Benefits of Tax Carryforwards and Carrybacks

Maximize tax benefits of carryforwards and carrybacks

Although the tax code contains some exceptions, income is generally taxable in the tax year received and expenses are claimed as deductions in the year paid. But “carryforwards” and “carrybacks” have special rules. In this case, certain losses and deductions can be carried forward to offset income in future years or carried back to offset income in prior years, providing tax benefits.

* Capital losses. After you net annual capital gains and capital losses, you can use any excess loss to offset up to $3,000 of ordinary income. Remaining losses can be carried over to offset gains in future years. The carryforward continues until the excess loss is exhausted.

* Charitable deductions. Your annual charitable deductions are limited by a “ceiling” or maximum amount, as measured by a percentage. For example, the general rule is that your itemized deduction for most charitable donations for a year can’t exceed 50% of your adjusted gross income (AGI). Gifts of appreciated property are limited to 30% of your AGI (20% in some cases) in the tax year in which the donations are made. When you contribute more than these limits in a year, you can deduct the excess on future tax returns. The carryover period for charitable deductions is five years.

* Home office deduction. If you qualify for a home office deduction and you calculate your deduction using the regular method, your benefit for the current year can’t exceed the gross income from your business minus business expenses (other than home office expenses). Any excess is carried forward to the next year. Caution: No carryforward is available when you choose the “simplified” method to compute your home office deduction.

* Net operating losses (NOLs). Business NOLs can be carried back two years and forward 20 years. Tip: As an alternative, you may opt to forego the carryback and instead carry the entire NOL forward.

Give us a call (757) 926-4109 for help in maximizing the tax benefits of carryforwards or carrybacks, planning has to be done on these strategies before the end of the year.

Tax Planning For Second Marriages

Tax planning is essential for second marriages.  Wedding bells bring rejoicing – and financial challenges.  If you’re marrying for the second time, the financial changes might seem overwhelming.  On the surface, tax and financial planning for a second marriage is similar to that of a first marriage.

For example, no matter what month you hold the ceremony, the IRS will consider you married for the full year. That means employer-provided fringe benefits and taxes withheld from your paychecks could require adjustment. Depending on how much each of you earns and your past financial history, you’ll have to decide what filing status will be most beneficial, and how best to take advantage of tax breaks that may become available.

With a second marriage, you have even more decisions to make, including how you’ll merge your assets.  Will you purchase a new home?  If both of you already own separate homes, you may each qualify for a $250,000 federal income tax exclusion on the profit from the sale, as long as you have lived in the home for at least two of the last five years. If only one of you meets the requirements for the exclusion, consider selling the qualifying home and living in the other for a while.

You or your spouse might also have substantial debt or financial obligations. Discuss your financial histories, including alimony or child support still owed and past bankruptcies. Decide who will provide for the college expenses of the children in your now-combined household. Depending on your age, you may want to investigate the effect of the marriage on your social security benefits.

A second wedding is a joyful event for you, your new spouse, and your extended families. To give your marriage an added advantage, call us before you say, “I do.” We’ll offer our congratulations – followed by useful financial and tax planning advice.

Preserve Tax Breaks With These Tips

Managing your modified adjusted gross income or ‘MAGI’ can help you save on your 2015 taxes.  Read on to find out how close to “the edge” are you when it comes to tax phase-outs?  As you begin your mid-year tax planning, consider the effects of these benefit-limiting provisions.  Knowing how close you are to the phase-out limits can help preserve tax breaks for 2015.

Your ‘MAGI’ is the adjusted gross income shown on your tax return but is “modified” by adding back certain deductions.  The “add-backs” vary with specific phase-outs.  That means you might have to choose between conflicting opportunities.  For instance, if you have a child in college this semester, the American Opportunity Credit and the Lifetime Learning Credit may be on your mind.  Both benefits are education-related, yet the qualifying rules differ – including the MAGI threshold.

Here are some common federal tax benefits with MAGI phase-outs.

EDUCATION CREDITS

The American Opportunity Credit is a partially refundable, dollar-for-dollar reduction of your tax bill, with a maximum of $2,500 per student. This year the credit starts to shrink when your MAGI reaches $160,000 and you’re married filing jointly ($80,000 when you’re single). The credit disappears completely when your MAGI is greater than $180,000 for joint returns ($90,000 if your filing status is single).

For 2015, the Lifetime Learning Credit begins to phase out at $110,000 when you’re married filing a joint return and $55,000 when you’re single. Once your MAGI reaches $130,000 (married) or $65,000 (single), the credit is no longer available.

RETIREMENT PLANS

Phase-outs affect retirement planning too. The deduction for contributions to your traditional IRA is limited when you are eligible to participate in your employer’s plan and your MAGI exceeds $98,000 ($61,000 when you’re single).

While Roth IRA contributions are not tax-deductible, the amount you can contribute for 2015 begins to phase out when your MAGI reaches $183,000 and you’re married filing jointly ($116,000 if you’re single).

In addition, the federal “saver’s” credit for contributing to retirement plans phases out when your 2015 MAGI is more than $61,000 and your filing status is married filing jointly ($30,500 for singles).

SOCIAL SECURITY

The phase-out for the exclusion of social security benefits from taxable income is calculated on the amount of your “combined income” (one half of social security benefits plus other income) over the base amount of $32,000 when you’re married filing jointly. The base amount is $25,000 when you’re single.

Phase-outs also reduce personal exemptions, itemized deductions, and the alternative minimum tax exclusion. Contact our office for guidance in managing your income for maximum tax breaks.

A Simplified Home Office Deduction

Do you ever take the home office deduction?

Do you work at home or have a home-based business?  If so, you should be aware that the IRS has created a simpler option for calculating the deduction for the business use of your home.  The new option makes record keeping easier because, instead of maintaining records of specific home office expenses, you can use a standard rate per square foot.  The rate is $5 per square foot (up to a maximum of 300 sq. feet or $1,500) for qualifying business use space in place of taking a pro rata percentage of items such as mortgage interest, taxes and repairs. Keep in mind there are good and bad aspects to this “simpler” method. The new method gives you back your full interest and tax deduction on schedule A, but you will lose your depreciation and loss carryover deductions. Of course, you must still use your home office regularly and exclusively for business.  This may be a welcome relief for some taxpayers, but it might not be the best choice for others.  Let our firm’s tax experts help you determine if the simplified deduction is the right choice for you.   Please contact us at (757) 926-4109 for answers to all your financial questions and concerns – it’s what we do.

Tax Implications of Selling or Trading in a Business Auto

The decision of whether to trade in an old business car or try to sell it for cash generally should be based on factors such as the amount you can get on a sale versus a trade-in, and the time and bother a sale will entail.   However, important tax factors also may affect your decision-making process. Here’s an overview of the complex rules that apply to what appears to be a simple transaction, and some pointers on how to achieve the best tax results.

In general, the sale of a business auto yields a gain or loss depending on the net amount you receive from the sale and your basis for it. Your “basis” is your cost for tax purposes and, if you bought the asset, usually equals your cost minus the depreciation deductions you claimed for the auto over the years. Under the tax-free swap rules, trading in an old business auto for a new one doesn’t result in a current gain or loss, and the new car’s basis will equal the old car’s remaining basis plus any cash you paid to trade up. As a general rule, you should trade in your old business car if you used it exclusively for business driving, and its basis has been depreciated down to zero, or is very low. The trade-in often avoids a current tax. For example, if you sell your business car for $9,000, and your basis in it is only $7,000, you will have a $2,000 taxable gain, but if you trade it in, a current tax is avoided because any gain is deferred.    Your basis in the new car will be lower than it would be if you bought it without a trade-in, but that doesn’t necessarily mean lower depreciation deductions on the new car. Because of the so-called “luxury auto” annual depreciation dollar caps, your annual depreciation deductions on a new car may be the same whether you sold the old car or traded it in.

However, you should consider selling your old business car for cash rather than trading it in if you used it exclusively for business driving and depreciation on the old car was limited by the annual depreciation dollar caps.   In this situation, your basis in the old car may exceed its value. If you sell the old car, you will recognize a loss for tax purposes. However, if you trade it in, you will not recognize the loss.

For example, let’s you bought a $30,000 car several years back and used it 100% for business driving. Because of the annual depreciation dollar caps, you still have a $16,000 basis in the car, which has a current value of $14,500. Now, you want to buy another $30,000 car. If the old car is sold, a $1,500 loss will be recognized ($16,000 basis less $14,500 sale price). If the old car is traded in for a new one, there will be no current loss. Of course, if the old car’s value exceeds its basis, the tax-smart move is to trade it in and thereby avoid the gain.

You also may be better off selling your old business car for cash rather than trading it in, if you used the standard mileage allowance to deduct car-related expenses. For 2016, the allowance is 54¢ per business mile driven.  The standard mileage allowance has a built-in allowance for depreciation, which must be reflected in the basis of the car.    When it’s time to dispose of a car, the depreciation allowance may leave you with a higher remaining basis than the car’s value. Under these circumstances, the car should be sold in order to recognize the loss. All of this sounds very complicated, and it is.  Before you sell or trade in your business car or lease a new one, please give us a call and we’ll set up a meeting to discuss your options.

Can You Deduct the Cost of Business Meals?

We often get asked about the requirements for deducting business meals and entertainment expenses. This type of expense requires you to jump through several extra hoops to qualify as deductible and is subject to limitations.   Nevertheless, if you pay careful attention to the rules outlined below, the expenses should qualify as deductible.

  1. Ordinary and necessary business expenses. All business expenses must meet the general deductibility requirement of being “ordinary and necessary” in carrying on the business. These terms have been fairly broadly defined to mean customary or usual, and appropriate or helpful. Thus, if it is reasonable in your business to entertain clients or other business people you should be able to pass this general test.
  2. “Directly related” or “associated with.” A second level of tests especially applicable to meals and entertainment expenses must also be satisfied. Under them, the business meal or entertainment must be either “directly related to” or “associated with” the business. “Directly related” means involving an “active” discussion aimed at getting “immediate” revenue. Thus, a specific, concrete business benefit is expected to be derived, not just general goodwill from making a client or associate view you favorably. And the principal purpose for the event must be business. Also, you must have engaged actively during the event, via a meeting, discussion, etc. The directly related test can also be met if the meal or entertainment takes place in a clear business setting directly furthering your business, i.e., where there is no meaningful personal or social relationship between you and the others involved. Meetings or discussions that take place at sporting events, night clubs, or cocktail parties—essentially social events—would not meet this test. If the “directly related” test cannot be met, the expense may qualify as “associated with” the active conduct of business if the meal or entertainment event precedes or follows (i.e., takes place on the same day as) a substantial and bona fide business discussion. This test is easier to satisfy. “Goodwill” type of entertainment at shows, sporting events, night clubs, etc. can qualify. The event will be considered associated with the active conduct of the business if its purpose is to get new business or encourage the continuation of a business relationship. For meals, you (or an employee of yours) must be present. That is, for example, if you simply cover the cost of a client’s meal after a business meeting but don’t join him at it, the expense does not qualify.
  3. Substantiation. Almost as important as qualifying for the deduction are the requirements for proving that it qualifies. The use of reasonable estimates is not sufficient to stand up to IRS challenge. You must be able to establish the amount spent, the time and place, the business purpose, and the business relationship of the individuals involved. Obviously, you must set up careful and detailed record-keeping procedures to keep track of each business meal and entertainment event and to justify its business connection. For expenses of $75 or more, documentary proof (receipt, etc.) is required.
  4. Deduction limitations. Several additional limitations apply. First expenses that are “lavish or extravagant” are not deductible. This is generally a “reasonableness” test and does not impose any fixed limits on the cost of meals or entertainment events. Expenses incurred at first class restaurants or clubs can qualify as deductible. More importantly, however, once the expenditure qualifies, it is only 50% deductible.   Obviously, this rule severely reduces the tax benefit of business meals and entertainment. If you spend about $50 a week on qualifying business meals, or $2,500 for the year, your deduction will only be $1,250, for tax savings of around $300 to $400. 

Please call if you have any questions or would like my help in setting up record-keeping procedures.

Manage Your Modified Adjusted Gross Income

Put the Squeeze on Your Tax Bill

Put the Squeeze on Your Tax Bill

Preserve tax breaks by managing your Modified Adjusted Gross Income (MAGI)-

How close to the edge are you when it comes to tax deduction phase-outs?   As you begin your midyear tax planning, consider the effects of these benefit-limiting provisions.  With close planning, you can know how close you are to the “edge” and that can help to preserve tax breaks for 2015.

Many phase-outs are based on modified adjusted gross income, or MAGI.  If your income is above certain levels, you may be subject to the phase-outs.  The income levels vary depending upon the deduction.  Some of them are lower than you might think too!  MAGI is the adjusted gross income shown on your tax return as “modified” by adding back certain deductions.  The “add-backs” vary with the specific phase-outs.  That means you might have to choose between conflicting opportunities.  For instance, if you have a child in college this semester, the American Opportunity Credit and the Lifetime Learning Credit may be on your mind. Both of these tax credits are education-related, yet the qualifying rules differ – including the MAGI threshold.

Here are some common federal tax benefits with MAGI phase-outs:

  • Education credits – The American Opportunity Credit is a partially refundable, dollar-for-dollar reduction of your tax bill, with a maximum of $2,500 per student.  This year the credit starts to shrink when your MAGI reaches $160,000 and you’re married filing jointly ($80,000 when you’re single). The credit disappears completely when your MAGI is greater than $180,000 for joint returns ($90,000 if your filing status is single).  For 2015, the Lifetime Learning Credit begins to phase out at $110,000 when you’re married filing a joint return and $55,000 when you’re single. Once your MAGI reaches $130,000 (married) or $65,000 (single), the credit is no longer available.
  • Retirement plans – Phase-outs affect retirement planning too. The deduction for contributions to your traditional IRA is limited when you are eligible to participate in your employer’s plan and your MAGI exceeds $98,000 ($61,000 when you’re single).  While Roth IRA contributions are not tax-deductible, the amount you can contribute for 2015 begins to phase out when your MAGI reaches $183,000 and you’re married filing jointly ($116,000 if you’re single).  In addition, the federal “saver’s” credit for contributing to retirement plans phases out when your 2015 MAGI is more than $61,000 and your filing status is married filing jointly ($30,500 for singles).
  • Social Security – The phase-out for the exclusion of social security benefits from taxable income is calculated on the amount of your “combined income” (one half of social security benefits plus other income) over the base amount of $32,000 when you’re married filing jointly. The base amount is $25,000 when you’re single.

Phase-outs also reduce personal exemptions, itemized deductions, and the alternative minimum tax exclusion. Contact our office for guidance in managing your income for maximum tax breaks.

New Tax-Exempt “ABLE” Accounts Help Pay Expenses for Disabled

Tax-Exempt Health Care

Tax-Exempt Health Care Help

The “tax extenders” legislation that became law in December 2014 included the “Achieving a Better Life Experience Act” (also called the ABLE Act). This law provides for tax-exempt accounts that can help you or a family member with disabilities pay for qualified expenses related to the disability. These “ABLE accounts” are exempt from income tax although contributions to an account are not deductible on your federal income tax return. ABLE accounts are generally not means tested and some can provide limited bankruptcy protection.

You or a family member are eligible to open an ABLE account if:

1. You’re entitled to social security disability benefits due to blindness or other disability, and that blindness or disability occurred before age 26; or

2. You file a disability certification with the IRS for the tax year.

Annual contributions to an ABLE account are limited to the amount of the annual gift tax exclusion ($14,000 for 2015). Distributions are tax-free as long as they are less than your qualified disability expenses for the year.

The list of qualified disability expenses includes the following:

  • housing
  • education
  • employment training/support
  • health prevention/wellness services
  • financial management
  • legal fees
  • funeral expenses

There are certain other expenses that are also approved under the regulations.

Distributions exceeding qualified disability expenses are included in taxable income and are generally subject to a 10% penalty tax. Distributions can be rolled over to another ABLE account for another qualified beneficiary and beneficiaries can be changed between family members.   Funds in the account can earn interest or dividends and are not subject to federal income tax as long as distributions are used for qualified disability expenses.   ABLE accounts do not have a “use it or lose it” feature and funds can carry over to future years.

After an account beneficiary dies the balance remaining in the account can be used to reimburse state Medicaid payments made on behalf of the beneficiary after the account was established.  The remaining balance goes to the deceased’s estate or to another qualified designated beneficiary.  After-death distributions that are not used for qualified disability purposes are subject to income taxes, but not the 10% penalty.

If you are thinking many of these rules sound familiar, you’re correct.  ABLE accounts are modeled on 529 college savings accounts  If you think you qualify for one of these accounts, give us a call so we can help you make the most of this new opportunity.

Did You Owe Tax This Year?

Now is the perfect time to check your 2015 tax projection – especially if you got a large tax refund or owed the IRS any money when you filed your 2014 tax return. Now is a good time to adjust your income tax withholding or estimated tax payments to avoid any surprises next tax season.

Many people like to receive a refund from the IRS, thinking of it as a form of forced savings.  If you’re of this opinion, that’s fine, but too big of a refund means you’re wasting your money and giving an interest-free loan to the government.  Wouldn’t you rather have that money earning interest in an account you control instead?

On the flip-side, if you underpay your taxes by more than $1,000 and don’t meet certain exceptions, you could be hit with an underpayment penalty.   Adjusting your income tax withholding is as simple as filing a new Form W-4 with your employer.  The form comes with a worksheet to figure out how many allowances you should claim. You can also use the W-4 form to increase your tax withholding by specifying an extra dollar amount to be withheld from every paycheck.

When reviewing your 2015 tax projection, keep these rules in mind – generally, you must pay (through withholding or quarterly estimated tax payments) at least 100% of last year’s tax liability (110% if your prior year’s adjusted gross income is over $150,000), or at least 90% of what you’ll owe for this year.

However you do it, you should adjust your withholding or estimated tax payments to match the taxes you expect to owe.   Breaking even is generally the goal when we prepare your tax projection.  If you need assistance figuring out your 2015 tax estimated tax liability, give us a call, it’s what we do.

Lending to Family Members

Ins and Outs of Family Hand-Outs

Ins and Outs of Family Hand-Outs

A Little Info on the Tax Issues Associated with Loans to and from Family Members –

Tax problems can arise when you first lend money to a family member or when you begin receiving payments or if you’re not repaid.  The tax issues usually involve three elements – imputed income on below-market rate loans, the imposition of gift tax on the giver, or the lack of a bad debt deduction in the case of default.

1) Imputed income is revenue presumed earned but neither recognized nor received by the alleged recipient. The IRS may impute interest on a loan at the “applicable federal rate” (AFR) when a lower rate (or no interest) is charged. The agency then assesses tax on the excess of the imputed interest over the amount required by the terms of the loan.  In recent years, the AFR has been fairly low, not even reaching 3% at the highest.  However, even though the AFR is still relatively low, lenders are required to charge at least the lowest rate as specified by the AFR.  Here is a link to the index for AFR rates.

* The Gift Tax issue arises when the IRS imputes phantom interest because it also creates phantom taxable gifts.  “Gifting” occurs because the imputed interest is treated as though the borrower actually paid the interest it to the lender and then the lender returned the same amount to the borrower as a gift.  Since the lender “constructively received” the additional interest, he or she owes income tax on it.  Since the lender then presumably gave the interest back to the borrower, he or she also owes gift tax on it, unless an exclusion or credit applies.  Gift tax only applies to annual gifts of $14,000 or more as of the time we posted this entry 6-5-15.

* There are limits on Bad Debt deductions for money lent to a related party.   Normally, a loan that goes bad is deductible, either against ordinary income (if made for a business purpose) or as a short-term capital loss. However, when the defaulting party is related, the IRS may demand clear and convincing evidence that the original loan was not actually a gift.  Once a loan is recharacterized as a gift, no bad debt deduction will be allowed if the loan isn’t repaid, and the lender also may owe gift tax on the principal unless an exclusion or credit applies.  Protect yourself by making sure all loans are structured as an arm’s length transaction and that all the terms are reasonable, and written, and signed by all parties.  Having the document notarized by an independent third party is also a good idea.

Interest need not be charged and will not be imputed on a family loan of $10,000 or less unless the loan directly relates to purchasing or carrying income-producing assets.  Without a written document imposing interest at the applicable federal rate (AFR) or higher, the loan probably will be considered a gift and thus will not be deductible if not repaid.

Interest will be imputed on a family loan over $10,000 if the stated rate is below the AFR. However, unless the principal exceeds $100,000, imputed interest will be limited to the borrower’s annual net investment income, and no interest will be imputed if that income is $1,000 or less.

Obviously, lending to relatives can create unintended tax consequences. You should always have a written loan agreement on family loans to document the transaction for the IRS. Please contact us for guidance before you make any family loans.

New 2014 Rules Affect Repairs, Maintenance & Supplies Expenses

The IRS issued “final” rules known as the “repair regulations” this year.  They will effect your 2014 tax return if you have any depreciable assets or if you regularly purchase materials & supplies in your line of business. The rules clarify which costs should be capitalized and which can be expensed when your business buys, makes, maintains, or improves certain fixed assets such as buildings, equipment, vehicles and machinery.

Here are three ways your business can be affected:

1. Accounting policies. You’ll need to update your accounting policies to reflect how you treat expenses for repairs, materials, and supplies, and the acquisition of assets. Having a written policy in place will help keep you in compliance with the rules.  Your accounting policy must be in effect as of January 1 of each year.  Contact us for a template to help you with tax compliant wording. 

2. Elections. The final regulations include six elections. You’ll want to review them to learn if they are beneficial to you. For example, by choosing the “de minimis safe harbor election,” you can opt to expense the cost of property below a specific dollar amount, typically $500 but your industry standard could dictate more.

3. Form 3115. You may want to file Form 3115, Application for Change in Accounting Method, with your 2014 federal income tax return to revise certain decisions you made regarding the treatment of tangible property in prior years. Alternatively, under simplified rules recently issued by the IRS, certain small businesses have the option of applying the repair regulations to 2014 and future years without filing Form 3115.

The final repair regulations will affect every business with fixed assets on the books as well as individuals with rental properties.   This law is very complex and requires a lot of paperwork to be in compliance.  Our tax preparers understand the ins and outs of the new repair regulations.  Please contact us to schedule an appointment so we can help you determine how to apply the rules.

Virtual Activity, Real-world Taxes

Online Transactions May Be Taxable

Online Transactions May Be Taxable

Whether you’re a long time technophile or newly computer literate, your use of technology can affect your income tax return.  Read below to learn about virtual transactions that can have taxable consequences on your individual income tax return.

 

  • Proceeds from sales of goods and services on Internet marketplaces can be taxable. This is the case whether you’re a hobbyist or running a business online.  Depending on your level of activity, tax rules may limit your deductions.
  • Receipts from crowd-funding sites such as indiegogo, gofundme or kickstarter – where you raise money from others to fund a project – most likely will be taxable income.  You probably think of the money as a gift but when the people providing the funds get something in exchange, such as a reward for participating, the amounts you receive are typically considered income from a sale.  It is extremely important that you keep track of all expenses related to the project and document how you spent the money.

Bitcoin-accepted-herePayments you receive in the form of virtual  currency (i.e. bitcoin) for goods and services are includible in your gross income at fair market value.  Other transactions involving virtual currency, such as the sale or exchange of the currency, can result in taxable gains or losses. Under guidance issued in 2014, the IRS treats virtual currency as property.

  • Money received from listing your home on websites offering temporary or short-term lodging is generally reportable as rental income. The tax impact can vary based on the length and frequency of the rental activity.

Questions?  Give us a call (757) 926-4109. We’ll help you sort out the real-world consequences of all of your virtual transactions.

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