Good and Bad News About The Home Office Tax Deduction

“Home office” is a type of tax deduction that applies to the business use of a home; the space itself may not actually be an office. This category also includes using part of a home for storing inventory (e.g., for a wholesale or retail business for which the home is the only fixed location); as a day care center; as a physical meeting place for interacting with customers, patients, or clients; or the principal place of business for any trade or business.

Generally, except when used to store inventory, an office area must be used on a regular and continuing basis and exclusively restricted to the trade or business (i.e., no personal use). Two methods can be used to determine a home-office deduction: the actual-expense method and the simplified method.

Actual-Expense Method – The actual-expense method prorates home expenses based on the portion of the home that qualifies as a home office; this is generally based on square footage. These prorated expenses include mortgage interest, real property taxes, insurance, heating, electricity, maintenance, and depreciation. In the case of a rented home, rent replaces the interest, tax, and depreciation expenses. Aside from prorated expenses, 100% of directly related costs, such as painting and repair expenses specific to the office, can be deducted.

Simplified Method – The simplified method allows for a deduction equal to $5 per square footage of the home that is used for business, up to a maximum of 300 square feet, resulting in a maximum simplified deduction of $1,500.

Even if you qualify for a home-office deduction, your deduction is limited to the business activity’s gross income—not, as many people mistakenly believe, its net income. The gross-income limitation is equal to the gross sales minus the cost of goods sold. This amount is deducted on a self-employed individual’s business schedule.

The good news is that, under the tax reform, the home-office deduction is still allowed for self-employed taxpayers. The bad news is that this deduction is no longer available for employees, at least for 2018 through 2025. The reason for this change is that, for an employee, a home office is considered an employee business expense (a type of itemized deduction); Congress suspended this deduction as part of the tax reform.

If you have concerns or questions about how the home-office deduction applies to your specific circumstances, please give us a call.

Preparing for Taxes for 2018 and Beyond

Tax reform has changed the way most taxpayers need to think about and plan for their taxes. It is no longer business as usual, and those who think it is are in for a rude awakening come tax time next year.

For most taxpayers, the most significant change is the increase in their standard deduction, which on the surface seems like a big benefit. But don’t overlook the fact that the same tax reform that nearly doubled the standard deduction took away the personal exemption as a deduction. So, for example, under old law, a married couple’s standard deduction would have been $13,000, and their two personal exemptions would have been $8,300 (2 x $4,150), for a total deduction of $21,300. Under the new law, they will be able to deduct $24,000, the new standard deduction for 2018. So, their total increase over what they would have gotten under prior law is only $2,700. If they have four children, their deductions for 2018 under prior law would have been $37,900 ($13,000 plus 6 x $4,150), as compared to the new law’s $24,000. However, for individuals with children under age 17, the child tax credit for 2018 was increased to $2,000 (with $1,400 being refundable) from the prior $1,000, in many cases making up for the loss in the exemption deduction. Note that a credit is a dollar-for-dollar reduction of the tax, while a deduction reduces the income that is taxable.

Tax reform also placed some limitations on itemized deductions by limiting the amount that can be claimed for state and local taxes as well as totally eliminating the deduction for employee business expenses along with some other commonly encountered deductions. Thus, the remaining allowable itemized deduction categories are medical (in excess of 7.5% of AGI), up to $10,000 of state and local taxes, home acquisition debt interest, investment interest, charitable contributions and gambling losses (limited to the amount of gambling income).

Some taxpayers may be able to employ what is referred to as the “bunching” strategy as a workaround. This strategy has the taxpayer taking the standard deduction one year and itemizing the next. This is accomplished by doubling up charitable contributions in one year and skipping donations the next year, deferring or pre-paying medical expenses where possible, and paying state estimates in advance for the year of itemizing and prepaying all assessed property taxes, while keeping in mind that the maximum deduction for taxes in any year is $10,000. This strategy should only be used if the shifting of deductions results in total itemized deductions being greater than the year’s standard deduction.

Another huge issue is the loss of employee business expenses. This means the likes of long-haul truckers, traveling salespeople and others with large employee business expenses should seek out accountable expense reimbursement plans with their employers, even if they have to reduce their pay to balance it out.

For taxpayers in business, tax reform offers 100% expensing of purchased tangible business assets other than structures. At the same time, it also offers a new 20% flow-through business deduction. The combination of these two deductions must be carefully considered because expensing rather than depreciating the cost of equipment, machinery, etc., will reduce the business’s profit, which will in turn reduce the flow-through deduction. On the flip side, the new 20% deduction is limited for certain higher-income individuals, and reducing income by expensing capital purchases may actually help one to qualify for the deduction.

Married couples contemplating divorce will have to understand how the law changes will affect their situation and whether they should finalize the divorce before the end of the year. Currently, alimony is deductible by the payer and taxable to the recipient. Tax reform has changed that long-standing rule for divorce agreements entered into after December 31, 2018, or pre-existing agreements that are modified after that date, to include a new provision saying that alimony is no longer deductible by the payer and is not income to the recipient. Of course, the treatment of alimony can be adversarial and can also be a planning issue for 2018.

Here are some additional issues of importance:

  • Business entertainment expenses are no longer deductible.
  • Up to $10,000 of Qualified Tuition Plan (Sec. 529) funds can be used for elementary and high school expenses, if permitted by the plan.
  • Taxpayers who convert their traditional IRA to a Roth IRA can no longer change their minds and undo the conversion.
  • Casualty losses, other than those incurred in a federally declared disaster area, are no longer deductible, so you should consider whether you have adequate insurance.
  • Moving expenses are no longer tax deductible, and employer reimbursement for moving costs is now taxable income. If an employer requires an employee to relocate, consider having the employer provide a tax gross-up reimbursement.
  • Taxpayers basing their ability to purchase a home on the tax deduction they will derive from the interest they’ll be paying need to be aware that for homes purchased after 2017, the home mortgage interest deduction is limited to the interest paid on the first $750,000 ($375,000) of home acquisition debt.
  • Taxpayers who have tapped their home’s equity in the past should be aware that they can no longer deduct home equity debt interest, even if the debt was acquired before 2018 and is $100,000 or less.
  • For taxpayers residing in a state that has a state income tax, some or all of the federal tax reform changes may not apply for state filing purposes, or they may apply only if the state legislature enacts conforming legislation.

As you can see, it is definitely not business as usual. If you have any questions about how tax reform may affect you, please contact us.

Big Changes Ahead For How Alimony is Treated for Tax Purposes

Note: This is one of a series of articles explaining how the various tax changes in the GOP’s Tax Cuts & Jobs Act (referred to as “the Act” in this article), which passed in late December of 2017, could affect you and your family, both in 2018 and in future years. This series offers strategies that you can employ to reduce your tax liability under the new law.

Alimony is the term used for payments to a separated spouse or ex-spouse as part of a divorce or separation agreement. Since 1985, to be alimony for tax purposes, the payments:

  • Must be in cash, paid to the spouse, ex-spouse, or a third party on behalf of a spouse or ex-spouse;
  • Must be required by a decree or instrument incident to a divorce, a written separation agreement, or a support decree;
  • Cannot be designated as child support;
  • Will be valid alimony only if the taxpayers live apart after the decree is issued or the agreement is signed. Spouses who share the same household don’t qualify for alimony deductions. This is true even if the spouses live separately within the dwelling unit.
  • Must end on the death of the payee; and
  • Cannot be contingent on the status of a child (that is, any amount that is discontinued when a child reaches 18, moves away, etc., is not alimony).

The payments need not be for support of the ex-spouse or based on the marital relationship. They can even be payments for property rights, as long as they meet the above requirements. Payments need not be periodic, but there are dollar limits and “recapture” provisions if there is excess front-loading of payments. Even if the payments meet all of the alimony requirements, the couple may designate in their agreement or decree that the payments are not alimony, and that designation will be valid for tax purposes.

Divorce Agreements Completed before the End of 2018 – For divorce agreements finalized before the end of 2018, the recipient (payee) of alimony must include it in his or her income for tax purposes. The payer is allowed to deduct the payments above the line (without itemizing deductions), technically referred to as an adjustment to gross income. The spouse receiving the alimony can treat it as earned income for purposes of qualifying to make an IRA contribution, thus allowing the recipient spouse to contribute to an IRA even if he or she has no other income from working.

Because the spouses making the payments will sometimes claim more alimony than they actually paid and some recipient spouses will sometimes report less alimony income than they received, the IRS requires the paying spouse to include on his or her tax return the recipient spouse’s Social Security number so the IRS can match by computer the amount received to the amount paid.

Divorce Agreements Completed after 2018 – Under the Act, for divorce agreements entered into after 2018, the alimony is not deductible by the payer and is not taxable income for the recipient. Since the recipient isn’t reporting alimony income, it cannot be treated as earned income for purposes of the recipient making an IRA contribution.

This revised treatment of alimony also applies to any divorce or separation instrument executed before January 1, 2019, that is modified after 2018, if the modification expressly provides that the change made by the Act is to apply.

If you have questions about the treatment of alimony or other tax matters related to divorce, please give us a call.


Employee Business Expenses & Tax Reform

Note: This is one of a series of articles explaining how the various tax changes in the GOP’s Tax Cuts & Jobs Act (referred to as “the Act” in this article), which passed in late December of 2017, could affect you and your family, both in 2018 and future years. This series offers strategies that you can employ to reduce your tax liability under the new law.

If you are an employee (i.e., a W-2 wage earner) with substantial work-related business expenses, the Act was not kind to you. It suspended (and effectively repealed), for 2018 through 2025, all miscellaneous itemized deductions, which were previously only subject to a floor of 2% of adjusted gross income (AGI). Employee business expenses are included in that category of miscellaneous itemized deductions.

This change affects those who are compensated as employees and who have work-related expenses—including salespeople with travel and entertainment expenses, long-haul truck drivers with away-from-home expenses, mechanics with tool expenses, and any other employees with large but unreimbursed business expenses. These employees, beginning in 2018, will no longer be able to count such expenses as itemized deductions.

Will this change hurt you? That depends. Because employee business expenses could previously only be deducted to the extent that they exceeded 2% of AGI, the effects of the Act will depend upon the extent of your expenses. Another consideration is whether your total itemized deductions would have exceeded the new standard deduction, which has increased for 2018.

As a remedy, you may want to contact your employer and try to negotiate an “accountable plan,” which is a business-expense reimbursement plan under which the employer can reimburse you, tax-free, for business expenses. With this arrangement, you would need to substantiate your business expenses to your employer and would have to return (within a specified time limit) any reimbursements that your employer pays in excess of the substantiated amount.

If you have questions related to the loss of this deduction or about how the change will impact your specific tax situation, please call us.

How Small Businesses Write Off Equipment Purchases

From time to time, an owner of a small business will purchase equipment, office furnishings, vehicles, computer systems and other items for use in the business. How to deduct the cost for tax purposes is not always an easy decision because there are a number of options available, and the decision will depend upon whether a big deduction is needed for the acquisition year or more benefit can be obtained by deducting the expense over a number of years using depreciation. The following are the write-off options currently available:

  • Depreciation – Depreciation is the normal accounting way of writing off business capital purchases by spreading the deduction of the cost over several years. The IRS regulations specify the number of years for the write-off based on established asset categories, and generally for small business purchases the categories include 3-, 5- or 7-year write-offs. The 5-year category includes autos, small trucks, computers, copiers, and certain technological and research equipment, while the 7-year category includes office fixtures, furniture and equipment.
  • Material & Supply Expensing – IRS regulations allow certain materials and supplies that cost $200 or less, or that have a useful life of less than one year, to be expensed (deducted fully in one year) rather than depreciated.
  • De Minimis Safe Harbor Expensing – IRS regulations also allow small businesses to expense up to $2,500 of equipment purchases. The limit applies per item or per invoice, providing a substantial leeway in expensing purchases. The $2,500 limit is increased to $5,000 for businesses that have an applicable financial statement, generally large businesses.
  • Routine Maintenance – IRS regulations allow a deduction for expenditures used to keep a unit of property in operating condition where a business expects to perform the maintenance twice during the class life of the property. Class life is different than depreciable life.
    Depreciable Item Class Life Depreciable Life
    Office Furnishings 10 7
    Information Systems 6 5
    Computers 6 5
    Autos & Taxis 3 5
    Light Trucks 4 5
    Heavy Trucks 6 5


  • Unlimited Expensing – The Tax Cuts and Jobs Act passed in December 2017 includes a provision allowing 100% unlimited expensing of tangible business assets (except structures) acquired after September 27, 2017 and through 2022. Applies when a taxpayer first uses the asset (can be new or used property).
  • Bonus Depreciation – The tax code provides for a first-year bonus depreciation that allows a business to deduct 50% of the cost of most new tangible property if it is placed in service during 2017. The remaining cost is deducted over the asset’s depreciable life. The 50% rate applies for new property placed in service prior to September 28, 2017 and, by election, to new or used property acquired and first put into use by the taxpayer after September 27, 2017 and before December 31, 2017.
  • Sec 179 Expensing – Another option provided by the tax code is an expensing provision for small businesses that allows a certain amount of the cost of tangible equipment purchases to be expensed in the year the property is first placed into business service. This tax provision is commonly referred to as Sec. 179 expensing, named after the tax code section that sanctions it. The expensing is limited to an annual inflation adjusted amount, which is $510,000 for 2017 and $1 million for 2018. To ensure that this provision is limited to small businesses, whenever a business has purchases of property eligible for Sec 179 treatment that exceed the year’s investment limit ($2,030,000 for 2017 and $2.5 million for 2018), the annual expensing allowance is reduced by one dollar for each dollar the investment limit is exceeded.
    An undesirable consequence of using Sec. 179 expensing occurs when the item is disposed of before the end of its normal depreciable life. In that case, the difference between normal depreciation and the Sec. 179 deduction is recaptured and added to income in the year of disposition.
  • Mixing Methods – A mixture of Sec. 179 expensing, bonus depreciation and regular depreciation can be used on a specific item, allowing just about any amount of write-off for the year for that asset.

For some individual taxpayers the alternative minimum tax (AMT) may be a concern. Bonus depreciation and Sec. 179 expensing are not preference items, and therefore their use will not trigger an AMT add-on tax. However, the difference between 200% MACRS depreciation, if claimed, and 150% MACRS depreciation is a preference item for AMT and could cause or add to the AMT tax.

If you have any questions related to this article, please give us a call.

Medical Deductions & The New Tax Law

Note: The is one of a series of articles explaining how the various tax changes in the GOP’s Tax Cuts & Jobs Act (referred to as “the Act” in this article), which passed in late December of 2017, could affect you and your family, both in 2018 and future years. This series offers strategies that you can employ to reduce your tax liability under the new law.

The Act’s final version retained the itemized deduction for medical expenses even though the original House version would have done away with this deduction altogether.

The medical deduction was not just retained; its adjusted gross income (AGI) floor was lowered from 10% to 7.5% for 2017 and 2018 (after which it returns to 10%). The AGI floor is meant to eliminate deductions for minor medical costs by only allowing those that are in excess of the given percentage of your AGI.

Example: You have wages of $100,000 for 2018 and no other income, losses, or adjustments, so your AGI for the year is $100,000. In this case, for the year, the first $7,500 (7.5% of $100,000) of your otherwise deductible medical expenses is not deductible. Thus, if you have $8,000 of medical expenses, only $500 ($8,000 – $7,500) is deductible. If you have the same amount of income and medical expenses in 2019, none of your medical costs will be deductible because of the 10% floor; 10% of a $100,000 AGI is $10,000, which is greater than the $8,000 of medical expenses. Of course, there’s always a chance that Congress will extend the reduced 7.5% floor beyond 2018, but you shouldn’t count on it. 

Here is where it gets a little complicated. Because medical deductions are itemized, to get any benefit from them, your itemized deductions must exceed the new standard deduction, which is $24,000 for a married couple filing jointly (or for a surviving spouse with a dependent child), $18,000 for a head of household, and $12,000 for anyone else.

Retaining the medical deduction is a necessary for the families of disabled individuals and for senior citizens who require extraordinary care. Without this deduction, those groups could have been saddled with enormous medical costs without any tax relief. However, this deduction is not just for disabled individuals, senior citizens, and their families. Regarding medical bills, you never know what will happen in the future.

Bunching Deductions – One strategy that works well for itemized deductions is to bunch deductions. That means paying as much of your medical expenses as possible in a single year so that the total will exceed the AGI floor and so that your overall itemized deductions will exceed the standard deduction.

Example: Your child is having orthodontic work that will cost a total of $12,000, and the dentist offers a payment plan. If you pay in installments, you will spread the payments out over several years and may not exceed the medical AGI floor in any given year. However, by paying all at once, you will exceed the floor and get a medical deduction.

Being Aware of Medical Deductions – Being aware of what is and is not deductible as a medical expense can also help you to maximize your medical deductions. Unreimbursed costs such as those from doctors, dentists, hospitals, and medical insurance premiums are deductible. The following is a list of some deductible medical expenses that you may not be aware of:

  • Adoptive children’s pre-adoption medical costs
  • Prescriptions for birth control pills
  • Chiropractors
  • Christian Science practitioners
  • Decedent’s medical costs
  • Adult diapers
  • Drug-addiction rehabilitation costs
  • Egg-donation expenses
  • Elderly devices
  • Medical equipment and supplies
  • Fertility enhancements
  • Guide dogs
  • Household nursing services
  • Impairment-related home modifications
  • In vitro fertilization costs
  • Lactation aids
  • Lead-based paint removal
  • Learning-disability tuition expenses
  • Medical-related legal fees
  • Meals from inpatient care
  • Medical-conference expenses
  • Medicare premiums
  • Nonhospital institution costs
  • Nursing-home expenses
  • Organ-donation costs
  • Smoking-cessation programs
  • Sterilization expenses
  • Weight-loss programs (limited)

Some of the foregoing have special requirements, so please call if you have any questions.

Under certain circumstances, you may even be able to deduct the medical expenses that you pay for others.

Medical dependents – This applies only if you had a dependent (a qualified child or other relative) either at the time the medical services were provided or at the time the expenses were paid. For medical purposes, an individual can be a dependent even if his or her gross income precludes qualification as a dependent.

Divorced parents – A child of divorced parents is considered a dependent of both parents for the purpose of medical expense, so each parent can deduct the medical expenses that he or she pays for the child.

If you have questions related to the deductibility of specific medical expenses or about how such deductions apply to your tax situation, please give us a call.

2018 Standard Mileage Rates Announced

As it does every year, the Internal Revenue Service recently announced the inflation- adjusted 2018 optional standard mileage rates used to calculate the deductible costs of operating an automobile for business, charitable or medical purposes.

Beginning on Jan. 1, 2018, the standard mileage rates for the use of a car (or a van, pickup or panel truck) are:

  • 54.5 cents per mile for business miles driven (including a 25-cent-per-mile allocation for depreciation). This is up from 53.5 cents in 2017;
  • 18 cents per mile driven for medical purposes. This is up from 17 cents in 2017; and
  • 14 cents per mile driven in service of charitable organizations.

The business standard mileage rate is based on an annual study of the fixed and variable costs of operating an automobile. The rate for medical purposes is based on the variable costs as determined by the same study. The rate for using an automobile while performing services for a charitable organization is statutorily set (it can only be changed by Congressional action) and has been 14 cents per mile for over 15 years.

Important Consideration: The 2018 rates are based on 2017 fuel costs. Based on the potential for substantially higher gas prices in 2018, it may be appropriate to consider switching to the actual expense method for 2018, or at least keeping track of the actual expenses, including fuel costs, repairs, maintenance, etc., so that the option is available for 2018.

Taxpayers always have the option of calculating the actual costs of using their vehicle for business rather than using the standard mileage rates. In addition to the potential for higher fuel prices, the extension and expansion of the bonus depreciation as well as increased depreciation limitations for passenger autos in the Tax Cuts and Jobs Act may make using the actual expense method worthwhile during the first year a vehicle is placed in business service. However, the standard mileage rates cannot be used if you have used the actual method (using Sec. 179, bonus depreciation and/or MACRS depreciation) in previous years. This rule is applied on a vehicle-by-vehicle basis. In addition, the business standard mileage rate cannot be used for any vehicle used for hire or for more than four vehicles simultaneously.

Employer Reimbursement – When employers reimburse employees for business-related car expenses using the standard mileage allowance method for each substantiated employment-connected business mile, the reimbursement is tax-free if the employee substantiates to the employer the time, place, mileage and purpose of employment-connected business travel.

The Tax Cuts and Jobs Act eliminated employee business expenses as an itemized deduction, effective for 2018 through 2025. Therefore, employees may no longer take a deduction on their federal returns for unreimbursed employment-related use of their autos, light trucks or vans.

Faster Write-Offs for Heavy Sport Utility Vehicles (SUVs) – Many of today’s SUVs weigh more than 6,000 pounds and are therefore not subject to the limit rules on luxury auto depreciation; taxpayers with these vehicles can utilize both the Section 179 expense deduction (up to a maximum of $25,000) and the bonus depreciation (the Section 179 deduction must be applied before the bonus depreciation) to produce a sizable first-year tax deduction. However, the vehicle cannot exceed a gross unloaded vehicle weight of 14,000 pounds. Caution: Business autos are 5-year class life property. If the taxpayer subsequently disposes of the vehicle before the end of the 5-year period, as many do, a portion of the Section 179 expense deduction will be recaptured and must be added back to your income (SE income for self-employed individuals). The future ramifications of deducting all or a significant portion of the vehicle’s cost using Section 179 should be considered.

If you have questions related to the best methods of deducting the business use of your vehicle or the documentation required, please give us a call.

New Tax Law Cracks Down on Home Mortgage Interest

Note: The is one of a series of articles explaining how the various tax changes made by the GOP’s Tax Cuts & Jobs Act (referred to as the “Act” in the article), passed late in December 2017, might affect you and your family in 2018 and future years. These articles offer strategies you might employ to reduce your tax liability under the new tax laws.

For years, taxpayers have been able to deduct home mortgage interest on their primary and second homes as an itemized deduction, subject to certain limitations. The interest deduction was limited to the interest on up to $1 million of acquisition debt and $100,000 of equity debt.

Acquisition debt is debt incurred to purchase, construct or substantially improve a taxpayer’s principal or second home. So when you purchased your home, that original loan was acquisition debt, and if you later borrowed additional money that you used to add a room, pool, etc., that loan was also acquisition debt. However, if the total of all of your acquisition loans exceeded the $1 million limit, then the interest on the excess debt over $1 million was not deductible as acquisition debt interest.

Consumer debt interest, such as interest on auto loans and credit card debt, is not deductible as an itemized deduction. However, years ago, Congress allowed homeowners to deduct the interest on up to $100,000 of equity debt. This allowed homeowners to use the equity in their homes for any purpose and deduct the interest on the equity debt as an itemized deduction.

Well, That Has All Changed. For 2018 through 2025, the new tax law reduces the $1 million limit on home acquisition debt to $750,000 ($375,000 for married separate filers), except that the lower limit won’t apply to indebtedness incurred before December 15, 2017. That is, the $1M cap continues to apply to acquisition mortgages on primary and second residences that were already in existence prior to December 15, 2017, as well as for taxpayers who entered into a binding written contract before that date to close on the purchase of a principal residence before January 1, 2018, and who purchase that residence before April 1, 2018.

The Equity Debt Interest Deduction Is No More – Congress has yanked the rug out from under those with equity debt on their homes. Beginning in 2018, interest paid on equity debt will no longer be allowed as a deduction, regardless of when the debt was incurred.

This seems a little unfair and can have an adverse impact on individuals who used their home as a piggy bank for personal expense purposes.

Whether any of this makes any difference in light of the new higher standard deduction amounts for 2018, and whether you should be looking for ways to pay down the equity debt, will depend upon the amounts of your other itemized deductions. Please call us if you have questions.

Not All Interest Is Deductible For Taxes

A frequent question that arises when borrowing money is whether or not the interest will be tax deductible. That can be a complicated question, and unfortunately not all interest an individual pays is deductible. The rules for deducting interest vary, depending on whether the loan proceeds are used for personal, investment, or business activities. Interest expense can fall into any of the following categories:

  • Personal interest – is not deductible. Typically this includes interest from personal credit card debt, personal car loan interest, home appliance purchases, etc.
  • Investment interest – this is typically paid on debt incurred to purchase investments such as land, stocks, mutual funds, etc. However, interest on debt to acquire or carry tax-free investments is not deductible at all. The annual investment interest deduction is limited to “net investment income,” which is the total taxable investment income reduced by investment expenses (other than expenses related to investments that produce non-taxable income). The investment interest deduction is only allowed to taxpayers who itemize their deductions.
  • Home mortgage interest – includes the interest on a taxpayer’s primary home and a single second home. However, the debt for which the interest is deductible is generally limited to $1 million of home acquisition debt (debt used to purchase or substantially improve the home(s)) and $100,000 of equity debt between the first and second homes. Both the acquisition debt and the equity debt must be secured by the home(s) to be deductible as home mortgage interest. In addition, home mortgage interest is only deductible by those who itemize their deductions. Tax Tip: Equity debt can be used to purchase personal use items, and thereby a tax deduction for the interest paid on that loan is allowed.
  • Passive activity interest – includes interest on debt that’s for business or income-producing activities in which the taxpayer doesn’t “materially participate” and is generally deductible only if income from passive activities exceeds expenses from those activities. The most common passive activities are probably real estate rentals. For rental real estate activities, there is a special passive loss allowance of up to $25,000 for taxpayers who are active but not necessarily material participants in the rental. The $25,000 phases out for taxpayers with adjusted gross income between $100,000 and $150,000.
  • Trade or business interest – includes interest on debts that are for activities in which a taxpayer materially participates. This type of interest can generally be deducted in full as a business expense.

Because of the variety of limits imposed on interest deductions, the IRS provides special rules to allocate interest expense among the categories. These “tracing rules,” as they are called, are generally based on the use of the loan proceeds. Thus interest expense on a debt is allocated in the same manner as the allocation of the debt to which the interest expense relates. Debt is allocated by tracing disbursements of the debt proceeds to specific expenditures, i.e., “follow the money.”

These tracing rules, combined with the restrictions associated with the various categories of interest, can create some unexpected results. Here are some examples:

Example 1: A taxpayer takes out a loan secured by his rental property and uses the proceeds to refinance the rental loan and buy a car for personal use. The taxpayer must allocate interest expense on the loan between rental interest and personal interest for the purchase of the car, and even though the loan is secured by the business property, the personal loan interest portion is not deductible.

Example 2: The taxpayer borrows $50,000 secured by his home to be used in his consulting business. He has no other equity debt on his home. He deposits the $50,000 into a checking account he only uses for his business. He cannot deduct the interest on his business and must instead deduct the interest as home equity debt interest on his Schedule A (if he itemizes his deductions), as the debt is secured by his home and is less than the $100,000 limit for equity indebtedness.

Example 3: The taxpayer owns a rental property free and clear and wants to purchase a home. He obtains a loan on the rental to purchase the home. Under the tracing rules, the taxpayer must trace the use of the funds to their use, and as the debt was not used to acquire the rental, the interest on the loan cannot be deducted as rental interest. The funds can be traced to the purchase of the taxpayer’s home. However, for interest to be deductible as home mortgage interest, the debt must be secured by the home, which it is not. Result: the interest is not deductible anywhere.

As you can see, it is very important to plan your financing moves carefully, especially when equity in one asset is being used to acquire another. Please call us for assistance in applying the various interest limitations and tracing rules to ensure you don’t inadvertently get some unexpected results.

Unique Charitable Giving Options

The end of the year and holiday season is the time of the year when everyone is feeling charitable, and a time when you are likely flooded with solicitations for charitable contributions. Before deciding about your charitable giving for the year, you may benefit from reading this article and learning ways to contribute that will help you tax-wise.

Some recent special tax deduction changes make 2017 a unique year for charitable giving. This article provides you a guide to these special provisions in addition to those that have historically provided tax benefits.

Normally, deductible charitable contributions are limited by a percentage of your income, more specifically your adjusted gross income (AGI), which is the number on your tax return before your deductions and exemptions are subtracted. For most charitable contributions the tax deduction limit is 50% of your AGI, but it can drop to 30% or even 20% in certain situations. Additionally, overall itemized deductions, including those for charitable contributions, are phased out for high-income taxpayers.

  • 2017 Hurricane Relief – After the devastation inflicted by Hurricanes Harvey, Irma and Maria, Congress passed a provision that allows taxpayers to donate money to hurricane relief charities without any percentage-of-AGI limitation. Further, the phaseout of itemized deductions for high-income taxpayers will also not apply to hurricane relief contributions. So, for example, if your AGI is $100,000 and you contribute $70,000 to a qualified hurricane relief charity in 2017, the full $70,000 will be deductible instead of being limited to $50,000. However, if you made other contributions during the year, they will be subject to the normal percentage-of-AGI limitations, and then the hurricane relief donation will be deductible for the balance of your AGI.To qualify, the contributions must have been made in cash between August 23 and December 31, 2017, and the donation documentation must verify that the donation is for Hurricane Harvey, Irma or Maria relief. If you contribute more than is deductible for 2017, the excess will carry forward to your tax returns for up to the next five years.
  • Donate Unused Employee Time Off – As it has done before in the wake of disasters, including Hurricane Katrina and Superstorm Sandy, the Internal Revenue Service is providing special relief that allows employees to donate their unused paid vacation, sick leave and personal leave time to Hurricane Harvey, Irma and Maria relief efforts.Here is how it works: If your employer is participating, you can relinquish any unused and paid vacation time, sick leave and personal leave, and your employer will then donate the cash equivalent to Hurricane Harvey, Irma and Maria relief charities. Your employer can deduct the amount donated as a business expense. You don’t get a deduction for a charitable contribution, but better yet, you won’t have to report the income, which is beneficial for both individuals who itemize deductions and those who use the standard deduction. This special relief applies to all leave-based donations made before January 1, 2019, giving individuals over a year to forgo their unused paid vacation, sick and leave time and have the cash value donated to a worthy cause.If your employer is unaware of this program, refer them to IRS Notice 2017-48 (related to Hurricane Harvey) for further details. Note: Notices 2017-52 and 2017-62 were later released, adding Irma and Maria, respectively, to the list. Your employer will also benefit from not being liable for payroll taxes on the money contributed.
  • Contributions of Appreciated Assets – Although this is not a new strategy, taxpayers can donate appreciated long-term capital gain assets to a charity and deduct the fair market value (FMV) of the assets as a charitable deduction. For example, suppose you donate to your church’s building fund a stock that is worth $10,000 but that only cost you $2,000. Your charitable contribution would be $10,000, and you do not have to pay tax on the $8,000 appreciation in the stock. This strategy can also apply to land, homes, rentals, equipment, etc. Determining the FMV for listed stock is easy since the value of the stock can be determined from quoted stock prices on the day of the contribution. For other capital assets, a certified appraisal is generally required. It would be good practice to contact this office before making a gift of appreciated property to make sure that it is appropriate for your tax bracket and that the appraisal is properly performed and documented.
  • IRA to Charity Contributions – For some time this unique method of making charitable contributions was a temporary provision of the tax law, but Congress made it permanent in 2016. This charitable contribution provision is limited to taxpayers age 70.5 and older. They can directly transfer up to $100,000 a year from their IRA to a qualified charity. So if you are 70.5 or older and make an IRA-to-charity transfer you won’t get a charity deduction, but instead and even better, you will not have to pay taxes on the distribution, and because your AGI will be lower, you can benefit from other tax provisions that are pegged to AGI, such as the amount of Social Security income that’s taxable and the cost of Medicare B insurance premiums for higher-income taxpayers. As an additional bonus, the transfer also counts toward your annual required minimum distribution.
  • Cash Contributions – Cash contributions include those paid by cash, check, electronic funds transfer, or credit card. To claim a cash contribution, you must be able to document that contribution with a bank record, receipt, or a written communication from the qualified organization; this record must include the name of the qualified organization, the date of the contribution, and the amount of the contribution. Valid types of bank records include canceled checks, bank or credit union statements, and credit card statements. In addition, to deduct a contribution of $250 or more, you must have certain payroll deduction records or an acknowledgment of your contribution from the qualified organization.
  • Non-cash Contributions – This is a type of contribution with which you can easily run afoul of the IRS because the contribution deduction is based on the FMV of the item being contributed, not the item’s original cost, and most used items such as clothing and household goods depreciate substantially.Do not include items of de minimis value, such as undergarments and socks, in the deductible amount of your contribution, as they are specifically not allowed. It is not uncommon to see taxpayers over-valuate their contributions. That is why the IRS has four levels of verification and documentation requirements for non-cash contributions, with each becoming more stringent as the valuation increases:
    Caution: The value of similar items of property that are donated in the same year must be combined when determining what level of documentation is needed. Similar items of property are items of the same generic category or type, such as clothing, household goods, coin collections, paintings, books, jewelry, privately traded stock, land and buildings.A. Deductions of Less Than $250 You must obtain and keep a receipt from the charitable organization that shows:

    1. The name of the charitable organization,
    2. The date and location of the charitable contribution, and
    3. A reasonably detailed description of the property.

    Note: The taxpayer is not required to have a receipt if it is impractical to get one (for example, if the property was left at a charity’s unattended drop site). This exception only applies if all the non-cash contributions for the year are less than $250.

    B. Deductions of At Least $250 But Not More Than $500 You must provide the same information as in the previous category and add:

    4. Whether or not the qualified organization gave the taxpayer any goods or services as a result of the contribution (other than certain token items and membership benefits).

    If the deduction includes more than one contribution of $250 or more, the taxpayer must have either a separate acknowledgment for each donation or a single acknowledgment that shows the total contribution.

    C. Deductions Over $500 But Not Over $5,000 You must provide the same acknowledgment and written records that are required for the two previous categories plus:

    5. Attach a completed IRS Form 8283 to the income tax return that reports:

      • a. How the property was obtained (for example, purchase, gift, bequest, inheritance, or exchange),
        b. The approximate date the property was obtained or—if created, produced, or manufactured by the taxpayer—the approximate date when the property was substantially completed, and
        c. The cost or other basis, and any adjustments to this basis, for property held for less than 12 months and (if available) the cost or other basis for property held for 12 months or more.

    D. Deductions Over $5,000 These donations require time-sensitive appraisals by a “qualified appraiser” in addition to other documentation (this requirement, however, does not apply to publicly traded securities). When contemplating such a donation, please call this office for further guidance about the documentation and forms that will be needed.

To help you document some of these noncash contributions, you can download a fillable Noncash Charitable Contribution statement. The statement includes an area for the charity’s agent to verify the contribution and a check box denoting whether the qualified organization provided any goods or services as a result of the contribution. Although not specifically endorsed by the IRS, this statement includes everything needed for noncash contributions of up to $500—provided, of course, that you and the charitable organization’s representative accurately complete the form.

Unfortunately, legitimate charities face competition from fraudsters, so if you are thinking about giving to a charity with which you are not familiar, do your research so that you can avoid swindlers who are trying to take advantage of your generosity. They show up in droves after disasters like the hurricanes and the California firestorms. Here are tips to help make sure that your charitable contributions actually go to the cause that you support:

  • Donate to charities that you know and trust. Be alert for charities that seem to have sprung up overnight in connection with current events.
  • Ask if a caller is a paid fundraiser, who he/she works for, and what percentages of your donation go to the charity and to the fundraiser. If you don’t get clear answers—or if you don’t like the answers you get—consider donating to a different organization.
  • Don’t give out personal or financial information—such as your credit card or bank account number—unless you know for sure that the charity is reputable.
  • Never send cash. You can’t be sure that the organization will receive your donation, and you won’t have a record for tax purposes.
  • Never wire money to someone who claims to be from a charity. Scammers often request donations to be wired because wiring money is like sending cash: Once you send it, you can’t get it back.
  • If a donation request comes from a charity that claims to help a local community group (for example, police or firefighters), ask members of that group if they have heard of the charity and if it is actually providing financial support.
  • Don’t make a contribution if it is solicited in an email claiming to be from the IRS. The IRS does not send emails to individuals and does not ask for donations to organizations related to natural disasters. Scammers are using this ploy to extract money from taxpayers who think their contributions will go for hurricane relief or to wildfire victims.
  • Check out the charity’s reputation using the Better Business Bureau’s Give.org or Charity Watch.

Remember that if you want to deduct a charitable contribution on your tax return, the donation must be to a legitimate charity. Contributions may only be deducted if they are to religious, charitable, scientific, educational, literary or other institutions that are incorporated or recognized as organizations by the IRS. Sometimes, these organizations are referred to as 501(c)(3) organizations (after the code section that allows them to be tax-exempt). Gifts to federal, state or local government, qualifying veterans’ or fraternal organizations, and certain nonprofit cemetery companies also may be deductible. Gifts to other kinds of nonprofits, such as business leagues, social clubs and homeowner’s associations, as well as gifts to individuals, cannot be deducted.

Be aware that, to claim a charitable contribution, you must also itemize your deductions. If you only marginally itemize your deductions, it may be beneficial for you to group your deductions in a single year and then to skip deductions in the next year.

Please contact us if you have questions related to the tax benefits associated with charitable giving for your particular tax situation.