This article is condensed from one by Brian Vnak published on Sept. 27, 2016 at www.Marketwatch.com.
I love how people come up with these strategies. Granted, it only fits a narrow swath of society, but for those it fits, it is awesome.
Our parents are aging and living longer than ever. Many of their children are helping with their parent’s finances in a caretaker role. Busy schedules often mean opportunities for tax deductions go unnoticed and are unused.
Like anyone else, people 65 and over can deduct medical expenses that exceed 10% of their adjusted gross income (AGI) if they itemize. Medical expenses typically increase as we age but we often also see income drop or level off. When this happens, you could see medical deductions that go unclaimed as the amounts claimed exceed taxable income. Let me explain.
Let’s say that John’s mother has an income of $40,000. $22000 of this is non-social security taxable income from an IRA and interest. She normally takes the standard deduction because her house is paid off and she can’t itemize. In 2015 with that income and the standard deduction of $7850 (this is higher for elderly people) and her $4000 exemption, she would have taxable income of $10150.
But let’s say that John’s mother had $30,000 of medical expenses. Her AGI was $22,000 so she can deduct all but $2200 of those bills on a Schedule A. She paid taxes on her home and gave some items to charities so let’s say her total deduction was $30,000. But she only had taxable income of $10150. Subtracting the $30,000 from that leaves a negative $19,850, which is the part of the deduction that is wasted. She doesn’t have enough taxable income to deduct the entire amount.
But she has an IRA. What if she converts some of a traditional IRA to a Roth IRA. If she converted $30,000, she would be able to use up all of the available deduction without paying any more taxes than she would have using the standard deduction. (In practice, a bit more of her social security would be taxable but that would be minimal.) And the Roth IRA is still under her control, available if she needs it but she will never have to pay taxes on the any withdrawals from the Roth in the future. Even on the earnings. And, upon her death, her beneficiaries are likely not to have to pay taxes on distributions from a Roth account either (though they would on distributions from traditional IRA’s).
At AFS, we are always looking for ideas like this that we can utilize for our clients.
Use the BEST for LESS. Call us for your tax needs at 303-745-3962.
Even Einstein didn’t understand how taxes work. He is famously quoted as saying “The hardest thing in the world to understand is the income tax”.
So, in a nutshell, here is how it all works…
- Add taxable income from all sources to figure total income. This includes investments, wages, jury duty, business income, royalties, etc.
- Then subtract allowed “adjustments to income” to determine adjusted gross income (AGI).
- Subtract standard or itemized deductions and personal exemptions to determine taxable income.
- Look up taxes owed in table.
- Subtract allowable credits to determine final tax bill.
That is how the Form 1040 works. Items 1 and 2 are on the first page, items 3-5 are on the 2nd page. The trick in reducing taxes is knowing the opportunities available in each of the aforementioned categories and which forms to use to capture those opportunities.
3 of the main strategies for reducing taxes then are:
- Earn as much nontaxable income as you can. You have more control over business or investment income than other income. For instance, there are ways to shift some personal expenses under the business umbrella to reduce taxable income. As for investments, that income can be accessed in a number of tax-advantaged ways if set up properly.
- Make the most of adjustments to income, deductions and credits. Adjustments to income and deductions both reduce taxable income. Credits reduce taxes owed and are thus generally more valuable than deductions. The size of credits can depend on income. Knowing the thresholds, breakpoints, etc. can help reduce taxes. Sometimes credits can be shifted from one taxpayer to another to increase their size.
- Shift income to other taxpayers and other tax years. Delaying income to a future tax year or bunching deductions in a current year would be examples of this. Shifting income to a lower tax bracket taxpayer, such as a parent or child, can save more. For example, if you have a business, hire your child. Money that you are already providing them could be paid in a wage, if done properly. Their tax bracket is typically much lower than yours or non-existent and the money you are paying out becomes deductible, reducing your taxes.
A good tax preparer recognizes opportunities in your personal situation that could be applied to each section of the tax form and helps you use them to reduce taxes. This generally takes years of experience and continuous training as tax laws change.
We at AFS have been doing this since 2004, and we do it at a much lower cost than the vast majority of our competition. Save on your tax preparation and save on your tax liability.
CALL US TODAY for your tax needs. 303-745-3962
Will I owe taxes when I sell my home? This is a very common question and I am happy to say that most people don’t owe taxes upon sale of a personal residence.
So, let’s review the rules.
Individuals are allowed to exempt up to $250,000 of gain and married couples can exempt up to $500,000 of gain on the sale of their principal residence. This is true if three provisions are satisfied:
- OWNERSHIP The individual, if filing single, or at least one of the spouses if filing joint, owned the home for at least 2 years during the 5-year period ending on the date of the sale.
- USE The individual (single filer) or both of the spouses (joint filers) used the home as a principal residence for at least 2 years during the 5-year period ending on the date of sale. (This means that sale of your rental property may or may not be eligible for the exclusion.)
- Neither the individual (single filer) nor either of the spouses (joint filers) excluded gain from the sale of another home during the 2-year period ending on the date of the sale.
A principal residence is defined as the taxpayer(s) main home, where he/she/they live most of the time. A taxpayer can only have one main home at any time.
Gain is calculated as the adjusted selling price minus the adjusted basis of the home. Basis, at minimum, is the purchase price of the home plus capital improvements. The selling price is reduced by costs of sale.
Let’s do a simple analysis. Assume you purchased a home in 1995 for $100,000 and invested $50,000 in it over the years for landscaping, fencing, new kitchen and bathroom. You sell it for $350,000 in 2016. There were $25,000 in selling costs (commissions, fees, etc.). Your gain is the adjusted selling price of $325,000 ($350,000 minus $25,000 = $325,000) minus the adjusted basis of $150,000($100,000 plus $50,000 = $150,000) or $175,000.
The three provisions listed above are all met. Therefore, whether you file as single or married, the $175,000 in gain is non-taxable, total profit.
There are often complications that need to be addressed in determining whether there is any taxable gain. If you,
- used the home as your principal residence for less than 2 years out of the last 4, the amount of gain exemption will be reduced, possibly (but not always) resulting in taxes owed on the sale
- used the home in a business and depreciated part of it (such as a day care) or claimed home office depreciation, then that depreciation has to be recaptured and there will be some taxable gain.
Also, basis adjustments can be very complicated. Sometimes they work in your favor and sometimes they don’t.
We can help you determine the tax implications of your home sale. Call us before you sell to avoid ugly situations at tax time.
AFS – USE THE BEST FOR LESS
With Trump as President and with a Republican House and Senate, there is likely going to be broad agreement on tax reform.
Here is what appears to be likely, though proposals are somewhat fluid:
- The corporate tax rate will be lowered to as low as 15%. If this happens, expect a large part of the $2.4 trillion in corporate profits to be brought home. The tax windfall would pay for a lot of pet projects in Congress and would likely be a way to garner some Democrat support. (I think there should be some way of assuring that much of that goes to capital development in the US and not into stock repurchase plans.)
- Lowering top tax rate to 33 percent from 39.5% (not counting Medicare surtax) and lowering number of brackets from 7 to 3. New brackets would be 12%, 25% and 33%.
- Capping the capital gains tax at 20 percent.
- Eliminating the estate tax (never could figure out why the government thought they owned half of what a private individual accumulated upon their death-I guess rationale is to prevent accumulation of too much wealth in a family but it just makes trust lawyers richer as the rich find ways to avoid the tax)
- Presumably the penalty or tax or whatever on your health plan will be eliminated as part of the repeal of Obamacare.
Pass through entities, partnerships and S Corps, will be very favorably impacted here which will be a big plus for small business which creates 2/3 of the jobs in the country.
The aforementioned changes are those that seem to align with the Republican plans. Other changes that might be put forth:
- Trump also discussed eliminating the “net investment income tax” which was part of Obamacare.
- Capping itemized deductions at $100,000 for single filers and $200,000 for married filers
- Eliminating the head of household filing status
- Make the standard deduction $15,000 for single individuals and $30,000 for married couples.
- An “above the line” child care deduction for children up to 13 years of age for average child care expenses. This deduction would be phased out for higher income earners.
- Adds credits of up to $1200 a year for child care costs as “spending rebates” for low-income taxpayers. These may be aligned in some manner with the earned income tax credit.
- Carried interest would be taxed at ordinary income rates instead of the current capital gains rates that currently aids Wall Street professionals. This proposal aligns with those of Warren and Sanders.
- The individual alternative income tax would be eliminated.
Those are the most recent proposals we have seen as of today. Their projected effect on the Treasury depends a lot on whether or not they are scored dynamically or via static models. I think the goal will be to try and break even when scored dynamically so there will be some bargaining that goes on with heavy input from all the usual sources but the end result will be the same.
My prediction will be some significant tax cuts passed by Congress within the first few months of the next session. This combined with cuts in regulations should cause a pretty good boost in the economy. If corporate profits also come back to US shores, that will be icing on the cake.
As proposals solidify, we will keep you try and keep you informed at to the effect on tax payers.
Questions or comments? Shoot us an email. What do you think of these proposals? What would you add? What are your concerns?
For small business owners, you should be aware that the IRS has moved up the filing due date for 1099-MISC forms that report non-employee compensation in Box 7. The new due date is January 31st, the same as the date the forms are supposed to be issued to recipients. For other types of 1099 filings, the due date is unchanged and is the end of February in the year after the income was paid.
Businesses have to file a 1099-MISC for payments of $600 or more to independent contractors during the course of the year.
The penalty for not issuing the form on time is $30-$100 per form, depending on how late the form is, up to $500,000. If non-issuance is intentional, the penalty can be $250 per form with no limit.
If you don’t receive a 1099-MISC, you should report the income anyway. It is not a mismatch if you report extra income. You will get a mismatch letter if the IRS has records of payment to you that you don’t report. This often happens when the issuer of the 1099 has the wrong address for you. The business that issues the form will be concerned with filing on time to avoid penalties, not on whether the address is correct.
If you don’t claim income reported to the IRS and get a mismatch letter, you will owe taxes, penalties and interest for under reporting income. These charges can add up quickly. You should always update the 1099 issuers with changes in your address but you should also be sure that the post office has a change of address on file if you move and you can also file a change of address Form 8822 with the IRS. You want to make sure that you get copies of anything the IRS receives to avoid extra costs and headaches.
The earlier filings will be a bit of a pain for businesses but should be helpful to contractors that like to file early in the tax season.
Here are a few tax planning tips to help reduce taxable income for 2016. It’s not too late to utilize some of these strategies.
- You can accelerate deductions and defer income- for example, make an extra mortgage payment before the end of the year or put off that bonus until 2017. The former exemplifies an increase in deductions while the latter is an example of reduced 2016 income.
- Sometimes you can bunch itemized deductions to exceed a threshold that will then result in a reduced tax liability. The best example of this is probably medical expenses. These have to exceed 10% of your AGI before they produce a deduction on your Schedule A (itemized deduction form). If you know you are going to be close to that number, and you need a medical procedure, schedule it for 2016 so that the cost of that procedure is deductible. Or, there is a 2% AGI threshold for miscellaneous expenses which include professional fees like legal advice or tax planning or other unreimbursed business expenses you may be incurring, such as travel.
- It’s getting late for this one but you can file a new W-4 with your employer and boost your withholding for the last few paychecks.
- Of course, you can always add more money to a retirement account. 2016 contribution limits are $18000 for a 401(k) and $5500 for an IRA (more if you are over age 50).
- If you converted a traditional IRA to a Roth IRA in 2016 and the account value went down, you can reverse that conversion and you have up until the extended deadline to make that change. You could then convert later and pay less tax on that transaction.
- Charitable deductions are very common. Just remember that any cash contributions must be documented in some fashion. If you claim more than $500 in donations of property, Form 8283 must be filled out and accompany your tax return. If you claim more than $250 for a car donation, you will need written acknowledgment from the charity that received the vehicle.
- If you are taking RMD’s (Required Minimum Distributions) from your IRA, you might consider contributing that amount directly to a charity. This will reduce your AGI and is very helpful for those that don’t itemize and the contribution still counts toward the satisfaction of your minimum RMD for the year.
- Reduce your taxable estate by giving up to $14,000 to as many people as you wish in 2016, free of gift or estate tax. You get a new gift tax exclusion each year. Both you and your spouse can combine your gift and give up to $28,000 to a single beneficiary.
If you need help determining if any of these are appropriate or beneficial, please give us a call. Always glad to help.
Owning a business often allows you to move what would otherwise be personal expenses into the business category. But many under use the deductions available to them.
The most common one is the home office deduction. This is actually well known but many hesitate to use this because of unnecessary fear of increased audit likelihood. However, this deduction is completely legitimate for most businesses that work out of the home. If you have good records and a legitimate claim, there is no reason not to claim it. If you are unsure, talk to your tax preparer.
Health care premiums These are deductible if you itemize but medical expenses are subject to the 10% threshold. Only those medical expenses that exceed 10% of your adjusted gross income are deductible. Also, many people don’t itemize in which case they are usually unable to claim any deductions for health care premiums or other medical expenses.
But if you are self-employed, these premiums are fully deductible on the front of your tax return. Even if you are incorporated or in a partnership, there are ways to deduct premiums and other medical expenses from your business income.
Pay your parents/pay your children If you have a valid business need for labor that is well documented, you can deduct wages or other payments to your family members. With a bit of recordkeeping, the allowance you pay your kids can be converted into a deductible wage. Or, here is a great example of payments to a parent. We had a client that wanted to help his Mom out but she didn’t want ‘charity’. He put her on the payroll where she performed light duties, one of which was baking cookies for weekly meetings.
Education If you are taking courses that maintain or improves a skill required in your business, it is probably deductible. This could include tuition, course fees, lab fees, webinars, certifications, and travel between your business and class location. Education credits may also be available and if so, you need to determine which is more advantageous. Don’t forget journals, subscriptions or other materials that help you improve your business or improve your skills.
Past missed depreciation We see this most often in home child care businesses, but it could apply to many others. Business owners often don’t take all the depreciation expenses they are entitled to. We recently helped one day care business owner recoup unclaimed depreciation for the prior 3 years for which they received an extra $800 in refunds.
Loss carryovers Many businesses just starting out operate at a loss and may end up with losses that can’t be used in that particular year. But, many of these losses can be carried over to future years where there benefit is fully used. Be aware of these and make sure they don’t get lost from one year to the next.
SAVE ON TAX PREP Don’t forget that savings can also come from where you have your taxes done. AFS tax services are typically priced at about 60% or less of that charged by the national chains and even less when compared to CPA’s and other accounting firms.
AFS – use the best for less
Well, I am getting tired of writing about these pfishing scams but the info needs to get out as new scams arise.
We get calls here all the time regarding phone calls from scumbags professing to be from the IRS and demanding immediate payment, usually accompanied by a threat of some sorts. The scams have progressively become more sophisticated with people that speak proper English and even with official caller ID’s that match the message. They are also becoming much more aggressive in collection efforts, often threatening with jail time and telling people “police are on the way”.
When our clients receive such a call, we tell them that the IRS does not make a first contact by phone and they do not use email. Their first contact with you is a letter; they do not call out of the blue and again, they do not use email or other internet channels. People receive letters for a variety of reasons. For instance, you may receive a letter asking for confirmation or substantiation of an item on a previously filed tax return, such as an 886A or a demand for payment, such as a CP501.
Each of these letters has an explanation as to the purpose of the letter and instructions on how to respond. If you receive one of these, follow the instructions or ask your tax preparer for assistance.
That advice is still good. If someone calls saying they are from the IRS you should probably hang up. But if you want to check them out, get their name, badge number, phone number and record the caller ID. Then you can find instructions on how to verify a phone call at https://www.irs.gov/uac/report-phishing, Never give out information in response to an email and never open an attachment in you are unsure of the sender.
But now the scammers are sending letters.
The latest scam is a fake tax notice (a CP2000) asking for an immediate payment by check made out to the I.R.S and mailed to the “Austin Processing Center” at a PO Box. The form looks official but their are subtle differences between the fake form and an actual CP2000, which can be viewed at the IRS website. Apparently this is working quite well so there will probably be any number of knockoffs.
Should you receive one of these, you can go to the web page https://www.irs.gov/individuals/understanding-your-cp2000-notice or contact your tax preparer and ask them to help you check it out. We do this for our clients and in most cases, we do not charge anything.
Note that a valid IRS letter should be responded to in a timely manner but never send money without verifying the validity of the request and understand that even a valid request from the actual IRS is often based on incorrect or missing information. Such erroneous requests are usually cleared up quickly with a letter or a phone call.
DON’T BE A VICTIM.
How does a 0% tax rate sound. Opportunities are rare, but here are some ways to earn or receive income, without paying taxes on it.
- Contribute to a Roth IRA – For most people, this is a no-brainer. The Roth is a retirement account that allows the money contributed to grow completely free of taxation as long as you make no unqualified withdrawals. As an example, let’s suppose that you sock away $50,000 over your lifetime into a Roth IRA which grows to $350,000. When you retire and start taking money out of the Roth, that $300,000 in earnings is completely tax free. The longer you save and the higher your tax bracket, the more beneficial the Roth will be. In comparing a Roth to a Traditional IRA, a useful analogy might be seed corn. With a traditional IRA, you don’t pay taxes on the seed but will pay an unknown amount on the corn when you harvest (it’s unknown because you don’t know future tax rates or what your tax bracket will be when you retire). With a Roth IRA, you pay taxes on the seed but none on the harvest.
- Sell your home – we talk to people every month that are downsizing or moving or whatever and are worried about the taxes they are going to owe when they sell their personal residence. If your gain on the sale is less than $500,000 (for a married couple, $250,000 for a single person) and you have lived in the home for 2 out of the last 5 years, you will not have to pay any taxes on that gain (assuming your home was not used in a business in which depreciation was deducted, such as a day care).
- Invest in municipal bonds – these are debt obligations of cities, states, counties or other government entities that help fund projects in their respective locales. Interest earned on these bonds is tax-free on the federal level and, if you buy a bond in the state in which you live, it is most likely (not 100%) not taxable on the state level either.
- Hold your investments for the long term and the capital gains when you sell may be tax-free. If you are in the 10 or 15% tax brackets, the Federal tax on those long-term capital gains is 0. If you are in one of the higher brackets, from 25% to 39.6%, the tax rates on those gains is only 20%, resulting in a tax savings.
- Contribute to a Health Savings Account (HSA). There are 3 conditions for this strategy to work; you have to be enrolled in a high-deductible health plan, you can’t be enrolled in Medicare and you can’t be a dependent on someone else’s return. If you meet these conditions, you and your employer can contribute to an HSA account and the contributions, up to certain limits, are deductible on your Federal return. If you withdraw the money and use it for qualified medical expenses, any such withdrawals are tax-free.
- Gifts from any individual to another are not taxable to the receiver of the gift. So, if your parents want to give you $14,000 each, it is not taxable to you. If you are married, they can each give you and your spouse $14,000 for a total of $56,000 with no tax consequences for either of you.
- Finally, if you want to make a little extra cash, consider renting out your home. As long as the rental period is 14 days or less, the income received is completely tax-free.
Tax-free income. It just takes a little planning. Give us a call.
The overall audit rate is about 1 in 119 returns but this increases drastically with increases in income.
The chance of audit for those making over $200,000 is 1 in 38 and for those making over a million, it’s 1 in 10. This compares to 1 in 132 odds for an audit if you make under $200,000.
- So, the first way to increase your chance of audit is to make more money, though I think we would consider that a nice problem to have.
- Fail to report income and odds are very high that you will get caught. The IRS receives copies of all 1099’s and W-2’s and their computers are pretty good at matching up what they have with what you report. Any mismatch automatically generates a letter which is usually a bill.
- If you take higher than average deductions, your return could be flagged. The IRS has algorithms which compare your reported deductions with others that have similar return characteristics, such as income, profession, etc. Exceed certain thresholds and your return will be flagged for audit. That being said, if you have proper documentation for a deduction, by all means report it. You are entitled to it.
- If you run a small business, the IRS is very familiar with those who claim excess deductions. Record keeping is often poor in small businesses and tax myths about allowed deductions are rampant. Claiming expenses that are not legally deductible and not having proper records of deductions claimed allows the IRS to win a large percentage of audits. Cash rich businesses, such as taxis, car washes, bars, hair salons, etc. are favorite targets.
- Taking large charitable deductions can also produce audits. The IRS knows the average deduction for people at your income level, and as in item 3, their computers will pick the returns that exceed certain thresholds. Fail to file Form 8283 for non-cash donations over $500 and you have become a bigger target. Record keeping is key to surviving these audits.
- Rental real estate loss claims have been a successful target for the IRS, especially concerning those taxpayers who claim real estate professional status. Most people don’t realize that rental losses are passive losses and can be deducted only against passive gains or when the property is disposed of. There are exceptions if you actively manage the property or claim real estate professional status. It is important that you can prove you qualify for one of these exceptions if you claim real estate rental losses.
- Take an alimony deduction? Make sure your court documents say it is alimony and not something else, like child support or non-cash property settlements. Also, make sure you show the recipient’s name and social security number on your return. If you receive alimony, make sure you claim it.
- Deducting business meals, travel and entertainment can raise alarms if the amounts seem too high for the business or profession. You must have records documenting the deduction amount, the place, the people attending and business purpose. No records and you are toast.
- Failng to report a Foreign Bank account is a hot button right now at the IRS, especially with all the foreign tax shelters that have been exposed in recent years.
- Claim 100% business use for a vehicle? This is red meat for the IRS. They know it is extremely rare for a vehicle to be used 100% for business, especially if there is not another vehicle in the household.
- If you take an early payout from an IRA or 401(k) account and you are under age 59 1/2, you likely have to pay a penalty on that early distribution. There are exceptions that can be claimed but make sure you qualify. This is an easy one to catch as the IRS has copies of the 1099’s for the distribution and your birth date. Make sure the distribution code on the 1099 reflects the exemption if you are claiming one.
- Finally, if you don’t report gambling winnings or claim big losses, prepare for the audit. Most gambling winnings are reported to the IRS on Form W-2G by the casinos or other venues. Claiming gambling losses is possible up to the amount of winnings but you must have records of those losses. For professional gamblers, more deductions are allowed but a discussion of those rules is beyond the scope of this article.
Come see us here at Aurora Financial Services if you are unsure of your record keeping We can help make sure you are prepared should you be audited, especially if you have a business.
If you are about to be audited, give us a call. We can help you prepare for that as well.
If you're an individual, a family or a small business, we can help you with all your tax needs. Contact us today to see how we can help.