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- Written by: Jerry Love
Without a doubt there is a wealth of information we already know about our clients’ financial status because we prepare their tax return. If we step back to see the forest instead of the trees there is much more the tax return is telling us about their overall financial well being and could lead to expanded services.
It is very important at the outset of this column to emphasize that all tax professionals who wish to offer services to their clients that are beyond tax compliance and tax planning, need to be familiar with Treasury Reg. Section 301.7216-2(n). These Regulations permit the tax return preparer to use their client list to send a newsletter to clients containing, “tax information and general business or economic information or analysis for educational purposes.” However, 7216 explicitly states that the client list may not be used to “solicit any service or product other than tax return preparation services.” You can find more information at www.pfp.aicpa.org.
You can use the tax return to identify personal financial planning needs of the client. It gives you an overall picture of clients’ financial situation and can uncover opportunities for planning that client should consider.
Items to consider include:
1. What is their ratio of investment income to their total income?
2. If they have a high level of income but little or no investment income, do they have a high level of debt or high level of consumption or a combination?
3. As you review their investment income, do they seem to have diversified investments?
4. Is there an appearance that the client’s assets may be low yield investments or at the opposite, concentrated in high-risk investments? Do they need assistance in defining their risk tolerance and/or assistance in understanding the principles of risk/reward?
5. Do they have a high cash balance in a limited number of financial institutions? Have they considered their balances in light of the FDIC insurance limits?
6. Have they established an emergency savings fund?
7. Are they maximizing their participation in a 401k or similar deferral plan?
8. Do they have an option to participate in a Flex Plan?
9. If they are self-employed, have they established a retirement plan? Is their plan structured to give them the maximum contribution possible?
10. If their primary investment and retirement is based on a closely held business, do they have a strategy for developing its value and have a succession plan to realize that value?
11. If they are self-employed, have they considered the opportunity to have dependents employed in the business?
12. Do they have children under age 18? Do they have plans to send them to college and if so, do they have a strategy for funding part or all of that cost?
13. Will they potentially have any financial responsibility for other family members whether that might be parents, siblings, adult children or grandchildren?
14. Is their spouse active in the business and if so, have they explored the compensation to the spouse including fringe benefits and retirement plans?
15. If they have an IRA, have they considered converting it to a Roth IRA? Have they considered funding the maximum non-deductible IRA in addition to their retirement plan funding?
16. Do they have items reflected on Schedule C, F or E that may be a drain on their overall cash flow and diminishing their liquidity? Have they considered the long-term benefit of the venture and how it may be contributing or hindering their financial goals?
17. If the client has been successful in the accumulation of assets and developing their net worth, do they need estate planning? Do they have plans to make significant charitable contributions during their lifetime or at their death?
18. Has the client considered their potential needs relative to life insurance whether it may be to provide income replacement or to provide cash to pay either estate taxes or fund a buyout of their closely held business?
19. If they are self-employed does their health insurance qualify to be deducted on page 1 of Form 1040?
20. Does the client qualify for a Health Savings Account? Have they considered using the HSA as an additional vehicle to accumulate tax deferred dollars for their retirement years?
21. Do they have disability insurance? Will it meet their needs?
22. Has the client given consideration to long-term care insurance and how to address the potential future medical expenses they may encounter?
23. How much is their annual mortgage interest expense? Do they have more than one mortgage? Do they have home equity loans or home equity line of credit? Do they need to evaluate their cash flow and consider a plan to reduce their overall debt?
24. Are they high-income taxpayers who are living paycheck to paycheck and putting their financial security on the back burner?
25. On Schedule E, what type of entities do they have? Do any of these give rise to concerns for unexpected liability?
26. On Schedule D, do they have a large volume of trading? Does their portfolio contain unrealized gains or losses?
This column and list is not an all inclusive list. For a more extensive list, refer to http://www.aicpa.org/InterestAreas/PersonalFinancialPlanning/Resources/TaxPlanning/DownloadableDocuments/AnalysisofaTaxReturnforPFP.pdf.
As indicated, this short column cannot give an in depth discussion of everything to consider when reviewing the Form 1040 and although the above referenced list gives more guidance, neither will replace a scheduled time to explore financial planning topics with your client. Clients both want and need to explore financial planning in more depth.
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- Written by: Jerry Love, CPA/PFS, ABV, CVA, CFP
By: Jerry Love, CPA/PFS, ABV, CVA, CFP | Earlier this summer, I wrote an article about the topic of when a person should start drawing their Social Security. I received several requests that I also write about what a spouse would receive from Social Security and the answer is, “it depends” based on a number of factors. In this article, I will walk you through some of these basic considerations addressing only the retirement benefits of the spouse. If a person dies with dependent children, that is a whole other topic; I only have a limited amount of information about that in this article.
In this article and in the materials written by the Social Security Administration (SSA), it can be confusing about who they are referring to as the spouse. So to help you know who is who, I am going to assume that John Doe is the spouse who made the most money and when this article is talking about the spouse or the worker with the larger earnings record, I will indicate it is John. Jane Doe is (or was, as the case may be) married to John Doe.
Basically the spouse (Jane) may draw the higher of the retirement benefit based on their own record or their spouse’s (John’s) record or even a spouse prior to John. Generally, drawing based on the spouse’s (John’s) record would yield them a retirement benefit equal to half of their spouse’s (John’s) retirement benefit. Any retirement benefits that Social Security pays to the spouse (Jane) does not decrease the retirement benefits of the other person (John). Furthermore, it may be that John may have more than one person whose retirement is based on his earnings and that does not diminish what any of them are entitled to, including John.
First fundamental principle, you (Jane) cannot receive retirement benefits based on your spouse (John) until your spouse files for retirement, if he is alive and you are still married. You may apply for and receive retirement benefits based on your own record starting as early as age 62.
Who Can Get Survivors Benefits Based on Your Work?
According to the Social Security Administration’s (SSA) site http://www.ssa.gov/pubs/EN-05-10084.pdf:
“Your widow or widower may be able to receive full benefits at full retirement age. The full retirement age for survivors is age 66 for people born in 1945-1956 and will gradually increase to age 67 for people born in 1962 or later. Reduced widow or widower benefits can be received as early as age 60. If your surviving spouse is disabled, benefits can begin as early as age 50.”
As to the broader topic of Benefits for other Family Members, in the Social Security Administration’s publication on Retirement Benefits, they tell us:
1. “Your widow or widower can receive benefits at any age if she or he takes care of your child who is receiving Social Security benefits and younger than age 16 or disabled.”
2. “Your unmarried children who are younger than age 18 (or up to age 19 if they are attending elementary or secondary school full time) also can receive benefits.”
3. “Your children can get benefits at any age if they were disabled before age 22 and remain disabled.”
4. “Under certain circumstances, benefits also can be paid to your stepchildren, grandchildren, step-grandchildren or adopted children.”
5. “Your dependent parents can receive benefits if they are age 62 or older. (For your parents to qualify as dependents, you would have had to provide at least one-half of their support.)”
For more information on widows, widowers and other survivors, visit www.socialsecurity.gov/survivorplan.
Now back to our basic question of what are a spouse’s benefits for SSA retirement. The SSA website tells us:
“A spouse (Jane) who has not worked or who has low earnings can be entitled toas much as one-half of the retired worker’s (John’s) full benefit. If you are eligible for both your own retirement benefits and for benefits as a spouse, we always pay your own benefits first. If your benefits as a spouse (Jane based on John’s earnings) are higher than your retirement benefits, you will get a combination of benefits equaling the higher spouse benefit.
“If you (Jane) have reached your full retirement age, and are eligible for a spouse’s (John’s) or ex-spouse’s benefit and your own retirement benefit, you may choose to receive only spouse’s benefits and continue accruing delayed retirement credits on your own Social Security record. You then may file for benefits later and receive a higher monthly benefit based on the effect of delayed retirement credits. If you are receiving a pension based on work where you did not pay Social Security taxes, your spouse’s benefit may be reduced.”
Can a spouse (Jane) begin to draw Social Security retirement benefits before they reach full retirement age?
Yes, but the amount of the benefit is reduced. The amount of the reduction depends on the combination of what their spouse’s (John’s) “full retirement age” is and the age they (Jane) wish to begin drawing. For example, if their spouse’s (John’s) full retirement age is 65 and the spouse elects to begin drawing retirement at age 62, they would get 37.5% of the worker’s unreduced benefit. Or if the spouse’s (John’s) full retirement age is 67, a spouse would get 32.5% of the worker’s (John’s) unreduced benefit at age 62.
What is the retirement benefits amount for the spouse (Jane) when their spouse (John) has a larger history of earning?
The following is taken from http://ssa-custhelp.ssa.gov/app/answers/detail/a_id/175.
"A spouse (Jane) receives one-half of the retired worker's (John’s) full benefit unless the spouse (Jane) begins collecting benefits before full retirement age.
"If the spouse (Jane) begins collecting benefits before full retirement age, the amount of the spouse's benefit is reduced by a percentage based on the number of months before he/she reaches full retirement age.
For example, based on the full retirement age of 66 (for John), if a spouse (Jane) begins collecting benefits:
- At age 66, Jane would get 50% of John’s full retirement benefit;
- At age 65, the benefit amount that Jane would get is about 46 percent of the retired worker's full benefit;
- At age 64, Jane would get about 42%;
- At age 63, 37.5 percent; and
- At age 62, 35 percent.
"However, if a spouse (Jane) is taking care of a child who is either under age 16 or disabled and receives Social Security benefits, a spouse (Jane) will get full benefits, regardless of age.
"If you are eligible for both your own retirement benefit and for benefits as a spouse, we will always pay you benefits based on your record first. If your benefit as a spouse is higher than your retirement benefit, you will receive a combination of benefits equaling the higher spouse's benefits."
Can I (Jane) receive reduced retirement benefits at age 62 under my record then at full retirement age receive full spouce' benefits?
According to SSA’s website at http://ssa-custhelp.ssa.gov/app/answers/detail/a_id/309/kw/spousal%20benefits.
"If you (Jane) choose to receive a reduced benefit before full retirement age on your own record, you are not entitled to the full spouse's (based on John’s earnings) benefit rate upon reaching full retirement age, and a reduced benefit rate is payable for as long as you remain entitled to spouse's benefits."
One concept that I find many people are unsure or unaware of is that they may be eligible to draw retirement benefits based on a former spouse. They may be entitled to retirement benefits based on the earnings record of a former spouse who is deceased or from whom they are divorced. First, I will explore the Survivors Benefits as discussed on the SSA website at: http://ssa-custhelp.ssa.gov/app/answers/detail/a_id/395. In order to determine eligibility to draw based on a deceased spouse’s record, we have to know how long they were married.
"Generally, you (Jane) qualify for survivor’s benefits if you were married to your spouse (John) for at least nine months before the worker (John) died. If your spouse could not have been expected to live for nine months when you married, you do not qualify for benefits on your spouse's record.
"In some cases, however, you do not need to be married to your spouse for any specific length of time to get benefits.
"As you (John) plan for your family's protection if you die, you should consider the Social Security benefits that may be available if you are the survivor (Jane)--that is, the spouse or child--of a worker who dies. That person (John) must have worked long enough under Social Security to be eligible for retirement benefits.
"The number of credits needed to provide benefits for survivors depends on the worker's (John’s) age when he or she dies. The younger a person is, the fewer credits he or she must have for family members to receive survivor’s benefits. But no one needs more than 40 credits (10 years of work) to be eligible for any Social Security benefit.
"However, benefits can be paid to the worker's children and the surviving spouse who is caring for the children even if the worker doesn't have the required number of credits. They can get benefits if the worker has credit for one and one-half years of work (6 credits) in the three years just before his or her death."
Qualifying for Divorced Spouse Benefits
Am I entitled to any benefits for a divorced spouse?
This poses an interesting twist and the answer is yes, you may be entitled to benefits based on a divorced spouse. You can find the discussion of this on SSA’s web site at http://ssa-custhelp.ssa.gov/app/answers/detail/a_id/299.
So we can keep the spouses straight in these discussions we introduce Sam, Jane’s ex-husband.
"A person (Jane) can receive benefits as a divorced spouse on a former spouse’s (Sam’s) Social Security record if he or she:
- Was married to the former spouse for at least 10 years;
- Is at least age 62 years old;
- Is unmarried; and
- Is not entitled to a higher Social Security benefit on his or her own record.
"The amount of benefits he or she gets has no effect on the amount of benefits you (Sam) or your current spouse (Sam’s next wife) can get. Also, if you (Sam) and your ex-spouse (Jane) have been divorced for at least two years and you and your ex-spouse are at least 62, he or she can get benefits even if you (Sam) are not retired.
"The former spouse (Jane) must be entitled to receive his or her own retirement or disability benefit. If the former spouse (Jane) is eligible for a benefit, but has not yet applied for it, the divorced spouse can still receive a benefit if he or she meets the eligibility requirements above and has been divorced from the former spouse for at least two years."
What if I Remarry?
Follow our example that Jane has remarried and is now married to John. Here is what the SSA’s rule is:
“Generally, we cannot pay benefits if the divorced spouse (Jane) remarries someone (John) other than the former spouse (Sam), unless the latter marriage ends (whether by death, divorce, or annulment), or the marriage is to a person entitled to certain types of Social Security auxiliary or survivor's benefits.
"A person can receive benefits as a surviving divorced spouse on the Social Security record of a former spouse who died fully insured, if he or she:
- Is at least age 60, or age 50 and disabled;
- Was married to the former spouse for at least 10 years; and
- Is not entitled to a higher Social Security benefit on his or her own record.
"If the surviving divorced spouse is age 60 or over applying for benefits remarried after age 60, or after age 50 and at the time of remarriage was entitled to disability benefits, we disregard the marriage. If a person is already entitled to benefits as an aged or disabled surviving divorced spouse and remarries, benefits continue regardless of the person's age at the time of remarriage.
"The benefits paid to a divorced spouse or a surviving divorced spouse will not affect the benefit amount paid to other family members who receive benefits on the same record.”
As you can see this portion of the question can become very complicated and may require a trip to the Social Security office to discuss the matter with them in person.
What Information Do You Need to Apply for Spouse's or Divorced Spouse's Benefits?
You can find this listing of what you need to have with you if you are planning to apply for retirement benefits based on a prior marriage. http://www.socialsecurity.gov/online/ssa-2.html
"Documents you may need to provide - We may ask you to provide documents to show that you are eligible, such as:
- Birth certificate or other proof of birth;
- Proof of U.S. citizenship or lawful alien status if you were not born in the United States
- U.S. military discharge paper(s) if you had military service before 1968;
- W-2 forms(s) and/or self-employment tax returns for last year.
- Final divorce decree, if applying as a divorced spouse; and
- Marriage certificate.
"Important - We accept photocopies of W-2 forms, self-employment tax returns or medical documents, but we must see the original of most other documents, such as your birth certificate. (We will return them to you.)
"Do not delay applying for benefits because you do not have all the documents. We will help you get them.
What if I am Eligible for Ex-Spouse Benefits Based on the Above Rules, but They are Deceased?
Again we go to the SSA’s website, http://ssa-custhelp.ssa.gov/app/answers/detail/a_id/1811/kw/spousal%20benefits.
"You (Jane) can receive retirement benefits as a surviving divorced spouse (Sam) on the Social Security record of a deceased former spouse (Sam) who is fully insured. If you:
- Are at least age 60, or age 50 and disabled;
- Were married to the former spouse for at least 10 years;
- Are not entitled to a higher Social Security benefit on your own record; and
- Are unmarried, unless the following exception applies: You remarried after age 60; or after age 50 and at the time of re-marriage you were entitled to Social Security disability benefits.
If you believe this article and the prior article have covered everything you need to know or want to try figuring out what you are eligible to receive, the SSA has a Do It Yourself (DIY) tool at http://www.benefits.gov/ssa.
"If you are inclined to assess what you might be eligible to receive, SSA has a DIY tool called BEST (Benefit Eligibility Screening Tool). BEST helps you find out if you could get benefits that Social Security administers. Based on your answers to questions, this tool will list benefits for which you might be eligible and tell you more information about how to qualify and apply.
BEST is NOT an application for benefits and:
- does not know, or ask for, your name or Social Security number.
- does not access your personal Social Security records.
- will not give you an estimate of benefit amounts."
However, if you are approaching retirement age (you are within 3 months of age 62 or older) you can apply online at http://www.socialsecurity.gov/applyonline/.
Otherwise you may call the SSA national toll-free service at 1-800-772-1213 (TTY 1-800-325-0778) or visit your local Social Security office. An appointment is not required, but if you call ahead and schedule one, it may reduce the time you spend waiting to apply.
"You can help by being ready to provide any needed documents; and answer the questions listed below.
What we will ask you
- Your name, gender and Social Security number;
- Your name at birth (if different);
- Your date of birth and place of birth (State or foreign country);
- Whether a public or religious record was made of your birth before age 5;
- Your citizenship status;
- Whether you or anyone else has ever filed for Social Security benefits, Medicare or Supplemental Security Income on your behalf (if so, we will also ask for information on whose Social Security record you applied);
- Whether you have used any other Social Security number;
- Whether you became unable to work because of illnesses, injuries or conditions at any time within the past 14 months. If "Yes," we will also ask the date you became unable to work;
- Whether you were ever in the active military service before 1968 and, if so, the dates of service and whether you have ever been eligible to receive a monthly benefit from a military or Federal civilian agency;
- Whether you or your spouse have ever worked for the railroad industry;
- Whether you have earned Social Security credits under another country's social security system;
- Whether you qualified for or expect to receive a pension or annuity based on your own employment with the Federal government of the United States or one of its States or local subdivisions;
- Whether you are currently married and, if so, your spouse's name, date of birth (or age) and Social Security number (if known).
- The names, dates of birth (or age) and Social Security numbers (if known) of any former spouses;
- The dates and places of each of your marriages and, for marriages that have ended, how and when they ended;
- The names of any unmarried children under 18, 18-19 and in secondary school or disabled before age 22;
- The name(s) of your employer(s) and/or information about your self-employment and the amount of your earnings for this year, last year and next year;
- Whether we may contact your employers for wage information;
- The month you want your benefits to begin; and
- If you are within 3 months of age 65, whether you want to enroll in Medical Insurance (Part B of Medicare).
"Depending on the information you provide, we may need to ask other questions."
Final Note
This has become part two of a discussion about applying for Social Security benefits. So if you are reading this article and have not already read the first one, I recommend that you obtain that one at www.cpamagazine.com and read it too. Its focus is more on the merits of starting your retirement payment at age 62, 66 or 70. Those elements are applicable to a person regardless of how their maximum benefit is determined.
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- Written by: Jerry Love, CPA
It has been estimated that approximately 90% of the businesses in the United States are closely held. According to statistics published by the Small Business Administration (SBA), “seven out of 10 new employer establishments survive at least 2 years and 51% survive at least 5 years.” Unfortunately, many of these businesses will fail as they attempt the next hurdle of transferring their business to either the next generation or to a loyal employee.
An article titled “A Transfer Tsunami for Family Biz” dated July 25, 2006 indicated that “Over the next 20 years, nearly $4.8 trillion of wealth is set to be transferred to the next generation of heirs. Much of that wealth will consist of the assets of family businesses, about 40% of which are due to hand the reins to the next generation during the current decade alone. However, most family businesses are not adequately prepared to handle the tidal-wave transfer of wealth. In fact, the majority of family businesses have made few or no provisions for turning the business over to the next generation.”
The successful transition of a closely held business is unique and in many cases can be problematic. Often the primary business owner has been key to the success of the business and has much of the critical management information in their head.
A successful transition of a business should begin with fundamental planning years in advance. Processes and procedures should be systemized and documented. Training is critical for those who will be in line to purchase and run the business. Transition of management responsibilities and contact with both key vendors and clients should be considered.
A sound succession plan should consider:
- How to transfer the control and ownership including choosing, grooming and training of the management successor.
- How the owner is paid for the business in order to afford a retirement income and/or provide for the surviving spouse.
- At what age the owner will be willing to begin a transition and make a complete transfer of the responsibilities.
- If the plan needs to address estate planning concerns relative to the transfer.
- If the transition is to a family member, does the plan address the other members of the family?
The financial aspect of a succession plan is of paramount importance to both the business owner and the successor, because in a majority of cases the business portion of the buy out will be paid out over time including:
- Receiving a down payment and then carrying a note for the balance.
- Agreeing to a smaller purchase price and receiving either some form of deferred compensation or payment for continued consulting services.
In many cases, the sale of the business is the primary source for the retirement of the business owner. There is a need for balance between the economic value of the business and the retirement desires/needs of the owner. Additionally, consideration is due to other family members who are not active in the business and may not be receiving any of the future income from the business.
Among the items to consider is whether there are assets in the business that can be distributed to the owner that would reduce the purchase price, including transferring ownership in the real estate to a separate entity whereby the owner and/or other family members would be receiving rent income. Perhaps, the same could be done with the equipment. Additionally, consider reducing the more liquid type assets whether they are cash or brokerage accounts.
If the business owner plans to transfer the business to a family member, then the use of a qualified plan to fund a large portion of the desired retirement is a very attractive option. Another alternative is the use of a nonqualified deferred compensation plan to facilitate the sale of the business. The value of the owner’s deferred compensation affords a method of getting cash to the owner from the future profits vs. the prior funding in a retirement plan while also decreasing the purchase price of the business. Using deferred compensation should afford the owner a deferred tax liability. However, there is an inherent risk of nonpayment to the owner if the business fails.
An alternative used by some to balance the interest of the children who will purchase and take over the business at a reduced value is to carry a life insurance policy payable to the children who will not be active in the business.
If one follows Steven Covey’s advice “to begin with the end in mind”, the business owner should lay out a plan decades before they plan to turn the business over to lay the foundation from organizational and financial aspects.
Jerry Love, CPA, is the sole owner of Jerry Love CPA, LLC in Abilene, TX. Contact him at
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Since the founding of our country, Americans have been drawn to owning our own land and in many cases, also have a strong attraction to owning our own businesses. In many instances, we see a person wishing to combine those two desires; hence, we see people with small tracks of land exploring ways to generate income and/or deductions from their ownership of land.
This is an area in which the IRS also has a great interest. The IRS has a one-sided perspective of this issue. Should you be fortunate enough to generate an income from this activity, it is taxable. But, if you, like many, have more expenses than income, then it is highly likely the IRS would consider this a “hobby loss.”
To add insult to injury, deductions attributable to the “hobby” activity are allowed only to the extent of its income or full amount of deductions, such as state and local property taxes that are otherwise allowable without regard to whether the activity is a hobby or is entered into for a profit.
Your first defense to an assertion by the IRS that your activity is a hobby would be for you to show you have generated a profit for a minimum of three out of the last five years. However, if your activity is the breeding, racing, showing or training of horses, the IRS will want you to show a profit two out of the last seven years.
As the IRS seeks to determine if you are engaged in the activity for a profit, they will consider issues such as the following:
- Do you operate this venture like a business? How do you keep records? Do you have a separate business bank account? Are you consulting with experts for advice on how to be profitable?
- What other sources of income do you have? Is this your only employment activity? How much time do you spend on the activity? For example, if you have a substantial income from other sources, the IRS may conclude that this is a hobby and not an active business enterprise.
- An additional factor to support your profit motive is the appreciation in value of the land or other assets involved.
- Does this activity generate any positive cash flow?
Do you have any prior experience in this field of interest? If so, were you able to generate a profit? Or stated in another way, do you have any expertise in this field, or is the primary benefit to you recreational in nature?
The tax code defines a farmer as someone who is raising or growing an agricultural or horticultural commodity. The term “farm” as defined in Code Sec. 3121(g) “includes stock, dairy, poultry, fruit, fur-bearing animal and truck farms, plantations, ranches, nurseries, ranges, greenhouses or other similar structures used primarily for the raising of agricultural or horticultural commodities, and orchards.” Fundamental to this distinction is that the taxpayer is participating in the raising or growing process.
As it relates to agriculture, the IRS seems to assert the hobby loss assertions most frequently to activities that have an element of personal recreation, such as horse breeding, showing and racing activities and cattle-raising activities.
There are many business ventures explored by landowners, such as farms, ranches, orchards and vineyards. Each of these ventures has unique challenges to make a profit.
For example, what does it take to make a profit with a vineyard? The initial investment can be hefty. Perhaps the first step is to obtain an expert advisor to help determine that the land can support a vineyard. The purchase price per acre could range from $50,000 to more than $100,000 for unplanted but suitable acreage. Existing acreage with vines could exceed $150,000 per acre. Further, it may run as much as $50,000 per acre to install a vineyard.
This article is not intended to provide operating benchmarks but is for illustrative purposes only.
The annual production costs for a vineyard might be in the range of $3,000 or $4,000 per acre. Additionally, you would incur harvesting costs and the carrying cost of the land purchase. So, a quick calculation will indicate that making a profit will require good weather and a consistent market for your grapes. The standard joke in the wine business is, “How do you make a small fortune in the wine business? Start with a big one.”
Jerry Love, CPA, is the sole owner of Jerry Love CPA, LLC in Abilene, TX. Contact him at
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By: Jerry Love, CPA/PFS, ABV, CVA, CFP | Retirement is the goal that most of us look forward to at the end of our career. There is much debate about whether Social Security is already bankrupt or will be completely defunct by the time you are eligible to draw retirement benefits. However, with an estimated 10,000 Baby Boomers per day turning 66 and entering the official “retirement age”, consulting with clients about the best options for them related to drawing their Social Security retirement benefits is a very common occurrence.
As CPAs, we all know the fundamental rules related to Social Security retirement benefits such as: you have to earn credits during your working career, you must be at least 62 and you will get a larger benefit if you delay when you start to draw the benefits. If you are not familiar with these basic concepts, you may want to read the two earlier articles published here in CPA Magazine.
The fundamentals of qualifying for retirement benefits begin with the fact that a person must (in most cases) be at least age 62 and must have earned 40 or more “Social Security Credits” (SSC). In 2014, one SSC can be earned for each $1,200 earned. A maximum of four SSCs can be earned in any calendar year.
A second important factor is to understand “full retirement age” (FRA). Full retirement age is the age at which a person may first become entitled to full or unreduced retirement benefits. If a person was born in 1937 or before, the FRA is age 65. If a person were born in 1960 or later, then the FRA is age 67. Those born between 1943 and 1954 have a FRA of 66. Your FRA varies between those ages if you were born between those dates. The SSA site http://www.ssa.gov/retire2/retirechart.htm#chart allows people to see what their FRA is based on their birth date.
SSA has a booklet, When to Start Receiving Retirement Benefits, that is available at http://www.ssa.gov/pubs/EN-05-10147.pdf. If someone’s FRA is age 66, they can start receiving retirement benefits at age 62 and will get 75% of the monthly benefit because they will be getting benefits for an additional 48 months. If this same person starts receiving their retirement benefits at age 65, they will get 93.3% of the monthly benefit because they will be getting benefits for an additional 12 months. A link to a web page on the SSA site shows what the reduction in retirement benefits will be based on when a person decides to start receiving them.
The next element to understand is that an SSA retirement benefit is based on that person’s earnings history; basically a person’s entire working career. A retirement benefit is based on a person’s highest 35 years of earnings. I have had some clients who have focused on keeping their earnings low throughout their working career to then be surprised when they go to apply for SSA retirement benefits that they will receive a very low benefit. It is a common misconception that retirement benefits will be based on the most recent few years or perhaps the best five years of earnings.
I find this discussion to be a difficult one no matter what age the client is at the time. It seems the younger the client, the more skeptical they are that Social Security will be there for them. Then on the other hand, when clients get closer to the age when they want to draw their retirement benefits, they are disappointed that they will be receiving a smaller amount than they expected due to their own tax planning to pay as little Social Security as possible. It is frequently important to remind the client that, “Social Security was never intended to be your sole source of retirement income”.
The next key element to understanding how much you will receive for retirement benefits is the Primary Insurance Amount (PIA). The Social Security Administration (SSA) defines it this way:
“‘The primary insurance amount’ (PIA) is the benefit (before rounding down to next lower whole dollar) a person would receive if he/she elects to begin receiving retirement benefits at his/her normal retirement age. At this age, the benefit is neither reduced for early retirement nor increased for delayed retirement.
“For an individual who first becomes eligible, old-age insurance benefits in 2014 will be the sum of: (a) 90 percent of the first $816 of his/her average indexed monthly earnings, plus (b) 32 percent of his/her average indexed monthly earnings over $816 and through $4,917, plus (c) 15 percent of his/her average indexed monthly earnings over $4,917. While the percentages of this PIA formula are fixed by law, the dollar amounts in the formula change annually with changes in the national average wage index. These dollar amounts, called "bend points," govern the portions of the Average Indexed Monthly Earnings (AIME).”
The SSA explains the importance of the Average Indexed Monthly Earnings (AIME) this way:
“When we compute an insured worker's benefit, we first adjust or ‘index’ his or her earnings to reflect the change in general wage levels that occurred during the worker's years of employment. Such indexation ensures that a worker's future benefits reflect the general rise in the standard of living that occurred during his or her working lifetime.
“Up to 35 years of earnings are needed to compute average indexed monthly earnings. After we determine the number of years, we choose those years with the highest indexed earnings, sum such indexed earnings, and divide the total amount by the total number of months in those years. We then round the resulting average amount down to the next lower dollar amount. The result is the AIME.”
The amount of retirement benefit a person will receive from the SSA is based on a person’s historical earnings, or more specifically, the “average indexed monthly earnings” (AIME). The calculation of your AIME is a four-step process:
1) Adjust your earnings from prior years to today’s dollars.
2) Select the 35 highest-earning years.
3) Add up the total amount of earnings in those 35 years, excluding any earnings for each year that were in excess of the maximum amount subject to Social Security tax.
4) Divide by 420 (the number of months in 35 years).
The SSA can calculate this for a person. It is, however, important to understand the concept so that you can understand how the benefit is calculated. Also there are software programs available to help with the calculations that are discussed later in this article.
See www.cpamagazine.com for spousal benefits, couples strategies and more.
Another factor that comes to light in this equation is that if you have fewer than 35 years in which you earned income subject to Social Security taxes, the calculation of your average indexed monthly earnings will include zeros for those years. If you have a client who this applies to then it may be beneficial for them to delay when they apply for retirement benefits, and work a few additional years to replace those zero-earnings years with higher earnings. The result may not make a drastic increase, but it is a strategy that may be worth including in your discussion with the client as you evaluate their overall retirement income. Again, the use of a software program will be of great benefit to determine the increase to their retirement benefit based on the additional earnings.
For the inquiring minds among the Baby Boom generation, a person retiring in 2014 who has been able to record the maximum earning for the minimum of 35 years, their retirement at their FRA of 66 would be $2,642 per month. If your spouse files for spousal benefit based on your record (50% of yours) the maximum they would receive is $1,321. This would give the couple a combined retirement benefit of $47,556.
Up until a few years ago the SSA would mail an annual benefit statement, which contained a summary of an individual’s earnings history and estimated retirement benefits at various ages. However, in 2011 SSA suspending mailing these due to a combination of the cost to mail them and concerns over identity theft. However, you can still get this information by going to the following the instructions at: http://www.socialsecurity.gov/myaccount/. The client should set up their online access or go into an SSA office to obtain the most accurate and dependable way to ascertain a solid estimate of their retirement benefit.
Of course, the closer the client is to applying for their benefit the more accurate this will be. But sometimes it can be beneficial for a client to take a look at this information as much as 10 to 15 years from when they expect to retire especially if they have some degree of control over the amount of income they receive.
Spousal Benefits
For a more detailed discussion of spousal benefits, you should read the article published on this topic earlier by CPA Magazine. However, as a very short refresher a spouse is entitled to a retirement benefit based on the larger of their own earnings record or 50% of their spouse’s record. The spouse must be at least 62 or have a qualifying child under their care. If the spouse begins to draw the benefit prior to their own FRA, they will receive a reduced benefit. However, if a spouse is caring for a qualifying child, the spousal benefit is not reduced.
In order for a spouse (Bill) to make a claim on their spouse’s (Jane) record that spouse (Jane) must have already filed for her own benefits. Furthermore, if a Bill files for retirement benefits based on Jane’s record prior to his FRA, it is considered that he has filed on both his own record and Jane’s. Bill would then receive the larger of his own or half of what Jane’s is entitled.
With this foundation, we can begin to discuss strategies on how to maximize the retirement benefits. Much of the following discussion is based on what a person considers their life expectancy to be. Very fundamentally, the longer the client expects to live the more benefit there will be from delaying when they apply for their SSA retirement benefits. Or to refine this fundamental concept if they are married, they should consider the life expectancy of both spouses as they develop their strategy. According to SSA statistics, life expectancy for a 62 year old is age 81.4 for a man and 84.3 for a woman.
Strategies for Couples
Similar to a single person, the starting point is based on life expectancy but instead of just the one person, you need to consider the life expectancy of both spouses. Basically a married couple will maximize their joint retirement benefit over their joint life expectancy if they coordinate the dates they begin drawing retirement benefits. The primary goal is to boost the benefit for the surviving spouse, since the surviving spouse will get greater of 100% of the higher earner's benefit or their own benefit. The benefit will include any of the higher earner's delayed retirement credits and cost-of-living adjustments.
According to research by William Meyer and William Reichenstein, principals of the consulting firm Social Security Solutions, “One of the most important rules of thumb for most married couples: If just one spouse is expected to live well beyond age 80, the couple's cumulative lifetime benefits will usually be highest if the higher earner delays claiming his benefits until 70”.
One hitch to a spouse drawing their retirement benefits based on the other spouse is that the other spouse must have already begun to receive their benefits. Based on the strategy the higher wage earning spouse delays until age 70 to begin drawing their retirement benefit to allow the maximum benefit over the joint life expectancy. So the solution would be for the higher earning spouse to file for their benefit which would allow the low earning spouse to begin drawing based on their higher record. Then the higher earning spouse will suspend their benefits which will allow their benefits to increase to the maximum amount allowed at age 70.
Restricted Application Strategy
At FRA, a married couple has the option of claiming the higher of their own record or half of the spouse’s benefit. When both spouses have similar earnings records but Jane is slightly higher than Bob, then at FRA, Jane files Restricted Application for just her “spousal benefit” and then at age 70 Jane files to claim on her own retirement benefit. By doing this, they are able to receive Bob’s full benefit from his FRA and Jane can claim on his record to receive 50% of that amount. Meanwhile, Jane’s benefit is increasing up to age 70 so that her retirement benefit will be larger.
File and Suspend
In this option, assume that Jane is the higher wage earner. For Bill to receive benefits based on Jane’s record, she must have filed for her own benefits. So in this strategy, Jane files to receive her benefits so that Bill can file and receive a benefit based on 50% of her benefit. But Jane wants to allow her benefit to increase to the max at age 70. So immediately after filing for her benefits, Jane files to suspend her benefits. This way Bill is allowed to receive a benefit based on her record and Jane is allowed to wait until she is 70, which allows hers to grow to the maximum amount. This will generally be beneficial when the higher wage earner has a PIA that is two and half times greater than the other spouse.
Combining Restricted Application with File and Suspend
In this strategy, both spouses make about the same amount and are both about the same age. Jane files and suspends her benefits so her benefits will increase until she turns 70 when she will start taking payments. This will allow Bob to file a restricted application at FRA for spousal benefits only based on Jane’s record. Then at age 70 they both apply to receive their full benefits based on their own records which have incremented to the maximum allowed. This strategy is especially attractive to spouses very similar in age with earnings very similar in amount and both may have long life expectancy.
Summary: Six Fundamental Rules of Thumb
1) The longer your life expectancy – it is better to delay when you begin to draw your SSA retirement.
2) For a single person who will be applying for SSA retirement based solely on their own record and is considering whether to start at 62 or as late as age 70 – break-even is approximately age 80.5.
3) Married couples benefits from having the higher earning spouse to delay, assuming either spouse will live beyond 80.5 or 85 depending on estimated inflation.
4) For married couples having the lower earning spouse to delay, only increases the amount received while both spouses are alive.
5) Combining File/Suspend with Restricted Application can produce a very attractive outcome.
6) However, the higher estimated after inflation rate of return you can earn on your investment portfolio the better it would be to begin drawing your SSA retirement earlier than later.
The important thing for CPAs as financial planners is to know the fundamentals as outlined in this article. You may be well served to invest in one of the following tools. Some of the resources below are free but most of them will require you to purchase a license. However, using one of these tools can give you confidence that you have considered the best available options.
Tools to use in Planning for Social Security
- Social Security Analyzer by Social Security Solutions
- https://www.ssanalyzer.com/analyst/
- Maximize my Social Security by Economic Security Planning, Inc.
- https://maximizemysocialsecurity.com/welcome
- Social Security Administration
- http://www.ssa.gov/myaccount/
Additional Tools
- Life Expectancy Calculator-SSA site
- http://www.socialsecurity.gov/planners/lifeexpectancy.htm
- Social Security Timing
- https://www.socialsecuritytiming.com/
Jerry Love, CPA, is the sole owner of Jerry Love CPA, LLC in Abilene, TX. Contact him at