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.

Not All Home Mortgage Interest Is Deductible

One of the current IRS audit initiatives is checking to see if taxpayers are deducting too much home equity debt interest. Generally, taxpayers are allowed to deduct the interest on up to $1 million of home acquisition debt (includes subsequent debt incurred to make improvements, but not repairs) and the interest on up to $100,000 of home equity debt. Equity debt is debt not incurred to acquire or improve the home. Taxpayers frequently exceed the equity debt limit and fail to adjust their interest deduction accordingly.

The best way to explain this interest deduction limitation is by example. Let’s assume you have never refinanced the original loan that was used to purchase your home, and the current principal balance of that acquisition debt is less than $1 million. However, you also have a line of credit on the home, and the debt on that line of credit is treated as equity debt. If the balance on that line of credit is $120,000, then you have exceeded the equity debt limitation and only 83.33% ($100,000/$120,000) of the equity line interest is deductible as home mortgage interest on Schedule A. The balance is not deductible unless you can trace the use of the excess debt to either investment or business use. If traceable to investments, the interest you pay on the amount traceable would be deductible as investment interest, which is also deducted on Schedule A but is limited to an amount equal to your net investment income (investment income less investment expenses). If the excess debt was used for business, you could deduct the interest on that excess debt on the appropriate business schedule.

Alternatively, the IRS allows you to elect to treat the equity line debt as “not secured” by the home, which would allow the interest on the entire equity debt to be traced to its use and deducted on the appropriate schedule if deductible. For instance, you borrow from the equity line for a down payment on a rental. If you make the “not secured” election, the interest on the amount borrowed for the rental down payment would be deductible on the Schedule E rental income and expense schedule and not subject to the home equity debt limitations.

However, one of the rules that allows home mortgage interest to be deductible is it must be secured by the home, and if the unsecured election is used, none of the interest can be traced back to the home itself. So, for example, if the equity line was used partly for the rental down payment and partially for personal reasons, the interest associated with the personal portion of the loan would not be deductible since you elected to treat it as not secured by your home.

Using the unsecured election can have unexpected results in the current year and in the future. You should use that election only after consulting with this office.

Generally, people not familiar with the sometimes complicated rules associated with home mortgage interest believe the interest shown on the Form 1098 issued by their lenders at the end of the year is fully deductible. In many cases when taxpayers have refinanced or have equity loans, that may be far from the truth and could result in an IRS inquiry and potential multi-year adjustments. In fact, for Forms 1098 issued after 2016 (thus effective for 2016 information), the IRS will be requiring lenders to include additional information, including the amount of the outstanding mortgage principal as of the beginning of the calendar year, the mortgage origination date and the address of the property securing the mortgage, which will provide the IRS with additional tools for audits.

When in doubt about how much interest you can deduct or if you have questions about how refinancing or taking on additional home mortgage debt will impact your taxes, please call this office for assistance.

All You Need to Know about the New Tax Extender Legislation

Congress has reached a bipartisan agreement on tax extenders, aptly named “Protecting Americans from Tax Hikes Act of 2015”. Much to everyone’s surprise, some were made permanent while others were only extended for a period of time. Congress also modified several provisions and added new ones to reduce tax fraud. Here is a look at some of the key provisions included in the legislation that pertain to individuals, small businesses, and certain energy-related provisions:

INDIVIDUAL PROVISIONS:

  • Child Credit – This credit was made permanent; it provides a $1,000 credit for each dependent child who is under the age of 17 at year’s end, who lived with the taxpayer for over half of the year and who meets the relationship test. The credit phases out for higher-income taxpayers, and a portion of the credit is refundable for lower-income taxpayers. The changes also include program integrity provisions that prohibit an individual from retroactively claiming the child credit by amending a return (or filing an original return if he or she failed to file) for any prior year in which the individual for whom the credit is claimed did not have an ITIN – generally a Social Security number). After 2015, when a taxpayer improperly claims the credit, the legislation includes a disallowance period when no credit is allowed. For fraud, the disallowance period is 10 years, and for reckless or intentional disregard of rules and regulations, the disallowance period is 2 years.
  • American Opportunity Credit (AOTC) – This credit, which was due to expire after 2017, has been made permanent. This is a tax credit equal to 40% of the cost of tuition and qualifying expenses for higher education, with a maximum credit of $2,500. The credit applies to 100% of the first $2,000 and 25% of the next $2,000 of qualifying expenses. The credit offsets any tax liability, and 40% of the credit is refundable even if the taxpayer does not have any tax liability. It also phases out between $160,000 and $180,000 for married taxpayers filing jointly and between $80,000 and $90,000 for others – except for married taxpayers filing separately, who get no credit.After 2015, when a taxpayer improperly claims the credit, the legislation includes a disallowance period when no credit is allowed. For fraud, the disallowance period is 10 years, and for reckless or intentional disregard of rules and regulations, the disallowance period is 2 years.A provision was added that prohibits an individual from retroactively claiming the AOTC by amending a return or filing a late original return for any prior year when the individual or a student for whom the credit is claimed did not have an ITIN (generally a Social Security number).
  • Earned Income Tax Credit (EITC) – The EITC is a refundable credit allowed to certain low-income workers who have W-2 wages and self-employed income. The credit is larger for taxpayers with children. The credit for taxpayers with children is based upon the number of children; those with three or more children receive the highest credit – as much as $6,269 in 2015. The higher credit for three or more children, which was a temporary provision that was set to expire after 2017, has been made permanent.The changes also include added program integrity provisions that prohibit an individual from retroactively claiming the AOTC by amending a return (or filing an original return if the individual failed to file) for any prior year in which the individual for whom the credit is claimed did not have an ITIN (generally a Social Security number). The changes also reduced the marriage penalty by increasing the income phase-out for those filing jointly.
  • Teachers’ $250 Above-the-Line Deduction – This provision, which was available from 2002 through 2014, allows teachers and other eligible educators (levels kindergarten through grade 12) to take an above-the-line deduction of up to $250 for unreimbursed expenses incurred as part of their educational work. This deduction has been made permanent and modified by adjusting the $250 for inflation in years after 2015. In addition, professional development expenses were added to the qualified expenses allowed as part of the $250 deduction.
  • Transit Pass & Parking Fringe Benefit Parity – From 2010 through 2014, the monthly exclusion amount for employer-paid transit passes and qualified parking were temporarily the same. The parity of these two fringe benefits has been made permanent. Thus, for 2015 they will both be $250.
  • Optional Deduction of State and Local General Sales Taxes – Since 2004, taxpayers who itemized their deductions have had the option to deduct the Larger of (1) state and local income tax paid during the year, or (2) state and local sales tax paid during the year. This provision, which had been previously extended through 2014, provides the greatest benefit to those taxpayers who reside in a state that has no income tax (which include Alaska, Florida, Nevada, South Dakota, Texas, Washington and Wyoming). This election has been made permanent.
  • Above-the-Line Deduction for Qualified Tuition and Related Expenses – This above-the-line deduction for qualified higher education tuition and related expenses had been available from 2002 through 2014. The deduction includes adjusted gross income (AGI) limitations; it is not allowed for joint filers with an AGI of $160,000 or more ($85,000 for other filing statuses). This deduction has been retroactively extended through 2016.
  • Tax-Free IRA Distributions For Charitable Purposes – This provision was temporarily added in 2004 and originally expired in 2011; it was not extended until late in the year during the years 2012, 2013 and 2014, thus limiting its application in those three years. The provision allows taxpayers age 70.5 and over to directly transfer (not rolled over) funds from their IRA accounts to a qualified charity. The distribution is not taxable, but it does count toward the individuals’ required minimum distribution (RMD) for the year. The maximum allowable transfer is $100,000 per year. No charitable deduction is allowed, as the distribution is not taxable. This provision has been made permanent; it provides four potential tax advantages:
    1. The distribution is not included in income, thus lowering the taxpayer’s AGI, which in turn helps to avoid various AGI phase-outs and limitations.
    2. Keeping the AGI lower also helps to minimize the amount of Social Security income that is subject to tax for some taxpayers.
    3. Taxpayers using the standard deduction cannot get a charitable deduction, but they are essentially deducting the charitable deduction from their gross income when making contributions this way.
    4. The transferred distribution counts towards the taxpayer’s RMD for the year.
  • Discharge of Qualified Principal Residence Indebtedness – When an individual loses his or her home to foreclosure, abandonment or short sale or has a portion of his or her loan forgiven under the HAMP mortgage reduction plan, that person generally will end up with cancellation of debt (COD) income. COD income is taxable unless the taxpayer can exclude it. A taxpayer can exclude the COD income in the extent that he or she is insolvent (with debts exceeding assets immediately before the event occurs) using the insolvency exclusion.Due to the housing market crash, in 2007, Congress added the qualified principal residence COD exclusion, which allowed taxpayers to exclude COD income to the extent that it was discharged acquisition debt. Acquisition debt is debt originally incurred to acquire a home or substantially improve it – not debt used for other purposes, which is called equity debt. However, equity debt is deemed to be discharged first, thus limiting the exclusion when both equity and acquisition debt are involved in the transaction.The qualified principal residence COD exclusion had been previously extended but had expired at the end of 2014. This exclusion has been retroactively extended through 2016 (a two-year extension).
  • Mortgage Insurance Premiums – For tax years 2007 through 2014, taxpayers could deduct (as an itemized deduction) the cost of premiums for qualified mortgage insurance on a qualified personal residence (first or second home). To be deductible, the premiums must have been related to acquisition debt incurred after Dec. 31, 2006. However, this deduction phases out for higher-income taxpayers (generally those whose AGI exceeds $100,000). This provision, which had expired after 2014, has been retroactively extended through 2016, a two-year extension.

BUSINESS PROVISIONS:

  • Research Credit – Tax law provides a tax credit of up to 20% of qualified expenditures for businesses that develop, design or improve products, processes, techniques, formulas or software (and similar activities). The credit has been available off and on since 1981 without being made permanent. It had been extended several times but had expired at the end of 2014. This credit has been retroactively made permanent. In addition, it is not a tax preference for small businesses.
  • 100% Exclusion of Gain – Certain Small Business Stock – Previously, for stock issued after September 27, 2010, and before January 1, 2015, non-corporate taxpayers could exclude 100% of any gain realized on the sale or exchange of “qualified small business stock” held for more than 5 years. In addition, there was no alternative minimum tax (AMT) preference when the exclusion percentage was 100%. Generally, the term “qualified small business” means any domestic C corporation with assets of $50 million or less. This provision has been made permanent.
  • Differential Wage Payment Credit – Through 2014, eligible small business employers – generally those that have an average of fewer than 50 employees and that pay a individual called into active duty military service all or part of the wages that they would have otherwise received from the employer – can claim a credit. This differential wage payment credit is equal to 20% of up to $20,000 of differential pay made to an employee during the tax year. This credit has been retroactively made permanent; for years after 2015, the credit will apply to any size employer.
  • Work Opportunity Tax Credit (WOTC) – Through 2014, employers could elect to claim a WOTC for up to 40% of employees’ first-year wages for hiring workers from targeted groups – not exceeding wages of $6,000 (a maximum credit of $2,400). First-year wages are wages paid during the tax year for work performed during the one-year period beginning on the date when the employee begins work for the employer. This credit has been retroactively extended for five years through 2019; it applies to veterans and non-veterans and adds qualified long-term unemployment recipients to the list of targeted groups for years after 2015.
  • Section 179 Election – Since 2003, the Section 179 election has been temporarily increased from its statutory limit of $25,000 to between $100,000 and $500,000. Since 2010, the expense cap has been $500,000 (or $250,000 on a married-filing-separate tax return), and the investment limit has been $2 million. However, the last extension expired after 2014; without an extension, the cap would have returned to the statutory $25,000 limit in 2015. The statutory expensing limit of $500,000 and the $2 million investment limit have both been made permanent.The application of the Section 179 election to “off-the-shelf” computer software, qualified leasehold improvements, qualified restaurant property and qualified retail improvements has also been made permanent.
  • Leasehold and Retail Improvements and Restaurant Property – The class life for qualified leasehold and retail Improvements and restaurant property had been temporarily included in the 15-year depreciation class life, as opposed to the 31-year category. Qualified leasehold and retail Improvements and restaurant property have been retroactively and permanently included in the 15-year MACRS class life.
  • Bonus Depreciation – As a means of stimulating the economy, a 50 percent bonus depreciation was temporarily implemented in 2008 and subsequently extended through 2014. For the period between September 8, 2010, and before January 1, 2012, it was even boosted to 100 percent. Bonus depreciation applies to personal tangible property placed in service during the year for which the original use began with the taxpayer.The 50% bonus depreciation has been extended for 2 years (through 2016) for property placed in service before January 1, 2017. This generally applies to property with a class life of 20 years or less, to qualified leasehold improvements and to certain plants bearing fruits and nuts that are planted or grafted before January 1, 2020.
  • Enhanced First – Year Depreciation for Autos and Trucks – This is the so-called “luxury limit” on the deprecation deduction of passenger automobiles and light trucks used for business. For such vehicles placed in service in 2015, the limits are $3,160 and $3,460, respectively. In the past, the bonus depreciation had increased the first-year luxury limits by $8,000. Under the new law, the bonus depreciation applicable to luxury vehicles will be phased out through 2019. Thus, the luxury auto rates will be increased by the following bonus depreciation rates: $8,000 for 2015 through 2017, $6,000 for 2018 and $4,800 for 2019.

ENERGY PROVISIONS:

  • Residential Energy (Efficient) Property Credit – From 2006 through 2014, a nonrefundable credit had been available for qualified improvements to make the taxpayer’s existing primary home more energy efficient. Qualified improvements generally included insulation, storm windows and doors certain types of energy-efficient roofing materials, and energy-efficient air conditioning and hot-water systems. The credit was equal to 10% of the improvement’s cost (not including installation), with a lifetime credit of $500. The credit has been retroactively extended through 2016 (two years).
  • Credit for Fuel-Cell Vehicles – Through 2014, a taxpayer could claim a credit for vehicles fueled by chemically combining oxygen with hydrogen to create electricity. Generally, the credit was $4,000 for vehicles weighing 8,500 pounds or less (and up to $40,000 for heavier vehicles, depending on their weight). An additional $1,000 to $4,000 credit was available for cars and light trucks to the extent that their fuel economy exceeded the 2002 base fuel economy set forth in the Internal Revenue Code. This credit has been retroactively extended for two years through 2016.

If you have questions related to these or other, less commonly encountered provisions of the new law (Protecting Americans from Tax Hikes Act of 2015), please give this office a call. Benefiting from these provisions for 2015 will require taking action before year’s end. Please call if you need assistance.

Will the Interest on Your Vehicle Loan be Deductible?

Whether or not the interest you pay on a loan to acquire a vehicle is deductible for tax purposes depends how the vehicle is being used (for business or personal purposes), the tax form on which the expenses are being deducted, and the type of loan.

If the loan were a consumer loan secured by the vehicle, then the following rules would apply:

  • If the vehicle is being used partially for business and the expenses are being deducted on your self-employed business schedule, then the business portion of the interest will be deductible as business interest, but the personal portion will not.
  • If the vehicle is being used partially for business as an employee and the expenses are being deducted as an itemized deduction, then neither the business portion nor the personal portion of the interest will be deductible.
  • If the vehicle is entirely for personal use, then none of the interest will be deductible, because the only interest that is still deductible as an itemized deduction is home mortgage interest and investment interest.

 

As an alternative to a nondeductible consumer loan, you might consider acquiring that vehicle with a home equity line of credit. Generally, current law allows individual taxpayers to borrow up to $100,000 of home equity and deduct the interest on that loan as home mortgage interest. This would also apply to the purchase of a vehicle or motor home. Using a home equity line will generally make the interest deductible.

Before borrowing against the home, you should consider the following:

  • Treat the home equity loan like a consumer loan and pay it off over the same period of time you would have had to pay the consumer loan. Otherwise, you may reach retirement age without having the home paid for.
  • When buying a car, you can sometimes get very favorable interest rates or a rebate.

 

To determine which is best, compare the difference in total loan payments over the life of the loans to the rebate amount.

  • It is also good practice to make sure the benefit of making the interest deductible is greater by using the home equity line of credit than the benefit of the low interest consumer loan or the rebate.
  • If there is any chance of defaulting on the loan, the repercussions from defaulting on a home loan are far more serious than on consumer debt.

 

If you need assistance in deciding on a course of action, please call our office.

President’s Budget Proposal

The President’s Fiscal Year 2016 Budget Proposal was just released and includes a number of tax proposals that would increase the taxes on higher-income taxpayers and provide more tax breaks for low- to middle-income taxpayers. The following are some highlights of the budget proposal that would impact individuals and small businesses, but remember these are proposals only.

Business Provisions

  • Section 179 Expensing – Would make the Sec. 179 expense cap $500,000 for 2015 (it is currently at $25,000, down from $500,000 in 2014). Would raise the expense cap to $1 million in 2016 and make the $1 million permanent with inflation adjustment for future years.
  • Cash Basis Accounting – Would expand use of the cash method of accounting to small businesses with less than $25 million in average annual gross receipts, estimated to apply to 99% of all businesses.
  • Qualified Small Business Stock – Would permanently extend the 100% exclusion on capital gains from sales of tax-qualified small business stock held by individuals for more than five years, and would eliminate the inclusion of excluded gain from the Alternative Minimum Tax.
  • Start-Up & Organizational Expenses – Would increase and consolidate the deduction for start-up and organizational expenditures.
  • Small Employer Health Insurance Credit – Would expand the credit for small employers to provide health insurance to apply to up to 50 (rather than 25) full-time equivalent employees, with phaseout between 20 and 50 employees (rather than between 10 and 25).
  • Mandatory Employer IRA Payroll Deductions – Would require employers with 10 or more employees who don’t have a 401(k) plan to automatically enroll full-time and part-time employees in an optional IRA payroll deduction plan.

 

Individual Provisions 

  • Child Care – Would allow a credit of up to $3,000 (50% credit for up to $6,000 of expenses per child) for each child under the age of 5 to enable gainful employment of the parent(s) or other qualified taxpayer. The regular credit for those ages 5 through 12 would also begin to phase out at $120,000 (instead of $15,000 under current law). Flexible spending accounts for child care would be eliminated.
  • Second Earner Tax Credit – Would provide a new tax credit up to $500 (5% of the first $10,000 of earnings for the lower-earning spouse) for joint filers with two wage earners. The credit would begin to phase out at income of $120,000 and would be fully phased out when family income reaches $210,000. It is estimated that this new credit would benefit 24 million joint filers.
  • Earned Income Tax Credit (EITC) – Would double the EITC for workers without a child and increase the credit applicability for childless workers with earnings up to 150% of the federal poverty level (currently about 125%). Would expand the applicability of the EITC to workers age 21 to 66 (currently 24 to 64).
  • Education Tax Benefits – The American Opportunity Tax Credit (AOTC) would be expanded to cover five years of post-secondary education, and the current $2,500 tax credit would be adjusted for inflation. The refundable portion of the AOTC would be increased to $1,500. Part-time students would be eligible for a $1,250 AOTC (up to $750 refundable). Duplicative and less effective provisions, including the Lifetime Learning Credit, the tuition and fees deduction, the student loan interest deduction (for new borrowers), and Coverdell accounts (for new contributions) would be repealed or allowed to expire. The credit would also be better coordinated with Pell Grants.
  • Top Capital Gains Rate – Would raise the top effective capital gains and qualified dividends tax rate to 28% (24.2% plus the 3.8% net investment income tax). For couples, the 28% rate would apply where income is more than $500,000 annually.
  • Itemized Deductions – Would limit to 28% the value of itemized deductions and other tax preferences for married taxpayers with incomes over $250,000 and individual taxpayers with income over $200,000. The limit would apply to all itemized deductions as well as other tax benefits, such as tax-exempt interest and tax exclusions for retirement contributions and employer-sponsored health insurance.
  • Limit Retirement Account Contributions – Would prohibit contributions to and accruals of additional benefits in tax-preferred retirement plans and IRAs once balances are about $3.4 million, which is about enough to provide an annual income of $210,000 in retirement.
  • Buffett Rule – Would implement the “Buffett Rule.” This rule, which is a carryover from prior year budget proposals, would require the wealthy to pay at least a 30% effective tax rate.

 

Gift & Inheritance Tax Provisions

  • Inheritances and Gifts – Would eliminate the current step-up in tax basis at death and require payment of capital gains tax on the increase in value of securities at the time they are inherited. Generally, a $100,000-per-person, portable-between-spouses exclusion would apply for inherited appreciated assets, along with exceptions for surviving spouses, small businesses, charities, and residences, among others. For couples, no tax would be due until the death of the second spouse. No tax would be due on inherited small, family-owned-and-operated businesses unless and until the business was sold, and any closely held business would have the option to pay tax on gains over 15 years. Couples would have an additional $500,000 exemption for personal residences ($250,000 per individual), with this exemption also automatically portable between spouses. Tangible personal property other than expensive art and similar collectibles – e.g., bequests or gifts of clothing, furniture, and small family heirlooms – would be tax-exempt.
  • Inheritance and Gift Tax – Would reinstate the prior, 2009, estate and gift tax rates with lower exclusions (generally at 45% at $3.5 million for estates and $1 million for gifts).

 

These are all proposals by the Obama administration and must be approved by Congress. The information is being passed along so you will have an idea of what might happen in the future.

Refinanced Mortgage Interest May Not All Be Deductible

Mortgage interest rates continue to be low, and home values are on the uptick. If you are considering a refinance, there are some important home mortgage interest rules you should be aware of.

Generally, the mortgage interest that you may deduct on your home includes the interest paid on the acquisition debt and on up to $100,000 of equity debt, provided the combined debt does not exceed the lesser of the value of the home or $1,100,000. Acquisition debt is the debt incurred to buy the home or substantially improve it, while equity debt is funds borrowed against the home for other uses.

A big problem arises when taxpayers fail to consider that acquisition debt steadily declines over the life of the loan. So, for example, if the original acquisition debt was $400,000 and you refinance 15 years later, the acquisition debt has probably been paid down to somewhere around $300,000. In this case, if the loan was refinanced for $475,000, the refinanced debt would be allocated $300,000 to acquisition debt, $100,000 to equity debt and $75,000 to debt for which the interest would not be deductible as home mortgage interest. In this case, the interest paid on the $300,000 acquisition debt and the $100,000 equity debt would be deductible as home mortgage interest. If the use of the $75,000 can be traced to another deductible use (e.g., purchase of taxable investments or expenses related to operating a business), then the interest on the $75,000 loan would be deductible per the limitations of the other deductible use. If the use of the $75,000 cannot be traced to an interest-deductible use, then the interest would not be deductible.

In the example above, the interest would be allocated as follows: 63.15% as acquisition debt interest, 21.05% as equity debt interest and 15.79% as interest not deductible as home mortgage interest. The result would be different if some or all of the new loan in excess of the $300,000 acquisition debt was used to make improvements to the home. For example, say that $125,000 of the new loan was used to add a bedroom and bathroom to the home. This increases the home acquisition debt to $425,000, leaving $50,000 as equity debt, and the interest would all be deductible because the equity debt amount would then be under $100,000.

If you have already refinanced or are thinking of doing so, it is imperative that you retain a record of the terms of the original acquisition debt in case you exceed the debt limitation and need to prorate your interest deduction.

When refinancing, you also need to watch out for the alternative minimum tax (AMT). The AMT is another way of computing tax liability that is used if it is greater than the regular method. Congress originally conceived the AMT as a means of extracting a minimum tax from high-income taxpayers who have significant items of tax shelter and/or tax-favored deductions. Since the AMT was created, inflation has driven up income and deductions so that more individuals are becoming subject to the AMT.

When computing the AMT, only the acquisition debt interest is allowed as a deduction; home equity debt interest is not. Neither is the interest on debt for unconventional homes such as boats and motor homes, even if they are the primary residence of the taxpayer.

Before you refinance a home mortgage, it may be appropriate to contact this office to determine the tax implication of your planned refinance and see if there are any other suitable alternatives.

Getting the Most Out of Employee Business Expense Deductions

Individuals can deduct as miscellaneous itemized deductions certain expenses that they incur in the course of their employment. Generally, qualified business expenses are un-reimbursed expenses that are both ordinary (common and accepted in your industry) and necessary and do not include personal expenses.

Employee Business Expenses

There are two major barriers to deducting employee business expenses. The most commonly encountered is the 2%-of-income (AGI) deduction floor that applies to most (Tier II) miscellaneous deductions, which besides employee business expenses also includes investment expenses, certain legal expenses, home office and other expenses. The amount deductible as miscellaneous expenses is the total of those expenses reduced by 2% of the taxpayer’s adjusted gross income for the year. Depending upon the taxpayer’s income, this reduction can substantially lessen or eliminate the deductible amount. The second major barrier is the alternative minimum tax (AMT), in which the Tier II miscellaneous expenses are not deductible at all. Thus, to the extent that the taxpayer is affected by the AMT, there is no benefit derived from these deductions. There are, however, some planning strategies that can be applied to overcome these barriers, such as the following:

  • Employer Accountable Plan – This is a plan under which your employer reimburses you for your employment-related expenses, but requires you to “adequately account” for the expenses. Expenses reimbursed by the employer under an “accountable plan” are excluded from income, thus essentially allowing 100% of the expenses to be deducted, while avoiding the 2%-of-income and AMT limitations. If the employer does not wish to add a reimbursement plan on top of the employee’s existing income, a salary reduction replaced with an accountable plan might be negotiated.
  • Bunch Deductions – With proper planning, employee business expenses for more than one year can be deferred or accelerated into one year, thus producing a larger deduction in that one year to overcome the 2% floor for miscellaneous deductions.
  • Education Expenses – Although certain employment-related education expenses can be taken as an employee business expense, there are other ways to gain a tax benefit and avoid the 2%-of-AGI and AMT limitations. These include income-limited education tax credits, and if your employer has an educational assistance plan, your employer can reimburse you up to $5,250 for most education expenses other than those associated with education travel.
  • Utilize the Section 179 Deduction – Generally, business assets with a useful life of more than one year must be deducted (depreciated) over several years. However, most business assets, other than real estate, qualify for the Code Section 179 expense deduction that allows the entire cost (up to $25,000 for 2015) to be deducted in one year. While vehicles used for business are eligible for Section 179 expensing, other limitations cap the deduction at lower amounts. The depreciation or Section 179 deduction of an employee’s business assets is part of employee business expenses subject to the 2%-of-AGI floor. However, by claiming the Section 179 deduction in the year the asset is purchased rather than deducting a lower depreciation amount over several years, there is a greater chance that the total miscellaneous deductions will be more than the 2%-of-AGI floor, thus allowing part of the expense to be deducted.

 

If you would like to explore any of these techniques, please give this office a call.