Solar Tax Credit is Sunsetting Soon

A federal tax credit for the purchase and installation costs of a residential solar system is fading away. After 30% of the value for several years through 2019, the credit amount drops to 26% in 2020 and then to 22% in 2021, the credit’s final year. 

The credit is nonrefundable, meaning it can only reduce an individual’s tax liability to zero. However, the credit portion that is not allowed because of this limitation may be carried to the next tax year and added to the credit allowable for that year. The tax code infers that any credit carryover can be added to the credit allowed in the subsequent year. However, it’s unclear whether any carryover will be allowed to 2022 once the credit expires at the end of 2021. In addition to the credit reducing the regular tax, it also reduces the alternative minimum tax should a taxpayer be subject to it. 

Qualifying Property – Only the following solar power systems are eligible for the credit: 

  • Qualified solar electric property – a property that uses solar energy to generate electricity for use in a home that is the taxpayer’s primary or second residence. 
  • Qualifying solar water heating property – qualifies if used in a dwelling located in the U.S. operated by the taxpayer as a primary or secondary residence where at least half of the energy used to heat water is derived from the sun. Heating water for swimming pools or hot tubs does not qualify for the credit. The solar equipment must be certified for performance by the Solar Rating Certification Corporation or a comparable entity endorsed by the state government where the property is installed.

When Is the Credit Available? The credit may be claimed on the year’s tax return in which the installation is completed. If a taxpayer has purchased and paid for a system and it is completed in 2020, the credit will be 26% of the cost. But if the project isn’t completed until 2021, the credit will only be 22%. This becomes an even bigger issue for systems being installed during 2021 that aren’t completed before 2022 when the credit rate will be zero. If you plan to purchase a solar system in 2021, the purchase should be made early enough in the year to ensure the installation is completed before 2022. 

Who Gets the Credit – It may come as a surprise, but the taxpayer does not need to own the residence where the solar property is installed to qualify for the credit, as the taxpayer need only be a “resident” of the home. The tax code does not specify that an individual has to own the home, only that it is the taxpayer’s residence. For example, a son lives with his mother, who owns the home. The son pays to have the solar system installed; the son is the one who qualifies for the credit. 

Multiple Installations – The credit is available for numerous installations. For instance, after the initial installation, if a taxpayer adds additional panels to increase capacity, these would be treated as original installations and qualify for credit at the credit rate applicable for the year the additional installation is completed, provided that the installation is done before 2022. On the other hand, if a taxpayer had to replace damaged panels or perform other maintenance on the system, these items would not be an original system, and their costs would not qualify for the credit. 

Battery – A battery qualifies for the credit if charged only by solar energy and not off the grid. This has become popular in areas where there are frequent power outages. However, this may be more of a convenience than a necessity, so carefully consider the cost. A software-management tool—whether part of the original installation or added later (before 2022)—also qualifies for the credit in cases in which the software is necessary to monitor the charging and discharging of solar energy from a battery attached to solar panels. 

Installation Costs – Amounts paid for labor costs allocable to onsite preparation, assembly, or original installation of property eligible for the credit. For piping or wiring, connecting the property to the residence are expenditures that qualify for the credit. This includes expenses relating to a solar system installed on a roof or ground-mounted installations. 

Basis Adjustment – The term basis is generally the cost of the home plus improvements and is the amount subtracted from the sales price to determine the gain or loss when the house is sold. The cost of a solar system adds to a home’s basis, and the credit reduces the basis. This will generally create a different basis for federal and state purposes where a state does not provide a solar credit, or it differs from the federal solar credit amount. 

Association or Cooperative Costs – A taxpayer who is a member of a condominium association for a condominium they own, or a tenant-stockholder in a cooperative housing corporation, is treated as having paid their proportionate share of any qualifying solar system costs incurred by the condo or cooperative association or corporation. 

Mixed-Use Property – In cases where a portion of a residence is used for deductible business use or is rented to others, the expenses must be prorated. Only the personal part of the qualified solar costs can be used to compute the credit. There is an exception when less than 80% of the property is used for non-business purposes, in which case the full amount of the expenditures is eligible for the credit. 

Newly Constructed Homes – If you plan to purchase a newly constructed home that includes a solar system, you may be entitled to claim the solar credit. However, to do so, the solar system’s costs must be separate from the home construction costs, and certification documents must be available. 

Utility Subsidy – Some public utilities provide a nontaxable subsidy (rebate) to their customers to purchase or install energy-conservation property. In that case, the cost of the solar system that’s eligible for the credit must be reduced by the amount of the nontaxable subsidy. 

Solar Installations are Not for Everyone – There are TV ads, telemarketing phone calls, and salespeople at your front door, all promoting solar power benefits. One of the key considerations and a frequently mentioned benefit is the federal tax credit. 

What isn’t included in the ads—and something most potential buyers are unaware of—is that the solar credit is a nonrefundable tax credit, meaning the credit can only be used to offset your tax liability. This can come as a very unpleasant surprise and is often a financial hardship when the purchaser of a home solar system finds out that the credit is nonrefundable and won’t benefit from the full credit. 

For example, a married couple with three children, all under age 17, and an annual income of $80,000 installed a solar system costing $20,000 in 2020, expecting a $5,200 ($20,000 x 26%) credit on their tax return. Their standard deduction in 2020 is $24,800, leaving them with a taxable income of $55,200. The tax on the $55,200 is $6,229. They are also entitled to a $2,000 child tax credit for each child, which reduces their tax liability by $6,000 and results in a tax liability of $229. Since the solar credit is nonrefundable, the only portion of the credit they can use is $229, not the $5,200 they had expected. 

On top of that, the family is probably financing the solar system, which significantly adds to its cost. If a 5% home equity loan financed the entire $20,000 price for 20 years, then the interest on that loan over its term would be $11,678, bringing the total cost of the solar system to $31,678 or a monthly fee of $132.

Instead of purchasing a solar system, some homeowners opt to lease a system. This arrangement is not eligible for the solar credit. 

As you can see, there is a lot to consider before making the final decision to install a solar system. Is it worth it, and is it the right financial move for you? Please contact us before signing any contract to make sure a solar system is appropriate for you.

Tax Consequences of Losing Your Job

Article Highlights: 

  • Severance Pay 
  • Unemployment Compensation 
  • Health Insurance 
  • Employer Pension Plan 
  • Coronavirus-related Distributions 
  • Home Sale 

If you lost your job, there are several tax issues you may encounter. How you deal with these issues can profoundly impact your taxes and finances. The following are typical issues related to tax treatment: 

Severance Pay – Your employer may provide you with severance pay. Severance pay and payment for unused vacation time will be included in your W-2 income, and both are fully taxable. 

Unemployment Compensation – If you do not find another job right away, you generally qualify for unemployment compensation. Unemployment benefits, both the regular benefits you receive from your state unemployment department and the enhanced unemployment payments during the COVID-19 emergency, are taxable for federal purposes and may or may not be taxable by your state of residence. To minimize the tax you may owe when you file your 2020 tax return; you may want to request federal income tax withholding of 10% of the unemployment benefit amount. Do that by submitting a Form W-4V (Voluntary Withholding Request) to your state’s unemployment office. 

Health Insurance – If you lose your job and have health insurance through your employer’s group health coverage plan, you will need to determine your available options for continued coverage via COBRA or a replacement policy. If you give up coverage, you may be subject to penalties in some states for not being insured. 

  • COBRA Coverage – The Consolidated Omnibus Budget Reconciliation Act (COBRA) requires continuation coverage to be offered to covered employees, their spouses, former spouses, and dependent children when group health coverage would otherwise be lost. COBRA continuation coverage is often more expensive than the amount that active employees must pay for group health coverage because they usually cover part of employees’ coverage costs. 102% of the total cost can be charged to individuals receiving continuation coverage (the extra 2% covers administration costs). COBRA generally applies to private-sector employers with 20 or more employees and state or local governments that offer group health coverage to their employees. In most cases, COBRA coverage is limited to 18 months. 
  • Health Insurance Marketplace Coverage – When existing health coverage is lost, a family may purchase health insurance through a government health insurance marketplace outside of the standard enrollment window. Depending upon your income for the year, you may qualify for the premium tax credit for the part of the year when you don’t have coverage through your employer, which will help pay for the insurance. Suppose coverage was already through a marketplace and not your employer; you should notify the Marketplace that you’ve lost your job and that your income has decreased, as you may then be eligible for a higher advance premium tax credit. However, advise the Marketplace once you are employed again to make appropriate adjustments to the advance premium tax credit amount. This may alleviate having to repay some of the credit when you file your 2020 return. 

Employer Pension Plan – Depending upon your employer’s pension plan, you may have the option of leaving your retirement funds in the employer’s plan or moving the funds to your IRA account. You can have the funds transferred to your IRA or take a distribution and roll it into your IRA within 60 days. However, this is where a tax trap exists; for distribution, the employer is required to withhold 20% for federal taxes, meaning only 80% of the funds will be available to roll over, and the remaining 20% will end up being taxable unless you can make up the difference with other funds. 

If you ever want to roll those funds into a new employer’s retirement plan, those retirement distributions should not be commingled with other IRA accounts. 

Should you be tempted not to roll the funds over, be aware that the distribution will generally be taxable, and if you are under the age of 59½, there will also be a 10% early withdrawal penalty. However, the CARES Act allows qualified taxpayers to make COVID-19-related distributions from qualified plans or IRAs (not to exceed $100,000 from January 1, 2020, to December 31, 2020) and receive favorable tax treatment. These distributions are penalty-free; they are taxed over three years and can be redeposited to an IRA or qualified plan within three years. 

Home Sale – If you relocate and have to sell your home and have owned and occupied the house as your primary residence for 2 of the previous 5 years, you will be able to exclude up to $250,000 of the gain ($500,000 if you are married and you and your spouse qualify for the exclusion). If you do not meet the 2-out-of-5-years qualifications, you will be allowed a prorated gain exclusion because you have lost your job.

As you can see, several issues may apply when a job loss occurs; this is even more relevant during the coronavirus emergency. To learn more about how these issues might affect your particular situation, please contact us

How to File Taxes After Moving to a New State

Moving to a new state can be an incredible new adventure. No matter what takes you to your new residence, you can’t forget about taxes. Here’s what you need to know about filing taxes in your new state as you settle into your new routine. 

Establish Residency in Your New State

Even if you haven’t sold your home or severed all ties with your previous hometown, you will need to make as many connections with your new residence as possible.

  • Change your mailing address 
  • Get your driver’s license and voter registration in your new state 
  • Register children for school (if applicable) in your new state 
  • Move your personal belongings and family pets to your new home 

This will help prove that you have fully moved from the original state and are no longer subject to taxes there as a resident. 

Cut Ties with Your Previous Jurisdiction 

If you have a second home in another state or you are still working or doing business in your previous state, you may still qualify as a resident in that state for tax purposes. 

If you still have ties in your previous state, make sure you understand the residency qualifications so that you can avoid any surprises at tax time. 

Determine What Kind of Tax Return Is Required 

Unless you moved on January 1st of the calendar year, you are likely – at a minimum – a part-year resident of each state. 

Typically, this means that you will allocate your income, deductions, credits, and other tax items based on the number of days you lived in each state. You would file a part-year tax return in each state unless the state that you are moving from or moving to does not have a state income tax requirement. 

Check Your Eligibility for Tax Credits, and Other Tax Benefits That You May Be Eligible for in Your New State 

The forms that each taxpayer may use are consistent when completing your federal tax return. However, no two states are exactly alike when it comes to filing a tax return. Credits and other benefits that you may be eligible for in one state may not apply in another state. 

You may find that you now qualify for extra credits or other incentives not previously available to you. 

Get Help from a Tax Professional 

When it comes to your taxes, it’s best to contact a tax professional if you’re unsure of the steps to take when completing your tax forms. 

We can assist with tax planning and identifying tax credits and deductions. Your Tarlow advisor can help you avoid mistakes when completing your tax return that can result in costly interest and penalties. Please contact us for more information.

Tax Benefits for People with Disabilities

Individuals with disabilities as well as parents of disabled children are eligible for a number of income tax benefits. This article explains some of these tax breaks. 

ABLE Accounts – A federal law allows states to offer specially designed, tax-favored ABLE accounts to people with disabilities. Qualified ABLE programs provide the means for individuals and families to contribute and save to support individuals who became blind or severely disabled before turning age 26 in maintaining their health, independence, and quality of life. The 2017 tax reform, known as the Tax Cuts and Jobs Act (TCJA), added some additional features to the ABLE accounts. 

The states run the ABLE programs authorized by the federal tax statute. A state that has established an ABLE account program can offer its residents the option of setting up one of these accounts or contract with another state that offers ABLE accounts. Contributions totaling up to the annual gift tax exclusion amount, currently $15,000, can be made to an ABLE account each year.  Furthermore, distributions are tax-free if used to pay qualified disability expenses. 

Beginning in 2018 and through 2025, a TCJA provision allows the beneficiary of the ABLE account (i.e., the disabled person) to contribute a maximum additional amount each year, equal to the lesser of: 

  • The beneficiary’s taxable compensation for the year, or

  • The prior year’s poverty level ($12,140 for 2019) for a one-person household.

However, the extra contribution isn’t allowed if the beneficiary’s employer contributes to a qualified retirement plan on the beneficiary’s behalf. 

The beneficiary’s additional contribution qualifies for the non-refundable saver’s tax credit, which, depending on the beneficiary’s actual income, can be 10%, 20%, or even as much as 50% of up to the first $2,000 contributed, for a maximum credit of $1,000. 

Disabled Spouse or Dependent Care Credit – A tax credit is available to individuals who incur childcare expenses for children under the age of 13 at the time the care is provided. This credit is also available for the care of the taxpayer’s spouse or of a dependent who is physically or mentally unable to care for him/herself, and has lived with the taxpayer for more than half the year. This is also true for individuals who would have been dependents except for the fact that they earned $4,200 or more (2019) or filed a joint return with their spouse. The credit ranges from 20% to 35%, with lower-income taxpayers benefiting from the higher percentage and those with an adjusted gross income of $43,000 or more receiving only 20%. The care expenses qualifying for the credit are limited to $3,000 for one and $6,000 for two or more qualifying individuals. 

Medical Expense Deductions – In addition to the “normal” medical expenses, individuals with disabilities can incur other unusual deductible expenses. However, to gain a tax benefit, an eligible taxpayer must itemize his or her deductions on Schedule A, and the taxpayer’s total medical expenses must exceed 10% of his or her adjusted gross income. Eligible expenses include: 

  • Prostheses

  • Vision Aids – Contact lenses and eyeglasses

  • Hearing Aids – Including the costs and repair of special telephone equipment for people who are deaf or hard of hearing

  • Wheelchair – Costs and maintenance

  • Service Dog – Costs and care of a guide dog or service animal

  • Transportation – Modifications or special equipment added to vehicles to accommodate a disability

  • Impairment-Related Capital Expenses – Amounts paid for special equipment installed in the home or for improvements may be included as medical expenses if their main purpose is medical care for the taxpayer, the spouse, or a dependent. The costs of permanent improvements that increase the property’s value may be partly included as a medical expense. The costs of the improvement are reduced by the increase in the property’s value. The difference is a medical expense. If the improvement does not increase the property’s value, the entire cost is included as a medical expense. Certain improvements made to accommodate a home to a taxpayer’s disabled condition, or to that of the spouse or dependents who live with the taxpayer, do not usually increase the home’s value, so the costs can be included in full as medical expenses. A few examples of full-cost medical expenses include constructing entrance or exit ramps for the home; widening entrance and exit doorways, hallways, and interior doorways; installing railings, support bars, or other modifications; and adding handrails or grab bars.

  • Learning Disability – Tuition fees paid to a special needs school for a child who has severe learning disabilities caused by mental or physical impairments, including nervous system disorders, can be included as medical expenses. A doctor must recommend that the child attend a special needs school. Fees for tutoring recommended by a doctor from a teacher who is specially trained and qualified to work with children with severe learning disabilities may also be included.

  • Special Schooling – Medical care includes the costs of attending a special school designed to compensate for or overcome a physical handicap in order to qualify the individual for future normal education or for normal living. This includes a school that teaches braille or lip reading. The principal reason for attending the school must be its special resources for alleviating the student’s handicap. The tuition for ordinary education that is incidental to the special services provided at the school as well as the costs of meals and lodging supplied by the school are also included as medical expenses.

  • Nursing Services – Wages and other amounts paid for nursing services can be included as medical expenses. Services need not be performed by a nurse as long as the services are of a kind generally performed by a nurse. This includes services connected with caring for the patient’s condition, such as giving medication, changing dressings, and bathing/grooming the patient. These services can be provided in the home or another care facility. Generally, only the amount spent for nursing services is a medical expense. If the attendant also provides personal and household services, these amounts must be divided between the time spent performing household and personal services and the time spent on nursing services.

If you have questions about any of the disability-related tax benefits discussed in this article, or if you have questions concerning potential medical expenses not discussed above, please contact us.

Don’t Overlook These Essential Small Business Tax Credits

At their core, tax credits are a very particular type of benefit designed to offset the actual tax liability associated with small businesses around the country. Tax credits are not the same thing as a tax deduction, which lowers that business’s actual income. Tax credits are typically offered to incentivize everything, from hiring more workers to stimulate the economy, to making meaningful contributions to specific industries.

While some tax credits are apparent, others are decidedly less so. This is why proper tax planning is essential as a small business owner. It is important to be proactive about getting the money that is owed to you. There are several crucial small business tax credits in particular that you’ll want to take advantage of when tax season rolls around.

The General Business Tax Credit

As the name suggests, this is something of a “kitchen sink” tax credit made up of many smaller, individual credits. Collectively, they are designed to act as a way to motivate savvy business owners, such as yourself, to participate in certain activities. If you purchased a qualified electric vehicle for your business, branched out into a new market, or retained a certain number of employees, you may very well be qualified.

Paid Family and Medical Leave

This particular tax credit is relatively new, having only just been authorized in 2017. It’s intended to motivate small business owners to provide paid leave to all employees who are covered by the Family and Medical Leave Act. Employees who qualify are entitled to up to 12 weeks of totally unpaid, job-projected leave — all while still retaining access to their group health benefits as well. Note that this is something that happens every year.

The credit itself is equal to a percentage of the wages that an employer pays to those qualified employees while they’re on leave for things like unexpected medical emergencies or even giving birth. 

The Alternative Motor Vehicle Credit

This credit is a sizable one of up to $8,000, so it is absolutely in your own best interest to claim it if you qualify. As the name suggests, it’s a way to incentivize small business owners to purchase an “alternative fuel source” vehicle. Note that the cars that fall into this category would be those that use hydrogen fuel-cell technology, not hybrids or electric cars since those are still considered to be “traditional” types of fuel.

Yes, the list of qualified vehicles is currently small — but that doesn’t mean it won’t expand in the future, and the credit itself is still worth keeping an eye on. 

Credits for Qualified Research Expenses

Depending on the specific type of small business you’re running, you may have to engage in a significant amount of research and development to better serve your customers. The United States government would like to encourage you to do as much of that as possible, which is how the qualified research expenses credit (otherwise known as the “Increasing Research Activities Credit”) came into being.

To qualify for this credit, you need to engage in domestic research and development for things like certification testing, environmental testing, developing or applying for patents, prototype and model development, and more. Research associated with the development of new or even improved products, processes, and formulas would also qualify.

This credit can cover up to 20% of all of your related expenses that fall under this umbrella. 

The New Markets Credit

Last but not least, we have the New Markets Credit — one designed to encourage investment in Community Development Enterprises and Community Development Financial Institutions, otherwise known as CDEs and CDFIs, respectively. These are the types of organizations that assist lower-income communities around the country.

The vast majority of all qualified projects involve either purchasing, renovating, or constructing real estate in areas that have a 20% poverty rate or with median family incomes that don’t exceed 80% of that of the larger area. This means building or renovating hospitals, for example, or industrial buildings that go on to create jobs. 

Note that while all of these small business tax credits are critical, they represent just a small fraction of those that may be available to you. For the complete list, be sure to review the IRS’s official website devoted to that very topic. As always, you should also enlist the help of your qualified Tarlow tax professional to prepare your business taxes. Not only can we help ensure you’re taking full advantage of these and other critical credits, but we can also help you avoid the types of costly mistakes that small business owners and the self-employed often make. Contact us for more information today.

Earned Income Tax Credit: Used, Abused and Altered

Article Highlights:

  • Purpose of the Earned Income Tax Credit
  • Qualifications
  • Earned Income
  • Qualified Child
  • Credit Phaseout
  • Computing the Credit
  • Investment Income Limit
  • Combat Pay Election
  • Fraud
  • Safeguards

Any discussion of the earned income tax credit (EITC) needs to begin with a discussion of why Congress created it in the first place. It has a twofold purpose: first, as an incentive for people to work and get off public assistance. And second, to provide financial assistance for low-income taxpayers and their families based upon their income from working, which the tax code refers to as “earned income.” When originally created back in 1979, it even allowed taxpayers to obtain the credit in advance through their employer’s payroll payments, based on projecting the credit they would be entitled to on their tax return for the year. This was referred to as advanced EITC. However, because of the many problems associated with the advanced payment credit, it was repealed for years after 2010.

The EITC is a refundable credit, meaning if any unused credit remains after offsetting all of a taxpayer’s tax liability, that remainder is refunded to the taxpayer. This refundable feature has made the EITC a giant target for fraud, which is discussed later in this article. In addition to the other requirements discussed below, the EITC is not allowed to married couples filing separately, nor can the taxpayer claiming the credit be a dependent of another taxpayer. In addition, the taxpayer must have been a U.S. citizen or resident alien all year and have a Social Security Number (SSN). Any children used to qualify the taxpayer for the credit are also required to have a SSN. Furthermore, because this credit is meant for lower-income individuals, if a taxpayer is working overseas and is able to exclude foreign earned income, he or she is barred from claiming the EITC. As previously mentioned, the EITC is based in part on the amount of a taxpayer’s (or in the case of a married couple, both a filer’s and a spouse’s) taxable earned income. For example, taxable earned income includes:

  • Wages, salaries, and tips;
  • Union strike benefits;
  • Long-term disability benefits prior to minimum retirement age; and
  • Earnings from self-employment.

Taxable earned income does not include any form of earned income that is excluded from income, such as a clergyperson’s housing allowance, excluded military combat pay (but see the election for combat pay later), tax-deferred retirement contributions, or excludable dependent care benefits.

Qualified Children – The EITC is also based upon the number of the taxpayer’s qualified children who lived with the taxpayer in the United States for more than half of the year for which the credit is being claimed. Generally, for EITC purposes, a qualified child must be younger than the taxpayer and be under the age of 19 or a full-time student under the age of 24 who had the same principal place of abode as the taxpayer for more than half of the tax year and is not married and filing a joint return (exceptions may apply).

For the EITC, “child” is defined as the taxpayer’s:

  • Son, daughter, adopted child, stepchild, eligible foster child, or a descendant of any of them (for example, a grandchild); or
  • Brother, sister, half-brother, half-sister, stepbrother, stepsister, or a descendant of any of them (for example, a niece or nephew).

Exceptions to the residency requirement include temporary absences from the home, such as for school, vacations, illness, and military service.

Computing the Credit and Phaseout – The amount of the EITC increases as the earned income increases until it reaches the maximum credit amount, and then it phases out as the taxpayer’s modified adjusted gross income (MAGI) increases above the phaseout threshold. The following table illustrates how the credit is determined and the maximum amount of the credit for 2019.

Number of Qualifying Children Credit Percentage Earned Income Maximum Credit
None 7.65 $6,920 $529
One 34.00 $10,370 $3,526
Two 40.00 $14,570 $5,828
Three or more 45.00 $14,570 $6,55

If a taxpayer has no qualifying children, the taxpayer must be age 25 or older but under the age of 65 before the end of the year. This is to prevent children and retired individuals from claiming the credit. As can be seen from the table above, the credit for a taxpayer who doesn’t have a qualifying child is significantly less than for someone with one or more children.

Example #1: Ted and Jane have two qualifying children, and their only income is Ted’s wages (earned income) of $31,738. From the table above, based on two children, we determine their EITC before the phase-out as being the lesser of $12,695 (40% of $31,738) or $5,828 (the maximum for taxpayers with two qualifying children). Thus, in this case, the EITC before phaseout is $5,828.

Phaseout – The tax law limits the EITC to lower-income taxpayers by phasing out (reducing) the credit as a taxpayer’s MAGI increases above a threshold, with the credit fully phased out when the MAGI reaches the complete phaseout amount shown in the table below.

Number of Qualifying Children Phaseout Percentage Phaseout Threshold Complete Phaseout
None 7.65 Joint Filers: $14,450
Others: $8,650
$21,370
$15,570
One 15.98 Joint Filers: $24,820
Others: $19,030
$46,884
$41,094
Two 21.06 Joint Filers: $24,820
Others: $19,030
$52,493
$46,703
Three or more 21.06 Joint Filers:$24,820
Others: $19,030
$55,952
$50,162

 

Example #2: Using Ted and Jane from example #1, who have two qualifying children, we had determined that their EITC before phaseout was $5,828. The next step is to determine their credit after phaseout. We do that using the chart above, and for a married couple with two qualified children, the phaseout threshold begins at $24,820 and the phaseout percentage is 21.06%. Ted and Jane’s only income was Ted’s wages, so their MAGI is also $31,738. Their MAGI exceeds the phaseout threshold by $6,918 ($31,738 – $24,820). Multiplying that amount by the 21.06 phaseout percentage equals $1,457, which is the amount of the EITC that will be phased out. Thus, Ted and Jane’s EITC for 2019 will be $4,371 ($5,828 − $1,457).

Each year, the IRS develops credit look-up tables that take into account the taxpayer’s filing status, number of qualifying children, earned income, MAGI, and phaseout, so that the math we did in the above example is not needed.

Investment Income Limit – Congress further limited the credit so that taxpayers with substantial financial assets will not qualify for the credit. A taxpayer’s income from investments is used as a gauge for financial assets, and for 2019, taxpayers with investment income of $3,600 or more are disqualified from the credit.

Special Election for Combat Pay – Military members can elect to include their nontaxable combat pay as earned income for the credit. If that election is made, then the military member must include in his or her earned income all nontaxable combat pay received. If spouses are filing a joint return and both spouses received nontaxable combat pay, then each one can make a separate election.

Fraud – As mentioned earlier, the EITC is also a target of major fraud by unscrupulous tax preparers and ID thieves. In fact, the fraud has been so prevalent that the IRS has developed procedures, and Congress has passed tax laws, to combat the abuse.

One of the major areas of fraud was scammers filing returns with stolen IDs and phony income as soon as the IRS began accepting e-filed returns around the end of January. Filing early prevented the IRS from verifying the reported income because employers were not required to file W-2s and 1099s until the end of February. That also minimized the chances that the individuals whose IDs the fraudsters were using would file before them and cause the IRS to reject the return. In fact, many scammers would file married joint returns using the names and SSNs of two unrelated individuals, taking advantage of the IRS’s privacy policies; thus, if one of the victims contacted the IRS, the IRS would be unable to communicate with the individual because the victim would not know the name or SSN of the other filer on the fraudulent joint tax return. Of course, the income reported on the fraudulent returns was an amount meant to maximize the EITC and minimize the phaseout. The scammers also took advantage of the automatic refund deposit feature and had the refunds deposited into bank accounts that they opened in the names of the individuals whose IDs they were using on the fraudulent returns. Once the refunds were deposited into the accounts, the accounts were quickly cleaned out, leaving absolutely no trace of the scammers who were rarely caught. However, in a notable case in Florida, the scammer got away with millions of dollars in fraudulent credits and would not have ever been caught had she not bragged about her exploits online.

The IRS has since altered its return-processing procedures and plugged that hole, by not issuing refunds that include the EITC until after mid-February. The filing due dates for W-2s and 1099s have been moved up to January 31, giving the IRS adequate time to verify the earned income before issuing the refunds.

The IRS has also established the Identity Protection Specialized Unit to assist taxpayers who have been victims of ID theft. These taxpayers can file their returns by using an Identity Protection PIN provided annually by the IRS. Taxpayers who are or suspect they are victims of ID theft can call the IRS at 877-438-4338 for assistance.

Safeguards – Congress has also included consequences for taxpayers who have been found to abuse the EITC rules and has included mandatory taxpayer identification procedures for tax preparers.

  • Taxpayers – For taxpayers who recklessly or intentionally disregard the EITC rules, the IRS can make them ineligible for the credit in the two subsequent years, and if fraud is involved, the suspension period can be for ten years.
  • Tax Preparers – Tax preparers are required to follow mandated EITC due diligence procedures that require them to complete an EITC due diligence check sheet and verify the identity of anyone claiming the EITC before a return can be filed. Failure to adhere to these safeguards can result in a $530 tax-preparer penalty for each failure to comply with the due diligence requirements.

Many taxpayers who legitimately qualify for this credit are failing to claim it because they don’t fully understand the credit. For instance, the IRS estimates that 1.5 million taxpayers don’t realize that taxable long-term retirement benefits received before reaching minimum retirement age qualify as earned income, making them eligible for the EITC. The IRS also estimates that between 20 and 25 percent of the individuals who qualify for the EITC don’t claim it.

If you have questions about your qualifications for this credit or need help amending or filing a prior year’s return to claim the credit, please contact us.

Don’t Overlook Tax Credits

Tax credits are a tax benefit that offsets your actual tax liability, as opposed to a tax deduction, which reduces your income. Congress provides tax credits to individual taxpayers for a number of reasons, including as a form of assistance for lower-income taxpayers, to stimulate employment, and to stimulate certain investments, among other things.

Tax credits come in two types: non-refundable and refundable. A non-refundable credit can only reduce your tax liability to zero; any excess is either carried forward or is simply lost. In the case of a refundable credit, if there is excess after reducing your tax liability to zero, the excess is refundable. The following is a summary of some of the tax credits available to individual taxpayers:

Childcare Credit – Parents who work or are looking for work often must arrange for care of their children during working hours or while searching for work. If this describes your situation and your children requiring care are under 13 years of age, you may qualify for a childcare tax credit.

The credit ranges from 20% to 35% of non-reimbursed expenses, based upon your income, with the higher percentages applying to lower-income taxpayers and the lower percentages applying to higher-income taxpayers.

Applicable Percentage of AGI for the Childcare Credit
AGI Over But Not Over Applicable Percent AGI Over But Not Over Applicable Percent
0 15,000 35 29,000 31,000 27
15,000 17,000 34 31,000 33,000 26
17,000 19,000 33 33,000 35,000 25
19,000 21,000 32 35,000 37,000 24
21,000 23,000 31 37,000 39,000 23
23,000 25,000 30 39,000 41,000 22
25,000 27,000 29 41,000 43,000 21
27,000 29,000 28 43,000 No Limit 20

The maximum expense amount allowed is $3,000 for one child and $6,000 for two or more, and the credit is non-refundable, which means it can only reduce your tax to zero, and the excess is lost.

As an example, say your adjusted gross income (AGI) is between $33,000 and $35,000. Your credit percentage would be 25%. If you paid childcare expenses of $4,000 for two children under the age of 13, your tax credit would be $1,000 ($4,000 x 25%). If your tax for the year was $5,000, the credit would reduce that tax to $4,000. On the other hand, if your tax for the year was $800, the credit would reduce your tax to zero, and the $200 excess credit would be lost.

This credit also applies when a taxpayer or spouse is disabled or a full-time student, in which case special “earned income” allowances are provided for months when the taxpayer or spouse is disabled or a full-time student. Please call this office for additional details if this situation applies in your case.

Earned Income Tax Credit (EITC) – Congress established the EITC as an income supplement for working individuals in lower-paying employment. If you qualify, it could be worth as much as $6,431 in 2018. It is a refundable credit.

The EITC is based on the amount of your earned income (income from work for wages and/or self-employment) and whether there are qualifying children in your household. Qualifying children are those who live with you for over half the year, are related, and are under the age of 19 or a full-time student under the age of 24. The credit increases as your earned income increases. The table below shows the earned income at which the maximum credit is achieved for 2018.

Qualifying Children Earned Income  Maximum Credit
None 6,780 $519
1 $10,180 $3,461
2 $14,290 $5,716
3 or more $14,290 $6,431

The credit amount phases out after reaching the maximum based on filing status and number of qualifying children. The 2018 phase-out ranges are shown in the table below.

Qualifying Children

Filing Status Phase-out Range
None Married Filing Joint $14,170–20,950
Others $8,490–15,270
1 Married Filing Joint $24,350–46,010
Others $18,660–40,320
2 Married Filing Joint $24,350–51,492
Others $18,660–45,802
3 or more Married Filing Joint $24,350–54,884
Others $18,660–49,194

In addition, there are some qualification requirements: you, your spouse (if married and filing jointly), and each qualifying child must have a valid Social Security number, and you cannot use the filing status married filing separately. You cannot be a qualifying child of another person, your investment income for the year cannot exceed $3,500 (2018), and you cannot exclude earned income from working abroad. If you do not have a qualifying child, you must be at least age 25 but under 65 at the end of the year.

Even though this credit can be worth thousands of dollars to a low-income family, the IRS estimates as many as 25 percent of people who qualify for the credit do not claim it, simply because they don’t understand the criteria. If you qualified for but failed to claim the credit on your return for 2015, 2016, and/or 2017, you can still claim it for those years by filing an amended return or an original return, if you have not previously filed. Please call for assistance.

Members of the military can elect to include their nontaxable combat pay in their earned income for the earned income credit. If that election is made, the military member must include in their earned income all nontaxable combat pay they received for the year.

Child & Dependent Tax Credit – As an aid to families with children, the tax reform increased the child tax credit from $1,000 to $2,000 for each qualified child. A qualified child for this tax credit is one who is under age 17 at the end of the year, is related, is not self-supporting, lived with you over half the year, has a Social Security number, and is claimed as your dependent. The refundable portion of this credit is equal to 15% of your earned income but limited to $1,400.

Beginning in 2018, you are also able to claim a non-refundable credit of $500 for each of your dependents who do not qualify for the child credit.

For both the child and dependent credits, the credit begins to phase out for married taxpayers with an AGI of $400,000 ($200,000 for others).

Saver’s Credit – Congress created the non-refundable saver’s credit as a means of stimulating retirement savings among lower-income individuals. It helps to offset part of the first $2,000 that workers voluntarily contribute to traditional or Roth individual retirement arrangements (IRAs), SIMPLE-IRAs, SEPs, 401(k) plans, 403(b) plans for employees of public schools and certain tax-exempt organizations, 457 plans for state or local government employees, and the Thrift Savings Plan for federal employees. The saver’s credit is available in addition to any other tax savings that apply as a result of contributing to retirement plans. The credit is a percentage of the first $2,000 contributed to an eligible retirement plan. The following table illustrates the percentage based upon filing status and AGI for 2018.

Adjusted Gross Income Range  Credit 
Married Filing Joint Head of Household Others Percentage
$0–$38,000 $0–$28,500 $0–$19,000 50
$38,001–$41,000 $28,501–$30,750 $19,001–$20,500 20
$41,001–$63,000 $30,751–$47,250 $20,501–$31,500 10
$63,001 & Over $47,251 & Over $31,501 & Over No Credit
Example – Eric and Heather are married, both age 25, and filing a joint return. Eric contributed $3,000 through his 401(k) plan at work, and Heather contributed $500 to her IRA account. Their modified AGI for 2018 was $28,000. The credit is computed as follows:

Eric’s 401(k) contribution was $3,000, but only the
first $2,000 can be used………………………………………………………………….. $2,000
Heather’s IRA contribution was $500, so it can all be used……………. 500
Total qualifying contributions…………………………………………………………… $2,500
Credit percentage for a MFJ AGI of $28,000 from the table……………. X .50
Non-refundable saver’s credit…………………………………………………………….$1,250

Vehicle Tax Credits – If you are considering purchasing a new car or light truck (less than 14,000 pounds), don’t overlook the fact that Congress included a substantial tax credit for the purchase of the many electric vehicles currently being offered for sale, providing a tax credit worth as much as $7,500.

To be eligible for the credit, you must acquire the vehicle for use or lease and not for resale. Additionally, the vehicle’s original use must commence with you, and you must use the vehicle predominantly in the United States.

Congress did include a phase-out provision for this credit that applies by vehicle manufacturer. The credit begins to phase out once the manufacturer sells 200,000 electric vehicles. To see if the make and model you are considering qualify, visit the IRS website.

The credit is available whether you use the vehicle for business, personally, or a combination of both. The prorated portion of the credit that applies to business use becomes part of the general business credit, and any amount not used on your return for the year when you purchase the vehicle can be carried back to the previous year and then carried forward until used up, but for no more than 20 years. The personal portion is non-refundable.

Adoption Credit – If you are an adoptive parent or are planning to adopt a child, you may qualify for the adoption credit. The amount of the credit is based on the expenses incurred that are directly related to the adoption of a child under the age of 18 or a person who is physically or mentally incapable of self-care.

This is a 1:1 credit for each dollar of qualified expenses up to the maximum for the year, which is $13,810 for 2018. The credit is non-refundable, which means it can only reduce your tax liability to zero (as opposed to potentially resulting in a cash refund). But the good news is that any unused credit can be carried forward for up to five years to reduce your future tax liability.

Qualified expenses generally include adoption fees, court costs, attorney fees, and travel expenses that are reasonable, necessary and directly related to the child’s adoption, and they may be for both domestic and foreign adoptions; however, expenses related to adopting a spouse’s child are not eligible for this credit. When adopting a child with special needs, the full credit is allowed, whether or not any qualified expenses were incurred.

The credit is phased out for higher-income taxpayers. For 2018, the AGI (computed without foreign-income exclusions) phase-out threshold is $207,140, and the credit is completely phased out at the AGI of $247,140. Unlike most phase-outs, this one is the same regardless of filing status. However, taxpayers filing as married filing separately cannot claim the credit.

Residential Energy Efficient Property Credit – This tax credit was created to reward individuals for investing in equipment that uses alternative energy sources to create electrical power for use in a taxpayer’s home or second home. It includes alternative power sources such as fuel cells, wind energy, and geothermal heat pumps, for which the credit expires after 2021.

However, the credit is most commonly associated with the home solar credit, which is equal to 30% of the cost of the solar electric system for an individual’s primary and second homes, with no limit on the cost of the solar system. Even though the credit is non-refundable, any amount not used in the first year carries over to subsequent years.

The credit percentage is phased-out as shown in the table.

Home Energy Credit Percentage
Year 2018–2019 2020 2021 2021
Percentage 30 26 22 None

Before deciding to add a solar electric system to your home, you need to consider if you can actually afford the system and whether it is worth having one, after taking into account the system’s cost, the financing interest, the reduced electricity costs, and the tax credit. You should make an objective analysis without pressure from a salesperson. These credits are substantial, but the one thing salespeople and contractors typically fail to mention is that the credit is not refundable, and even though it carries over through 2021, there is a good chance you will never use it all. It may be appropriate for you to consult with this office before entering into a contract for a home solar system.

If you have questions or would like additional details related to any of these credits, please call us to speak to your tax advisor.

Credit for Family and Medical Leave Benefits

The Tax Cuts and Jobs Act that was passed last year included a new tax credit for employers that allows them to claim a credit based on wages paid to qualifying employees while they are on family and medical leave.

To qualify for the credit, an employer must have a written policy that provides at least two weeks of paid family and medical leave annually to all qualifying employees who work full time, which can be prorated for part-time. The wages paid during the leave period cannot be less than 50 percent of what the employee is normally paid.

The credit is variable. It begins at 12.5% and increases by 0.25%, up to a maximum of 25%, for each percentage point that the rate of payment exceeds 50% of the employee’s normal pay.

Example: ABC, Inc. has qualifying written policy to pay an employee 70% of their normal wage while on family or medical leave. The rate of 70% is 20 percentage points above the 50% credit threshold. Thus the credit is increased by 5% (.25 x 20), which when added to the base credit of 12.5% results in a credit percentage of 17.5% (12.5% plus 5%). Assuming the total leave wages paid for the year were $15,000, the credit would be $2,625 (.175 x $15,000).

A qualifying employee for this credit is any employee who has been employed for one year or more and who had compensation that did not exceed a specified amount for the preceding year. For 2018, the employee must not have earned more than $72,000 in 2017. Thus leave benefits for higher income taxpayers will not qualify for this credit.

For the purposes of this credit, “family and medical leave” is leave for one or more of the following reasons:

  • Birth of an employee’s child and to care for the newborn.
  • Placement of a child with the employee for adoption or foster care.
  • Care for the employee’s spouse, child or parent who has a serious health condition.
  • A serious health condition that makes the employee unable to perform the functions of his or her position.
  • Any qualifying event due to an employee’s spouse, child or parent being on covered active duty — or being called to duty — in the Armed Forces.
  • Care for a service member who is the employee’s spouse, child, parent or next of kin.

The credit only applies to qualified leave wages paid to a qualifying employee for up to 12 weeks per taxable year, and the employer must reduce its deduction for wages or salaries paid or incurred by the amount determined as a credit. Any wages taken into account in determining any other general business credit may not be used toward this credit.

CAUTION – CREDIT TIME LIMITED
The credit is generally only effective for wages paid in taxable years of the employer beginning after December 31, 2017. It is not available for wages paid in taxable years beginning after December 31, 2019

The credit is part of the general business credit, where business incentive credits are combined into one “general business credit” for purposes of determining each credit’s allowance limitation for the tax year. A general business credit is generally limited to the taxpayer’s tax liability for the year (excluding self-employment tax), and any excess over the tax liability is carried back one year and forward 20 years. “Carrying back” means, in most instances, amending the return of the year to which the credit is carried; if no return was filed for that year, then the carryback credit would be claimed on an original late-filed return for that year.

If you have any questions relating to this credit, please give us a call.

Solar Tax Credit – The Dark Side

There are TV ads, telemarketing phone calls and sales people at your front door all promoting the benefits of solar power, and one of the key considerations and a frequently mentioned benefit is the 30% federal tax credit.

What isn’t included in the ads — and something most potential buyers are unaware of — is that the solar credit is a nonrefundable tax credit, meaning the credit can only be used to offset your tax liability. This can come as a very unpleasant surprise and is often a financial hardship when the purchaser of a home solar system finds out that the credit is nonrefundable and that they won’t get the full credit.

For example, a married couple with three children, all under age 17, and an annual income of $78,000 installed a solar system costing $20,000 in 2018, expecting a $6,000 credit on their tax return. Their standard deduction in 2018 is $24,000, leaving them with a taxable income of $54,000. The tax on the $54,000 is $6,099. They are also entitled to a $2,000 child tax credit for each child, which reduces their tax liability by $6,000 and results in a tax liability of $99. Since the solar credit is nonrefundable, the only portion of the credit they can use is $99, not the $6,000 they had expected.

On top of that, the family is probably financing the solar system, which significantly adds to the system’s cost. If the entire $20,000 cost were financed by a 5% home equity loan for 20 years, then the interest on that loan over its term would be $11,678, bringing the total cost of the solar system to $31,678 or a monthly cost of $132.

Some municipalities even allow home energy improvements to be financed through the property tax system by adding the payments to the quarterly or semi-annual property tax bills. Interest rates on these arrangements are generally higher than home equity loans, reaching levels of 9 to 10%. If the loan in our prior example would have been at 9%, then the interest on the loan over 20 years would be $23,187, bringing the total cost to $43,187 or a monthly cost of $180. It is also a common misconception that solar system payments added to the property tax bill can be deducted as property taxes. That is incorrect; however, the interest portion of the loan payment is generally deductible as home acquisition debt interest. The lender should supply a loan amortization schedule indicating the annual interest amount.

The unused credit does carry over from year to year as long as the solar energy credit is available. Currently, the credit is being phased out, and 2021 is the last year it can be claimed. Furthermore, the credit percentage rate is being phased down, with the 30% continuing through 2019 and then dropping to 26% in 2020 and 22% in its final year.

In lieu of purchasing a solar system, some homeowners opt to lease a system. This arrangement is not eligible for the solar credit.

As you can see, there is a lot to consider before making the final decision to install a solar system. Is it worth it, and is it the right thing financially for you? Please call for a consultation before signing any contract to make sure a solar system is appropriate for you.

Education Tax Credit Nuances — Don’t Leave Money on the Table

There are actually two higher-education tax credits. The American Opportunity Tax Credit (AOTC) provides up to $2,500 worth of credit for each student, 40% of which is refundable. The credit is equal to 100% of the first $2,000 of college tuition and qualified expenses and 25% of the next $2,000. The AOTC only applies to the first 4 years of post-secondary education.

The other credit is the Lifetime Learning Credit (LLC), which only provides a maximum $2,000 of credit (20% of up to $10,000 of eligible expenses) per family. None of it is refundable, meaning it can only be used to offset the taxpayer’s tax liability, and any additional credit amount is lost.

When it comes to these credits, it is easy to leave money on the table. Here are the reasons why:

  1. Many students attend local colleges for the first two years and then transfer to a university for the remainder of their education. Knowing the university tuition will be higher, some parents take the LLC and wait on the AOTC, thinking they can use it in years with higher tuition and get a larger credit. What they don’t realize is that the AOTC credit is only good for the first four years of post-secondary education. Thus, it is always better to claim the AOTC in the first four years.
  2. Parents don’t realize what constitutes a year of post-secondary education. Most students start college in the autumn after their May or June graduation from high school. Thus, for them, the first four years of post-secondary education actually span parts of five calendar years, and as a result, the student will qualify for the AOTC in five calendar years. With careful planning, students can qualify for the full $2,500 of the refundable credit in all five calendar years.
  3. A special rule allows the tuition for an academic period that begins in the first three months of the next year to be paid in advance and thus increase the amount of tuition qualifying for the credit in the year the tuition is paid. This allows for planning when to make tuition payments to maximize credits, especially in the first partial calendar year.
    Example: Cameron just graduated from high school and will be beginning college in September. Her tuition and credit-qualifying expenses for the semester covering the last four months of the year and January of the next year are $1,500. Her mother, Tricia, is aware of the 3-month rule, and in December she prepays Cameron’s $1,500 tuition for the semester beginning February 1 of the next year, bringing the qualifying expenses to a total of $3,000. The AOTC is equal to 100% of the first $2,000 of qualifying expenses and 25% of the next $2,000. Thus the AOTC for Cameron is $2,250 ($2,000 + 25% of $1,000). Tricia could increase the credit for the year to the full $2,500 maximum by purchasing $1,000 worth of course materials needed for “meaningful attendance or enrollment” in Cameron’s course of study.
  4. Qualifying expenses other than tuition are often overlooked, especially in light of a recent tax regulation change that specifies for the AOTC that qualifying expenses include course materials needed for “meaningful attendance or enrollment” whether purchased from the school or an outside vendor. Previously, only course material purchased from the school qualified (and this is still the rule for the Lifetime Learning Credit). This is a significant change and opens up the possibilities of including expenses not previously allowed.
  5. Taxpayers also often overlook another very important fact: Whoever claims the tax exemption for the student gets to claim the education credit even if someone else paid for the tuition and qualified expenses.
    Example: Suppose Cameron’s Uncle Lee pays her tuition but Tricia, her mother, claims Cameron on her tax return. Tricia is the one who qualifies for and receives the credit.
  6. What many also overlook is the fact that the AOTC is phased out for higher-income taxpayers based on their adjusted gross income (AGI). It phases out for AGIs between $160,000 and $180,000 for married taxpayers filing jointly, and between $80,000 and $90,000 for others. The LLC phases out a little quicker than the AOTC: between $112,000 and $132,000 for joint filers and between $56,000 and $66,000 for others. As an exception, married taxpayers filing separately aren’t eligible to claim either credit. (Note: the LLC phaseout ranges are adjusted for inflation annually, and the one quoted is for 2017.)
    Thus, in cases when the parent claiming the student has an AGI above the phaseout range, regardless of who paid the tuition and qualified expanses, no one will be able to claim the credit. So it is important to consider the income of the individual who is claiming the student when there is an option of who claims the child, such as in cases of divorced parents.
  7. Because of gift tax issues, a person other than the one qualifying for the credit, such as a grandparent, may hesitate to volunteer to pay a tuition expense. Where payments are made directly to the educational institution, they are excluded from gift tax rules. However, depending on the amounts involved, there may be a gift tax reporting requirement if a monetary gift is given to the student or the individual who is claiming the credit and then the gift money is used to pay tuition.
  8. A question often arises as to whether tuition payments to a trade school or foreign university will count toward the education credit. To qualify for the credit, the tuition must be paid to any accredited public, nonprofit or proprietary post-secondary institution eligible to participate in the student aid programs administered by the Department of Education. This would rule out foreign educational institutions because they don’t qualify for the student aid program administered by the Department of Education, but it would generally include most accredited public nonprofit or privately owned, profit-making post-secondary educational institutions in the U.S.

As you can see, there are several nuances associated with the education credits that must be considered. Please call this office if you need assistance with education planning or the application of the education tax credits to your particular circumstances.