Its advertising makes filing your tax return with TurboTax by Intuit® seem easy. As with any software or computer program, the age-old adage applies: garbage in, garbage out. Yes, it is a very robust piece of software, and yes, it walks you through the process with a series of questions. If your tax situation is very simple, this software might be a viable option for you. Then again, if your tax situation is very simple (i.e. one source of income, no dependents, no need to itemize deductions, etc.), using TurboTax simply saves you from adding and subtracting the numbers you would be entering on your 1040EZ form with a pencil, for example.
If you’ve completed your own tax return in the past and have a basic sense of how the calculations on Form 1040 flow (e.g. income and adjustments on the front, credits and payments on the reverse side), you may become frustrated or at least a bit confused when following the TurboTax process. “Why is it asking for that information now? I’m not to that part of 1040 yet.”
Choosing the TurboTax Version
There are several different versions of TurboTax from which to choose, depending on your personal tax situation. While the website can help you select an appropriate version (e.g. asking if you own a home or rent, have children, made charitable contributions, sold stock or own rental property, paid out-of-pocket medical expenses, etc.), if you don’t consider all of the implications of your situation or if you happen to answer incorrectly, you could either buy a version that can’t address your more complicated tax scenario or buy a version that is more robust than you actually need. In either case, you’re wasting money.
With the former mistake (buying a cheaper version than you need), you will end up either buying a more expensive version (and paying twice: Intuit won’t refund your money because you bought the wrong version) or you will have to manually calculate some of the more complex areas of your tax return as well as the end result (because TurboTax cannot consider what you are doing outside the program when the software is making its own final calculations). There have been many tax payers who bought the software only to give up and use a professional tax preparer instead.
It’s Still Your Time and Your Responsibility
Although TurboTax has built its reputation on simplifying your tax return by asking you questions, the tax code is still very, very complicated. There are no shortages of pop up “learn more” windows inside the software; however, keep in mind that these explanations are simplified, and even in their simplified state may not make more sense to you than reading the instructions from the IRS. Only you can determine how much time you want to spend researching and learning about the tax code when TurboTax poses a question to which you are not sure of the answer. Additionally, if you answer something incorrectly that alters your tax liability, the IRS still holds you solely responsible.
TurboTax also offers an online version. Use extreme caution with this version. In fact, the best advice is to avoid using it at all. Why? You will be entering the most sensitive personal and financial data that exists about you – social security number, address, income, etc. Despite any and all precautions the company takes regarding security, hacking is a real possibility when data exists “in the cloud.”
One of the biggest complaints about TurboTax is “the program won’t let me….” You may not be able to change a number or make a correction after you’ve entered data. Additionally, if you fail to update whenever prompted – and certainly before you e-file, your return could be inaccurate. It is not unusual for Congress to make last-minute changes to the tax code, even as late as December, when the software may already be available for purchase.
The common TurboTax errors that we’ve seen at Waddy Financial Services involve the complexity of childcare issues and credits when there are multiple children in the household. Also, there are certain deductible job expenses that are missed as well as improperly claiming net operating losses for business filers.
Finally, depending on the version of TurboTax you purchase, you will not have access to a live person to whom you can pose questions and ask for clarification. If you do have that access and misunderstand the answer you’re given, it could lead to an error on your return. Once again, you and only you are responsible.
When you use Waddy for your tax preparation, you’ll be working with an individual who can answer your questions and who will ask questions of you to ensure that you are capturing all of the deductions and credits to which you are entitled. Most importantly, Eric Waddy is an enrolled agent and can represent you before the IRS should you be audited. That’s a peace of mind that no software can offer.
“It’s the least wonderful time of the year….” Yes, it’s time to prepare to file your tax return. While this time of the year is met with dread by many individuals, it doesn’t have to be quite as bad as it’s purported to be or as you may think. By following these steps, you can make it as stress-free as possible.
First, gather your information. By now, you should have received all the reporting documentation you’ll need. Here’s a checklist:
- Social security numbers: yours, your spouse’s (if filing jointly), and those of all your dependents
- W-2 forms from your employer(s) and those of your spouse (if filing jointly)
- 1099 forms (if applicable):
- 1099-MISC: for miscellaneous income earned as an independent contractor or self-employed person who earned more than $600 from an individual client. Provided by your client(s).
- 1099-INT: for interest income. Provided by your bank or investment firm.
- 1099-DIV: for dividend income. Provided by your bank or investment firm.
- 1099-R: for retirement income from withdrawals from your traditional IRA or 401(k) account. Provided by your bank or investment firm where the account is held.
- 1099-G: for unemployment compensation or a state tax refund. Provided by the appropriate government agency.
- 1099-C: for debt cancellation that the IRS treats as income. Provided by the company forgiving your debt (e.g. credit card company).
- Income from state and local tax refunds from the previous year (that may not be reported on a 1099-G)
- Accounting records for business income
- Social Security benefits
- Rental or royalty income
- Miscellaneous income (e.g. jury duty stipend, gambling/lottery winnings, prizes or awards, and distributions from a medical savings account [reported on Form 1099-MSA])
You can reduce your tax liability with deductions and credits. You should have the documents and amounts you paid for mortgage interest, student loan interest, IRA contributions, medical savings account contributions, moving expenses, childcare costs, charitable contributions and donations, qualified job and business expenses, casualty and theft losses, and any homebuyer or green energy tax credits for which you may be eligible.
Also, please share with us any life changes (marriage, divorce, new child, job change or relocation, death, etc.) that you experienced in the last year, so that we can fully and effectively address your tax situation and take advantage of certain credits, exemptions, deductions, etc. to which you may now be entitled.
Please provide your updated mailing address and bank account information to avoid a potential delay in your refund.
Finally, ask questions! We are here to serve you, so please don’t hesitate to ask any questions you may have.
Using Waddy’s Organizer
We understand that taxes can be complex, so we’ve created a tax Organizer to help you expedite the process. The Organizer walks you through your personal tax situation with a series of yes/no questions and easy-to-follow worksheets on which we’ll collect needed information about your dependents, income, healthcare coverage, as well as other income and adjustments. For those who need it, we’ll help you cover every detail for Schedules C (business), E (rental & royalties), and F (farming) as well as itemized deductions for which you may qualify to potentially reduce your tax liability.
With the Organizer complete, you can easily upload it to use via our secure online portal.
The average timeframe for Waddy to complete your tax return is two hours to two weeks depending on how your information is organized.
Once your return is filed, if you are getting a refund, the IRS issues most refunds in fewer than 21 calendar days. However, it may take longer, especially if you are claiming the Earned Income Tax Credit or an Additional Child Tax Credit. By law, the IRS cannot issue a refund in that case until at least Feb. 15, 2017.
You must also take into consideration the time it takes for your bank or financial institutions to post the refund to your account when getting the refund via direct deposit.
You can use the IRS “Where’s My Refund” site to track the status of your tax return.
When there is a death in the family, one of the last things you probably want to think about is the settling up with the IRS; however, a final tax return must be filed for the year in which the person (the decedent) died. Additionally, tax returns must be filed for any years preceding the year of death if the decedent had not done so.
For example, John Q. Public died in February 2016 before he filed his tax return for tax year 2015. His personal representative would be responsible for completing and filing two returns on his behalf: one for tax year 2015 (due on the normal date of April 15, 2016 or extension request filed by that date) and one for tax year 2016 (due on the normal date of April 15, 2017 or extension request filed by that date) that would cover the time from the start of the year until his death.
The typical IRS Form 1040 is used. Or, if the decedent would qualify, Form1040-A or 1040-EZ can be used instead. According to the IRS, “All income up to the date of death must be reported and all credits and deductions to which the decedent is entitled may be claimed.”
A personal representative must be named to oversee the decedent’s property and take responsibility for filing tax returns. This person is typically the person named as the executor/executrix on the decedent’s will and/or testamentary documents. If no will exists (or no executor named or the executor is unable to carry out the duties), the court will appoint an administrator to serve as the personal representative.
The personal representative is responsible for gathering all of the decedent’s assets, paying creditors, and distributing any remaining assets to heirs and/or beneficiaries. With regard to tax filing, the IRS states that the personal representative must also:
- Apply for an employer identification number (EIN) for the estate (if needed).
- File all tax returns, including income, estate, and gift tax returns, when due.
- Pay the tax determined up to the date of discharge from duties.
Apply for an EIN as soon as possible as this number will be needed on the documents you file on behalf of the decedent and the estate. You can apply for this for free at www.irs.gov (“Apply for an Employer ID Number”), and when applying online, you will receive the EIN immediately upon completion of the application.
It is important to note that funeral expenses are generally not deductible from the decedent’s income when filing the final tax return; however, executor fees and administration fees are deductible to the estate on the final return. That said, if you serve as the personal representative, any fees paid to you from an estate must be included in your own tax return as gross income for the year in which you receive them.
As noted, you must file the decedent’s return (or file for an extension) on the normal tax deadline (April 15th or the next business day when the due date fall on a weekend or other legal holiday). Include the word “Deceased” along with the date of death at the top of the return. If there is a surviving spouse on a joint return, include that person’s name and address in the appropriate fields. If there is no spouse or a joint return is not being filed, the personal representative’s name and address are included in the address field.
The personal representative signs the return. In the case of a joint return with a surviving spouse, the surviving spouse also signs the return as they normally would.
If you are the personal representative (with no surviving spouse), file the return for the place of your residence (if it is different from that of the decedent).
If the decedent would be due a refund, that money is not forfeited upon death. You would use Form 1310 to claim the refund. The IRS states, this form “does not have to be filed if you are claiming a refund and you are:
- “A surviving spouse filing an original or amended joint return with the decedent, or
- “A court-appointed or certified personal representative filing the decedent’s original return and a copy of the court certificate showing your appointment is attached to the return.”
If you inherit assets from the decedent, it may or may not be taxable. To determine any tax liability, you must first determine your “basis” in the property. According to the IRS, “The basis of property inherited from a decedent is generally one of the following:
- “The fair market value (FMV) on the property on the date of the decedent’s death.
- “The FMV of the property on the alternate valuation date if the executor of the estate chooses to use the alternate valuation.”
Sale of the property is reported on Schedule D (Capital Gains and Losses) and on Form 8949 (Sales and Other Dispositions of Capital Assets). If you sell the property for more than your basis, there is a taxable gain. It’s advisable to get an appraisal for the most accurate assessment of a gain (or loss).
Estate and Inheritance Taxes
An estate tax is levied on the net value of all of a decedent’s assets, and this tax is paid by the estate prior to distribution of inherited assets to the beneficiaries. At the federal level, a filing is only required for estates that exceed $5,490,000 in 2017.
An inheritance tax is the responsibility of the recipient/beneficiary. Currently, there are only six states that impose an inheritance tax, including Iowa, Kentucky, Maryland, Nebraska, New Jersey, and Pennsylvania. Each state has different laws, thresholds, and tax rates.
One of life’s happiest transitions is welcoming a new family member. While you are getting adjusted to a new schedule and every other detail that comes with a new baby or child, it’s important to keep in mind that family expansion brings with it changes to your tax picture regardless if expansion is due to the birth of a new baby, adoption, or foster care.
First Things First: Your W-4
The first thing you should do is update your W-4 form. This is the form your employer uses to calculate the amount of federal income tax that is withheld from each paycheck. You now have another exemption to claim, and that lowers your tax liability as you will be adding a dependent. When you file for the tax year in which you added to your family, your exemptions increase. The personal exemption amount for tax year 2016 is $4,050 per exemption (depending on your adjusted gross income).
Depending on your situation and whether you itemize on your tax return, updating your W-4 may not be as easy as simply increasing the number of dependents you claim by one. If you claim other credits or income adjustments, you should take these into account when completing your W-4 form. Check out the IRS Withholding Calculator to help make the process a little easier.
Child Care Expenses
Babies and children come with lots of expenses. The majority of these expenses are not tax deductible; however, the cost of providing care while you work may entitle you to a tax credit. Because of the cost of child care, either parent may re-evaluate the feasibility of resuming employment. This credit can make the decision easier by reducing the economic strain of the cost of child care. Remember that this is a credit, not a deduction, so there is a dollar-for-dollar reduction to your overall tax liability.
Additionally, you can claim this credit regardless of income. While the credit is reduced at higher incomes, the Child and Dependent Care Credit does not entirely disappear at higher income thresholds as do many of the credits offered by the IRS. This is certainly a credit that you’ll want to take advantage of. The maximum credit is $3,000 for one qualifying child or individual or $6,000 for two or more qualifying dependents. You may not claim this credit, however, if your filing status is “married, filing separately.” According to the IRS, “The amount of the credit is a percentage of the amount of work-related expenses you paid to a care provider for the care of a qualifying individual. The percentage depends on your adjusted gross income.”
The percentage ranges from 20 to 35 percent of allowable expenses.
For children, a dependent qualifying child is one who is under age 13 when care is provided. (This credit is also available for older qualifying dependents in the case of physical or mental incapacity for self-care.) Additionally, your payments for child care cannot be made to someone you (or your spouse) can claim as a dependent. You will need to report identifying details for the caregiver or organization on your return. Use Form W-10 to request this information from your caregiver.
If you choose to use an in-home nanny for child care and other domestic support, you should withhold and pay Social Security and Medicare tax on the wages you pay. If you pay cash wages of $2,000 or more, you should withhold and pay those taxes. The taxes are currently 15.3 percent of cash wages. The employee’s share and your share (as the employer) are both 7.65 percent which combined equals the 15.3 percent.
You are not required to withhold federal income tax (but you may agree to do so); however, you may be responsible to pay federal unemployment tax. If so, this tax is covered by you and not withheld from your employee’s wages. You can learn more about “nanny tax” at the IRS site.
Adoption and Foster Care
Adopting is a wonderful way to open your heart and home to a child, but there are expenses involved with the process. The adoption tax credit is now a permanent part of the American Taxpayer Relief Bill. The credit is designed to help offset qualified adoption expenses including adoption and attorney fees, court costs, travel expenses, and other expenses involved in the legal adoption of a child.
For 2016, the adoption credit is $13,460 for those with a modified adjusted gross income (MAGI) of $201,920 or less. For those over that threshold but with a MAGI of less than $241,920, the tax credit is reduced. If your MAGI exceeds $241,920, you are not eligible for the credit.
This is a non-refundable credit, so it is limited to your tax liability for the year. In other words, this credit cannot drive your tax liability below zero, resulting in a refund to you. However, any credit that does exceed your tax liability for the year isn’t completely lost. You may carry the excess forward for up to five years. Learn more about the adoption credit at the IRS site.
If you provide care as a foster parent, there are also tax implications of which you should be aware. Foster children are typically not eligible for the same credits and deductions that your biological or adopted children are; however, there may be some tax breaks for you. First, to be considered, a foster child must be placed with you by a judgement, court order, or authorized placement agency. If this is not the case, you may not claim foster care tax benefits. That said, if you receive payments for providing care to a foster child that are paid by a child placement agency or state or local government, these payments are not considered taxable income. Additionally, you may also be able to deduct unreimbursed foster care expenses as a charitable donation if the placement agency is a recognized 501(c)3 organization. If not, those expenses may qualify as support, and the support you provide changes whether or not you can claim the foster child as a dependent. To learn more about claiming a foster child as a dependent, visit the IRS site.
As you can see, there is far greater tax implication when you add a child to your family than simply increasing your W-4 form by a single dependent, especially if you are adopting or providing foster care. It can be complicated, so feel free to contact us, and we can help you throughout the entire process.
Career changes, whether you’re starting a new one or facing a job loss, will impact your taxes. After all, the bulk of your tax liability very likely comes from earned income, and when that increases (or decreases), your taxes will be significantly affected.
When you are starting your career or changing jobs, there are a number of documents and expenses that need your attention. First, you’ll need to complete or update your W-4 form, so your employer withholds the correct amount of federal income tax. However, before you starting filling out that form, you’ll need to know what your personal allowances and deductions may be; otherwise, you may have too much or too little withheld from each paycheck.
To start, you’ll claim yourself (provided no one else claims you as a dependent for tax purposes). You can also claim your spouse and the number of dependents you will claim on your tax return. Be careful in claiming your spouse on your W-4 if he or she is also employed full time, or you may end up having too little tax withheld and a tax bill due in April. Additionally, if you typically itemize deductions on your return or claim certain credits or income adjustments, you should take these into account when completing your W-4 form. Check out the IRS Withholding Calculator to help make the process a little easier.
If you relocate for your new career, you may be able to deduct moving expenses. In order to do so, you must meet three requirements: timing of your move, the distance test, and the time test. For more details on these requirements and whether or not you are eligible for this deduction, please see Deducting Moving Expenses.
There are also some job-related deductions that you may be able to claim, and these are not limited to those who are self-employed or own their own businesses. You can deduct unreimbursed employee expenses that are required for you to complete your job function as long as the IRS considers them to be “ordinary and necessary.” Some examples include: legal fees; licenses; occupational taxes; dues to professional groups, unions, or trade groups; required education; work clothes or uniforms; subscriptions; and medical exams required by your employer. Mileage is also deductible, but generally excludes your commute to and from work. If you work multiple jobs or are required to drive for your position (e.g. sales rep driving to a client’s office), this mileage can be deducted.
Keep in mind that these items are only deductible if you do not receive reimbursement from your employer, and you must itemize your deductions in order to claim these. Additionally, you can only claim the amount of expenses that exceed two percent of your adjusted gross income.
Another deduction that can have a very big impact on your tax situation is the cost of health insurance premiums. If you pay a portion (or all) of the health insurance that may be offered by your employer, you can deduct this expense. As with unreimbursed job-related expenses, you will need to itemize deductions and may only claim medical expenses that exceed 10 percent of your adjusted gross income. There are other medical and dental expenses in addition to health insurance premiums that can also be deducted.
Job Loss Tax Implications
If you lose your job, there are also impacts to your tax liability. The first thing to keep in mind is that unemployment compensation may very likely be taxable as income. (Learn more about how the IRS defines unemployment compensation.) As taxable income, you will need to include any unemployment payments as gross income on your tax return. In the same way you would have an employer withhold taxes for you, you can also have taxes withheld on unemployment compensation. This is handled on Form W-4V, Voluntary Withholding Request. This is often a more convenient approach than making quarterly estimated tax payments. Withholding percentages are fixed at 7, 10, 15, or 25 percent.
You may also elect to tap some of the money in your traditional retirement account in the case of job loss. There is a 10 percent penalty for early withdrawal (before age 59½), but there are some exceptions. If you use an early distribution to cover the cost of medical insurance premiums for yourself, your spouse, or your dependents, you can quality for an exception from the penalty. There are other requirements tied to this exception (e.g. you must have received unemployment compensation for at least 12 weeks).
Regardless of any exception to the early withdrawal penalty, distributions from a traditional IRA or 401(K) are taxed as regular income. As with unemployment compensation, you should choose to have at least some of the taxes due withheld at the time of distribution.
There are also job-seeking expenses that you will be able to deduct when you file your tax return. To qualify, your job search must be in your current occupation, and you cannot deduct job-search expenses if there is a substantial time lapse between the end of your last job and your current search. These expenses include things like employment and outplacement agency fees; resume preparation, printing, and mailing; and travel expenses for job search or interview.
As with unreimbursed job expenses, your job-search expenses can only be deducted when you itemize and are subject to the same thresholds.
When you face a life transition that involves your career, be prepared for paperwork and the need to keep receipts and otherwise document your expenses in order to avoid overpaying taxes. It can be complicated, so feel free to contact us, and we can help you throughout the entire process.
The IRS has announced plans for processing returns next year, and the result could mean a delay in refunds. This delay affects those taxpayers who claim the Earned Income Tax Credit (EITC) and/or the Additional Child Tax Credit (ACTC). Early filers who claim either of these credits will not see a refund (if one is due) until after Feb. 15, 2017.
Congress enacted the Protecting Americans from Tax Hikes Act of 2015 (PATH Act) on Dec. 18, 2015. This law mandates that “no credit or refund of overpayment for a taxable year shall be made to a taxpayer before Feb. 15 if the taxpayer claimed the Earned Income Tax Credit or Additional Child Tax Credit on the return,” according to theIRS.
The IRS must hold the entire refund until the specified date, including the portion not associated with the EITC or ACTC. The reason for delaying the refund is to allow the IRS more time to investigate the possibility of identity theft and refund fraud related to either of these two credits. The IRS estimates that approximately one quarter of EITC claims are paid in error and attribute that to the complexity of the law and intentional disregard of the law (www.eitc.irs.gov/Tax-Preparer-Toolkit/faqs/fraud).
AccountingWeb.com reports that for fiscal year 2013, the IRS paid an estimated $13.3 billion to $15.6 billion in error regarding the EITC.
What Should You Do?
First, ensure that you are entitled to either of these credits. To qualify for the EITC, you must meet all of the criteria:
- Have earned income and adjusted gross income within certain limits
- Meet certain basic rules
- Either meet the rules for those without a qualifying child OR have a child that meets all the qualifying child rules for you, or your spouse if filing jointly.
You may also qualify for the ACTC which is the refundable portion of the Child Tax Credit (CTC). The CTC is up to $1,000 per qualifying child and is non-refundable (i.e. it cannot reduce your tax liability to less than zero, generating a refund). However, if you do not qualify for the full amount of CTC, you may be able to take the refundable ACTC. If you qualify for the EITC, you may also qualify for the CTC and ACTC, but there are different criteria. Namely for CTC, the qualifying child must be under age 17.
If you may be affected by this refund delay, you should still file as you normally do or schedule an appointment with us as you normally do. Once filing season begins, the IRS will process returns normally. The only change is withholding refunds until Feb. 15 for EITC- and ACTC-related tax returns that are filed early in the year. The IRS states that it still expects to issue most refunds in fewer than 21 days.
Reduce Your Refund
If you are affected by the refund delay regarding the EITC and ACTC, you can change your withholdings to get more of your money throughout the year. If you are anticipating a refund and need help with cash flow issues, it is recommended that you change your federal withholdings by updating your W4.
It’s not too late to make an adjustment to your withholding if you are one who gets a large refund. File an adjusted W-4 with your employer to reduce the amount of tax withheld from each paycheck.
If you are uncertain about the steps to take, review IRS Publication 505 (Tax Withholding and Estimated Tax) and/or Publication 919 (How Do I Adjust My Tax Withholding?). Orcontact us. We will be happy to review your situation and help you adjust accordingly. It’s your money, so it’s better to bank it now rather than wait on that refund.
Moving can be a huge headache with plenty of logistical details that must be addressed: packing, hiring a mover, disconnecting and connecting utilities, temporary storage for your things, lodging expenses for you and your family, and this list goes on. Despite the challenges associated with relocating, there may be a bright spot for you. Some or many of your moving expenses may be deductible, reducing your tax liability for the year.
The IRS first defines your home as meaning your main residence. It can be a house, condo, apartment, trailer, houseboat, or any other dwelling, but it cannot include secondary homes you may own such as a beach house.
In order to deduct moving expenses, you must meet three requirements: timing of your move (e.g. closely related to the start of work), the distance test, and the time test.
By closely related in time, the IRS states that your moving expenses must be incurred “within one year from the date you first reported to work at the new location…. It is notnecessary that you arrange to work before moving to a new location as long as you actually go to work in that location.” If you do not move within the one-year time frame, you may still be able to deduct moving expenses; however, you must show that there were extenuating circumstances that prevented you from meeting this requirement.
Next you have to pass the distance test. Your new home must be at least 50 miles farther from your former/existing home than your previous job was from your former home. As an example: If you commuted three miles to work previously, the commute to your new job location from your existing/former home must be 53 miles or greater. If that distance is shorter, you may not deduct moving expenses. If you are taking a first job or are returning to work full time, your place of employment must be at least 50 miles from your former home to meet the distance test.
Finally, you have to pass the time test. After your move, you must work full time at your new job for 39 weeks in the first year (consecutive 12 months). If you are self-employed, the time test extends to 78 weeks of full-time work during the first two years in your new location (39 weeks during the first 12 months and at least 78 weeks during the first 24 months). The IRS lists four rules regarding the time test for full-time employees:
- You count only your full-time work as an employee, not any work you do as a self-employed person.
- You do not have to work for the same employer for all 39 weeks.
- You do not have to work 39 weeks in a row.
- You must work full time within the same general commuting area for all 39 weeks.
If you are self-employed, the following three rules apply:
- You count any full-time work you do either as an employee or as a self-employed person.
- You do not have to work for the same employer or be self-employed in the same trade or business for the 78 weeks.
- You must work within the same general commuting area for all 78 weeks.
You can deduct moving expenses in the year in which you incur them as long as you expect to meet the time test within the following year (or two years if self-employed). If you ultimately fail to meet the time test after taking the deductions, you must then report the deductions as income in the year in which you fail the time test or file an amended return.
Expenses You Can Deduct
Once you meet the three requirements, there are a number of deductions you can take. First, you can deduct the cost of travel and lodging expenses for yourself and your family during the move from your old home to your new one. You cannot, however, deduct the cost of meals during your transit. If traveling by car, you can deduct actual expenses (with receipts) or take the standard mileage deduction.
You may also deduct the cost of packing, packing materials, crating, and moving company expenses. If you don’t travel by car, you can deduct the cost of shipping your car to your new home. If they can’t travel with you, you can also deduct the cost of shipping pets to your new home.
If your personal effects (e.g. furniture, household items, etc.) must be stored, you can deduct that cost as well. (Note: there are limits to the length of storage time.) You may also deduct the costs associated with disconnecting and connecting utilities.
You may not deduct any costs associated with the purchase of a new home, selling your old home, or entering or breaking a lease. If your employer reimburses you for moving expenses, you may need to include that amount as income.
If you are in the Armed Forces or if you are a retiree working abroad (or a survivor of one), different rules apply.
Yes, moving can be a headache but don’t overlook the possibility of taking all deductions that are due to you.Contact us and let us help you with all of the requirements and details. It will be one less thing for you to worry about!
Operating your own business has many benefits. In addition to being your own boss, there are numerous tax deductions you can take for expenses created by business operations. Those can include use of your home for business, supplies, vehicle expenses, utilities as well as travel, meals, and entertainment just to name a few. They’re often expenses that you could not otherwise deduct to lower your tax liability.
Many entrepreneurs launch their businesses as a result of their hobbies. For example, John enjoys woodworking and begins making cabinets. He renovates his kitchen with the cabinets he made. Family and friends comment on how great they are – good looking with quality craftsmanship. John makes cabinets for his parents, and folks suggest he should start his own business. So he starts making and selling cabinets on the side. Since he’s just starting out, it’s not unusual that he operates at a loss. He has to buy additional tools, lumber, hardware, and other supplies and hasn’t yet covered those expenses with what he’s earned so far (i.e. profit).
Can John declare a loss and use it as a deduction from other income? It all depends on whether John is engaged in a hobby or running a business.
If it’s the former, a hobby, expenses for his cabinet-making venture can only be deducted against John’s hobby income. So if his expenses for the year are $10,000 and he’s charged $7,500 for his cabinets, he can only deduct $7,500 in expenses and cannot take a $2,500 loss against his total income.
Business or Hobby Litmus Test
Now if John could declare that he’s running a cabinet-making business and not simply indulging in his woodworking hobby, he could claim the full loss against his total income for the year and could likely take additional deductions, like the expense for business use of his home workshop.
Hobby businesses like John’s can create a tax shelter by allowing owners to deduct losses against total income to reduce taxable income and very possibly drop them into a lower tax bracket. If there’s another source of income (e.g. full-time job or working spouse), that may seem like an attractive proposition; however, the IRS certainly has something to say about it, especially when someone deducts business losses year after year.
Before you decide to do that and venture down that troublesome path (huge red flag for an audit), you should ensure that the IRS will deem your own business to, in fact, be a business and not a hobby. In the hobby vs. business debate, the IRS does not have clear rules; however, it does have guidelines.
According to the IRS, “Internal Revenue Code Section 183(Activities Not Engaged in for Profit) limits deductions that can be claimed when an activity is not engaged in for profit. IRC 183 is sometimes referred to as the ‘hobby loss rule.’”
Proving You Have a Business
There are nine factors that are used to prove an entity is operating as a business and not a hobby:
- Whether you carry on the activity in a businesslike manner.
- Whether the time and effort you put into the activity indicate you intend to make it profitable.
- Whether you depend on income from the activity for your livelihood.
- Whether your losses are due to circumstances beyond your control (or are normal in the startup phase of your type of business).
- Whether you change your methods of operation in an attempt to improve profitability.
- Whether you or your advisors have the knowledge needed to carry on the activity as a successful business.
- Whether you were successful in making a profit in similar activities in the past.
- Whether the activity makes a profit in some years and how much profit it makes.
- Whether you can expect to make a future profit from the appreciation of the assets used in the activity.
While someone indulged in a hobby might carry on activities in a businesslike manner, the remaining factors tend to focus on one word: profit. Granted, not every business is profitable every single year. The IRS has an allowance for this and states, “An activity is presumed for profit if it makes a profit in at least three of the last five tax years, including the current year.” (Note: For horse training, breeding, or racing, profitability must occur in two of the prior seven years.)
If it turns out that you have a hobby and not a business, allowable deductions can be claimed on Schedule A if you itemize but can never exceed your gross receipts.
So, are you working or having fun? If it’s the latter and you’re taking too many deductions, you could end up facing an audit and severe penalties. Contact us to discuss your situation. We’ll help you adhere to the law and can make suggestions to help you become more profitable as well.
Real estate investing can serve to diversify your portfolio. With the housing market stabilized and even trending upward, now might be a reasonable time to jump in. However, just because there are plenty of shows on the HGTV and DIY networks about flipping houses, there’s a lot more to making real estate investments pay off than any of those shows may lead you to believe.
First, what is an “investment property”? It is any real estate that you purchase with the intent of generating income or gain that will not be used as a personal residence. That income can be in the form of monthly rent or appreciation upon selling the property.
In addition to generating income, you can also take advantage of certain tax benefits with investment property.
Investment Property Deductions
In the case of real estate investing, you can deduct expenses that are otherwise non-deductible on your primary residence. For a property that will be held less than a year (in the case of flipping a property), all renovation costs, monthly mortgage interest payments, and staff overhead (e.g. property manager or staff contractor) is deductible. Normally, the goal with a property flip is to gain income through forced appreciation as quickly as possible. Any short-term capital gain (property sold in less than one year) will be taxed at your ordinary income tax rate.
Property held longer than one year is generally held for rental income. Here is a list of items that you can deduct on a rental investment property:
- Auto and Travel Expenses
- Cleaning and Maintenance
- Mortgage Interest
- Legal and Professional Fees
- Management Fees
- Property Taxes
- License Fees
In real estate investing, nearly every invested dollar is tax deductible, including purchase price, property taxes, loan interest, and depreciation. Depreciation can be a big tax advantage for property held longer than one year. By simple definition, depreciation is the reduction in value of a property due to wear and tear over time.
Depreciation of Investment Property
In understanding depreciation on investment property, keep in mind that land does not depreciate, only the structure upon it, so you need to determine the value of the improvement (i.e. the structure) separate from the value of the land. According to the IRS, “Three factors determine how much depreciation you can deduct each year: (1) your basis in the property, (2) the recovery period for the property, and (3) the depreciation method used. You cannot simply deduct your mortgage or principal payments, or the cost of furniture, fixtures, and equipment, as an expense.” Additionally, you can only deduct depreciation on investment property, so if you have a rental unit at your main residence, only the value of the rental property is subject to a depreciation deduction.
In order to depreciate a property, each of the following criteria must be met, according to the IRS:
- You own the property
- You use the property in your business or income-producing activity
- The property has a determinable useful life
- The property is expected to last more than one year
As a very simple example, let’s say the value of a house used as an investment property (excluding the value of the land it sits on) is $200,000. The calculation for depreciation, according to the IRS, is 27.5 years of useful life for a residential structure (39 years for non-residential property). Divide the value ($200,000) by that amount, and the yearly depreciation expense is $7,272.
That would be the amount you would take as a deduction against your annual income. That depreciable deduction also reduces the cost basis of the property which is a determining factor in the gain or loss when it’s time to sell.
Depreciation Recapture Tax
So far, so good. But… Uncle Sam will ultimately want his share, and that occurs in the form of depreciation recapture. You’ve enjoyed a benefit of reducing your income via depreciation, so you paid less overall tax during the time you owned the investment property. When you sell the property, it will be time to pony up. The monies you took as depreciation will be added back to your capital gain, and that recapture tax can be as high as 25 percent.
Let’s look at our example above again, presuming you held the property for five years. In that time, you enjoyed $36,360 ($7,272 x 5) in depreciation and deduction from your taxable income. You sell the property for $250,000, and to keep it as simple as possible, we’ll assume no other deductible expenses at the time of sale. Your capital gain is $86,360. How can that be possible if I only paid $200,000? Well, when you depreciate your property, that reduces your cost basis, so in the eyes of the IRS you actually paid $163,640 ($200,000 – $36,360). Of that $86,360 gain, $36,360 is subject to a maximum 25 percent tax. The remainder will be taxed at your normal capital gain rates (0 to 20 percent).
Depreciation recapture is limited to the lesser of the overall gain or the depreciation you took. If, in our example, you sold the property for $200,000, the entire gain of $36,360 would be taxed at the maximum 25 percent rate.
Joint Property Ownership
There are two ways in which a property can have multiple owners: joint tenancy or tenancy in common (TIC). In joint tenancy, each owner has equal interest. For example, two owners of a rental property each hold 50 percent interest, so expenses and income are shared evenly. However, in TIC, the amounts can be different. For example, in TIC, one owner could hold 60 percent interest with another holding 40 percent interest.
Problems can easily arise at tax time because the IRS isn’t concerned with who owns how much. The IRS sees the property as a single entity. The tax breaks (e.g. depreciation) and other deductions must be determined by the owners, and the IRS will defer to state and local laws regarding legally defined ownership. The situation regarding either joint ownership or TIC can quickly become very complicated. You’d be wise to consult with your attorney and accountant before entering either arrangement. This is especially true regarding investment property!
One of the smartest things you can do is let your money work for you. No doubt you’ve heard that advice before. With interest rates as low as they are and have been for some time, letting your money sit in a savings account or even a CD currently amounts to little more than stuffing it in the mattress. If you really want to get a reasonable return on your money – that is, letting your money do some work – you’ll have to invest it.
Yes, investing carries risk, and market drops can lead to a decline in your principal; however, with risk comes reward, and capital gains and dividends typically will pay off better in the long run. It’s also important to understand how these investments are taxed.
Very simply, a capital gain occurs when you sell something for more than you paid for it. These gains aren’t limited to stocks. Hopefully, you’ll incur a capital gain when you sell property, either real estate or other property that may increase in value such as antiques, artwork, cars, and other collectibles. In order to calculate a capital gain, you must first know the basis for the item. The basis includes the amount you paid for an asset as well as other costs you paid in order to acquire it. Depending on the asset, those costs may include things like sales taxes, excise taxes, fees, and/or shipping costs.
A capital gain is not realized (and therefore not taxable) until you sell the asset. “Unrealized” capital gains and losses occur every day. For example, if you bought stock in XYZ Company for $1000 and the market rises, increasing its value to $1200, you have an unrealized gain of $200. You don’t have a capital gain until you actually sell the asset. Unrealized capital gains and losses affect your portfolio but not your tax return.
There are also long- and short-term capital gains, and those classifications are driven by the length of time for which you hold an asset. If you sell an asset that you’ve owned for a year or less, any profit from that sale is a short-term capital gain. Gains realized on assets that you sell after owning them for longer than one year are long-term gains. The long- and short-term differentiator comes into play at tax time. Short-term gains are taxed at a much higher rate than long-term gains, and that tax rate can be 10 to 20 percent higher. Depending on your tax bracket and income (i.e. the lowest brackets), you may not have to pay any tax on a long-term capital gain.
A dividend is a payment made to shareholders by a corporation. That payment may be in the form of cash or additional stock shares. Not all companies pay dividends, and those that do can set their own payout schedules (e.g. quarterly, annually, etc.) and formats (cash or additional shares). You might think of a dividend as a reward for owning stock in a corporation, and corporations may use dividend payouts as a way to attract more investors.
Companies can also change their dividend policies at any time. Dividend payouts typically reflect the profitability of a company. Start-ups and growth-oriented companies may re-invest their profits back into the company rather than paying dividends. That doesn’t necessarily make those companies bad investments. Re-investing for growth may very likely drive the value of the stock up, so you might not get a dividend but will rather see a greater capital gain.
For tax purposes, dividends are classified as ordinary or qualified. Like interest, ordinary dividends are taxed as regular income. Qualified dividends are taxes at a lower rate that ranges from zero to 20 percent. There are several criteria a dividend must meet in order to be classified as “qualified.” According to the IRS, “The payer of the dividend is required to correctly identify each type and amount of dividend for you when reporting them on your Form 1099-DIV for tax purposes.”
While you want to let your money work for you through investing, you’ll also want to keep an eye on the tax implications of investment proceeds. Currently, the tax rates for long-term capital gains and qualified dividends are the most favorable.
For 2016, the tax rate on long-term capital gains and qualified dividends is zero for those whose tax rate on ordinary income is up to 15 percent. For those whose ordinary tax rate is 25 to 35 percent, they will pay a 15 percent tax on long-term capital gains and qualified dividends. Finally, those paying the highest tax rate (39.6 percent) will only pay 20 percent on long-term gains and qualified dividends.
If you happen to incur a capital loss (i.e. selling an asset for less than you paid for it), you can subtract the loss from any incurred gains up to an annual limit of $3,000 ($1,500 if married, filing separately). If you loss exceeds $3,000, you can carry the unused portion of the realized loss in future tax years.
Capital gains and dividends are integral components in successful investing. At Waddy, we’re here to help you make the most of your money by leveraging the investments with the most favorable tax rates. Contact usto set up an appointment.