Holidays and Tax Planning

Thanksgiving is history. Black Friday’s gone. Cyber Monday’s in the books. What’s there to look forward to? The second half of Hanukkah? Christmas? Are you kidding, we’re talking tax planning, people!

That’s right, rather than thinking about ways to spend money, think about ways to save money, especially on taxes. Since there’s about a month left in 2013, you still have a little time to save a few dollars in tax before the ball drops in Times Square.

Net Investment Income Tax – starting with the 2013 tax year, taxpayers with adjusted gross income (AGI) over $200K single/$250K married filing jointly are subject to an additional tax of 3.8% on net investment income above the threshold amounts. This tax applies to income that includes capital gains, interest, dividends, rents, and others. While some of these items may be beyond your control (such as how much dividend is paid on a stock or mutual fund), you may be able to control your AGI, to keep it below the threshold where the 3.8% tax kicks in. One way is if you’re taking retirement plan (IRA etc) distributions. If you’re considering taking more than a minimum distribution, consider whether a higher distribution would put you above the level where the 3.8% tax kicks in.

Personal Exemption Phase-out – this “gem” has been (thankfully) missing from tax returns for the last three years, but has come roaring back for 2013. For AGI over $250K single/$300K joint, the deduction for personal exemptions reduces (phases out), and goes down to zero with AGI of about $372K single/$422K joint. Taxpayers closing in on the phase-out range of AGI should consider if there are ways to push off 2013 income to 2014, to keep personal exemptions intact.

Itemized Deduction Phase-out – similar to the personal exemption phase-out, the reduction of itemized deductions returns in 2013. Common itemized deductions are mortgage interest, real estate tax, charitable contributions, and others. As with the exemption phase-out, when AGI goes above the thresholds, the total allowed itemized deductions begin to reduce. Note that reduced deductions and exemptions have the effect of subjecting more income to tax, which has the effect of increasing your overall net tax rate.

As you may have concluded, the tax and phase-outs I mentioned above are driven by your level of AGI, so it’s important to look at ways to reduce your adjusted gross income. The best way to address this is to look at page 1 of your 2012 tax return, since the page 1 ends at AGI. Consider if there are ways of delaying income, taking losses on investments (which would reduce income/AGI up to $3K), switch investments to tax free municipal bonds/funds, and increasing retirement plan contributions, among other things.

While increasing itemized deductions won’t reduce your AGI, they will still probably net you some tax savings. Making additional charitable contributions could help, as would bunching medical or miscellaneous itemized deductions, both of which are subject to AGI related “floors”.

So while you’re in the middle of a tug of war with that jerk at Walmart over the last Xbox 360 on the shelf, just think about how much more fun it would be to save some money on your taxes!

How are you planning on saving on your taxes this year? Or next? Leave a comment and let me know what you’re thinking. And please forward this article to a friend or family member who might (tax) benefit from it.

Is it a Business, or is it a Hobby?

How many of you out there make really good homemade hummus? I’m typing with one hand, while I raise the other. My wife thinks that it’s better than the pre-made store bought stuff, and that I should sell it to the public. For all my clients, no, I’m not quitting my day job (yet, haha!). Aside from figuring out a catchy name for it (JayTheCPA’s hummus doesn’t quite roll off the tongue), could I really make a go of this as a business, or is it really just a hobby?

If you’ve been doing some sort of activity that you love to do (baking cakes for friends, for example), is this something that you can deduct the expenses for, and reduce your taxes? I’ll give you a big resounding maybe!

IRS has various rules to determine whether an activity is a bona fide business, or just a hobby. If an activity is an actual business, for a sole proprietor the income and expenses are shown on Schedule C, as part of your individual income tax return, and if your expenses exceed your income, the resulting loss can offset other income items on your tax return. If the activity is a hobby, expenses can only be deducted to the extent of income, so if you have no income, you can’t deduct any expenses. If you do have income, the expenses are deducted as a miscellaneous itemized deduction, subject to a floor/deductible/”haircut” of 2% of your adjusted gross income. The bottom line is that if you’ve got a hobby, you’re probably not going to get much of a tax deduction for it, if at all.

So how do you know whether your activity is a business or a hobby? Here are a few of IRS’s factors for determining the answer:

1-how is the activity carried on – IRS will look at whether the activity is being conducted in a businesslike manner. Is there a separate bank account? Are books and records being kept?

2-what is the individual’s expertise – there should be extensive knowledge of the activity, potentially showing that advice has been sought from experts.

3-time and effort on the activity – if you have a full time job and pursue the activity an hour a week, it may indicate that this is not a serious business activity for you.

4-history of income or losses from the activity – while you may be able to get away with showing a loss on Schedule C for a year or two, showing losses year after year would indicate that there’s no real profit motive for the activity, in which case IRS will deem the activity a hobby, and disallow previous losses claimed.

IRS looks at a number of other factors when making a determination of whether an activity is a business or a hobby. At this point, my hummus making (and other culinary adventures) is strictly a hobby, so I’ll keep IRS out of what’s left of my hair, and will leave the expenses off my tax return. Before you start taking deductions for your hobby, contact your friendly neighborhood CPA for advice. Do you have any interesting tax stories regarding hobbies? Please share.

Home Sales and Taxes

With the housing market as hot as it’s been, you may be thinking of selling a home, and hopefully taking the profit and running. But will you owe any taxes to Uncle Sam? The short answer is, it depends (hey, nothing’s ever straightforward when it comes to taxes!) This article will discuss various aspects of home sales and taxes.

Principal Residence?

If the home being sold is your principal residence, up to $500K of gain on the sale can be excluded from tax on a married joint return ($250K for a single taxpayer). Note that this is gain on the sale, which is generally the difference between the selling price and the cost basis of the home. Also remember that this is for the place that you call home, normally your primary residence, and not a second or vacation home. The exclusion can be claimed if you’ve lived in this residence for at least two of the previous five years. If you don’t meet the two year requirement due to certain specific unforeseen circumstances, a reduced exclusion can be available.

Rental Property?
Do you live in a home that’s also partially rented out to somebody else? If you do, the two parts (residence and rental) need to be split into two transactions for tax purposes, and only the residence part is subject to the gain exclusion. Any gain on the rental portion will be 100% taxable.

3.8% Medicare Tax

For tax years starting in 2013, there’s a 3.8% Medicare tax on “net investment income”, and I’ll give you one guess what gets included in this computation. The good news is that if the principal residence exclusion amount wipes out your gain on sale, you won’t be subject to the 3.8% tax either.

Sale of Principal Residence at a Loss

Sorry, this one just isn’t deductible, period, end of story. The story has a different ending if it’s a property you rented out to others, but that’s beyond the immediate scope of this article.

Home Office Depreciation

If you took depreciation deductions on a home office, this will reduce the basis of your home, for purposes of computing the gain on sale. Not only that, but the amount of depreciation taken in previous tax years will be recaptured on sale as taxable income, and also be subject to the 3.8% Medicare tax.

Obviously there are lots of non-tax related things to think about when selling a home (moving, for one), but don’t lose sight of the tax laws surrounding the sale, because if you do, you may have a nasty surprise come tax time. My recommendation is to speak with your favorite CPA (hint hint) and do some pre-sale tax planning.

Please forward this article to anybody you know who is considering selling a home, and if you have any personal stories or comments about home sales and taxes, please leave a comment.

The Penalty of Marriage

It’s June, and what better time for love, weddings, and marriage penalties? Yes my friends, while you’re busy picking out flowers, caterers, and tacky bridesmaid dresses, start thinking about how much more tax you’re going to be paying, come tax time. That’s right, I said more tax, and if you’re in the majority of taxpayers, you’ll most probably wind up paying more tax as part of a married couple than you would as a single bachelor(ette). I wrote about this a couple of years ago, but a recent meeting with a new client reminded me of how often this subject has come up over the years, so I thought I’d revisit it.

You may or may not have heard of the term “marriage penalty”. What this refers to is combining two spouses’ incomes on one married tax return which will result in a higher tax than the same amount of income split between the two spouses on two single tax returns. In one of the more recent tax law changes within the last few years, Congress had attempted to eliminate the marriage penalty, but the problem is, they didn’t do it for all the tax brackets. For the lowest (10%) and next lowest (15%) tax brackets, the amount of joint income that falls into each bracket is exactly double the amount of single income that falls into each bracket. And that’s where marriage penalty relief ended. Taxable income for a single taxpayer in the next bracket (25%) falls between $36,250 and $87,850, while married joint taxpayers will find that bracket only covers income between $72,500 (double the single amount) and $146,400, (only 167% of the single amount). So if you have two taxpayers with taxable income of $87,850 each, they’ll both be in the 25% bracket, but add those up ($175,700), and on a joint return they’ll now be in the 28% bracket…penalty! For those in the uppermost tax bracket (39.6%), single taxpayers will hit that bracket with taxable income of $400K, while joint taxpayers will hit that bracket at $450K.

This may have you thinking “what about married filing separately?” Unfortunately, the answer is that the tax brackets are even less forgiving than the single ones, and you’ll be in the top tax bracket with only $225K of taxable income, compared to $400K single and $450K joint. There are reasons to file separately that are more legal and protective than tax saving (e.g. divorcing couples who want to keep their taxes/finances separate), and in my experience, in a majority of cases, filing jointly will be cheaper than filing separately, so for the happily married couple, filing jointly will probably be the best course of action.

There are limited ways to try to reduce the effect of the marriage penalty, but that wasn’t the goal of this article. The idea here is to make you aware that the marriage penalty is “out there”, so if you’re planning on tying the knot this year (or know somebody who is), when the dust has settled from the wedding, and the honeymoon is (literally) over, the next thing to think about is meeting with your friendly neighborhood CPA, and do some tax planning early, to help avoid a major tax headache next April 15th.

Summertime Child Care

No more pencils, no more books, no more teacher’s dirty looks…school’s out for summer. If you’re old enough to remember the Alice Cooper song, you can blame me when you’re still humming it six hours from now!

Now that another school year is coming to a close, how are you going to keep the kiddies occupied and out of trouble for the next few months? Chances are, you and your spouse will both be working during the lazy hazy crazy days of summer, and you’ll have to pay for child care, so why not have Uncle Sam pay for part of the cost? The federal Child and Dependent Care Tax Credit is applicable for summertime child care too, so take advantage of it, but first you need to know how it works. Here are some important points:

1-you have to pay for care so you (and your spouse if filing jointly) can work or actively look for work. The spouse can meet this test for any month that he/she is a full-time student or physically or mentally incapable of self-care.

2-you must have earned income, and if you’re filing jointly, your spouse must have earned income too. Earned income is generally wage and self-employment income.

3-the care must be for one or more qualifying people. In the case of this article, since I’m writing about children, they must be under age 13 and be claimed as a dependent.

4-the care can be provided at home, at a daycare facility, or even at a day camp. If it’s inside your home, then you also have to think about the household employer requirements.

5-the credit is a percentage of the qualified expenses that you for the qualifying person. This percentage starts at 35% and drops to a minimum of 20%, depending on income.

6-up to $3,000 of expenses for one person or $6,000 for two or more qualifying people can be used to compute the credit.

7-the cost of overnight camps or summer school tutoring doesn’t qualify, nor does anything paid to a spouse or other dependent. If either spouse receives dependent care benefits from an employer, special rules apply.

8-the credit is claimed on Form 2441, and basic information on the provider will need to be entered on this form, so make sure you have the provider’s name, address, and identifying number (social security or employer i.d. number). Keep good records to substantiate the credit claimed.

I’ve had many clients over the years who had unrealistic expectations of how much money they were going to save by claiming this credit. Realistically, if you have two or more eligible kids, $6,000 is the maximum amount of child care expenses you can use to compute the credit, and if your income is over $43,000, the percentage for the credit will be 20%, so the maximum credit you can get is $1,200, which isn’t a lot. Obviously it’s better than nothing, and it’s a credit so it will reduce your tax dollar for dollar, as opposed to a deduction which will only reduce your tax by whatever marginal tax rate you’re at. But with good record keeping you’ll save a few bucks, and will be able to afford to give each of your kids (and your spouse) their very own copy of Alice Cooper’s “School’s Out”.

Please forward this article to all parents who incur child care expenses, and have a good summer.

No more pencils, no more books…

To Err is Human, To Deduct Divine

I think I erred once, but it turns out I was just plain wrong! Anyhow, this article isn’t about erring, but about claiming some of those divine tax morsels, deductions!

If you’re a new small business owner, you may not know what the @#$% is deductible and what isn’t. Even if you’re not a new owner, there could still be deductions available that you may not have thought of. I’ll give you a little bit of free advice right now…contact a CPA! I have to try; after all, it is my blog. O.K., since I’m such a nice guy, I’ll give you a few ‘freebies’.

Business Meals-unfortunately only 50% of what you spend on business meals is deductible, but 50% is better than zero! The key to getting the deduction is to keep good records, which includes having an entry in your calendar or organizer showing the name of the person you’re dining with, and having a receipt with the date. I’m often asked about whether you need to keep every business meal receipt, and isn’t there a minimum amount, below which you don’t need a receipt? My answer is “don’t argue with me, just keep your receipts”. No, I’m not really that tough, but the fact is, if you’re ever audited, and you tell the auditor that all of your business meals were $20 so you didn’t keep any receipts, you’re gonna get your deduction tossed out. It’s better to be able to substantiate most of your meals than none of them, so keep your receipts; it’s really not difficult to do.

Cell Phones-or smartphones; who doesn’t use them these days? Yes, I understand that you use yours to yack with your friends, send text messages, write a five-star review of your favorite CPA on Yelp (thank you everybody!), and IRS understands it too. If you use your cell phone for business, don’t be afraid to take some sort of deduction for it.

Cost of Incorporating-if you set up a corporation or LLC, the cost of doing that (attorney fees, filing fees, etc) is deductible. There are certain rules for how much can be deducted and when, so consult a professional (another shameless plug; gotta love it).

Business Use of Car-when it comes to using your car for business, remember one thing; commuting is never deductible, so if you drive from home to the office (or vice versa), forget it. On the other hand, if you drive to a client site or to one of those business meals, that auto use is deductible. The rules to follow for claiming a business auto deduction are too numerous for this article; just know that it’s something to take advantage of.

Cabs and Public Transportation-I took the Metro last week to go to a client in DC. Am I going to take a deduction for the cost of that round trip fare? You’re damned right I’m going to. And you should too, if you’re taking a bus, train, cab, etc to a client, or to that business meal.

CPA-yes, another shameless plug, but you can write me off…as a tax deduction..that is..not as a person, or trusted advisor. Think of it as Uncle Sam paying part of my bill!

Those are but a few of the many things that you can claim as a deduction as a small business owner. Employees of others may also be able to claim some of these deductions, but there are a few more hoops to jump through to be able to do that. I hope you found this helpful, and please pass this along to somebody you think might benefit from this information. If you’ve got any favorite deductions you’d like to share with the masses, please leave a comment. Now get out there and start deducting, woo hoo!

Identity Theft and Taxes

I tried to think of a snappy title to this post, but the truth is, identity theft is serious s#$%, and when combined with income tax fraud, it can be financially and emotionally devastating, so I’ll skip the levity and get right to it.

Tax return identity theft is when someone uses a taxpayer’s personal information (name, social security number) to file a fraudulent return to claim refunds on that return. The returns are usually filed early in the filing season, before most taxpayers have received all of the W-2s and 1099s they’re expecting. Taxpayers are usually unaware that anything has happened until they file their return, and then receive a notice from IRS that a return was already filed with the taxpayer’s social security number. In 2011, approximately 75% of all returns filed had refunds due, averaging about $3,000. In May 2012, IRS had identified about 2.6 million returns for possible identity theft, and they recently reported about 450,000 active identity theft cases.

IRS’s Publication 4535 (Identity Theft Prevention and Victim Assistance) states that people who have had their identity stolen can spend months or years (and their hard earned money) repairing their good name and credit record, and may lose job opportunities, be refused loans, education, housing or transportation, and may even be arrested for crimes they didn’t commit! An immediate result of a fraudulently filed return by an identity thief is the delay of a refund due, from the legitimately filed return, until IRS can sort things out with the real taxpayer.

What steps can you take to minimize becoming a victim of tax return identity theft, or other identity theft?

-Don’t carry your Social Security card with you, or any document with your SSN on it.
-Don’t give out your Social Security number to any business, just because they ask for it. Question why it’s needed and how it will be used.
-Check your credit report at least every 12 months.
-Secure your personal information at home, and get yourself a shredder. Shred everything that you think has anything remotely resembling personal information, including unsolicited credit card offers.
-Protect your personal computers with firewalls and anti-spam/virus software, and regularly change passwords for accounts with sensitive information (such as banks, brokers, credit cards).
-Don’t give out personal information over the phone, by mail, or on the internet unless you are the one who initiated contact or you’re sure you know who is asking. And remember, IRS will NEVER contact taxpayers by email, so if you receive an email that says it’s from IRS, forward it to phishing@irs.gov to alert IRS.
-Whenever possible, ask for masked SSNs on insurance cards or any other place where the SSN is used as an identifying number. Beginning this tax season, my tax software vendor is enabling me to mask SSNs on returns. You can bet that I’ll use this feature on every client return copy that I send out, plus the pdf file will be passworded.

What do you do if you find that your identity has been stolen (either via a fraudulent tax return or otherwise)?
-Contact the Federal Trade Commission at ftc.gov/complaint.
-File a report with the local police.
-Close any affected bank or credit card accounts.
-Inform the major credit bureaus, and consider putting a freeze on the accounts.
-Contact the IRS Identity Protection Specialized Unit at 800-908-4490. They will have you file Form 14039 (Identity Theft Affidavit).
-Respond to all IRS notices you receive in the mail, using the phone numbers listed on the notice.

As with any crime, identity theft can be a harrowing experience. I hope this information helps, and please forward it along to anybody you feel might benefit from the information I’ve provided.

Cliff Diving 101

Who needed to watch the ball drop in Times Square, if you were looking for New Year’s Eve excitement? We had Congress giving us plenty of excitement (and heart attacks) with their dillydallying about the “fiscal cliff”. For better or for worse, the American Taxpayer Relief Act of 2012 was signed into law on January 2, 2013, and thank you very much, but I’ll stay out of any political discussion as to whether it’s good or bad for American taxpayers. What I will do is summarize a few of the key provisions of the “Act”, for your reading pleasure/misery.

Individual Income Tax Rates

The Act retains the 10%, 15%, 25%, 28%, and 33% marginal tax rates that had been in effect previously. The 35% tax bracket will end at $400K of taxable income (single) and $450K taxable income (joint). Above those thresholds, the 39.6% rate that was in effect “pre-Bush-tax-cuts” will kick in.

Estate and Trust Tax Rates

The top rate for estates and trusts rises to 39.6%, for taxable income over $11,950. As you can see, the top tax rate kicks in at a comparatively low taxable income amount, so executors and trustees are advised that whenever possible/practical, the income should be distributed out of estates/trusts to beneficiaries, especially when the beneficiaries are in a lower tax bracket than the estate/trust.

Long-term Capital Gains and Qualified Dividends

In recent tax years, long-term capital gains and qualified dividends have generally enjoyed a relatively low 15% tax rate. This will continue under “The Act”, but (always a but, eh?!) in cases where taxpayer’s taxable income (including the gains and the dividends) exceeds that magic threshold of $400K single/$450K joint, long-term gains and qualified dividends will be taxed at 20%.

15% Tax Rate Bracket for Joint Filers

The size of the 15% bracket for joint filers remains at 200% of the size of the 15% bracket for single taxpayers. Before all you single taxpayers run off to get married, keep in mind that this 200% amount does not apply to higher brackets, and remember what as I said above, about the top 39.6% bracket for joint taxpayers being only $50K higher than it is for single taxpayers, so there will definitely be some “marriage penalty” effects.

Standard Deduction For Joint Filers

The standard deduction for joint returns will remain at 200% of the standard deduction for single taxpayers, woo hoo!

Itemized Deduction Phase-Outs

This is something that we haven’t had to face for a few years, and it’s baaack! Beginning in 2013, when Adjusted Gross Income, (not taxable income) exceeds $250K single/$300K joint, itemized deductions will generally be reduced by 3% of AGI. The net effect here is to actually increase your effective tax rate. It’s been estimated that taxpayers in the 33% bracket will effectively pay 33.99%, those in the 35% bracket will effectively pay 36.05%, and those in the 39.6% bracket will effectively pay 40.79%!

There are a lot more provisions to the Act, but I think I’ve been more than sadistic enough by telling you about the items above. For CPAs like me, each of these tax acts should really be called “The Tax Preparer Job Security Act”, since it keeps all of us busy, sorting through provisions, and advising our clients.

Questions? Comments? Gripes? Feel free to leave a comment. Stay tuned for more “stupid Congress tricks”!

Should Your Independent Contractors Really Be Employees?

About a half year ago, I wrote about some mistakes that small business owners make https://mycpajay.wordpress.com/2012/03/19/mistakes-small-business-owners-make-that-can-cost-themdoh/. One of the items that I briefly discussed was classifying employees as independent contractors, which has become an issue that IRS and state unemployment funds have zeroed in on, in recent past. This article will discuss the issue in a little more detail, and give a few tips on how to stay on the right side of the law.

Here are some interesting stats:

-a 2005 Bureau of Labor Statistics report indicated that contractors made up only 7.4% of all workers, or about 10.3 million workers

-a 2011 study found that 16 million workers were classified as independent contractors, and predicted a higher use of contractors in the next ten years

-a 2000 Department of Labor study found that 10-30% of all employers misclassified workers, and in 2008, IRS found that when employers asked IRS for proper classification, only 3% of workers in question were actually independent contractors, and not employees. You don’t need to be a math whiz to see that most workers are employees!

Considering that it can be about 30% cheaper to call somebody an independent contractor, you can understand why people would want to take that route, even if a person really should be considered an employee. To throw a little fear into you, a 2009 Government Accountability Office report said that 71% of IRS worker misclassification examinations resulted in a change of the worker status. Based on that, the odds are not on your side if you misclassify an employee as a contractor, and you’re called in for an audit. So what can you do to better your odds of classifying correctly?

Review Form 1099s for proper classification-Form SS-8 (Determination of Worker Status For Purposes of Federal Employment Taxes…) is a great guide for determining who has control over the worker, which is one of the main determinants of whether the worker is independent or not. Figure out whether similar workers are categorized differently.

Review workers who received Form W-2 are now treated as contractors-If there’s a reason why somebody who had been an employee is now considered independent, make sure you’ve got a clear, documented explanation for the change.

Review your vendor list, check register, and accounts payable-you can add to your troubles if you were required to file Form 1099-MISC for people who actually are independent, but you didn’t. Penalties can add up. Starting with 2011 business returns, there are now two specific questions about this, so if you have 1099 filing responsibilities, don’t forget to do it.

As I mentioned at the beginning, the employee vs independent contractor issue is something that’s receiving more and more attention, and probably won’t go away any time soon, so make sure you’re doing the right thing, to save yourself from potential major headaches in the future.

Please pass this article on to any small business owner you know, who may benefit from this information, and leave a comment if you’ve had any experiences with this issue, or were audited.

Jay E Reiner CPA PLLC, 1400 14th St N, Arlington, VA 22209

Gambling and Taxes

If you like to gamble, then I have a wager for you. I’ll bet that you can learn something new about gambling and taxes from this article!

Whether you’re into rolling the dice, horse racing, cards, slot machines, or even betting on the Super Bowl or playing bingo, did you know that your gambling winnings are fully taxable and must be reported on your tax return? Did I win the bet yet?

Here’s some information about gambling and taxes:

1-Gambling income isn’t just limited to casinos or horse racing, but also includes lottery winnings, raffles, and even the fair market value of prizes, such as cars and trips.

2-The payer (casino, race track, etc) is required to give you a Form W-2G (Certain Gambling Winnings) if you receive $1,200 or more in winnings from bingo or slot machines, more than $5,000 from a poker tournament, or $600 or more in other gambling winnings (and the payout is at least 300 times the amount of the wager). There are other instances where Form W-2G is required, but I’ve covered the more common ones.

3-Generally you will report your gambling winnings on the “other income” line of your tax return (Form 1040).

4-You can claim your gambling losses to the extent of your winnings, as an itemized deduction on Schedule A, under “other miscellaneous deductions”. Note that this type of deduction is not subject to the 2% adjusted gross income limitation that’s applicable to items such as tax preparation fees, safe deposit box fees, and unreimbursed employee expenses. While you may have gambling losses, you’re not allowed to net them against the income; you must report the income as I indicated in #3, and report the losses as I just described.

5-You must keep accurate records to substantiate any gambling losses. These records can include receipts, tickets, statements, a diary, and any other documentation you have. As with any tax deduction, if you’re audited and don’t have adequate substantiation, the deduction will be disallowed.

I hope you found this information useful, whether I won the bet or not. Please forward this along to any of your gambling buddies, and happy (but responsible) gambling!