Archive for the ‘California’ Tag
Do I Need to Set up an LLC or Incorporate?
Filed under: Business Entity | Tags: C-corporations, California, double-entry accounting, entity, Franchise Tax, inherent risk, insurance, liability, liability protection, LLC, risk, S-Corporation, tax returns
Comments (2) Originally published in the Cedar Street Times
October 3, 2014
Two weeks ago I discussed some of the pitfalls of using an online service to help you set up an entity such as an LLC, C-Corporation, or S-Corporation for your business. In a nutshell, you really need tailored advice from an accountant and an attorney to address your circumstances and you should use an attorney to properly set everything up. I have found that people that utilize these services generally do not have a good understanding of what they did and why, and they don’t know much about their ongoing responsibilities, the importance of carrying them out, or the consequences of failing to do so.
Now I am going to turn the tables and ask you why you think you need a formal entity at all? When I say this I am thinking about small businesses getting started. If your accounting and legal advice is from family or friends, hopefully they actually are accountants and business attorneys and reviewing your WHOLE situation. Or maybe you read something online – maybe even an article like this! Be careful what you read!
My personal feeling is that there are a lot of small businesses out there that have set up entities prematurely, and have entangled themselves in a lot of extra cost, record keeping, and administrative hassle for very little benefit.
The vast majority of people setting up entities for small businesses do it because of perceived liability protection for their personal assets. Some do it for certain circumstances that can lead to tax benefits, and others do it in rare circumstances where a major customer requires it.
It is important to understand there is no bullet proof solution when it comes to shielding yourself from liability. There is almost always a way to spoil a good plan. Legions of lawyers make their living at this. Layers of protection are often implemented to mitigate the risk of chinks in your armor. For instance have an entity and also having insurance would be a good example.
It is also important to understand that entities do not protect you from all forms of claims. For instance, professionals cannot be shielded by an entity for acts of malpractice. Malpractice insurance, however, could cover you.
If you do not respect the entity by following all the rules of corporations, s-corporations, or LLCs promulgated by various government authorities, then if there is a lawsuit, the courts could say, “You didn’t respect the entity, so why should we?” They could look right through your entity and allow a creditor to go after your personal assets.
Small businesses are at a much higher risk for this since they generally don’t have a legal department trying to keep up with all the details! I have seen small businesses that have gone through the hassle and expense of setting up corporations, filing tax returns and paying the California Franchise Tax each year and yet they have never held a corporate meeting or elected officers, never recorded any corporate minutes (and even if it is just you wearing all hats, you can’t ignore these things!), and treated the bank accounts of the company like an extension of their personal checking account. And all the while they were thinking they had solid liability protection because they were a corporation…uhh no. The devil is in the details as it is said!
Besides the initial cost of setting up an entity properly which could run two or three thousand dollars or more, you then have to file separate business tax returns, file an informational filing with the Secretary of State, possibly have an attorney draft a document or two each year, have better accounting for the tax returns (true double-entry accounting which includes an accurate balance sheet in addition to the profit and loss statement), and then you get the privilege of paying California at least $800 a year whether you make a dime or not. So you have at least another couple thousand dollars each year of ongoing costs (more if you need to hire a bookkeeper when you find out that QuickBooks actually requires a fairly good amount of accounting knowledge to operate it properly.)
If the inherent risk of the business is relatively small or moderate, and especially if you are starting very small and do not even know if the business is going to be successful, then I think you need to carefully way the benefits and costs. Could you just carry really good insurance and mitigate your risk to an acceptable level? Do you need the additional layer of protection? You can always incorporate or set up an LLC later. Do you have employees, and what amount of risk do they expose you to? Are they driving vehicles a lot for your business? Or do you have rental property with lots of tenants? Maybe you are a free-lance graphic artist designing business cards remotely from your home – not much risk there! What are you trying to protect anyway – maybe the bulk of your personal assets you have would be considered exempt assets from creditors already? Although attorneys are generally risk-averse because they see all the things that can go wrong, and therefore would prefer to set up an entity, I think these types of discussions can be had with them and really question if it is right to set up an entity for your business for liability reasons.
Taxwise, there can be benefits to setting up an entity, depending on your circumstances, but it is rarely a driving force in and of itself for most small businesses. The most common one people ask about deals with reducing self-employment taxes for the owner of an S-corporation. There are ways this can be successful, but it is an issue that is in jeopardy of being eliminated. It also has the drawback of possibly reducing your future Social Security benefits – although our government will probably beat you to the punch on that one anyway.
If you read this article and think, gee, I am not sure I really need the entity I have – do not just ignore the entity and pretend it doesn’t exist anymore! Besides getting the proper tailored advice for you, you generally must properly dissolve it, or you will be plagued with continuing mandates for tax returns as well as Franchise Tax fees to California. (There are limited circumstances where you can just walk away.)
In summary, get competent advice from an accountant and an attorney in light of YOUR facts and circumstances before jumping into an entity. And question its necessity if you are small or if your business has low or moderate inherent risk and you have access to insurance that could protect you sufficiently.
Prior articles are republished on my website at www.tlongcpa.com/blog.
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.
Relief if You Paid Tax on a Short-Sale 2011-2013
Filed under: Foreclosures and Short-Sales, Residence Sale | Tags: 580(b), 580e, anti-deficiency, Barbara Boxer, California, cancellation of debt, Chief Counsel, debt, exclusion, Foreclosure, Franchise Tax Board, FTB, Internal Revenue Service, IRS, nonrecourse, principal residence, qualified debt, qualified principal residence indebtedness, recourse, refund, section 121, Senate bill 458, Senate bill 931, Short-Sale
Leave a comment Originally published in the Cedar Street Times
February 21, 2014
Hopefully we are nearing the end of the short-sale and foreclosure saga that has continued since 2008. My litmus test based on tax return filings is indicating that things are much closer to being back on track. Prior to 2008, it was all about 1031 exchanges. Those turned off like a faucet when the markets crashed, and then short-sales and foreclosures took center stage. I have seen those tapering off over the last couple years, and I am starting to see 1031 exchanges again. The cycles continue!
But before we leave short-sales and foreclosures in the dust, there is a possible silver-lining handed down by the IRS and FTB in the last few months. Taxpayers that generated income tax as a result of a short-sale in California on their principal residence, retroactive to January 1, 2011, may be entitled to a refund.
California Code of Civil Procedure Section 580b has been dubbed California’s “anti-deficiency laws” for years. It had a positive effect on homeowners because it basically said if you had never refinanced your home and you lost it in a short-sale or foreclosure that you could not be pursued for the balance you still owed (the deficiency), and the remaining debt would not be taxable income to you because the debt was considered nonrecourse debt.
This, however, left many people out in the cold that had refinanced. Suddenly, it was a different ball game if you had done a refinance (and who didn’t during the run of good years up through 2007!?), and the debts were then allowed by lenders to be treated as recourse debts and they could pursue your personal assets. Alternatively they could cancel the debt if it was not worth pursuing, leaving you with taxable income for the amount cancelled.
Congress stepped in (and California generally conformed) during the housing crisis and enacted favorable legislation which said you could exclude cancellation of debt income generated by your personal residence. The catch, however, was that the debt had to be “qualified debt.” In short, if you lived off the equity in your house by refinancing to pull cash out and did anything with it other than improve the property, then you were not eligible for the exclusion on that portion and would still have to pay tax.
Then, a few years ago, California passed Senate bills 931 and 458 which were codified into law as California Code of Civil Procedure Section 580e as of January 1, 2011. This resulted because some unscrupulous lenders were entering into short-sale agreements to allow sellers to go through with the sale of their property for less than the amount owed to the bank, but then still pursuing the seller for the remaining debt after the fact (often a big surprise to the seller). California’s enactment of this law was good news for homeowners because it basically said, even if you had refinanced, but had entered into a short-sale agreement with a lender, then you could not be pursued for the remaining balance owed and that lenders would basically have to cancel the debt. Of course, cancelling the debt could mean tax was owed, but that was still better than being pursued for the remaining balance!
Finally, in November 2013 a letter from the Office of the Chief Counsel at the IRS written to Senator Barbara Boxer, due to an inquiry from her, stated that the IRS would treat any debt pursuant to California’s 580e as nonrecourse debt! The Chief Counsel’s office at California’s Franchise Tax Board followed up with their own letter a month later saying they will conform to the IRS interpretation.
This means that anyone who filed a tax return in 2011 or 2012, or even this year, and reported cancellation of debt income related to the short sale of a principal residence, should consider filing an amendment for a possible refund. It is still possible to have income tax, primarily if you did not live in the house for two of the last five years prior to your short-sale. The reason is that when a home is disposed of with nonrecourse debt, the total amount of debt outstanding at the time of the short-sale becomes the sales price of the home. You then subtract your cost basis, and the difference is your gain on sale. However, if you lived in the home for two of the last five years, then you get a $250,000 gain exclusion for filing as a single status, and $500,000 gain exclusion if married filing jointly, pursuant to IRC Section 121.
You need to act on this during the next year if your short sale was in 2011 as the statute of limitations expires three years after filing.
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.
Aren’t All Tax Returns Created Equal?
Filed under: General, Switching Preparers | Tags: Attorney, bond, California, California Tax Education Council, Certified Public Accountant, commodity, continuing education, CPA, CRTP, CTEC, CTEC Registered Tax Preparer, EA, Education, Enrolled Agent, exam, H&R Block, Jackson Hewitt, Liberty Tax Service, license, Registered Tax Return Preparer, requirements, RTRP, tax returns, TurboTax
Leave a comment Originally published in the Cedar Street Times
February 7, 2014
There is a belief by many people that a tax return is a bit of a commodity – basically you are going to get the same results no matter if you or anybody else prepares the return. If that were true, your only goal would be to find the absolute cheapest tax preparer in town (or do it yourself).
A number of years ago Money magazine used to annually send out the same hypothetical family’s tax return to be prepared by 45-50 tax preparers across the country. The surprising result was that it was rare in any year to have even two tax returns prepared the same way. The most recent one that I could find resulted in only 25 percent of the preparers coming within $1,000 of the theoretical correct answer. That means 75 percent missed the mark by more than $1,000. This certainly speaks to the complexity of the tax code, and why you really need to have someone with as much relevant experience, education, and training as possible to navigate the tax terrain. You may think you are being savvy by saving $200-$300 by getting a deal on your tax preparation, but what did you get? Maybe you overpaid your tax by a $1,000 in the process of saving $300. And how would YOU ever know.
When it comes to hiring someone to prepare your returns, credentials are not everything, but they certainly are a measuring stick of the education, training, testing, and commitment required. Here are your options:
Do-It-Yourself Software (i.e. TurboTax) – Tax software, whether for professionals or amateurs is certainly a requisite tool to bring any measure of accuracy or efficiency to preparing a tax return. Computers are quick at math and very accurate at crunching numbers (that is the part that is “guaranteed” to be accurate by do-it-yourself software providers), but if you provide the wrong input, or your software is not even programmed to ask you or accept all the variables you might need, then you will get a wrong answer every time (that part they don’t guarantee).
In addition, without an understanding of the forms and tax law, you will have no idea if there is a glaring error staring you in the face when you are ready to submit the forms. I have seen countless returns butchered through the use of tax preparation software over the years. I am currently amending three years of tax returns for a family that overpaid their taxes by $1,000 a year for the past twelve years due to a simple mistake that the software was not able to point out to them. Unfortunately the statute of limitations has run out on the first nine years and they cannot get a refund at this point.
RTRP -“Registered Tax Return Preparer” – This is the current basic credential required by the IRS to prepare tax returns for pay. There is no formal high school or college education required, no professional class and exam process to become licensed, and no continuing education requirement. You just pay $65 to the IRS and you can prepare tax returns professionally! This designation was created in the last few years with the intent of having a basic exam and some continuing education, but the testing and education requirements have been put on hold pending legal challenges to the requirements. RTRPs have limited practice rights before the IRS.
CRTP – “CTEC Registered Tax Preparer”– (CTEC stands for CA Tax Education Council) – This is the current basic credential required by California to prepare tax returns for pay. Again, there is no formal high school or college education required. There is a 60 hour professional class (equivalent to three or four semester units in college – one class) that is offered by many providers in person, on the internet or by self-study with an exam on the material covered. There is 20 hours of continuing education each year, and a $5,000 bond. This is the license that the vast majority of preparers hold in California at chains such as H&R Block, Liberty Tax Service, and Jackson Hewitt. CRTPs also have limited practice rights before the IRS.
EA – “Enrolled Agent” – This is the highest of the two designations offered by the IRS, and EAs can practice in any state. Again there is no formal high school or college education required, and there is no required professional class (although an intensive prep course is generally taken). There is a 10.5 hour proctored three-part exam with 100 question each – one on individual, one on business returns, and one on practice procedures and ethics with essentially 24 hours of continuing education each year. EAs have unlimited practice rights before the IRS.
CPA – “Certified Public Accountant” – Licensed by each state (although there is reciprocity to practice with nearly every state now). California requires a college degree with 150 semester units (five years) including 24 semester units of accounting and 24 semester units of business related courses in taxation, economics, finance, management, etc., 10 semester units of ethics, and another 20 semester units of accounting studies which a masters of taxation or masters of accountancy would satisfy. You must then work for a year under the direct supervision of a CPA. If you want to be able to sign audit reports, you have to have 500 supervised audit hours. You must also pass a 14 hour proctored four-part national exam and then a CA ethics exam. California also requires a LiveScan background check and fingerprinting of all applicants. There is essentially 40 hours of continuing education required each year for California CPAs. CPAs have unlimited practice rights before the IRS. Although CPAs are trained in, and can do a lot more than just your tax returns, most small CPA firms focus on tax preparation.
Attorney – Licensed by each state. We won’t discuss the requirements to become an attorney, as attorneys rarely prepare tax returns. Some attorneys that specialize in tax will prepare tax returns, although most of those are focused on estate tax returns. Attorneys that do prepare tax returns will often have obtained a CPA license also. Attorneys have unlimited practice rights before the IRS.
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.
New Tax Impacts for Trusts with Capital Gains – Part II
Filed under: Trusts and Estates | Tags: $11950, 1040, 3.8%, B trust, beneficiary, bypass trust, California, Capital Gains, dividends, gifting trust, income, income beneficiary, interest, irrevocable trust, IRS, lawsuit, net investment income, principal, private, remainder beneficiary, revocable living trust, revocable trust, Social Security Number, tax, Uniform Principal and Income Act, UPIA
Comments (1) Originally published in the Cedar Street Times
November 15, 2013
Two weeks ago I laid the groundwork of some of the basics on revocable and irrevocable trusts in order to start discussing new implications due to law changes in 2013. Revocable trusts such as the common revocable living trust most people use for estate planning is disregarded for tax purposes as separate from the owner – in other words all of the income generated by its assets gets reported on your personal 1040 tax return. Irrevocable trusts, such as a bypass trust commonly used in estate planning, or a gifting trust, are treated as separate tax paying entities, get their own taxpayer identification number, and file their own tax returns.
In early 2013 new laws were passed that increased the personal income tax rates from 35 percent to 39.6 percent on people in the highest tax bracket ($400,000 filing single or $450,000 married filing joint). It also raised the capital gains rate to 20 percent for these same people (up from 15 percent). In addition, a new 3.8 percent Medicare surtax is assessed on net investment income (think interest, dividends, capital gains, among others) for people making over $200,000 single or $250,000 filing joint. Most people do not make $450,000 or even $250,000 a year, so this seems innocuous to many.
However, many people making less than these thresholds do have irrevocable trusts – most commonly after a spouse has passed away. The problem with irrevocable trusts is that the thresholds to be impacted are so much lower. Once your trust has just $11,950 (2013) of income, you have hit the top bracket and will be subject to the 39.6 percent income tax rate, 20 percent capital gains rate, and the 3.8 percent Medicare surcharge! One stock sale could easily put you in the top bracket! This effectively means an 8.8 percent tax increase on capital gains and 4.6 percent to 8.4 percent increase on other types of income. That is a big hit every year, and will be something new to battle.
If you can avoid having the income taxed to the trust, and instead have it distributed out and taxed to the beneficiaries, you can probably save a chunk of taxes since it will be taxed at the lower rates on the beneficiary tax returns – assuming your individual beneficiaries are not in the top tax bracket!
Whether or not you have discretion or are required to distribute income to beneficiaries is defined in your trust document. Even the very definition of “income” itself, for trust accounting purposes, is governed by your trust document primarily and the state’s principal and income act, secondarily. The proper allocation of income and expenses to trust accounting income or principal is very important to beneficiaries (whether they realize it or not), since trust accounting income generally goes to one beneficiary, and the principal often goes to a different beneficiary down the road…so it determines the amount the beneficiaries receive. Many common irrevocable trusts are written to require the distribution of trust accounting income each year to the current beneficiaries with rights to dip into principal as needed to maintain an ascertainable standard of living. Upon death, the remaining principal goes to the remainder beneficiaries.
The California Uniform Principal and Income Act does not define capital gains as income, but as a principal transaction – basically an asset changing form – for instance from real estate to cash. I hardly ever see trusts that even mention capital gains, much less defining it as a part of income. In the absence of trust language, the principal and income act governs, therefore many trusts in California are not permitted to distribute capital gains to the beneficiaries.
It is amazing to me how many trust tax returns I have seen over the years that violate this – often because the preparer does not really understand trust taxation rules. I have even run into cases where the prior preparer has never even asked for the trust document, and thus relies on the default settings in their tax software in conjunction with “the way we’ve always done it” to govern! This would be analogous to creating a detailed shopping list and asking your neighbors to go shopping for you; in lieu of taking your list, they go on the internet and print out a list of common things people buy, and then supplement it with things they have bought for other neighbors in the past! Chances are pretty good; you will not get what you need! Enforcement of correct trust income tax preparation comes much more often by threats of lawsuit against the trustee than by IRS audit. Keep in mind the remainder beneficiary’s attorney would be happy to sue the trustee for shorting his client’s share by not following the terms of the trust.
In two weeks we will conclude our discussion.
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.
Rental Property Outside CA: LLC Options and Issues – Part I
Filed under: California, Rental Property | Tags: $800, Arizona, CA, California, corporate formalities, double taxation, Franchise Tax, liability protection, LLC, Nevada, New Mexico, rental property, Texas, Wyoming
Comments (1) Originally published in the Cedar Street Times
June 28, 2013
A lot of Californians find themselves with rental property outside the state at some point in their lives. Sometimes it is from a past life in another state, or from an inheritance when a parent passes away. Military folks often jog around the country collecting houses like refrigerator magnets from each state in which they have lived. There are also a lot of people that invest in rental properties in Nevada, New Mexico, Arizona, and Texas because you actually have a shot at a positive cash flow situation right out of the gates, unlike California. And then there is the Hawaiian contingency that buy investment properties that always need at least two to four weeks of maintenance work done by the owners each year – not sure if I want one of those with all that work – it’s funny, I never hear of clients having to go to Phoenix for a month in the summer to work on those properties.
Anyway, the question always arises about whether or not to form an entity such as a corporation or Limited Liability Company (LLC) to hold the real property. An LLC is generally the preferred vehicle to hold real property for many good reasons, including liability protection for your personal assets in the event you are sued, and the elimination of double taxation that can plague corporations. They also have less formalities to follow compared to a corporation and avoid some nasty pitfalls of corporate tax rates and structure that could cause a lot of pain upon sale of the property.
As a result, a lot of people these days do hold property in LLCs. Of course this comes at a price. If you create an LLC in California (or a corporation for that matter) to hold your property, and are therefore granted the privilege of doing business in California, you are also granted the privilege of paying California a minimum $800 franchise tax each year. You also have to pay someone like me to file another tax return every year, and you have to keep better books. Don’t forget you have to hire an attorney to set it up initially for another $1,500 to $3,000.
I would not recommend an online filing company or do-it-yourself approach, as you are not getting any legal advice and have no one keeping you on track with formalities which could completely blow the liability protections and the whole reason you went to all the effort in the first place. Correcting or trying to close ill-formed or mishandled entities can be a real pain as well.
So what if you form your LLC in another state such as Texas or Wyoming to hold your property? Many states have much lower or no annual LLC fee and they have simpler annual filing requirements. (You generally do not have to form the LLC in the state where the property is located.) Could you save some dollars by setting up your LLC in another state? In two weeks we will discuss California’s current position on non-California LLCs and some new rules that are just coming into play. If you have a non-California LLC, you do not want to miss the next installment.
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 MyFTB Account
Filed under: California | Tags: 1099s, access, Account, adjustments, balance owed, California, credit cards, direct bank transfer, FTB, installment agreement, interest, MyFTB, online, pay your balance, payments and credits, Penalties, tax withholdings, www.ftb.ca.gov
Leave a comment Originally published in the Cedar Street Times
June 14, 2013
Clip this out and save it in your tax file…did you know you (or your authorized tax professional) can get easy, instant, online access to a wealth of information about your California tax account as an individual or a business?
One of the most common issues I use this for as a professional is to confirm estimated tax payments when a client is uncertain how much they paid throughout the year. This can often save a lot of time searching through bank statements or checkbooks. Of course, the best practice is to track the information yourself to make sure the Franchise Tax Board (FTB) posted it to your account, but sometimes life does not fit within a nice, square box. To the credit of the FTB, I have found they do a pretty good job of tracking estimates paid, however, so I feel it is pretty reliable.
You can also see the past four years of your wage and California tax withholdings reported to the FTB by your employers. This would be great if you misplaced a W-2 and could not get access to it for some reason. If the FTB issued any 1099s to you for tax refunds or interest income, you can see that information for the past three years as well. Another feature is the ability to look at a summary of the core information of your tax returns for the past ten years such as total tax liability, taxes withheld, payments and credits, plus any interest, penalties, or adjustments made on the account. The system will also tell you if you have any outstanding balances still owed from the past ten years.
Besides historical tax reporting information you also have the ability to perform a variety of functions. For instance, you can change your address and telephone number, or you can check on the current status of your refund. You can also pay your tax balance or make estimated payments via direct bank transfer, Western Union, or credit cards (a fee applies for credit card payments). So no filling out vouchers and making unnecessary trips to the post office, and you have instant confirmation that the funds have been credited.
There are also quick links to key information on topics like penalties, interest, common fees, etc., as well as links to common forms to fill out and mail in such as applying for an installment agreement if you owe tax. Hopefully, some of these other processes will become automated online in the future as well. Another nice feature is that you can sign up for e-mail reminders to pay your estimates, for example.
To gain access to this information, you can set up an account online at http://www.ftb.ca.gov. Look for the link to “Access MyFTB Account” and click “Register.”
As telephone hold times seem to get longer and longer, having access to more information online is definitely handy. There are a lot of areas I could criticize the FTB about, but I think this is definitely a positive service they are providing. It also functions pretty much like any other commercially designed site online. I only wish the IRS had something as user friendly! They do have an electronic system for tax professionals to gain access to information, but I think it was designed when dinosaurs roamed the earth.
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.
Health Savings Account – Your Tax Friend
Filed under: Healthcare Costs | Tags: 213(d), beneficiary, California, custodian, estate, family plan, Flexible Spending Arrangement, FSA, HDHP, health savings account, healthcare, high deductible health plan, HSA, individual plan, itemized deductions, Medicare, nonqualified expenses, ObamaCare, out-of-pocket, qualified medical expenses, RMD, spouse
Leave a comment Originally published in the Cedar Street Times
May 17, 2013
Perhaps you remember a time when you thought you would get a nice fat tax deduction because you spent thousands of dollars on health care costs that insurance did not cover, only to realize you got nothing out of the deal? The cause that lead to this depressing realization was either because you did not meet the threshold for medical expenses, based on a percentage of your adjusted gross income, or even if you did, you still did not have enough itemized deductions to get you over the standard deduction.
As of January 1, 2013, that threshold was raised even higher – now 10 percent of your adjusted gross income (7.5% for another three years for people over 65). For most people this would generally mean if you make $100,000, you get no benefit for the first $10,000 of medical expenses.
A health savings account is a fantastic option which basically allows even people taking a standard deduction to effectively get a tax deduction for much, if not all, of their out-of-pocket medical expenses. There is also no “use-it-or-lose-it” clause such as can be found in the less flexible “Flexible Spending Arrangement” (FSA). Qualified medical expenses for HSA purposes used to be a broader definition than medical expenses in IRC section 213(d) used for itemized deductions, but a few years ago it was essentially unified.
Eligibility to open a health savings account is dependent on whether your health plan qualifies as a high deductible health plan (HDHP). For 2013, an individual plan must have a minimum deductible of $1,250, and $2,500 for a family plan, among other requirements. The premiums for high deductible plans are much lower (but shop around!) since you are paying a good chunk of the first-dollar costs – just like car insurance deductibles.
You then open a checking account with a company that provides custodial health savings accounts and contribute money to this account. Any contributions to the account lower your taxable income in the year of contribution, just like contributing to an IRA. Then you in turn use that account to directly pay all your qualified medical expenses (as well as spouse or dependent expenses) with a checkbook or debit card. With the savings created by lower health insurance premiums you should already have some money to contribute to your account. For 2013 you can contribute up to $3,250 for a single plan or $6,450 for a family plan (add a thousand to those figures if you are over 55).
Whatever you do not use stays in your account for the future, and you can keep contributing each year. If you never use it, you can take it out and use it for whatever purpose you want with no penalty after age 65. It would be taxable income, however, if not used for medical purposes. If you use it before age 65 for nonqualified expenses, there is a 20 percent penalty, plus it is taxable income.
Some people even view an HSA as another way to stuff a few more dollars into a “retirement plan,” but without the requirement to have earned income, plus the benefit of not having to take minimum distributions by age 70 1/2. If you are enrolled in Medicare, however, you can no longer contribute. Some custodians also allow you to link the account to an investment firm and then invest the money in stocks, bonds, mutual funds, etc.
If you pass away and your spouse is named as the beneficiary, your spouse steps into your shoes and becomes the new HSA owner. If it passes to your estate, it becomes taxable income included on your final 1040 tax return. If it passes to any other beneficiary, the HSA becomes taxable income to the recipient except for medical expenses paid within one year after death. One other tidbit of information – the State of California does not conform to Federal legislation regarding HSAs, so you receive no deduction for contributing to an HSA account and any income generated by the funds is taxable for California purposes.
Many companies have been switching to these plans over the past five or six years due to the savings in premiums, and many of the companies pass some of the savings back to the employees by contributing to the HSA account.
At this point, it looks like HSAs will still exist under ObamaCare, and could conceivably become even more popular if ObamaCare does not pan out and insurance rates keep rising. HSA plans have been found to lower the consumption of healthcare services since they do place an economic incentive for consumers to find lower cost options since the consumers pay for 100 percent of the care up to the deductible. Plans that shelter the consumer from any cost at all do not provide this incentive.
However long they stay around, HSAs certainly are a great option for many people today.
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.
Military Taxation in CA Part II – Nonresidents
Filed under: California, Military | Tags: California, domicile, military, Military Spouses Residency Relief Act", MSRRA, nonmilitary, nonresident, PCS, Permanent Change of Station, residency, Servicemember Civil Relief Act
Leave a comment Military Taxation in CA Part II – Nonresidents
Originally published in the Cedar Street Times
February 22, 2013
Two weeks ago I laid the groundwork for important definitions related to taxing military servicemembers. I also discussed how servicemembers are taxed just like California residents if their domicile is California, and they are stationed in California. If a member whose domicile is California has a permanent change of station (PCS) outside of California, they are considered nonresidents. Under California law, nonresidents are not taxed on their military income or intangible income such as interest and dividends. They would also not be subject to taxation on military income in the other state either due to the federal Servicemembers Civil Relief Act which prohibits another state from taxing a servicemember’s military income while domiciled in another state.
Due to the Military Spouses Residency Relief Act of 2009 (MSRRA), spouses that go with the military servicemembers now receive similar treatment and their earnings from personal services and intangible income such as interest and dividends are exempt from tax. In the past they had to file as residents whenever they met the requirements of wherever they were physically living. This act applies to all military servicemembers’ spouses regardless of domicile or station as long as both spouses have the same domicile. This is a very important distinction. And you cannot simply adopt your military spouse’s domicile.
If the military spouse was domiciled in Texas, for instance, and then gets married in another state, the new spouse cannot claim Texas unless he or she actually lives in Texas and takes proper steps to make it his or her domicile. They could both claim the same domicile in the state they are living at the time, but that may be undesirable if that state has unfriendly military tax laws. Regardless, until both spouses are able to claim the same domicile, the coveted provisions of MSRRA generally do not apply.
Another interesting twist to watch out for is if a California domiciled servicemember gets PCS orders to another state and the spouse stays in California. In this case, all of the spouse’s income is now taxable to California as well as half of the military servicemember’s military pay and interest/dividends, etc. as community property of the spouse!
All the same rules apply to servicemembers whose domicile is in another state but are stationed in California, except they would look to their own state of domicile to see how that state may tax or exempt its servicemembers for its own state tax purposes. California, however, would not be able to tax the servicemember or the spouse (assuming they have the same domicile). The most common places I see for military domicile are Texas and Florida: neither has a state income tax. This way, whether they are stationed in their own state of domicile or elsewhere, they have no threat of paying state income taxes.
It is also important to know that the military servicemember’s nonmilitary income would still generally be subject to taxation wherever it is being earned,and so would items like rental property income. Many military people own homes in multiple states. They should be aware they may have to file a tax return in those states. Depending on the state, some people may need to file state returns even if the property produces losses every year which create carryovers to be utilized when the property is sold.
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.
Military Taxation in CA Part I – Domicile, Residency, and CA Residents
Filed under: California, Military | Tags: California, domicile, home of record, military, nonresident, PCS, Permanent Change of Station, residence, residency, resident, service members, servicemember, servicemembers, SLR, state of legal residence, taxation, temporary or transitory
Leave a comment Originally published in the Cedar Street Times
February 8, 2013
Here in this little part of California that some call heaven, we have a number of military related institutions drawing servicemembers from around the world. The next few articles will focus on military taxation in California.
The first thing we need to do is define a few important terms.
Home of record is a term that indicates the place you were living when you entered the military, and cannot be changed. This generally does not affect taxation, but can affect benefits.
Your residence is the place you are physically living.
State of legal residence for military purposes is typically synonymous with domicile to be discussed next. Do not confuse this with legal residence which you see on many non-military legal forms indicating a desire to know your residence address as opposed to your mailing address!
Domicile is the place that you consider your permanent home; if you are living away from your home, it is the place you would return to after being absent for temporary or transitory purposes (or away on military orders). It is usually the place you are registered to vote, have your bank accounts, have your driver’s license, register your vehicles, perhaps still own a home and store personal items, etc. You have the option of changing your domicile by making convincing changes to items such as the above, but you generally have to be present in the state at the time, show that you have abandoned your prior domicile, and notify the military of this change.
Residency more closely determines how you are to be taxed, but is affected by domicile. For a civilian, residency is a term given if someone is in California for other than a temporary or transitory purpose (generally nine months or more), or conversely someone whose domicile is in California but out of the state for temporary or transitory purposes.
For a military servicemember, residency is even more closely tied to domicile. A military servicemember whose domicile is California is considered a resident if stationed in California, and a non-resident if stationed elsewhere due to Permanent Change of Station (PCS) orders (not temporary orders regardless of duration). A military servicemember whose domicile is outside of California but that is stationed in California is considered a non-resident unless he or she works to change his or her domicile to California. Most people are trying to get out of California taxation, so I rarely see military people changing their domicile to California!
Now let’s start to talk about what this means for tax purposes, including how it affects spouses. Based on the above definitions we will start with those that are considered California residents (again, those that are domiciled and stationed in California). It is pretty straight-forward: these individuals are taxed on all their income including their military income. The spouse will generally also be considered a resident and will be taxed the same, unless the spouse is also a military servicemember, and has a different domicile. That spouse would then be a nonresident and taxed differently.
In my next column in two weeks, we will begin talking about nonresident military personnel, which accounts for the majority of servicemembers living in this area.
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.
Retroactive Tax Increase on Highest Taxed State
Filed under: California, Tax Rates | Tags: Alabama, Alaska, California, Dakota, Florida, Hawaii, high tax state, Iowa, Louisiana, Mississippi, Montana, New Jersey, New York, Oregon, proposition 30, South Carolina, Tax rates, Tennessee, Texas, Vermont, Washington D.C., Wyoming
Leave a comment Originally published in the Cedar Street Times
November 30, 2012
Depending on how you look at it, Californians could now consider themselves the highest taxed state in the U.S. after our recent passage of Proposition 30 on our November ballots. Proposition 30 increased income tax rates by one to two percent on people earning over $250,000. It also made these increase retroactive as of 1/1/2012. If you are subject to these higher tax rates, be aware that your state withholdings are likely inadequate and you should talk to your tax professional about making an additional payment by April. No penalties will be assessed for under withholding to the extent that it is attributable to the tax hike, and you pay it by April 15, 2013.
Our top rate on our highest earners is now 13.3%, commanding an impressive 2.3% margin over second place Hawaii (11%), and 3.4% over third place Oregon (8.9%). Other states in the high eights include Iowa, New Jersey, Washington D.C., Vermont, and New York.
You do have to keep in mind that some places have city taxes also. But even a penthouse occupant in New York City that has a state tax of 8.82% and a city tax of 3.876% (combined 12.696%) would not have to muster up the cash of a wealthy dessert dweller in California.
Of course, there are many ways that states bring in revenue, such as sales tax, property tax, inheritance tax, auto taxes, etc. So you cannot really base overall tax burden on income taxes alone. If you are looking for overall low tax burden states you may wish to consider Wyoming, Alaska, Florida, the Dakotas, Montana, Texas, Tennessee, Mississippi, South Carolina, Louisiana, or Alabama. Different states also have distinct advantages for people earning different types of income or have different types of deductions. The more you have at stake, the more tax planning may become a factor in where you choose to reside.
If you want to know more specifically how California’s new increases may affect you, here are the details: California taxable income over $250,000 for single filers, $500,000 for married filers, and $340,000 for Head of Household filers will be taxed at 10.3%. Taxable income over $300,000 single, $600,000 married, and $408,000 HOH will be taxed at 11.3%. Taxable income over $500,000 single, $1,000,000 married, and $680,000 HOH will be taxed at 12.3%. And anyone with over $1,000,000 taxable income will also be assessed an additional 1% mental health tax.
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.
Travis H. Long, CPA, Inc. Blog 