Employee Holiday Gifts May Be Taxable

Article Highlights: 

  • De Minimis Fringe Benefits 
  • Cash Gifts 
  • Gift Certificates 
  • Group Meals 
  • FICA and Wage Withholding 

It is common practice this time of year for employers to give their employees gifts. A gift is infrequently offered and has a fair market value so low that it is impractical and unreasonable to account for it; the gift’s value would be treated as a de minimis fringe benefit. It would be tax-free to the employee, and its cost would be tax-deductible by the employer. 

De Minimis Benefits – In general, a de minimis benefit is one that, considering its value and the frequency with which it provides, is so minor as to make accounting for it unreasonable or impractical. De minimis benefits are excluded from income under Internal Revenue Code section 132(a)(4) and include items not expressly excluded under other Code sections. Examples of de minimis benefits include such things as: 

  • Controlled, occasional employee use of a company photocopier. 
  • Occasional snacks, coffee, doughnuts, etc., furnished to employees. 
  • Occasional tickets for entertainment events are given to employees. 
  • Holiday Gifts from the employer to the employees. 
  • Occasional meal money or transportation expenses paid for by the employer for employees working overtime. 
  • Group-term life insurance on the life of an employee’s spouse or dependent with a face value, not more than $2,000. 
  • Flowers, fruit, books, etc., are provided to employees under particular circumstances, such as birthdays or illnesses. 
  • Personal use of a cell phone provided by an employer primarily for business purposes.

In determining whether a benefit is de minimis, you should always consider its frequency and value. An essential element of a de minimis benefit is that it is occasional or unusual in frequency. It also must not be a form of disguised compensation. 

Whether an item or service is de minimis depends on all the facts and circumstances. Also, suppose a benefit is too large to be considered de minimis. In that case, the entire value of the benefit is taxable to the employee, not just the excess over a designated de minimis amount. The IRS has ruled previously that items with a value exceeding $100 cannot be considered de minimis, even under unusual circumstances. 

Holiday Gifts – A cash gift, regardless of the amount, is considered additional wages and subject to employment taxes (FICA) and withholding taxes. Caution: If the gift recipient is a W-2 employee, the employer may not issue them a Form 1099-NEC or a 1099-MISC for a holiday gift of cash; the amount must be treated as W-2 income. 

When an employer gives gift certificates, debit cards, or similar items that are convertible to cash, the value is considered additional wages regardless of the amount. However, suppose the gift is a non-transferable coupon and convertible only into a turkey, ham, gift basket, or the like at a particular establishment. In that case, the gift coupon is not treated as a cash equivalent. 

Holiday group meals, cocktail parties, picnics, or similar events for employees are also treated as de minimis fringe benefits. 

If you have questions about the tax treatment of holiday gifts to employees, please contact us

Preparing for 2021: Tax Planning Strategies for Small Business Owners

If you are a small business owner, every penny of your income counts. This means that you want to optimize your revenue and minimize your expenses and your tax liability. Unfortunately, far too many entrepreneurs are not well-versed in the tricks and tools available to them and end up paying far more than they need to. You don’t need an accounting degree to take advantage of tax-cutting tips. Here are a few of our favorites. 

Think About Changing to a Different Type of Tax Structure 

When you started your business, one of the first decisions you needed to make was whether you wanted to operate as a sole proprietor, partnership, LLC, S corporation, or C corporation. But as more time goes by, the initial reasons for structuring your business the way that you did may no longer be applicable or in your best interest from a tax perspective. There is no requirement that you stick with the business structure you initially chose. 

Ever since the Tax Cuts and Jobs Act of 2017 (TCJA) changed the highest corporate income tax rate from 35% to 21%, sole proprietorships, LLCs, partnerships, and S corporations can realize significant tax savings by electing to be taxed as a C corporation. This simple change can make sense if these pass-through businesses’ owner is taxed at a high tax bracket. If so, all you need to do is fill out and file Form 8832. Before doing so, make sure that the tax savings you can realize are a reasonable tradeoff for the other reasons that you may have initially selected the structure you are currently in. 

Pass-Through Businesses Can Get a 20% 

One of the most impactful changes that the TCJA made for pass-through businesses whose income is passed-through for taxation as their owners’ income is a valuable tax break known as the qualified business income (QBI) deduction. For eligible recipients, this deduction is worth a maximum 20% tax break on the income they receive from the business – but determining whether or not you qualify can be a challenge. 

There are several restrictions on taking advantage of the deduction, particularly regarding specified service trade or businesses (SSTBs) whose owners either earn too much income or rely specifically on their employees’ or owners’ reputation or skill. Though architecture and engineering firms escape this limitation, other business models – including medical practices, law firms, professional athletes and performing artists, financial advisors, investment managers, consulting firms, and accountants – fall into the category that loses out of their income is too high. In 2019 single business owners of SSTBs began phasing out at $160,700 and are excluded once their income exceeds $210,700, while those who are married filing a joint return phase out at $321,400 and are excluded at $421,400. To calculate the deduction, use Part II of Form 8995-A

Businesses that are not SSTBs are eligible to take the deduction even when they pass the upper limits of the thresholds, but only for either half of the business owners’ share of the W-2 wages paid by the business or a quarter of those wages plus 2.5% of their share of qualified property. 

These limitations and specifications for what type of business is and is not eligible are head-spinning. Though it is tempting to take the deduction simply, it’s a good idea to confirm whether you qualify and how to claim it with our office before moving forward. 

Know How You’re Going to Pay Your Taxes

It is gratifying to live the dream of owning your own small business, but the hard work required to generate revenue makes paying taxes extra painful. This is especially true because of the “pay as you go” tax system that the United States uses, asking business owners to make estimated quarterly payments. While employees pay their taxes ahead via payroll deductions withheld by their employers, no such automatic system is set up for small business owners. That leaves many with the temptation of delaying making payments to maintain liquidity. 

Unfortunately, failing to pay taxes quarterly can put you in the uncomfortable position of still having to pay at one point, with the additional burden of penalties and interest resulting from your delay. Though setting aside the money to pay taxes requires discipline, doing so will save you from the penalties charged by the IRS. These are calculated based on the amount you should have paid each quarter multiplied by your shortfall and the effective interest rate during the specific quarter (established as 3 percent over the federal short-term rate – C corporations pay a different rate). Even if you don’t calculate your quarterly estimated rates correctly, the safe harbor rule allows small businesses to pay the lower amount, which is either 90% of the tax due on your current year return or 100% of the tax shown on your last filed tax return. For those whose AGI was over $150,000 in the previous tax year, the safe harbor percentage is 110% of the previous year’s taxes. 

It is always a good idea to increase the amount you send in if you have a higher-income year. By doing a simple calculation of your safe harbor number and dividing it by four, you have a reasonable quarterly payment that you can safely send in on the due dates (April 15th, June 15th, September 15th, and January 15th of the following year). By setting aside the appropriate percentage that you will owe from each payment you receive, you can easily set aside the money you will need to pay and entirely avoid concerns about penalties or interest. Payment is most easily submitted using the online link for IRS Direct Pay, though many people opt for sending in the paper vouchers for IRS Form 1040-ES, along with a check. There is also an EFTPS system available for C Corporations’ use. 

Choose Your Accounting Method Carefully

Each small business owner calculates their income and revenue differently, with many using a method of accounting that is based on when money is received rather than when an order is placed and counts expenses when they are paid rather than the item or service ordered. This is known as the cash method of accounting. 

Whatever method of accounting you use, smart business owners can strategically adjust their approach—reporting their annual income based on cash receipts to reduce their end-of-year revenues, especially if there is reason to believe that next year’s income will be lower or they anticipate being in a lower tax bracket. 

An example of how this approach would be helpful can be seen in a business that expects to add new employees in the new year. Between that expense and other improvements planned, it makes sense to anticipate that net income will be down. The tax bracket for the business will be lower, so any work is done or orders placed towards the end of the current tax year should be accounted for when payments arrive so that the income can be taxed at a lower rate. The contrast to this is if you anticipate your business revenue to increase and be forced into a higher tax bracket in the new year. In that case, it makes sense to try to collect monies for work done in the current year early so that you can take advantage of your current, lower tax rate. This can be done for business expenses such as office supplies and equipment, which can be deferred and accelerated in the same way so that you can take advantage of tax deductions in the most advantageous way. 

Establish and Make Deposits Into a 401(k) or SEP 

One of the smartest ways to lower your taxable income is to contribute to a retirement account. Not only does doing so reduce your business’ tax liability, but it also ensures a more secure future. As a small business owner, either a 401(K) plan or a Simplified Employee Pension (SEP) plan will do the trick while benefiting both you and those who work for you in the future. 

While a 401(k) that is established before year-end will let you deduct any contributions you make (with contributions limited to the lower of $57,000 or the employee’s total compensation), business owners who fail to set up this type of plan by December 31st can still turn to the SEP as an alternative. Though SEP contributions are restricted to 25% of the business owner’s net profit, less the SEP contribution itself (technically 20%), a SEP can be established, and contributions made up until the extended due date of your return. Suppose you obtain an extension for filing your tax return. In that case, you have until the end of that extension period to deposit the contribution, regardless of when you file the return.

If You Took Out a PPP Loan, Plan on it Being Forgiven 

Many small businesses took advantage of the PPP loans that were offered by the government in the face of the COVID-19 crisis. While these loans were attractive because they are forgivable and gave businesses a chance to survive the dire circumstances, in April of 2020, the IRS issued Notice 2020-32, which indicated that even though the forgivable loans can be excluded from gross income, the expenses associated with the money received cannot be deducted. This effectively erases the tax benefit initially offered because losing the employee and expense deduction increases the business’ income and profitability. 

There is some chance that this issue will be resolved by Congress, as it contradicts the original intent of the tax benefit that accompanied the PPP funds, but that action has not yet been taken. It’s a good idea to talk to our office about this as soon as possible. Having to pay taxes on expenses incurred may be particularly challenging in the face of the difficulties the pandemic has imposed. Being financially prepared to pay more taxes than you originally intended may be a bitter pill to swallow. However, it will still be better than paying penalties and interest if you fail to pay what the government says that you owe. 

Though all of these strategies can be helpful, they may not all be appropriate for your situation. Keep them in mind as you go into the end of the year, and be prepared to ask questions to determine which apply to you when you speak with our office. Contact us to discuss tax planning for your business today.

Gambling and Tax Gotchas

Article Highlights: 

  • Winnings 
  • Losses 
  • Social Security Income 
  • Health Care Insurance Premium Subsidies 
  • Medicare B & D Premiums 
  • Online Gambling Accounts 

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 above your winnings. There are far more tax issues related to gambling than you might expect, and they may impact your taxes in more ways than you might believe. Here is an overview of the many issues and the “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 returns. 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 cars, houses, trips, or other non-cash prizes. The full amount of the winnings must be reported, not the net, after subtracting losses. The last statement’s exception is that the cost of the winning ticket or winning spin on a slot machine is deductible from the gross winnings. For example, if you put $1 into a slot machine and won $500, you would include $499 as the number 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, while that form is only issued for “Certain Gambling Winnings,” 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 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 your other 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, 50–85% of the SS benefit is taxable. 

GOTCHA #3 – 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 up to 85% of your Social Security benefits to become taxable.

Health Insurance Subsidies – 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. Most people eligible for the tax credit use it to reduce their monthly health insurance premiums. That tax credit is based upon the AGIs of all members of the family. The higher the family income, the lower the subsidy becomes. 

GOTCHA #4 – The addition of gambling income to your family’s income can result in significant reductions in the health insurance subsidy, requiring you to pay more for your family’s health insurance coverage for the year. If your subsidy was based upon your estimated income for the year, your premiums were reduced by applying the subsidy in advance. If you subsequently had some gambling winnings, then you could get stuck with paying back some or all 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 $144.60 per month and is based on your AGI two years prior. However, if that AGI was above $87,000 ($174,000 for married taxpayers filing jointly), the monthly premiums can increase to as much as $491.60. If you also have prescription drug coverage through Medicare Part D, and if your AGI exceeds the $87,000/$174,000 threshold, your monthly surcharge for Part D coverage will range from $12.20 to $76.40 (2020 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 gambling 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 violation time. The $10,000 and $100,000 penalty amounts are subject to adjustment for inflation, and after February 19, 2020 are $13,481 and $134,806, respectively.

Other Limitations – Those as mentioned above are the most significant “gotchas.” Numerous different tax rules limit tax benefits based on AGI, as discussed in gotcha #1. These include medical deductions, certain casualty losses, child and dependent care credits, the Child Tax Credit, and the Earned Income Tax Credit, to name a few. 

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

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.

Congress Allowing Higher Medical Deductions for 2019 and 2020

Article Highlight:

  • Appropriations Act of 2020
  • Medical AGI Limitations
  • Sometimes Overlooked Deductions
  • Deductible Health Insurance
  • Above-the-Line Health Insurance Deduction for Self-Employed

On December 20, 2019, President Trump signed into law the Appropriations Act of 2020, which included several tax law changes. The changes include extending specific tax provisions that expired after 2017 or were about to expire, some retirement and IRA plan modifications, and other changes that will impact a large portion of U.S. taxpayers as a whole. This article is one of a series of articles dealing with those changes and how they may affect you.

Medical expenses are deductible as an itemized deduction, but only to the extent they exceed a percentage of a taxpayer’s adjusted gross income (AGI). For a long time, the rate was 7.5%, which was then raised for under-age-65 taxpayers to 10% for 2013 through 2016 and then lowered back to 7.5% for all taxpayers for years 2017 and 2018. It was scheduled to go back up to 10% starting with the tax year 2019. However, with the passage of the Appropriations Act of 2020, Congress reduced that percentage back to 7.5% for tax years 2019 and 2020, allowing more taxpayers to qualify for the medical deduction.

However, keep in mind that the total of the itemized deductions must exceed the standard deduction before the itemized deductions provide a tax break. So even if your medical deductions exceed the 7.5% floor, this doesn’t necessarily mean you will have a tax benefit from them.

To help you maximize your medical deductions, the following are some medical expenses other than those for doctors, dentists, hospitals, and prescriptions that are sometimes overlooked:

  • Adult Diapers
  • Acupuncture
  • Birth Control
  • Chiropractor Visits
  • Drug-Addiction Treatment
  • Fertility Enhancement Therapy
  • Gender Identity Disorder Treatments
  • Guide Dog Expenses
  • Health Insurance Premiums

*Including the premiums you pay for coverage for yourself, your dependents, and your spouse, if applicable, for the following types of plans:

    • Health Care and Hospitalization Insurance
    • Long-Term Care Insurance (but limited based upon age)
    • Medicare B
    • Medicare C (aka Medicare Advantage Plans)
    • Medicare D
    • Dental Insurance
    • Vision Insurance
    • Premiums Paid through a Government Marketplace, Net of the Premium Tax Credit

* However, premiums paid on your or your family’s behalf by your employer aren’t deductible because their cost is not included in your wage income. If you pay premiums for coverage under your employer’s insurance plan through a “cafeteria” plan, those premiums aren’t deductible either because they are paid with pre-tax dollars.

  • Home Modifications for Disabled Individuals
  • Lactation Expenses
  • Learning Disability Special Education
  • Nursing Home Costs
  • Nursing Services (which need not be performed by a nurse)
  • Pregnancy Tests
  • Smoking-Cessation Programs

This is not an all-inclusive list, so please contact us with questions related to expenses that you think might qualify as a medical expense.

As a tax tip, if you are self-employed, you may be able to deduct 100% (no 7.5%-of-AGI reduction) of the cost of medical insurance without itemizing your deductions. This above-the-line deduction is limited to your net profits from self-employment. If you are a partner who performs services in that capacity and the partnership pays health insurance premiums on your behalf, those premiums are treated as guaranteed payments that are deductible by the partnership and includible in your gross income. In turn, you may deduct the cost of the premiums as an above-the-line deduction under the rules discussed in this article.

No above-the-line deduction is permitted when the self-employed individual is eligible to participate in a “subsidized” health plan maintained by an employer of the taxpayer, the taxpayer’s spouse, any dependent, or any child of the taxpayer who hasn’t attained age 27 as of the end of the tax year. This rule is separately applied to plans that provide coverage for long-term care services. Thus, an individual who is eligible for employer-subsidized health insurance may still deduct long-term care insurance premiums, as long as he or she isn’t eligible for employer-subsidized long-term care insurance. Also, to treat the insurance as subsidized, 50% or more of the premium must be paid by the employer.

This above-the-line deduction is also available to more-than-2% S corporation shareholders. For purposes of the income limitation, the shareholder’s wages from the S corporation are treated as his or her earned income.

The above-the-line deduction includes the premiums you pay for health coverage for yourself, your dependents, and your spouse, if applicable, for the types of plans listed under “Health Insurance Premiums” above.

If you have any questions related to medical itemized deductions or the self-employed above-the-line deduction for health insurance premiums, please contact us.

Deducting the Costs of Modifications for Senior-Proofing a Home

Article Highlights

  • Improvements for Medical Care or Treatment
  • Improvements That Increase the Home’s Value
  • Improvements That Do Not Increase the Home’s Value
  • Medical AGI Limitations

While Americans may argue about any number of hot-button political topics, there’s no disagreement on one issue: the country’s population is aging fast. According to the Social Security Administration, 10,000 baby boomers a day are reaching the age of 65. Many individuals, for either themselves or an older family member, are senior-proofing their homes. To make the home safer and more accessible for elder occupants, homeowners add grab bars in showers, modify stairways, and adjust areas of the house to accommodate for wheelchairs. If you are planning to make such home improvements, you may be wondering whether any of the costs will be tax-deductible.

Generally, the costs of home improvements are not deductible except to offset home gain when the home sells. However, you may claim a medical expense deduction when the primary purpose of the home modification is for a medical reason. The tax law says that deductible medical expenses are those paid for the “diagnosis, cure, mitigation, treatment, or prevention of disease, and the costs for treatments affecting any part or function of the body.”

So, if you are modifying because you, your spouse, or a dependent has a medical need for doing so, then the modification expense may be deductible as a medical expense, but only to the extent that it exceeds any resulting increase in the property’s value. For example, a doctor recommends that a taxpayer with severe arthritis have daily hydrotherapy. The taxpayer has a hot tub installed at the cost of $21,000. A certified home appraiser determined the hot tub addition increased the home’s value by $20,000. The taxpayer’s medical deduction for installing the hot tub will only be $1,000. The other $20,000 of expenses will increase the home’s basis, meaning that it will add to the home’s cost and will offset the sales price when the house goes on the market.

While the tax rules don’t require a prescription from a doctor for most medically-related home modifications, the taxpayer, if questioned by the IRS, needs to be able to demonstrate how the expenditure is related to his or her medical care or that of a spouse or dependent. And having a letter from the individual’s doctor that explains the type of modifications that would be medically beneficial would help to prove a medical need.

Not all improvements result in an increased home value. Some, such as lowering cabinets for an occupant who uses a wheelchair, could actually decrease the home’s resale value.

The IRS has identified specific improvements as not usually increasing a home’s value and for which the cost can be included in full as a medical expense. These improvements include, but are not limited to, the following items:

  • Constructing entrance or exit ramps for the home;
  • Widening doorways at entrances or exits to the house;
  • Widening or otherwise modifying hallways and interior doorways;
  • Installing railings, support bars, or other modifications;
  • Lowering or modifying kitchen cabinets and equipment;
  • Moving or modifying electrical outlets and fixtures;
  • Installing porch lifts and other forms of lifts (but generally not elevators);
  • Modifying fire alarms, smoke detectors, and other warning systems;
  • Modifying stairways;
  • Adding handrails or grab bars anywhere (whether or not in bathrooms);
  • Modifying hardware on doors;
  • Modifying areas in front of the entrance and exit doorways; and
  • Grading the ground to provide access to the residence.

Only reasonable costs to accommodate a home to a disabled condition or an elderly individual are considered medical care costs. Additional fees for personal motives, such as for architectural or aesthetic reasons, are not medical expenses (but could be additions to the home’s tax basis).

Unfortunately, the total of all medical expenses can be deducted only to the extent that they exceed 10% of the taxpayer’s adjusted gross income (AGI) and only if the taxpayer itemizes deductions. With tax reform’s higher standard deduction, only between 5% and 12% of taxpayers are expected to itemize their deductions in the years through 2025, down from 30% before 2018. So even if a medically needed home improvement is made and qualifies to be deducted, only a small percentage of taxpayers will end up with a tax benefit as a result of the expenditure.

However, all is not lost. To the extent that the taxpayer doesn’t claim the expense as an itemized deduction, the improvement costs, including those that might not meet the medically necessary standard, can be added to the home’s purchase cost to determine the home’s tax basis. Thus, when you sell your home, the capital gain from the sale will be lower.

Either to substantiate the currently deductible improvements or with a future home sale in mind, taxpayers should be sure to keep records of the home improvements they make, including the receipts for the costs.

Please contact us if you have questions related to this deduction and whether you will benefit, tax-wise, from any medically related home modifications.

School’s Out – Who Is Going to Take Care of the Kids?

Article Highlights:

  • Child Age Limits
  • Employment-Related Expense
  • Married Taxpayer Earnings Limits
  • Disabled or Full-Time-Student Spouse
  • Expense Limits

Summer has just arrived, and working parents should know about a tax break. Many working parents must arrange for care of their children under 13 years of age (or any age if disabled) during the school vacation period. A popular solution — with a tax benefit — is a day camp program. The cost of day camp can count as an expense toward the child and dependent care credit. However, expenses for overnight camps, summer school, or tutoring programs do not qualify.

For an expense to qualify for the credit, it must be an “employment-related” expense; i.e., it must enable you and your spouse, if married, to work, and it must be for the care of your child, stepchild, foster child, brother, sister or stepsibling (or a descendant of any of these) who is under 13, lives in your home for more than half the year and does not provide more than half of his or her own support for the year. Married couples must file jointly, and both spouses must work (or one spouse must be a full-time student or disabled) to claim the credit.

The qualifying expenses are limited to the income you or your spouse, if married, earn from work, using the figure for whoever earns less. However, under certain conditions, when one spouse has no actual earned income and that spouse is a full-time student or disabled, that spouse is considered to have a monthly income of $250 (if the couple has one qualifying child) or $500 (two or more qualifying children). This means the income limitation is essentially removed for a spouse who is a student or disabled.

The qualifying expenses can’t exceed $3,000 per year if you have one qualifying child, while the limit is $6,000 per year for two or more qualifying persons. This limit does not need to be divided equally. For example, if you paid and incurred $2,500 of qualified expenses for the care of one child and $3,500 for the care of another child, you can use the total, $6,000, to figure the credit. The credit is computed as a percentage of your qualifying expenses; in most cases, 20%. (If your joint adjusted gross income [AGI] is $43,000 or less, the percentage will be higher, but it will not exceed 35%.)

Example: Al and Janice both work, each with earned income in excess of $40,000 per year. Janice has a part-time job, and her work hours coincide with the school hours of their 11-year-old daughter, Susan. However, during the summer vacation period, they place Susan in a day camp program that costs $4,000. Since the expense limitation for one child is $3,000, their child credit would be $600 (20% of $3,000).

The credit reduces a taxpayer’s tax bill dollar for dollar. Thus, in the above example, Al and Janice pay $600 less in taxes by virtue of the credit. However, the credit can only offset income tax and alternative minimum tax liability, and any excess is not refundable. The credit cannot be used to reduce self-employment tax, or the taxes imposed by the Affordable Care Act.

If the qualifying child turned 13 during the year, the care expenses paid for the child for the part of the year he or she was under age 13 will qualify.

If you have questions about how the childcare credit applies to your specific tax situation, please contact us.

Eldercare Can Be a Medical Deduction

Article Highlights:

  • Nursing Homes
  • Meals and Lodging
  • Home Care
  • Nursing Services
  • Caregiver Agencies
  • Household Employees

Because people are living longer now than ever before, many individuals are serving as care providers for loved ones (such as parents or spouses) who cannot live independently. Such individuals often have questions regarding the tax ramifications associated with the cost of such care. For these individuals, the cost of such care may be deductible as a medical expense.

Incapable of Self-Care – For the cost of caring for another person to qualify as a deductible medical expense, the person being cared for must be incapable of self-care. A person is considered incapable of self-care if, as a result of a physical or mental defect, that person is incapable of fulfilling his or her own hygiene or nutritional needs or if that person requires full-time care to ensure his or her own safety or the safety of others.

Assisted-Living Facilities – Generally, the entire cost of care at a nursing home, home for the aged, or assisted-living facility is deductible as a medical expense, provided that the person who lives at the facility is primarily there for medical care or is incapable of self-care. This includes the entire cost of meals and lodging at the facility. On the other hand, if the person is living at the facility primarily for personal reasons, then only the expenses that are directly related to medical care are deductible; the cost of meals and lodging is not a deductible medical expense.

Home Care – A common alternative to nursing homes is in-home care, in which day helpers or live-in caregivers provide care within the home. The services that these caregivers provide must be allocated into (nondeductible) household chores and (deductible) nursing services. These nursing services need not actually be provided by a nurse; they simply must be the same services that a nurse would normally provide (e.g., administering medication, bathing, feeding, and dressing). If the caregivers also provide general housekeeping services, then the portion of their pay that is attributable to household chores is not deductible.

The emotional and financial aspects of caring for a loved one can be overwhelming, and as a result, caregivers often overlook their burdensome tax and labor-law obligations. Sadly, these laws provide for no special relief from these tasks.

Is the Caregiver an Employee? – Because of the way that labor laws are written, it is important to determine if an in-home caregiver is an employee. The answer to this question can be very subjective. Caregivers’ services can be obtained in several ways:

  • Agency-provided caregivers are employees of the agency, which handles all the responsibilities of an employer. Thus, loved ones do not have any employment-tax or payroll-reporting responsibilities; however, such caregivers generally come at a substantially higher cost than others.
  • Self-employed caregivers pay all their expenses, are responsible for their own income reporting and taxes, and are not considered employees under federal or state law. The IRS lists 20 factors that it uses to determine whether an individual is an employee; the main factors are financial control, behavioral control, and the relationship between the parties. The household workers are typically classified as employees.
  • Household employees are subject to Social Security and Medicare taxes. The employer is thus responsible for withholding the employee’s share of these taxes and paying the employer’s share of payroll taxes. Fortunately for these employers, the special rules for household employees greatly simplify the payroll-withholding and income-reporting requirements. Any resulting federal payroll taxes are paid annually in conjunction with the employer’s individual 1040 tax return. Federal income-tax withholding is not required unless both the employer and the employee agree to do so. However, the employer is still required to issue a W-2 to the employee and to file that form with the federal government. The employer also must obtain federal and state employer ID numbers for reporting purposes. Some states have special provisions for the annual reporting and payment of state payroll taxes; these may be like the federal requirements.

    The employer’s portion of all employment taxes (Social Security, Medicare, and both federal and state unemployment taxes) related to deductible medical expenses are also deductible as a medical expense.

You may be thinking, “Wait a minute – the household employers I know pay in cash and do not pay payroll taxes or issue W-2s to their household employees.” This observation may be accurate, but such behavior is illegal, and it is not right to ignore the law. Think about what could happen if one of your household employees is injured on your property or if you dismiss such an employee under less-than-amicable circumstances. In such circumstances, the household employee will often be eager to report you to the state labor board or to file for unemployment compensation.

Note, however, that gardeners, pool cleaners, and repair people generally work on their own schedules, invest in their own equipment, have special skills, manage their own businesses, and bear the responsibility for any profit or loss. Such workers are not considered household employees.

Here are some additional issues to consider:

Overtime – Under the Fair Labor Standards Act, domestic employees are nonexempt workers and are entitled to overtime pay for any work beyond 40 hours in a given week. However, live-in employees are an exception to this rule in most states.

Hourly Pay or Salary – It is illegal to treat nonexempt employees as if they are salaried.

Separate Payrolls – Business owners may be tempted to include their household employees on their companies’ payrolls. However, any payments to household employees are personal expenses and thus are not allowable as business deductions. Thus, business owners must maintain separate payrolls for household employees; in other words, personal funds (not business funds) must be used to pay household workers.

Eligibility to Work in the U.S. – It is illegal to knowingly hire or continue to employ an alien who is not legally eligible to work in the U.S. When a household employee is hired to work on a regular basis, the employer and employee each must complete Form I-9 (Employment Eligibility Verification). The employer must carefully examine the employee’s documents to establish his or her identity and employment eligibility.

If you have questions related to eldercare or about how your state deals with related employment issues – or if you would like assistance in setting up a household payroll system – please contact us.

Short-Term Rental, Special Treatment

With the advent of online sites such as Airbnb, VRBO, and HomeAway, many individuals have taken to renting out their first or second home through these online rental sites, which match property owners with prospective renters. If you are doing that or are planning to do so, there are some special tax rules you need to know.

These special (and sometimes complex) taxation rules are based upon the length of time you rent your property out and with varying tax outcomes. In some situations, the rental income may be tax-free. In other situations, your rental income and expenses may need to be treated as a business, as opposed to a rental activity. The following is a general synopsis of the rules governing short-term rentals (those rented for average rental periods of 30 days or less).

  • Rented for Fewer Than 15 Days during the Year – When a property is rented for fewer than 15 days during the tax year, the rental income is not reportable, and the expenses associated with that rental are not deductible. Interest and property taxes are not prorated, and the full amounts of the qualified mortgage interest and property taxes are reported as itemized deductions (as usual) on the taxpayer’s Schedule A.
  • The 7-Day and 30-Day Rules – Rentals are generally passive activities. However, an activity is not treated as a rental if either of these statements applies:
    • A. The average customer use of the property is for 7 days or fewer—or for 30 days or fewer, if the owner (or someone on the owner’s behalf) provides significant personal services.
    • B. The owner (or someone on the owner’s behalf) provides extraordinary personal services without regard to the property’s average period of customer use.
  • If the activity is not treated as a rental, then it will be treated as a trade or business, and the income and expenses, including prorated interest and taxes, will be reported on Schedule C instead of Schedule E, the IRS form used to report longer-term real estate rentals. IRS Publication 527 states: “If you provide substantial services that are primarily for your tenant’s convenience, such as regular cleaning, changing linen, or maid service, you report your rental income and expenses on Schedule C.” Substantial services do not include furnishing heat and light, cleaning public areas, collecting trash, and such.
  • Exception to the 30-Day Rule – If the personal services provided are similar to those that generally are provided in connection with long-term rentals of high-grade commercial or residential real property (such as public area cleaning and trash collection), and if the rental also includes maid and linen services that cost less than 10% of the rental fee, then the personal services are neither significant nor extraordinary for the purposes of the 30-day rule.
  • Profits and Losses on Schedule C – Profit from a rental activity is not subject to self-employment tax, but a profitable rental activity that is reported as a business on Schedule C is subject to this tax. A loss from this type of activity is still treated as a passive activity loss unless the taxpayer meets the material participation test – generally, providing 500 or more hours of personal services during the year or qualifying as a real estate professional. Losses from passive activities are deductible only up to the passive income amount, but unused losses can be carried forward to future years. A special allowance for real-estate rental activities with active participation permits a loss against nonpassive income of up to $25,000 – but phases out when one’s modified adjusted gross income is between $100K and $150K. However, this allowance does NOT apply when the activity is reported on Schedule C.

These rules can be complicated; please call us to determine how they apply to your particular circumstances and what actions you can take to minimize the tax liability and maximize the tax benefits from your rental activities.