Finally ….. your son or daughter is off to college, a whole new stage of life begins. As the celebration fades and classes begin it’s time to start thinking about the tax planning and taking full advantage of all of your benefits and avoiding unnecessary tax burdens. It’s it just great that your loved one has received a huge scholarship and you have been socking money away in a 529 fund. Well you need to also understand there can be a tax consequence involved if you aren’t careful.

FACT: Scholarship amounts that exceed “qualified education expenses” are taxable as ordinary income and furthermore require the payment of “self-employment” tax to the person receiving the 1098-T, the student.

FACT: If the scholarship amount reduces your out of pocket costs of college it would interfere with you taking advantage of a huge tax break.

During the 2017 tax season (ending in April 2018) I saw a number of 1098-T (tax statements from college) that showed substantially more “Scholarship” income than Qualified Expenses. Somebody is paying tax on this income! Another example is scholarship or fellowship money that represents compensation, say a $20,000 teaching assistant fellowship went primarily to pay for tuition and books, that $20,000 would still be considered taxable income! Even if the scholarship amount is substantial, you could miss out on your tax break.

But there is some good news here also, beyond having your kid in college. There are various tax breaks including, if you qualify, the American Opportunity Tax Credit (AOTC). The AOTC can be worth up to $2,500 per undergraduate every year for 4 years, that’s $10,000 over 4 years. There are some income limits and the credit gets phased out as your modified adjusted gross income rises.  Different college-related credits and deductions have different rules, so it pays to look into which will work best for you.

The AOTC is calculated as 100% of the 1^st $2,000 in qualified expenses and 25% of the next $2,000. So $4,000 is the maximum “qualified expenses” that apply. 

So, since you as a parent still claim the student as a dependent (you pay more than ½ of his/her total expenses) YOU can claim the AOTC on YOUR taxes! Kids away at college are deemed to be “temporarily gone” but still living with you. 

HOWEVER … if you scholarship income is more than the “qualified expenses”, there are no real “expenses” and therefore you, the parent won’t get the $2,500 American Opportunity Tax Credit.

So, there is a legal way around this that may not be apparent to many taxpayers.

Here is what you do:
Have the parents claim tuition, up to a max of $4,000 to get the full AOTC, then show the scholarship income on the students tax return with the balance of the expenses. The assumption is that the student will be in a much lower tax bracket than the parent. The parent will get the $2,500 tax credit. This credit in a higher tax bracket is much better that the lower taxes paid by the student. You can do this every year. In addition, there is a portion of the AOTC that is “refundable in 2018, up to $1,000. This means that if your tax bill was only say $1,500 and you applied the $2,500 tax credit, you would have a $0 tax bill PLUS get a $1,000 refund.

Also keep in mind that you can’t double-dip if you have a 529 plan. Therefore, before you write that first tuition check: You can’t use the same qualified college expenses to calculate both your tax-free withdrawal from a 529 college savings plan and the AOTC tax break. In other words, if you pay the entire college bill with an untaxed 529 plan withdrawal, you probably won’t be eligible for any college tax credit or deductions.

You can check IRS Publication 970 for qualified education expenses. In addition if you pay qualified expenses from “tax-free” funds like Pell grants etc. you can’t use these expenses in your calculations for the credit.

See what I mean, you may need a tax plan if you have kids in college. You may also need professional tax help to develop a plan.

Many people either approaching or already in retirement spend a lot of time coming up with an investment strategy as they should but don’t have a tax avoidance strategy. Prior to retirement we are in the “accumulation” phase, we are accumulating wealth to be used later. Once we retire, the paychecks stop and we begin the “decumulate” or draw-down phase of our lives.

Decumulating type investments in a tax-efficient manner is a part of retirement planning that is often overlooked.  That’s probably because a $xx,000 reduction in after-tax wealth over several years due to a poor tax strategy is much less visible than an $xx,000 decline in your investment portfolio.

Here are some suggestions to help

1. Delaying Social Security benefits (SSB) until the age 70 is a huge investment and tax decision. The delay from age 66 to 70 is a non-taxable 32% gain, 100% safe from any market conditions.
2. During this delayed benefits time you can take advantage of the new tax rates and doubling of the Standard Deductions. Plan to live off cash and withdraws from a taxable brokerage account. The idea is pay $0 in Federal taxes while taking advantage both the 0% tax rate on up to $77,200 in Capital Gains and Qualified Dividends. Bundle into this “tax loss harvesting” and more cash can be raised.
3. Beyond this you can look to max out the benefits of being in a low 0%, 10% or 12% tax brackets by converting IRA funds into your ROTH IRA account. Just a broad statement, the very best scenario is to have 100% of all investments in a ROTH account! For example, during this SSB delay period every year convert enough IRA stock/funds into your ROTH to just hit the $77,400 threshold. That’s when every extra dollar is taxed at 22% instead of 12%. Make sure you factor this into your calculations in #3 above.
4. Keep in mind that the above strategies work best if done BEFORE taking Social Security Benefits at 70 and the need to take Required Minimum Distributions (RMD) at age 70 ½. Up to 85% of SSB benefits can be taxed as ordinary income, all RMD is taxed as ordinary income also.
5. Once you are getting Social Security and RMD you will already be in a “fixed” tax situation, the question will become what additional income do you need beyond SSB and RMD? This additional income will become the new tax strategy. It is not at all uncommon that your RMD (including SSB) is much more than you need to live on, this is a tax burden, hence the discussion above about conversions from IRA to ROTH’s.
6. If you need additional income beyond your SSB and RMD look again to the maximizing of the Capital Gains and Qualified Dividends from your taxable account.

These are just a few suggestions and each family has unique situations. However, one this is pretty constant, tax planning runs hand in hand with investment planning. The ideal situation is that you are putting this overall master plan into place while you are in your late 50’s, probably the peak of your “accumulation” phase. However, you can make some of these decisions even while in retirement.

As many of my followers know, I like to invest in real estate as part of my overall investment strategy. Unlike others, I’m just not into buying specific properties and replacing toilets. Instead I invest in REIT’s, Real Estate Investment Trusts, they buy and manage the properties and i just collect the dividends and watch my investments grow in value. My REIT’s are part of my “Cash Machine” portfolio.  

REIT’s are considered “pass through” businesses, they don’t pay Federal income tax themselves, they pass that tax on to us investors (similar to you owning rental property). This is not very complicated at all, prior to the new 2017 Trump Tax Law if you held REIT’s in a taxable account, you paid tax on all dividends as “ordinary income”. 

HOWEVER – REIT investors will pay less tax on their dividends under new tax law. It allows investors to deduct 20% of the dividend income, with the remainder of the income taxed at the tax payers ordinary income rate. It is available even if the taxpayer doesn’t itemize deductions.

Of course if you hold your REIT’s in a tax advantaged account like an IRA or a ROTH IRA you don’t pay taxes on the dividends, until you take money out.

I own the following REIT’s:

American Capital (AGNC) 11.32% yield   – Residential Mortgage’s
ARBOR Rlty (ABR) 9.12% yield  – Commercial
Annaly (NLY) 11.45% yield  –  Residential Mortgage’s
Blackstone Mortgage (BXMT) 7.60% yield – Senior Loans Commercial Mortgages
Iron Mountain (IRM) 6.40% yield – Data storage (not really a REIT?, but it is)
Ladder Capital (LADR) 8.09%   – Fixed & Floating Rate Commercial Mortgages
Realty Income Corp (O) 4.74% yield – Over 5,000 Net Leases, 575 straight monthly dividends paid
Stag Industrial (STAG) 5.14% yield – Industrial Buildings

REIT’s can be a valuable component to your investments, and now you may get a tax savings too!

Meet Dr. Atul Gawande, a highly experienced surgeon, writer and Harvard professor, who starts this week as the CEO of a new health-care initiative formed by Amazon, Berkshire Hathaway  and JPMorgan Chase. 

So why do I like Dr. Gawande? Well he wrote one of the very best books I ever read, The Checklist Manifesto: How to Get Things Right.  I have already written on how this book influenced me and Boeing, check out that story here. Over the years I bought copies of this book for dozens of my employees, friends and customers. It will truly change your life, and it’s an easy read!

As I read the announcement of Dr. Gawande, I just know he’ll be successful in his new endeavor. I’ll bet that over time he will revolutionize the way Amazon, Berkshire Hathaway and JPMorgan implement healthcare in their businesses. 

“We said at the outset that the degree of difficulty is high and success is going to require an expert’s knowledge, a beginner’s mind, and a long-term orientation,” Amazon Chief Executive Jeff Bezos said in the press release. “Atul embodies all three, and we’re starting strong as we move forward in this challenging and worthwhile endeavor.”

Atul is also well known for a 2009 New Yorker magazine article, “The Cost Conundrum,” that found excessive care was being used in a Texas town, on Medicare’s dime. It’s one of the most influential magazine article of the past decade on the topic of Medicare. Not only was it shocking but Gawande reported, years later that costs had dramatically dropped in the town, saving taxpayers about half a billion dollars! The story goes that Charlie Munger from Berkshire sent $20,000 to him via The New Yorker since he was so impressed by the article. Dr. Gawande donated the money to a charity.

Good luck Dr. Atul Gawande!