Monday, October 17, 2016

How Do the Dependent Care Credit and Dependent Care Flexible Spending Accounts Work?

How Do the Dependent Care Credit and Dependent Care Flexible Spending Accounts Work?
Occasionally we are asked about how the dependent care credit works and if it is better for a taxpayer to use a dependent care flexible spending account or FSA to pay for dependent care. This summary explains how both the credit and the FSA work to benefit the taxpayer.

Dependent Care Credit

First, for an expense to qualify for the credit, it must be an "employment-related" expense, i.e., it must enable you and your spouse to work, and it must be for the care of your of a qualified dependent under the age of 13. It can also be for the care of your spouse or dependent who is handicapped and lives with you for over half the year. Domestic help expenses, can also qualify if at least in part goes towards the care of the individual.

The typical expenses that qualify for the credit are payments to a day-care center, nanny or nursery school. Sleep-away camp doesn't qualify. The cost of first grade or above doesn't qualify because it's primarily an education expense. Surprisingly, the rules on kindergartens aren't clearly defined. Apparently, if the school offers a program similar to a nursery school's (more play than education) it can qualify. If it offers more of an educational program, it may not.

To claim the credit, you and your spouse must file a joint return. You’ll include the care-giver's name, address, and social security number (or tax ID number if it's a day-care center or nursery school) on form 2441 as part of your federal tax return. 

Qualifying expenses cannot exceed the lesser income you or your spouse earns from work. If one of you has no earned income, you won't be entitled to any credit unless the nonworking individual is a full-time student or disabled. In that case, that spouse is considered to have monthly income of $250 per qualified child up to 2 qualifying children.

A second limitation is that qualifying expenses can't exceed $3,000 per year for the first qualifying child, or $6,000 per year for two or more qualifying children. If your employer has a dependent care assistance program under which you receive benefits excluded from gross income, the dollar limits ($3,000 or $6,000) are reduced by the excludable amounts you receive.

The credit is computed as a percentage of your qualifying expenses-in most cases, 20%. (If your joint adjusted gross income [AGI] is $43,000 or less, the percentage will be higher, but never to exceed 35%).

For example a couple with AGI of over $43,000 paying $6,000 or more for childcare receive dependent care credits of $1,200 on their federal tax return.

Dependent Care Flexible Spending Accounts

Many large and even mid-sized employers offer flexible spending accounts with the dependent care option. Taxpayers participating in a dependent care FSA may contribute up to $5,000 per year to the FSA. These contributions are made on a pretax basis. The taxpayer then submits dependent care expenses to the FSA plan administrator for reimbursement from the FSA.

For taxpayers with marginal tax rates of 15% or higher, participating in the FSA is more advantageous than taking the dependent care credit. This is because the exclusion from income under the FSA gives a tax benefit at your highest tax rate, while the credit rate for taxpayers with AGI over $43,000 is limited to 20%.

For example let’s assume a couple with two children in daycare and a marginal tax rate of 25% take advantage of the FSA offered by one of their employers. The tax savings of making the $5,000 contribution to the FSA would be $1,250 ($5,000 X 25%), a $50 savings over the dependent care credit.

In addition to a federal income tax savings, participating in a dependent care FSA will result in savings on FICA (social security) taxes, because the amount contributed to the FSA isn't included in wages for FICA purposes. Consequently, you may save up to 7.65% of the amount contributed to the dependent care FSA, depending upon your income and the FICA tax wage base for the year in which the contribution is made.

If your marginal rate is 15% or less, taking the credit may be more advantageous than participating in the FSA. In making the choice, you must consider the effect of the earned income credit, the refundable child tax credit, and Social Security tax.

Depending on where you reside, some states also have a dependent care credit based on the federal dependent care credit. As well, the pretax FSA deduction can reduce you state income taxes.

Before you sign up for an FSA you need to ask you employer about some of the possible drawbacks to dependent care FSAs. First, money may be deposited in an FSA on a "use it or lose it" basis. If you don't incur dependent care expenses that equal or exceed the amount you deposit in the FSA, you forfeit the surplus. In addition, once you elect to participate in an FSA, and elect the amount withheld, with limited exceptions, you may not change your election. Finally, it may takes several weeks to receive reimbursement for the expenses submitted.

The dependent care credit and the dependent care FSA are both good options for taxpayers with dependent care expenses. Before making a decision to utilize an FSA in lieu of the dependent care credit, consult a qualified tax advisor.

Monday, October 10, 2016

The Tax Benefits of Employing a Child

Employing Children under the age of 18 (and full-time students age 19 to 23):

If you are self-employed, paying wages to a child can be an effective income-shifting tax strategy:

·         Earned income can be sheltered by the child's standard and other deductions.

·         Earnings in excess of allowable deductions will be taxed at the child's low rates.

·         You will most likely need to withhold taxes on the child’s income, but your child will most likely get a refund for part of all of the withholding when filing a tax return.

·         Save on Social Security taxes - services performed by a child under the age of 18 while employed by a parent isn't considered employment for FICA tax purposes.

·         Save on Federal Unemployment - earnings paid to a child under age 21 while employed by his or her parent are exempted from FUTA (unemployment) tax.

·         Start saving for your child’s retirement – If your business has a retirement plan such as a SEP, you can contribute up to 25% of their earnings.

·         Continue saving for your child’s retirement - your child's participation a SEP does not prevent the child from making tax-deductible IRA contributions.

Wages paid to a child are only deductible by the parent-employer if:

·         The work is done in connection with the parent’s business or income producing property, and

·         The child actually renders the services, and

·         The payments are actually made. Payments must be reasonable for the services provided and the parent must keep records supporting the services performed and wages paid.

For example, let's say a sole proprietor pays $5,700 to her 17-year-old child. The sole proprietor's self-employment income would be reduced by $5,700, saving her over $800 in self-employment taxes. The parent also saves on income taxes by shifting the $5,700 from her higher income tax bracket by moving the $5,700 to the child’s return taxed at a low or possibly 0% tax rate. This could be as much as another $2,000 in tax savings.

Keep in mind that some of the rules about employing children (such as the maximum amount they can earn tax-free) change from year to year, and may require your income-shifting strategy to change, too. Before employing a child seek advice from a qualified tax professional.


Monday, October 3, 2016

Trade-in or Sale a Vehicle Used for Business

Trade-in or Sale Vehicle Used for Business

Here's an overview of the complex rules that apply to what appears to be a simple transaction, and some pointers on how to achieve the best tax results.
For business vehicles that have been depreciated:
·         The sale of a vehicle yields a taxable gain or loss while trading vehicles qualifies as a tax free exchange.

·         In a tax free exchange, the basis of the new vehicle is equal to the basis of the trade-in vehicle plus any cash paid in the trade.

·         As a general rule, it is better to trade-in vehicles that have been used exclusively for business and that have been substantially depreciated.

·         Conversely, it is generally better to sell a vehicle used exclusively for business when the basis depreciation has been limited by annual limitations and the vehicle has a relatively high basis as compared to the fair market value.

When you have used the standard mileage rate

      ·         Generally you are better off selling the old vehicle rather than trading it in.

·         The standard mileage rates have a built-in allowance for depreciation that reduce the basis of the car. (24¢ per mile in 2016).

·         Using the standard mileage rate usually means lower depreciation on the vehicle and may allow you to recognize a loss on the sale.

For vehicles used partially for business and partially for personal use the rules are more complicated. This may occur if you are self-employed, or an employee required to supply a car for business use.

  • If you sell the part-business, part-personal-use car, cost and depreciation must be allocated between the business and personal portions. Gain or loss on the business part is recognized; gain, but not loss, is recognized on the personal part.
  • If you trade in the part-business, part-personal-use car, the basis of the new car as computed under the normal trade-in rules is reduced by any difference between (1) the depreciation that would have been allowable had the old car been used 100% for business driving, and (2) the depreciation claimed for its actual business use.
Some business owners choose to lease a vehicle due to the simplicity of deducting the business/investment use portion of annual lease costs.
If you pay an additional sum up-front, it should be amortized over the life of the lease.
  • Any refundable deposit required as part of the lease deal can't be deducted at all.
  • Be aware that the IRS requires you add back to income each year an income inclusion amount derived from IRS tables for “luxury” vehicles.

Monday, September 26, 2016

It’s football season! So how does that skybox rental work for taxes?

If you are fortunate enough to afford a skybox or work for a company that has one, how does the box fit into taxes? First, skybox rentals are subject to the general business-related entertainment expense rules as well as rules specific to skybox rentals.

General Business Related Entertainment Expenses

Entertainment expenses are deductible if they are either "directly related to" or "associated with" the active conduct of your trade or business or investment activities.

·         “Directly related to” requires an active business discussion during the entertainment event aimed at getting immediate revenue (as opposed to generalized good relations).

·         The "associated with" test only requires that you have engaged in a substantial and bona fide business discussion before or after the entertainment event. If the discussion and entertainment event occur on the same day, the test is passed.

In general, qualifying entertainment expenses are only 50% deductible.

Meals are 50% deductible to the extent their cost is not "lavish or extravagant" under the circumstances, and either an owner or employee is present at the meal.

Special Skybox Rules

When a skybox is leased for multiple events, the deduction can only be based on the value of non-luxury box seats for the same event. For example, say you rent a 20-seat skybox at a stadium for $6,000 for three ballgames, where a non-luxury box seat costs $20. Twenty seats times $20 for three events totals $1,200. Applying the general 50% limitation, the deduction would be $600.

Skyboxes leased for single events are deductible at 50% and subject to the general business related entertainment rules discussed above.

Other factors in determining the deductibility of the skybox rental include whether the tickets for the event are included in the price of the skybox lease. If included in the skybox lease, the expense is not deductible.


Multiple event skybox lease deductions are limited to 50% of the value of non-luxury box seats when the lease does not include the tickets.

Single event skybox rentals are deductible at 50% subject to the general 50% limitation.

If you are looking into leasing a skybox, consult with a qualified tax professional to understand the deductibility of the lease.



Thursday, February 28, 2013

How to Split Income and Deductions when filing separately

If you and your spouse file MFS, how do you split your income and deductions, etc.?
  • Each of you report your respective income, deductions, exemptions and credits on your own return.
  • Each taxpayer is generally allowed a deduction only for those items actually paid by the taxpayer. State law may determine who paid the item.

In some cases, specific rules for splitting income and deductions, etc., on a separate return are provided by the  IRS and the courts . Some of the more problematic areas for splitting these items are discussed below.

Personal services income. Income earned from personal services presents few problems- Each spouse reports the amount of income from wages, salaries, or other pay for services reported to the spouse on Form W-2 or Forms 1099.

Joint bank accounts can vary from state to state, bank to bank, and even from account to account in the same bank. 
  • Each spouse reports interest to the extent of his or her share under local law. Thus, in the case of a true joint account (where each spouse has a right to one-half the deposited funds), each spouse reports half the income.
  • In the case of a revocable account (where each spouse has a right to withdraw any or all of the funds) or an accommodation account (where one spouse provided all of the funds), each spouse would report interest in proportion to the amount of funds provided by the spouse.

Jointly owned U.S. series EE savings bonds. If only one spouse purchased the savings bonds, the interest income is taxed to that spouse. If both spouses contributed to the purchase price, the interest is taxed to each spouse in proportion to his or her contribution.

For other jointly owned property, each spouse reports his or her share of the income or gain from the property. 
  • As a general rule, each spouse reports one-half the income or gain from the property. But this is not always the case.
  • State law determines the various forms of joint ownership, and each spouse's right to share in the income from the property is also determined under state law.  Under the law of some states, income from property held as tenants by the entirety belongs to the husband, and thus all of the income would be taxed to him.
Exemptions are a little bit more straightforward.

  • You may claim an exemption for your spouse on a separate return only if your spouse had no gross income and was not a dependent of another taxpayer.
  • You may claim an exemption for any dependent for whom you meet the regular dependency tests.
Medical expenses paid out of a joint checking account are presumed to be paid equally by each spouse. However, one spouse can deduct all of the expenses paid for medical care on a separate return if the expenses are shown to be paid by that spouse alone.

For mortgage interest and real estate taxes on jointly owned property where both spouses are jointly and severally liable for the mortgage debt and for taxes on the property, each spouse is entitled to deduct the interest and taxes that he or she pays. But the spouse claiming the deduction must prove that he or she actually paid the interest or taxes.

Casualty losses. A spouse can only deduct half the loss to jointly owned property on a separate return, even if he or she pays all of the cost to repair the property.

In addition to the above items, there are many other items of income and deductions for which there are no specific rules. Each of these items must be examined separately, taking into account the applicable state law and the particular facts, to determine how they should be split on separate returns. Consult your CPA or tax professional for more specific information

Monday, February 25, 2013

When to file Married Filing Separately

Your decision to file as Married Filing Separately (MFS) will depend upon which filing status results in the lowest tax. However you might file MFS to avoid being jointly and severally liable for the tax on your combined income if you were to file Married Filing Jointly (MFJ). Even if a joint return results in less tax, you may choose to file a separate return if you want to be certain of being responsible only for your own tax.

In most cases, filing jointly offers the most tax savings, particularly where the spouses have different income levels. The “averaging” effect of combining the two incomes can bring some of it out of a higher tax bracket.

MFS doesn't mean you go back to using the “single” rates that applied before you were married. But rather, each spouse uses the MFS rates based on brackets that are exactly half of the married filing joint brackets but less favorable than the “single” rates. This means the “marriage penalty” isn't eliminated by filing separate returns.

There is a potential for tax savings from filing separately, however, where one spouse has significant amounts of medical expenses, casualty losses, or “miscellaneous itemized deductions.” If these deductions are isolated on the separate return of a spouse, that spouse's lower (separate) AGI, as compared to the higher joint AGI, can result in larger total deductions.

Other tax factors may point to the advisability of filing a joint return. Here are some things to consider:

  • Child and dependent care credits, adoption expense credit, American Opportunity tax credit, and Lifetime learning credit are available to a married couple only on a joint return.
  • The credit for the elderly or the disabled is not allowed if you file separate returns unless you and your spouse lived apart for the entire year.
  • You cannot deduct qualified education loan interest unless a joint return is filed. 
  • You may also not be able to deduct contributions to your IRA if either you or your spouse was covered by an employer retirement plan and you file separate returns. 
  • Also you cannot exclude adoption assistance payments or any interest income from series EE or Series I savings bonds that you used for higher education expenses if you file separate returns.
In addition, social security benefits may be more heavily taxed to a couple that files separately.

The decision you make for federal income tax purposes may have an impact on your state or local income tax bill, so the total tax impact has to be compared.

Unfortunately, there are no hard and fast rules of thumb for when it pays to file separately. The tax laws have grown so complex over the years that there are often a number of different factors at play for any given situation. However, if any of the above situations and factors apply to you ask your CPA or tax professional if MFS status should be considered.

Friday, February 22, 2013

Death of a Spouse

How do you file a tax return for the years following your spouse's death? While you can't file a joint return for a tax year after the year in which your spouse died, you can continue to use the joint return rates for two more years if you qualify as a “surviving spouse.” The joint return rates are more favorable than the single rates or the head-of-household rates. A surviving spouse also gets a larger standard deduction than a single taxpayer or head of household and has other tax advantages.

Qualifying as a “surviving spouse.” If you meet all of the following requirements, you can qualify as a surviving spouse:
  • Your spouse died during one of the two years immediately preceding the tax year for which the return is being filed. 
  • You have a child (by blood or adoption) or stepchild, but not a foster child, who qualifies as your dependent for the tax year. 
  • The child lived with you for the entire year, except for temporary absences, such as for vacation, school, medical care, or military service. There are exceptions for a child who was born or died during the year. 
  • You paid over half the cost of maintaining your home. 
  • You were eligible to file a joint return with your deceased spouse for the tax year of the death (even if you didn't actually file jointly). 
  • You haven't remarried before the end of the tax year for which the return is being filed. 
If you don't meet the requirements for surviving spouse status, you may still qualify to file as a “head of household,” as discussed below under “Filing in later years.”

When is a child your dependent? Generally, a child or stepchild who lived with you for the entire year is your dependent if the child is less than 19 years old at the end of the calendar year (less than 24 years old if a full-time student for at least five months during the calendar year) and didn't provide over half of his or her own support for the year.

A child or stepchild can also be your dependent if the child's gross income for the calendar year was less than $3,700 for 2011 ($3,800 for 2012) and you provided over half of the child's support for the year.

Maintaining a household. In measuring the cost of maintaining a household, include house-related expenses incurred for the mutual benefit of household members, including property taxes, mortgage interest, rent, utilities, insurance on the property, repairs and upkeep, and food consumed in the home. Do not include items such as medical care, clothing, education, life insurance, or transportation.

Capital loss carryovers. Capital losses on the sale of property in excess of capital gains can be deducted only up to $3,000, but any loss in excess of this limit can be carried forward and deducted in later years. Capital losses are deductible only by the spouse who actually had the loss. They can be deducted on a decedent's final income tax return, but can't be carried over after death. Thus, you cannot carry over a capital loss from the sale of your spouse's separate property, even though the sale was made in a year when you filed a joint return. However, losses from the sale of your separate property are unaffected by your spouse's death.

Charitable contribution carryovers. The deduction for gifts to charity is subject to a limit based on the donor's income, but any excess can be carried forward for five years. If you and your spouse made a contribution during the previous five years that was subject to the limitation, the contribution must be allocated using a specific formula. The portion allocated to you can be carried over for the full five years. The portion allocated to your late spouse can be used in the year of death but not in later years.

Adjusting income tax withholding. As a result of your spouse's death, you may be have to adjust the amount of income tax that your employer withholds from your paycheck. To ensure that the correct amount of tax is withheld, you should check your withholding and, if necessary, submit a new Form W-4 with the revised information. I will be happy to assist you in making this calculation.

Filing in later years. As noted above, you can only qualify as a “surviving spouse” for two tax years. In later years, you may qualify as a “head of household,” which is a more favorable tax status than “single.”

You may claim head-of-household status if you furnished more than half the cost of maintaining a household that was the main home for more than half the year for your qualifying child or a person who would have been your qualifying child if you hadn't released the dependency deduction to the other parent.

Also, you may claim head-of-household status if you (1) pay more than half of the cost of maintaining as your home a household that is the principal place of abode for more than half the year of a dependent or (2) maintain a household (not necessarily your own) that for the tax year is the principal place of abode for either of your parents, if you are entitled to a dependency deduction for either parent.

Remarriage. If you remarry, you won't be able to file as a surviving spouse, but you will be able to file a joint return with your new spouse.