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.

Natural Disaster Charity Volunteer Tax Breaks

If you volunteered your time for a charity in the aftermath of a natural disaster, you probably qualify for some tax breaks. Although no tax deduction is allowed for the value of services performed for a qualified charity or federal, state or local governmental agency, some deductions are permitted for out-of-pocket costs incurred while performing the services. The following are some examples:

  • Away-from-home travel expenses while performing services for a charity, including out-of-pocket round-trip travel costs, taxi fares, and other costs of transportation between the airport or station and hotel, plus 100% of lodging and meals. These expenses are only deductible if there is no significant element of personal pleasure associated with the travel or if your services for a charity do not involve lobbying activities.
  • The cost of entertaining others on behalf of a charity, such as wining and dining a potentially large contributor (but the costs of your own entertainment and meals are not deductible).
  • If you use your car or other vehicle while performing services for a charitable organization, you may deduct your actual unreimbursed expenses that are directly attributable to the services, such as gas and oil costs, or you may deduct a flat 14 cents per mile for the charitable use of your car. You may also deduct parking fees and tolls.
  • You can deduct the cost of the uniform you wear when doing volunteer work for the charity, as long as the uniform has no general utility. The cost of cleaning the uniform can also be deducted.

There are some misconceptions as to what constitutes a charitable deduction, and the following are frequently encountered issues:

  • No deduction is allowed for the depreciation of a capital asset as a charitable deduction. This includes vehicles and computers.

Example: Kathy volunteers as a member of the sheriff’s mounted search and rescue team. As part of volunteering, Kathy is required to provide a horse. Kathy is not allowed to deduct the cost of purchasing her horse or to depreciate her horse. She can, however, deduct uniforms, travel, and other out-of-pocket expenses associated with the volunteer work.

However, a taxpayer may deduct the cost of maintaining a personally owned asset to the extent that its use is related to providing services for a charity. Thus, for example, a taxpayer is allowed to deduct the fuel, maintenance, and repair costs (but not depreciation or the fair rental value) of piloting his or her plane in connection with volunteer activities for the Civil Air Patrol. Similarly, a taxpayer—such as Kathy in our example, who participated in a mounted posse that is a civilian reserve unit of the county sheriff’s office—could deduct the cost of maintaining a horse (shoeing and stabling).

  • A taxpayer who buys an asset and uses it while performing volunteer services for a charity can’t deduct its cost if he or she retains ownership of it. That’s true even if the asset is used exclusively for charitable purposes.

No charitable deduction is allowed for a contribution of $250 or more unless you substantiate the contribution with a written acknowledgment from the charitable organization (including a government agency). To verify your contribution:

  • Get written documentation from the charity about the nature of your volunteering activity and the need for related expenses to be paid. For example, if you travel out of town as a volunteer, request a letter from the charity explaining why you’re needed at the out-of-town location.
  • You should submit a statement of expenses to the charity if you are paying out of pocket for substantial amounts, preferably with a copy of the receipts. Then, arrange for the charity to acknowledge the amount of the contribution in writing.
  • Maintain detailed records of your out-of-pocket expenses—receipts plus a written record of the time, place, amount, and charitable purpose of the expense.

For additional details related to expenses incurred as a charity volunteer, please contact us.

When is a Charitable Contribution Appraisal Required?

A commonly overlooked requirement of taking a tax deduction for donating clothing and household goods to charity is the substantiation requirement, for both what is donated and the value placed on the donation. Because the IRS has encountered so much abuse in this area, it has increased the donation verification requirements over the years, and taxpayers risk losing the deduction if their donations are not correctly documented and reasonably valued.

Fair Market Value – Generally, it is up to you, the donor, to reasonably determine the fair market value (FMV) of the items you donate. If your return is reviewed, the values you claimed can be challenged. A deduction for household goods or clothing is not allowed unless they are in good used condition or better. The FMV of used household goods, furniture, appliances, linens, used clothing and other personal items are usually worth far less than the price they sold for new. Valuing these items as an arbitrary percentage of the original cost or by using another fixed formula is not appropriate – the condition of each item, whether it is still in style and other factors need to be considered. The value of the donated item(s) will determine the type of verification needed. The documentation and verification requirements are broken down into four categories:

  • Deductions of less than $250 – These donations require a receipt from the charity that includes the date and location of the contribution and a reasonably detailed description of the donated property.
    CAUTION – Don’t always rely on door hangers as a valid acknowledgment, since they generally do not include all of the required information (especially the reasonably detailed description of the donated item), and their use as documentation has been denied in tax court.
  • Deductions of $250 to $500 – Such deductions require a written acknowledgement from the charity that includes the date and location of the contribution and a reasonably detailed description of the donated property, whether the qualified organization gave you any goods or services as a result of the contribution, and if goods and/or services were provided to you, a description of the goods/services and an estimate of their value.
  • Deductions of over $500 but not over $5,000 – You must have the same acknowledgement and written records as for contributions of at least $250 but not more than $500, as described above. In determining whether your deduction is worth $500 or more, combine your claimed deductions for all similar property items donated to any charitable organization during the year. In addition, the records must also include:
    • How the property was obtained – for example, by purchase, gift, bequest, inheritance, or exchange.
    • The approximate date when the property was obtained or, if you created, produced, or manufactured it, the approximate date when the property was substantially completed.
    • The cost or other basis, and any adjustments to the basis, of property held for less than 12 months and, if available, the cost or other basis of property held for 12 months or more. However, this requirement does not apply to publicly traded securities. If you are unable to provide either the date the property was obtained or the cost basis of the property and there is reasonable cause for not being able to do so, you need to attach a statement to your return with an explanation.When your total deduction for all noncash contributions for the year is over $500, Form 8283 must be completed and attached to your Form 1040.
  • Deductions over $5,000 – You must have the same acknowledgement and written records as for contributions of at least $250 but not more than $500, as described above. In addition, if the contribution exceeds $5,000 for a single property item or group of similar items, then a qualified appraisal is required, and IRS Form 8283 must be completed, signed by the qualified appraiser and attached to the return. The exception to this rule is publicly traded securities.

Example: Jay and Emily made three donations of used clothing during the year: $2,500 worth to the Salvation Army, $1,500 worth to the Vietnam Veterans of America and $2,000 to Goodwill, for a total of $6,000. Because the items were all similar in nature (clothing) and because the total exceeded $5,000, Jay and Emily will need to obtain a qualified appraisal.

Qualified Appraisal – A qualified appraisal of any property is an appraisal that’s treated as qualified under IRS regulations. This means that the person doing the appraisal is generally someone who earned an appraisal designation from a recognized professional appraiser organization, has met certain education or experience requirements relative to the type of property being appraised, regularly prepares appraisals for a fee and has not been prohibited from practicing before the IRS.

Appraisal Timing– You must obtain the appraisal no earlier than 60 days before the appraisal property’s contribution date and no later than the extended due date of your tax return.

CAUTION – If you don’t bother to obtain an appraisal and the IRS later challenges your deduction, it will be too late to get the appraisal, and the deduction will most likely be denied.

Donations of vehicles, boats and airplanes have a special set of rules not covered in this article if the claimed deduction exceeds $500. Please give us a call about the documentation requirements for vehicle donations and any questions you might have related to any charitable contribution. Click here to download a special non-cash contribution form.

Elusive Employee Business Expense Tax Deduction

One major difference between being an employee and being self-employed is how you deduct the expenses you incur related to your work. A self-employed individual is able to deduct expenses on his or her business schedule, while an employee is generally limited to deducting them as itemized deductions.

That means self-employed individuals benefit by deducting their expenses directly on their business schedule, which can then result in a reportable business loss if the expenses exceed their business income.

On the other hand, an employee can only deduct employee business expenses on an IRS Form 2106, and the total from the 2106 is deducted as a miscellaneous itemized deduction. Thus, in order to claim employee business expenses, the employee is forced to itemize their deductions and cannot utilize the standard deduction. In addition, the employee’s business expenses fall into a category that is reduced by 2% of the employee’s adjusted gross income (AGI), which means that if the employee’s AGI for the year is $100,000, for example, only job-related expenses—combined with other miscellaneous expenses in that category—in excess of $2,000 (2% of $100,000) would be deductible. On top of that, miscellaneous itemized deductions are not deductible at all under the alternative minimum tax (AMT). Thus, if an individual is subject to the AMT, he or she may gain little or no tax benefit from employee business expenses.

Employee business expenses are unreimbursed expenses that are both ordinary (common and accepted in your industry) and necessary (appropriate and helpful in business) and do not include personal expenses. Although not all-inclusive, examples of allowed expenses include the costs of tools, job-related education, job-seeking expenses, business travel away from home, and business use of a car and home.

If you have questions related to employee business expenses and strategies to deduct them, such as bunching deductions, taking advantage of fast write-off provisions of the tax law, or working out a tax-favored reimbursement plan with your employer, please give us a call.

Can You Deduct a Home Office, and Is It Worth It?

Home office is a term used to describe the tax deduction for the business use of your home, which may or may not be an office. It is often misunderstood and claimed by those who don’t qualify for it or not claimed to the taxpayer’s best advantage. Understanding the requirements, options, limitations, advantages and disadvantages will help you determine if you qualify for the deduction and whether it is right for you.

Qualifications – In general, for you to deduct home office expenses, the office area must be used exclusively (no personal use) in your trade or business on a regular, continuing basis, and one of the following must apply—it is:

  1. Used for storing inventory for a wholesale or retail business for which your home is the only fixed location. Use of the area need not be exclusive under this test, but it must be regularly used;
  2. Used as a licensed day care center (exclusive use not required);
  3. A separate structure not attached to your home but used for business;
  4. A place where you meet with customers, patients or clients (just telephone contact with clients isn’t enough to meet this test); or
  5. The principal place of business for any of your trades or businesses.

Employee Issues – If you are an employee, in addition to the general qualifications for a home office discussed above, the home office use must also be for the convenience of your employer. Convenience of the employer means a business necessity—the use of the home must be a condition of employment. The employee needs a place to work, but the employer doesn’t provide one (or the office provided by the employer is inadequate or unsafe). Usage by the employee for personal convenience is not enough.

Method Options – Two methods are available for determining the amount of the home office deduction: the actual expense method and the simplified method (sometimes termed the safe-harbor method).

  • Actual Expense Method – The actual expense method uses home expenses that are prorated based upon the portion of the home that qualifies as a home office, generally based upon square footage. The prorated expenses include mortgage interest, real property taxes, insurance, heating, electricity, maintenance and depreciation. In the case of a rented home, the interest, tax and depreciation expenses are replaced by rent. Besides the prorated expenses, 100% of the costs directly related to the office, such as painting the office or repairs specific to the office, are allowed.
  • Simplified Method – In lieu of the actual expense method, the simplified method can be elected annually. The deduction is $5 per square foot, with a maximum square footage of 300. Thus, the maximum deduction is $1,500 per year. If the space was not used the entire year as a qualified home office, then this simple method becomes a little more complex, as the deduction must be limited to $5 times the average monthly square footage. Under the actual expense method, since part of the home mortgage interest and taxes are deducted as home office expenses, only the difference between 100% of the mortgage interest and taxes and the amount claimed for the office expense is allowed as a Schedule A itemized deduction. With the simplified method, all of the qualified home mortgage interest and taxes can be deducted on Schedule A.

When using the actual method, the unused deduction as a result of the income limitations (discussed below) carries over to future years, but none of the unused deduction figured by the simplified method will carry over.

Income Limitations – Even if you qualify for a home office deduction, the home office deduction is limited to the business activity’s gross income or, in the case of an employee, wages from the employer. Many people mistakenly believe that the limitation is the activity’s net income. The gross income limitation is actually the gross sales less the cost of goods sold, the business portion of the home’s mortgage interest and taxes and the otherwise deductible business expenses that are not related to the home’s business use. If the simplified home office deduction is used, there is no adjustment for home mortgage interest and taxes.

Relocation – There are additional things to consider when you deduct a home office and subsequently leave the rental or sell the home.

  • Renter – When you rent your home, move and use space at the new location as a home office, for the year of the move, you’ll need to figure the deduction separately for each home office based on the specific expenses and business use area of each home. If you don’t use space at your new living quarters for business purposes, then your home office deduction for the year of the move will only need to factor in the expenses for the time you lived in the first home.
  • Homeowner – If you own the home, sell it and had lived in it for 2 of the 5 years prior to the sale date, you can exclude up to $250,000 of gain ($500,000 for a married couple). However, you cannot exclude the part of any gain to the extent of depreciation you claimed for the home office after May 6, 1997.
    In addition, if the home office was within the same structure as the home, the exclusion will apply to the entire gain from the home except for the deprecation claimed. On the other hand, if the office was within a separate structure, then the sale must be treated as two sales – one for the home and one for the office – and the gain from the home office portion cannot be excluded, which can be a huge negative to claiming the home office deduction in the first place.

As you can see, there is more to the home office deduction than meets the eye. If you have questions about how a home office might fit into your tax situation, please give this office a call.

Using Home Equity for Business Needs

Small business owners frequently find it difficult to obtain financing for their businesses without pledging their personal assets. With home mortgage interest rates at historic lows, tapping into your home equity is a tempting alternative but one with tax ramifications that should be carefully considered.

Generally, interest on debt used to acquire and operate your business is deductible against that business. However, depending upon the circumstances of the loan structure, debt secured by your home may be nondeductible, only partially deductible or wholly deductible against your business.

Home mortgage interest is limited to the interest on $1 million of acquisition debt and $100,000 of equity debt secured by a taxpayer’s primary residence and designated second home. The interest on the debts within these limits can only be treated as home mortgage interest and must be deducted as part of your itemized deductions. Only the excess can be deducted for your business, provided that the use of the funds can be traced to your business use. This creates a number of problems:

  • Using the Standard Deduction – If you do not itemize your deductions, you will be unable to deduct the interest on the first $100,000 of the equity debt, which cannot be allocated to your business.
  • Subject to the AMT – Even if you do itemize your deductions, if you happen to be subject to the alternative minimum tax (AMT), you still would not be able to deduct the first $100,000 of equity debt interest, since it is not allowed as a deduction for AMT purposes.
  • Subject to Self-Employment (SE) Tax – Your self-employment tax (Social Security and Medicare) is based on the net profits from your business. If the net profit is higher, because not all of the interest is deductible by the business, your SE tax may also be higher.

    Example: Suppose the mortgage you incurred to purchase your home (acquisition debt) has a current balance of $165,000 and your home is worth $400,000. You need $150,000 to acquire a new business. To obtain the needed cash at the best interest rates, you decide to refinance your home mortgage for $315,000. The interest on this new loan will be allocated as follows:

    New Loan: $ 315,000
    Part Representing Acquisition Debt – 165,000   52.38%
    Balance $ 150,000
    First $100,000 Treated as Home Equity Debt – 100,000   31.75%
    Balance Traced to Business Use $ 50,000   15.87% 

    If the interest for the year on the refinanced debt was $10,000, then that interest would be deducted as follows:

    Itemized Deduction Regular Tax      $ 8,413   84.13%
    Itemized Deduction Alternative Minimum Tax $ 5,238   52.38%
    Business Expense      $ 1,587   15.87%

There is a special tax election that allows you to treat any specified home loan as not secured by the home. If you file this election, then interest on the loan can no longer be deducted as home mortgage interest, since tax law requires that qualified home mortgage debt be secured by the home. However, this election would allow the normal interest tracing rules to apply to that unsecured debt. This might be a smart move if the entire proceeds were used for business and all of the interest expense could be treated as a business expense. However, if the loan were a mixed-use loan and part of it actually represented home debt (such as a refinanced home loan), then the part that represented the home debt could not be allocated back to the home, and the interest on that portion of the debt would become nondeductible and would provide no tax benefit.

Example: Using the same scenario as the previous example but electing to treat the mortgage as unsecured by the home, the deductible business interest for the year would be $4,762 [($150,000/$315,000) x $10,000]. None of the balance of the interest would be deductible.

As you can see, using equity from your home can create some complex tax situations. Please contact this office for assistance in determining the best solution for your particular tax situation.

Deducting Convention Expenses

Generally, an individual can deduct travel expenses from attending conventions, seminars or similar types of meetings within the North American area, provided that attendance benefits the taxpayer’s trade or business. However, family members’ travel expenses are not deductible, and neither are expenses from attending investment, political, social or other types of meetings not related to the taxpayer’s trade or business.

The North American area includes the United States, U.S. possessions, Canada, Mexico, Bermuda, Barbados, Costa Rica, Dominica, the Dominican Republic, Grenada, Guyana, Honduras, Jamaica, Saint Lucia, and Trinidad and Tobago. For a more detailed list, consult IRS Publication 463.

Thus, the entire cost of transportation and lodging, plus 50% of the meal expenses, is deductible for meetings held within the North American area.

Meetings Outside the North American Area – Deducting travel expenses for a convention or meeting outside the North American area has requirements:

  • The meeting must be directly related to the taxpayer’s trade or business (whereas meetings within the North American area need only benefit the taxpayer’s trade or business), and
  • It must be reasonable to hold the meeting outside the North American area. There is no specific definition of “reasonable” for this purpose, which places the burden of proof on the taxpayer. Considerations include the meeting’s purpose and activities and the location of the meeting sponsors’ homes.

Even if the above requirements are met, the amount of deduction allowed depends upon the primary purpose of the trip and on the time spent on nonbusiness activities:

  1. If the entire time is devoted to business, all ordinary and necessary travel expenses are deductible.
  2. If the travel is primarily for vacation and only a few hours are spent attending professional seminars, none of the expenses incurred in traveling to and from the business location are deductible.
  3. If, during a business trip, personal activities take place at, near or beyond the business destination, then the expenses incurred in traveling to and from the business location have to be appropriately allocated between the business and nonbusiness expenses.
  4. If the travel is for a period of one week or less, or if less than 25% of the total time is spent on nonbusiness activities (on a day-by-day basis), then the travel deductions are treated the same as they would be for travel within the North American area.

Meetings Held on Cruise Ships – When a convention or meeting is held on a cruise ship and is directly related to a taxpayer’s trade or business, the taxpayer is limited to $2,000 per year in deductions for expenses from attending such conventions, seminars, or similar meetings. All ships that sail are considered cruise ships. The following rules also apply:

  • The cruise ship must be registered in the United States.
  • All of the cruise ship’s ports of call must be in the United States or its possessions.

If you have questions related to the deductibility of expenses from conventions and meetings or from foreign travel, please give this office a call.

Tax Deductions for Owner-Operator Truckers

There are certain tax deductions for owner-operator truckers that are unique. You benefit from special allowances for meals, are allowed very large write-offs for tractors and other equipment, must pay additional taxes and permit costs, and may have special reporting requirements in addition to your tax returns. The following is an overview of the tax issues that may apply to owner-operators.

  • Meals Away from Home – As an owner-operator trucker, you may deduct the actual cost of your meals; this requires you to save your receipts. Alternatively, you can deduct the IRS’ standard meal allowance for the transportation industry, using your logbooks as substantiation. For 2016 and 2017, amount for meals and incidental expenses is $63 per day. Whether you use the actual-expense method or the standard method, only 80% of the total for the year is deductible. Even though only 80% is deductible, keep track all expenses for tax purposes, as the 80% adjustment is made during the tax-return preparation process
    Meals are deductible if you need to stop for substantial rest in order to properly perform your duties while traveling on business.
  • Lodging – Lodging expenses are deductible. Unfortunately, there is no standard allowance for lodging; thus, you must keep a receipt for each lodging expense. Generally, to deduct lodging expenses, you must be away from home overnight.
    One issue that could result in the disallowance of lodging and other travel expenses is not having a regular place of business or place of residence. In this case, you would be considered an itinerant (or transient), and your home for tax purposes would be wherever you work. As an itinerant, you would not be able to claim a deduction for lodging and meals because you would never be considered to be away from home.
  • Other On-The-Road Expenses -Generally, to be deductible, items must be both ordinary and necessary to your job. For truckers, these expenses include laundry (when away overnight), gloves, logbooks, maps, cell phones, CB radios, tools, safety gear, cargo straps, and any other incurred expenses that are ordinary and necessary in the business. Generally, receipts are required, but if the business expense is less than $75, a receipt is not necessary, provided that you record all of the information in a diary in a timely manner.
  • Vehicle (Tractor) Cost Write-Offs – The current tax code provides several options for writing off the cost of a vehicle, including immediate expensing of up to $510,000 (as of 2017) during the year the property is put into service; first-year depreciation equal to 50% of the vehicle’s cost; normal deprecation; or a combination of all three. These options allow owner-operators to pick almost any amount of write-off to best suit their particular circumstances. For normal depreciation, the IRS allows a recovery period of 3 years for over-the-road tractor units and of 5 years for trailers, trailer-mounted containers and heavy-duty trucks (13,000 pounds or more).
  • Vehicle (Tractor) Operating Expenses – Of course, vehicle operating expenses – including fuel, licenses, taxes, maintenance and insurance – are deductible. Depending on the nature and cost, some expenses may have to be depreciated.
  • General Business Expenses – Owner-operators can usually deduct the following expenses: trucking-industry and business-related subscriptions, association dues, computers and software, Internet service, cleaning supplies, business interest, office supplies, DOT physicals, drug testing, sleep apnea studies, postage and other business-related expenses.
  • Heavy Highway Vehicle Use Tax – The heavy highway vehicle use tax (Form 2290) applies to highway vehicles weighing 55,000 pounds or more. The due date for this form is based on when (during the annual filing period) the vehicle is first used on a public highway. For the period of July 1, 2016, through June 30, 2017, Form 2290 is due by the end of August 2016 for vehicles first used on a public highway in July 2016. For vehicles first used on a public highway after July, the use tax is prorated, and the form is due by last day of the month following the month of first use. See when to file for more details. The use tax ranges from $100 to $550 per vehicle for a full year, depending on the vehicle’s weight. You will need to have an employer ID number to file the Form 2290; your Social Security number cannot be used as the ID number.
  • Subcontractor Payments – If you paid an individual for services during the year, that person was most likely a subcontractor. Payments of $600 or more to subcontractors must be reported to the government by filing Form 1099-MISC. This form requires the subcontractor’s name, address and tax ID number as well as the payment amount. There are penalties for failing to file this form, for filing it late and for filing it without the tax ID number. All these penalties can be avoided by (1) having contractors complete Form W-9 before you pay them and (2) filing the 1099-MISC forms by January 31 of the subsequent year.

Some expenses are not deductible; those with limited knowledge of trucker expenses may take these deductions, potentially triggering IRS inquiries and audits. One example is deducting the cost of street clothing. For clothing, only the cost of uniforms or protective clothing is allowed as a deduction.

Another example is deducting lost income:

  • For time you spend repairing or maintaining your own equipment,
  • As a result of a deadhead, or
  • Because of downtime.

Lost income is already accounted for, as you do not have to report the income on your tax return in the first place.

If you have any questions related to trucking and taxes, please call. This office is knowledgeable regarding the drivers’ and owner-operators’ tax issues, and are here to help you eliminate the stress of accounting and tax filing.

Tax Benefits for Parents

If you are a parent, whether single, married or divorced, there are a significant number of tax benefits available to parents, including deductions, credits, filing status and exemptions that can help put a dent in your tax liability.

Exemptions – Regardless of filing status, you receive a $4,050 income exemption for each of your qualifying children whom you claim as a dependent on your tax return. In the case of divorced or separated parents, the exemption is allowed to the custodial parent unless the custodial parent releases the exemption to the non-custodial parent. If you are the custodial parent, you can release the exemption on a year-by-year basis or for multiple years if you wish to do so. However, being unable to foresee the future means it is generally wiser to release the exemption annually. The exemption amount gradually decreases to zero once a certain income threshold is reached; this phase out generally applies to higher income taxpayers.

Child Tax Credit – If you have dependent children, you are also entitled to a nonrefundable tax credit of $1,000 for each child under the age of 17 at the close of the year. The term “nonrefundable” means the credit can only be used to offset any tax liability you may have, and the balance of the credit is lost. If you are not filing jointly with the child’s other parent and have released the exemption to that parent, then you will not qualify for the child tax credit for that child. In addition, this credit also phases out for higher income taxpayers. For lower income parents, a portion of the child tax credit, which is normally nonrefundable, can become refundable.

Earned Income Tax Credit – The earned income credit benefits lower income parents based upon your earned income, filing status (either married filing jointly or unmarried) and the number of qualifying children you have up to three. The credit for 2017 can be as much as $6,318, and better yet, the amount not used to offset your tax liability is fully refundable. This credit is phased out for higher income filers, and those with investment income of more than $3,450 for 2017 aren’t eligible.

Head of Household Filing Status – The tax code provides a special filing status – head of household – for unmarried and separated taxpayers. The benefit of head of household filing status is that it provides lower tax rates and a higher standard deduction than the single status ($9,350 as opposed to $6,350 for a single individual in 2017). If you are an unmarried parent and you pay more than one-half the cost of the household for yourself and your child, you qualify for this filing status. Even if you are married, if you lived apart from your spouse the last six months of the year and pay more than one-half the cost of the household for yourself and your child, you qualify for this filing status.

Childcare – Many parents who work or are looking for work must arrange for care of their children. If this is your situation, and your children requiring care are under 13 years of age, you may qualify for a nonrefundable tax credit that can reduce your federal income taxes.

The childcare credit is an income-based percentage of up to $3,000 of qualifying care expenses for one child and up to $6,000 of qualifying care expenses for two or more children. The allowable expenses are also limited to your earned income, and if you are married, both you and your spouse must work and the limit is based upon the earned income of the spouse with the lower earnings. The credit percentages range from a maximum of 35% if your adjusted gross income (AGI) is $15,000 or less to 20% for an AGI of over $43,000.

If your employer provides dependent care benefits under a qualified plan that pays your child care provider either directly or by reimbursing you for the expenses, or your employer provides a day care facility, you may be able to exclude these benefits from your income. Of course, the same expenses aren’t eligible for both tax-free income and the child care credit.

Education Savings Plans – The tax code provides two plans to save for your children’s future education. The first is the Coverdell Education Savings Account, which allows non-deductible contributions of up to $2,000 per year. The earnings on these accounts are tax-free provided the amounts withdrawn from the accounts are used to pay qualified expenses for kindergarten and above. Coverdell contributions will phase out for higher income taxpayers beginning at an AGI of $190,000 for married taxpayers filing jointly and half that amount for other taxpayers.

A second plan, called a Qualified Tuition Plan (sometimes referred to as a Sec 529 plan), allows individuals to gift large sums of money for a family member’s college education while continuing to maintain control of the funds. The earnings from these accounts grow tax-deferred and are tax-free if used to pay for college tuition and related expenses.

Contributions to these plans are not limited to the child’s parents and can be made by virtually anyone, although if not the parents, then typically it is the grandparents who fund the accounts.

Education Credits – If you are a parent with a child or children in college, don’t overlook the American Opportunity Tax Credit (AOTC). It provides a tax credit equal to 100% of the first $2,000 of qualified tuition and related expenses and 25% of the next $2,000 for each child who was enrolled at least half time. Better yet, 40% of the credit is refundable. This credit is good for the first four years of post-secondary education.

There is a second education credit called the Lifetime Learning Credit (LLC) that provides a nonrefundable tax credit equal to 20% of up to $10,000 of qualified tuition and related expenses. Unlike the AOTC, which is allowed per student, the LLC is calculated on a per-family basis with a maximum credit of $2,000 but is not limited to the first four years of post-secondary education.

You don’t even have to pay the expenses to get the credits. The credits are allowed to the person claiming the exemption for the child. So if the child’s grandparent, uncle, aunt or even an ex-spouse or the child’s other parent pays the tuition, you still get the credit as long you claim the child as your dependent.

Student Loan Interest – Generally, personal interest you pay, other than certain mortgage interest, isn’t deductible on your tax return. However, there is a special deduction, up to $2,500 per year, allowed for interest paid on a student loan (also known as an education loan) used for higher education. You don’t have to itemize deductions to take advantage of this deduction, but you must have paid the interest on a loan taken out for your own or your spouse’s education or that of a dependent. So if you were legally obligated to pay the loan for one of your children who was your dependent when the loan was taken out, you may be able to claim this deduction, even if the child is no longer your dependent.

The student must have been enrolled at least half-time, and the loan must have been taken out solely to pay qualified higher education expenses. The lender can’t be a related person. This deduction phases out if your AGI is more than $65,000 ($130,000 if filing a joint return) and isn’t allowed if you use the married filing separate status.

Child’s Medical Expenses – If you itemize deductions, the unreimbursed medical expenses you pay for your dependents are counted for figuring your total medical expenses. This is true for both parents even if they do not file together as long as one of them is able to claim the child as a dependent.

If you have questions related to any of these tax benefits, please give this office a call.