Tax Reform Framework Released

President Trump announced a nine-page framework for tax cuts on September 27, 2017. The Framework capitalizes on many ideas previously presented in the President’s Tax Outline and in the House Republican Blueprint. Congressional tax-writing committees have a lot of work to do in refining the details, but it gives us an idea of where tax reform may be headed.

Individual Tax Rates

The current rates now fall into seven brackets, ranging from 10% to 39.6%. The proposed plan would consolidate the current individual tax brackets into three: 12%, 25% and 35%. An additional top tax rate may be added and apply to the “highest-income taxpayers,” but it fails to mention the income level at this might take effect, or the rate that would be imposed.

The plan also does not specify which income levels would be taxed at each rate— and if the highest rate is set at 35 percent—it would greatly benefit the wealthiest taxpayers, who currently pay a top rate of 39.6 percent on income greater than $418,400 for single filers.

Child and Dependent Care Credits

Although the rate applied to the lowest income bracket would increase, typical families in the existing 10 percent bracket may be better off because of a larger child tax credit as well as an increase in the standard deduction. The child tax credit would be “significantly” increased, including a refundable portion offered to taxpayers who have higher levels of income than current law allows.

A new, non-refundable credit of $500 for those caring for non-child dependents (such as an elderly parent) would be added.

Standard and Itemized Deductions

Most itemized deductions would be eliminated, meaning that large medical expenses, state and local income taxes, real estate taxes, investment expenses and investment interest expense would no longer be deductible. However, home mortgage interest, charitable contributions, and tax benefits encouraging work, higher education and retirement savings would be retained.

The standard deduction and personal exemptions would be combined into one larger standard deduction: $12,000 for single filers and $24,000 for married taxpayers filing jointly. Home mortgage interest, charitable contributions, and tax benefits encouraging work, higher education and retirement savings would be retained. This means that Such a revision of the tax code, if enacted, would greatly increase the number of taxpayers choosing the standard deduction. The new, single deduction would be higher for many filers, except those who claim multiple children

The Alternative Minimum Tax (AMT) and the federal estate tax and generation-skipping transfer tax would be repealed under this framework. It is suspected that that the repeal will apply to gift taxes, as well.

Business and Corporate Taxes

The tax rate would be reduced for regular or “C” corporations from 35% to 20%. The corporate Alternative Minimum Tax (“AMT”) would be eliminated along with other methods to reduce the double taxation of corporate earnings.

Many small businesses are structured as “S” corporations, partnerships, limited liability companies (LLCs), or sole proprietorships; all of which pass through business profits and losses to their owners’ personal tax returns. Thus, “C” corporation income taxes may be avoided but the owners face personal tax rates as high as 39.6%. Pass-throughs now make up about 95 percent of businesses in the country and the bulk of corporate tax revenue for the government.

Under the proposed framework, business income from these “pass-through entities” would be taxed at a rate no higher than 25%. Such a measure would need to be drafted carefully in order to prevent personal income of wealthy individuals from being reclassified into lower-taxed business income. Whether these distributions would then be subject to a second level of tax at the individual owner level also needs to be addressed.

Deductions and Tax Credits

Most special deductions and tax credits, other than the R&D credit and the low-income housing tax credit, would be eliminated. It’s not clear which deductions will be eliminated; however, the Section 199 deduction was specifically mentioned as being eliminated.

Replace system of taxing companies’ worldwide income with a 100% exemption for dividends from foreign subsidiaries in which U.S. parent has a 10% stake or more. Reduce tax rate and tax on a global basis the foreign profits of U.S. multinational corporations.

Tax Write Offs for Depreciable Assets

Businesses that invest in depreciable assets, other than buildings, after September 27, 2017 would write them off immediately. This tax benefit, with no upper limit, would be in place for at least five years. As a tradeoff, the tax-deductibility of interest expense incurred by most taxable corporations would be partially limited.

If you have questions about how the proposed tax reform might affect you, please call us.

 

Are Your Important Tax Documents Safe in Case of a Disaster?

You may think a natural or man-made disaster will never happen to you, but it can be a nightmare when it does. The 2017 hurricane season is a good example, not to mention the wildfires in the West, the tornados in the Midwest, plus the potential for inevitable earthquakes.

You could lose all of your tax records, business records, insurance policies, birth certificates, and other key documents.

You can help yourself by storing duplicates of important or irreplaceable documents in a waterproof container away from the original set. If you think this will be too difficult, at least keep the original documents in a waterproof container.

If you are computer savvy, an easier way to keep your records out of harm’s way is to store digital copies of the documents on a remote server (i.e., in the cloud). It may cost a few bucks, but the digital files will be there when you need them, regardless of what happens to your home or business location.

Most financial institutions these days provide all of their documents digitally, and you can store those documents on your remote server or even retrieve them from the financial institution’s website. However, before relying on the financial institutions, make sure they retain your records for long enough to meet your needs.

For example, you generally need to keep individual tax records for up to 3 years after the tax return due date for the tax year or the date when you filed the return, if it was filed after the due date. For example, your 2016 return was due April 18, 2017. If you filed it on or before April 18, the statute of limitations for the 2016 return would not run out until April 15, 2020. So, you would have to keep the records until then for the 2016 tax return. (The statute of limitations runs for 4 years for some states, and some records need to be kept longer for both federal and state purposes.) If some of your files are not already available digitally, you can always scan the originals to create digital copies.

Another very important thing to everyone is family photos. Modern-day pictures are digital, so you can save them on a remote server, or many photo services will save them online for you. For the older important ones, you can scan them or take digital pictures of them with your camera.

Another important document to have is a list of your home’s and business facility’s contents for insurance purposes. The quick and easy way is to take a video or pictures throughout the house or business showing the furnishings and equipment. A better method is to take the pictures or video and back them up with a detailed list of the items in each room.

Self-Help Publications:

Please give us a call if you have questions about retaining records or if we can provide any other assistance.

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.

Taking Advantage of Tax-Free Gifting

If you are fortunate enough to have a large estate – one large enough to be subject to the estate tax upon your death – you might be considering ways to give away some of your wealth to your family and loved ones now, thereby reducing the estate tax when you pass on.

Frequently, taxpayers think that gifts of cash, securities, or other assets they give to other individuals are tax-deductible; in turn, the gift recipient sometimes thinks income tax must be paid on the gift received. Nothing can be further from the truth. To fully understand the ramifications of gifting, one needs to realize that gift tax laws are interrelated with estate tax laws, and Uncle Sam does not want you giving away your wealth before you pass away to avoid the estate tax. For 2017, Uncle Sam allows $5.49 million (lifetime estate tax exclusion) to pass to your heirs’ estate tax free, and any excess amount is subject to an estate tax as high as 40%.

Amounts you gift prior to your death reduce the lifetime estate tax exclusion and will therefore subject more of your estate to taxation.

The law does provide exceptions where gifts can be made without reducing the lifetime exclusion, including the following:

  • $14,000 each to any number of individuals during every tax year. The amount is periodically adjusted for inflation, but the amount for 2017 is $14,000. The recipient does not have to be a relative and can be a minor.
  • Directly pay medical expenses. This applies to amounts paid by one individual on behalf of another individual directly to a medical care provider as payment for that medical care. Payments for medical insurance qualify for this exclusion.
  • Directly pay education expenses. This applies to amounts paid by one individual on behalf of another individual directly to a qualifying educational organization as tuition for that other individual. The tuition can be for any level of schooling – elementary, secondary and post-secondary. Costs of room and board aren’t eligible as direct payments, nor are contributions to qualified tuition programs (also known as Sec. 529 plans), which have their own gifting rules not covered in this article.

If the gift giver is married and both spouses agree, gifts to recipients made during a calendar year can be treated as split between the husband and wife, even if only one of them made the cash or property gift. Thus, by using this technique, a married couple can give $28,000 a year to each recipient under the annual limitation discussed previously.

Gifting Techniques:

High-Wealth Individuals – If you are a high-wealth individual who would like to pass on as much to your heirs as possible while living without reducing the lifetime exemption, you could directly pay your heirs’ medical expenses and education expenses in addition to annual gifts of cash or property of up to $14,000. You may want to do this, even if you are not a high-worth individual, to avoid having to file a gift tax return.

Medical Expenses – Except in rare circumstances, you cannot deduct the medical expenses you pay for another person, and they cannot deduct the expenses either, since they did not pay the expenses. Thus, careful consideration should be given regarding whether you make the gift directly to the individual, subject to the $14,000 annual limit – which would allow the recipient of your generosity to pay the medical expenses and claim the medical deduction on his or her tax return – or whether you pay the medical expenses directly. If the medical expenses you want to pay are greater than $14,000, then you could always gift $14,000 to the individual and pay the balance directly to the care provider(s) to avoid reducing your lifetime exclusion. Under rare circumstances, the recipient who will benefit from your gifts may qualify as your medical dependent, under which circumstance you would be able to deduct the medical expenses if they had been paid directly to the doctor, hospital or other provider.

Education Expenses – When you pay the qualified post-secondary education tuition for another individual, it does not mean – as is usually the case for medical expenses – that someone cannot benefit taxwise. Tax law says that whoever claims the exemption for the student is entitled to the American Opportunity Credit or Lifetime Learning Credit for higher education expenses if they otherwise qualify.

Gifts of Appreciated Property – Consider replacing your cash gifts with gifts of appreciated property, such as stock for which you have a “paper gain.” When you gift an appreciated asset, the potential gain on the asset transfers to the recipient. This works for individuals, except for children who are subject to the kiddie tax, which requires the child’s income to be taxed at the parent’s tax rate if it is higher than the child’s rate. It also works great for contributions to charitable organizations. Although not subject to the gift tax rules, not only does an appreciated asset gifted to a charity get you out of reporting any gain from the appreciation, but you also get a charitable tax deduction equal to the fair market value (FMV) of the asset. The deduction for these gifts is generally limited to 30% of your adjusted gross income (AGI), but the excess carries over for up to five years of future returns.

Please call this office if you need assistance with planning your gifting strategies.

Does Your Employer Misclassify You as an Independent Contractor Instead of as an Employee?

It is not uncommon for employers to misclassify employees as independent contractors, either to intentionally avoid their withholding and tax responsibilities or because they are not aware of the laws regarding the issue. If your employer reports your income on a Form 1099 (as opposed to a W-2), you are being treated as an independent contractor, not as an employee. This can have significant ramifications in terms of how much you have to pay in income, Social Security, and Medicare taxes.

The general distinction, of course, is that an employee is an individual who works under the direction and control of an employer, and an independent contractor is a business owner or contractor who provides services to other businesses.

To determine whether a worker is an independent contractor or an employee, the IRS examines the relationship between the worker and the business and considers all evidence regarding control and independence. This evidence falls into the following three categories:

(1) Behavioral control covers whether the business has the right to direct or control how the work is done through instructions, training, or other means. Employees are generally given instructions on when and where to work, what tools to use, where to purchase supplies, what order to follow, and so on.

(2) Financial control covers whether the business has the right to control the financial and business aspects of the worker’s job. This includes the extent to which the worker has unreimbursed business expenses; the extent of his or her investment in the facilities being used; the extent to which his or her services are made available to the relevant market; how he or she is paid; and the extent to which he or she can realize a profit or incur a loss.

(3) Type of relationship includes any written contracts that describe the relationship the parties intended to create; the extent to which the worker is available to perform services for other, similar businesses; whether the business provides the worker with employee-type benefits, such as insurance, a pension plan, vacation pay, or sick pay; the permanency of the relationship; and the extent to which the worker’s services are a key aspect of the company’s regular business.

When a worker’s status is in doubt, Form SS-8 (Determination of Employee Work Status for Purposes of Federal Employment Taxes and Income Tax Withholding) can be used. This form may be completed by an employer or a worker; it asks the IRS to determine whether the worker is an employee or an independent contractor for federal tax purposes. Form SS-8 is filed separately from the requestor’s tax return. The IRS does not issue determinations for proposed employment arrangements or hypothetical situations, and it will only issue a determination if the statute of limitations for the year at issue hasn’t expired.

If an employee wants to avoid paying self-employed tax on 1099-MISC income after he or she has already been determined to be an employee – or when he or she has filed an SS-8 but has not received a response – that individual can file Form 8919, which only requires payment of what would have been withheld if the worker had been treated as an employee. Form 8919 requires the employee to choose one of these codes:

Code A. I filed Form SS-8 and received a determination letter stating that I am an employee of this firm.
Code C. I received other correspondence from the IRS that states I am an employee.
Code G. I filed Form SS-8 with the IRS but have not received a reply.
Code H. I received a Form W-2 and a Form 1099-MISC from this firm for the same tax year. The amount on Form 1099-MISC should have been included as wages on the Form W-2.

If using Code H, do not file an SS-8. Here are some examples of amounts that are sometimes erroneously included (but not necessarily deliberately misclassified) on Form 1099-MISC and that should be reported as wages on Form W-2: employee bonuses, awards, travel expense reimbursements not paid under an accountable plan, scholarships, and signing bonuses.

If Code G is used, both the employee and the firm that paid the employee may be contacted for additional information. Use of this code is not a guarantee that the IRS will agree with the worker’s opinion as to his or her status. If the IRS does not agree that the worker is an employee, the worker may be billed an additional amount for the employment tax, as well as penalties and interest resulting from the change in the worker’s status.

If the IRS determination is for multiple open years, the employee can amend returns for open years to recover a portion of the self-employed tax paid.

If you have questions about being misclassified as an independent contractor, please give this office a call.

Tax Implications of Crowdfunding

Raising money through Internet crowdfunding sites prompts questions about the taxability of the money raised. A number of sites host money-raising projects for fees ranging from 5 to 9%, including GoFundMe, Kickstarter, and Indiegogo. Each site specifies its own charges, limitations, and withdrawal processes. Whether the money raised is taxable depends upon the purpose of the fundraising campaign.

Gifts – When an entity raises funds for its own benefit and the contributions are made out of detached generosity (and not because of any moral or legal duty or the incentive of anticipated economic benefit), the contributions are considered tax-free gifts to the recipient.

On the other hand, the contributor is subject to the gift tax rules if he or she contributes more than $14,000 to a particular fundraising effort that benefits one individual; the contributor is then liable to file a gift tax return. Unfortunately, regardless of the need, gifts to individuals are never tax deductible.

The “gift tax trap” occurs when an individual establishes a crowdfunding account to help someone else in need (whom we’ll call the beneficiary) and takes possession of the funds before passing the money on to the beneficiary. Because the fundraiser takes possession of the funds, the contributions are treated as a tax-free gift to the fundraiser. However, when the fundraiser passes the money on to the beneficiary, the money then is treated as a gift from the fundraiser to the beneficiary; if the amount is over $14,000, the fundraiser is required to file a gift tax return and to reduce his or her lifetime gift and estate tax exemption. Some crowdfunding sites allow the fundraiser to designate a beneficiary so that the beneficiary has direct access to the funds.

Charitable Gifts – Even if the funds are being raised for a qualified charity, the contributors cannot deduct the donations as charitable contributions without proper documentation. Taxpayers cannot deduct cash contributions, regardless of the amount, unless they can document the contributions in one of the following ways:

  • Contribution Less Than $250: To claim a deduction for a contribution of less than $250, the taxpayer must have a cancelled check, a bank or credit card statement, or a letter from the qualified organization; this proof must show the name of the organization, the date of the contribution, and the amount of the contribution.
  • Cash contributions of $250 or More – To claim a deduction for a contribution of $250 or more, the taxpayer must have a written acknowledgment of the contribution from the qualified organization; this acknowledgment must include the following details:
    • The amount of cash contributed;
    • Whether the qualified organization gave the taxpayer goods or services (other than certain token items and membership benefits) as a result of the contribution, along with a description and good-faith estimate of the value of those goods or services (other than intangible religious benefits); and
    • A statement that the only benefit received was an intangible religious benefit, if that was the case.

Thus, if the contributor is to claim a charitable deduction for the cash donation, some means of providing the contributor with a receipt must be established.

Business Ventures – When raising money for business projects, two issues must be contended with: the taxability of the money raised and the Security and Exchange Commission (SEC) regulations that come into play if the contributor is given an ownership interest in the venture.

  • No Business Interest Given – This applies when the fundraiser only provides nominal gifts, such as products from the business, coffee cups, or T-shirts; the money raised is taxable to the fundraiser.
  • Business Interest Provided – This applies when the fundraiser provides the contributor with partial business ownership in the form of stock or a partnership interest; the money raised is treated as a capital contribution and is not taxable to the fundraiser. (The amount contributed becomes the contributor’s tax basis in the investment.) When the fundraiser is selling business ownership, the resulting sales must comply with SEC regulations, which generally require any such offering to be registered with the SEC. However, the SEC regulations were modified in 2012 to carve out a special exemption for crowdfunding:
    • Fundraising Maximum – The maximum amount a business can raise without registering its offering with the SEC in a 12-month period is $1 million. Non-U.S. companies, businesses without a business plan, firms that report under the Exchange Act, certain investment companies, and companies that have failed to meet their reporting responsibilities may not participate.
    • Contributor Maximum – The amount an individual can invest through crowdfunding in any 12-month period is limited:
      • If the individual’s annual income or net worth is less than $100,000, his or her equity investment through crowdfunding is limited to the greater of $2,000 or 5% of the investor’s annual net worth.
      • If the individual’s annual income or net worth is at least $100,000, his or her investment via crowdfunding is limited to 10% of the investor’s net worth or annual income, whichever is less, up to an aggregate limit of $100,000.

If you have questions about crowdfunding-related tax issues, please give this office a call.

Consequences of Filing Married Separate

If you are married and thinking about not filing a joint return with your spouse, you will most likely use the married filing separate (MFS) filing status. If you are considering filing MFS, then you should be aware that the tax code is laced with special restrictions so that married individuals cannot benefit by filing MFS. This article describes some of the more frequently encountered issues when making the choice of filing status. Note: dollar amounts are those for 2017.

Joint & Several Liability – When married taxpayers file joint returns, both spouses are responsible for the tax on that return. What this means is that one spouse may be held liable for all the tax due on a return, even if the other spouse earned all the income on that return. In some marriages, this becomes an issue and causes the spouses to decide to file separately. In other cases, especially second marriages, the couple may want to keep their finances separate. Unless all the income, exemptions, credits and deductions are divided equally, which usually happens in community property states, this generally causes the incomes to be distorted and could easily push one of the spouses into a higher tax bracket and create a greater combined tax than filing jointly. Being in a separate property state, where each spouse claims their own earnings, can also create an uneven allocation of income and a higher tax bracket for one of the spouses.

Exemptions – Taxpayers are allowed a $4,050 tax exemption for each of their dependents. However, the $4,050 allowance cannot be divided between the MFS filers, so only one of the filers can claim a dependent’s exemption, and where there are multiple dependents, the spouses would need to allocate the exemptions between them.

Itemizing Deductions – To prevent taxpayers from filing MFS and one spouse taking advantage of itemized deductions and the other utilizing the standard deduction, the tax regulations require both to itemize if one of them does.

Social Security Income – When filing a joint return, Social Security (SS) income is not taxable until the modified AGI (MAGI) – which is regular AGI (without Social Security income) plus 50% of the couple’s Social Security income plus tax-exempt interest income and plus certain other infrequently encountered additions – exceeds a taxable threshold of $32,000. However, for married taxpayers who have lived together at any time during the year and are filing married separate, the threshold is zero, generally making more of the Social Security income taxable.

Section 179 Deduction – Businesses can elect to expense, instead of depreciate, up to $510,000 of business purchases, generally including equipment, certain qualified leasehold property and off-the-shelf computer software. The $510,000 cap is reduced by $1 for every $1 that the qualifying purchases exceed $2,030,000 for the year. Married taxpayers are treated as one taxpayer for purposes of the Section 179 expense limit. Thus, they generally must split the limit equally unless they can agree upon and elect an unequal split.

Special Passive Loss Allowance – Passive losses are generally losses from business and rental activities in which a taxpayer does not materially participate. Those losses are not allowed except to offset income from other passive activities. Rental property is an example of a passive activity, and for lower-income taxpayers, a special allowance permits taxpayers who are actively involved in the rental activity to currently deduct a loss of up to $25,000 if their AGI does not exceed $100,000. That $25,000 special loss allowance phases out by 50 cents for each $1 of AGI over $100,000 and is completely eliminated when the AGI reaches $150,000. When filing separately, this special allowance is not allowed unless the spouses live apart the entire year, and then the allowance is reduced to $12,500 each.

Traditional IRA Deduction Phase-Out – If a married taxpayer filing jointly is participating in a qualified employer pension plan, the deductibility of a traditional IRA contribution is phased out ratably for an AGI between $99,000 and $119,000. If the taxpayers file married separate, the phase-out begins at $0 if the taxpayer participates in their employer’s plan, and when the AGI reaches $10,000, no traditional IRA deduction is allowed. So little, if any, IRA deduction will be available to such an MFS filer.

Roth IRA Contribution Phase-Out – Taxpayers may choose to contribute to a non-deductible Roth IRA. However, Roth IRA contributions are ratably phased out for higher-income married filing jointly taxpayers with an AGI between $186,000 and $196,000. For a married taxpayer filing MFS status, that AGI phase-out range drops to $0 through $9,999, virtually eliminating the possibility of a Roth contribution.

Coverdell Education Accounts – Taxpayers are allowed to contribute up to $2,000 per beneficiary to a Coverdell education savings account annually. However for joint filers, the amount that can be contributed ratably phases out for AGIs between $190,000 and $220,000. For married filing separate taxpayers, the phase-out is half that amount, from $95,000 to $110,000.

Education Tax Credits – Taxpayers are allowed a tax credit, called the American Opportunity Tax Credit, of up to $2,500 per family member enrolled at least half-time in college for the cost of tuition and qualified expenses. This credit phases out ratably for higher-income married taxpayers filing jointly with an AGI between $160,000 and $180,000. There is a second higher-education credit called the Lifetime Learning Credit, which provides a credit of up to $2,000 per family. This credit also phases out ratably for higher-income married taxpayers filing jointly with an AGI between $112,000 and $132,000.

However, neither credit is allowed for married filing separate taxpayers.

Higher Education Interest – Taxpayers can take a deduction of up to $2,500 for student loan interest paid on higher-education loans. Like other benefits, it is phased out for higher-income married taxpayers filing jointly, in this instance when the AGI is between $135,000 and $165,000. It is not allowed at all for taxpayers filing as married separate.

Education Exclusion For U.S. Savings Bond Interest – Although not frequently encountered, interest from certain U.S. Savings Bonds can be excluded if used to pay higher-education expenses for the taxpayers and their dependents. The exclusion phases out for married taxpayers with an AGI between $117,250 and $147,250. This deduction is not allowed at all when filing married separate.

Premium Tax Credit – For married taxpayers who qualify for the PTC (health insurance subsidy) under Obamacare, if they file married separate, they may be required to repay the subsidy.

Earned Income Tax Credit – This is a refundable tax credit that rewards lower-income taxpayers for working and can be as much $6,318 for families with three or more qualifying children. Taxpayers filing as married separate are not qualified for this credit.

Child Care Credit – If both spouses work and incur child care expenses, they qualify for the child care credit. However, for those married filing separate, the credit is not allowed.

Halved Deductions & Credits – Many of the deductions and credits allowed to a married couple filing jointly are cut in half for the married filing separate filing status. They include:

  • Standard Deduction
  • Standard Deduction Phase-Out
  • Alternative Minimum Tax Exemptions
  • Alternative Minimum Tax Exemptions Phase-Outs
  • Child Tax Credit Phase-Out

Head of Household Filing Status – Where a married couple is not filing jointly, one or both spouses may qualify for the more beneficial Head of Household (HH) filing status rather than having to file using the MFS status. A married individual may use the HH status if they lived apart from their spouse for at least the last six months of the year and paid more than one-half of the cost of maintaining his or her home as a principal place of abode for more than one-half the year of a child, stepchild or eligible foster child for whom the taxpayer may claim a dependency exemption. (A nondependent child only qualifies if the custodial parent gave written consent to allow the dependency to the non-custodial parent or if the non-custodial parent has the right to claim the dependency under a pre-’85 divorce agreement.)

As you can see, there are a significant number of issues that need to be considered when making the decision to use the married filing separate status. And these are not all of them, but only the more significant ones. The filing status decision should not be made nonchalantly, as it can have significant impact on your taxes. Please contact this office for assistance in making that crucial decision.

Who Controls the Funds in a Section 529 Plan?

This question frequently arises: Who controls the funds held in a Section 529 qualified tuition account? These accounts can become quite large, as they are limited only by the projected cost of a college education, and those costs will vary between state plans. Some states base their maximums on the cost of an in-state, four-year education, but others use the cost of the most expensive schools in the U.S.—including graduate studies. Most have limits in excess of $200,000, and some can reach $475,000 or more. Thus, it is only natural that those who fund an account would be concerned about who controls the account’s distributions. This is especially true when grandparents or others are making contributions to an account that is limited only by gift-tax considerations.

Some parents will simply save money for their minor children’s college costs in a custodial account; these accounts become the children’s property once they reach the age of majority, depending upon state law, which is usually 18 or 21. At that point, the parents lose control. Unlike these child custodial accounts, Section 529 plans are not irrevocable gifts: The parent or other account owner retains control.

Generally, the same person who contributed the money controls the Section 529 account. This doesn’t have to be the case, however. Someone else, such as a grandparent, could make a donation but name the child’s parent as the account owner, or a parent could establish the account and allow others to contribute to it.

Money cannot be removed from the account without the permission of the account owner. If the child (the designated beneficiary of the plan) decides not to go to school, the account owner can simply change the beneficiary to another “family member,” a term that, for the purposes of beneficiary changes, can refer to the beneficiary’s sons, daughters, brothers, sisters, nephews and nieces, certain in-laws, and any spouse of any of those individuals—but not the spouse of the original beneficiary.

This rule for beneficiary changes gives parents and other donors the flexibility to use the funds for the family member who needs them the most. For example, if a designated beneficiary decides not to attend college or receives a full scholarship, another child can be named (as long as the new child is a member of the family). Alternately, if funds remain in the plan after a child has finished school, a younger family member can be named as the beneficiary for the balance.

There are no tax issues if the transfer is within the same generation or an older generation of the family, such as changing the beneficiary to a sibling of the original beneficiary. However, if the transfer is to a beneficiary in a younger generation, the transfer is considered a taxable gift from the old beneficiary to the new beneficiary, and a gift tax return will need to be filed.

If you have questions related to Section 529 plans and how they might be used to save for a child’s future education, please call us.

Childcare Providers Enjoy Special Tax Deductions

If you are a childcare provider, tax law provides you with special tax breaks, including deductions for travel, capital purchases, supplies, children’s meals and the business use of your home.

Travel – Your auto expenses are based on the number of qualified business miles that you drive. Auto expenses for you (as a day care provider) could include transportation:

  • To and from a class taken to enhance your day care skills;
  • For field trips with those for whom you are providing care;
  • For errands related to day care business (e.g., going to the bank to deposit day care receipts or to the store to shop for day care supplies); or
  • To chauffeur day care attendees.

To claim business use of your vehicle, use the actual expense method or the standard mileage rate. However, the actual method requires far more detailed records; you must keep track of your business miles and total miles to prorate the costs of fuel, insurance, repairs, etc. You will probably find the standard mileage rate to be far less complicated, as you only need to contemporaneously record your business miles and the purpose of each trip. Even with the standard method, you’ll still need to know the total miles driven for the year. For 2017, the rate is 53.5 cents per mile, down from 54.0 cents per mile in 2016.

Capital Purchases – Capital items are those that normally last more than one year, including cribs and playground equipment. Be sure to keep receipts for these items, as they can generally be depreciated or expensed, whichever works best for you.

Supplies and Business Expenses – The cost of items such as crayons, coloring books, paper plates, cups, cleaning supplies, and first aid supplies are also deductible in the year they are purchased. However, you need to keep receipts for all such purchases.

Food – You can also deduct the actual cost of any food that is provided to the children in your care. It can be a bookkeeping nightmare to keep track of which grocery items were purchased for the childcare business and which were for personal consumption. Luckily, the government allows a care provider to deduct standard meal rates in lieu of actual amounts. This method does not require you to keep grocery receipts, and the IRS will not contest a food deduction based on the standard rates. The rates are the same throughout the contiguous U.S. states, with higher allowances for Alaska and Hawaii.

Business Use of the Home – Generally, when a taxpayer claims a business deduction for the use of his or her home, the portion of the home that is used must be exclusively used for business purposes. Knowing that childcare providers do not use a specific space in the home 100 percent of the time, Congress added an exception related to the business’s licensing, certification, registration, or approval as a day care center or family/group care home under the provisions of any applicable state law. This exception applies only if the childcare owner or operator has applied for, been granted, or is exempt from such approval. In addition, the exception does not apply if the services performed are primarily educational or instructional in nature (e.g., musical instruction). However, the exception does apply if the services are primarily custodial, such that any educational, developmental or enrichment activities are only incidental to the custodial services. The services must be provided for adults age 65 or older, children, or other individuals who are physically or mentally incapable of caring for themselves.

When calculating the percentage use of a home for business, there are two factors: the space used to operate the day care business and the amount of time that the space is used to provide day care, including preparation and cleaning time.

There is also a simplified deduction method for the business use of a home; it may be useful for individuals who work from a home office, but it is generally unsuitable for a childcare business.

The deduction for the business use of a home is limited to gross income from the business. If that limit applies to you, any home mortgage interest and property taxes that you have paid, as well as any casualty losses that you have incurred for the year, are always deductible when you itemize deductions, regardless of whether you claim a deduction for the business use of the home.

If you have questions related to how any of these tax breaks apply to your childcare business, please give this office a call.

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.