Wednesday, August 4, 2010

Q&A: Business Expenses and Tax Deductions

Question: A friend of mine recently told me that he deducts most of his meals with his family because he is self-employed and his wife helps him out with his business. Thus, any of these meals are deductible because they discuss some business while eating. Is this true?

Joe B, Phoenix, AZ

Answer: No, this is definitely not true and is certainly not recommended. In order to deduct your business meals, you must make sure that your business discussion is both “substantial” and “bona fide.” Your friend would fail both of these tests. First, while there are no rules telling you how much time during the meal you must discuss business matters (i.e. it does not need to be a majority of the time), you must be sure that the business discussion is the primary purpose of having the meal. This does not mean that you cannot have a relationship with the person being entertained, but you had better have a valid business relationship with the person before you try to claim any tax deductions. In addition, the IRS would most certainly argue successfully that the primary purpose of your meal was not business related. When you entertain family members, you may be able to show a legitimate business purpose, although this will certainly be more difficult than someone who was not related to you. You should be sure to remember these rules, as it is up to you to prove that you are entitled to deduct the entertainment expenses as legitimate business expenses.

Tuesday, August 3, 2010

Q&A: Rental Property and Tax

Question: I have a rental property that I have been renting out since 2006. I plan on moving into the home next year and want to sell it in a few years. What are my tax consequences of this plan?

Nancy S, Nashville, TN

Answer: There are no tax prohibitions to moving into a rental property and subsequently obtaining the tax benefits of the capital gain exclusion under Section 121 of the Internal Revenue Code. When you sell the rental property, you will need to pay taxes on the amount of depreciation that was claimed while it was a rental property. The tax rate of this “depreciation recapture” is 25%. In addition, any gain that you have on then property (after depreciation) for any period of time after 2008 that it was a rental property is not excludable. For instance, if you rented out the property in 2009 and 2010 and the property increased in value by $20,000 during these 2 years, the $20,000 would be taxable as a gain and not excludable. The good news here, especially if you convert from a rental to a personal residence in 2010, is that it is likely that the property did not go much (if at all) in these 2 years due to the current real estate conditions. As long as you live in the home at least two years as your personal residence after converting it from a rental property, you will be eligible for a capital gains exclusion of $250,000 (single) or $500,000 (married filing a joint tax return).

Monday, August 2, 2010

Q&A: Assistance Dogs and Tax Deductions

Question: I have a dog that I use for medical reasons. Are the costs of this dog tax deductible?

Sarah Y, Vancouver, WA

Answer: Yes. The IRS has ruled that any service dogs used for medical purposes are tax deductible. These animals have been used for a long time to assist blind and deaf citizens.

Now, the IRS has extended this to include those with mental disabilities, including depression and post-traumatic stress disorder. In order to back up this tax deduction, make sure that you have something in writing from your medical professional so that you can prove that the dog is a medical necessity rather than a strictly personal expense. Please also remember that any medical expenses are limited to amounts over and above 7.5% of your income and you must itemize tax deductions in order to claim this deduction at all. It could also be reimbursed under a medical reimbursement plan with a business.

Sunday, August 1, 2010

August: Greetings from the IRS

If you have employees, you will be required to report the value of any health insurance you paid for the employee’s benefit beginning with 2011. Thus, you will need to be able to track these amounts beginning in January 2011.

The IRS Treasury Inspector has reported many compliance issues relating to the homebuyer tax credit. For instance, 256 taxpayers took a tax credit for homes at just five addresses. Several prisoners filed claims and had them approved (where their housing should have been a bit easier to verify!). Many amended returns filed questionable claims and the IRS did not devote resources to examining these returns. And if this wasn’t enough, more than 100 current IRS employees filed claims for the credit when they were not entitled to receive this credit. They are now under an internal investigation! And on a related matter: Congress has extended the time to claim the $8,000 first time homebuyer credit or $6,500 credit for longtime owners. This credit was set to expire on April 30 but now any contracts that were signed prior to April 30, 2010, will have until September 30, 2010, to actually close on the transaction. This extension was done to relieve the backlog of homes trying to close before the prior deadline (delays due to lenders and the federal government administering the lending programs). Congress did NOT extend the deadline of April 30 to contract for the purchase of the home.

The IRS offshore income probes just got a bit stronger, with Swiss bank UBS agreeing to turn over more than 4,000 accounts to the IRS where U.S. tax fraud is suspected. If you have an offshore account and did not report any income earned, you may want to talk to a tax professional about your options, as it does not appear that the IRS is slowing down in any way in the offshore tax fraud investigations.

The IRS has released filing data for the 2007 tax year (the most recent year available) and it showed that 4,535,623 US taxpayers reported an Adjusted Gross Income of at least $200,000. This represented about 3.2% of all individual tax returns filed. The actual number and percentage were record highs. Interestingly, more than 10,000 of these tax returns showed no US income tax liability. The IRS has attributed this to tax-exempt income being earned, along with numerous tax deductions (primarily Schedule A itemized deductions).

The IRS has announced that it will be doing more than 1,000,000 audits via mail this year, as it had a great deal of success with last year’s audits (i.e. they raised a lot of new revenue!). They are going to focus on unreimbursed employee business expenses, large charitable donations, earned income credit and advertising and car expenses for self-employed taxpayers.

August Tax Tips

As we have recently reported, Congress is making some major tax law changes now that will impact taxes for many years in the future.

One of the biggest changes will occur after 2012 and will involve a 3.8% Medicare tax on investment income. First, this tax will apply only to those single taxpayers who earn at least $200,000 and any married couple earning at least $250,000 ($125,000 if filing separately- just another example of a marriage penalty in our tax code). The tax also applies to estates and trusts (but not to any charitable trusts that are otherwise exempt from paying taxes).

For purposes of this new tax, “investment income” includes income from interest, dividends, annuities, capital gains, royalties and rents. For any rents and royalties, the tax would only apply to a net amount (after expenses). The tax does NOT apply to tax-exempt bond interest and gains from the sale of a principal residence (unless there is a tax due after the exclusion has been claimed). Thus, if you are planning to sell your primary residence in the next year or two and will have a taxable gain (if the gain exceeds the $250,000 or $500,000 exclusion amounts for single or married taxpayers), it would be wise to consider selling the home before 2013 so that the gains are not hit with an extra 3.8% tax. The tax savings could be huge, depending upon the extent of the overall gain that is taxable.

This same rule applies to sales of second homes or other investment real estate (not rental properties). Thus, if you are planning on selling a second or vacation home soon, it may make a lot of sense to sell before 2013 if there will be a taxable gain.

Given that tax-exempt municipal bonds are exempt from this tax, we are expecting many financial planners to be recommending these tax-favored investments when the new 3.8% tax goes into effect. Furthermore, this 3.8% tax increase will be in addition to any other tax increases in the future. We continue to expect the tax rates to increase, certainly before 2013.

For instance, we are expecting the taxes on long-term capital gains to increase from 15% to at least 20%. Beginning in 2013 for high-income taxpayers, this tax will actually be 23.8% (assuming our 20% rate prediction is correct). Thus, this new tax will certainly cause us to think about selling appreciated assets before the tax increase goes into effect.

There are a few other planning opportunities present here as well. The new tax does not apply to business income earned from a trade or business. It does not matter how the business is set up, as this will not apply to business income from a sole proprietorship, partnership, LLC or S corporation. It will apply to any business that results in passive income, so entities such as limited partnerships may be subject to this extra tax. We are awaiting additional IRS guidance on this issue.

One investment that is specifically excluded is distributions from tax-favored retirement plans, including individual retirement accounts (IRA) and qualified employer plans (such as 401(k) or 403(b) plans). This will make these plans even more advantageous than they are today.

If you are not fully funding a retirement plan at work or contributing the maximum to an IRA every year, it would be a good idea to review this plan and see if you can now fully fund these plans. If you fund a taxable account and then receive dividends or capital gains, this income would be subject to the 3.8% tax. But if you make these same exact investments in a retirement plan, these will NOT be subject to the 3.8% tax. This again leads us to favor IRAs in general and Roth IRAs in specific, as a Roth IRA will not generate any taxable income in most situations and thus the 3.8% tax will not apply to Roth IRA distributions. If you have been considering a rollover to a Roth IRA from a regular, traditional IRA, it again should be done before 2013 as this rollover will count in your overall income for purposes of the threshold for the 3.8% tax. Thus, if you are married filing jointly and your income is $250,000 (the threshold), converting an IRA to a Roth IRA would push your income over the threshold and subject some of your investment income to the extra taxes. Thus, tax planning will become even more key in the upcoming years as we work to find ways to legally avoid these new taxes.

Thursday, July 1, 2010

Summer Jobs and Taxes

For any students or others who have summer jobs, there are some nice tax planning moves that can made now to maximize the tax effects of the employment. First, all workers should consider putting as much money into their IRA each year as is allowed by law. For 2010, any worker can contribute up to $5,000 to an IRA. The amount cannot exceed the total amount of wages earned, so if a worker earned $3,000 this year, the maximum contribution would be $3,000 instead of $5,000. If a 16 year-old worker earned at least $5,000 this year and contributed $5,000 to a Roth IRA, he or she would have $217,000 by age 65 and $319,000 by Age 70, assuming an annual return of 8%. These funds could be removed tax free at that time. Of course, the numbers will be much higher if future contributions are made, as these numbers represent the earnings on one $5,000 contribution.

The other nice tax planning move is that no income taxes are due and owing on the first $5,700 of wages, assuming no other income (earned or investment/passive) is actually taxable this year. We will have an article on full tax planning for hiring your children in the next issue, but please remember that no payroll taxes are due on wages paid to your children if your business is a sole proprietorship or a husband-wife partnership and your child is under Age 18. This also includes the federal unemployment tax (FUTA), in addition to the FICA and Medicare taxes.

Tuesday, June 8, 2010

Business Tax Planning

We are beginning a periodic series on business tax planning so all readers will have a better roadmap for their own personal successes. We will attempt to cover several topics in the coming few months, beginning with this month’s feature on basic tax planning tactics. While every taxpayer is unique, there are a few rules that apply to most business owners and individuals. Here they are:

Legally avoid the recognition of income (such as not paying taxes on municipal bond income in many instances, being able to rent a property for a few days every year with no income tax consequences, etc.).

Deferring tax by deferring income (such as waiting to bill clients for December’s work until January to defer the taxes on this income until the following tax year).

Deferring taxes by accelerating deductions (such as prepaying mortgage expenses in December to get the deduction in the current year).

Use of the proper business entity (such as the choice between a C and S corporation).

Use of the proper tax year (such as selecting the year end for a C corporation of June 30 to provide planning opportunities).

Spreading income to utilize different tax rates (such as gifting certain dividend paying stocks to a child to gain the benefit of a lower tax rate for the child).

Converting ordinary income to capital gains (especially if the holding period is more than one year- the difference can be as much as 20% plus state tax rates).

Selecting a proper accounting method for your business (cash vs. accrual vs. hybrid).

Sunday, June 6, 2010

Medical Expenses and Tax Deductions

We often get questions as to the deductibility of medical expenses by non-business taxpayers (business taxpayers have more opportunities to claim tax deductions because they can utilize a medical reimbursement plan or other tax savings methods for their employees). In order to claim a deduction on your personal tax return (Schedule A- Itemized Deductions), you must make sure that the expense relates to the cost of diagnosis, cure, treatment, mitigation or prevention of any specific disease. You are not permitted a deduction for general health benefits (even if prescribed by your physician) and expenses done solely for cosmetic reasons.

Here are some medical expenses you should consider:

(1) doctor bills (such as for a physician, chiropractor, dentist, Christian Science practitioner, and psychiatric service fees)

(2) any medical equipment/supplies (wheelchair, braces, crutches, ambulances, eyeglasses, splints, oxygen equipment, etc.)

(3) medical treatments (childbirth, injections, vasectomy, insulin, abortion, acupuncture, etc.)

(4) premiums (health insurance, blue cross, etc.)

(5) Hospital Services (room and board, emergency and operating room fees, etc.)

(6) Medicine and Drugs (prescriptions only)

(7) laboratory tests (blood, urine, X-Rays, etc.)

(8) miscellaneous (alcohol/drug treatment, birth control, travel to medical facility (your mileage is tax deductible here), organ donor costs and expenses, lifetime care payments for retirement home, dog/Braille for blind individuals, special telephones for deaf individuals, stop-smoking programs, special schools for handicapped individuals, childbirth classes, education costs for handicapped children, etc.). As long as the expense is for a legal medical procedure (do not try to deduct illegal drugs!), you should be safe in claiming it.

Please also recall that the recent Health Care bill made some changes to what can be claimed as tax deductions in future years. We will report on these changes and how to plan for them as we get closer to the implementation date for this new law.

Saturday, June 5, 2010

June Tax Tip

A recent Tax Court case, McNair Eye Center v. Commissioner, T.C. Memo 2010-81, has held that reliance on a CPA is NOT a valid defense to the failure to file employment taxes. In this case, Dr. McNair hired a CPA in 2004 to tax care of all tax filing matters, including payroll taxes. The CPA failed to prepare or file the tax returns, and also failed to make tax deposits of the amounts withheld from the employees’ wages. Unfortunately, Dr. McNair did not realize these failures until the CPA left his employment in 2006.

The IRS assessed penalties for the failure to deposit the withheld taxes, the failure to file the tax returns timely and the failure to pay the amounts due on the tax returns. The Tax Court upheld all three penalties, noting that the duty to file a tax return rests with the taxpayer and cannot be delegated to a third party for purposes of the late-filing penalty. The Court also noted that it was Dr. McNair’s responsibility to check on the CPA and make sure that all work was being done properly, especially given that the CPA was hired after Dr. McNair had already had problems with the filing and paying of these tax returns. The Court held that the failure to monitor the tax filings and the progress of paying was an indication of the lack of “ordinary business care and prudence” such that all of the penalties were appropriate.

This case should make it very clear to all taxpayers that the duty to file is theirs alone and cannot be delegated. Thus, it is important to keep tabs on any tax professional that you hire, either for you personally or your business.

Friday, June 4, 2010

Q&A: IRA Distributions

Question: I am 74 years old and I did not take any distributions from my IRA in 2009. Do I need to take any in 2010?

Steven, Anaheim, CA

Answer: Yes. Congress waived any Required Minimum Distributions (RMD) for 2009 due to the economy but this rule was NOT extended to 2010.

Thus, for 2010, all taxpayers who are over Age 70 1/2 must take out the RMD. Hopefully, your IRA trustee or custodian has provided these calculations to you so you know what your RMD actually is for 2010. If you have not yet received this information, please contact your custodian so that any RMD can be taken by the end of 2010 as the law requires.

Wednesday, June 2, 2010

Q&A: Youth and IRA Contributions

Question: My 16 year old son is working this summer and I wondered if he can contribute to an IRA?

Steve H., Denver, CO.

Answer: Steve, your son is in luck, as he can contribute up to $5,000, or the amount of his earnings, whichever is less. You can even gift this amount to him, although this will count against the $13,000 annual gift amounts.

If a 16 year old contributes $5,000 to his Roth IRA (the most attractive IRA for younger workers) this year, it would be worth $137,650 when he turns 65 and $193,061 at age 70, assuming an annual rate of return of 7% per year and no future contributions (i.e. only the initial $5,000 contribution). A Roth IRA is tax free when withdrawn and the funds can also be used for other purchases, such as a first home.

Tuesday, June 1, 2010

Q&A: Buying Assets

Question: I own a small business outside of Chicago and I was wondering if leasing or buying assets for my business is better from a tax perspective.

Lou, Palatine, IL

Answer: Lou, there are certain situations in which leasing makes sense over buying and here are some general rules and guidelines for you:

With a short-term lease (often three years or less for most business property), you get a faster write off using a lease than depreciating property over the 5 or 7 year useful life cycles.

With a lease you do not need to worry about resale value (especially if equipment is becoming obsolete, such as the computer industry and the rapid changes with technology).

If your company only needs the equipment for a short period of time, leasing makes sense, as you would not need to worry about reselling the equipment if you bought it.

It is more cost effective to lease in that you can typically put down a small % of the asset’s value rather than having to use up valuable capital to make an asset purchase.

The lease transaction may not need to appear on your balance sheet such that your financial ratios will appear better if your business is in the market for financing.

There are, of course, some advantages to buying and actually owning an asset. For instance:

You can elect to expense, under Section 179, up to $250,000 of equipment purchases in 2010. This applies when the equipment is placed into service and not when it is actually paid for.

The low current interest rates (relative to recent history) makes buying very favorable right now.

You can take advantage of any appreciation in an asset with a purchase that is not available for a lease.

The decision whether to lease or own can be quite complicated and hopefully these general guidelines will assist in the decision-making process.

Wednesday, April 14, 2010

In the News: CNN Money

Just got back from the CNN studios to film a segment called, How to Avoid a Tax Audit.

It was a great experience being on CNNMoney and I definitely look forward to more of these!

D-Day is tomorrow...are you ready?

Watch: How to Avoid a Tax Audit

Tuesday, April 13, 2010

NBC 9News in Denver - Tax Tips before D-Day

It's been awhile since my last post -- I've been busy doing a ton of media and of course, working to help my clients meet their deadline on April 15!

Just wanted to share the interview I did yesterday with 9News at NBC in Denver.

Standing up to the tax man

Here's a link to the video clip.

April Tax Tip

Personal tax returns are due this year on April 15, 2010. Here are some last minute tips to check and see if they apply to your return:

Fund your retirement accounts. You have up to April 15, 2010, to fund many different plans, and a SEP plan can be funded up to the due date for the tax return, including extensions (so you may have up to October 15, 2010, to fund this type of plan). This remains one of the best tax strategies, and it is even better now that there are higher contributions permitted depending upon the type of plan and your age.

Don’t forget about the tax deductions for state and local sales taxes. If you live in a State that does not impose an income tax (Alaska, Florida, Nevada, South Dakota, Texas, Washington and Wyoming), you are permitted to deduct sales taxes paid in lieu of claiming a tax deduction for State and local income taxes. If you live in one of the states which does impose an income tax, you still may benefit from this if the amount of sales taxes paid was higher than the amount of income taxes paid (or if you purchased a car, boat or other big ticket item, it may pay to calculate this both ways).

Don’t forget to claim any credits for children, including child care costs. There are income limitations here but it never hurts to ask.

Don’t forget to claim any loan origination or other discount fees associated with a loan refinance.

Don’t miss thecollege education expenses. There are several different ways to claim these expenses, including the HOPE Credit, Lifetime Learning Credit and the qualified tuition expense deduction. There are different rules for eligibility for each of these college-related expenses.

Watch your prior years’ losses so no amounts that can be carried forward to 2010 and future years are missed. This is especially true for taxpayers who have real estate losses, along with capital losses from stocks and other sales of capital assets.

Make sure you verify any Forms 1099 you receive for 2009, as the IRS estimates that up to 10% of these common forms from brokers, banks and businesses contain errors. Also, if you sold any mutual funds in 2009 and previously had your dividends reinvested, make sure you include these reinvested dividends in your cost basis.

Finally, make sure that you did not overpay your Social Security (FICA) taxes in 2009. If you switched jobs in 2009, this is very common. The maximum you were required to pay in 2009 was $6,622- if your total amounts paid for FICA exceeded this amount, you may be entitled to a larger refund this year.

Sunday, April 4, 2010

Q&A: Roth IRA and Joint Tax Returns

Question: I am planning on converting my regular IRA to a Roth this year and so is my husband. I want to report all of the conversion in 2010 and pay the taxes while my husband wants to spread out the tax payments over two years. What can we do as we file a joint tax return?

Allison B., Cambridge, MA

Answer: For married couples who file a joint tax return, you do have some options. First, the tax laws allow you and your husband to each convert the IRAs in 2010 and elect different tax treatment. Thus, it is possible for both to convert in 2010 and the husband (in this case) can elect to defer the taxes while the wife can elect to have all taxes paid for 2010. There are some different reasons why you may want to make either of these elections- it may be better to pay the taxes for 2010 because you believe (as do I) that tax rates will be increasing in 2011 (and thus by deferring you will end up paying more in taxes than paying the tax bill in 2010). However, some taxpayers may want to defer the taxes to take advantage of a rule that allows the taxes to be paid in 2011 and 2012 (with or without tax rate increases).

In addition, there is another rule present in these cases: each individual must be consistent in his or her tax treatments with respect to the conversions. For instance, if the husband has 3 different Traditional IRAs that he wants to convert to Roth IRAs, he must use the same tax treatment on all three IRAs. This means that if he elects to defer the taxes, he can do so but must do so for all three of his IRAs that he is converting. He is NOT permitted to pay taxes on one in 2010 and defer the other two until 2011 and 2012.

Thus, it is fine for each spouse to choose a different method of paying the taxes due on a Roth conversion as long as each spouse is consistent with his or her own tax treatment of these conversions.

Friday, April 2, 2010

New Health Legislation and Tax

As you are no doubt aware, Congress has recently passed a comprehensive overhaul of the U.S. health care system. Whether one agrees with the merits of this legislation is irrelevant for purposes of this article, as there are numerous tax ramifications associated with this legislation that will be discussed herein.

Initially, it is important to note that this is one of the more complex pieces of legislation that we have seen and it contains numerous tax provisions, many of which do not take effect for several years. Here is a tax synopsis of the legislation:

2010. Small businesses (25 employees or less and no more than $50,000 in average annual wages) would receive a tax credit up to 35% of the cost of health insurance for employees as long as the business pays at least 50% of the health insurance premium costs. In addition, the adoption credit has been increased by $1,000 and it now becomes refundable.

2011. Individuals who spend money from a health care savings account on ineligible items will face an extra 20% tax on the amounts spent. In addition, only prescription drugs and insulin will now be eligible for reimbursement. This WILL affect medical reimbursement plans, as over-the-counter medicine and medical items such as bandages would no longer be covered (or be reimbursable). All amounts paid for health insurance will be required to be reported on the employee’s W-2 for this year. Finally, a new employee benefit cafeteria plan will be introduced that eases restrictions to allow small businesses to provide tax-free benefits to their employees.

2012. Forms 1099 will be required for ANY payment of $600 or more made to any corporation or other business entity in addition to payments made to individuals.

2013. Individuals can now contribute a maximum of $2,500 per year on flexible health care spending accounts (the limit until 2013 is $5,000 per year). In addition, the threshold for deducting medical expenses on Schedule A goes from 7.5% of income to 10% of income (for those taxpayers who are under 65 years old- if you are 65 or older, the threshold will remain at 7.5%). Finally, individuals who earn over $200,000 (or married couples who earn over $250,000- another example of the Congressional “marriage penalty”) will see their Medicare taxes (a part of Employment and/or Self-Employment taxes) will increase from 1.45% to 2.35%. In addition, an extra tax of 3.8% will be imposed on unearned income (i.e. interest, dividends, royalties, rents, passive income, capital gains, etc.). This is called the Unearned Income Medicare Contribution.

2014. January 1, 2014, is the first date that all Americans must have health insurance or face potential fines up to 1% of their taxable household income. There are exemptions in place for those who cannot afford the insurance. Tax credits would also begin for those individuals who earn $43,420 or less (single) or $88,200 for a family of four. This is also the first year that large employers (over 50 employees) must fund health insurance or be faced with excise tax penalties. Small employers (25 or less employees) can also begin to obtain a 50% tax credit for the amounts of the health care insurance contributions the business makes.

2015. Penalties will increase for those who do not have health insurance to a potential 2.5% of household taxable income.

2016. The penalties for the failure to carry health insurance are now indexed for inflation.

2017. This is the first year that an excise tax (40%- and this is a non-deductible tax) applies to health insurance policies that cost more than $10,200 for a single employee and $27,500 for family coverage.

Thursday, April 1, 2010

April: Greetings from the IRS

Business owners making an automobile purchase in 2010 will get less in tax benefits from the purchase than in 2009. This is the case because the bonus depreciation has lapsed and as of this writing Congress has yet to reinstate it. Thus, for 2010, the maximum first year deduction (not including Section 179 for vehicles that weigh in excess of 6,000 pounds) is $3,060, down from $10,960 in 2009.

The IRS has finally agreed to grant relief to taxpayers who have attempted a like-kind (1031) exchange but had the exchange fail due to the bankruptcy or receivership of the Qualified Intermediary (thus preventing the sale transaction from closing). Prior to IRS Revenue Procedure 2010-14, the taxpayer was out of luck in these situations and simply lost the tax benefits of the exchange. Now, a 1031 exchange can still work its magic from a tax perspective if a Qualified Intermediary is bankrupt if the taxpayer satisfied the following requirements: he or she must have transferred the relinquished property to the Qualified Intermediary properly and properly and timely identified the replacement property. In addition, the taxpayer must not have received any funds from the Qualified Intermediary with respect to the relinquished property and did not complete the exchange solely due to the bankruptcy or receivership situation of the Qualified Intermediary. There are a number of complicated calculations that must be performed here (better left for your tax return preparer!) but this revenue procedure is welcome news for those who have been victims of a bankrupt Qualified Intermediary. These new rules apply only to those exchanges in which the Qualified Intermediary defaulted on or after January 1, 2009.

The IRS has ruled that a company that hires a nanny to watch the owners’ children will have the nanny be treated as an employee of the business. While this may sound like good news in that the business will get a tax deduction for the wages, it will also need to pay employment taxes and will also make all corporate fringe benefits available to the nanny. This is simply another good reason why you want to keep your business and personal financial matters separate from each other.

The IRS and Department of Justice have completed a series of successful criminal prosecutions associated with tax fraud. Several tax preparers were caught, including those who were claiming tax withholdings on fictitious Forms W-2, identity theft issues (and using the information to claim tax refunds before the actual folks filed their tax returns), abuse of the homeowners tax credit and many other scams involving false credits and deductions. Given that we are in the middle of Tax Season 2010, it is important that you, as the taxpayer, review your tax preparer’s work very carefully before you sign the return. It is up to you to ask questions if you do not understand your tax return!

Wednesday, January 6, 2010

Real Estate and Tax Issues (Part 2)

Some Personal Use of the Rental Property

If you used the rental property for your own personal use, the tax treatment will depend upon how many days it was used for personal reasons.

If you used it less than 15 days or 10% of the days it was available as a rental property, there are no limitations to the deductions other than the $25,000 rule as stated above. All expenses, including depreciation, are deductible and a loss can be recognized if you meet the income tests. However, the situation changes drastically if your personal use exceeds 14 days or 10% of the rental days. In this situation, you still are permitted to claim tax deductions for your expenses, but the expenses cannot exceed the rental income reported on the tax return.

If your expenses for mortgage interest and taxes exceed your rental income, you are permitted to deduct any of the excess interest and/or tax expenses on Schedule A (this tax deduction is often missed). For example, if you rent your real estate out for 300 days in 2009 and you used it for 12 days, you would be fine as your personal use was less than 10% of the days it was available for rent (30 days in this case) or 15 days. All of the expenses would be deductible and a loss would be permitted, assuming you meet the income requirements. If you used it for 25 personal days, no loss would be permitted.

Rental Property Rented Less Than 14 Days Per Year

In this category, you are not permitted to deduct any expenses except for mortgage interest, taxes and possibly an uninsured casualty loss for the property. While this may sound like a bad deal, it is actually very good, as the flip side of this is that you are not required to report any of the rental income for this property.

It does not matter how much money you received for the rental income– it is not considered to be taxable income. This very favorable tax provision works well for many different locations in the United States. For instance, if you own a ski condominium in Colorado and rent it out over the Christmas or Spring Breaks, you can charge a premium rental amount and have no income to report on your tax return. The same can be said for special events (such as renting your home to spectators at sporting events, such as the World Series, golf tournaments, Olympics, etc.).

Conversion to Personal Residence

If you sell your rental property, you will almost certainly be subject to capital gains taxes and possibly the need to recapture any depreciation claimed on the property.

One possible way to save some dollars on taxes (although the depreciation recapture rules may still apply) is to covert your rental property into your personal residence before you make the sale. In order to do this, you will need to satisfy the “two years out of five years” rules for ownership and occupancy. If you can do this, you will avoid the capital gains taxes and be able to qualify for up to $500,000 of tax-free gains.

Real Estate and Tax Issues (Part 1)

At some point the economy will pick back up and real estate will again be an attractive investment (if it is not already). There are several different possible tax considerations that you should understand before you jump (back) into the real estate market.

Second Home Only

If you have purchased a second home and do not intend to rent it out, you are entitled to deduct the real estate taxes and mortgage interest you paid on this residence. These deductions are claimed on Schedule A in the same manner that the deductions for your personal residence are claimed. You are not entitled to claim deductions for any repairs or maintenance, or depreciation, although any capital expenditures (such as for repairs or maintenance) can be added to your cost basis and used to reduce the overall gain (or increase the loss) if and when you sell the property.

Property Used As A Rental

In this large category, you will obtain the most favorable tax breaks available to holders of real property. There are a few possibilities and these depend upon the amount of time that you personally use the property for non-rental uses.

No Personal Use Time

If you did not use the property for your own personal use (other than making repairs, painting, etc.), you will find yourself in the most favorable tax situation. All rental income and expenses, including advertising, repairs, interest, taxes, utilities, dues, etc. are deductible. However, the most favorable deduction is depreciation. This will, in many cases, cause the rental property to show a tax loss for the year, as this is not an out-of-pocket expense but rather is a “paper” tax deduction.

There are special rules for rental property losses, as rental properties are considered to be a “passive activity” in most cases and, as such, there are limitations on the amount of the loss that you are entitled to deduct.

In general, the maximum loss permitted in any given year is $25,000, and this loss is permitted only if your total income for 2009 is less than $100,000. If your income is between $100,000 and $150,000, the loss is reduced and for any income above $150,000, there is no loss permitted. However, if you are unable to use a loss due to your income, this loss can be carried forward until your income does permit you to use it. Thus, you do not lose this valuable tax loss but instead must wait for the right time to be able to claim it. This assumes you do NOT qualify as a real estate professional (no limits for a RE pro). If your property is treated as a rental property for tax purposes, all income and expenses are reported on Schedule E of your tax return.

Saturday, January 2, 2010

January Tax Tip

You are now permitted to make a direct rollover from your 401(k) plan at work to a Roth IRA (assuming your income is less than $100,000 per year and you do not file married separate).

This conversion is a taxable event (like a conversion from a regular IRA to a Roth IRA) and thus tax planning must be done before making the conversion, as you want to do this in a year in which the tax bills will be minimized to the extent possible.

All taxpayers will be able to do this beginning January 1, 2010, as the income limits are eliminated.