Archive for the ‘itemized deductions’ Tag
Back to Basics Part XXXIII – Form 8889 – Health Savings Accounts (Cont.)
Filed under: Back to Basics, Healthcare Costs | Tags: beneficiary, custodian, death, directly paid, estate, Form 8889, health savings account, HSA, itemized deductions, medical expenses, nonqualified distribution, over 65, prohibited transactions, qualified distribution, reimbursement, Schedule A, Section 4975, self-dealing, separate HSA accounts, spouses
Leave a comment Originally published in the Cedar Street Times
February 19, 2016
Two weeks ago we started a discussion on Health Savings Accounts. We discussed why they are so valuable, how you qualify for an HSA, what type of an account it is, how you contribute to it, whether or not you can fund it with an IRA transfer, and what you can spend the money on and for whom. If you would like to read the article, you can find it on my website at www.tlongcpa.com/blog .
Do Expenses Have to Be Paid Directly From the HSA?
Another important tip is that technically you do not have to pay the medical expenses directly from the HSA account. You can reimburse yourself if needed. In fact, you can reimburse yourself at any point in the future from your HSA account for qualified expenses that were incurred at any point after you first established the HSA. It could be ten years later or more, and you can still reimburse yourself as long as you keep really good records, and can prove you did not deduct those expenses somewhere else, such as on Schedule A, or pay for them out of the HSA account in the past. Then you can reimburse yourself for them in the current year and treat the reimbursement as a qualified distribution, and not be subject to any tax or penalties.
This could come in very handy if some year you have a big expense, but do not have enough money in the account to cover it all. You could pay yourself back over a period of years. Remember, by paying the expenses out of this account, you have been able to use pretax dollars to pay for or reimburse yourself for medical expenses you incurred. That said, I would recommend always paying directly from the HSA account unless it is impossible to do so.
Should Spouses Have Separate HSA Accounts?
Here is an important pointer, if you have family coverage, you should consider setting up an HSA account for each spouse. You can only make the additional contribution for your 55 plus spouse if he has his own HSA account. There are a few other advantages to having separate accounts as well. As mentioned before, people over 65 can pay their health insurance and Medicare premiums out of their HSA, unlike people under 65. They can also pay these expenses for their spouse, or dependents, if each is over 65. However, if you were under 65 and were the only HSA account holder, and your spouse or dependent was over 65, you would not be able to pay the premiums. You would need your 65+ spouse to have an HSA account and have money in it in order to pay the premiums. You also cannot transfer money from one spouse’s HSA account to another. So you need to contribute over the years to each spouse’s account in order to prepare for this.
Another advantage of each spouse having an HSA account is for the payment of long-term care insurance. It is clear that if each spouse has an HSA, they can each pay their respective long-term care insurance subject to the normal caps. Without separate accounts, the instructions to the Form 8889 seem to imply you cannot take the deduction for a spouse.
What Happens When I Pass Away?
When you pass away, your spouse can take over the account and use it like his or her own. However, if it is left to a beneficiary other than a spouse, or is undesignated and goes to your estate, then it is considered an immediate distribution, and the entire balance is included in taxable income. It is not, however, subject to the 20 percent penalty tax. Whoever is the named beneficiary and receives the HSA money, pays the tax. If an estate receives it, it is taxable income on the decedent’s final 1040. If some other person receives it, then it is taxable to that person’s 1040. If any final medical expenses are paid from the account within one year of death, those would be qualified distributions and reduce the taxable portion.
Any Pitfalls?
Be alert to prohibited transactions covered by IRC Section 4975 – these are basically self-dealing transactions where you or someone or an entity related to you receives a special benefit in some way from the account. For instance, if you could borrow money from the account, that could be self-dealing. Fortunately, the custodian buffer will prevent you from doing a lot of things that might happen otherwise, but there are still some things you could do that would be considered self-dealing that the custodian would not know about. For instance, if you named your HSA as collateral for a personal loan. That would be a prohibited transaction, and the entire balance would be deemed distributed immediately, and it would trigger taxable income and a 20 percent penalty on the entire balance.
Form 8889
The Form 8889 itself is a fairly simple two page form. Part I deals with determining your current year deduction for contributing money to the HSA, and making sure you did not overcontribute. You add up the contributions from yourself, your employer, plus contributions to any MSAs which count toward the HSA cap, plus if you happen to do a once in a lifetime rollover from your IRA, that would get added in as well.
Part II deals with the distributions from the HSA. Here you essentially list the total distributions, and then subtract any rollovers to other HSA custodians, and subtract any qualified medical expenses. Anything left over would generally be a nonqualified distribution subject to the 20 percent penalty unless one of the exceptions applies – turning 65, becoming disabled, or passing away.
Part III calculates the penalty for overcontributing due to changes in your health insurance coverage status.
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. This article is for educational purposes. Although believed to be accurate in most situations, it does not constitute professional advice or establish a client relationship.
Back to Basics Part XXII – Form 6251 – AMT
Filed under: Back to Basics | Tags: 6251, adjustment, Alternative Minimum Tax, Alternative Minimum Taxable Income, AMT, AMT patch, AMTI, depreciation, employee business expenses, ESPP, home equity debt, investment advisory fees, ISO, itemized deductions, minimum tax credit, mortgage interest, parallel, preference, real estate taxes, standard deduction, state taxes, Tentative Minimum Tax
Leave a comment Originally published in the Cedar Street Times
September 4, 2015
AMT, or “Alternative Minimum Tax” was enacted in 1969 in response to a disturbing report by the Secretary of the Treasury that 155 taxpayers with adjusted gross incomes over $200,000 paid zero tax on their 1967 tax returns.
In its simplest form, AMT is a separate taxation system with its own set of rules that runs parallel to the regular tax system. You are supposed to run the calculations under both systems, and if the AMT system says you owe more tax than the regular system, then you pay the incremental difference as “AMT.” That incremental difference shows up as additional tax on Line 45 (2014) of your Form 1040. The calculation of AMT is summarized on Form 6251 and accompanying worksheets, as well as AMT versions of traditional schedules.
The irony of the AMT system is that most of the loopholes it was originally designed to prevent, no longer exist, and it has become a tax that affects the middle and upper-middle class more than the wealthy, yet we still have it and all of its complications. Today, those who are subject to it, despise its existence, and not many people fully understand it, tax practitioners included.
For people still preparing returns by hand, AMT is an absolute nightmare since many of your other schedules have to be calculated a second time using AMT rules. For instance, depreciation rules differ between the AMT system and the regular system, as accelerated depreciation methods are generally not allowed. This means you have to keep an entirely separate set of depreciation schedules just for AMT. And to make matters more complicated, California does not conform to all of the Federal AMT rules either. So now you end up with four sets of depreciation schedules – Federal regular, CA regular, Federal AMT, and CA AMT.
I do not think I have ever seen a hand-prepared return done correctly when AMT is involved. (Actually, in the last ten years, I do not think I have seen any hand-prepared returns done correctly!)
So when do you hit AMT? It depends. AMT is calculated on taxable income under about $185,000 at a flat 26 percent rate, and income over that mark at 28 percent. There is a $53,600-$83,400 AMT exemption amount depending on filing status.
Compared to the regular system, the standard deduction is thrown out (meaning itemizing is your only option), your normal exemptions for yourself, spouse and dependents get the boot, as do many itemized deductions such as state taxes, real estate taxes, mortgage interest on home equity debt (if the funds were not used to improve your home), unreimbursed employee business expenses, tax preparation fees, investment advisory fees and more.
As mentioned before, depreciation methods are not as generous, also ISOs and ESPPs have less tax-friendly rules, investment interest can be hacked, and a whole bunch of other specific differences that apply to certain situations.
Since some people will have more AMT adjustments and preferences than other people, there is no set dollar threshold that will trigger AMT. That said, I feel that I rarely see it for a Married Filing Joint return with under $100,000 of adjusted gross income. It also starts phasing out for people with high incomes. The top AMT rate is 28 percent, but has fewer deductions than the regular system. Besides a handful of lower brackets, the regular system also has 33, 35 and 39.6 percent brackets, but with more deductions. At some point, however, the higher tax rates outweigh the additional deductions and the regular system results in more tax than the AMT system. You may pay no AMT once you get to $600,000 or $700,000 of income, depending on your AMT adjustments.
People in AMT that are employees often feel trapped, especially those in the sales industry that are used to generating a lot of deductions from vehicle mileage and other expenses their employers do not reimburse. It does not matter how many unreimbursed expenses they come up with, they will all get thrown out in the AMT system.
For people that flip back and forth between years of AMT and no AMT, there can be a minimum tax credit generated by the AMT you paid that can be helpful. If you paid AMT in one year, and the next year the regular tax system is higher than the AMT system, you can get a credit against your regular tax to the extent of the difference between the two tax systems limited to the credit amount generated by certain deferral type AMT adjustments/preferences. Got it? Just trust me, sometimes it can help! There are also sometimes when flipping can be a negative…fairness is not always the result of our tax system.
The best news we have had about AMT in recent years was that in 2013 Congress finally legislated an annual inflation adjustment for the AMT exemption. For years Congress was in a habit of passing an AMT patch in late December or January to make up for the fact that the exemption was not inflation adjusted, and would return to 1993 levels if nothing was done.
Tax professionals were biting their nails some years wondering if it would happen. The impacts on middle class Americans would have been tremendous, and many were oblivious. I read estimates in 2011 that 4 million taxpayers were subject to the AMT, but without a patch that number would have swelled to 31 million! I can remember running scenarios for a family making around $100,000 and realizing they would have a surprise tax bill of an additional $2,000 or so without a patch.
The form itself is only two pages. Part I is a summary of all the adjustments and preferences that differ from the regular tax system, to arrive at Alternative Minimum Taxable Income (AMTI). Part II deals with calculating your AMT exemption, your Tentative Minimum Tax (tax calculation under the AMT system), and then the AMT itself (the amount your Tentative Minimum Tax exceeds the regular tax system amount). Part III is a supplemental calculation that feeds into Part II when your return includes capital gains, qualified dividends, or the foreign earned income exclusion.
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 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.
Back to Basics Part V – Schedule A Wrap-Up
Filed under: Back to Basics | Tags: 2%, amortizable bond premiums, business miles, casualty and theft, casualty loss, education expenses, employment agreement, Federal estate tax, gambling losses, home office, income in respect of decedent, investment expenses, IRA fee, itemized deductions, job search expenses, legal expenses, meals and entertainment, miscellaneous itemized deductions, not subject to two percent, other miscellaneous deductions, phase-out, Ponzi schemes, reimbursement plan, Schedule A, tax preparation fees, theft loss, two percent limit, union dues, unrecovered investments in annuities, unreimbursed employee business expenses
Leave a comment Originally published in the Cedar Street Times
December 12, 2014
In this issue, we are finishing our discussion on Schedule A – Itemized Deductions. Prior articles are republished on my website at www.tlongcpa.com/blog if you would like to catch up on our Back to Basics series on personal tax returns.
The fifth section of Schedule A is for personal casualty and theft losses. This is designed to help people with major losses. The deduction on schedule A is calculated by taking the amount of the loss, subtracting $100, then subtracting 10 percent of your adjusted gross income. Any amount left over will be an itemized deduction (if any). There are several ways to calculate the amount of the loss but it is generally limited to the lesser of your adjusted cost basis or the decrease in the fair market value. Sometimes appraisals are necessary to establish the decrease, but in all cases, the amount of any insurance proceeds received would reduce the loss. Another salient point is that the loss generally has to be sudden, unexpected, and permanent in nature; it is not the result of degrading over time. For instance, a car accident or theft would qualify; termite damage would not qualify. Losing something does not qualify either. Business casualty losses are not reported on Schedule A.
The next section deals with miscellaneous itemized deductions subject to two percent. This means you take all the deductions in this section, subtract two percent of your adjusted gross income, and the left over amount is your itemized deduction for this section (if any). Some of the deductions here include unreimbursed employee business expenses, union dues, investment expenses, income tax consultations and preparation, legal expenses related to your job or to the extent they deal with tax issues or the protection of future taxable income, job search or education expenses (if they relate to your current field), etc.
Unreimbursed employee business expenses are those which are ordinary and necessary and the employer expects the employee to pay for the expenses. If the employer has a reimbursement plan, but the employee simply fails to request reimbursement, the expense will not qualify. It is best if the employer has a written policy, or as part of the employment agreement, spells out what things the employee is expected to cover. Sales people can often have high deductions in this area through business miles on their vehicles and meals and entertainment for clients. If a company provides no office space for an employee and the person has an office in his or her home, deductions can be taken for that as well.
Investment expenses paid to financial advisors or even IRA fees can be deductible. Financial advisor fees must be prorated if you have taxable investment income and tax free investment income such as municipal bond interest. Only the portion allocated to taxable income is deductible. For IRA fees to be deductible, they must be paid with funds outside the retirement plan. This is preferred anyway so as not to deplete your retirement account by using IRA funds to pay the fees.
The last section of deductions on Schedule A is called “Other Miscellaneous Deductions.” These are NOT subject to the two percent of adjusted gross income floor, and the full amount become itemized deductions. These are less frequently encountered and include things like Federal estate tax on income in respect of decedent, gambling losses up to the amount of winnings, losses from Ponzi schemes, casualty and theft losses on income-producing assets, amortizable bond premiums, unrecovered investments in annuities and other items.
The final part of Schedule A is one more “gotcha.” If your income is over $305,050 for Married Filing Joint or $254,200 Single, part of your deductions begin to phase out. Medical expenses, investment interest, casualty, theft, and gambling losses are not subject to the phase out. The rest of the deductions can be reduced by as much as 80 percent! The amount is determined by taking your adjusted gross income, subtracting the above figure based on your filing status, and multiplying the result by three percent. That is your adjustment capped at the 80 percent maximum.
In two weeks we will continue our Back to Basics series with Schedule B – Interest and Ordinary Dividends.
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.
Back to Basics Part I – Overview of 1040
Filed under: Back to Basics | Tags: 1040, above the line, adjusted gross income, adjustments to income, Alternative Minimum Tax, AMT, basics, below the line, charitable contributions, childcare credit, credits, direct deposit, educator expenses, energy efficient upgrades, exemptions, filing status, first-time home buyer credit, health savings account contributions, Household employees, interest, itemized deductions, medical expenses, miscellaneous itemized deductions, moving expenses, other taxes, paid preparer, real estate taxes, retirement plan contributions, self-employment taxes, student loan interest, tax return, taxes, tuition and fees, understanding
Leave a comment Originally published in the Cedar Street Times
October 17, 2014
On Wednesday October 15, the 2013 personal tax filing season came to a close. Or at least it did for most timely filers. People who requested the six-month extension finally had to lay down their cards, or face increased penalties, and being branded delinquent by the taxing authorities. But I am sure you had your returns done long ago!
It is hard to believe that 2014 is rapidly drawing to a close, and soon we will start filing taxes all over again. This coming year, I would like to challenge you to spend some time looking at your tax returns and learning something new. I am a firm believer that everyone should have at least a basic understanding of the flow of a tax return. This document is a linchpin in your financial life. Let’s spend a few minutes talking about the big picture. You may wish to do this with a copy of a 1040 close at hand.
Tax returns can be hundreds of pages long with many supporting forms and schedules, but it all boils down to a two page summary whether you are John Doe or Warren Buffett…this is your Form 1040. Essentially, the first page lists your income, adjusted by a few preferential items leaving you with your all important “adjusted gross income.” “Below the line,” as it is known, is the second page, and lists your deductions and credits, calculates your tax, and determines what you owe or will get refunded.
Looking at page one in more detail, the top section captures your name, mailing address, and Social Security number. There is also a somewhat passe little box to designate three dollars of the tax you are already paying to the Presidential Election Campaign fund. If you want to learn more about this, I wrote an entire article on its history on April 18th. You can find it at www.tlongcpa.com/blog.
The first real section is where you designate your tax return “filing status” – single, married, head of household, etc. This is very important because it determines how much your standard deduction is and how quickly you will climb the tax brackets as your income increases. Your status is determined by rules, not choice. That said, married people do have the choice of the generally unfavorable Married Filing Separate status.
The next section deals with “exemptions.” This is where you list the dependents in your household – generally your children up through college (even if away at college). A parent or someone not even related can qualify, but they have to meet strict limiting rules. You get an exemption from your taxable income of $3,950 (2014 amount) for each of your dependents. Children under 17 may also qualify you for child tax credits which would go on page two.
The income section falls next. Wages from your job, interest, dividends, business income, rental income, sales of stock, money received from retirement accounts or plans, pensions, social security, etc.
After getting your total income figure, you then are allowed certain favorable “above the line” deductions for things like educator expenses, moving expenses, retirement plan contributions, health savings account contributions, student loan interest, tuition and fees, etc. After subtracting these adjustments, you arrive at your AGI (adjusted gross income). AGI is a key figure and is used in a lot of calculations which could affect your taxes in many areas. Above the line deductions are therefore preferable for that reason, but also because they will have a direct impact on taxable income. Below the line deductions such as itemized deductions are less certain and do not impact your AGI.
The taxes and credits section is at the top of the second page. This is where you get to subtract all your itemized deductions listed on Schedule A- things like medical expenses, taxes paid, interest, charitable contributions, and miscellaneous other deductions (like tax preparation fees!). If you don’t have many itemized deductions you get the standard deduction instead (for example – $12,200 for married status) as determined by your filing status from the first page.
Next, the number of exemptions you claimed on the first page is multiplied by $3,950 (2014) and that is subtracted out to leave you with your taxable income. Your tax is then calculated using tax tables and other rules.
With income generally in the $100,000 to $200,000 range ore more, you may also hit alternative minimum tax (AMT). In simple terms, AMT is a parallel tax system that has a different set of rules and allows less deductions. You calculate the AMT system on every return. If the AMT tax calculation yields a larger tax bill than the regular system, you pay the incremental difference as alternative minimum tax. Real estate taxes and miscellaneous itemized deductions subject to two-percent such as unreimbursed employee business expenses are common items that get kicked out in the AMT system.
Next you get to subtract any tax credits you may have. Tax credits are a dollar-for-dollar reduction of tax owed and are therefore more valuable than deductions, which only save you a fraction on the dollar. Depending on your circumstances there are credits for education, childcare, children in general, energy efficient upgrades, etc.
The next section is “Other Taxes.” There are a handful of other taxes people might incur , such as tax on taking money out of retirement plans too early, household employee taxes, repaying a first-time home buyer credit, etc. The most common, however, is self employment taxes. Business owners must pay the employer and employee side of their Social Security and Medicare taxes. After you add these taxes and determine your total tax liability, you then look at the payments section to see was has been paid in or credited to your account, and whether you will end up owing, or getting a refund.
At the bottom of the second page, you can choose things like direct deposit, or applying the payment to the following year. You can also designate a third party such as the tax preparer to be able to discuss the return with the IRS, if the IRS wants to discuss it. At the bottom, a paid preparer also has places to sign and fill out.
In two weeks we will start examining Schedule A – Itemized Deductions.
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.
Home Improvements as Medical Deductions
Filed under: Healthcare Costs | Tags: 10% floor, 7.5% floor, aesthetic, architectural, doorways, hallways, home, improvements, itemized deductions, medical deduction, medical expense, personal motivations, railings, ramps, Revenue Ruling 87-106, stairs, support bars
Leave a comment Originally published in the Cedar Street Times
September 6, 2013
Unless you have a tax favored plan such as a Health Savings Account, Flexible Spending Account or the like, you have probably found that medical deductions have generally eluded your tax returns.
The main reason for this is the floor of 7.5 percent of your adjusted gross income which your medical expenses must exceed before even one dollar becomes an itemized deduction. This floor of 7.5 percent is now ten percent starting with the 2013 tax year. If you or your spouse are 65, you get a grace period through the end of 2016 to remain at 7.5 percent. If either of you turn 65 before 2016 you will then qualify for the 7.5 percent rate for that tax year and any subsequent ones through 2016.
Due to the high threshold, many people do not even bother to track the expenses, especially, if they make a decent income. If people are close to the threshold, one common strategy is to bunch expenses into one year to get as high of a deduction as possible in that year.
Something else to be aware of, is that some improvements to your home, which can be substantial in cost, are considered medical expenses if medically required. For people in the grace period through 2016 of 7.5 percent, it would be good to think about having any of these types of improvements done before 2017 in order to yield the greatest tax benefit.
So what types of improvements can qualify as medical expenses? Well, if the primary purpose is to serve the medical needs of you, your spouse, or your dependent, then just about anything could qualify. (You should be prepared to provide supporting documentation that your healthcare provider agrees with your needs assessment.) The catch, however, is that if the improvement increases the value of your home, you have to deduct the increase in value from the amount you spent to arrive at your deductible portion.
But how in the world do you know the exact answer to that question? Short of having before-and-after appraisals prepared, it could be a bit of an arm-wrestling match with the taxing authorities if ever questioned. Fortunately, however, the IRS has come up with a list of items in Revenue Ruling 87-106 which they have agreed generally will not increase the value of your home (thus fully deductible), and they will rarely pursue if done for medical reasons. These items include installing entrance or exit ramps or lifts, regrading the land to provide access, widening doorways and hallways, modifying stairs, installing railings or support bars, lowering kitchen cabinets, moving electrical outlets and fixtures, modifying smoke alarms and other warning systems, or modifying door hardware. Other similar modifications can also be fully deductible, but are not specifically listed.
One sticky area is that additional cost to satisfy personal motivations such as architectural or aesthetic compatibility with your existing home is not deductible. In other words, if throughout your house you have ornate solid gold hand railings, and you need some additional ones installed for handicapped purposes, the IRS is only going to let you deduct what it would have cost to put in some ugly, basic aluminum railings! They don’t care about things blending in: it is purely a functional consideration. I suppose you may have a legitimate argument if a strict architectural review board refuses to allow you to build something that doesn’t blend well. I would save all documentation regarding a rejection.
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.
Home Office Part I – New Option for 2013
Filed under: Home Office | Tags: $5, 2013-13, 300 sf, 300 square feet, allowed or allowable, business use of home, carryover, carryovers, depreciation, exclusion, garbage, home office, itemized deductions, maintenance, mortgage interest, office-in-home, property taxes, recapture, repairs, Rev. Proc., Revenue Procedure 2013-13, safe harbor, section 121, self-employment, standard mileage deduction, utilities, water
Comments (2) Originally published in the Cedar Street Times
July 26, 2013
In January, the IRS issued Revenue Procedure 2013-13 which discusses a new option for calculating the home office deduction. (You may want to clip this article and put it in your tax file as a reminder.) Instead of tracking the actual expenses of operating your home office such as water, utilities, garbage, repairs and maintenance, depreciation, etc., you can now elect a safe harbor $5 per square foot of qualified office space, up to 300 square feet ($1,500). It is kind of like taking a standard mileage deduction on your car instead of tracking gas and repair receipts, and calculating depreciation expense. Unlike vehicles, however, you can switch methods back and forth from one year to the next.
There are a few interesting provisions that will make it a good option for some people, and a bad option for others. In other words, when preparing your return you will need to analyze the short and long term impacts, and determine which method is best each year. Since the $5 per square foot figure is not adjusted by region or for inflation, individuals living in high cost states like California are at a disadvantage.
If there is more than one person in the house, such as a spouse or roommate, they can each use the safe harbor as long as they are not counting the same space. If one person has more than one office in the home for more than one business, the person can either use actual expenses for all the businesses, or the person must use the safe harbor for all the businesses. However, the maximum deduction allowed is still $1,500 for all the businesses in the home combined, which may have to be allocated pro rata to the businesses based on square footage used by each. If one person has qualified home offices in more than one home, the person can use the safe harbor for one home, but must use actual expenses for the other home.
When claiming the safe harbor deduction, you are allowed to take your property taxes and mortgage interest in full as itemized deductions on Schedule A as well as claiming the safe harbor deduction. On the surface this sounds like a plus, but for self-employed individuals you are effectively converting expenses that used to be on your Schedule C reducing self-employment taxes to itemized deductions which do not reduce self-employment taxes, and perhaps do not even reduce income taxes if you do not itemize.
Another big difference when claiming the safe harbor deduction is that no depreciation expense is allowed to be taken. Traditionally, any depreciation expense taken on your home is required to be recaptured at the time you sell your house, and you must pay tax on it. Even the section 121 exclusion ($250,000 tax-free gain for single/$500,000 for married couples) when living in the house for two out of the last five years will not exempt you from recapture taxes. Occasionally that can produce negative results, but it is usually helpful because it often helps people avoid income AND self-employment tax which are typically higher than recapture rates. Nonetheless, I regularly see tax returns where no depreciation was taken on a home office, to “avoid recapture.” This is incorrect as recapture rules require you to recapture any depreciation “allowed or allowable.” It does not matter whether you took the deduction or not, you are technically still on the hook for the recapture.
One other notable exception in the 15 pages of new rules explaining the safe harbor is that carryover expenses are not allowed for safe harbor years. Ordinarily, if your business produces a loss, you are not allowed to create a bigger loss from business use of home expenses with the exception of the portion of mortgage interest, property taxes, or casualty losses which would have been allowed as itemized deductions even if you had no business. The rest of the expenses get carried over to future years until you make a profit and can use the losses. Using the safe harbor, any loss generated by the safe harbor disappears forever. You would be better off in these years using actual expenses in order to preserve the losses for the future.
At the end of the day, you might as well just continue to track the actual expenses, and let your tax professional figure out which method will give you the best benefit each year.
In two weeks, we will go over the basic requirements in order to claim a home office deduction.
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.
Your Future Tax Return: Romney Versus Obama
Filed under: General, Tax Rates | Tags: American Opportunity Credit, Buffett Rule, candidate, Capital Gains, child tax credit, corporate rates, dividends, earned income credit, Education, election, Estate Tax, FICA, foreign earnings, health insurance, HSA, income exclusions, interest, itemized deductions, Medicare, MSA, net investment income, Obama, retirement plans, Romney, student loan interest, Tax brackets, tax positions, tax-exempt interest, territorial tax system
Comments (2) 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.
