Losses on 401(k)s, IRAs, and 529 Plans
Filed under: Retirement Assets, Tax Strategy | Tags: 401(k), 529 plan, basis, Coverdell ESA, Form 8606, IRA, losses, miscellaneous itemized deductions, nondeductible IRA contributions, retirement, Roth-IRA, SEP-IRA, SIMPLE IRA
Leave a Comment Originally published in the Pacific Grove Hometown Bulletin
September 21, 2011
The stock market seems like a pinball these days bumping off financial forecasts and being paddled by fiscal policy promises. Unable to stomach some of the lows over the past few years more than a few people gave up the game and pulled money out of investments seeking the “security” of cash. Others may have felt they had no choice, and cashed out their retirement savings to live on; some realizing they contributed more money to the plan than they got back! Perhaps this happened to your retirement or education savings accounts, or will happen at some point. But can you get a tax deduction for the loss in value you have incurred?
Well, it depends. The chief determining factor is whether or not you have basis in your account. Basis in a retirement or education account is created if you make contributions for which you receive no tax deduction when contributed. For example – Roth-IRA contributions are not deductible when they are made, so the original contribution amount each year adds to your basis. Education savings through section 529 plans and Coverdell Education Savings Accounts are the same way. Many employers now offer a Roth contribution option within a 401(k) plan. These contributions also create basis.
Traditional 401(k), SEP IRAs, SIMPLE IRAs, and traditional IRA contributions provide you with an immediate tax deduction, so they provide no basis. However, if you were over a certain income threshold and tried to make traditional IRA contributions, you may have been allowed to contribute to the account, but prohibited from taking the deduction. This is termed a “nondeductible IRA contribution;” it would have created basis; and it is tracked on Form 8606 in your tax returns.
If it is determined you do have basis, and for a strategic reason (or by necessity) you end up liquidating the IRA (all IRAs of the same type must be liquidated for this to work), and the value of the IRA is less than your basis in the account, then you are eligible to take the loss as a miscellaneous itemized deduction subject to the two percent threshold. If you have more than one section 529 plan, the calculation is a little different.
Liquidating your retirement accounts to get a possible tax deduction is not typically an advisable course of action for many reasons, and you would want to discuss this with your tax professional and investment advisor first. However, sometimes, this can be a strategic move. More often, it will have been done out of perceived necessity or by accident. If it happens, however, you certainly want to make your tax professional aware of your losses and take the deduction if you are eligible.
Two quick examples: 1) Melissa, a parent, starts a 529 account (only has one) and contributes $10,000 towards her child’s future education. A year later, the investments have fallen, and the account is only worth $6,000. Melissa could liquidate the account and take a $4,000 loss on Schedule A. Then she could start a new 529 plan putting the $6,000 back into the plan. Melissa has just harvested a $4,000 loss. 2) Joseph opened his first Roth-IRA three years ago and contributed $14,000 over the three years. He received some bum advice from a friend and invested most of it in a penny stock mail-order belly-dancer business that went belly-up. Joseph’s account is now only worth $1,000. He could liquidate his Roth-IRA and take a $13,000 loss on Schedule A.
There may be other circumstances and specific rules that affect you, and you should consult with a qualified tax professional regarding your tax situation. Prior articles are republished on my website at www.tlongcpa.com/blog.
IRS Circular 230 Notice: To the extent this article concerns tax matters, it is not intended to be used and cannot be used by a taxpayer for the purpose of avoiding penalties that may be imposed by law.
Travis H. Long, CPA is located at 706-B Forest Avenue, PG, 93950. He can be reached at 831-333-1041.
Foreclosures and Short-Sales – Part VI – Rental Properties
Filed under: Foreclosures and Short-Sales | Tags: cancelled debt, Foreclosure, qualified real property business indebtedness, recourse, rental properties, Short-Sale
Leave a Comment Originally published in the Pacific Grove Hometown Bulletin
September 7, 2011
The last five issues I went over the basic concepts of foreclosures and short-sales, an overview of ways to exclude the resulting taxable income, the effects of recourse/nonrecourse debt, and principal residence and insolvency exclusions. If you missed these articles they are re-published on my website at www.tlongcpa.com/blog. This issue I will specifically discuss the exclusion typically available for rental properties.
When someone loses real property through short-sale or foreclosure, potential taxable income can result since recourse cancelled debt is taxable income. As I have discussed in prior issues, there may be ways to exclude this income on the tax return. With solid, early planning, we may be able to even change the characteristic of a property and drive the outcome to the most tax favorable result should a short-sale or foreclosure occur. All or part of the cancellation of debt income associated with losing a rental property may qualify for the Qualified Real Property Business Indebtedness exclusion assuming you are not going through a bankruptcy and you are not insolvent, in which case other exclusions take precedence. Another key issue is whether or not a rental property is a business. This concept is requisite to use the exclusion. The courts have a long history of upholding this construct, but the IRS does not always agree, and it comes down to facts and circumstances.
Notice the word, “Qualified,” in the name of the exclusion. This is a subtle hint that certain criteria must be met to receive this treatment, and is sometimes misunderstood by preparers not well-versed in the governing code sections. As with other exclusions discussed in past articles, the cancelled debt must have been used to purchase or construct the property, additions, remodels, etc. If you borrowed against the equity in the property to finance your personal life or to purchase or renovate another property, that portion will not qualify for the exclusion. There are also limitations on the amount of income that can be excluded relating to the fair market value of the property, basis in depreciable property, and other factors.
The amount determined to be excludable then becomes a reduction of your cost basis in the property (the timing and calculation of this basis reduction is affected by several other factors as well). This is important, because we also have to calculate a gain or loss when you dispose of the property, and yes, in ugly situations, you can have a gain on sale even if you owe a lot more than the property is worth. Ouch! For example, ignoring transaction costs, depreciation, loan payments, etc., assume you bought a property for $250K, refinanced and took another $400K out to live-on as the property value soared to $750K and now it is only worth $350K and is foreclosed. You have $300K ($650K Debt – $350K Value) of cancelled debt and a taxable gain of $100K ($350K Value – $250K Cost).
When handling one of these transactions, it is a bifurcated process whereby we handle the cancellation of debt issue on the one hand, and the gain/loss calculation on the other. The two dance a bit, but are generally separate calculations. The beauty of rental properties, unlike personal residences, is if a loss is generated, it may be deductible, whereas, losses created by the disposition of personal residences are nondeductible. This is where planning comes in to play.
This is just a summary of some of the key provisions. There are many other circumstances and specific rules that could affect you, and you need to consult with a qualified professional to review your situation. Consult as soon as you can foresee the possibility of losing a home in order to plan the most tax efficient way to lose it.
IRS Circular 230 Notice: To the extent this article concerns tax matters, it is not intended to be used and cannot be used by a taxpayer for the purpose of avoiding penalties that may be imposed by law.
Travis H. Long, CPA is located at 706-B Forest Avenue, Pacific Grove, CA, 93950. He can be reached at 831-333-1041.
Foreclosures and Short-Sales – Part V – Insolvency
Filed under: Foreclosures and Short-Sales | Tags: basis reduction, cancelled debt, carryovers, Foreclosure, foreign tax credits, general business credits, insolvency, net operating losses, nonrecourse, passive activity losses, recourse, Short-Sale, tax attributes
Leave a Comment Originally published in the Pacific Grove Hometown Bulletin
August 17, 2011
The last four issues I went over the basic concepts of foreclosures and short-sales, an overview of ways to exclude the resulting taxable income, the effects of recourse/nonrecourse debt, and the principal residence exclusion. If you missed these articles they are re-published on my website at www.tlongcpa.com/blog. This issue I will specifically discuss the exclusion available when you are insolvent.
Insolvency means your liabilities are greater than the fair market value of your assets – essentially you have a negative net worth. In such cases, the IRS may allow you to exclude cancellation of debt income, created as a result of losing a home or rental property, to the extent that you are insolvent. This insolvency calculation is performed based on your assets and liabilities the moment before your debts are discharged.
Let us assume you are losing a second home with recourse loans so the principal residence exclusion does not apply to you. You have a house worth $300,000 and the value of everything else you own – cars, savings, retirement plans, household items, etc. is $100,000 for a total of $400,000 in assets. Then assume your home loan was $550,000 and you have you have $50,000 in credit card debt and car loans for a total of $600,000 in liabilities. You are insolvent by $200,000. If your home was foreclosed, you would have cancellation of debt income of about $250,000. You can exclude $200,000 of the $250,000, from income, leaving you with only $50,000 of taxable income.
When calculating your insolvency, do not forget to include the fair market value of pension plans, annuities, etc. If you have a plan such as CalPers, for instance, that pays you a monthly retirement benefit, you need to call your plan administrator and ask for an actuarial calculation of the value of your plan. Some people are surprised to learn that that pension can easily be worth $500,000 or $1,000,000, and would drastically change your insolvency calculation!
After determining how much debt can be excluded, you then have to reduce any tax attributes you may have. In exchange for excluding the $200,000 of income as in the above example, you then have to reduce or eliminate tax benefits that may have been useful to you in the future, or defer tax to a later date through basis reductions in items you may sell later. There is a specific order, method, and timing for doing this, but items such as carryovers of net operating losses, general business credits, minimum tax credits, and capital losses; basis in depreciable and nondepreciable property; passive activity loss carryovers and foreign tax credit carryovers are all on the chopping block. If after all these rules are applied and you still haven’t traded enough to equal your exclusion, then you are off the hook!
Oh, and you still have to calculate the gain or loss on the disposition of the property. We will not discuss that in this issue.
It is possible for the insolvency exclusion to be used in conjunction with other exclusions, and there are ordering rules to the exclusions themselves. This is just a summary of some of the key provisions. There are many other circumstances and specific rules that could affect you, and you need to consult with a qualified professional to review your situation. Consult as soon as you can foresee the possibility of losing a home in order to plan the most tax efficient way to lose it.
If this exclusion does not help you completely, and you are losing a rental property, you may be eligible for the qualified real property business indebtedness exclusion – next issue’s topic!
IRS Circular 230 Notice: To the extent this article concerns tax matters, it is not intended to be used and cannot be used by a taxpayer for the purpose of avoiding penalties that may be imposed by law.
Travis H. Long, CPA is located at 706-B Forest Avenue, Pacific Grove, CA, 93950. He can be reached at 831-333-1041.
Foreclosures and Short-Sales – Part IV – Primary Residence
Filed under: Foreclosures and Short-Sales | Tags: Foreclosure, Mortgage Foregiveness Debt Relief Act, nondeductible personal loss, primary residence, qualified principal residence indebtedness, section 108, section 121, Short-Sale
Leave a Comment Originally published in the Pacific Grove Hometown Bulletin
August 3, 2011
The last three issues I went over the basic concepts of foreclosures and short-sales, an overview of ways to exclude the resulting taxable income, and the effects of recourse/nonrecourse debt. If you missed these articles they are re-published on my website at www.tlongcpa.com/blog. This issue I will specifically discuss the exclusion available to people losing a principal residence.
Due to the tsunami of defaults anticipated when the markets began to fall in late 2007, Congress enacted the Mortgage Forgiveness Debt Relief Act on December 20, 2007 which resulted in an additional exclusion in IRS Code Section 108 trying to help people going through short-sales, foreclosures, or mortgage reductions on a principal residence. There is a lot of incomplete and incorrect tax advice that floats around regarding this exclusion – not only from water-cooler talk and media blurbs, but from ill-trained tax preparers as well.
As discussed in my previous articles, cancelled debt on recourse loans is taxable income to you. The Qualified Principal Residence Indebtedness exclusion allows you to exclude the resulting income if the home was your principal residence (you can only have one and it is determined by facts and circumstances) subject to limitations. One of the common oversights is not understanding that only “qualified” debt is eligible for the exclusion. Generally speaking, this is the original debt to purchase or construct the property as well as debt subsequently obtained to improve the property (such as additions or remodels). If you refinanced your home to get cash out, and used the money for a new car, vacations, for a down payment on another home or rental property, education, to pay down other debts, or to pay your living expenses or even the mortgage on your home, or anything else – none of this is qualified for the exclusion. Yikes! In addition there are different Federal and California limits for how much qualified debt you can exclude. Any amount you cannot exclude will be taxable as ordinary income to you unless you can qualify for another exclusion.
Any amount you can exclude reduces your cost basis in the home. When the home is sold or the bank forecloses, you also have to calculate your gain or loss on the disposition. If you bought the home shortly before prices fell significantly, chances are that even with the basis reduction, the sales price will be less than your cost basis resulting in a nondeductible personal loss. (In a foreclosure the “sales price” is the fair market value of the home when foreclosed.) In cases where the calculation results in a gain, you may be able to exclude the gain, or part of the gain per Section 121, if you lived in the home for two out of the last five years.
If your loan was nonrecourse, you do not have cancellation of debt income, but you still have to calculate the gain/loss on disposition. Unfortunately, the “sales price” in these cases is the amount of debt outstanding when the home was disposed – and not the low, actual sales price (or fair market value if foreclosed). This can create taxable gains, but Section 121 may help you here as well.
This is just a summary. There are many other circumstances and specific rules that could affect you, and you need to consult with a qualified professional to review your situation. Consult as soon as you can foresee the possibility of losing a home in order to plan the most tax efficient way to lose it.
If this exclusion does not help you completely, you may be eligible for the insolvency exclusion – next issue’s topic!
IRS Circular 230 Notice: To the extent this article concerns tax matters, it is not intended to be used and cannot be used by a taxpayer for the purpose of avoiding penalties that may be imposed by law.
Travis H. Long, CPA is located at 706-B Forest Avenue, Pacific Grove, CA, 93950. He can be reached at 831-333-1041.
Foreclosures and Short-Sales – Part III – Recourse and Nonrecourse Debt
Filed under: Foreclosures and Short-Sales | Tags: 1099-A, 1099-C, 580(b), anti-deficiency, Foreclosure, nonrecourse, recourse, refinanced, Short-Sale
Leave a Comment Originally published in the Pacific Grove Hometown Bulletin
July 20, 2011
The last two issues I went over the basic concepts of foreclosures, short-sales, and an overview of excluding the related income and what you give up in return. If you missed these articles they are re-published on my website at www.tlongcpa.com/blog. This issue I was intending to discuss the exclusion available to people losing their principal residence, but I am going to bump that to the next issue in order to cover one other fundamental concept – recourse and nonrecourse debt.
Recourse debt means that you are personally liable for the debt and the lender has the right to pursue you for the full balance of what you owe if the home is not enough to satisfy the debt you owe. Nonrecourse debt means the lender has agreed, in event of default, to take the house as full settlement for the debt, and they cannot pursue you for the amount you are deficient. This effectively means there is no debt for them to cancel, which means you can have no taxable income from cancelled debt. Clearly, you hope your debt is nonrecourse! How do you know?
Actually, if you have never refinanced your property, it is almost certainly nonrecourse. Hooray! This is due to the California anti-deficiency laws in California Code of Civil Procedures Section 580(b) which essentially makes it illegal for lenders to pursue borrowers for a deficiency on original purchase loans. Unfortunately these same provisions do not apply if you refinanced, and you will almost always find those loans to be recourse. Un-hooray.
Even with a recourse loan, it is rare to hear of lenders pursuing the deficiency because they do not find it particularly cost effective (think legal fees) or good press to sue someone who just lost a home and has a family to support with no job. It is often simpler for the lender to cancel the debt, take a loss, and write-it off as a bad debt on their tax returns.
There are two tax documents you may receive in the process of losing a property through foreclosure or short-sale. A 1099-A is a tax notification that you have given up or “A”bandoned the property. The other document is a 1099-C which should be issued if the lender “C”ancels a recourse debt. Both of these include the lender’s idea of its fair market value and if you are personally liable. Both are notoriously incorrect assuming you receive them at all. The 1099-C also includes the amount of debt you owed when cancelled. A savvy tax professional will recognize these issues can affect your taxes and will help you take appropriate action. If you have a foreclosure or short-sale looming, get help early.
IRS Circular 230 Notice: To the extent this article concerns tax matters, it is not intended to be used and cannot be used by a taxpayer for the purpose of avoiding penalties that may be imposed by law.
Travis H. Long, CPA is located at 706-B Forest Avenue, Pacific Grove, CA, 93950. He can be reached at 831-333-1041.
Foreclosures and Short-Sales – Part II – Exclusions from Income
Filed under: Foreclosures and Short-Sales | Tags: bankruptcy, cancelled debt, Foreclosure, insolvency, qualified farm indebtedness, qualified principal residence indebtedness, qualified real property business indebtedness, section 108, Short-Sale, tax attributes
Leave a Comment Originally published in the Pacific Grove Hometown Bulletin
July 6, 2011
In the last issue I went over the basic concepts of foreclosures and short-sales and explained that your debt forgiven in these transactions is considered taxable income. It is difficult to face a tax bill in congruence with losing a property so Congress provided some options to possibly exclude the cancelled debt from your taxable income.
Section 108 of the Internal Revenue Code will likely be your hero. This code section and its related code sections and regulations are not for the faint of heart as I have witnessed by the glazed eyes of a sea of tax professionals trying to grasp the nuances in the rules, as well as phone calls I have received from other CPAs and attorneys.
Based on my experience with over 80 of these transactions, if you distill the mess of complex code down to its core, you will find after the dust settles and the house is gone, if you truly have nothing left, you will typically get off the tax hook. For everyone else, to the extent you have a positive net worth or future tax benefits, these code sections swallow your benefits or act as a deferral of tax to a later date – do not be misled, however, this is still a great stamp in your passport (summer cliché). To receive these benefits, however, you have to apply the code and file the forms and additional statements correctly with an original, timely filed return. If you foresee the future chance of losing a property, consult early to strategize how to best “lose the property” – it may save you a lot of money.
Section 108 covers all discharges of debt, but I will focus on it from the perspective of debts discharged due to the loss of a home or rental property. The circumstances that may qualify you to exclude the debt or part of the debt from income are: bankruptcy, insolvency (you have more liabilities than assets), qualified farm indebtedness, qualified real property business indebtedness (typically rental property debt falls here), and qualified principal residence indebtedness (debt on your main home usually qualifies here). You see the word qualified in a number of these exclusions because not all debt is eligible. The escape hatch may get smaller, for instance, if you lived off the equity of your home and did not reinvest refinance proceeds back into improving it.
Once it is determined how much debt can be excluded from income (which can come from a combination of exclusions), we then apply tax attribute reduction rules – on the chopping block include items that could have saved you tax in the future: net operating losses, general business credits, minimum tax credits, capital loss carryovers, tax basis in your other assets (most people have at least some of this), passive activity loss and credit carryovers, and foreign tax credit carryovers. The order, timing, and calculation of these rules are different depending on which of the previously mentioned exclusions you are using. Next issue, I will focus on the principal residence exclusion.
IRS Circular 230 Notice: To the extent this article concerns tax matters, it is not intended to be used and cannot be used by a taxpayer for the purpose of avoiding penalties that may be imposed by law.
Travis H. Long, CPA is located at 706-B Forest Avenue, Pacific Grove, CA, 93950. He can be reached at 831-333-1041.
Foreclosures and Short-Sales – Part I – Overview
Filed under: Foreclosures and Short-Sales | Tags: cancellation of debt, cancelled debt, COD, credit scores, deed-in-lieu, Foreclosure, Short-Sale, taxable income
Leave a Comment Originally published in the Pacific Grove Hometown Bulletin
June 15, 2011
Over the past three years I have been involved with approximately 80 foreclosures and short-sales. Ultimately, it is a combination of strong tax and legal advice that will help you safely navigate these troubled waters. The stakes are high, the rules are complex, and we have no roadmap for future audits on these transactions. The common thread I have seen is that each foreclosure or short-sale is surprisingly unique and there is no one-size-fits-all approach to handling them successfully. Let’s start with an overview…
In a foreclosure, you stop paying the loan and the bank eventually repossesses the home and sells it. In a short-sale, you find a buyer, but the buyer will not offer enough for you to pay off the loan you owe. So you go to the bank and say, “Hey, I found someone willing to pay this much. I know it is short of the amount I owe you, but will you let the sale proceed, and let me off the hook for the rest?” These processes can take anywhere from three to 15 months from my experience, and in the end, most short-sales fail to materialize. Another animal, deed -in-lieu of foreclosure, is where you voluntarily give the home back to the bank in exchange for cancelling your debt obligation. A deed-in-lieu of foreclosure is rarely seen in California (zero out of my 80) because it does not absolve the bank of the junior lien holders on the property. Liens can be tricky to find and the bank does not want to get stuck with your other debts.
I am often asked which is better for credit scores and future ability to buy a home. I cannot tell you for sure – it depends on a lot of factors, but generally I think a short-sale is better for a lot of people (not all). Whether it is a short-sale or foreclosure, credit scores will be impacted significantly – maybe 200-300 points. With credit counseling you can typically rebuild it substantially in two to three years. Your future ability to buy a home will often depend on the loan program (FHA, VA, conforming loan, jumbo, etc.) and how much money you can put down. At this point, the best advice is to plan on three to seven years for foreclosures and two to seven years for short-sales (although I have heard less). Given the vast number of people losing their homes, I tend to think banks will become more lenient than in the past. I also think they will reward people who worked to accomplish a short-sale.
From a tax perspective, the big problem with these transactions is that they can create potentially taxable income…and a lot of it! The reason for this is quite simple – by cancelling your debt, the bank effectively gave you money to pay off your loan. Just as lottery winnings are taxable, so is debt that is cancelled. Fortunately, the IRC also contains sections which allow you to exclude the income. Next issue I will start discussing your tax options.
IRS Circular 230 Notice: To the extent this article concerns tax matters, it is not intended to be used and cannot be used by a taxpayer for the purpose of avoiding penalties that may be imposed by law.
Travis H. Long, CPA is located at 706-B Forest Avenue, Pacific Grove, CA, 93950. He can be reached at 831-333-1041.
National Debt
Filed under: National Debt | Tags: Blackstone Group, Comptroller General, David Walker, G.A.O., I.O.U.S.A., I.O.U.S.A.: Solutions, national debt, Pete Peterson, Peter G. Peterson Foundation
Leave a Comment Originally published in the Pacific Grove Hometown Bulletin
June 1, 2011
Last issue, I concluded that tax rates are likely to rise if you look at the historical relationship between tax brackets and macro-economic events. Despite an economic climate indicating that higher tax rates are needed, we are pretty much witnessing the lowest tax rates since before World War II or the Great Depression depending on which end of the bracket spectrum you lie. These two forces have compounded to magnify our national debt to $14 trillion.
You hear a lot about the national debt, but so what? Have you ever personally felt affected by it? Has the government ever asked you to ante up $165,000 for your share as a family of four (or $800,000 if you include enough to ensure the promises made for future obligations will be met as well)? I think we as Americans are blasé on the subject because we do not connect the dots back to ourselves. It often seems distant or a problem for someone else in another time. This may not be the case.
We have set the stage for doubt. The strength of our financial system is largely built on the belief that the U.S.will make good on its borrowed money. If large debt holders begin to doubt this for economic or malign political reasons, the mental atmosphere about the stability of the U.S.could change quickly. It would likely send us and the rest of the world into a global depression that would be painfully felt by all. The U.S. would struggle with a collapsing currency, inflation, unemployment, and irate nations from around the world that watched their investments in the U.S. evaporate.
David Walker, the former U.S. Comptroller General feels our biggest threat to national security is not terrorism, but our own fiscal irresponsibility. Walker left the G.A.O. in 2008 to run the newly formed Peter G. Peterson Foundation (www.pgpf.org) because he felt his warnings had little impact in the political arena. He has since left to start a similar organization – Comeback America Initiative.
Peter G. Peterson, founder of The Blackstone Group – a financial services company, created the Peter G. Peterson Foundation with $1 billion of his profits after the 2007 IPO of The Blackstone Group. The purpose of the foundation is to educate Americaabout the urgency of the fiscal challenges threatening our future, and working towards solutions. The foundation funded a critically acclaimed full-feature movie released in theaters across the nation in 2008, I.O.U.S.A., (available on Netflix), and a five-part follow up, I.O.U.S.A.: Solutions in 2010. A shortened version of the movie and the follow-up can be viewed at www.iousathemovie.com.
I encourage you to watch. It is fascinating and will leave you with an enlarged perspective. We can overcome this challenge, but we have to act, and we need to act as soon as possible.
Travis H. Long, CPA is located at 706-B Forest Avenue, Pacific Grove, CA, 93950. He can be reached at 831-333-1041.
Are Tax Rates on the Rise?
Filed under: National Debt, Tax Rates | Tags: Bush, historical lows, national debt, Reagan, Tax rates
Leave a Comment Originally published in the Pacific Grove Hometown Bulletin
May 18, 2011
Earlier this week, I pulled out my crystal ball and posed a few questions about future personal federal income tax rates – strangely, it became suddenly murky. So I pulled out my history books instead and drew some conclusions. Let me set the stage and give you some history. Keep in mind since 2003 our bottom tax bracket has been 10 percent and our top tax bracket has been 35 percent.
Wars have historically been fantastic reasons to raise taxes. In fact, our first national income tax was created to raise money for the Civil War. After the Civil War the tax was abolished. Although income taxes were permanently revived in 1913 (some people still questioning its legitimacy from their prison cells) a logical pattern seemed to develop– when our country needed money, tax rates went up; when it did not need money, tax rates went down.
In 1913 the bottom bracket was at 1 percent and the top bracket was at 7 percent – perhaps a special introductory rate. During World War I the bottom bracket moved as high as 6 percent and the top bracket shot up to 77 percent! Then brackets fell dramatically until the depression in the 1930s. The government needed money so brackets shot back up flowing right into World War II where they peaked in 1944 and 1945 with the bottom bracket at 23 percent and the top bracket (income over $200K) at 94 percent! Rates dropped after World War II, but stayed relatively high with the bottom bracket not dipping below 14 percent and the top bracket not dipping below 70 percent until after 1980.
During the Reagan and H. W. Bush years dramatic changes took place (Reaganomics). The bottom bracket dropped as low as 11 percent and the top bracket dropped as low as 28 percent. The brackets rose a little during the Clinton years and then dropped again when W. Bush took the reigns.
Tax brackets are not everything, but to the extent they are an indicator, it is difficult to say we are overtaxed. With the exception of a three year period in the late 1980s, the tax rates on our bottom and top tax brackets are both at their lowest levels since before World War II. We have maintained this course during our worst economic decline since the 1930s while simultaneously fighting a war and spending at all-time highs. Our logical pattern seems to have been broken. Our national debt has been rising substantially to pay for our record-low tax brackets and our loose wallet. The longer we as Americans continue to cast our vote beyond our means the more painful it will be.
So from my perspective, tax rates only have one direction to go – up. Next issue, I will discuss the national debt.
Travis H. Long, CPA is located at 706-B Forest Avenue, Pacific Grove, CA, 93950. He can be reached at 831-333-1041.
Do I have to withhold taxes for my babysitter, maid, or gardener?
Filed under: Household Employees | Tags: Household employees, nanny tax, Schedule H, tax on babysitter, tax on gardener, tax on maid, withholding taxes
Leave a Comment Originally Published in the Pacific Grove Hometown Bulletin
May 4, 2011
Do I have to withhold taxes for my babysitter, maid, or gardener?
Well…it depends. If you ever plan on running for office you should really consider it, as the seeds for many embarrassing political moments found root in avoiding the so-called “Nanny Tax!” Even if you do not have your heart set on politics there are good reasons you should take the time to consider if you are complying with the law.
General rules: If you pay household employees (defined later) a total between $750 and $999 during a quarter, you are required to withhold California State Disability Insurance (SDI). If the amount is $1,000 or more you also must pay California Unemployment Insurance (UI), California Employment Training Tax (ETT), and Federal Unemployment Tax (FUTA). If you pay over $1,700 during the year to a single employee, you are also required to withhold Social Security and Medicare taxes including your share as the employer. You would have to file payroll tax returns and possibly Schedule H with your personal tax returns, and have the employee fill out a Form I-9 Employment Eligibility Verification. These are all manageable tasks you can perform, but most people would rather spend their free time doing something else, and hiring a payroll service instead.
So what is a household employee? This means you have a high degree of control over what, when, and how they do their job. Examples: If your gardeners provide their own supplies, tools, set their own schedules and hold themselves out to the public as providing gardening services, they are not likely to be considered your employees. If you hire a gardener from 8-10 on Tuesdays and Thursdays, tell him what you want him to focus on and he uses your tools, you likely have an employee. A babysitter in your home is likely your employee, but if at their home maybe not. The cleaning person using your supplies and equipment at a time you control is likely your employee whereas the person that shows with window cleaner in-hand, a vacuum, and a business card “sometime on Wednesday” – probably not. If your household employee is under 18 and a student you are generally exempt. If you call a company and they send their employee to babysit, clean, garden, etc. then the service provider is the employer and not you. It is a gray area, and you may want to contact a tax professional to discuss.
So I have an employee, but who reports this anyway? It may be true that many people do not report this correctly and not a lot of resources are devoted to enforcement, but that does not help you if you become that example of enforcement. You have to ask yourself is it worth the potential trouble? You would likely be held liable for all taxes including the employee’s share with interest and penalties. If the individual files an unemployment claim or gets hurt at your home, you could be held liable for unemployment or disability payments. And what if the worker is illegal – that has its own potential civil and criminal penalties. Following the law does serve as a protection to you.
For more information, you can reference the guidance in IRS Publication 926-Household Employer’s Tax Guide and CA EDD-Household Employer’s Guide – both available online.
Travis H. Long, CPA is located at 706-B Forest Avenue, Pacific Grove, CA. Travis can be reached at 831-333-1041.
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