Monday, December 26, 2016

Qualified dividends taxed at favorable capital gain rates

Ever look at your year-end investment tax forms and wonder what “Qualified Dividend” means? In a nutshell, it means you are taxed at the favorable capital gains rates. 

Capital Gains Rates - Qualified dividends are taxed at the same favorable 0%, 15%, or 20% rates that apply to long-term capital gains. Dividends that aren't qualified are taxed as ordinary income, at rates as high as 39.6%. 

Additional Net Investment Income Tax - If you are a “high earning” taxpayer(1), the qualified dividends are subject to a 3.8% tax on net investment income tax. After the 3.8% tax is factored in, the top rate on capital gains and qualified dividends is 23.8%. 

What are Qualified Dividends? - Qualified dividends are received from domestic corporations or from qualified foreign corporations, which include U.S. possessions corporations, foreign corporations whose stock is traded on established U.S. securities markets, and foreign corporations eligible for income tax treaty benefits. 

Holding Periods – Be aware that there are 61 day and 91 day holding period rules for common and preferred stocks, respectively. We won’t discuss the details here. 

Dividends That Are Not Treated as Qualified - Qualified dividend income does not include the following:
 (1) dividends on any share of stock to the extent the taxpayer is under an obligation to make related payments with respect to positions in substantially similar or related property, for example, in connection with a short sale;

(2) any payment in lieu of dividends, for example, payments received by a person who lends stock in connection with a short sale;

(3) dividends that you elect to treat as investment income for purposes of the rules governing the deduction of investment interest;

(4) dividends from a tax-exempt charitable, religious, scientific, etc., organization, religious or apostolic organization, qualified employee trust, or farmers' cooperative;

(5) deductible dividends paid by mutual savings banks, etc.;

(6) deductible "applicable dividends" paid on "applicable employer securities" held by an employee stock ownership plan (ESOP);

(7) dividends received as a nominee.
Mutual Fund Dividends - If you own shares of a mutual fund that holds dividend-paying stock then, to the extent that the dividends received by the mutual fund are qualified dividend income the dividends are taxable at the 0%, 15%, or 20% maximum rates. The mutual fund reports your dividend income on Form 1099-DIV including the qualified dividend income.

Other Pass Through Entities - Dividends received partnerships, S corporations, estates, trusts, and real estate investment trusts (REITs) you own are tracked and reported to you by that entity. By and large, the qualified dividend income of these entities is taxed as qualified dividend income by the partner, shareholder or beneficiary.
Effect of capital losses on dividends - While qualified dividend income is taxed at the same rates as long-term capital gain, it isn't actually long-term capital gain. Therefore, you can't use capital losses that otherwise enter into the computation of your taxable "net capital gain" (the excess of net long-term capital gain over net short-term capital loss) to offset your qualified dividend income. As a result, generally, your qualified dividend income will be taxed in full at the 0%, 15%, or 20% rates.
However, if your capital losses exceed your capital gains for the tax year, the excess, up to $3,000, can be used to offset other income. This offset can be used against qualified dividend income, but only after it's been used against taxable income other than qualified dividend income. However, this "ordering" rule is actually a benefit, because offsetting taxable income other than qualified dividend income, which is taxable at rates up to 39.6%, saves more tax than offsetting qualified dividend income, which is taxed at no more than 20%.
Planning - The taxation of dividends at the favorable 0%, 15%, and 20% rates may make investments in dividend-paying stock significantly more advantageous than investments that produce income taxed at rates as high as 39.6% (for example, rental real estate, or any type of investment that produces taxable interest).
Please consult a qualified tax advisor if you have any questions on whether any of your dividend income is qualified dividend income.

(1) Taxpayers with modified adjusted gross income (MAGI) that exceeds $250,000 for joint returns and surviving spouses or $200,000 for single taxpayers and heads of household.

Monday, December 19, 2016

Deducting Foreign Business Travel

In today’s business environment, even small businesses may have the opportunity to conduct business with customers outside of the United States. Along with this opportunity comes the question can such costs be deducted for tax purposes? Depending on the facts and circumstances, foreign business travel can be deducted.

Business versus Personal Travel

For a trip entirely for business purposes, you can deduct all the travel costs, plus meals (at 50%), lodging, and some incidental costs such as for laundry and dry cleaning.

If the trip is primarily personal, none of the costs of travel to and from the destination are deductible, even if some time is spent on business. However, lodging, meals, etc. would be deductible for the business days.

Mixed Purpose Travel

When a primarily business trip incorporates personal travel, the rules are more complex. In this case, the costs allocable to the personal (vacation) part of the trip generally cannot be deducted. For example, a trip covering ten days includes four personal and six business days. Meals, lodging, etc. are only deductible for the business days and only 60% of the travel costs (airfare, etc.) are deductible, reflecting the fact that only 60% of the days of the trip were business days.

One Week Test

If the primary purpose of the trip is business and the trip does not last for more than a week, the allocation of part of the travel costs to the nondeductible portion is not required. A week is defined as seven consecutive days, not counting the day of departure, but counting the day of return.

25% Test

For trips lasting more than a week, no allocation is required if the personal days are less than 25% of the total days spent on the trip. In this test, the total days of the trip include the day of departure and the day of return. As long as business is conducted during a day, it's counted as a business day. Business days also include days spent traveling to or from a business destination and weekend days or holidays falling between two business days.

Deducting Trips that Fail the One Week and 25% Tests

If your trip does not pass the one week or 25% tests, you may still be able to deduct all of the travel costs if you can show that the chance to take a vacation was not a major consideration for the trip. The larger the vacation portion, the more difficult it will be to make your case.

As you can tell from the above discussion, the tax implications of foreign travel can get quite complex, depending on the nature of trip. Before planning a foreign trip and taking the deduction, consult a qualified tax professional.

Monday, December 12, 2016

Taking Advantage of the Self-Employed Health Insurance Deduction

Taking Advantage of the Self-Employed Health Insurance Deduction

Many of us small business owners are faced with the rising costs of company provided health insurance. If you are a sole proprietorship, partner or more than 2% shareholder in an S Corporation (referred to as “self-employed”), proper treatment of health insurance costs allows you a 100%, helping to offset the rising cost of health insurance.

Normal Limitations on Health Insurance Deductions

For taxpayers that are not self-employed, the ability to deduct health insurance costs is limited. Health insurance premiums included with other medical expenses are deductible as an itemized deduction, only to the extent that total medical costs exceed 10% of the taxpayer’s adjusted gross income (7.5% if over age 65). For most taxpayers, the deduction does not exceed the threshold and thus there is no tax benefit for the medical expenses they have paid.

Different Rules for Self-Employed Health Insurance

Self-employed taxpayers have a tax advantage when it comes to health insurance. Their health insurance deduction is an "above the line" deduction, reducing adjusted gross income (AGI)-100% of the health insurance costs for the self-employed owner, spouse, dependents, and for any child of the self-employed who is under age 27 as of the end of the tax year.

Example. Mark is self-employed and pays $6,000 in health insurance premiums and has no other medical expenses. His AGI is $100,000. Since 10% of $100,000 equals $10,000, Mark cannot claim an itemized medical expense deduction for the health insurance premiums. However, since Mark is self-employed, he can deduct the entire $6,000 above the line.

Partners in partnerships that provide health insurance can also benefit from this treatment. The cost of the health insurance is reported on the partner’s K-1 and treated similarly as described above. Keep in mind that the partner must be subject to self-employment income from the partnership to qualify for the deduction.

If you own 2% or more of an S Corporation that provides you with health insurance, the deduction works slightly different. In this case, the health insurance is included in the shareholder’s taxable earnings on their W-2. Wait, that sounds like it created taxable income for the shareholder. Yes it did, but the increase in taxable earnings for the shareholder also decreased earnings from the S Corporation that are reported from the shareholder’s K-1. So the net effect is no increase in taxable earnings. The shareholder is then able to deduct cost of the health insurance above the line and realize a 100% deduction.

If the health insurance plan is a High Deductible High Premium plan, the self-employed taxpayer can contribute to a health savings plan that if also deductible above the line, further increasing tax savings for the self-employed taxpayer.

A Few Rules to Consider

These rules only apply for any calendar month in which you aren't otherwise eligible to participate in any subsidized health plan maintained by any employer of yours or of your spouse, or any plan maintained by any employer of your dependent or your under-age-27 child.

Also, the deduction can't exceed your earned income from the trade or business for which the health insurance plan was established.

For partners and S Corporation owners, proper treatment of the health insurance and any HSA contributions on the K-1 or W-2 is critical for the deduction. Make sure to review the presentation and reporting of this information with your tax professional before the end of the tax year.


The tax benefits of a self-employed individual's health insurance costs effectively reduces your cost of health insurance. You may wish to consider changing your coverage in light of these savings. Proper reporting of these costs are critical to taking the 100% deduction, otherwise you may limited or prevented from deducting the health insurance costs.

Please consult a qualified tax professional to discuss how best to structure your compensation and health insurance before taking the self-employed health insurance deduction.

Monday, December 5, 2016

Hardship Withdrawals and Loans from 401(k) Plans

Hardship Withdrawals and Loans from 401(k) Plans

Life doesn’t always go as smoothly as we have planned. Sometimes we are faced with an immediate financial need that has us eyeing our 401(k) retirement plan as a solution to that need. If you find yourself in this situation, you should be aware of the possible ways you may access this source of funds before you reach retirement.
Generally, distributions from a 401(k) plan while you're still employed and before you reach age 59½ are not permitted. However, an unusual financial obligation and an immediate need for cash, may permit you to take a distribution for financial hardship. IRS rules spell out what is an immediate and heavy financial need, which include funeral expenses for a family member. On the other hand, distributions to purchase a boat or a television do not qualify as an immediate and heavy financial need.

Limits on Hardship Withdrawals

Hardship withdrawals are limited to amounts attributable to elective contributions to the plan. Elective contributions are the amounts you have contributed to the 401(k) plan, not including employer matching or profit sharing contributions. This also includes the earnings attributable to your contributions. Hardship withdrawals are taxable distributions (except to the extent of Roth 401(k) contributions) and if you're under age 59½, you may be subject to a 10% addition to tax on premature distributions.

Consider the possible 10% early withdrawal penalty as well as ordinary income taxes when establishing the amount of tax to be withheld from the hardship withdrawal. Many times clients withhold for the 10% penalty thinking they have covered the taxes only to be surprised that they also owe income tax on the withdrawal.

Also, special rules apply to the withdrawal of any "after-tax" or voluntary contributions, other than Roth 401(k) contributions, that you may have made to your plan.

A Loan from the 401(k) Plan May Be a Better Alternative

Another way to get cash from your 401(k) plan is through a plan loan. If your plan provides for loans and certain conditions are met, you can borrow the funds tax-free. Loans must be repaid along with interest within a five-year term. The amount of any plan loan is generally limited to 50% of the value of your vested balance with a limit of $50,000. The five-year repayment requirement doesn't apply if the loan is for the purchase of a residence.

Unlike a taxable hardship distribution, a plan loan doesn't require that you establish an immediate and heavy financial need. Your ability to borrow from your 401(k) plan depends on requirements under the terms of the plan.

Another point to keep in mind is that a plan loan-unlike a hardship distribution-doesn't reduce the value of your 401(k) assets. Your account remains fully vested, subject, of course, to your obligation to repay the loan, with interest. If you are unable to repay the loan or leave employment before the loan is fully repaid, the unpaid balance will be considered as a withdrawal, subject to early withdrawal penalties (if under age 59½) and ordinary income taxes.


If you participate in your company's 401(k) plan, the value of your account balance may well be your most significant financial asset. While contributions to your 401(k) plan are intended for retirement savings, if you happen to be facing, or anticipate facing, major financial obligations, you should be aware of the possible ways you may access this source of funds while you're still working.

Before making a 401(k) hardship withdrawal or loan, consult a qualified tax advisor.

Monday, November 28, 2016

529 Education Savings Plans

529 Education Savings Plans

Do you have a child or grandchild who is going to attend college or trade school in the future? Are you concerned with how to pay for their education? If so, you are like many of us that desire our children or grandchildren to continue their education and are concerned with how to pay for it.

You have may have heard about qualified tuition programs, also known as 529 plans (named for the Internal Revenue Code section that provides for them). 529 plans allow prepayment of higher education costs on a tax-favored basis, by deferring or even completely eliminating the taxes on any earnings of the account. You can think of it as a Roth IRA for education.

Types of 529 Plans

There are two types of programs:

Prepaid plans allow you to buy tuition credits or certificates at present tuition rates, even though the beneficiary may not be starting college for some time. Prepaid plans were popular when first introduced, but have declined in availability; and
Savings plans that allow the account owner to make contributions and earn a return until the funds are withdrawn at a later date.

How 529 Plans Work

Contributions are not deductible for federal income taxes however, many states offer credits and deductions for contributions to state sponsored plans. Using a state sponsored plan doesn’t limit the beneficiary to attending school in that state. Most state plans offer great investment choices with low investment costs. The website publishes information on states offering credits and deductions for 529 contributions. 

The earnings on the account aren't taxed while the funds are in the program. Beneficiaries can be changed on the account and account owners can roll over the funds in the program to another plan for the same or a different beneficiary without income tax consequences.

Distributions from the program are tax-free up to the amount of the student's qualified higher education expenses. These include tuition, fees, books, supplies, and required equipment. Reasonable room and board is also a qualified expense if the student is enrolled at least half-time.

Distributions in excess of qualified expenses are taxed to the beneficiary to the extent that they represent earnings on the account. A 10% penalty tax is also imposed.

Eligible schools include colleges, universities, vocational schools, or other postsecondary schools eligible to participate in a student aid program of the Department of Education. This includes nearly all accredited public, nonprofit, and proprietary (for-profit) postsecondary institutions. A school should be able to tell you whether it qualifies.

Contributions made to the qualified tuition program are treated as gifts to the student, but the contributions qualify for the annual gift tax exclusion, which is currently $14,000. If your contributions in a year exceed the exclusion amount, you can elect to take the contributions into account ratably over a five-year period starting with the year of the contributions. Distributions from a qualified tuition program are not subject to gift tax, but a change in beneficiary or rollover to the account of a new beneficiary may be.


529 Plans are a great way to save for a child or grandchild’s education. These plans can yield tax savings since earnings are not taxed if used for qualified education expenses. Many states offer credits or deductions, so it may be beneficial to start a plan to use for paying current post-secondary education expenses. If you are considering how to pay for college expenses of a child or grandchild, consult a qualified tax professional.

Monday, November 21, 2016

Can I Deduct the Cost of Spouse Business Travel?

Can I Deduct the Cost of Spouse Business Travel?

Have you ever been enticed by professional education or a customer meeting in an exotic destination? Even thought about how nice it might be to bring your spouse along to make the trip more enjoyable? Wouldn’t it be even better if you could write-off that trip? Read on and learn how to maximize those travel costs.

Rules on Spousal Travel Costs

The IRS has some very restrictive rules for deducting a spouse's travel costs. First of all, to qualify, your spouse must be your employee. So unless your spouse is an employee, you can't deduct the travel costs of a spouse, even if his or her presence has a bona fide business purpose. This requirement prevents deductibility in most cases.

If your spouse is your employee and their presence on the trip serves a bona fide business purpose, you can deduct his or her travel costs. Make certain that the spouse’s presence is more than incidental and that it is necessary. For example, attending for customer goodwill isn’t considered necessary. Document the purpose of their travel to support the deduction. This is especially important when there is a vacation element to the trip, i.e., if your spouse will be spending time sightseeing, etc.

If your spouse's travel satisfies these tests, the normal deductions for business travel away from home can be claimed. These include the costs of transportation, meals, lodging, and incidental costs such as dry cleaning, phone calls, etc.

Deductible Costs When a Spouse’s Travel Doesn’t Qualify

If your spouse's travel doesn't satisfy the requirements, you may still be able to deduct a substantial portion of the trip's costs. The rules don't require you to allocate 50% of your travel costs to your spouse. You need only allocate to any additional costs you incur for your spouse. In many hotels the cost of a single room isn't that much lower than the cost of a double. If a single costs you $150 a night and a double costs you and your spouse $200, the disallowed portion of the cost allocable to your spouse would only be $50. And if you drive your own car or rent a car, the cost will be fully deductible even if your spouse is along. Of course, separate transportation, meals or other costs, incurred by your spouse wouldn't be deductible.

Discuss these rules with a qualified tax advisor before planning a business trip that includes your spouse. Hopefully, you can have a successful business trip while enjoying time with your spouse and getting to benefit from the tax deduction.


Monday, November 14, 2016

Installment Sales of Business Property

Installment Sales of Business Property

Entrepreneurs build businesses and hopefully reap the benefits of their hard work when they can ultimate sell the business.

When it comes to selling a business or business property, sellers may be confronted with the decision to carry the financing. During times when bank financing for buyers tightens up, seller financing a portion or all of the transaction may be the seller’s only option to complete a transaction. Aside from the seller’s risk associated with carrying the financing, there are tax implications that must be taken into consideration.

Taxable Gain versus Recovery of Basis

When a business or business property is sold, the gross proceeds can generally be broken into two categories, recovery of the seller’s basis with the remaining portion being treated as a taxable gain. In the case of seller financing, there is also be interest income that is received based on the terms of the installment agreement.

General Tax Benefits of an Installment Sales

Generally speaking, an installment sale allows the seller to take taxable gains over the period of the agreement. This most often leads to the seller being taxed at lower rates versus receiving the payment upfront and taxed at higher marginal rates in the year of the sale. Lump sum payments in the year of the sale can also subject the seller to addition taxes such as the net investment income tax and other “high earner” taxes. And there’s always the possibility of Alternative minimum tax that should be considered in the transaction.

Tax Reporting in an Installment Sale

When a seller receives payments from the buyer over time, sellers report the gain on the payments in the year received, rather than reporting the entire gain in the year of the sale. Thus, with each payment received, the seller recognizes a pro rata portion of the gain which is subject to tax. You must use the installment method unless you elect out of it. However, here are some things to be aware of:

Recapture of Depreciation

When using an installment note, any depreciation previously taken on real or business property and equipment must be recaptured in the year of the sale, regardless of the timing of the payments on the note. The portion of the gain related to depreciation recapture is recognized at the time of the sale even if you do not receive any cash at that time. Business owners are often surprised to find out they are taxed on the recapture of depreciation even though they did not collect a significant portion of the sales in the initial year.

Work with your advisor to ensure that the initial year of proceeds are adequate to cover any initial taxes resulting from the recapture of depreciation.

Avoid Constructive Receipts

A seller’s effort to mitigate risk in an installment sale can trigger recognition of the gain and defeat any benefit of taking the gains over the installment period. Receiving payment in an installment sale is not the only trigger for recognizing gains.

The buyer's debt cannot be payable on demand or readily tradable on an established securities market. In addition, the debt cannot be secured directly or indirectly by cash or a cash equivalent, such as a certificate of deposit or a treasury note. If this is the case, the IRS considers the seller to have constructively received payment on the installment note. However, the debt can be backed up by a third party guarantee or secured by a standby letter of credit.

Property Excluded from Installment Sales

The installment method cannot be used for all sales of business property. Sales of property by a dealer or sales of publicly traded property, such as stock or securities that are traded on an established securities market are excluded from installment sales. Thus, the installment method is not available to the extent the gain includes gain on your inventory or gain on publicly traded property.

Transfer of Installment Notes

Selling or discounting the installment note will trigger recognition of gains for the seller. Thus, the advantage of an installment sale is limited if you intend to transfer the note in the future. However, the transfer to a spouse or a transfer at death continue the deferral of the gain.

Plan Your Sale to Minimize Taxes

Often times sellers wait to consult with their tax advisors until the sale has be substantially negotiated. The process of selling a business has been likened to dancing with a bear. Once you are in step with the bear, it is very hard to change the dance. Work with your advisor in advance of negotiating a business sale to avoid any tax surprises and/or the possibility of having to renegotiate a deal.

Monday, November 7, 2016

Explaining College Savings Plan AR 529 Tax Deduction

We all know that college education costs have risen significantly over the past several years and the trend is expected to continue.  We also hope that our children or grandchildren will receive scholarships and financial aid to cover those costs.  Some of you may have even planned ahead by saving for college costs in excess of scholarships and financial aid.  Generally saving for college is done through a Section 529 plan which allows for tax free growth.
If your child or grandchild is ready to attend college and you have not funded a 529 plan, you can still benefit by establishing a state sponsored 529 account.  Taxpayers in Arkansas are allowed a deduction on their state tax return of up to $5,000 for individuals and $10,000 for married couples.  The savings on your Arkansas taxes for making this contribution can be as much as $700 for a married couple. As an Arkansas taxpayer, this opportunity is available even if the student attends an out of state school.
If you have established a 529 plan with a provider other than the state sponsored plan, you can still benefit. Rollovers from outside plans to the Arkansas sponsored plan qualify for the contribution deduction. Under this scenario, we recommend transferring not more than $10,000 per year to the state sponsored plan to maximize the state tax benefit. Please consult us before implementing this strategy, as rollovers from other state sponsored plans may have tax implications from those states.
You can establish the 529 plan for Arkansas on-line at We can assist you at establishing the 529 account at no charge. Once established, you contribute the funds needed to pay the qualified education costs and then use the 529 account to pay such costs.  Provide us with the contribution information when we file your taxes and we will take the appropriate deduction on your Arkansas tax return.
States Other Than Arkansas
Many states offer deductions for education savings accounts and some states even offer credits. Here’s a link to the Saving for College website that lists the plans for each state .
Consult a tax professional before establishing a 529 or other college savings plan. If you have questions about this potential tax savings strategy, please give us a call.

Monday, October 31, 2016

Taxation of Social Security Benefits

How are Social Security Benefits Taxed?

If you are approaching retirement you are probably wondering how your social security benefits will be taxed. Like most tax questions, the answer is depends on the taxpayer’s specific circumstances.

Depending on your income level, up to 85% of your social security benefits may be taxed. This doesn't mean you pay 85% of your benefits back to the government in taxes-merely that you would include 85% of the benefit in your income subject to your regular tax rates.

To determine how much of your benefits are taxed, you must first determine your other income, including certain items otherwise excluded for tax purposes (for example, tax-exempt interest). Add to that the income of your spouse, if you file jointly and half of the Social Security benefits you and your spouse received during the year. The figure you come up with is your total income plus half of your benefits. Now apply the following rules:
1.   If your income plus half your benefits is not above $32,000 [$25,000 for single taxpayers], none of your benefits are taxed.

2.   If your income plus half your benefits exceeds $32,000 but is below $44,000, you will be taxed on (1) one half of the excess over $32,000, or (2) one half of the benefits, whichever is lower.

For example (1): Sam and Catherine have $20,000 in taxable dividends, $2,400 of tax-exempt interest, and combined Social Security benefits of $21,000. Thus, their income plus half their benefits is $32,900 ($20,000 plus $2,400 plus 1/2 of $21,000). They must include $450 of the benefits in gross income (1/2 ($32,900 − $32,000)). (If their combined Social Security benefits were $5,000, and their income plus half their benefits were $40,000, they would include $2,500 of the benefits in income: 1/2 ($40,000 − $32,000) equals $4,000, but 1/2 the $5,000 of benefits ($2,500) is lower, and the lower figure is used.)

Single Taxpayers

The formula for single taxpayers is slightly different. Item 2 above is changed as follows when computing for a single taxpayer.

2.   If your income plus half your benefits exceeds $25,000 but is below $34,000, you will be taxed on (1) one half of the excess over $25,000, or (2) one half of the benefits, whichever is lower.

For example (1A): Sam has $20,000 in taxable dividends, $2,400 of tax-exempt interest, and Social Security benefits of $9,000. Thus, his income plus half his benefits is $26,900 ($20,000 plus $2,400 plus 1/2 of $9,000). He must include $950 of the benefits in gross income (1/2 ($26,900 − $25,000)). (If his Social Security benefits were $3,000, and his income plus half his benefits were $30,000, he would include $1,500 of the benefits in income: 1/2 ($30,000 − $25,000) equals $2,500, but 1/2 the $3,000 of benefits ($1,500) is lower, and the lower figure is used.)

When Your Income Plus ½ of Your Benefits Exceeds $44,000

When your income plus half your benefits exceeds $44,000 ($34,000 for single taxpayers), the computation in many cases grows far more complex. Generally, however, unless your income plus half your benefits is fairly close to $44,000 ($34,000 for single taxpayers), if you fall into this category, 85% of your Social Security benefits will be taxed.

Don’t Be Surprised With a Higher Tax Bill

If you aren't paying tax on your Social Security benefits now because your income is below the above floor, or are paying tax on only 50% of those benefits, an unplanned increase in your income can have a triple tax cost. You'll have to pay tax (of course) on the additional income, you'll also have to pay tax on more of your Social Security benefits (since the higher your income the more of your Social Security benefits that are taxed), and you may get pushed into a higher marginal tax bracket.

This situation might arise, for example, when you receive a large distribution from a retirement plan (such as an IRA) during the year or have large capital gains. Careful planning might be able to avoid this stiff tax result. For example, it may be possible to spread the additional income over more than one year, or liquidate assets other than an IRA account, such as stock showing only a small gain or stock whose gain can be offset by a capital loss on other shares. If you should need a large amount of cash for a specific purpose, contact your tax advisor before liquidating any assets to estimate what your additional tax cost will be.

We once had a client that took a large IRA distribution to pay medical bills. This client was surprised with the significant increase in taxes during that year resulting from the higher income level and the increase in the amount of his social security benefits that were taxed. It was even more difficult for the client to handle when he discovered that he was unable to itemize the most of the medical expenses that were paid with the IRA distribution due to the floor on medical expense deductions. A little planning in this situation could have saved our client taxes. Simply deferring the payment of the medical expenses until the following year would have allowed him to itemize most of the medical expenses.

If you know your social security benefits will be taxed, you can voluntarily arrange to have the tax withheld from the payments by filing a Form W-4V. Otherwise, you may have to make estimated tax payments.

Monday, October 24, 2016

Understanding the Home Office Deduction

Understanding the Home Office Deduction

  • Direct expenses include the costs of painting or repairing the home office, depreciation deductions for furniture and fixtures used in the home office, etc.
  • Indirect expenses of maintaining the home office include utility costs, depreciation, insurance, mortgage interest, real estate taxes, and casualty losses allocated based on the square footage.

Tests for Home Office Deductions

Home office expenses are deductible if you meet any of the three tests described below:

·         The management or administrative activities test is met if you use your home office for administrative or management activities of your business, and if you meet certain other requirements.

·         The relative importance test is met if your home office is the most important place where you conduct your business, in comparison with all the other locations where you conduct that business.

Place for Meeting Patients, Clients or Customers Test - You're entitled to home office deductions if you use your home office, exclusively and on a regular basis, to meet or deal with patients, clients, or customers. The patients, clients or customers must be physically present in the home office.

Separate Structures - You're entitled to home office deductions for a home office, used exclusively and on a regular basis for business, that's located in a separate unattached structure on the same property as your home—for example, an unattached garage, artist's studio, workshop, or office building.

Alternative Simplified Method – Some taxpayers may choose to forgo tracking home office expenses and choose the Simplified Method for computing the home office deduction. Under this method, the deduction equals $5 (for 2015) multiplied by the home’s square footage used for qualified business use (up to 300 square feet).

Employees Working From Home – Employees working from home may take a home office deduction on Schedule A subject to the 2% of AGI limit if they meet the tests above and the business use of the home is for the convenience of the employer.


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.