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.

Wednesday, February 20, 2013

Can a Married Taxpayer File Under a Single Status?

Is it possible for a married taxpayers to file as a single? A married taxpayer can always use the filing status “married filing separately.” However, it is less favorable than the “single” filing status.

In many cases a couple is “separated” but with no decree of divorce or separate maintenance. In that case, they are still considered to be married in the eyes of state law. And the tax law follows state law on this matter. The couple can still file “jointly,” but this may be impractical in some cases depending on the nature of the separation.

If the following tests are met, you can file as “single” even though you're married (i.e, you will not have to use the “married filing separately” filing status):
  1. You maintain as your home a household which for more than half the year is the principal living place of a child of yours whom you can claim as your dependent (or could have claimed as your dependent except that you signed away your right to the exemption to the child's other parent).
  2. You furnish more than half of the cost of maintaining the home. This includes all house-related costs, plus the cost of food consumed in the home.
  3. Your spouse cannot have been a member of the household for the last six months of the year.
Note that if each of the separated spouses meets these tests (e.g., they have more than one child and each has custody of a child), they can both qualify to file singly. If only one meets the tests, then the other, nonqualifying, spouse will have to file as married filing separately.

Monday, February 18, 2013

What is the Head of Household filing status?

For those who qualify, the Head of Household filing status is a more favorable tax status than single. But how do you qualify? You must maintain as your home a household which for more than half the year is the principal home of:

1. A “qualifying child,” i.e., someone who 
  • lives in your home for over half the year, 
  • is your child, stepchild, adopted child, or foster child, or your sibling or stepsibling (or a descendant of any of these), 
  • is under 19 years old (or a student under 24), and
  • does not provide over half of his or her own support for the year. (If a child's parents are divorced, the child will qualify if he meets these tests for the custodial parent even if that parent released his or her right to a dependency exemption for the child to the noncustodial parent.) A person will not be a “qualifying child” if he is married and cannot be claimed by you as a dependent because he filed jointly or is not a U.S. citizen or resident. Special “tie-breaking” rules apply if the individual can be a qualifying child of (and is claimed as such by) more than one taxpayer. 
2. Any other relative of yours whom you can claim as your dependent (unless you only qualify due to the multiple support rules). See below for a special rule for your parents.

Maintaining a household. You are considered to “maintain a household” if you live in the household for the tax year and pay over half the cost of running it. In measuring the cost, 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.

Special rule for parents. Under a special rule, you can qualify as head of household if you maintain a home for a parent of yours even if you don't live with the parent. To qualify under this rule, you must be able to claim the parent as your dependent.

Marital status. You must be unmarried to claim head-of-household status. If you are unmarried because you are widowed, you can use the married filing jointly rates as a “surviving spouse” for two years after the year of your spouse's death if your dependent child, stepchild, adopted child, or foster child lives with you and you “maintain” the household. The joint rates are more favorable than the head-of-household rates.

If you are married, you must file either as married filing jointly or separately, not as head of household. However, if you have lived apart from your spouse for the last six months of the year and your dependent child, stepchild, adopted child, or foster child lives with you and you “maintain” the household, you are treated as unmarried. If this is the case, you can qualify as head of household.

Friday, February 8, 2013

Corporate Capital Gains and Losses


Just what is the tax treatment of your corporation's capital gains and losses?

The treatment of capital gains and losses for corporations is differs from the treatment for individual taxpayers. As discussed below, there is no favorable treatment for corporate long-term capital gains. Also, there is no deduction (not even up to $3,000) for capital losses that exceed capital gains. Be sure to consider the tax rules described below when planning your corporation's capital gain and loss transactions.

A corporation's capital losses are first “netted” or offset against the company's capital gains. However, unlike an individual that can deduct up to $3,000 of the excess losses against other income, a corporation cannot deduct any capital losses in excess of capital gains. That is, the $3,000 loss allowance is not available for corporations.

The “carryover” rules are different and more limited for corporations as well. An individual carries excess capital losses forward only, but indefinitely. A corporation carries its excess capital losses backward or forward, but for limited time periods: backward only up to three years, and forward only up to five years. Any capital loss not used within the three or five year period is forfeited. Be careful, therefore, not to let capital losses expire: cash-in any capital gains you can in the last year to take advantage of the losses.

The corporation cannot pick and choose the year to which to carry the losses. The losses must be used in the earliest year they can be used, i.e., in the earliest year in which there are net capital gains against which the losses can be offset. (Note, however, that a corporation's capital losses cannot be carried back to a year in which they would increase or produce a net operating loss). If capital losses from more than one year are being carried to other years, the earlier year losses are used first.

Unlike individuals that are taxed at favorable capital gain rates, there is no favorable treatment for corporations and the regular corporate tax rates apply.

Tuesday, January 29, 2013

Just what is the "Kiddie Tax"?

Can you can save taxes by transferring assets into your children's names?
Referred to as "income shifting", this technique seeks to take income out of the higher tax bracket of parents and place it in the lower tax brackets of their children.
If the child hasn't reached age 18 before the close of the tax year, or the child's earned income doesn't exceed one-half of his support and the child is age 18 or is a full-time student age 19 to 23, the “kiddie tax” rules impose substantial limitations.
The kiddie tax rules apply to children who are under the above-described cutoff age, and who have more than $1,900 of unearned (investment) income in 2012 ($2,000 for 2013). Essentially, these rules tax the child's investment income above this amount at the parents' tax rate. While some tax savings on up to $1,900 of income for 2012 ($2,000 for 2013) can still be achieved by shifting income to children under the cutoff age, the savings aren't substantial.
If you have investment income and children, consider income shifting to reduce your tax, but be prepared that the savings are going to be limited.
Note that, to transfer income to a child, you must actually transfer ownership of the asset producing the income: you cannot merely transfer the income itself. Ownership is generally transferred to minor children using custodial accounts under the state Uniform Gifts or Transfers to Minors Acts.
The portion of investment income of a child that is taxed at the parents' tax rates under the kiddie tax rules may be reduced or eliminated if the child's investments produce little or no current taxable income. Such investments include:
  • securities and mutual funds oriented toward capital growth that produce little or no current income;
  • vacant land expected to appreciate in value;
  • stock in a closely-held family business, expected to become more valuable as the family business expands, but which pays little or no cash dividends;
  • tax-exempt municipal bonds and bond funds;
  • U.S. Series EE bonds, for which recognition of income can be deferred until the bonds mature, the bonds are cashed in, or an election to recognize income annually is made.
Investments that produce no taxable income—and which are therefore not subject to the kiddie tax—also include tax-advantaged savings vehicles such as:
  • traditional and Roth individual retirement accounts (IRAs and Roth IRAs), which can be established or contributed to if the child has earned income;
  • qualified tuition programs (QTPs, also known as “529 plans”); and
  • Coverdell education savings accounts (“CESAs”).
Where the kiddie tax applies, it's computed and reported on Form 8615, which is attached to the child's Form 1040.
Parents can elect to include the child's income on their own return, if certain requirements are satisfied. This avoids the need for a separate return for the child, but, generally, doesn't change the tax on the child's unearned income, which is still taxed at the parents' tax rate. However, it's important to consider that the addition of the child's income to the parent's adjusted gross income may affect the various floors and ceilings for, and therefore the amounts of, the parents' deductions and limitations.
The election to include a child's income on the parents' return is made, and the additional taxes resulting to the parents are computed and reported, on Form 8814.