Archive for the ‘Schedule A’ 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 XXXII – Form 8889 – Health Savings Account
Filed under: Back to Basics, Healthcare Costs | Tags: 2015, COBRA insurance, contribution limit, custodial parent, dependent, disabled, distribution, divorce, earnings, exemption, health insurance, health savings account, high deductible health plan, HSA, IRA, long-term care, Medicare, penalty, rollover, Roth-IRA, Schedule A
Leave a comment Originally published in the Cedar Street Times
February 5, 2016
Why Would an HSA Be Valuable to Me?
A Health Savings Account, or HSA for short, is a fantastic vehicle to pay for out-of-pocket qualified medical expenses which insurance does not cover in-part or in-full. It effectively allows you to get a tax deduction for nearly all of your unreimbursed expenses whether or not you itemize deductions. It also works great for those who itemize, but do not have enough medical expenses to get over the 7.5 percent or 10 percent (depending on your age) of adjusted income threshold before those deductions are counted. Many people assume they are receiving a tax benefit for these expenses when they are not. Simply look at your Schedule A, line 4. If it says $0, or if you do not even have a Schedule A, you are not benefitting from your itemized medical deductions. Even if you have a number there, line three will show you how much you are getting zero benefit from due to the threshold.
How do I Qualify and What Kind of Account Is It?
In order to qualify for an HSA, you must have a “high deductible” health insurance plan. For 2015, this means you have to have a minimum annual deductible of $1,300 for self-only coverage, or $2,600 for family coverage (or approximately the cost of breathing the air in a hospital lobby). Your plan must also have a maximum annual out-of-pocket limit of $6,450 for self-only coverage or $12,900 for family coverage. If you meet these requirements, you are eligible to set up an HSA account for yourself.
An HSA account is kind of like having a checking account just for qualified medical expenses, but is shares characteristics with an IRA account. A lot of people think the accounts are married to the health insurance providers, but they are not. Lots of banks and investment companies offer them. The account is a custodial account held for your benefit, and you get to choose the company that is the custodian, and you can move the money from one custodian to another, just as you could move your IRA from Fidelity to Vanguard, for instance. You often get a checkbook and/or a debit card. The custodian follows certain rules laid out by the IRS, and reports to the IRS at the end of each year the total contributions to and distributions from your account. The custodian is not responsible, however, for verifying that your expenses are qualified medical expenses, as that responsibility falls to you.
If you have health insurance through an employer and the plan qualifies, often your employer and its health insurance representative are instrumental in getting this account established, and they will select an initial custodian. Many employers will even contribute a monthly amount to your HSA account since the high deductible aspect often saves the employer money on the premiums. But even if your employer does not set an HSA up, you can do it. And as long as your health insurance plan qualifies, you can contribute to it.
How Do I Put Money Into the HSA?
Anyone is actually allowed to contribute to your HSA account (if you should be so lucky!), but there is a total contribution limit of $3,350 per year for self-only plans, and $6,650 for family plans in 2015. And you get an above-the-line tax deduction for the amount put into the account each year. Unlike IRAs, there are not even any income phaseouts that would prevent you from getting the tax deduction if you are a high-income earner. If your employer does not contribute enough to max out the contribution limit, you can always write a check to the account for the difference. You even have until April 15 (18 this year) to make the contribution for the prior year (similar to an IRA). If you are over 55 years old (IRAs are 50), you can make an additional $1,000 contribution each year.
If you are enrolled in Medicare or are being claimed as a dependent on someone else’s return, you cannot contribute to an HSA. In years where you change from self-only coverage to family coverage, or if you get married, or go through a divorce, stop insurance, start insurance, etc. be aware that there are special rules and limitations on contributions during those years, and you could subject yourself to a penalty if handled incorrectly. If you find that you have overcontributed for any reason, you generally have until the extended due date of your tax returns to get the money out without penalty. You do have to take out any earnings it generated as well, and those would be taxable in the year you physically take the money out of the account.
Can I Transfer Money Into My HSA from an IRA?
If you are desperate to get some additional money into your HSA, you can make a once in a lifetime transfer from your Traditional or Roth IRA to the HSA via a trustee to trustee transfer. However, it is still limited to the annual contribution cap, and it would be reduced by any other contributions you made to the account during the year! So it has very limited usefulness. If you were going to do that, your first choice would almost inevitably be the traditional IRA since the Roth IRA is already a tax-free account.
What/Who Can I Spend the Money On?
All medical expenses that would normally qualify for a deduction on Schedule A, would be a qualified HSA distribution, except for insurance. Generally, you cannot pay your health, vision, dental premiums, etc. from your HSA. Exceptions to this which you could pay from your HSA include long-term care insurance for the HSA account holder (subject to normal limits on long-term care insurance deductions found in the Schedule A instructions), COBRA insurance premiums for you, your spouse, or your dependents, or health insurance paid while you, your spouse, or dependents are receiving federal or state unemployment compensation. Also, if you are 65 or older, you can pay your Medicare and other health insurance premiums (except supplemental Medicare policy premiums) from your HSA.
For the bulk of the qualified medical expenses, you can deduct them for yourself, your spouse, your dependents, or for someone you could have claimed as a dependent except that they were disqualified simply because they filed a joint return, had gross income over $4,000, or were married filing jointly and one of the spouses could have been claimed as a dependent. If you are divorced with children, you can also pay for your children’s medical expenses whether or not you are a custodial parent or claim a dependency exemption, as long as least one of you qualifies to claim the dependency exemption.
If you take money out of the account and do not use it for medical expenses, it will be taxable income, and you will hit a 20 percent tax penalty as well. When you reach age 65, however, you can take the money out and use it for any purpose with no penalty (as opposed to 59.5 for most IRA owners). So in a lot of ways, should you never use it for medical expenses, it acts like another IRA.
Also for people that become permanently disabled, they can escape the 20 percent penalty tax even if used for nonqualified expenses.
In two weeks we will conclude the discussion on HSA accounts and discuss topics such as whether or not you have to pay qualified medical expenses directly from your HSA, strategy for large bills that exceed your HSA balance, having separate accounts for spouses, what happens to the account when you pass away, pitfalls to avoid, and a discussion of the Form 8889 itself.
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.
Back to Basics – Part XX – Form 4952 – Investment Interest Expense
Filed under: Back to Basics | Tags: annuities, baseball cards, bonds, dividends, financial advisory fees, incidental, interest, investment expense, investment income, Investment Interest Expense, long-term, margin loans, net capital gains, passive activities, qualified dividends, royalties, safe deposit box, Schedule A, short-term, stocks, suspended, vacant land
Leave a comment Originally published in the Cedar Street Times
August 7, 2015
Today is my brother, Justin’s, birthday, and I know just what to get him. We were both avid baseball card collectors from the time we were seven and eight years old on up through our middle school years. Once, we even put on a “Kids Baseball Card Show” to buy, sell, and trade cards. We went around advertising the show with flyers on telephone polls all over the local neighborhoods, and secured the neighborhood pool clubhouse facility to host our show. It was a great success!
At the conclusion of my baseball card collecting career I had amassed over 10,000 cards with albums full of rookie cards and great players at the time. One of my most prized cards was a 1954 Topps Willie Mays. I remember wondering, how much money have I invested in all these cards over the years? Would I be able to retire after selling the cards years later? The Beckett Baseball Card Monthly price guide certainly made me think so based on the prices they listed and the rapid rates of increase. Old cards from the 1940s – 1960s were worth hundreds or even thousands of dollars each.
A few years after my interest in card collecting waned, a mass of new brands flooded the markets. That combined with other problems in baseball at the time sent the card market into an unrecoverable nose dive. Over 20 years later, most cards are still worth a tiny fraction of their peak.
Although my desire was primarily the personal fun of collecting, there were many adult investors that had serious money in cards. As with any investment bubble, I am sure there were collectors mortgaging their homes, running up credit card debt and borrowing from family in order to get a piece of the action.
As I reflect on that now, I see there would have been an opportunity for these people to take advantage of today’s topic – Form 4952 – Investment Interest Expense Deduction. 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 .
Investment interest expense is reported on Schedule A as an itemized deduction and is essentially interest paid on debt used to buy property that produces or hopefully will produce income at some point. It doesn’t include interest expense incurred in your trade or business, or for passive activities like most rental properties. These types of interest get reported elsewhere. So, borrowing money to buy investments such as stocks, bonds, or annuities would qualify. Many financial companies offer margin loans. The interest on these loans would certainly qualify as investment interest expense if the proceeds were used to buy more stocks and bonds. Borrowing money to buy the right to royalty income or to buy property held for investment gain, such as vacant land, art, or even baseball cards would also qualify, among other things.
Due to passive activity rules which limit or even eliminate current deductions on passive rental activities such as a home you rent out, many people would like to be able to deduct the interest as investment interest instead. However, interest on passive activities is specifically excluded from being classified as investment interest expense. The interest on vacant land can usually escape this clause, even if small amounts of rent are collected since the rent is incidental to the paramount investment purpose of appreciation. To be considered incidental, the principal purpose must be to realize gain from appreciation AND the gross rents received for the year must be less than two percent of the lesser of the property’s unadjusted basis or its fair market value.
The rub with investment interest expense is that it is only deductible to the extent that you have investment income! If you have no investment income, you can’t deduct the expense, and it gets suspended until a year you actually do have investment income. So what qualifies as investment income? Well, all of the things we just discussed for which you borrowed money and can deduct as investment interest expense – so interest, dividends, gains from property held for investment, etc. Prior to being applied against investment interest expense, the investment income figure is reduced by other investment expenses that you may have reported on Schedule A – such as investment advisory fees, safe deposit boxes, investment subscriptions, etc.
By default, your net capital gains (meaning net long-term capital gains in excess of net short-term capital losses) as well as qualified dividends are not included in investment income. This is done because both of these already get taxed at favorable lower capital gains rates, so the thinking is, “Why would you want to waste a deduction to offset income that is already getting a lower capital gains rate, when you could instead use it to offset ordinary income taxed at higher rates ?” The answer is that sometimes you may not be able to ever foresee having much ordinary investment income taxable at higher rates. And instead of just suspending the deduction and getting n0 current tax benefit, you elect to include your net capital gains and qualified dividends as investment income and use the deduction to help wipe that income out, thus saving you current taxes.
The Form 4952 itself is a rather simple form – only a half page in length. Part I is a summary of the gross investment interest expense including any current interest and past interest that was carried over. Part II helps you calculate the net investment income from interest dividends, gains, capital gains, less investment expenses from Schedule A. Part III compares parts I and II and calculates the investment interest expense that will be currently deductible, as well as the part that is being suspended to the future if there is not enough investment income to absorb the expenses.
As for the card collecting Justin and I did, I sure am glad we didn’t go into debt buying baseball cards and having to file 4952s! Now about that gift – how about a box of wax packs or a factory sealed set – I know just where to get them…
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 XVIII – Form 4684 – Casualties and Thefts
Filed under: Back to Basics | Tags: business loss, Casualties and Thefts, CCH, Cedar Street Funding, Form 4684, Form 4797, fraud, Internal Revenue Code, IRS, IRS scam, lottery, Madoff, personal loss, Ponzi, Schedule A, Schedule D, Zubick
Leave a comment July 10, 2015
My colleague next door enjoys kidding me every two weeks when my next installment of Back to Basics comes out! Although there will not be 10,000 parts as he suggests, there could be! CCH, one of the leading publishers on tax research materials has about 75,000 pages in its Standard Federal Tax Reporter – a product which includes the code, regulations, court case cites, commentary, and other related information. So, if I cover it in 35 articles or so, I probably can’t even call it the “basics” – maybe introductory remarks would be more fitting!
Nonetheless, it is designed to be an overview for commonly used Schedules and Forms. It is also interesting to note with today’s connectivity that people all over the country and the world find the articles reposted on my website and I regularly receive calls and e-mails. Earlier this week I received this response, “Just wanted you to know how much I enjoyed your blog. I wish you were in my hometown in Louisiana!” Thanks for the message, Dianne!
This week we will touch on Form 4684 – Casualties and Thefts. If you would like to catch up on our Back to Basics series on personal tax returns, prior articles are republished on my website at www.tlongcpa.com/blog .
Casualty and theft sounds like language stolen from an insurance agent, and like a good insurance agent, Uncle Sam wants to help you too…sometimes. If you have a large personal financial catastrophe resulting from something like a fire, storm, wreck, robbery, embezzlement, etc. you can claim the loss on Form 4684. Hopefully you have insurance, but if not, or to the extent that it is not covered, such as your deductible, you can claim the unreimbursed portion on this form.
The wheels are already turning – “Wow, I have had several car accidents in the past and I had to pay a $500 deductible – you mean I could have claimed that?” The answer is, “Yes.” However, it likely would not have done you any good since the loss of personal use property has to be in excess of 10 percent of your adjusted gross income (AGI) plus $100. That is a relatively big number for most people. If your AGI is $100,000, for example, that would equate to a $10,100 out-of-pocket loss threshold. Everything over that amount would then go to Schedule A as an itemized deduction. But, if you are retired and not actively earning income that threshold could be much smaller.
Q. “What about a stock market crash, where my portfolio drops by 40 percent – can I claim my losses from that as a casualty/theft loss?” A. – If you have not sold anything, then no. When you do sell, that loss gets reported on Schedule D instead along with gains and losses from capital assets.
Q. “I parked my Ferrari at a sports event and my insurance had lapsed. There were so many parking lots, I never could find it. Can I deduct that loss?” A. – Losing or misplacing money or things (stupidity) is not deductible. Hopefully you will have realized it was stolen, filed a police report, and then the answer would be, “Yes,” assuming there was no reasonable expectation of recovery. If you claim the loss on your tax return, and then two years later the police locate it three states away you would then have to claim it as income when recovered.
Q. “I have been using my yacht for twenty-five years and it has finally worn out and has stopped working. Can I claim that as a loss?” A. – Wear and tear and breakage from normal use are not deductible.
The area where I have seen Form 4684 actually come to significant aid for taxpayers over the years has been regarding financial theft. It is often large and there is generally no insurance reimbursement. Caretakers that get access to accounts, telephone or e-mail scams, and Ponzi schemes are all examples of items that find some relief on the 4684. Local residents may recall Jay Zubick’s $16 million financial investment scheme in Monterey in 2007. Cedar Street Funding would be another example, as well as Bernard Madoff’s massive national scam.
Ponzi schemes are considered business or investment losses since the original intent was to earn a profit. As such they are not subject to the 10 percent threshold. The same would be true for other casualty/theft losses related to business or income-producing property. Caretaker financial abuse, telephone and e-mail scams bilking people out of their personal financial resources, however, are theft of personal assets, and the 10 percent threshold would apply.
Anyone who uses e-mail regularly has no doubt received a fake e-mail from a friend that is stranded in another country and needs money ASAP. This type of fraud would certainly go on the Form 4684. The IRS has warned of numerous scams of people posing as IRS collections agents. Sometimes scams are quite elaborate involving long time periods and multiple con-artists all painting a picture of legitimacy. Fake lottery and other winnings are common fodder for scams where they claim money is needed for fees to transport cash across state borders, or to pay taxes. Often the scammers will start with requests for small amounts of money. They are probing for susceptible people. When they find someone who bites, they start working other scams and raising the stakes each time to soak you for more money.
I have had several occasions to work with people that have had hundreds of thousands of dollars stolen through such means. In these situations, the Form 4684 allows the taxpayer to get a large deduction which can even create a net operating loss on the current year tax return. This net operating loss can then be carried back several years to recoup past taxes paid and/or carried forward to the future to reduce taxes then as well.
The Form 4684 is a three-page form. The first page deals with casualties and thefts related to personal property, and helps you calculate the amount of loss after the 10 percent plus $100 deduction to carry to Schedule A as an itemized deduction.
The second page helps you calculate the losses related to business or income-producing property. Depending on the exact type of business or income producing property, the loss could carry over to the Form 4797 and eventually make its way to page one of the Form 1040 and directly offset ordinary income and lower adjusted gross income. Other types still go to Schedule A where they may not be quite as beneficial, but still helpful.
The third page deals specifically with Ponzi type schemes. Note that there are many types of financial investment schemes out there, but to be deductible on the Form 4684 as such, they must fall under the definition the IRS uses. There are also special ways to calculate the losses since Ponzi schemes generally wind up in court for years while the records are sorted out and funds are attempted to be recovered.
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 IV – Even More Sch. A
Filed under: Back to Basics | Tags: acquire, cash donations, cash out, charity, construct, Form 1098, home equity debt, improve, investment income, investment interest, line of credit, mortgage interest, noncash donations, nondeductible personal interest, points, private mortgage insurance, qualified home, refinance, Schedule A, second loan, substantiation, volunteer expenses
Leave a comment Originally published in the Cedar Street Times
November 28, 2014
In this issue, we are continuing 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 third section on Schedule A covers deductible interest you have paid. For most people the big item here is the mortgage interest on their principal residence. You can also deduct mortgage interest on one other personal residence as well. A lot of people assume that if the interest shows up on a Form 1098 that it is deductible. Contrary to popular belief, that does not determine deductibility. People with rental and personal properties, for instance, that refinance and pull money out of one property and put it into another are especially at risk of having made a major mistake.
The home mortgage interest deduction requires the debt to be secured by a qualified home and have been used to acquire, construct, or improve the home up to $1,000,000 of debt and up to $100,000 of additional debt for any purpose. Assume someone refinances a rental property and pulls $200,000 out of it to buy a personal residence. The interest on the $200,000 is not a rental property deduction on Schedule E because the funds did not go into the rental property activity. It is also not deductible on Schedule A as home mortgage interest because the debt is not secured by a qualified personal residence – it is secured by the rental property! Oops – nondeductible personal interest! There are some work-arounds to this, but they are not always easily accomplished, and the problem is more likely to be found in an audit when it is too late.
Another common problem crops up for people on personal residences who take out a second loan, open a line of credit, or do a cash-out refinance and do not use the cash to improve the home. This portion is called home equity debt. You can only deduct the interest on up to $100,000 of total home equity debt. Anything beyond that becomes non-deductible personal interest, and would need to be tracked properly. If you later refinance your primary loan and the home equity loan into one loan, the character of the debt remains the same. This means you have to keep track of the portion of the debt that is home equity debt versus acquisition debt that comprises the one loan.
Other deductible interest would include points paid during a purchase or refinance. Often these are not included on the 1098 and you must look to the escrow closing statement to pick them up. New purchases allow 100% deduction of the points in the year purchased. Refinances, require amortizing and taking a portion of the deduction each year over the life of the loan term. Private Mortgage Insurance (PMI) used to be deductible as interest, subject to limitations, but is not currently slated for a deduction in 2014. Investment interest is another item that falls into this section of Schedule A. A simple example would be borrowing money to invest in the stock market – like a margin loan. However, investment interest expense is only deductible to the extent that you have investment income (Form 4952). So, if you paid $1,000 of interest, you better have made a $1,000 of investment income, otherwise the excess gets suspended and carried forward for the future.
The fourth section on Schedule A deals with gifts to charity. Volumes have been written on this topic! Gifts to charity must be made to qualifying organizations for U.S. tax purposes. There is a 50 percent of your adjusted gross income limit each year regarding regular donations to charities. There are also 30 percent and 20 percent limitations for donations to certain types of organizations and types of property donated. So if you gave a very large gift, it could get suspended and carried over to the future. There is generally a five-year carryover limit, at which point any remaining deductions would be lost.
All donations must have substantiation, no matter how small. Cash donations under $250 must be substantiated with a properly worded letter from the organization, a cancelled check, a bank statement, or a credit card statement. Cash donations over $250 require a letter from the organization. Noncash donations have a lot of rules. Every noncash donation requires a receipt from the organization. Noncash donations over $500 require the filing of an 8283. Noncash donations over $5,000 require a qualified appraisal as well. It would be in your best interest to ensure you have properly planned when making (or anticipating to make) a donation over $5,000. The $5,000 threshold is cumulative throughout the year for similar items. This means that many trips throughout the year of donating to the local charitable thrift store of household goods would retroactively require an appraisal to claim over $5,000. And it is hard to appraise items you no longer have! As you can see there can be much to consider.
You can deduct out-of-pocket charitable volunteer expenses such as uniforms or gear necessary for the volunteer work. If you travel on your own dime overnight, and you have substantial duties and very little personal activities, you may be able to deduct airline tickets, meals, lodging, etc. Volunteer excursions that are not away from home overnight do not qualify for meal deductions. If you use your vehicle for charitable purposes you can deduct the mileage at 14 cents per mile, or track gas and oil expenses.
A few things that are definitely not deductible but are commonly misunderstood by individuals as well as by small charitable organizations: 1) gifts to needy or worthy individuals – even if you give to a qualified organization be sure you do not earmark your donation for a particular person or family, or your deduction is not legitimate , 2) gifts of your time or services – like the artist trying to deduct a self-created painting at “fair market value” – you can only deduct hard costs such as the canvas and paint costs. Since you never included in income and paid tax on your services, you cannot take a deduction for them, 3) charity raffles, bingo, lotteries 4) charitable auctions or other donations to the extent of the value you received in return – such as paying $75 in a charity silent auction, but you get a $100 gift certificate – no deduction allowed. Or the local public radio station sends you a set of CDs they value at $100 in return for your $125 donation – you only get to deduct $25.
In two weeks we will continue our discussion regarding Schedule A.
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 III – More Sch. A
Filed under: Back to Basics | Tags: 1040, chiropractors, Christian Science practitioners, contacts, copays, dentists, doctors, eyeglasses, health insurance, hospital bills, medical expenses, medical mileage, Medicare, personal property taxes, prescription drugs, real estate taxes, Schedule A, SDI, state income taxes
Leave a comment Originally published in the Cedar Street Times
November 14, 2014
Two weeks ago we discussed the purpose of schedules and forms in a tax return and then began a discussion on Schedule A – Itemized Deductions. We discussed that itemizing deductions is an option if you have more than what the IRS allots as a standard deduction to everyone for things like medical expenses, taxes, charitable donations, and other miscellaneous deductions. This week we are going to look more closely at the different types of deductions that you can itemize on Schedule A and how these deductions can get a shave and a haircut and look like less than when you started.
The first section on Schedule A covers out-of-pocket medical expenses (not reimbursed by insurance). Things like doctors, dentists, chiropractors, Christian Science practitioners, hospital bills, prescription drugs (not over the counter), eyeglasses, contacts, copays, etc. all fit into this category. Health insurance is also deductible here unless it is for self-employed people, in which case it can get potentially better treatment as an adjustment to income on page one of the 1040 instead. Health insurance would include your Medicare payments which most people see deducted from their Social Security checks.
Sometimes people are surprised to learn that substantial expenditures on your home can be deductible if done to improve accessibility – such as widening doors and bathrooms, installing ramps, hand rails, etc. (there are a number of rules to be aware of, however). You can also deduct medical related miles at 23.5 cents per mile and even deduct overnight travel expenses if you must drive to a hospital that is not local, for instance. The problem with medical expense deductions is that for the vast majority of people, none of the expenses even make it towards counting as an itemized deduction.
You have to have in excess of 10 percent of your adjusted gross income (the bottom number on page one of your 1040) in medical expenses before a single dollar counts. So, if your adjusted gross income is $100,000, and you have $10,500 of out-of-pocket medical expenses, only $500 counts towards your itemized deductions. If you or your spouse are over 65 you have a 7.5 percent threshold through 2016, and then you will jump to ten percent as well. A really nice planning opportunity around this dilemma is having a health savings account in connection with a high deductible plan. It has the ability to effectively convert some or all of your nondeductible medical expenses to deductible expenses. Ask your tax preparer or insurance agent about this.
The second section on Schedule A covers deductible taxes you have paid. This includes state income taxes you paid during the year, SDI withholdings from your CA paycheck, real estate taxes on your personal residence(s), personal property taxes assessed on value such as annual vehicle taxes (license fee on your CA DMV renewal), boat, aircraft, etc. Remember, as a cash basis taxpayer, these (as with generally all income and expenses on your tax returns) count in the year you actually pay them (or charge them in the case of a credit card), so it doesn’t matter what year they are supposed to cover – just look at when they were paid. There has been an option in past years to deduct sales taxes you paid during the year if they were greater than the state income taxes you paid, but that is currently not an option for 2014, unless Congress takes action.
In two weeks we will continue our discussion regarding Schedule A.
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.
Back to Basics Part II – Schedule A
Filed under: Back to Basics | Tags: 1040, 2014, charitable deductions, Forms, medical expenses, miscellaneous itemized deductions, mortgage interest, real estate taxes, Schedule A, Schedules, standard deduction, state taxes, unreimbursed employee business expenses
Leave a comment Originally published in the Cedar Street Times
October 31, 2014
Two weeks ago we discussed a general overview of the Form 1040 – a personal income tax return. The 1040 can be thought of as a two-page summary of your taxes in a nutshell. (I should mention also there are two other shorter forms that could be filed instead: a 1040A and a 1040EZ. These are for simpler returns and have income limits and other restrictions. In practice, however, anyone using tax software does not really have to decide which form to use and the software will generally optimize as appropriate. For our discussion we will focus on the 1040.)
The details for many of the items on the Form 1040 are actually determined on subsequent Schedules and Forms. Schedules are labeled with letters of the alphabet and additional forms are generally four digit numbers. Schedules are generally more major topical areas. For instance, Schedule C – Profit or Loss from Business, which is a summary of all the activity of a sole proprietorship. It may in turn have subsequent forms that support it. Forms are often more narrowly focused and would generally support other schedules or forms. For instance Form 4572 Depreciation, could support the calculation of depreciation expense for a business on Schedule C, a rental property on Schedule E, a farm on Schedule F, etc. I have not counted them all, but I have read the IRS has over 800 forms and schedules. The reality is that most people are covered by 30 or 40 of those 800!
Let’s start at the beginning of the alphabet – Schedule A. (I am sure this saddens you, but we will not be going through all 800 in this series of articles, but we will hit on a number of the most common ones!) Schedule A is for itemized deductions. You probably hear lots of people justify expenses by tossing around the phrase, “it’s deductible.” However, just because something may be deductible, does not mean it will benefit you. This is easily seen with Schedule A. Schedule A covers a host of “expenses” that most people have that our tax code has graced as good behavior and therefore allows a deduction for it. Medical expenses, state and local taxes, real estate taxes, mortgage interest, charitable deductions, unreimbursed employee business expenses, my favorite – tax preparation fees, investment expenses, etc.
Since Congress realized that everyone had some of this, and it would be a pain for people to track it, they decided to allow as an option a “standard deduction” for everyone in lieu of tracking and itemizing all those deductions. The standard deduction was created to generally cover what many people would have on the average anyway. For 2014 this standard deduction is $6,200 if you file as Single or Married Filing Separate, $12,400 if you file Married Filing Jointly or Qualifying Widow(er), and $9,100 if you are filing Head of Household status. If you believe you would have more than this, then you would itemize the deductions using Schedule A.
Mortgage interest and real estate taxes are the two areas that push most Californians into the itemizing zone. In other words, if you do not own a home, there is a good chance you won’t be itemizing. This is not always true: sometimes people don’t own a home, but make a lot of money and pay a lot of deductible state income taxes which would push them over the standard deduction, or maybe they work in sales jobs where they have lots of unreimbursed employee business expenses, or have major unreimbursed medical expenditures, or are perhaps like you dear reader, and have a heart of gold giving away buckets of money to charitable organizations each year! Or it could be a combination of things – paid some income taxes, have a stingy boss that won’t reimburse, and maybe you have a heart of bronze.
Next week we will discuss more specifically the deductions on Schedule A and how they can come out looking a little thin after running the Schedule A gauntlet.
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 Office Part III – How Big is My Deduction?
Filed under: Home Office | Tags: 39-year, business use of home, cable, carryover, daycare, deduction, depreciation, Form 2106, Form 8829, furniture, home office, improvements, insurance, janitorial, landscaping, maintenance, miscellaneous itemized deductions, mortgage interest, repairs, satellite, Schedule A, Schedule C, square foot, taxes, trash, utilities, water
Leave a comment Originally published in the Cedar Street Times
August 23, 2013
Four weeks ago, I discussed a new simplified option for calculating the home office deduction that is effective for 2013. Two weeks ago I discussed the rules to qualify for a home office deduction. In this final installment on home office deductions, we will discuss the standard method of determining your deduction, which will still yield the greatest benefit for most people – especially in high cost localities. (If you missed the prior two articles, you can find them on my website at www.tlongcpa.com/blog.)
The standard method of calculating your home office deduction is done on a Form 8829 or on tax worksheets. It typically starts with a square footage calculation of the livable space in your home, and a calculation of the portion used exclusively for your business activity, to determine the percentage used by the business. You can use a calculation based on the number of rooms in the house if they are similarly sized, but in practice hardly anybody uses this method.
The next step is to gather your expenses and multiply them by the business percentage you just determined. Add up in separate categories your utilities, water, trash/recycling service, janitorial (house cleaner), repairs and maintenance, homeowner’s or renter’s insurance, and any other recurring expenses used to maintain your house. If you regularly meet with clients at your house, you can generally do the same for your landscape maintenance expenses as well.
If you rent your home, you add up your total rent and multiply it by the business percentage. If you own, you apply the business percentage to your mortgage interest and real estate taxes (the balance go on Schedule A). Some people will throw their internet access fees on the 8829, but often a better deduction is obtained by thinking about actual business use versus personal use, as square footage is not a great metric for internet use. You could then put that directly on your schedule C if you run a business, or Form 2106 if you are an employee with a qualifying home office. If you buy furniture or equipment exclusively for your office, that is generally put on a depreciation schedule and often linked directly to your Schedule C or Form 2106 instead of running it through your business use of home form.
The first telephone line into the house is not deductible at all. A second line could be, however. But in that case it is typically a dedicated business line, and you would put that on your schedule C or Form 2106 in full to get a better deduction. Your cable or satellite service is probably off limits for most people since there is such a high degree of personal use and it is an area subject to abuse. Based on facts and circumstances some people may be able to build a case for part of it – such as a day trader that depends on the financial channels, or if you have a waiting area which clients regularly use to watch television.
If you own the home you need to set up the home and and any improvements on a 39-year depreciation schedule (not 27.5 like a rental home – common mistake) and run depreciation deductions through your business use of home calculation (beyond the scope of this article). Many people fail to do this thinking it is a choice. It is not. There is a use or lose it rule, and you are responsible for depreciation recapture taxes upon the sale of the home whether or not you claimed the deduction. So you might as well take it!
Facts and circumstances and reasonableness will generally rule the day as an overarching principle to the application of all of these rules. Technically, if you only painted your office, you can take 100% of the cost into consideration for your business use of home deduction. On the flip-side, if you painted everything but your office, you shouldn’t really take any deduction. In practice, records are generally not kept that precisely, and the dollar figures are not that large, so you often end up applying the business percentage to everything in that category for the year for practical purposes.
Even after calculating the deduction, there is another hurdle you must pass – you cannot create an overall loss on your Schedule C from business use of home expenses with the exception of real estate taxes, mortgage interest, or casualty losses which would be deductible on Schedule A regardless. If you have a loss, the excess business use of home expenses will get suspended and carried over to a future year when your business is profitable.
Employees have a different hurdle since their home office deduction is an employee business expense which is a miscellaneous itemized deduction subject to a two percent of adjusted gross income floor. So if their total miscellaneous itemized deductions exceed two percent of their adjusted gross income, then the excess is an itemized deduction, and if their itemized deductions exceed the standard deduction, then they can benefit!
Of course there are many other considerations that can come into play depending on your circumstances such as separately metered properties, or separate structures, multiple offices in the same home, or different homes, a daycare home office, etc. This article should be enough to give you the gist, but it is always best to consult with a professional to ensure you are complying with the laws as well as getting all the deductions you deserve.
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.
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