I Didn’t File My Tax Return; Now What?

There are a lot of perfectly reasonable reasons for not having filed your income taxes. Many people who fail to file are new to the job market, and never having filed before may simply have been unaware of the requirement to do so. Some people know but are too overwhelmed with other life events, including illnesses, death, or job loss. Whatever your reason and whether you’ve only missed one year of filing or several, there comes a point when you either remember on your own or are prompted for a request for a copy. Now, what do you do? And how much trouble are you in?

Here’s the Good News
First of all, if you’re the one who realized that you haven’t filed rather than getting a notice from the IRS or your state tax authority, then you’re probably not in too much trouble. Even if you’ve gotten a notice, there’s a specific legal process that gets followed when a taxpayer hasn’t filed a return, and it is a perfectly reasonable procedure that can be addressed and managed. There is no reason to panic, as nobody is going to break down your door and haul you away. Filing taxes is a matter of paperwork and payment. If you haven’t been in compliance, you simply need to amend the situation and pay some penalties, and possibly some interest.

As A Matter of Fact …
You may not even have been required to file a return.

There are plenty of taxpayers whose circumstances are such that they aren’t required to file a tax return, and when that’s the case, the state frequently follows their lead (which is a good thing, as many times the penalties that a state charges for failure to file tax returns are higher than those imposed by the federal government.)

The best and easiest way to find out whether you are one of those who didn’t need to file is to visit the IRS website, where there is a handy tool called “DO I NEED TO FILE A TAX RETURN?” Plug in your relevant information about the tax year in question, your income, household composition and filing status for a quick answer. You may be in for a pleasant surprise unless you fall into one (or more) of the following categories:

  • You earned at least $400 in profit from being self-employed. This can include any job for which you received a 1099, and anything from doing freelance work as a writer to providing landscaping services for your neighbors. Driving for Lyft or Uber counts too.
  • You sold your house, even if it was a break even or loss and you had no income that year
  • You received unemployment benefits
  • You are a worker who earns tips and they weren’t reported to your employer. Even if you reported them you may have to file a tax return if they didn’t submit payroll taxes for them.

In each of these situations, you are required to file a tax return, regardless of how much or how little you earned and whether you paid taxes on those earnings or not.

Fortunately, filing a tax return is always possible, though you may have to pay a penalty.  On the flip side, you may actually have a refund coming which obviously will benefit you to file.

Did the Government Do It For You?
Though the IRS doesn’t always catch every time that a taxpayer fails to file a tax return, when they do they will send out a notice. And if your Social Security Number was linked to any type of document or paperwork that they received, whether that’s a W-2, a 1099 or any other type of form, they also probably filed a substitute tax return to make up for your oversight. These substitute returns represent a bare minimum of information. They don’t enter any of the information that you might have provided in order to minimize your tax liability – they use the standard deduction and personal exemption, then record the income information that they have. It’s also what they’ll use to figure out your penalties, interest, and fines owed.

There are a lot of reasons why you should take action to get a real tax return in for yourself instead of the substitute return that the government provided, but one of the best reasons is that when you’re asked for a previous year’s tax return so you can take out a loan, the substitute won’t satisfy the lender’s requirements.

Better Late Than Never, But It Has to be Right
When you’re filing a past-due tax return, you want to make sure that every “t” is crossed and every “I” is dotted. This is no time for making mistakes or leaving out important information. Even if your returns are generally simple, you’d be wise to work with an experienced tax professional in getting your papers turned in to the federal and state authorities. They will look out for your best interest, helping you to avoid any potential pitfalls and acting on your behalf to address complex questions and offering authoritative explanations of your inaction if necessary.  In some circumstances a tax professional can even get your penalties abated or minimized.

Is Bunching Right for You?

 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 increased the standard deduction and placed new limitations on itemized deductions. Beginning with 2018 tax returns, the standard deductions will be:

  • $12,000 for single individuals and married people filing separately,
  • $18,000 for heads of household, and
  • $24,000 for married taxpayers filing jointly.

If your deductions exceed the standard deduction amount for your filing status, you are allowed to itemize the following deductions:

  • Medical expenses, to the extent they exceed 7.5% of your adjusted gross income (AGI);
  • Taxes paid during the year (for state or local income or sales tax and for real property or personal property taxes), limited to $10,000;
  • Home mortgage interest;
  • Investment interest;
  • Charitable contributions;
  • Gambling losses, to the extent of your gambling winnings; and
  • Certain infrequently encountered tier-1 miscellaneous deductions.

Are your itemized deductions typically roughly equal to the new standard deduction amount? If so, think about using a tax strategy known as bunching. In this technique, you take the standard deduction in one year and then itemize in the next. This is accomplished by planning the payment of your deductible expenses so as to maximize them in the years when you itemize deductions. Commonly bunched deductible expenses include medical expenses, taxes, and charitable contributions.

To clearly illustrate how bunching works, here are a few examples of deductible payments that generally provide enough flexibility:

  • Medical Expenses – Say that you contract with a dentist for your child’s braces. This dentist offers you the option of an up-front lump-sum payment or a payment plan. If you make the lump-sum payment, the entire cost will be credited in the year you paid it, thereby dramatically increasing your medical expenses for that year. If you do not have the cash available for the up-front payment, then you can pay by credit card, which is treated as a lump-sum payment for tax purposes. If you do so, you must realize that the interest on that payment is not deductible; you need to determine whether incurring the interest is worth the increased tax deduction. Another important issue related to medical deductions is that only the amount of medical expenses that exceeds 7.5% of your AGI is actually deductible. In addition, this 7.5% floor will increase to 10% after 2018. There is thus no tax benefit to bunching medical deductions if the total will be less than 7.5% of your AGI (or 10% beginning in 2019).
    If you have abnormally high income in the current year, you may wish to put off medical expense payments until the following year (e.g., if 10% of the following year’s income will be less than 7.5% of this year’s income).
  • Taxes – Property taxes are generally billed annually at midyear; most locales allow for these tax bills to be paid in semiannual or quarterly installments. Thus, you have the option of paying them all at once or paying them in installments. This provides the opportunity to bunch the tax payments by paying only one semiannual installment (or 2 quarterly installments) in one year and pushing off the other semiannual (or 2 quarterly) installments until the next year. Doing so allows you to deduct 1½ years of taxes in one year and half a year of taxes in the other. However, if you are thinking of making late property tax payments as a means of bunching, you should be cautious. Late payment penalties are likely to wipe out any potential tax savings.
    If you reside in a state that has a state income tax, any such tax that is paid or withheld during the year is deductible on federal taxes. For instance, if you are making quarterly estimated state tax payments, the fourth quarter estimated payment is generally due in January of the subsequent year. This gives you the opportunity to either make that payment before December 31 (thus enabling you to deduct the payment on the current year’s return) or pay it in January before the due date (thus enabling you to use it as a deduction in the subsequent year).
    Here is a word of caution about itemized tax deductions: Under the Act, a maximum of $10,000 is allowed under itemized tax deductions, so there is no benefit gained by prepaying taxes when your tax total is already $10,000 or more. In addition, taxes are not deductible at all under the alternative minimum tax, so individuals under that tax generally derive no benefits from itemized deductions.
  • Charitable Contributions – Charitable contributions are a nice fit for bunching because they are entirely at the taxpayer’s discretion. For example, if you normally tithe to your church, you can make your normal contributions during the year but then prepay the entire subsequent year’s tithe in a lump sum in December of the current year. If you do this for all contributions that you generally make to qualified organizations, you can double up on your contributions in one year and have no charitable deductions in the next year. Normally, charities are very active in their solicitations during the holiday season, which gives you the opportunity to make forward-looking contributions at the end of the current year or to simply wait a short time and make them after the end of the year. Charitable deductions do have a limit, but for most types of contributions, it is high: 60% of AGI, beginning in 2018.

If you have questions about bunching your deductions, or if you wish to do some in-depth strategizing about how this technique could benefit you, please call for an appointment.

Living Abroad? Here Is How Tax Reform May Affect You

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 was passed in late December 2017, could affect you and your family, in both 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 expatriate living abroad, you may be wondering how the provisions of the Tax Cuts and Jobs Act (TCJA) will impact you. This is the most extensive tax change in over 30 years, and although it was touted as tax simplification when it was in the planning stages, nothing was simplified related to U.S. citizens and resident aliens working abroad. The following is an overview of how things will play out for you beginning in 2018.

The Foreign Earned Income Exclusion Is Still Alive and Well – The inflation-adjusted maximum exclusion for 2018 is $104,100 (up from $102,100 in 2017). However, the Act did change the measure of inflation so that the inflation adjustments in future years will be lower. The housing exclusion was also retained, and for 2018, the maximum is $14,574 (up from $14,294 in 2017). For certain high-cost areas, the IRS allows higher housing exclusions.

Foreign Information Reporting Remains the Same – The troublesome burden of reporting foreign financial relationships continues unchanged. So if the aggregate value of the foreign financial accounts that you have a financial interest in or signature authority over exceeds $10,000 any time during the year, you are generally required to file Form 114 (commonly referred to as FBAR) with FinCEN. If you have specified foreign financial assets generally having a year-end value of $200,000, or $300,000 at any time during the year (double those amounts for married taxpayers), you are required to file Form 8938 with your tax return. Other reporting requirements include Form 5471 to report ownership or voting power in a foreign corporation, Form 3520 for ownership or transactions with foreign trusts and for reporting foreign gifts or bequests and Form 3520-A when a foreign trust has a U.S. owner.

Ownership in a Foreign Corporation – The Act transforms the U.S. into a territorial system of taxation for corporations instead of a worldwide system. As a result, all U.S. taxpayers who own at least 10% of a foreign corporation must include in their income pro rata shares of all accumulated post-1986 deferred foreign income that has not previously been taxed. After all of the adjustments, this deferred foreign income is generally taxed at an effective rate of 15.5%. The TCJA allows, by election, for this tax to be spread over a period of 8 years.

Foreign Tax Credit – The foreign tax credit remains unchanged, although the TCJA does not allow it to offset the tax on accumulated post-1986 deferred income, as previously discussed.

Other 1040 Changes – It seems that the Act’s only attempts at simplification were eliminating personal exemptions (which were $4,050 each for taxpayer, spouse and dependent in 2017); limiting itemized deductions (or suspending some deductions through 2025); and increasing the standard deduction to $12,000 for single taxpayers, $18,000 for head-of-household filers and $24,000 for those filing married joint. The Act also suspended the deduction for foreign property tax as itemized deduction.

The new tax law increased the child tax credit to $2,000, and up to $1,400 is refundable. However, if you exclude foreign earned income or the foreign housing allowance, you are prohibited from claiming the refundable part of the child tax credit. You must include the Social Security number of each qualifying child on your return for whom you claim the credit, and the Social Security number must be issued before the due date of your return. The Act added a new $500 nonrefundable credit for qualifying dependents other than qualifying children. The AGI threshold at which the child tax credit begins to phase out was substantially raised: to $400,000 for those filing a married joint return and $200,000 for others.

Moving Deduction – If you are planning a move in the future, the Act did deal you a bad hand. The deduction for moving expenses is suspended until after 2025, and to make matters worse, any moving reimbursement provided by your employer is taxable.

There have been, of course, many other changes brought about by the Act. If you have questions related to taxes and living abroad, please give us a call.

Can’t Pay Your Taxes by the April Due Date?

If you aren’t one of those lucky Americans who gets a tax refund from the IRS you might be wondering about your options for paying off your tax liability by the April due date.

The IRS encourages taxpayers to pay the full amount of their tax liability on time, and it imposes significant penalties and interest on late payments. Thus, if you are unable to pay the taxes that you owe, it is generally in your best interest to make other arrangements to obtain the full funds to pay your taxes so that you are not subjected to the government’s penalties and interest. Here are a few options to consider.

  • Family Loan – Obtaining a loan from a relative or friend may be the best bet because this type of loan is generally the least costly in terms of interest.
  • Credit Card – Another option is to pay by credit card by using one of the service providers that works with the IRS. However, as the IRS will not pay the credit card discount fee, you will have to pay that fee. You will also have to pay the credit card interest on the payment. Caution: Depending on the amount owed, it may be less expensive just to pay the IRS penalties and interest rate on the unpaid balance rather than the normally higher credit card interest rates.
  • Installment Agreement – If you owe the IRS $50,000 or less, you may qualify for a streamlined installment agreement that allows you to make monthly payments for up to six years. You will still be subject to the late payment penalty, but it will be reduced by half. In addition, interest will also be charged at the current rate, and you will have to pay a user fee to set up the payment plan. By signing this agreement, you agree to keep all future years’ tax obligations current. If you do not make payments on time or if you have an outstanding past-due amount in a future year, you will be in default of the agreement, and the IRS will then have the option of taking enforcement actions to collect the entire amount that you owe. If you seek an installment agreements exceeding $50,000, the IRS will need to validate your financial condition and your need for an installment agreement through the information you provide in the Collection Information Statement (in which you list your financial statements). You may also pay down your balance to $50,000 or less so as to take advantage of the streamlined option.
  • Tap a Retirement Account – This is possibly the worst option for obtaining funds to pay your taxes because it jeopardizes your retirement and because the distributions are generally taxable at the highest bracket, which adds more taxes to the existing problem. In addition, if you are under age 59½, such a withdrawal is also subject to a 10% early-withdrawal penalty that compounds the problem even further.

Whatever you decide, don’t ignore your tax liability since that is the worst thing you can do. Please call us if you have any questions or would like assistance.

Checking Your Federal Refund Status Is Easy

If you have already filed your federal tax return and are due to receive a refund, you can check the status of your refund online.

Where’s My Refund? is an interactive tool on the IRS website. Regardless of whether you have split your refund among several accounts, opted for a direct deposit into one account, or asked the IRS to mail you a check, Where’s My Refund? will give you online access to your refund information 24 hours a day and 7 days a week.

If you e-file, you can use this tool to get your refund information 24 hours after the IRS acknowledges receipt of your return. Nine out of 10 taxpayers typically receive refunds in fewer than 21 days when they use e-file with direct deposit. If you file a paper return, refund information will be available starting four weeks after mailing your return. When you go to check the status of your refund, have a copy of your federal tax return handy. To access your personalized refund information, you must enter

  • your Social Security Number (or Individual Taxpayer Identification Number);
  • your filing status (single, married filing jointly, married filing separately, head of household, or qualifying widow(er)), and
  • the exact refund amount shown on your tax return.

Once you have entered your personal information, one of several personalized responses will come up:

  • acknowledgement that your return has been received and is being processed,
  • your refund’s mailing date or direct deposit date, or
  • a notice that the IRS could not deliver your refund due to an incorrect address, at which point, you can update your address online using the Where’s My Refund? feature.

Where’s My Refund? also includes links to customized information based on your specific situation. The links guide you through the steps to resolve any issues that are affecting your refund. For example, if you do not receive your refund within 28 days of the mailing date shown on Where’s My Refund?, you can start a refund trace online.

Where’s My Refund? is also accessible to visually impaired taxpayers who use the Job Access with Speech screen reader with a Braille display. Where’s My Refund? is compatible with various modes of this screen reader.

IRS2Go is a free IRS smartphone app that lets taxpayers check on the status of their tax refunds. For download information, visit IRS2Go. It is available for both Apple and Android.

Where’s My Refund? provides the most up-to-date information that the IRS has. There’s no need to call the IRS unless Where’s My Refund? tells you to do so. Where’s My Refund? is updated every 24 hours (usually overnight), so you only need to check it once a day. Please call us if you have any questions or encounter any problems.

Sold Your Home Last Year? Thinking of Selling? Read This!

If you sold your home last year, or if you are thinking about selling it, you should be aware of the many tax-related issues that could apply to that sale so that you will be prepared at tax time and not have to deal with unpleasant surprises. This article covers home sales and the home-sale gain exclusion, particularly when that gain exclusion applies and what portion of it applies. Certain special issues always affect home sales, such as the use of a portion of the home as an office or daycare center, previous use of the property as a rental, and acquisition in a tax-deferred exchange. Other frequently encountered issues are related to the “2 years out of 5” rules for ownership and use, as these rules must be followed to qualify for gain exclusion.

Home Sale Exclusion – Generally, the tax code allows for the exclusion of up to $250,000 ($500,000 for married couples) of gain from the sale of a primary residence if you lived in it and owned it for at least 2 of the 5 years immediately preceding the sale. You also cannot have previously taken a home-sale exclusion within the 2 years immediately preceding the sale. There is no limit on the number of times you can use the exclusion as long as you meet these time requirements. However, extenuating circumstances can reduce the amount of the exclusion. The home-sale exclusion only applies to a primary residence, not to a second home or a rental property.

2 out of 5 Rule – To qualify for the home-sale gain exclusion, you must have used and owned the home for 2 out the 5 years immediately preceding the sale. If you are married, both you and your spouse must meet the use requirement, but only one of you needs to meet the ownership requirement. Vacations, short absences and short rental periods do not reduce the use period. When only one spouse in a married couple qualifies, the maximum exclusion is limited to $250,000 instead of $500,000. Although this situation is quite rare, if you acquired the home as part of a tax-deferred exchange (sometimes referred to as a 1031 exchange), then you must have owned the home for a minimum of 5 years before the home-gain exclusion can apply.

Some provisions allow you to reduce your gain by a prorated amount if you were required to sell the home because of extenuating circumstances such as a job-related move, a health crisis or other unforeseen events. Another rule extends the 5-year period to account for the deployment of military members and certain other government employees. Please call this office if you have not met the “2 out of 5” rule to see if you qualify for a reduced exclusion.

Business Use of the Home – If you used your home for business—for instance, by claiming a tax deduction for a home office, storing inventory in the home or using it as a daycare center—that deduction probably included an amount to account for the home’s depreciation. In that case, up to the extent of the gain, the claimed depreciation cannot be excluded.

Figuring Gain or Loss from a Sale – The first step is to determine how much the home cost, combining purchase price and the cost of improvements. From this total cost, subtract any claimed casualty losses and any depreciation taken on the home. The result is your tax basis. Next, subtract the sale expenses and this tax basis from the sale price. The result is your net gain or loss on the sale of the home.

If the result is negative, the sale is a loss. However, losses on personal-use property such as homes cannot be claimed for tax purposes.

If the result is a gain, however, subtract any home-gain exclusion (discussed above) up to the extent of the gain. This is your taxable gain, which is, unfortunately, subject to income tax and possibly to the net-investment income tax as well. If you owned the home for at least a year and a day, the gain will a be a long-term capital gain; as such, it will be taxed at the special capital-gains rates, which range from zero for low-income taxpayers to 20% for high-income taxpayers. Depending on the amount of your income, the gain may also be subject to the 3.8% net investment income surtax that was added as part of the Affordable Care Act. The tax computation can be rather complicated, so please call us for assistance.

Another issue that can affect your home’s tax basis (discussed above) applies if you owned your home before May 7, 1997 and purchased it after selling another home. Prior to that date, instead of a home-gain exclusion, any gain from a sale was deferred to the replacement home. Although this is now rare, if it matches your situation, the deferred gain would reduce your current home’s tax basis and add to any gain.

Another Twist – If you previously used your home as a rental property, the law includes a provision that prevents you from excluding any gain attributable to the home’s appreciation while it was a rental. The law’s effective date was the beginning of 2009, which means that you only need to account for rental appreciation starting in that year. This law was passed to prevent landlords moving into their rentals for 2 years so that they could exclude the gains from those properties. Some landlords did this repeatedly.

Records – Assets that are worth hundreds of thousands of dollars, including your home, need your attention, particularly regarding records. When figuring your gain or loss, you will, at a minimum, need the escrow statement from the purchase, a list of improvements (not maintenance work) with receipts, and the final escrow statement from the sale. When you encounter any of the issues discussed in this article, you may need additional documentation.

A few other rare home-sale rules are not included here. As you can see, home-sale computations and tax reporting can be very complicated, so please call us if you need assistance.

Driving For Uber Or Others? Your Tax Situation Is Unique

With tax time approaching, if you drive for Uber, Lyft or a competitor, here is some tax information related to reporting your income. You are considered self-employed and will report your income and deductible expenses on IRS Schedule C to arrive at your taxable income for income tax and self-employment tax.

Your driving income will be reported on IRS information Form 1099-K, which reflects the entire amount for your fares charged on credit cards through the Uber reporting system. So if the 1099-K includes the total charges, then it also includes the Uber fee and credit card fees, both of which are deductible by you on your Schedule C. To determine the amount of those fees, you must first add up all the direct deposits made by Uber to your bank account. Then subtract the total deposits from the amount on the 1099-K; the result will be the total of the Uber fees and credit card processing fees. If you drive for multiple services, you will have multiple 1099-Ks and deposits from multiple services. It is highly recommended that you keep copies of your bank statements for the year so you can verify deposits in case of an IRS audit.

You will also need to include in your income any cash tips you received that were not charged through Uber. You should keep a notebook in your vehicle where you can record your cash tips. Having a contemporaneously maintained tip logbook is important in case of an audit.

Your largest deduction on your Schedule C will be your vehicle expenses. The first step in determining the deduction for the business use of a vehicle is to determine the total miles the vehicle was driven, and then, of the total miles, the number of deductible business miles and non-deductible personal miles. Recording the vehicle’s odometer reading at the beginning of the year and again at year-end will give you the information needed to figure total miles driven during the year. Although the Uber reporting system provides you with the total fare miles, it does not include miles between fares, which are also deductible. Thus it is important that you maintain a daily log of the miles driven from the beginning of your driving shift to the end of the shift. The total of the shift miles driven will be your business miles for the year. If you know the business miles driven and total miles driven, you can determine the percentage of vehicle use for business, which is used to determine what portion of the vehicle expenses are deductible.

You may use the actual expense method or an optional mileage method to determine your deduction for the use of the vehicle. If you choose the actual expense method in the first year you use the vehicle for business, you cannot switch to the optional mileage method in a later year. On the other hand, if you choose the optional mileage rate in the first year, you are allowed to switch between methods in future years, but your write-off for vehicle depreciation is limited to the straight line method rather than an accelerated method. For 2017, the optional mileage rate is 53.5 cents per mile. The IRS generally only adjusts the rate annually. If using the optional mileage rate, you need not track the actual vehicle expenses (but you still need to track the mileage).

The actual expense method includes deducting the business cost of gas, oil, lubrication, maintenance and repairs, vehicle registration fees, insurance, interest on the loan used to purchase the vehicle, state and local property taxes, and depreciation (or lease payments if the vehicle is leased). The business cost is the total of all these items multiplied by the business use percentage. Since the vehicle is being used to transport persons for hire, it is not subject to rules that generally limit depreciation of business autos, allowing for substantial vehicle write-off in the first year where appropriate. However, if you converted a vehicle that was previously used only personally, the depreciation will be based upon the lower of cost or current fair market value, and no bonus depreciation will allowed unless the conversion year was the same year as the purchase year.

Other deductions would include cell phone service, liability insurance and perks for your fares, such as bottled water and snacks. Depending on your circumstances, you may qualify for a business use of the home (home office) deduction. However, to qualify, the home office must be used exclusively in a taxpayer’s trade or business on a regular, continuing basis. A taxpayer must be able to provide sufficient evidence to show that the use is regular. Exclusive use means there can be no personal use (other than de minimis) at any time during the tax year. The office must also be the driver’s principal place of business.

Uber provides its drivers with detailed accounting information, and the only significant additional record keeping required is the miles traveled between fares, which is accomplished while in the vehicle. So justifying a home office is problematic. Even a portion of the garage where the vehicle is parked could qualify, but the use must be exclusive, which means the vehicle must be used 100% for business.

As a self-employed individual, you also have the ability to contribute to a deductible self-employed retirement plan or an IRA. Also, being self-employed gives you the option to deduct your health insurance without itemizing your deductions. However, these tax benefits may be limited or not allowed if you are also employed and participate in your employer’s retirement plan or if your employer pays for 50% or more of your health insurance coverage.

If you have additional questions about reporting your income and expenses, or the vehicle deduction options, please give us a call.

Tax Breaks for Military Personnel

Military service members have special obligations and take risks while performing their service to our country, which impact their tax situation. As a result, they are entitled to a number of special tax breaks. The following are the predominant tax breaks available to military personnel:

  • Residence or Domicile – A military service member does not lose or acquire a residence or domicile for tax purposes due to being absent or present in any tax jurisdiction in the U.S. solely to comply with military orders. Thus, for example, a member of the military who is a resident of Texas and is assigned under military orders to a duty station in California continues to be treated as a Texas resident and is not subject to California state income tax.
    Another special rule exempts any personal service income of a military spouse from being taxed by any state other than the military spouse’s resident state. For the income to be exempt from the nonresident state’s taxes, the couple must have relocated to another state under military orders. They must also share the same “domicile” or true home outside the duty station state where they intend to return and relocate permanently.
  • Moving Expenses – A member of the Armed Forces on active duty who is required to move because of a permanent change of station can deduct the reasonable unreimbursed expenses of moving themselves and members of their household. They are not subject to the 50-mile distance test or 39-week employment test that civilians are subject to for claiming a moving expense deduction. Reasonable expenses include shipping, a moving van, truck rental, travel expenses (not meals), packing, insurance and storage en route, moving pets, and utility connect/disconnect charges.
  • Combat Pay Exclusion – If a member of the Armed Forces serves in a combat zone as an enlisted person or as a warrant officer for any part of a month, all of the military pay that he or she receives for military service that month is excluded from taxation. For officers, the monthly exclusion is capped at the highest enlisted pay plus any hostile fire or imminent danger pay received.
  • Living Allowances – The basic housing allowance and both housing and cost-of-living allowances abroad, whether paid by the U.S. Government or by a foreign government, are excluded from taxation.
  • Home Mortgage Interest and Taxes – A military taxpayer can deduct mortgage interest and real estate taxes on his or her tax return as an itemized deduction, even if they are paid with nontaxable military housing allowance pay.
  • Home Sale Gain Exclusion – In order to claim the $250,000 ($500,000 for qualifying married taxpayers) home gain exclusion, taxpayers must generally own and use the home for 2 of the 5 years immediately prior to the home’s sale. A military taxpayer may choose to suspend the 5-year look-back period for up to 10 years when on qualified official extended duty.
    A military taxpayer who sells his or her primary residence and does not meet the 2- of-5-years ownership and use tests due to a move to a new permanent duty station may qualify for a reduced maximum exclusion amount.
  • Reservist Travel Expenses – Armed Forces reservists who travel more than 100 miles away from home and stay overnight in connection with service as a member of a reserve component can deduct travel expenses as an adjustment to their gross income. This differs from the rules for other employees, who may only deduct job-related travel expenses as a miscellaneous itemized deduction (subject to the 2% of AGI limitation). Thus, this deduction can be taken even if the reservist does not itemize his or her deductions.
  • Reservist Early Withdrawal Exception – Qualified reservists are permitted penalty-free withdrawal from IRAs, 401(k)s, and other arrangements if ordered or called to active duty for a period in excess of 179 days and if the distribution is taken during the active duty period.
  • Extension of Deadlines – The time limit for taking care of certain tax matters can be postponed. The deadlines for filing tax returns, paying taxes, filing claims for refund, and taking other actions with the IRS are automatically extended for qualifying members of the military.
  • Uniform Cost and Upkeep – If military regulations prohibit you from wearing certain uniforms when off duty, the costs and upkeep of those uniforms can be deducted, but the deductible expense must be reduced by any allowance or reimbursement that is received.
  • Joint Returns – Generally, a joint return must be signed by both spouses. However, when one spouse may not be available due to military duty, a power of attorney may be used to file a joint return.
  • Tax Forgiveness – When members of the military lose their life in a combat zone or as the result of a terrorist action, their income taxes are forgiven for the year of their death and for any prior year that ends on or after the first day of service in a combat zone.
  • ROTC Students – Subsistence allowances paid to ROTC students participating in advanced training are not taxable. However, active duty pay – such as pay received during summer advanced camp – is taxable.
  • Transitioning Back to Civilian Life – You may be able to deduct some costs that are incurred while looking for a new job. Such expenses may include travel, resume preparation fees, and outplacement agency fees. Moving expenses may be deductible if your move is closely related to starting work at a new job location and if you meet certain tests.

If you or your spouse have questions about any of the above or questions related to your designated state of residence for state tax-filing purposes, please give us a call.

Hobby or Business? It Makes a Difference for Taxes

Taxpayers are often confused by the differences in tax treatment between businesses that are entered into for profit and those that are not, commonly referred to as hobbies. The differences are:

Businesses Entered Into for Profit – For businesses entered into for profit, the profits are taxable, and losses are generally deductible against other income. The income and expenses are commonly reported on a Schedule C, and the profit or loss—after subtracting expenses from the business income—is carried over to the taxpayer’s 1040. (An exception to deducting the business loss may apply if the activity is considered a “passive” activity, but most Schedule C proprietors actively participate in their business, so the details of the passive loss rules aren’t included in this article.)

Hobbies – Hobbies, on the other hand, are not entered into for profit, and the government does not permit a taxpayer to deduct their hobby expenses, in excess of any hobby income, on their tax return. Thus, hobby income is reported directly on their 1040, and any expenses not exceeding the income are deductible as miscellaneous itemized deductions on their Schedule A, assuming the taxpayer is not claiming the standard deduction, in which case they would be reporting income but not deducting the expenses.

So, what distinguishes a business from a hobby? The IRS provides nine factors to consider when making the judgment. No single factor is decisive, but all must be considered together in determining whether an activity is for profit. The nine factors are:

  1. Is the activity carried out in a businesslike manner? Maintenance of complete and accurate records for the activity is a definite plus for a taxpayer, as is a business plan that formally lays out the taxpayer’s goals and describes how the taxpayer realistically expects to meet those expectations.
  2. How much time and effort does the taxpayer spend on the activity? The IRS looks favorably at substantial amounts of time spent on the activity, especially if the activity has no great recreational aspects. Full-time work in another activity is not always a detriment if a taxpayer can show that the activity is regular; time spent by a qualified person hired by the taxpayer can also count in the taxpayer’s favor.
  3. Does the taxpayer depend on the activity as a source of income? This test is easiest to meet when a taxpayer has little income or capital from other sources (i.e., the taxpayer could not afford to have this operation fail).
  4. Are losses from the activity the result of sources beyond the taxpayer’s control? Losses from unforeseen circumstances like drought, disease, and fire are legitimate reasons for not making a profit. The extent of the losses during the start-up phase of a business also needs to be looked at in the context of the kind of activity involved.
  5. Has the taxpayer changed business methods in an attempt to improve profitability? The taxpayer’s efforts to turn the activity into a profit-making venture should be documented.
  6.  What is the taxpayer’s expertise in the field? Extensive study of this field’s accepted business, economic, and scientific practices by the taxpayer before entering into the activity is a good sign that profit intent exists.
  7. What success has the taxpayer had in similar operations? Documentation on how the taxpayer turned a similar operation into a profit-making venture in the past is helpful.
  8. What is the possibility of profit? Even though losses might be shown for several years, the taxpayer should try to show that there is realistic hope of a good profit.
  9. Will there be a possibility of profit from asset appreciation? Although profit may not be derived from an activity’s current operations, asset appreciation could mean that the activity will realize a large profit when the assets are disposed of in the future. However, the appreciation argument may mean nothing without the taxpayer’s positive action to make the activity profitable in the present.
There is a presumption that a taxpayer has a profit motive if an activity shows a profit for any three or more years within a period of five consecutive years. However, the period is two out of seven consecutive years if the activity involves breeding, training, showing, or racing horses.

All of this may seem pretty complicated, so please call this office if you have any questions or need additional details for your particular circumstances.

Thinking of Tossing Old Tax Records? Read This First

Now that your taxes have been completed for 2016, you are probably wondering which old records can be discarded. If you are like most taxpayers, you have records from years ago that you are afraid to throw away. It would be helpful to understand why the records must be kept in the first place.

Generally, we keep tax records for two basic reasons: (1) in case the IRS or a state agency decides to question the information reported on our tax returns, and (2) to keep track of the tax basis of our capital assets so that the tax liability can be minimized when we dispose of them.

With certain exceptions, the statute for assessing additional taxes is three years from the return due date or the date the return was filed, whichever is later. However, the statute of limitations for many states is one year longer than the federal law. In addition to lengthened state statutes that cloud the recordkeeping issue, the federal three-year assessment period is extended to six years if a taxpayer omits from gross income an amount that is more than 25 percent of the income reported on a tax return. And, of course, the statutes don’t begin running until a return has been filed. There is no limit where a taxpayer files a false or fraudulent return to evade taxes.

If an exception does not apply to you, for federal purposes, most of your tax records that are more than three years old can probably be discarded; add a year or so to that if you live in a state with a longer statute.

Examples – Sue filed her 2013 tax return before the due date of April 15, 2014. She will be able to dispose of most of the 2013 records safely after April 15, 2017. On the other hand, Don files his 2013 return on June 2, 2014. He needs to keep his records at least until June 2, 2017. In both cases, the taxpayers may opt to keep their records a year or two longer if their states have a statute of limitations longer than three years. Note: If a due date falls on a Saturday, Sunday or holiday, the due date becomes the next business day.

The big problem! The problem with the carte blanche discarding of records for a particular year because the statute of limitations has expired is that many taxpayers combine their normal tax records and the records needed to substantiate the basis of capital assets. These need to be separated, and the basis records should not be discarded before the statute expires for the year in which the asset is disposed. Thus, it makes more sense to keep those records separated by asset. The following are examples of records that fall into that category:

  • Stock acquisition data – If you own stock in a corporation, keep the purchase records for at least four years after the year the stock is sold. This data will be needed to prove the amount of profit (or loss) you had on the sale.
  • Stock and mutual fund statements (If you reinvest dividends) – Many taxpayers use the dividends they receive from stocks or mutual funds to buy more shares of the same stock or fund. The reinvested amounts add to the basis in the property and reduce gain when it is finally sold. Keep statements at least four years after the final sale.
  • Tangible property purchase and improvement records – Keep records of home, investment, rental property, or business property acquisitions AND related capital improvements for at least four years after the underlying property is sold.

For example, because of the generous $250,000 ($500,000 for joint filers) home gain exclusion available to most homeowners, some taxpayers have become lax in maintaining home improvement records, thinking the large exclusions will cover any potential appreciation in the home’s value. But that exclusion may not always be enough to cover sale gains, particularly in markets where property values have steadily risen, so records of home improvements are vital. Records can be important, so please use caution when discarding them.

If you sell securities (stocks, bonds or mutual funds) that result in a loss, after you’ve offset any capital gains from other sales, you may end up with a larger loss than can be deducted in one year (maximum $3,000 or $1,500 if married filing separate). In that case, you are allowed to carry over the excess loss to use in future years. When this happens, you will need to keep the purchase and sale records of the securities for four years after filing the return when the last of the carryover loss is used.

Similarly, if you have a net operating loss from a business that is being carried forward to future years, you’ll need to keep the business records from the loss year until four years after the return on which all of the loss was used up.

What about the tax returns themselves? While disposing of the backup documents used to prepare the returns can usually be done after the statutory period has expired, you may want to consider keeping a copy of your tax returns (the 1040 and attached schedules/statements plus your state return) indefinitely. If you don’t have room to keep a copy of the paper returns, digitizing them is an option.

If you have questions about whether or not to retain certain records, give this office a call first; it is better to check before discarding something that might be needed down the road.