Archive for the ‘American Opportunity Credit’ Tag

Back to Basics Part XXXI – Form 8863 Education Credits

Originally published in the Cedar Street Times

January 29, 2016

There are two main tax credits for qualified spending on degree seeking higher education: 1) the American Opportunity Credit (AOC), and 2) the Lifetime Learning Credit (LLC).  The AOC is generally the more valuable of the two.  It is a tax credit of up to $2,500 with $1,000 of that refundable to you even if you paid no tax and have no tax liability.  You get 100 percent of the first $2,000 spent, and 25 percent of the next $2,000 spent.  Whenever your hear “refundable credit,” think potential fraud.  So it is not only an opportunity for college kids, but an opportunity for criminals to make up false returns and claim fake credits.  Naturally increased scrutiny follows on behalf of the IRS.  But I digress.

The AOC is available to you only during your first four years of college as defined by the educational institution – so a 5th or 6th year senior would still qualify, except that you are only allowed to take the credit for a total of four times no matter how long it takes you to get through school!  With that in mind you may even choose to forgo claiming the credit in a particular year if for instance you were attending a community college and had less than the $4,000 of expenses to max out the credit, but knew you would be transferring to a more expensive school, and would still have the opportunity to claim the credit four times before graduating.

The AOC allows you to include tuition and required fees of the school, like athletic fees, and student activity fees (but not health fees or room and board) for the tax year at hand plus the first three months of the next year if paid in the current year, plus the cost of any books or school supplies whether or not bought from the school or any other seller.  You have to be enrolled half time in at least one academic period such as a semester or quarter in the tax year, or during the first three months of the next year if the payment was made in the current year for the following year school.

If your modified adjusted gross income (for most people this is the same as their AGI) is between $160,000 and $180,000 for married filing jointly ($80,000 – $90,000 for other statuses), the credit phases out.  If a parent is claiming you as a dependent, then you are not allowed to deduct it on your tax returns – only the parent would.  Even if a third party paid the fees for a student’s benefit (such as a relative, or an institution), as long as the parent is still claiming the child as a dependent, then the parent is eligible to claim the credit as well.  You would need a copy of the 1098-T to claim the credit (this is a new requirement signed into law by Obama in 2015 – all filers must have in their possession a 1098-T when filing their taxes to claim education credits).  Another interesting tenant is that you cannot claim the credit if you have been convicted of a felony possession or distribution of a controlled substance.

The Lifetime Learning Credit (LLC) is a nonrefundable credit of 20 percent of the first $10,000 spent – capping out the credit at $2,000.  The LLC is available to anyone in their life for an unlimited number of years for post secondary education – even if you just take one course at a time – so you don’t even have to be seeking a degree.  You just can’t claim the LLC and AOC in the same year for the same person.

The LLC is eligible for the same expenses as the AOC, except that books and supplies that are not absolutely required to be bought from the school, do not count.  The modified adjusted income phaseout is between $110,000 – $130,000 for married filing jointly and $55,000 – $65,000 for other statuses.  Also, it is nice to know that you can still smoke crack and deal heroin and be eligible for the credit, as there are no denials of the credit for felony possession or distribution of controlled substances with the LLC!

The form used to claim the expenses, Form 8863 – Education Credits (American Opportunity and Lifetime Learning Credits), is a two page form.  You start with the second page, which is basically a flow chart questionnaire determining what you are eligible for, and it also has you transfer some numbers to the first page.  The AOC is handled in Part I of page one and the LLC is handled in part II of page one, and these walk you through the credit calculation and limitations.

If you have questions about other schedules or forms in your tax returns, prior articles in our Back to Basics series on personal tax returns are republished on my website at www.tlongcpa.com/blog .

Travis H. Long, CPA, Inc. is located at 706-B Forest Avenue, PG, 93950 and focuses on trust, estate, individual, and business taxation. Travis can be reached at 831-333-1041.

Get Ready for 2015 Taxes

Originally published in the Cedar Street Times

January 8, 2015

 

We are going to take a break from our Back to Basics series to address a few timely issues.

At the beginning of every year, I send each of my clients a tax organizer to assist in gathering all the information necessary to complete the tax returns in an efficient manner.  The tax organizer is customized for the client and includes his or her prior year amounts for comparative purposes (and it serves as a great memory jogger so nothing is left out).

There is also a questionnaire to assist in alerting us to items that may not occur every year, but that may be present in the current year.  I also ask clients additional questions about the status of things like their estate planning, retirement planning, assets, debts, insurance, health care directives, etc. in order to ensure that they are thinking about these important issues each year.

Organizers are a fairly common practice among CPA firms, and for good reason.  They result in more accurate and more efficient tax preparation which should translate into a more accurate calculation of your tax liability, less problems with the taxing authorities, and less cost to you in the long-run.  Some of you may find yourselves saying, “Oh, I never use the organizer.  My CPA knows how I do things, and I have been doing it this way for years, plus my tax stuff is very simple.”

Behind the scenes this translates into moments of, “Oh, yeah, I remember these yellow sheets with the small scribbles from the past – now where did she put the real estate taxes again?”  And then if there is staff involved, there may be an additional conversation, “Okay, now here is what you need to know about how Mrs. Jones organizes her information…”    Since time is a precious commodity, the more of it that is used in the process of assisting you, the higher your bill is going to be.  With some firms, you will see this reflected in your bill each year.  In other firms, your pricing will be more consistent, but will trend higher or lower as a result over a period of years.

Ask yourself, is the firm going to be faster at learning, remembering, and extracting information from hundreds of different client systems with information in different orders, or from one system which is perfectly ordered with its software and that it knows backwards and forwards?  You can minimize the fees related to data collection and entry, and just spend your money on the real value of strategy in preparing the returns.

That said, maybe it is worth it to you to keep doing it the way you have always done it.  A CPA firm is generally going to be intelligent enough to figure it out and let you know what is unclear or what else may be missing in most cases, it just might cost you a little more, and have a little more risk associated with it.

In addition to the organizer each year, I send clients an engagement letter for services to be provided, a limited tax power of attorney to speed up the process in case we need to resolve an issue on a client’s behalf, and an additional organizer letter.  The organizer letter explains new tax developments over the past year, as well as revisiting issues from prior years that remain important and still somewhat fresh.  This year’s organizer letter was six pages long.  I don’t expect clients to necessarily read it all, but it is laid out in an easier manner to skim the topics and see what might be important to read further.

Here is a high level summary of some of the issues from my organizer letter you may want to be aware of:

  1. The IRS took a clear position this year that businesses sending 1099 forms this January must send them to LLCs as well, unless the LLCs have made a special election to be taxed as a corporation.  Fees for not properly sending 1099s have doubled.
  2. President Obama signed a new law this year that requires anyone claiming education credits or education deductions to have a 1098-T when filing their tax returns.
  3. The PATH Act (Protecting Americans from Tax Hikes) was signed into law on December 18, 2015.  This was the extender bill for this year which we have grown accustomed to getting at the last minute each year from Congress.  Some notable provisions made permanent include the sales tax deduction as an option in lieu of state income taxes, the IRA‐to‐charity exclusion, enhanced child tax credit, enhanced American opportunity tax credit, enhanced earned income tax credit, above‐the‐line deductions for qualified tuition expenses, the section 179 depreciation deduction for up to $500,000, built‐in‐gains holding period of 5 years for s‐corporations, and enhanced exclusion of gain on sale of small business stock. The qualified tuition deduction, mortgage insurance premiums deductible as interest, and exclusion of income for debt on discharged principal residences where extended through 2016. Bonus depreciation and first‐year bonus depreciation on automobiles was extended through 2019.
  4. Do not do more than one indirect rollover from one retirement plan to another in any 365 day period (not calendar year based), or you will face penalties.  Indirect rollovers are where the retirement plan custodian issues you a check directly, and then you have 60 days to deposit the money with another retirement plan custodian or consider it a distribution.  (You can still do unlimited direct rollovers from one trustee to another.)
  5. Several tax return due dates are changing affecting 2016 returns (not 2015 returns) – due dates for partnerships move to March 15, c-corporations move to April 15, and FinCen 114 for foreign bank accounts move to April 15 and are now eligible for a six month extension.
  6. The new capitalization and repair regulations of 2014 were modified to allow taxpayers to have a capitalization policy of $2,500.  This means businesses can now deduct any item $2,500 or less as an expense without having to include it on a depreciation schedule or take a section 179 deduction for it.  You do not even have to have a written policy to this effect, but you do have to make an annual 1.263(a)-1(f) election on your returns each year to do this.
  7. Watch for 1095-A, B, and/or Cs this year as they will be much more prevalent and will be needed in the preparation of your tax returns to ensure you meet the health care insurance requirement.  Last year was lax.  This year the noose has been tightened.  If you did not have health insurance for all or part of the year, be aware, some exemptions from the health insurance mandate require you to apply to Covered California to get an exemption for use in your preparation.  In other words – get moving!

Prior articles are republished on my website at www.tlongcpa.com/blog .

Travis H. Long, CPA, Inc. is located at 706-B Forest Avenue, PG, 93950 and focuses on trust, estate, individual, and business taxation. Travis can be reached at 831-333-1041.

What Are Your Chances of Being Audited? Part III – Red Flags

Originally published in the Cedar Street Times

June 13, 2014

Four weeks ago I discussed some of the statistics regarding your chances of being audited by the IRS, and two weeks ago I discussed audit selection methodology.  A few of the high points from the articles were: 1) on the average, audit rates for individuals are generally less than one percent each year, and increase as you make more money, 2) about 75 percent of audits are actually mail correspondence audits focused on a narrow request of information for specific items on your return rather than a full-blown in-person, field audit, 3) the IRS does not release its exact methods of selecting audits, and many people have incorrect notions about this process, 4) the IRS does tell us audit selection is aided by a computer scoring system to help find returns that will likely yield a change; it uses computer matching to ensure information reported on 1099s by third parties matches what you report; it uses publicly available information; and it uses statistical random sampling.  The rest of this article will be devoted to “red flags.”

So what are these “red flags” everyone talks about?  One fairly obvious assumption we can make from the audit statistics released by the IRS is that they follow the money!  You are three times more likely to be audited if you make over $200,000 a year and over eleven times more likely to be audited if you make over $1,000,000 a year.  C-corporations face a similar dynamic of increasing audit rates on larger corporations – for instance, one out of every three corporations with assets over $250 million are audited.

Not reporting all your income even when it is reported to the IRS should not be a surprising red flag, but it happens frequently.  I see this most commonly with stock sales reported on a 1099-B when people prepare their own returns – they either forget, or do not understand the form.  I also see this with contract work where a 1099-Misc is issued and the individual forgets to report it.

There are a number of issues related to small businesses that raise eyebrows.  Keep this in mind – anytime there is an easy path for someone to pass-off personal expenses as business expenses, you are going to have a higher level of scrutiny.  For instance – relatively high amounts of: business automobile mileage (or claiming 100% business use on your vehicle – very rare in reality), home office deductions, meals and entertainment, or travel expenses.  All of these can be easily abused, so they are highly scrutinized.  If you are beyond the norms, you are a clearer target.

Here is another golden nugget – if your job is one that millions of people do for fun as a hobby (although perhaps not nearly as well!), then you have a higher level of audit risk, particularly if you are losing money.  Think of the arts – photography, video, music, drawing, painting, performing, etc.  Also, think of horse racing and breeding for the wealthier set.

That brings us to another “red flag,” businesses that lose money every year.  The IRS is trying to determine which of these three describes your nonprofitable business situation: 1) Are you really trying to make this successful and genuinely feel it will be profitable overall?  2)  Are you trying to deduct your personal expenses, your hobby, or keep up appearances? or 3) Are you just plain nuts?  By allowing people to continue businesses circumscribed in two and three, the rest of the country is having to foot the bill for the lost tax revenues.  This is because the “losses” generated are offsetting the person’s other income that would otherwise be taxable.  With no realistic future expectation to recuperate the losses, the IRS is ready to pounce.

Claiming rental losses in California is fairly common due to the high cost of our real estate, but claiming a real estate professional designation in combination with these losses is an area of greater concern.  If your main occupation is in the real estate related field, and you work at least 750 hours in this trade, you are allowed to deduct all of your rental losses in the year they are incurred.  Everyone else get to deduct $25,000 at most, and are rapidly phased out to no deductions for the losses based on income levels.  The losses get suspended until the property is disposed of or until there is passive gain to offset.  There are a lot of challenges when it appears the person has substantial earned income from a trade or business unrelated to real estate or if there is very little income from real estate related trades.

Refundable tax credits such as the Earned Income Tax Credit, Child Tax Credit, American Opportunity Credit (for education), and Health Care Tax Credit can also be a point of concern, particularly when the total refund on your return is higher than the tax paid in to the system!  The IRS receives thousand of fraudulent returns each year that use refundable credits to steal money from the government.

Although harder to catch, unreported foreign income is an area worth mentioning due to the extremely high penalties by the Treasury Department for failure to report foreign accounts, and it has been a hot-button issue that has raised billions in revenues.

The above is not an exhaustive list, but it does describe many commonly seen areas of concern.

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 and focuses on trust, estate, individual, and business taxation. He can be reached at 831-333-1041.

Your Future Tax Return: Romney Versus Obama

Originally published in the Cedar Street Times

November 2, 2012

If tax positions would sway your Tuesday vote, here is what Obama and Romney would like to see.  Keep in mind, however, you don’t always get what you want!

Tax brackets: Romney reduce to 80% of current levels. Obama keep the same as 2012 except allow top bracket to split into two higher brackets like pre-2001. (Romney, Current 2012 Rates, Obama, 2013 rates if no congressional action ) (8%, 10%, 10%, 15%), (12%, 15%, 15%, 15%), (20%, 25%, 25%, 28%), (22.4%, 28%, 28%, 31%), (26.4%, 33%, 33%, 36%), (28%, 35%, 36% and 39.6%, 39.6%)

Capital gains, interest, dividends: Romney reduce tax rate to zero for AGI below $200K.  15% max if AGI above $200K. Obama increase long-term capital gains rate to 20% max and up to 39.6% on dividends – leave interest taxed at ordinary bracket rates.

2013 3.8% Medicare surtax on net investment income and existing 0.9% medicare surtax for married filers over $250K AGI and others over $200K: Romney repeal.  Obama keep.

Itemized deductions: Romney cap itemized deductions (maybe $17,000-$50,000 cap) and maybe eliminate completely for high income.  Obama reduce your itemized deductions by 3% of your AGI in excess of $250K married, $225K HOH, $200K single, and $125K MFS (up to 80% reduction of itemized deductions) and limit the effective tax savings to 28% even if you are in a higher bracket.

Income exclusions: Romney keep as is. Obama cap the effective tax savings to 28% on exclusions from income for contributions to retirement plans,  health insurance premiums paid by employers, employees, or self-employed taxpayers, moving expenses, student loan interest and certain education expenses, contributions to HSAs and Archer MSAs, tax-exempt state and local bond interest, certain business deductions for employees, and domestic production activities deduction.

AMT: Romney repeal. Obama keep but set exclusion to current levels and index for inflation.

2009 expanded Child Tax Credit, increased Earned Income Credit, and American Opportunity Credit: Romney – Allow to expire as scheduled 12/31/12.  Obama – Make permanent.

Buffett Rule: Romney “Not gonna do it.” Obama households making over $1 million should not pay a smaller percentage of tax than middle income families.  This is accomplished by raising the rates on capital gains and dividends as discussed earlier.

Temporary two percent FICA cut you have been enjoying in 2011 and 2012: Both candidates favor allowing to expire at 12/31/12.

Estate tax: Romney repeal.  Obama set at $3.5 million and index for inflation with top rate of 45% on excess.

Top corporate tax rates: Romney 25%. Obama – keep at 35% for 2013 but maybe reduce to 28% in the future.

Corporate international tax: Romney don’t tax U.S. companies on income earned in foreign countries. Obama discourage income shifting to foreign countries.

Corporate tax preferences: Romney extend section 179 expensing another year, create temporary tax credit, expand research and experimentation credit. Obama increase domestic manufacturing incentives, impose additional fees on insurance and financial industries, reduce fossil fuel preferences.

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 and focuses on trust, estate, individual, and business taxation. He can be reached at 831-333-1041.