally, the more control you have over a worker’s tasks and hours of work, the more likely that individual is an employee. In the case of employees, you must withhold federal income tax and FICA taxes, pay your share of FICA taxes, and pay unemployment taxes. You are not required to withhold income or FICA taxes from an independent contractor. Independent contractors pay income taxes and self-employment taxes on their own. If the IRS determines that your business has misclassified employees as independent contractors, it could prove to be costly.

Keep Business and Personal Transactions Separate

Personal bank and credit card accounts should always be kept separate from business accounts. Doing so makes it easier to identify all appropriate business expenses at tax time. That, in turn, simplifies things when it comes to claiming business tax deductions.

Substantiating Business Expenses

Like every business, your company will incur various expenses that are simply the cost of doing business. Many of these business expenses will be deductible. You should have proof of purchase for those expenses that you intend to deduct. Proof can be a cancelled check (or a legible image of the check), or a credit card, debit card, or electronic funds transfer (EFT) statement that shows the payee, amount of purchase or transfer, and the date of the transaction.

It’s also important that you can provide an invoice or receipt that identifies the purchase. If it’s not clear what the business purpose for the purchase is, then you should attach a note of explanation or write directly on the invoice or receipt. This can be helpful if the deductibility of the purchase is ever questioned by the IRS. Deductions for business travel expenses have very specific substantiation requirements, so be sure you are familiar with them before claiming these expenses.

Determining what taxes your business is subject to and when those taxes must be remitted is complex. Unfortunately, errors can be costly to your business. A professional who specializes in small business tax and accounting matters can help your business put systems and procedures in place so that it can claim all the deductions it is entitled to and meet its tax obligations in a timely and accurate manner.

You may not think about taxes often, but they can prove to be a large expense. That’s why it’s important to make the most of any opportunities you may have to lower your tax liability. Here’s a look at some of the factors you may want to consider in your planning.

Standard Deduction or Itemizing

The Tax Cuts and Jobs Act (TCJA) contained many provisions that will be in place through the 2025 tax year. For example, there are significantly higher standard deductions for each filing status and various itemized deductions have been reduced or eliminated. As a result, many people who previously itemized are now better off taking the standard deduction. But don’t automatically rule out itemizing, especially if you expect to make a large charitable contribution or will have a lot of medical and dental expenses. By bunching these items in one tax year, to the extent possible, you may have enough to make itemizing worthwhile that year.

Home/Work Tax Breaks

If you are a traditional full-time employee and work from home, home office expenses are not deductible, even if you itemize. The deduction for unreimbursed employee business expenses (and various other miscellaneous expenses) won’t be restored until 2026. However, if you are a self-employed/gig worker, you may qualify to deduct your home office expenses. Certain requirements apply.

Moving Expenses

Work-related moving expenses may now be deducted only if you are an active-duty member of the Armed Forces and the move is per a military reassignment. This deduction is available whether you itemize or claim the standard deduction.

Health Savings Accounts (HSAs)

HSAs continue to offer tax breaks. If you are covered by a qualified high-deductible health plan and meet other requirements, you can contribute pretax income to an employer-sponsored HSA or make deductible contributions to an HSA you open on your own. An HSA can earn interest or be invested, growing in a tax-deferred manner similar to an individual retirement account (IRA). And HSA withdrawals for qualified medical expenses are tax free. You can also carry over a balance from year to year, allowing the account to grow.

Family Related Tax Credits

The TCJA expanded tax credits for families, doubling the child credit and adding a family credit for dependents who don’t qualify for the child credit. Credits include one for each child under age 18 at the end of the tax year and another for each qualifying dependent who isn’t a qualifying child. The latter category includes an older dependent child or a dependent elderly parent.

The adoption credit and the income exclusion for employer adoption assistance are still in place. You’ll want to check into the details if you are adopting a child.

Section 529 Plans*

These tax-advantaged savings plans assist in paying for education. While initially used to pay for a college education, 529 plans may now cover elementary through high school education as well. Some states offer tax breaks for 529 plan contributions. However, contributions are not deductible on your federal return. Growth related to 529 contributions is tax deferred, and withdrawals for qualified education expenses — including elementary and secondary school tuition of up to $10,000 per year per student — are free of federal income taxes.

A special break allows you to front-load five years’ worth of gift tax annual exclusions and make up to a $85,000 contribution per beneficiary in one tax year free of federal gift tax. If you make the contribution with your spouse, the total can be extended to $170,000. (These limits may be inflation adjusted.)

Other Education Tax Breaks

As before, you may be able to take advantage of either the American Opportunity credit or the Lifetime Learning credit for higher education costs. The first credit can be up to $2,500 per student per year for the first four years of college. The second credit is limited to $2,000 per tax return and is available for qualified expenses of any post-high school education at an eligible educational institution, including graduate school.

In addition, if you are paying off your student loans, you may be able to deduct the interest, up to $2,500 per year. This deduction is available whether you claim the standard deduction or itemize.

Keep in mind that there are income limits for these tax breaks.

Investments

To help reduce the taxes you pay on investment gains in taxable accounts, you may want to consider:

• Selling securities with unrealized losses before year end to offset realized capital gains.
• Choosing mutual funds** with low portfolio turnover rates that tend to generate long-term capital gains, since the lower long-term rates offer a tax savings.
• Factoring in that you can deduct only $3,000 of net capital losses per year against other income ($1,500 if you’re married filing separately), but you can carry forward excess losses to subsequent tax years.

You should also be aware that if you have modified adjusted gross income of over $200,000 ($250,000 if married filing jointly; $125,000 if married filing separately), you may owe a 3.8% “net investment income tax,” or NIIT.

Retirement

While the TCJA made only minimal changes in the area of retirement planning, there are still issues to consider. The main one is whether you want to pay taxes on your retirement account contributions later (when you eventually take distributions from your account) or pay taxes on them now (which means potentially tax-free distributions when you retire). It all depends on the type of savings vehicle you use.

Traditional 401(k), 403(b), and 457 plans and traditional IRAs allow you to save for retirement on a tax-deferred basis. Your employer may also choose to make contributions to your plan account. Salary deferrals to 401(k) and similar plans are generally pretax, while traditional IRA contributions are tax deductible under certain circumstances.

Roth alternatives — available in some employers’ 401(k), 403(b), and 457 plans, as well as through a Roth IRA you open on your own — provide no tax break on contributions. However, investment earnings accumulate tax deferred. And, when requirements are met, distributions from your account are tax free. Since Roth accounts in employer plans lack income restrictions, you may be able to make larger contributions to an employer’s Roth plan than to a Roth IRA.

As always, make sure that you obtain professional advice before making tax-related decisions. Your tax professional can provide detailed information and help you evaluate what might be appropriate for your personal tax situation.