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Investments and How They’re Taxed

May 25, 2016adminBlog0

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.

Capital Gains
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.”

Tax Differences
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.

You Owe Taxes… Now What?

April 26, 2016adminBlog0

So you’ve completed your tax return and discovered that the last line of your 1040 form shows that you owe taxes, despite all of the deductions and credits that you may have amassed. Now what?

First and foremost, pay your tax bill. Admittedly, depending on the amount you owe, that may be far easier said than done. If you can’t pay the entire amount, pay as much as you can in order to reduce interest and penalties for late payment. The IRS accepts payment in various ways. You can pay online via your credit or debit card or by using IRS Direct Pay to direct funds from your checking or savings account at no cost to you. Depending on the deadline, you may opt for a same-day wire transfer from your bank (bank fees may apply), send a check or money order, or pay with cash at an IRS retail partner. (Note: cash payments require five to seven business days to process, so be certain you allow enough time to avoid a penalty.) Businesses can also pay the IRS via EFTPS® (Electronic Federal Tax Payment System) upon enrollment.

Installment Agreement
If you are unable to pay your tax bill in full, you can make monthly payments through an installment agreement. Individuals can apply for an online payment agreement provided their total tax liability (including payment, interest, and penalties) is $50,000 or less and all required returns have been filed. For businesses, that threshold is $25,000 or less. If you don’t qualify for the online payment agreement, you can still make installment payments by completing Installment Agreement Request (Form 9465) and Collection Information Statement (Form 433-F).

You may opt for a short-term extension to pay if you can pay your tax bill in full within 120 days or less. There is usually no set-up fee for a short-term extension. Keep in mind that you will still be responsible for interest and penalties.

Offer in Compromise
According to the IRS, “An offer in compromise allows you to settle your tax debt for less than the full amount you owe. It may be a legitimate option if you can’t pay your full tax liability, or doing so creates a financial hardship.” The IRS first considers these factors: ability to pay, income, expenses, and asset equity. For the IRS to consider your Offer in Compromise, you must be current with all filing and payment requirements and may not be in an open bankruptcy proceeding. The IRS provides an online guide to determine your eligibility (Offer in Compromise Pre-Qualifier). It’s important to note that interest and penalties continue to accrue during the consideration of your offer. A Notice of Federal Tax Lien will also attach to your property during this time.

There is an application fee (currently $186), and you will have two payment options. The Lump Sum Cash option requires 20 percent of the total offer paid with the offer and the remaining balance paid in five or fewer payments or within five or fewer months of the date your offer is accepted. The Periodic Payment option requires first payment with the offer and the balance paid in six to 24 months, according to the terms of your offer.

How Long Do I Have to Pay My Taxes?
Your tax return and your payment are due on April 15th (or an adjusted date depending on weekends and holidays). First and foremost, regardless of your ability to pay, be certain that you file your return (or a request for extension) by the due date. Keep in mind that filing for an extension on your return does not change the date on which your tax bill is due. The interest and penalty clock starts ticking immediately even if you’ve filed for an extension (with the exception as noted below).

The late-payment penalty is 0.5 percent of the unpaid amount per month, up to 25 percent of the balance; however, the failure-to-file penalty is five percent per month, so be certain your return or extension request is filed by the deadline. If you file for an extension, the late-penalty fee won’t apply during the extension period provided you’ve paid at least 90 percent of your tax liability.

The Next Step
Normally a balance due to the IRS is caused because you’re not withholding enough taxes throughout the year or need to pay more estimated taxes.  Contact us, so we can review your overall financial picture and realign your withholding so that you’re not faced with a big tax bill next year.

Also, remember that not every accountant or tax professional has the ability to represent you before the IRS. Eric Waddy is an enrolled agent and has completed the comprehensive testing and continuing education required by the IRS to represent you.

Tax Differences for Businesses

March 25, 2016adminBlog0

Different business structures have different taxation rules, and the wrong structure for your business can lead to greater tax liability or unnecessary paperwork. First, incorporating your business (even if you are a sole proprietorship) creates a firewall between the assets and liabilities of the business and your personal monies. That said, there are various ways to incorporate: C corporation, S corporation, or limited liability corporation (LLC).

A C corp is its own legal entity, owned by its shareholders. Taxes are levied against the corporation on its net income or loss, and it is a taxpaying entity with requisite returns filed each year. Shareholders are paid via dividend distributions that are then also subject to taxation at the individual level as income.

An S corp is different in that it elects special tax status with no federal tax levied at the corporate level. Instead, the corporations’ profits (and losses) are “passed through” to the shareholders to be claimed on their individual returns. This eliminates the double taxation that occurs for a C corp. So with the elimination of double taxation, why would a business ever opt for C corp structure? The regulations for S corps are stricter: there can be no more than 100 shareholders, and those shareholders must be U.S. citizens and resident aliens. The accounting rules for S corps are also more complex.

An LLC provides an alternative. It offers the benefits of corporations in the protection of business owners’ personal funds and the ability to elect a taxation format. If an LLC is owned by a single member, then it is considered adisregarded entity by the IRS and will simply file taxes like a sole proprietorship. If an LLC has multiple members, then it will be taxed as a partnership unless the LLC elects to be taxed differently. An LLC can elect to be taxed as a C corporation or an S corporation thereby offering the required growth flexibility that most startup businesses desire.

Self-Employment Tax

While “pass-through” taxation seems like a great alternative (after all, why pay tax twice on the same earnings), if you derive your income from an S corp or LLC, you’ll likely have to pay self-employment tax. According to the IRS, “Self-employment tax is a tax consisting of Social Security and Medicare taxes primarily for individuals who work for themselves. It is similar to the Social Security and Medicare taxes withheld from the pay of most wage earners.”

It is important to keep in mind that self-employment tax is a tax in addition to regular income tax at the federal level.

For 2015, this tax rate was 15.3 percent on the first $118,500 of net income and 2.9 percent on net income exceeding $118,500. The breakdown is as follows:

  • 6.2% as the employee’s portion of Social Security tax ($118,500 limit)
  • 6.2% as the employer’s portion of Social Security tax ($118,500 limit)
  • 1.45% as the employee’s portion of Medicare tax (no limit)
  • 1.45% as the employer’s portion of Medicare tax (no limit)

Those required to pay self-employment tax may deduct the employer’s portion of the tax from income when figuring their adjusted gross income.

Limiting Self-Employment Tax

Self-employment tax applies only to earned income – salaries and wages. It does not apply to dividends you earn, and dividends are the distributions paid to you from corporations. This is where the S corp business structure (despite its regulations and restrictions) can pay off. If your business operates as an S corp, you can take 40 percent, for example, of your earnings as a dividend rather than a salary, so you’ll reduce the amount on which you pay self-employment tax by that much.

For example, if your earn $100,000 in your S corp and take $60,000 as a salary and $40,000 as dividends, your self-employment tax liability is $9,180 (rather than $15,300 levied on the entire amount), and you can deduct half of that ($4,590) from your federally taxable income. That means you pay income tax on $55,410 rather than $60,000 before other available deductions.

Even if you don’t operate as an S corp, there are ways to lower your self-employment tax liability. Start with deductions: Be sure you are taking every business deduction available including office space and supplies, advertising, commissions and fees, business travel, etc. If you’re self-employed, you can also deduct the cost of health insurance even if you don’t itemize to lower your adjusted gross income.

The tax laws and rates that apply to various business structures can be complicated, and improperly structuring your business can lead to greater unnecessary tax liability.Contact us and let us review your business structure to ensure you’re paying the correct amount of tax but not more!

Tuition Expenses and Taxes

February 27, 2016adminBlog0

There is no denying that college tuition and related costs are expensive. Whether or not you’ve saved to offset the expense or are using student loans to pay for higher education, there are tax credits and deductions available that will help reduce the sting. For the most part, college students can be claimed as dependents, but they can still file for a refund. Even if the credit reduces tax owed to less than zero, you may be eligible for a refund.

There are two education credits available in addition to deducting education expenses: the American Opportunity Tax Credit (AOTC) and the Lifetime Learning Credit (LLC). The rules for each of these vary, but they both have three eligibility requirements in order to take the credit.

First, you, your dependent, or a third party pays qualified education expenses. These expenses can include tuition, fees, and other related student expenses that are required for enrollment at an eligible educational institution. That brings up the second requirement: eligible educational institution. The IRS defines an eligible educational institution as: “a school offering higher education beyond high school. It is any college, university, vocational school, or other post-secondary educational institution eligible to participate in a student aid program run by the U.S. Dept. of Education.” The good news is that most accredited higher education institutions qualify. The third common qualifier is that the eligible student must be you, your spouse, or a dependent that you list on your tax return.

American Opportunity Tax Credit

The AOTC provides a maximum credit of $2,500 annually per eligible student. It’s a dollar-for-dollar reduction of your taxes owed. Additionally, if the applying this credit reduces your tax liability to less than zero, “you can have 40 percent of any remaining amount of the credit (up to $1000) refunded to you” according to the IRS. Plus, you may be able to claim this credit for each qualified student (you, your spouse, and/or dependent(s)) on your tax return.

In addition to the eligibility requirements covered above, the AOTC has additional eligibility requirements. The IRS states that the student must be pursuing a degree or other recognized credential and be enrolled at least half time for at least one academic period beginning in the tax year. Additionally, the student may not:

  • Have completed the first four years of higher education at the beginning of the tax year.
  • Have claimed the AOTC (or the former Hope credit) for more than four tax years.
  • Have a felony drug conviction at the end of the tax year.

There are also income limits that may prevent you from taking the full credit. If your modified adjusted gross income (MAGI) is $80,000 or less ($160,000 or less if filing jointly), you may take the full $2,500 credit. If your MAGI is more than $80,000 but less than $90,000 ($180,000 if filing jointly), the amount of the credit will be reduced. If your MAGI is more than $90,000 ($180,000 if filing jointly), you may not take the credit at all.

Lifetime Learning Credit

Unlike the AOTC, there is no limit on the number of years in which you can claim this credit to help offset the cost of higher education, including undergraduate, graduate, and professional degree courses. The maximum LLC is $2,000 per return. However, also unlike the AOTC, this credit is not refundable (i.e. you will not get monies refunded to you if this credit drives your tax liability to less than zero).

The income limits in place to claim this credit are also lower than those set for the AOTC. The MAGI limit for the LLC is $64,000 ($128,000 if filing jointly). Another differentiator is that while you may claim up to $2,500 per student for the AOTC credit, the LLC credit is limited to $2,000 per return.

Tuition and Fees Deduction

Finally, you may also deduct tuition costs and qualified educational fees from your income to reduce your tax liability. You may deduct up to $4,000 from your income per return for qualified expenses. There is no limit to the number of years in which you can take this deduction, and as with the credits, there are income limits (MAGI cannot exceed $80,000 [$160,000 if filing jointly]).

It is important to keep in mind that while a deduction will reduce your overall income, it does not carry the dollar-for-dollar tax reduction that either of the credits will. That said, you may be able to claim all three on a single tax return, but they may not cover the same student or the same educational expense. Get the IRS overview of Education Credits and Tuition Deduction Comparison.

With the extraordinary expense of higher education and complexities of the available tax credits and deductions (for example: who should claim the credit – parent or student?), we strongly encourage you to contact us for help to weed through all available opportunities to lower your tax bill! With April 15th approaching, schedule your tax appointment now.

Tax Hike Protection

January 27, 2016adminBlog0

On Friday, December 18, 2015, Congress passed and the President signed the “Protecting Americans from Tax Hikes Act of 2015” (PATH). Here are some of the items included in that bill that may affect your personal tax situation.

To start, some of the widely used tax credits have been made permanent and retroactive to the beginning of 2015. These include the Child Tax Credit, the American Opportunity Tax Credit, and the Earned Income Tax Credit.

The Child Tax Credit may be worth as much as $1000.00 per qualifying child, depending on income. The American Opportunity Tax Credit, designed to help offset the cost of tuition, has broadened eligibility and may be worth up to $2,500.00 per student annually. The Earned Income Tax Credit which helps lower-income individuals and families received a permanent increase to the credit percentage for three or more qualifying children.

The deduction allowed to teachers (elementary and secondary education) of $250.00 was also made permanent with an inflation adjuster built in.

For employees who receive employer-provided mass transit and parking benefits, the exclusion from income was raised to $175.00 from $100.00.

Also made permanent in PATH is the state and local tax deduction.

This legislation also impacts financial planning for seniors. The ability to make charitable contributions from an IRA without facing taxes is now permanent. This applies to taxpayers who are over age 70 ½ as they can now distribute money to a qualifying charitable organizations free of taxation. In the past, this particular provision underwent several last-minute revisions each year.

Tax Benefits for Business

The PATH Act makes the expansion of Section 179 limits permanent. Section 179 of the tax code allows businesses to immediately deduct up to $500,000 of investments. That limit was scheduled to reduce to $25,000. Additionally, bonus depreciations (allowing businesses to immediately deduct 50 percent of some investment costs, applying to a larger share of investments than Section 179) have been extended until the end of 2019. Whether or not this benefit becomes permanent at that time remains to be seen.

The Research and Experimentation credit has historically been one of the most unstable credits in the tax code; however, the PATH Act now makes it permanent. This credit allows businesses to lower their tax burdens by engaging in certain research activities.

The bill also includes a 100 percent exclusion of gains on certain small business stock (Section 1202) to encourage taxpayers to invest in small businesses. Additionally, the “built-in gains” tax period has been extended to five years for conversions of C corporations to S corporations or S corporations acquiring assets from C corporations in a tax-free transaction.

Temporary Extensions

For individual taxpayers, the PATH Act temporarily extended two popular exclusions/deductions. The Mortgage Debt Relief was extended through 2016 as was the deduction for mortgage insurance premiums. In the first case, a taxpayer can exclude from income up to $2 million of debt discharged before Jan. 1, 2017. (Note: For married taxpayers filing separately, the allowable exclusion is $1 million.) In the second instance, taxpayers may deduct the cost of mortgage insurance on a qualified primary residence.

Also extended through 2016 is the above-the-line deduction for qualified tuition and related higher-education expenses.

The PATH Act also extended certain tax provisions in place to encourage energy conservation including the alternate fuel vehicle refueling facility, fuel cell vehicle, and two-wheel electric vehicle credits.

If you are uncertain how the PATH Act benefits you, please contact us (or use our convenient online scheduler) to discuss your particular situation, so we can take full advantage of these benefits in lowering your overall tax liability.

Explanation of Partnerships and Their Taxation

November 25, 2015adminBlog0

Like all business entities, the decision to launch a business as a partnership has its advantages and disadvantages as well as certain complexities.

To start, the IRS defines a partnership as: “the relationship existing between two or more persons who join to carry on a trade or business. Each person contributes money, property, labor or skill, and expects to share in the profits and losses of the business.”

The latter part of the IRS definition underscores many of the partnership benefits. A partnership provides more initial capital than a sole proprietorship and generally greater management resources. Very simply, two heads are better than one… as are two wallets. The partnership brings with it fewer administrative burdens than a corporation, and income is taxed at the personal level, much like a sole proprietorship. This pass-through taxation is generally favorable, and there is flexibility in the income and loss allocations in a partnership.

However, also like a sole proprietorship, there is no liability limitation in a partnership unless a limited partner or limited liability partnership is created, in much the same way a sole proprietor can create an LLC to limit personal liability for protection against obligations generated by the business. Partnership business income may be subject to self-employment tax whether or not a partner is actively involved in the business, and partners have very few tax-deductible employee fringe benefits. Another partnership disadvantage is the complexity of basis adjustment rules and interest transfer.

Partnership Taxation
For taxation, a partnership is a “flow-through” (or “pass-through”) entity. Unlike a corporation that is its own taxable entity, the partnership’s income is not taxed at the entity level. Instead, income flows through to the partners and is taxed as income on their respective personal levels.

Although the partnership itself does not pay taxes, it must file a return using IRS Form 1065. It must also provide Schedule K-1 to the IRS and to each partner that itemizes each partner’s share of the profit and loss. Partners then report this information on their personal returns. On the other hand, a C-corporation is effectively taxed twice: once at the corporate level as its own income-generating entity and again at the shareholder level when income is distributed.

Partnership Basis
A partnership does not need to be a 50/50 or otherwise even split regarding investing in the business. In many cases, it is not. For example, one partner may contribute and own 60 percent of the business (hence entitled to 60 percent of the business’s profit and loss) while the second partner may own the remaining 40 percent.

A partner’s initial basis typically reflects the amount of money or value of property contributed to the partnership or, in the case of purchased interest, the amount paid for the interest. Unless partners create a written partnership agreement, state law usually allocates the business profit and loss to partners based on their basis or ownership.

A partner’s basis is typically not static and may increase or decrease over time. According to the IRS, a partner’s basis “is increased by:

  • The partner’s additional contributions to the partnership, including an increased share of, or assumption of, partnership liabilities.
  • The partner’s distributive share of taxable and nontaxable partnership income.
  • The partner’s distributive share of the excess of the deductions for depletion over the basis of the depletable property, unless the property is oil or gas wells whose basis has been allocated to partners.”

Conversely, a partner’s basis is “decreased (but never below zero) by:

  • The money (including a decreased share of partnership liabilities or an assumption of the partner’s individual liabilities by the partnership) and adjusted basis of property distributed to the partner by the partnership.
  • The partner’s distributive share of the partnership losses (including capital losses).
  • The partner’s distributive share of nondeductible partnership expenses that are not capital expenditures. This includes the partner’s share of any section 179 expenses, even if the partner cannot deduct the entire amount on his or her individual income tax return.
  • The partner’s deduction for depletion for any partnership oil and gas wells, up to the proportionate share of the adjusted basis of the wells allocated to the partner.”

Ending a Partnership
As you can imagine, there are various reasons to end a partnership, or if not ending it, re-adjusting its basis. Ideally, executing a dissolution will be cleanest if its steps have been clearly outlined in the original partnership agreement. The bottom line is all partnerships will end eventually either through the death of one or more partners or a decision for the partners to go their separate ways. Therefore, a written partnership agreement is necessary to have an amicable ending.

Two ways to remove a partner from a partnership are either through a partnership redemption or a purchase, and there is a distinct difference between them. While redemption by definition means to “buy back,” it is the partnership itself (as an entity) that buys back a partner’s interest in a redemption. On the other hand during a purchase (or sale), one partner (or a new partner) buys the partnership interest of the selling partner.

While this may seem a bit of “six of one, half dozen of the other,” there are tax consequences to be considered and pros and cons to either a redemption or purchase.

Partnerships may also close as the result of a technical termination: the sale or exchange of 50 percent or more of the capital and profits within a 12-month period (Section 708(b)(1)(B) vs. cessation to do business as a partnership under Section 708(b)(1)(A)). There can be many complex tax implications and severe penalties levied as a result of a technical termination. Partners want to avoid a technical termination when at all possible.

If you are considering creating a partnership or altering one that you may be in, please contact us to discuss the most prudent next steps. The professionals at Waddy Accounting Services can help you navigate the process and avoid making costly mistakes either now or in the future.

What’s The Budget?

November 5, 2015adminBlog0

Budgets have been in the news a lot lately since the partisan battle over the federal budget continually contributes fodder to the media. Where money should be spent and where should costs be reduced? The answer to those two questions is, indeed, at the heart of balancing the budget… any budget, whether it’s for government, your household, or your business.

According to Merriam-Webster, the definition of a budget is: “an amount of money available for spending that is based on a plan for how it will be spent; a plan used to decide the amount of money that can be spent and how it will be spent.” The critical word in the definition is not “money”; it’s “plan.” The adage “If you fail to plan, you plan to fail” never rang truer than when applied to money management.

Creating a Budget
Many people break into a cold sweat or at least shudder at the thought of creating a budget. Some equate budgeting with eliminating the fun and pleasures from life. This is not true at all, and in fact, somewhat the opposite. By understanding your overall financial picture with a budget, you’ll know where and how much you can spend on those things, and you’ll end up enjoying them more.

If you’re struggling month after month in your business, creating a budget will help you see more of the hard-earned dollars fall to the bottom line and generate the return on investment that you’d like to see.

In every scenario, a budget is about learning the facts and taking control.

Determine Expenses
Most financial experts agree that the first step in creating a budget is to determine where the money is going. That is typically the side of the financial statement that has the greatest variability. How you go about determining your expenses is up for debate. Some gurus insist that you track every single penny you spend for a month, including writing down every cup of coffee, every ATM fee, and every purchase no matter how small. If you are very disciplined, this approach may work. However, for many people, this somewhat draconian approach derails their efforts before they get halfway through the process.

With the automation available through many sources (e.g. your bank and credit card statements), this work may already be done for you. Regardless, no matter how you go about it, you must line item your expenses.
Consider your monthly expenses:

  • Mortgage or rent
  • Utilities (electric, water, gas, phones, cable)
  • Food
  • Vehicle expenses (gas, maintenance, insurance)
  • Health care
  • Insurances (life, homeowners, etc.)
  • Entertainment, clothing, school supplies

These are the easy and obvious categories. However, you must also create a line item for taxes that are not automatically withheld. Plus you should also be budgeting for your savings accounts (emergency savings, wish list items, tuition, and retirement).

You can be as broad or as detailed about your expenses as you would like; however, the more detailed you can be, the more information you will have to make the best financial decisions for you and your family.

Determining Income and Setting Priorities
Itemize how much money you have coming in: Your paycheck(s), interest and dividends, money from a side business, rents and royalties. Typically, income is far less variable than expenses. In other words, it’s usually easier to eliminate costs (eating out less, not spending as much on clothing) than it is to increase your income (get a second job). In a nutshell, your income less your expenses should equal zero. If you have more left over, great! You’re on your way to building wealth. If the answer is a negative number, you’re on your way to financial trouble.

Once you have a clear picture of your budget, you’ll also have a picture of your actual priorities. Reality about your priorities is reflected in where your money is going. You might say that saving for your kids’ college tuition is a priority, but that’s not true if the tuition account is not growing. You might say that you know retirement saving is critical, but it’s not really your priority if that money is going to this season’s latest wardrobe.

Measure Success
Once you’ve collected all of the facts regarding expenses and income, now you are able to build your plan of how, when, and where to spend. You don’t have to eliminate fun (entertainment, eating out, etc.), but you do need to establish how much you can spend on those line items. You will also have clarity about where money may be wasted and can eliminate or reduce those expenses.

Ensure that savings is part of the plan and think of it as an expenditure. Don’t wait until the end of the month, thinking you’ll save whatever is left over. That answer will always be zero. Establish the amount and funnel that money into the account.

You will get a sense of accomplishment and feel good about your success as you track your budget every month. Whatever gets measured improves. Measuring your financial health should be a priority! There are plenty of automated ways to create and track your budget. Check out www.mint.com, www.quicken.comwww.quickbooks.com, to name a few. Or run a search on online budget tools to learn about even more.

Business Budgeting
Budgeting for business uses the same principle: revenue (income) less expenses equals profit (or loss). It’s also important to keep in mind the difference between budgeting and forecasting. The former is a quantified expectation and the latter is an estimate of what will be achieved. In other words, the budget is the plan for where the business wants to go; the forecast is an indication of where it is actually going.

In business, budgeting typically occurs annually and takes into account the details of expenses, income, and cash flow. Forecasting occurs monthly or quarterly and considers short-term operational changes (staffing, inventory, sales projections).

Budgeting and forecasting are both critical for business profitability and more complex than personal budgeting. Waddy Accounting Services is always here to help you with this vital aspect of running your business.

Contact us and we’ll be happy to help you with either your personal or business budgeting needs.

Understanding Foreign Earned Income

September 1, 2015adminBlog0

As a U.S. citizen, all of your income—no matter where it was earned or how it was received—must be reported on your annual tax return. This includes income you earned while working in a foreign country either as an employee or independent contractor. However, you may be able to exclude some or even all of your income (to a maximum of $100,800 for 2015) as part of the Foreign Earned Income Exclusion.

Of course, some conditions apply and you must meet various criteria in order to take this income exclusion. To start, you must meet either the Bona Fide Resident or Physical Presence tests.

Bona Fide Resident Test
For the Bona Fide Resident test, you must first reside and work in a foreign country (or countries) for an uninterrupted entire tax year—Jan. 1 through Dec. 31, not simply 12 continuous months. You may take short trips back to the U.S. or elsewhere for vacation or business without negating your Bona Fide Resident status. However, the duration of your stay and nature of your work are only two factors in determining Bona Fide Resident status. You must set up permanent living quarters even if you maintain your domicile in the U.S. and eventually plan to return there. Any questions about whether or not you are a Bona Fide Resident are determined by the IRS on a case-by-case basis according to the facts you report on Form 2555, Foreign Earned Income.

If you think you are earning tax-free money as a Bona Fide Resident, think twice! To be a Bona Fide Resident youcannot make a statement to the authorities of the foreign country that you are not a resident in order to avoid that country’s taxation. The bottom line: You probably have to pay taxes somewhere. Any treaties or international agreements may also impact your status as might the type of visa you have to live and work in that country.

Physical Presence Test
The Physical Presence Test offers a bit more flexibility regarding your time abroad. According to the IRS, you meet this test “if you are physically present in a foreign country or countries 330 full days during a period of 12 consecutive months.” When the IRS says “full day,” it means the full 24-hour period, so travel days into or out of a foreign country probably don’t count toward the 330-day threshold.

As a taxpayer, you get to choose the 12-month period for the Physical Presence Test, so you gain flexibility in choosing the period that will provide the greatest exclusion.

Excluded Income and Taxes
The Foreign Earned Income Exclusion applies to just that: earned income. This includes wages, salaries, professional fees, and other compensation amounts for services rendered. Other types of income (e.g. investment income) cannot be excluded.

This exclusion applies to federal income tax. It does not reduce the self-employment tax (the vehicle through which those who are self-employed pay Social Security and Medicare taxes) unless the foreign country in which you reside has a similar type taxation to which you are subjected. If so, self-employment tax may be excluded or reduced.

Taking this exclusion does not reduce your tax rate. Your federal income tax rate is calculated on your total income before excluding qualified foreign income. Also keep in mind that there is a maximum exclusion allowed—$100,800 for 2015.

Foreign Housing Exclusion
If you are working abroad, you can also claim an exclusion or deduction from income for housing expenses. You must first meet either the Bona Fide Resident or Physical Presence test. Some of the qualifying excludable expenses include (but are not limited to): rent, fair rental value of employer-provided housing, repairs, utilities (excluding telephone), property insurance, and occupancy taxes.

Expenses you may not exclude or deduct include (but are not limited to): lavish housing (determined by your circumstances), cost of buying property, domestic labor, home improvement, or depreciation.

For complete information and calculations, see IRS Publication 54, Tax Guide for U.S. Citizens and Resident Aliens Abroad. Or contact Waddy Accounting Services for expert tax advice and guidance to pay the correct amount you owe. Additionally, we can help you keep track of currency fluctuations while you are abroad as this rate is an important factor in your overall tax scenario.

Always keep in mind that there are very stiff penalties if you fail to disclose your income and investments or otherwise attempt to hide money from taxation.

Understanding Taxes on Retirement Accounts

August 1, 2015adminBlog0

You’ve heard over and over about how important it is to save for retirement… and hopefully you are heeding that advice or have done so to be able to enjoy your golden years, reaping the benefit of years of hard work.

The first thing to understand is the various accounts you can use to save for retirement. Company-sponsored pensions are a rarity, having now been replaced by the 401(k) account or similar vehicle, depending on the industry in which you work (e.g. those working for tax exempt or nonprofit organizations may have 403(b) plans, etc.).

401(k) Accounts
In a 401(k) plan, often referred to as defined contribution plans, you contribute to the account on a tax-deferred basis. The contribution comes from your paycheck before taxes on your wages are calculated. The good news for the defined contribution is that it lowers your immediate tax liability.

Your eligibility to participate in your company’s 401(k) plan depends on the rules set by your employer. You may have to wait a month or even a year before you can begin participating in the plan. Likewise, your company may or may not make contributions to your account. These contributions are not required by law and the amount can range from 0 percent to 100 percent of your contributions, typically set as a match against what you are personally contributing. It’s also important to keep in mind that whatever monies you contribute to the account are yours; however, contributions made by your employer may have stipulations attached (e.g. not vested until you’ve reached a certain service level [years of employment] with the company, etc.).

IRA Accounts: Traditional and Roth
Traditional IRA accounts have been around since 1975 and allow saving for retirement outside of or in addition to a 401(k) account. The Roth IRA was created as part of the Taxpayer Relief Act of 1997. There is a critical difference between the two, and it hinges on when taxes are paid on the contributions. Very simply, contributions to a traditional IRA are deferred: You get to deduct contributions from your current tax return (thereby lowering your immediate tax liability), and the taxes are levied when you remove money from the account at retirement.

On the other hand, the Roth IRA does not offer an immediate tax break. You pay taxes on the money, thencontribute it to the Roth IRA. Because the money has already been taxed, it is not taxable upon distribution. The benefit of this type of IRA is that any interest or investment increase that occurs is also tax free once you reach retirement age.

Contribution Limits
There are limits on how much money you can contribute to any retirement plan, whether it’s a 401(k) or either of the IRA plans. If your company offers a 401(k) plan and offers to contribute to it, by all means, take full advantage of it and maximize your employer’s contribution. This is as close to “free money” as you will ever get. For 2015, taxpayers may contribute up to $18,000.00 to their 401(k) plans, according to the IRS.

You may be limited to how much you can contribute to either a traditional or Roth IRA if you are also contributing to a 401(k), depending on your total income. For 2015, the limit is $5,500.00 ($6,500.00 if you are 50 or older). Click here to learn more about IRA contribution limits and regulations.

Taking Your Retirement Money

The majority of questions about retirement accounts arise when it’s time to actually remove the money. People always ask, “Why do I have to pay taxes on my own money?” The answer is pretty straightforward: Because you never paid tax on the money in the first place. This is true of a 401(k) account because the money was contributed as “pre-tax dollars.” And it is true for a traditional IRA because you subtracted your contribution every year on your tax return and took the benefit at that time.

On the other hand, Roth IRA distributions can be taken tax free because the money has already been taxed: You contributed it without taking a tax reduction at the time (i.e. “post tax dollars”). And remember, one of the huge benefits of the Roth IRA is that interest and investment increases are also tax free!

The next common question is: “I already paid taxes when I requested my distribution, so why do I owe tax now that I’m completing my tax return?” This occurs because the mandatory 20 percent that is withheld when you take a distribution is generally not enough to cover most people’s tax bracket (i.e. the tax bracket falls above 20 percent).

In addition to owing taxes on distributions (from 401(k) plans and traditional IRAs), there is a ten percent penalty for withdrawing from a retirement account early (before reaching age 59½). There are some exclusions to the penalty when withdrawing the money so it is very important to contact us to see if you qualify.

Required Minimum Distributions (RMD)
So you can’t take your money out too early (before age 59½) and you can’t leave it in your account too long either. Once you reach age 70½, you must begin taking money out of traditional IRAs (including SIMPLE and SEP IRAs) and 401(k)s. These distributions will then be calculated as income and taxed accordingly when you complete your annual tax return. If you do not take any distributions, or if the distributions are not large enough, you may have to pay a 50 percent excise tax on the amount not distributed as required!

The only account that doesn’t require an RMD is a Roth IRA. Money in a Roth IRA can continue to grow until the death of the account holder.

The date by which you must take your first RMD depends on when you reach age 70½ (calculated as six calendar months after your 70th birthday). Subsequent RMDs must then be taken by December 31st each year. Learn more about IRS details regarding RMDs.

Navigating Retirement Contributions and Distributions
In general, it’s better to pay taxes on the “seed” rather than on the “harvest.” In other words, take the tax hit early if possible, so less of your money is taxable in your retirement.

The only way to access your retirement money without paying taxes is to ensure that your beneficiary forms for your retirement accounts are set up properly. We are currently offering free reviews to make sure they are correct. Contact us to set up your appointment for this important free review.

Saving for retirement is critical. However, there is no shortage on rules and regulations on making contributions while you are working or on taking distributions once you retire. Waddy Accounting Services is here to help you make the right decisions no matter where you are in the process.

Summer Starts Home-Buying Season

July 29, 2015adminBlog0

Easy, breezy days aren’t the only thing for which summer is known. With the start of summer comes the start of the home-buying season. If you’re in the real estate market, there’s no shortage of paperwork and details in the buying process, but don’t overlook the positive impact buying a house will have on your overall tax picture. It’s more than “home sweet home.” Home ownership brings a number of tax benefits and is very likely your largest deduction.
As a homeowner, there are quite a number of deductions you can take when you itemize on your tax return, and these deductions are typically substantial. They include:

  • Mortgage interest: If you itemize, you can deduct the interest you pay on your mortgage. According to Tax Policy Center, the average savings on income tax for this deduction for a homeowner is between $1,500.00 and $2,000.00. The limit for this deduction is interest paid on up to $1 million of debt for the purchase of a home. Additionally, you can also deduct the interest paid on up to $100,000 of home equity debt, as long as the funds were used to buy, build, or improve the property.
  • Taxes: You may also deduct the taxes you pay on the property levied by local and state governments. Most property taxes are assessed locally to fund schools and other services provided at the local level, but some states also have property tax.
  • Points and PMI/MIP: You may also deduct any points paid at closing as well as PMI/MIP (Private Mortgage Insurance/Mortgage Insurance Premium).

Another great benefit of home ownership is the potential for tax-free investing. When you sell, the capital gain may be excluded (at least in part) from your taxable income. The maximum exclusion is $250,000 ($500,000 for joint filers) as long as certain criteria are met: The home must have been your principal residence for two of the five years preceding the sale and you may not have claimed the capital gain exclusion from another property sale in the previous two years.
Be certain to keep copies of your settlement statement(s) for your tax records.

Rental Property Benefits
Rental properties carry tax deductions as well. To start, you may also deduct mortgage interest, taxes, points and PMI/MIP as you can on a property that is your primary residence. Additionally you can deduct the following expenses on a rental property:

  • Homeowner’s/Hazard insurance
  • Utilities that you pay
  • Repairs
  • Home warranty
  • Depreciation
  • Any other property-related expenses

Home Improvements
As a homeowner, you will likely make improvements to your home and property over the course of ownership. These improvements may include renovations (think bathroom or kitchen upgrades), additions, window or door replacements, roof replacements, adding amenities like pools or hot tubs… and the list goes on.
These improvements are not deductible, but they will very likely increase the value of your property and benefit you when it’s time to sell. Be certain to keep receipts and documentation of improvements as you can subtract the cost of these against any capital gain on the sale. This is especially important if your gain is nearing the threshold for the capital gain exclusion.
Some improvements that create energy savings (e.g. geothermal heat pump or solar water heating) may qualify for an energy credit on your current taxes. The regulations for residential energy credits may change, so be certain to keep receipts, so you can claim this credit as long as it is renewed. Learn more aboutResidential Energy Credits.


If you already own a home you may want to look at refinancing for various reasons.  Here are a couple of reasons why you might decide to refinance:

  • You may have an older interest rate that is higher than the current average.
  • You may want to get out of an adjustable-rate mortgage.
  • You may have a FHA loan that closed prior to January 2015 and you are paying the old MIP premiums rate.
  • You may also want to consolidate debt if you have a home equity loan in addition to your original mortgage.

In order to determine if refinancing makes fiscal sense, you need to determine the closing costs associated with the refinance and how long it will take for your realized monthly cost savings to offset those closing fees. If you plan to stay in your home for a while, it typically works out in your favor; however, if not, you could easily lose money on refinancing.  We can run some scenarios to help you determine if you should refinance. Contact usfor an appointment.

Cancelling PMI
You might be able to save on your monthly mortgage payment without refinancing. According to Consumer Financial Protection Bureau, your private mortgage insurance (PMI) can be cancelled when you have reached the date when the principal balance of your mortgage is scheduled to fall below 80 percent of the original value of your home. This date should be included on a PMI disclosure form issued with your original mortgage.
There are other criteria involved with PMI cancellation including good payment history and being current with your payment, certification of no additional liens, and property appraisal.