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.