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.

Monday, January 28, 2013

Why an S Shareholder Reports More Than He Receives

As CPAs and tax professionals, we are often asked why, in a given year, you may be taxed on more S corporation income than was distributed to you from the S corporation in which you are a shareholder.
Like many tax questions, it's not always that easy to explain. But before explaining those rules, let us assure you that when you are taxed on undistributed income, you won't be taxed again if and when the income ultimately is paid to you.
Unlike C corporations, an S corporation generally isn't subject to income tax. However, each shareholder is taxed on the corporation's earnings, whether or not the earnings are distributed. Similarly, if an S corporation has a loss, the loss is passed through to the shareholders. Keep in mind that the losses passed through to shareholders are subject to various rules that may prevent a shareholder from currently using his share of the S corporation's loss to offset other income.
While an S corporation generally isn't subject to income tax, it is treated as a separate entity for purposes of determining its income, gains, losses, deductions and credits. An S corporation must file an information return (Form 1120-S). Each shareholder gets a Schedule K-1 showing his share of these items. Examples of such items include capital gains and losses, charitable contributions, and interest expense on investment debts.
Basis and distribution rules ensure that shareholders aren't taxed twice. A shareholder's initial basis in his stock (the determination of which varies depending on how the stock was acquired) is increased by his share of the S corporation's taxable income. When that income is paid out to shareholders in cash, they aren't taxed on the cash if they have sufficient basis. Rather, shareholders merely reduce their basis by the amount of the distribution. If a cash distribution exceeds a shareholder's basis, then the excess is taxed to the shareholder as a capital gain.
In reality, the basis and distribution rules are far more complicated. For example, many other events require basis adjustments and there are a host of special rules covering distributions from an S corporation having accumulated earnings and profits from a tax year when it was a regular corporation.
S Corporations are very popular entities for small businesses. But before you decide to become an S Corporation, you should consult a CPA and determine if the election is right for your circumstances. Also, make sure that you discuss the tax treatment of S corporations with your CPA and understand the concepts covered in this post.

Tuesday, January 22, 2013

Tax Laws Do Not Treat All "Couples" Equal

With states passing laws on what constitutes marriage, there are a lot more questions about the tax implications of being something other than just single or married. While we always had nontraditional "couples", the idea of what constitutes a nontraditional couple has changed over the past several years. Same-sex couples continue to push for equal rights and there have been states that have passed laws in this area. But even with those laws, there seems to be more unanswered questions than ever before. We attempt to address some of the common federal tax questions that might arise from a same-sex couple, domestic partnership or civil union below.

Filing Status and Dependents

Married filing jointly is a tax filing status that is not available for same-sex spouses or civil union and domestic partners (spouse/partner). However, the head of household status is an option that might be available to one of the taxpayers.

A taxpayer can file as head of household if they maintain a household that is a the main home of a relative who qualifies as a dependent. But, keep in mind that the dependent cannot be the other spouse/partner, or a child of the spouse/partner that is not the taxpayer's biological or adopted child.

However, the spouse partner can still qualify as a dependent of the taxpayer if all of the following requirements are met:

  • The spouse/partner is a member of the taxpayer's household. So if the taxpayer maintains a household for  the spouse/partner by paying over half of the household expenses for the tax year. However, the taxpayer's relationship with the spouse/partner cannot violate state law for the spouse/tax payer to be considered a dependent.
  • The taxpayer pays more than 50% of the spouse/partner's support. Support includes food, clothing, lodging, medical and dental care, education and recreation. Be sure and determine how social security, scholarships and Medicare benefits are treated in this test.
  • And one final consideration, the spouse/partner cannot have gross taxable income over $3,800 and be treated as a dependent of the taxpayer.
Child Tax Credit May Be Allowable

Subject to phase out, the taxpayer maybe entitled to the Child Tax Credit for the child of the spouse/partner if state law considers the taxpayer as the stepparent.

Other Tax Items To Consider

The taxpayer may be able to itemize the medical expenses (if more than 7.5% of AGI) paid for a spouse/partner if the spouse/partner qualifies as a dependent.

Home mortgage interest is an itemized deduction by the person who owns and pays the interest. So same-sex spouse/partners need to look at the ownership and who actually paid the interest in order to determine the who gets the deduction. Gifting between the spouse/partners can be used to allow one of the spouse partners to make the interest payments.


Tax is complicated and tax issues encountered by same-sex spouse/partners and nontraditional couples are even more complicated. Make sure that you consult a tax professional in addressing these issues. Talk to the tax professional about the tax positions you elect and make certain that those positions are well documented. 

Monday, January 21, 2013

Initial Decisions for Start-ups

Yeah we know-Tech start-ups and youthful entrepreneurs don't have time to think about such mundane things as taxes and accounting. But nonetheless, here are 6 recommendations that you should consider.

  1. Select and form a legal entity that will meet your future needs and requirements. Why? It can be costly to undo the wrong entity. Whether you chose on an LLC, S Corp or C Corp, think through the process, engage a professional to help you with the choices and get it right from the start.
  2. Surround yourself with competent professionals. Yes it costs money, but it might just save you money in the end. Select your attorney and CPA based on their expertise, not based on the fact you used them in the past for a divorce or to prepare a 1040EZ. They might be well qualified to help you, but make certain before you commit.
  3. If intellectual property is involved, seek out an even more specialized attorney. IP laws are complicated and if your start-up is based on IP, you want to minimize the risks in this area and maximize your value in the end.
  4. If you are selling across state lines or internationally, understand your sales tax obligations. Finding out you have a sales tax obligation two or three years into a venture can be very costly.
  5. Understand and pay your payroll and income taxes timely. It's hard to explain to potential investors that you need the money to pay back taxes.
  6. Separate your personal finances from the business finances. It's not hard to do, but it might kill a deal later down the road if you haven't maintained good business records.
For more on initial start-up decisions see http://goo.gl/JIs9x.

Thursday, January 17, 2013

Educator Expense Deduction

An eligible educator is allowed an above-the-line deduction for up to $250 for classroom expenses paid during the tax year. Eligible expenses include books, supplies (other than nonathletic supplies for courses of instruction in health or physical education), computer equipment (including related software and services) and other equipment and supplementary materials used by the educator in the classroom. These expenses must meetbe ordinary and necessary employee business expenses.

An eligible educator is a kindergarten through grade 12 teacher, instructor, counselor, principal, or aide in a K-12 school for at least 900 hours during a school year.

Taxpayers filing joint returns who are both eligible educators are each eligible for the $250 deduction, for a total of $500 on the return. However, neither spouse can deduct more than $250 of his or her own expenses.

The school year is used in determining if an individual meets the 900-hour requirement for defining an eligible educator, whereas the $250 deduction is for expenses paid during the tax year. Because a school year spans two tax years, an individual who qualifies as an eligible educator for 2012/2013 school year is eligible for the deduction for 2012 tax year.

For other commonly missed tax deductions, go to http://goo.gl/ZBx90.

Tuesday, January 15, 2013

Child Care Expense Credit

Many people do not realize the significant tax savings that the child care credit can produce. Depending on the amount of income, 20 percent to 35 percent of child care expenses can be used as a tax credit for amounts paid for child care while you work.

The expenses must enable you and your spouse to work, and it must be for the care of your child, stepchild, or foster child, or your brother or sister or stepsibling (or a descendant of any of these), who is under 13, lives in your home for over half the year, and does not provide over half of his or her own support for the year. It can also apply to a handicapped spouse or dependent that is over the age of 13.

Typical expenses that qualify for the credit are payments to a day-care center, nanny or nursery school however, sleep-away camps do not qualify. The cost of first grade or above doesn't qualify, but 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 and you must provide the care-giver's name, address, and social security number (or tax ID number if it's a day-care center or nursery school). A day-care center must be in compliance with state and local regulations.

You are also required to include the social security number of the children who receive the care. There's no credit without it.

Several limits apply. First, qualifying expenses are limited to the income you or your spouse earns from work, using the lesser of the two. Under this limitation, if one of you has no earned income, you won't be entitled to any credit. However, there is an exception when a nonworking spouse is a full-time student or disabled.

Qualifying expenses are limited to $3,000 per year if you have one qualifying child, or $6,000 per year for two or more. In most cases, this dollar limit will set the ceiling for you. Note that 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.

For other commonly missed tax credits and deductions see http://goo.gl/ZBx90.

Friday, January 11, 2013

Self Employed Health Insurance Deduction

Self-employed taxpayers are allowed an above-the-line deduction for 100% of the cost of providing medical, dental, and qualifying long-term care insurance for themselves and their families. In addition to their spouse and dependents, this deduction is available to any non-dependent child under age 27 at the end of the year.

The deduction applies only for calendar months when the self-employed taxpayer is not eligible to participate in a subsidized health plan maintained by any employer of either the taxpayer or the taxpayer's spouse.

Taxpayers eligible to participate in an employer plan that does not include long-term care coverage can deduct the applicable percentage of their own long-term care policy in computing AGI.The deduction applies for long-term care insurance premiums only if the policy is a qualified contract.

The deduction applies only if the medical insurance plan is established by the taxpayer's business and only to the extent of the taxpayer's earned income from that business.The medical insurance plan established with respect to the taxpayer's specific sole proprietor business can be purchased in the individual's name.

Who Is Self-employed?

The individuals eligible for the health insurance deduction generally include those whose income is reportable on Schedule C (sole proprietorship), E [partnership, limited liability company (LLC), or S corporation] or F (farming) of Form 1040. However, the underlying business must be one in which the personal services of the self-employed person are a material income-producing factor.

Also, most statutory employees (i.e., certain agent or commission drivers, traveling salespersons, and certain piecemeal homeworkers, but not full-time life insurance salespersons) who receive a Form W-2 but are allowed to report their wages on Schedule C qualify for the deduction.

Partners and LLC Members. Partners or LLC members who directly pay their own health insurance premiums are subject to the same rules for claiming a deduction of those premiums as a sole proprietor (Schedule C) or an individual with farming (Schedule F) income. 

However, if the partnership or LLC pays the premiums for these individuals, if the premium payments are for services rendered in the capacity of a partner and made without regard to partnership income, they are deducted by the partnership and treated as guaranteed payments paid to the partner. The partner is then allowed to deduct these payments on their individual tax return assuming the requirements are met.

If the premium payments are not for services rendered in the capacity of a partner or when the payments depend on partnership income, they are not deducted by the partnership. Instead, the premiums are treated as distributions to the affected partners. The partner is then allowed to deduct the payments paid by the partnership on his behalf assuming the requirements.

Are S Corporation Owners Eligible? 

Yes, more than 2% S Corporation Shareholder-employees are eligible if the corporation established a medical plan that covers a shareholder. This can be handled in one of two ways. The S corporation can directly pay the premiums, and the company-paid premium amounts are reported as compensation on the more-than-2% shareholder-employee's Form W-2 and included in gross income on his or her Form 1040. 

An alternative method is for the more-than-2% shareholder to pay the premiums, and have the S corporation reimburse the shareholder in the current year for the premium payments. The premium amounts must be included as compensation on the more-than-2% shareholder-employee's Form W-2 and included in gross income on his or her Form 1040. 

Under this each of these methods, the premiums are deemed to be paid under a plan, the compensation is not subject to FICA tax and the corporation can claim a wage deduction for the premiums on its Form 1120S. However, if the health insurance premiums are not paid or reimbursed by the S corporation and included in the more-than-2% shareholder's gross income, the requisite medical plan does not exist and no Section 162(l) deductions are allowed.

For information on other commonly missed tax deductions see http://goo.gl/ZBx90.

Wednesday, January 9, 2013

Some Energy Saving Home Improvements Still in Play for 2012 Taxes

Deductions are no longer allowed for window and door replacement, expenses for insulation or amounts paid to upgrade furnaces to more energy-efficient models. 

But some are still available-30 percent of the cost (including labor) of installing qualified residential alternative energy equipment is still deductible through 2016 with no dollar limit. These items include solar water heaters, geothermal heat pumps and wind turbines.

For other commonly overlooked tax deductions go to http://goo.gl/ZBx90

Monday, January 7, 2013

Who Gets Student Loan Deduction?

During tax season, we get a lot of questions regarding student loan interest. You would think that would be a simple topic to discuss and clarify with clients, but like most tax questions, those related to student loan interest are generally answered "It depends".

Who Can Deduct Student Loan Interest?

For students, the student loan interest paid by parents is deductible. The IRS treats the interest as money given to the child, so children who are not claimed as dependents on their parents’ tax return can deduct up to $2,500 of interest paid by their parents, and the student does not have to itemize deductions to get the benefit. Parents cannot claim the deduction because they are not legally liable for the debt.

No deduction is allowed to a taxpayer who can be claimed as a dependent on another's return. For example, in the typical situation where a parent is paying for the college education of a child whom the parent is claiming as a dependent, the interest deduction is only available for interest the parent pays on a qualifying loan, not for any interest the child/student may pay on a loan the student may have taken out. The child will be able to deduct interest that is paid in a later year when he or she is no longer a dependent.

What Qualifies as Student Loan Interest?

The interest must be for a “qualified education loan,” which means a debt incurred to pay tuition, room and board, and related expenses to attend a post-high school educational institution, including certain vocational schools. Certain post-graduate programs also qualify. Thus, an internship or residency program leading to a degree or certificate awarded by an institution of higher education, hospital, or health care facility offering post-graduate training can qualify.

Other requirements. The interest must be on funds borrowed to cover qualified education costs of the taxpayer or his spouse or dependent. The student must be a degree candidate carrying at least half the normal full-time workload. Also, the education expenses must be paid or incurred within a reasonable time before or after the loan is taken out.

Is the Deduction Limited?

Yes, as mentioned above, the maximum deduction is limited to $2,500 and the student loan interest deduction is phased out for taxpayers who are married filing jointly with AGI between $125,000 to $155,000 ($60,000 to $75,000 for single filers) for 2012. The deduction is unavailable for taxpayers with AGI of $155,000 ($75,000 for single filers) or more.

Married taxpayers must file jointly to claim this deduction.

Does the Taxpayer have to Itemize?

No, the deduction is taken “above the line.” In other words, it's subtracted from gross income to determine AGI. Thus, it's available even to taxpayers who don't itemize deductions.

Keep Good Records

Taxpayers must keep records to verify qualifying expenditures. Documenting a tuition expense isn't likely to pose a problem. However, care should be taken to document other qualifying education-related expenditures such as for books, equipment, fees, and transportation.

Documenting room and board expenses should be straightforward for students living and dining on campus. Student who live off campus should maintain records of room and board expenses, especially when there are complicating factors such as roommates.

Consult a tax professional to help you navigate this complex field and realize the largest amount of tax savings possible. And don’t forget – any fees paid for tax preparation services are deductible, too.

For other commonly missed tax deductions, see: http://goo.gl/ZBx90.

Wednesday, January 2, 2013

Looking for Work? Looking for Tax Deductions?

Did you incur job hunting expenses in 2012? Don't forget this potential tax deduction!

Both job-hunting costs and moving expenses are commonly overlooked deductions. If you were looking for employment in the same line of work, you can deduct transportation expenses, food and lodging for overnight stays, employment agency fees, and the costs of printing resumes and business cards. 

If you moved your residence at least 50 miles away from your old home for the purpose of work, moving expenses are deductible even if you do not itemize your deductions.

Other commonly overlooked tax deductions at: http://goo.gl/ZBx90.

State and Local Tax Deduction Saved in Fiscal Cliff Act

The deduction for state and local sales taxes was extended as part of the Fiscal Cliff Act. This deduction often seems overly cumbersome to deal with when preparing your taxes, but it can provide significant tax savings, especially in states with no income tax.

The IRS allows taxpayers to choose between deducting state and local income taxes paid and state and local sales taxes paid. Taxpayers can either save all their receipts and add up the amount of sales tax paid during the year or use IRS tables that are based on income and state of residence to determine the amount that is deductible. In addition, people who claim the state sales tax deduction do not have to include a state tax refund in income the following year. As a result, if your sales tax deduction is about the same as your state income tax deduction, the sales tax deduction will probably yield greater savings.

Check out other commonly overlooked tax deductions at http://goo.gl/ZBx90.