Penalty for Not Having Health Insurance Surprises Many

Many taxpayers are surprised by the size of the penalty being imposed for not having health insurance in 2015. This may be a wake-up call for many who didn’t realize the penalty is being phased in over a three-year period between 2014 and 2016, and the increases are substantial each year.

The penalty is determined by two methods, the flat dollar amount or a percentage of the taxpayer’s income, and the penalty is the GREATER of the two amounts.

The flat dollar amount is the sum of fixed dollar amounts for the year that apply to each member of the taxpayer’s family. However, there is a cap on the total flat dollar amount, which is equal to 3 times the adult penalty for the year. The table below shows the amount per family member and maximum flat dollar amounts for each of the three penalty phase-in years.

Year    2014 2015 2016
Adult Family Member $ 95.00 $325.00 $   695.00
Member Under Age 18 $ 47.50 $162.50 $   347.50
Maximum Flat Dollar Penalty $285.00 $975.00 $2,085.00

 

Example: Suppose, in 2015, a family of 3 (2 married adults and 1 child) all went without insurance for the entire year. Their flat dollar amount penalty would be $812.50 ($325 + $325 + 162.50).

 

The percentage-of-income penalty is a little more complicated, as the income used in the computation is the taxpayer’s household income reduced by the taxpayer’s tax return filing threshold for the year. Household income is the adjusted gross income from the tax returns for the year of all members of the taxpayer’s family who must file a tax return for income tax purposes.

The table below shows the percentage-of-income penalty for each of the three penalty phase-in years.

Year   2014 2015 2016
Percentage of income 1.0% 2.0% 2.5%

 

Example: Suppose the family in the previous example has a household income of $80,000 and their filing threshold is $20,600. Thus the income used in the computation would be $59,400 ($80,000 – $20,600), and the percentage-of-income penalty would be $1,188 ($59,400 x .02).

In our example, the taxpayer’s penalty for 2015 would be the greater of the two methods, which is $1,188. This substantially penalizes higher-income taxpayers, who can more readily afford health care insurance.

Another surprise to some taxpayers is that even if only one member of the family is uninsured, the percentage-of-income penalty applies if it is larger than the flat dollar amount for that one employee.

In closing, the penalties are actually computed by the month, so for example, if a taxpayer is uninsured for five months, then 5/12 of the penalty will apply.

If you have questions related to the penalty for not being insured or other tax provisions of the Affordable Care Act, please give the office a call.

Automatic Tax Filing Extensions Available

A taxpayer who needs more time to complete his or her 2015 individual tax return can request an automatic six-month extension. The extension is obtained by filing IRS Form 4868 on or before the April 18, 2016 deadline.

The extension gives the taxpayer until October 17, 2016 to file a return and avoid the late filing penalty. Normally these due dates fall on the 15th day of the month. However, when they fall on a holiday or a weekend, they are automatically extended to the next business day. April 15, 2016 falls on a Friday, but that is Emancipation Day, a holiday in the District of Columbia. Thus, the due date becomes Monday, April 18, even for taxpayers who don’t live in D.C. October 15, 2016 falls on a weekend, so the extended due date is Monday, October 17, 2016.

There are several issues you may need to consider when filing an extension:

  • Late Payment Penalty – The extension will give you extra time to file a tax return but not extra time to pay any taxes owed. If you end up owing when you do file your tax return, you will be subject to the late payment penalty of 0.5% per month (maximum 25%), plus interest on the unpaid amount. Thus, filing an extension but delaying payment can add a substantial amount to what is owed. The 4868 extension form includes the ability to make a payment toward one’s tax liability. To avoid substantial late payment penalties, it is generally a good idea to estimate your tax liability, including any shortfall in withholding or estimated tax prepayments, with Form 4868.
  • Taxpayers abroad – June 15, 2016 is the filing due date for U.S. citizens and resident aliens who live and work abroad, as well as for members of the military on duty outside the U.S. As a caution, note that even though these taxpayers are allowed two extra months to file a return, all their tax payments are still due on April 15. Interest will be charged from the April 18, 2016 due date until the date the tax is paid. This 2-month extension is not available to citizens and resident aliens who are merely traveling outside the country on the normal due date. Members of the military and others serving in combat zones have until 180 days after they leave those zones to file returns and pay any taxes due.
  • Retirement Plan Contributions – April 18, 2016 is the last day that 2015 contributions can be made to a Roth or traditional IRA, even if an extension is filed. However, 2015 contributions can be made to self-employment retirement plans through the October 17, 2016 extended due date.
  • Individual estimated tax payment – Taxpayers, especially those who have filed for an extension, are cautioned that the first installment of the 2016 estimated (ES) taxes is due on April 18, 2016. The first ES payment of the tax year is often overlooked by taxpayers who file extensions, which can lead to an underpayment penalty for that year.
  • Foreign Bank Account Reporting (FBAR) – Taxpayers with an ownership or signature authority over certain foreign accounts are required to file online with the Treasury Department on or before June 30, 2016. There are no extensions, and there are stiff penalties. Don’t be confused by the recently passed legislation that changes the FBAR filing due date to the same April due date as the individual tax return. That law does not take effect until 2017, at which time a provision for a 6-month extension will be included.

This office can project your 2015 tax liability to determine if a payment should be made with the extension; it can also file the extension form and, if required, prepare the first 2016 estimated tax payment voucher. Don’t procrastinate; the extension must be filed by April 18, 2016. If you have a FBAR filing requirement, this office can also assist you with that.

Must I, or Should I, File a Tax Return?

This is a question many taxpayers ask during this time of year, and the question is far more complicated than people believe. To fully understand, we need to consider that there are times when individuals are REQUIRED to file a tax return, and then there are times when it is to individuals’ BENEFIT to file a return even if they are not required to file.

When individuals are required to file:

  • Generally, individuals are required to file a return if their income exceeds their filing threshold, as shown in the table below. The filing thresholds are the sum of the standard deduction for individual(s) and the personal exemption for the taxpayer and spouse (if any).
  • Taxpayers are required to file if they have net self-employment income in excess of $400, since they are required to pay self-employment taxes (the equivalent to payroll taxes for an employee) when their net self-employment income exceeds $400.
  • Taxpayers must also file when they are required to repay a credit or benefit. For example, taxpayers who underestimated their income when signing up for health insurance on a government health insurance marketplace and received a higher advance premium tax credit than they were entitled to are required to repay part of it.
  • Filing is also required when a taxpayer owes a penalty, even though the taxpayer’s income is below the filing threshold. This can occur, for example, when a taxpayer has an IRA 10% early withdrawal penalty or the 50% penalty for not taking a required IRA distribution.

2015 – Filing Thresholds

 

Filing Status Age Threshold
Single Under Age 65
Age 65 or Older
$10,300
$11,850
Married Filing Jointly Both Spouses Under 65
One Spouse 65 or Older
Both Spouses 65 or Older
$20,600
$21,850
$23,100
Married Filing Separate Any Age   $4,000
Head of Household Under 65
65 or Older
$13,250
$14,800
Qualifying Widow(er)
with Dependent Child
Under 65
65 or Older
$16,600
$17,850

Consequences of Not Filing – If you have been procrastinating about filing your 2015 tax return or have other prior year returns that have not been filed, you should consider the consequences if you are REQUIRED file. The April 18 due date for the 2015 returns is just around the corner.

Failing to file a return or filing late can be costly. If taxes are owed, a delay in filing may result in penalty and interest charges that could substantially increase your tax bill. The late filing and payment penalties are a combined 5% per month (25% maximum) of the balance due.

April 18, 2016 is also the last day to file a 2012 return and be able to claim any refund you are entitled to.

Even if you expect to have a tax liability and cannot pay all the tax due, you should file your tax return by the due date to minimize penalties. When it is beneficial for individuals to file – There are a number of benefits available when filing a tax return that can produce refunds even for a taxpayer who is not required to file:

  • Withholding refund – A substantial number of taxpayers fail to file their returns even when the tax they owe is less than their prepayments, such as payroll withholding, estimates, or a prior overpayment. The only way to recover the excess is to file a return.
  • Earned Income Tax Credit (EITC) – If you worked and did not make a lot of money, you may qualify for the EITC. The EITC is a refundable tax credit, which means you could qualify for a tax refund. The refund could be as high as several thousand dollars even when you are not required to file.
  • Additional Child Tax Credit – This refundable credit may be available to you if you have at least one qualifying child.
  • American Opportunity Credit – The maximum credit per student is $2,500, and the first four years of postsecondary education qualify. Up to 40% of that credit is refundable when you have no tax liability and are not required to file.
  • Premium Tax Credit – Lower-income families are entitled to a refundable tax credit to supplement the cost of health insurance purchased through a government health insurance marketplace. To the extent the credit is greater than the supplement provided by the marketplace, it is refundable even if there is no other reason to file.

DON’T PROCRASTINATE!

There is a three-year statute of limitations on refunds, and after it runs out, any refund due is forfeited. The statute is three years from the due date of the tax return. So the refund period expires for 2015 returns, which are due in April of 2016, on April 15, 2019.

For more information about filing requirements and your eligibility to receive tax credits, please contact this office.

Don’t Have a Retirement Plan? Maybe a SEP Is the Answer

If you are like many small business owners, you probably find the year-end period to be a very busy time. You can’t close your books and determine your business’s profit until after the close of the year, and if this has been a good year, you may want to establish a retirement plan and make a contribution for 2015.

There are a number of retirement plan options available, including Keogh plans and 401(k)s. However, a simplified employee pension plan (SEP) may be your best option. Unlike with a Keogh plan, you don’t have to scramble to get a SEP established before year-end.

The reason a SEP is “simplified” is that its retirement contributions are deposited into an IRA account under the control of the SEP participant, thus eliminating most of the employer’s administrative duties. That is why these plans are sometimes referred to as SEP-IRAs.

Simplified Retirement Plan

SEPs function much like Keogh plans, and they allow tax-deductible contributions for both employees and self-employed individuals. For an employee, the maximum contribution for 2015 is the lesser of 25% of that employee’s compensation or $53,000. These contributions are excluded from the employees’ wages and are not subject to withholding for income tax or FICA. A self-employed person can contribute 25% of his or her compensation after deducting the employer’s contribution, which boils down to the smallest of 20% of the business’ net profit or $53,000. Each year, the employer can specify a compensation amount between zero and 25% (not exceeding the maximums for the year).

SEPs are a great option for startups and other small businesses that have unpredictable income and that may be leery of the long-term contribution matches required with other types of retirement plans. SEPs are also a great option for self-employed individuals with no employees, as the contributions are based upon net profits, allowing the business owner to select the maximum percentage while knowing that the required contribution will be small in low-income years.

Except for when employees are covered by collective bargaining agreements, an employer that elects to make a SEP contribution for the year must contribute to an employee’s retirement account if the employee is at least 21 years of age, has worked for the employer in at least three of the prior five calendar years, and has compensation for the year of at least $600.

Another advantage of SEP plans is that contributions are allowed after the account owner has reached the age of 70½—the age limit for traditional, non-SEP IRA contributions. This is true even though individuals must begin the required minimum distributions (RMDs) from the SEP once age 70½ is reached.

As with all traditional IRAs and qualified plans, distributions from a SEP are taxable and subject to a 10% early withdrawal penalty if withdrawn before age 59½.

To set up a SEP plan, you can adopt the IRS model plan by using Form 5305-SEP. This form is completed and retained for your records (not filed with the IRS). You can also open one with a financial institution. It may be prudent to adopt whatever plan is offered by the financial institution you’ll be dealing with to ensure that all plan requirements are met. If using a financial institution’s plan, be sure to discuss the plan’s fees.

A SEP may be the best option for your business’s retirement fund. Please call this office for more information on how a SEP plan might work for your particular business structure or to determine whether other options should be considered.

Can You Deduct Employee Expenses?

If you are an employee, you may be curious about which expenses relating to your employment are deductible on your tax return. This is a complicated area of tax law, and many expenses are deductible only if the expense is a “condition of employment” or is for the “convenience of the employer,” two phrases that are effectively the same.

Deducting Employee Expenses

In addition, other factors affect an employee’s ability to deduct expenses incurred as part of employment:

  1. If an employer would have paid for or reimbursed the employee for an expense, but the employee chooses not to apply for or take advantage of that reimbursement, the employee cannot take a tax deduction for the expense.
  2. Only those employees who itemize their deductions can benefit from business expense deductions. Thus, if you are using the standard deduction, you cannot receive any tax benefit for your job-related expenses. In addition, even when itemizing, miscellaneous itemized deductions must be reduced by 2% of your adjusted gross income (AGI). Employee business expenses fall into the miscellaneous itemized deduction category. As an example: if your AGI is $80,000, the first $1,600 (2% x AGI) of your miscellaneous deductions provide no benefit.
  3. Miscellaneous deductions are not included in the itemized deductions allowed for computing the alternative minimum tax (AMT). Thus, if you are unlucky enough to be subject to the AMT, you will not benefit from your miscellaneous deductions for the extent of the AMT.

The following includes a discussion of the various expenses that an employee might feel they are entitled to deduct and the IRS’s requirements for those deductions.

  • Home Office – An employee can deduct a home office only if his or her use of the home office is for the convenience of the employer. According to the U.S. Tax Court, an employee’s use of a home office is for the convenience of his employer only if the employee must maintain the home office as a condition of employment. In an audit, the auditor will require a letter from the employer to verify that fact. Most employers are reluctant to make a home office a condition of employment due to labor laws and liability. In addition, an employee would also have to comply with the IRS’s strict usage requirements for home offices.
  • Computer – An individual’s property, such as computers, TVs, recorders, and so on, that is used in connection with his or her employment is eligible for expense or depreciation deductions only if that property is required for the convenience of the employer and as a condition of employment. Even if the condition of employment requirement is satisfied, a computer’s usage must be prorated for personal and business use.
  • Uniforms and Special Work Clothes – The cost and maintenance of clothing is allowed if:(1) The employee’s occupation is one that specifically requires special apparel or equipment as a condition of employment and(2) The special apparel or equipment isn’t adaptable to general or continued usage (so as to take the place of ordinary clothing).Generally, items such as safety shoes, helmets, fishermen’s boots, work gloves, oil clothes, and so on are deductible if required for a job. However, other work clothing and standard work shoes aren’t deductible—even if the worker’s union requires them.
  • Education – To qualify as job-related, courses must maintain or improve the skills required by the employee’s trade or business (such as by helping the employee to meet professional continuing education requirements) or be required as a condition of employment. However, these courses must not be necessary to meet the minimum requirements of the job and must not qualify the employee for a new trade or promotion. If a course meets this definition, its cost is considered deductible as an ordinary and necessary business expense, and as such, it may be excluded from an employee’s income if the employer reimburses the employee for its cost. Note: Some education expenses may qualify for more beneficial education credits or an above-the-line-deduction.
  • Impairment-Related Work Expenses – Taxpayers who have a physical or mental disability that limits their activities can deduct impairment-related work expenses. For example, an allowable expense would be the cost of attendant care at the place of the taxpayer’s work.
  • Job-Search Expenses – Expenses related to looking for a new job in the taxpayer’s current occupation are deductible even if a new job is not obtained. To be deductible, the expenses cannot be related to seeking a first job or a job in a new occupation. If there is a substantial time gap between the taxpayer’s last job and the time when he or she looks for a new job, the expenses are not deductible.

Of course, all sorts of employee situations exist, including those in which the employee works at his or her local employer’s office and those in which the employee lives and works in a remote location. The deductions available to each employee vary significantly based upon that individual’s unique situation.

For more information related to employee expenses and what might be deductible in your situation, please give this office a call.

Minimizing Tax on Social Security Benefits

Whether your Social Security benefits are taxable (and, if so, how much of them are) depends on a number of issues. The following facts will help you understand the taxability of your Social Security benefits.

  • For this discussion, the term “Social Security benefits” refers to the gross amount of benefits you receive (i.e., the amount before reduction due to payments withheld for Medicare premiums). The tax treatment of Social Security benefits is the same whether the benefits are paid due to disability, retirement or reaching the eligibility age. Supplemental Security Income (SSI) benefits are not included in the computation because they are not taxable under any circumstances.
  • How much of your Social Security benefits are taxable (if any) depends on your total income and marital status.

    o If Social Security is your only source of income, it is generally not taxable.

    o On the other hand, if you have other significant income, as much as 85% of your Social Security benefits can be taxable.

    o If you are married and filing separately, and you lived with your spouse at any time during the year, 85% of your Social Security benefits are taxable regardless of your income. This is to prevent married taxpayers who live together from filing separately, thereby reducing the income on each return and thus reducing the amount of Social Security income subject to tax.

  • The following quick computation can be done to determine if some of your benefits are taxable:

    Step 1. First, add one-half of the total Social Security benefits you received to the total of your other income, including any tax-exempt interest and other exclusions from income.

    Step 2. Then, compare this total to the base amount used for your filing status. If the total is more than the base amount, some of your benefits may be taxable.

The base amounts are:

  • $32,000 for married couples filing jointly;
  • $25,000 for single persons, heads of household, qualifying widows/widowers with dependent children, and married individuals filing separately who did not live with their spouses at any time during the year; and
  • $0 for married persons filing separately who lived together during the year.

Where taxpayers can defer their “other” income from one year to another, such as by taking Individual Retirement Account (IRA) distributions, they may be able to plan their income so as to eliminate or minimize the tax on their Social Security benefits from one year to another. However, the required minimum distribution rules for IRAs and other retirement plans have to be taken into account.

Individuals who have substantial IRAs—and who either aren’t required to make withdrawals or are making their post age 70.5 required minimum distributions without withdrawing enough to reach the Social Security taxable threshold—may be missing an opportunity for some tax-free withdrawals. Everyone’s circumstances are different, however, and what works for one may not work for another.

If you have questions about how these issues affect your specific situation, or if you wish to do some tax planning, please give this office a call.

Deducting Startup Costs for Your New Business at Tax Time

Before you earn your first dollar, before you are even open for business, your startup can incur considerable expenses. The money you spend opening your business can often be deducted; the IRS allows you to deduct many of these one-time startup costs. Speaking with an accountant in the early stages can help you decide which of these deductions to take – and may also help you discover additional ways to save money as you operate your new startup. There are several types of startup costs that may be deductible for your new business.

Preparing your business

The costs associated with training employees, hiring consultants, early advertising and marketing to generate interest, and even the costs associated with sourcing suppliers and locations can all be deducted. If you have to hire and train employees to work in your business, but are not yet open to customers, then you can usually deduct these costs at tax time. If you are researching the feasibility of a business, testing the market, creating prototypes or analyzing production costs, these expenditures are generally deductible as well for your startup. These costs count only if you actually begin a business.

If you research or dabble and then change your mind, you usually cannot deduct these costs.

Organizational costs

If you are incorporating, setting up a partnership or incurring expenses as you legally set up your new business, you can likely deduct these costs as well. Incorporation fees, legal fees, accounting fees and filing fees can often be deducted from your first year costs but may also be amortized over the lifetime of your business. An accounting professional can help you learn more about your options and discover which method is best for your particular circumstances.

What about equipment costs?

From kitchen appliances to office equipment and even machinery, you’ll likely have to spend some cash to get up and running, but your equipment purchases are not deductible as part of your startup and cannot be deducted until actually placed in business service (use). Thus the equipment you buy to use when your business becomes operational is not included in the startup costs by the IRS; these items are generally considered assets, and must be capitalized and depreciated or written off in the first year using the Sec 179 expense deduction.

How much of your startup costs can be deducted?

While the IRS does allow you to deduct some startup costs, there are limits to what you can deduct in your first year. For most entrepreneurs with startup costs of $50,000 or less, up to $5,000 in startup costs and $5,000 of organizational expenses can be deducted in the first year. Each of the $5,000 amounts is reduced by the amount by which the total start-up expense or organizational expense exceeds $50,000. Startups with more than $55,000 in costs won’t be able to claim either $5,000 deduction in the first year. Start-up and organizational expenses not deductible in the first year of the business must be amortized over 15 years.

A professional familiar with startups can help you determine which of your costs can be deducted and help you find the right path for your new business. The decisions you make as you start your business will have a long-term impact on your operating costs and bottom line for years to come; choose wisely at the outset for the best possible start for your new company.

Tax Filing Deadline Rapidly Approaching

Just a reminder to those who have not yet filed their 2015 tax return that April 18, 2016 is the due date to either file your return and pay any taxes owed, or file for the automatic six-month extension and pay the tax you estimate to be due. Usually April 15 is the due date, but because Friday, April 15, is a legal holiday in the District of Columbia (where the IRS is headquartered), the filing date is advanced to the next day that isn’t a weekend or holiday – Monday, April 18 – even for taxpayers not living in DC.

In addition, the April 18, 2016 deadline also applies to the following:

  • Tax year 2015 balance-due payments – Taxpayers that are filing extensions are cautioned that the filing extension is an extension to file, NOT an extension to pay a balance due. Late payment penalties and interest will be assessed on any balance due, even for returns on extension. Taxpayers anticipating a balance due will need to estimate this amount and include their payment with the extension request.
  • Tax year 2015 contributions to a Roth or traditional IRA – April 18 is the last day contributions for 2015 can be made to either a Roth or traditional IRA, even if an extension is filed.
  • Individual estimated tax payments for the first quarter of 2016 – Taxpayers, especially those who have filed for an extension, are cautioned that the first installment of the 2016 estimated taxes are due on April 18. If you are on extension and anticipate a refund, all or a portion of the refund can be allocated to this quarter’s payment on the final return when it is filed at a later date. If the refund won’t be enough to fully cover the first installment, you may need to make a payment with the April 18 voucher. Please call this office for any questions.
  • Individual refund claims for tax year 2012 – The regular three-year statute of limitations expires on April 18 for the 2012 tax return. Thus, no refund will be granted for a 2012 original or amended return that is filed after April 18. Caution: The statute does not apply to balances due for unfiled 2012 returns.

Note: The deadline for any of the above actions is increased by an additional day, to April 19, 2016, for taxpayers who live in Maine or Massachusetts because of a holiday observed on the 18th in Massachusetts which affects the IRS Service Center located in Massachusetts that serves these two states.

If this office is holding up the completion of your returns because of missing information, please forward that information as quickly as possible in order to meet the April 18 deadline. Keep in mind that the last week of tax season is very hectic, and your returns may not be completed if you wait until the last minute. If it is apparent that the information will not be available in time for the April 18 deadline, then let the office know right away so that an extension request, and 2016 estimated tax vouchers if needed, may be prepared. If your returns have not yet been completed, please call right away so that we can schedule an appointment and/or file an extension if necessary.