Gambling and Tax Gotchas

Gambling is a recreational activity for many taxpayers, and as one might expect, the government takes a cut if you win and won’t allow you to claim a loss in excess of your winnings. In fact, there are far more tax issues related to gambling than you might expect, and they may be impacting your taxes in more ways than you might believe. So here is a rundown on the many issues, which I like to call “gotchas,” that can affect you.

Reporting Winnings – Taxpayers must report the full amount of their gambling winnings for the year as income on their 1040 return. Gambling income includes, but is not limited to, winnings from lotteries, raffles, lotto tickets and scratchers, horse and dog races, and casinos, as well as the fair market value of prizes such as cars, houses, trips, or other non-cash prizes. The full amount of the winnings must be reported, not the net after subtracting losses. The exception to the last statement is that the cost of the winning ticket or winning a spin on a slot machine is deductible from the gross winnings. For example, if you put $1 into a slot machine and win $500, you would include $499 as the amount of your gross winnings, even if you’d previously spent $50 feeding the machine.

Frequently, taxpayers with winnings only expect to report those winnings included on Form W-2G. However, that form is only issued for “Certain Gambling Winnings,” but the tax code requires all winnings to be reported. All winnings from gambling activities must be included when computing the deductible gambling losses, which is generally always an issue in a gambling loss audit.

GOTCHA #1 – Since you can’t net your winnings and losses, the full amount of your winnings ends up in your adjusted gross income (AGI). The AGI is used to limit other tax benefits as discussed later. So, the higher the AGI the more the tax benefits may be limited.

Reporting Losses – A taxpayer may deduct gambling losses suffered in the tax year as a miscellaneous itemized deduction (not subject to the 2% of AGI limitation), but only to the extent of that year’s gambling gains.

GOTCHA #2 – If you don’t itemize your deductions, you can’t deduct your losses. Thus, individuals taking the standard deduction will end up paying taxes on all of their winnings, even if they had a net loss.

Social Security Income – For taxpayers receiving Social Security benefits, whether those benefits are taxable depends upon the taxpayer’s income (AGI) for the year. The taxation threshold for Social Security benefits is $32,000 for married taxpayers filing jointly, $0 for married taxpayers filing separately, and $25,000 for all other filing statuses. If the sum of AGI (before including any SS income), interest income from municipal bonds, and one-half the amount of SS benefits received for the year exceeds the threshold amount, then 50–85% of the SS benefits is taxable.

GOTCHA #3 – So, if your gambling winnings push your AGI for the year over the threshold amount, your gambling winnings, even if you had a net loss, can cause some (up to 85%) of your Social Security benefits to be taxable.

Health Insurance Subsidies – Under Obamacare, lower income individuals who purchase their health insurance from a government marketplace are given a subsidy in the form of a tax credit to help pay the cost of their health insurance. That tax credit is based upon the AGIs of all members of the family, and the higher the family income, the lower the subsidy becomes.

GOTCHA #4 – Thus, the addition of gambling income to your family’s income can result in significant reductions in the insurance subsidy, requiring you to pay more for your family’s health insurance coverage for the year. Additionally, if your subsidy was based upon your estimated income for the year, if your premiums were reduced by applying the subsidy in advance, and if you subsequently had some gambling winnings, then you could get stuck with paying back some part of the subsidy when you file your return for the year.

Medicare B & D Premiums – If you are covered by Medicare, the amount you are required to pay (generally withheld from your Social Security benefits) for Medicare B premiums is normally between $109 and $134 per month and is based on your AGI two years prior. However, if that AGI is above $85,000 ($170,000 for married taxpayers filing jointly), the monthly premiums can increase to as much $428.60. If you also have prescription drug coverage through Medicare Part D, and if your AGI exceeds the $85,000/$170,000 threshold, your monthly surcharge for Part D coverage will range from $13.30 to $76.20 (2017 rates).

GOTCHA #5 – The addition of gambling winnings to your AGI can result in higher Medicare B & D premiums.

Online Gambling Accounts – If you have an online gambling account, there is a good chance that the account is with a foreign company. All U.S. persons with a financial interest or signature authority over foreign accounts with an aggregate balance of over $10,000 anytime during the prior calendar year must report those accounts to the Treasury by the April due date for filing individual tax returns or face draconian penalties.

GOTCHA #6 – Regardless of whether you are a winner or loser, if your online account was over $10,000, you will be required to file FinCEN Form 114 (Report of Foreign Bank and Financial Accounts), commonly referred to as the FBAR. For non-willful violations, civil penalties up to $10,000 may be imposed; the penalty for willful violations is the greater of $100,000 or 50% of the account’s balance at the time of the violation.

Other Limitations – The forgoing are the most significant “gotchas.” There are numerous other tax rules that limit tax benefits based on AGI, as discussed in gotcha #1. These include medical deductions, miscellaneous itemized deductions, casualty losses, overall itemized deductions, exemptions, child and dependent care credits, the child tax credit, and the earned income tax credit, just to name a few.

If you have questions related to gambling and taxes, please call us.

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.

Borrowing Money to Finance an Education?

If you are considering borrowing funds to finance your education or the education of your spouse or children, you may wish to take advantage of the available tax benefits.

If you itemize your deductions and have sufficient equity in your home, you might consider borrowing the needed cash from your home. Generally, homeowners can take $100,000 of equity debt on their home and still deduct interest against the regular tax. Unfortunately, the interest on equity debt is not deductible against the alternative minimum tax (AMT), so consider other alternatives first if you are subject to the AMT. However, even if you are subject to the AMT, your best option may still be taking equity from your home. You may lose the benefit of the interest deduction, but the low interest rate on home loans is still in your favor.

If you don’t itemize your deductions or are subject to the AMT, you may still be able to utilize the above-the-line education interest deduction. This deduction has several restrictive qualifications and is limited to a maximum annual deduction of $2,500. It is phased-out ratably for taxpayers with an AGI (income) of $65,000 to $80,000 ($135,000 to $165,000 for joint returns). These amounts are for 2017; contact this office for the amounts for other years.

The above-the-line interest deduction may only be claimed by a person who is legally obligated to make the payments on the qualified educational loan. However, tax regulations allow payments on above-the–line education interest made by someone other than the taxpayer/borrower to be treated as a gift, allowing the interest to be deductible by the taxpayer.

The above-the-line deduction is not limited to interest on government student loans. The interest paid on other types of loans qualifies, including a home equity loan and even credit card interest, if only qualified education expenses are charged on the account. The borrowed funds must be used solely for qualified educational purposes, and the lender cannot be a relative. Generally, the funds must be used for qualified expenses within a reasonable period of time, usually 90 days before or after borrowing the funds. A home equity line of credit can be used to meet these requirements by paying education expenses as they become due, provided that the loan is not used for another purpose.

If you are considering borrowing money to pay for education, it may be appropriate to consult with this office, since there are other limitations. Please call for assistance.

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.

Checking the Status of Your Federal Tax Refund is Easy

If your 2016 federal return has already been filed and you are due a refund, you can check the status of your refund online.

Where’s My Refund?” is an interactive tool on the IRS web site at IRS.gov. Whether you have split your refund among several accounts, opted for 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 nearly 24 hours a day, 7 days a week.

If you e-file, you can get refund information within 24 hours after the IRS has acknowledged receipt of your return. Generally refunds for e-filed returns are issued within 21 days, however not before February 15 for returns with the earned income tax credit and/or the additional child credit. If you file a paper return, refund information will be available within four weeks. When checking the status of your refund, have 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 Joint Return, Married Filing Separate Return, 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 responses may come up, including the following:

  • Acknowledgement that your return has been received and is in processing.
  • The mailing date or direct-deposit date of your refund.
  • Notice that the IRS has been unable to deliver your refund, on account of an incorrect address. You can update your address online using the “Where’s My Refund?” feature.

The quickest refunds are via direct deposit. Allow additional time for checks to be processed through the mail.

“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 affecting your refund. For example, if you do not get the refund within 28 days from the original IRS mailing date shown on “Where’s My Refund?,” you can start a refund trace online.

If you have questions related to your refund, please give this office a call.

Thinking of Becoming a Real Estate Flipper? Here’s a Primer on the Tax Rules

With mortgage interest rates low and home prices finally making a comeback, flipping real estate appears to be on the rise. This activity is even the theme of several popular reality TV shows. House flipping is, essentially, purchasing a house or property, improving it and then selling it (presumably for a profit) in a short period of time. The key is to find a suitable fixer-upper that is priced under market for its location, fix it up and resell it for more than it cost to buy, hold, fix up and resell.

Are you contemplating trying your hand at flipping? If so, keep in mind that you will have a silent partner, Uncle Sam, who will be waiting to take his share of any profits in taxes. (And most likely, Sam’s cousin in your state capitol will expect a share, too.) Taxes play a significant role in the overall transaction, and tax treatment can be quite different depending upon whether you are a dealer, an investor or a homeowner. The following is the current tax treatment for each.

  • Dealer in Real Estate – Gains received by a non-corporate taxpayer from business operations as a real estate dealer are taxed as ordinary income (10% to 39.6%), and in addition, individual sole proprietors are subject to the self-employment tax of 15.3% of their net profit (the equivalent of the FICA taxes for a self-employed person). Higher-income sole proprietors are also subject to an additional 0.9% Medicare surtax on their earnings. Thus, a dealer will generally pay significantly more tax on the profit than an investor. On the other hand, if the flip results in a loss, the dealer would be able to deduct the entire loss in the year of sale, which would generally reduce his or her tax at the same rates.
  • Investor – Gains as an investor are subject to capital gains rates (maximum of 20%) if the property is held for more than a year (long term). If held short term (less than a year, as will likely be the case for most flippers), ordinary income rates (10% to 39.6%) will apply. An investor is not subject to the self-employment tax, but could be subject to the 3.8% surtax on net investment income for higher-income taxpayers. A downside for the investor who has a loss from the transaction is that, after combining all long- and short-term capital gains and losses for the year, his or her deductible loss is limited to $3,000, with any excess capital loss being carried over to the next year. The rules get a bit more complicated if the investor rents out the property while trying to sell it, but such rules are beyond the scope of this article.
  • Homeowner – If the individual occupies the property as the primary residence while it is being fixed up, he or she would be treated as an investor, with three major differences: (1) if the individual has owned and occupied the property for two years and has not used a homeowner gain exclusion in the two years prior to closing the sale, he or she can exclude gain of up to $250,000 ($500,000 for a married couple); (2) if the transaction results in a loss, the homeowner will not be able to deduct the loss or even use it to offset gains from other sales; and (3) some fix-up costs may be deemed to be repairs rather than improvements, and repairs on one’s primary residence are neither deductible nor includible as part of the cost basis of the home.

Being a homeowner is easily identifiable, but the distinction between a dealer and an investor is not clearly defined in the tax code. A real estate dealer is a person who buys and sells real estate property with a view to the trading profits to be derived and whose operations are so extensive as to constitute a separate business. A person acquiring property strictly for investment, though disposing of investment assets at intermittent intervals, generally does not deal in real estate on a regular basis.

This issue has been debated in the tax courts frequently, and both the IRS and the courts have taken the following into consideration:

  • whether the individual is already a dealer in real estate, such as a real estate sales person or broker;
  • the number and frequency of sales (flips);
  • whether the individual is more committed to another profession as opposed to fixing up and selling real estate; and
  • how much personal time is spent making improvements to the “flips” as opposed to another profession or employment.

The distinction between a dealer and an investor is truly based on the facts and circumstances of each case. Clearly, an individual who is not already in the real estate profession and flips one house is not a dealer. But one who flips five or more houses and/or properties and has substantial profits would probably be considered a dealer. Everything in between becomes various shades of grey, and the facts and circumstances of each case must be considered.

If you have additional questions about flipping real estate or need assistance with your specific situation, please give this office a call.

Married to a Non-U.S. Citizen?

With modern transportation the world continues to shrink, and it is increasingly common for a U.S. citizen to marry someone from another country who is not a U.S. citizen. If this describes your marital circumstances, there are some special tax filing issues you will have to deal with. Based on your particular situation, the filing issues could be very complicated or straightforward. But in either case, someone knowledgeable with non-U.S. citizen issues should complete the preparation of your return.

There are two important tax principles that apply in all situations:

  • U.S. citizens are taxed on worldwide income, and
  • If you are married, you must either file jointly with your spouse, file as a married person filing separately, or file as head of household if you otherwise qualify.

The next issue is the status of your non-U.S. citizen spouse, which dictates how you are taxed. Although there may be certain special situations, the status of your non-U.S. citizen spouse is generally one of the following:

A permanent resident of the U.S. – A permanent resident, also referred to as a green card holder, is taxed in the same manner as a U.S. citizen, so there are no special filing requirements and the return, or returns if filing separately, are prepared in the same way and under the same rules as they would be if you were married to a U.S. citizen.

A non-resident alien – A non-resident alien is someone who is not a U.S. citizen and who has not met the requirements to have a green card (which would give the non-U.S. citizen the privilege, according to immigration laws, of residing permanently in the United States as an immigrant) or who hasn’t been in the U.S. long enough to meet the substantial presence test described later. Often a non-resident alien resides outside of the U.S. If you are married to a non-resident alien, you generally have the following two filing options:

  • File as a married individual filing separately or head of household if you have provided over half the costs of keeping up a home for a qualifying individual and you have not made the election described next to treat your spouse as a resident alien, or
  • Elect to file jointly with your non-resident alien spouse, effectively treating the spouse as a resident alien for tax purposes. However, this election is binding until revoked, and both spouses must affirmatively agree to the election. Once the election is made, the joint U.S. tax return must include the worldwide income of both spouses.

An undocumented alien – If you are married to an undocumented alien, there are two possible situations:

  • Spouse meets the substantial presence test – An individual who meets the substantial presence test is taxed in the same manner as a U.S. citizen or resident alien, so there are no special filing requirements and the return, or returns if filing separately, are prepared in the same way as when married to a U.S. citizen or resident alien.
    To meet the substantial presence test, your spouse must have been physically present in the United States on at least 31 days during the current year and 183 days during the 3-year period that includes the current year and the 2 years immediately before it, counting all the days present in the current year, 1/3 of the days present in the first year before the current year, and 1/6 of the days present in the second year before the current year.
  • Spouse does not meet the substantial presence test – If the spouse does not meet the substantial presence test, the spouse is treated as a non-resident alien, as discussed previously.

Where your spouse is a non-resident alien and has U.S. source income and does not elect to file jointly with you, then your spouse must file a Form 1040NR to pay the taxes on the U.S. source income, generally at a flat rate of 30%.

If you reside in a foreign country with your non-U.S. citizen spouse, that does not exempt you from U.S. taxes. As was noted at the beginning of this article, U.S. citizens are taxed on worldwide income.

There are provisions that help shield you from double taxation, such as an exclusion of foreign earned income (limited each year to an inflation-adjusted amount, $101,300 for 2016), a foreign tax credit (not available on the same foreign income that is excluded), and provisions spelled out in the tax treaties between the U.S. and foreign countries.

These and other nuances encountered when you are married to a non-U.S. citizen need to be addressed based upon your particular circumstances. Please contact us at 212-697-8540 with questions.

Tax Breaks for Hiring Your Children in Your Family Business

With school vacation time just around the corner and employees heading out for summer vacations, you might consider hiring your children to help out in your business. Financially, it makes more sense to keep the family employed rather than hiring strangers, provided, of course, that the family member is suitable for the job.

Rather than helping to support your children with your after-tax dollars, you can instead hire them in your business and pay them with tax-deductible dollars. Of course, the employment must be legitimate and the pay commensurate with the hours and the job worked. The following are typical situations encountered when hiring family members.

Employing a Child – A reasonable salary paid to a child reduces the self-employment income and tax of the parents (business owners) by shifting income to the child. When a child under the age of 19 or a student under the age of 24 is claimed as a dependent of the parents, the child is generally subject to the kiddie tax rules if their investment income is upward of $2,100. Under these rules, the child’s investment income is taxed at the same rate as the parent’s top marginal rate using a lower $1,050 standard deduction. However, earned income (income from working) is taxed at the child’s marginal rate, and the earned income is reduced by the lesser of the earned income plus $350 or the regular standard deduction for the year, which is $6,300 for 2016. Assuming that a child has no other income, the child could be paid $6,300 and incur no income tax. If the child is paid more, the next $9,275 he or she earns is taxed at 10%.

Example: You are in the 25% tax bracket and own an unincorporated business. You hire your child (who has no investment income) and pay the child $11,800 for the year. You reduce your income by $11,800, which saves you $2,950 of income tax (25% of $11,800), and your child has a taxable income of $5,500, $11,800 less the $6,300 standard deduction) on which the tax is $550 (10% of $5,500).

If the business is unincorporated and the wages are paid to a child under age 18, he or she will not be subject to FICA – Social Security and Hospital Insurance (HI, aka Medicare) – taxes since employment for FICA tax purposes doesn’t include services performed by a child under the age of 18 while employed by a parent. Thus, the child will not be required to pay the employee’s share of the FICA taxes, and the business won’t have to pay its half either. In addition, by paying the child and thus reducing the business’s net income, the parent’s self-employment tax payable on net self-employment income is also reduced.

Use the same example from above. Assuming your business profits are $130,000, by paying your child $11,800, you not only reduce your self-employment income for income tax purposes, but you also reduce your self-employment tax (HI portion) by $316 (2.9% of $11,800 times the SE factor of 92.35%). But if your net profits for the year were less than the maximum SE income ($118,500 for 2016) that is subject to Social Security tax, then the savings would include the 12.4% Social Security portion in addition to the 2.9% HI portion.

A similar but more liberal exemption applies for FUTA, which exempts from federal unemployment tax the earnings paid to a child under age 21 while employed by his or her parent. The FICA and FUTA exemptions also apply if a child is employed by a partnership consisting solely of his parents. However, the exemptions do not apply to businesses that are incorporated or a partnership that includes non-parent partners. Even so, there’s no extra cost to your business if you’re paying a child for work that you would pay someone else to do anyway.

Retirement Plan Savings – Additional savings are possible if the child is paid more (or works part-time past the summer) and deposits the extra earnings into a traditional IRA. For 2016, the child can make a tax-deductible contribution of up to $5,500 to his or her own IRA. The business also may be able to provide the child with retirement plan benefits, depending on the type of plan it uses and its terms, the child’s age, and the number of hours worked. By combining the standard deduction ($6,300) and the maximum deductible IRA contribution ($5,500) for 2016, a child could earn $11,800 of wages and pay no income tax.

However, referring back to our original example, the child’s tax to be saved by making a $5,500 traditional IRA contribution is only $550, so it might be appropriate to make a Roth IRA contribution instead, especially since the child has so many years before retirement and the future tax-free retirement benefits will far outweigh the current $550 savings.

If you have questions about the information provided here and other possible tax benefits or issues related to hiring your child, please give this office a call.

It’s Time for Year-End Tax Planning

For the past few years, year-end tax planning has been challenging due to the lateness of action by Congress. This year is no different because of uncertainty over whether Congress will extend any of the many expired or expiring tax provisions. However, regardless of what Congress does later this year, solid tax savings can still be realized by taking advantage of tax breaks that are still on the books for 2015. For individuals and small businesses, these include:

  • Capital Gains and Losses—You can employ several strategies to suit your particular tax circumstances. If your income is low this year and your tax bracket is 15% or lower, you can take advantage of the zero percent capital gains bracket benefit, resulting in no tax for part or all of your long-term gains. Others, affected by the market downturn earlier this year, should review their portfolio with an eye to offsetting gains with losses and take advantage of the $3,000 ($1,500 for married taxpayers filing separately) allowable annual capital loss allowance. Any losses in excess of those amounts are carried forward to future years.
  • Roth IRA Conversions—If your income is unusually low this year, you may wish to consider converting your traditional IRA into a Roth IRA. Even if your income is at your normal level, with the recent decline in the stock markets, the current value of your Traditional IRA may be low, which provides you an opportunity to convert it into a Roth IRA at a lower tax amount. Thereafter, future increases in value would be tax-free when you retire.
  • Recharacterizing a Roth Conversion—If you converted assets in a traditional IRA to a Roth IRA earlier in the year, the value of those assets may have declined due to this summer’s market drop; and, as a result, you will end up paying more taxes than necessary on the higher conversion-date valuation. However, you may undo that conversion by recharacterizing it, which is accomplished by transferring the converted amount (plus earnings, or minus losses) from the Roth IRA back to a traditional IRA. This must be done via a trustee-to-trustee transfer. You can later (generally after 30 days) reconvert to a Roth IRA.
  • Don’t Forget Your Minimum Required Distribution—If you have reached age 70 1/2, you must make required minimum distributions (RMDs) from your IRA, 401(k) plan and other employer-sponsored retirement plans. Failure to take a required withdrawal can result in a penalty of 50% of the amount of the RMD not withdrawn.
  • Take Advantage of the Annual Gift Tax Exemption—Although gifts do not currently provide a tax deduction, you can give up to $14,000 in 2015 to each of an unlimited number of individuals without incurring any gift tax. There’s no carryover from this year to next year of unused exemptions.
  • Expensing Allowance (Sec 179 Deduction)—Businesses should consider making expenditures that qualify for the business property expensing option. For tax years beginning in 2015, the expensing limit is $25,000. That means that businesses that make timely purchases will be able to currently deduct most, if not all, of the outlays for machinery and equipment. Note: There is a good chance the Congress will increase that limit before year’s end and after this newsletter has gone to press, so watch for further developments.
  • Self-employed Retirement Plans—If you are self-employed and haven’t done so yet, you may wish to establish a self-employed retirement plan. Certain types of plans must be established before the end of the year to make you eligible to deduct contributions made to the plan for 2015, even if the contributions aren’t made until 2016. You may also qualify for the pension start-up credit.
  • Increase Basis—If you own an interest in a partnership or S corporation that is going to show a loss in 2015, you may want to increase your investment in the entity so you can deduct the loss, which is limited to your basis in the entity.

Also keep in mind when considering year-end tax strategies that many of the tax breaks allowed for calculating regular taxes are disallowed for alternative minimum tax (AMT) purposes. These include deduction for property taxes on your residence, state income taxes, miscellaneous itemized deductions, and personal exemption deductions. Other deductions, such as for mortgage interest, are calculated in a more restrictive way for AMT purposes than for regular tax purposes. As a result, accelerating payment of these expenses that would normally be made in early 2016 to 2015 should—in some cases—not be done.