Sole Proprietors

One in seven 2009 tax returns contained a schedule C which is where you report the income and expenses of a sole proprietor business. You have to be engaged in the business with the intent to make a profit which is determined by facts and circumstances. If you fail the facts and circumstances test, then your business is a hobby and you can't deduct any losses. What kind of deductions can you take? The IRS says you can deduct "all the ordinary and necessary expenses paid in carrying on any trade or business." The IRS further defines ordinary and necessary as appropriate or helpful. What kind of deductions can you not take? The following is just a partial list: charitable contributions unless they qualify as advertising, gifts over $25 unless you can make the case it is marketing, penalties and fines, political contributions, personal living expenses, club dues, and lobbying expenses. Returns with a schedule C have a higher audit profile with the IRS.

Annual Gift tax Exclusion for 2013

The amount you can give to any donee in a calendar year without having to file a gift tax return goes up to $14,000 from $13,000 in 2013. The $14,000 is a cumulative amount for the year so you need to consider other gifts given during the year to see if you go over the total requiring a gift tax return.

Student Loan Interest

Only the person who is legally obligated to repay the student loan can take the deduction for the interest.  Someone who is a dependent on the parent's return cannot take the deduction, and joint filers with income over $150,000 cannot take the student loan interest deduction either. Higher income taxpayers may want to consider having the student be liable for the student loan so when they leave the nest the student can qualify for the deduction.

IRS Standard Mileage Rates for 2013

The standard mileage rate for business miles has increased 1 cent to 56.5 cents per mile. The medical and moving rate is 24 cents per mile, and the charitable rate stays at 14 cents per mile. Mileage should be documented by a taxpayer by some type of contemporaneous written record such as the "enter company mileage" under the company section in Quickbooks or a mileage log.

New Hospital Insurance Tax of .9%

Last week I talked about the new 3.8% tax on investment income or unearned income. Earned income of wages and self employment income also gets hit by Obamacare. Beginning in 2013 there is a new tax of .9% on wages and self employment income for those single filers making over $200,000 or joint filers making over $250,000. For example, if you have a joint return with wages of $100,000 and self employment income of $500,000, the calculation of the tax would be as follows: .009 x ($100,000+$500,000-$250,000) = $3,150.

New 3.8% Net Investment Tax

This is the new Obamacare tax that starts 1/1/2013 for all single filers making over $200,000 and joint filers making over $250,000. Given the following set of facts the new tax would be $3,800 on the 2013 income tax return:

Single filer with adjusted gross income of $300,000 and net investment income of $200,000 included in the $300,000:
Tax is the lesser of 300,000-200,000 x 3.8%=$3,800 or 200,000 x 3.8%= $7,600

Net investment income is defined as all dividends, interest, capital gains, net rental income, and passive activity income. Earned income and retirement income are not included.

Charitable Cash Donations $250 or More

When you write a check to a charity for this amount, the charity is required to issue you a written receipt that indicates, the name and address of the charity, amount contributed, the date of the donation, and whether any goods or services were provided to you in return for the contribution. A charity will usually provide you with a receipt immediately. This acknowledgement letter must be received by you prior to the due date or the extended due date of the return. You will lose this deduction upon audit if you don't have a timely acknowledgement letter even if you have a cancelled check. Look at your records now to make sure you have a written receipt for each applicable donation you have made in 2012.

Social Security Benefits for Those Born 1943-1954

Your normal retirement age for social security for this age group is 66 at which point you would get 100% of your monthly benefit. If you start taking social security at age 62 which is the earliest you could take it, your benefit would be 75%. At age 65 the benefit is 93.33%, and at age 67 it is 108%. At age 70 you stop earning any bonus percentage, and your benefit maxes out at 132%. You can go online at www.ssa.gov to apply to view your annual social security benefit statement.

Business Travel Expenses

Taxpayers and the IRS have disagreed on the deductibility of travel expenses many times. If the trip is primarily for business, then most of the expenses are deductible such as meals, lodging and transportation costs. How does one determine if the trip is primarily for business? You have to look at all the facts and circumstances and see if you can make a reasonable case. How much time was spent on personal activities versus business activities? Was your spouse with you? Does your spouse have a legitimate business reason to be on the trip? Is your spouse one of your employees or independent contractors? If the trip is primarily for personal reasons, then no costs are deductible except direct business expenses such as a business meal. This issue reminds me of an old tax saying, "When a pig becomes a hog it gets slaughtered."

Alternative Minimum Tax for 2012

Alternative minimum tax or AMT will hit a lot more taxpayers on their 2012 income tax return unless Congress increases the exemption amount like they have in prior years. The increase in exemption (about $30,000 for joint filers) has been done in the past only on a yearly basis so it gets revisited every year. The AMT is a fun parallel tax that disallows certain deductions like taxes, miscellaneous itemized deductions, and personal exemptions. You have to pay the higher of the regular income tax or the AMT on form 6251. Let's hope that Congress fixes this again for 2012 before the end of this year.

New Obamacare Taxes

There are twenty new or higher taxes in Obamacare. Here are some of the more significant ones: Unless noted the new taxes start in 2013 or are already in place.

1. Dividends and other investment income earned by higher income taxpayers will have a new 3.8% surtax. The tax on dividends will be 43.4% for taxpayers in the highest income tax bracket.
2. Medical device manufacturers will have to pay a 2.3% excise tax on gross sales which will increase the cost of health care.
3. Medical itemized deductions for individuals will have a new 10% threshold of adjusted gross income which is up from 7.5%. You don't get the benefit of a medical deduction unless it is more than the threshold. This could hurt if you have high medical bills and itemize deductions.
4. Medicare payroll taxes on wages and  self employment income will increase from 2.9% to 3.8% on wages and self employment income exceeding $200,000 for individuals and $250,000 for joint returns.
5. There is a 10% tax on indoor tanning services.
6. You won't be able to contribute more than $2,500 to a flexible spending account. This is a pretax contribution for medical expenses that used to be unlimited.
7. Employers will have to pay a 40% tax on too generous healthcare plans starting in 2018. These are defined as Cadillac health care plans costing $10,200 for an individual or $27,500 for families.
8. Those not buying health insurance are subject to taxes of between $695 per person to $4,700 per person depending on income. This penalty tax will phase in between 2014 and 2016 and be collected by the IRS. Those making less than $9,500 will be exempt from the penalty, along with Indian tribes, and members of certain religions. The penalty tax though is generally going to be less than the cost of health insurance so many people, particularly young people will still choose just to pay the penalty.

Failure to File Penalty

The failure to file penalty is the reason it is so important to file a return by the extended due date which is today for 2011 individual returns. The Federal penalty is 5% for each month or part of a month up to a maximum of 25% of any unpaid balance of tax due. Georgia has the same penalty also. It is better to file an incomplete return and then amend later when you have all of the information.

IRS and Georgia Interest Rates on Tax Liability

The IRS charges 3% on an annual basis on past due tax liabilities for this current quarter. You have to pay in all the tax you owe by April 15 each year or you will be charged this interest. That also goes for Georgia, but Georgia charges a whopping 12% on an annual basis on past due tax. Usually it it better then to pay off  Georgia before the IRS. The IRS interest rate is subject to change each calendar quarter. The Georgia rate has been the same for over 10 years.  

Offers in Compromise

An offer in compromise(OIC) is a process which allows  taxpayers to settle their debt with the IRS for less than what was originally owed. The taxpayer fills out a form showing assets, liabilities, monthly income, and monthly basic living expenses. Documentation must be provided to support the amounts on the form. Using this information, the form calculates the offer amount. There is no negotiation involved. There is a $150 application fee and a 20% down payment if you propose to pay the tax in 5 or fewer installments. You can  submit a schedule to pay with more than 5 installments and then the first payment is due with the application. The payments are nonrefundable even if the IRS rejects the offer. As part of an acceptance of an OIC, the taxpayer agrees to comply with all tax return filing requirements for 5 years. In case of a default on a payment or a failure to file a return, the IRS can then sue the taxpayer for the balance due. The OIC is a difficult road to take with the IRS as most are rejected, but may be appropriate in some situations.

Term or Whole Life Insurance?

Buy term insurance since it is generally 20% or more cheaper than whole life insurance for the same coverage. Insurance agents push whole life because they get a higher commission than they do on term. Whole life does protect you for a lifetime and the cash value grows tax-free. However, the cash value piece is just a  way to force you to save. You are much better off to just save on your own and pay a premium that is only for insurance instead of for insurance and forced savings.

Emergency Fund

Everyone should strive in these uncertain times to have an emergency fund to cover of at least 6 months of normal living expenses in easy accessible cash. You may want to have even more to give you that extra peace of mind.

Production Deduction

The production deduction is one of those needlessly complicated deductions that only a government bureaucrat or a politician would love. However, it does result in some good tax savings if you qualify. The deduction is available to any type of business entity that generally makes something in the U.S. Also qualifying are construction activities and engineering and architectural services supporting construction in the United States. Even film production  qualifies.The deduction is equal to the lesser of 9% of the net qualified income or 50% of related W-2 wages of the taxpayer. To compute the deduction you fill out form 8903.

EMail from the IRS

Any email from the IRS is a scam because they don't do email. If you open or respond to such an email, you may end up infecting your computer.

January 1, 2013 A Date Which Will Live In Tax Infamy

The Bush tax cuts expire and the Obamacare taxes kick in on this date. It will really hurt those Americans who pay taxes. Below is a list of some of the changes to our taxes which are already scheduled to happen on 1/1/2013.

1. The 10% tax bracket goes to 15%. The middle 3 brackets all go up 3% points. The highest bracket goes to 39.6% from 35%.
2. The estate tax rate goes from 35% to 55%. The estate tax exemption and the lifetime gift tax exemption drops to $1,000,000 from $5,120,000.
3. The long term capital gains rate increases to 20% from 15%.
4. Qualified dividends will be taxed at ordinary tax rates instead of capital gains rate.
5. Net investment income will be subject to a medicare surtax rate of 3.8% for higher income taxpayers.
6. Higher income taxpayers will also be subject to an additional medicare tax of .9% on wages and self employment income.
7. Families covered by very expensive health care plans will be subject to a 40% excise tax.
8. The threshold for deductible medical expenses increases to 10% from 7.5% making it more difficult for those with big medical or dental bills to get  tax benefits from the expenses.
9. The child credit drops to $500 from $1,000.
10. The student loan interest deduction goes away.
11. Exemptions and itemized deductions are limited for higher income taxpayers.
12. The higher alternative minimum tax thresholds are reduced back to a very low threshold. Millions of more taxpayers will be affected by this tax.
13. The child care deduction limit drops to $2,400 from $3,000.
14. The marriage tax penalty is back in play.
15. The American Opportunity college education credit expires.

The First Income Tax

The very first income tax imposed by the Federal government was in 1862 because President Lincoln needed money for the war effort to prevent the Southern States from becoming an independent country. The tax ended after the war and was later declared unconstitutional by the Supreme Court in 1894. Before 1862, the country was able to cover the cost of government and defense with import duties and excise taxes. A per capita property tax was imposed twice by the Federal government on the States to raise money when extra was deemed needed.

Working in a Foreign Country

I believe the US is the only country to tax its citizens on their worldwide income. Mitigating this harsh policy is the rule that allows those working in foreign countries to exclude $92,900 in foreign income from their taxable income. To qualify you have to be either a full time resident of a foreign country for a year or be present in a foreign country for all but 35 days in a 12 month period. Foreign taxes paid on the excluded income don't qualify for the foreign tax credit.

1913 Form 1040

Our current Federal tax system dates back to 1913. The highest rate on the tax return for that first year was only 6% on net income over $500,000 compared to 35% now. Form 1040 was only 4 pages long too. Those were the good old days.

When to File a Gift Tax Return

Only individuals can file a gift tax return and no joint returns can be filed. A return is required if any of the following situations are applicable in a calendar year:
1. You gave more than $13,000 to any individual other than your spouse. Direct payments of another person's medical or tuition costs are not considered gifts and don't have to be considered regardless of the amount.
2. You and your spouse together gave more than $26,000 to anyone.
3. You gave more than $136,000 to a non citizen spouse.

Gifts can be stock, cash, debt forgiveness, and below market sales.
A taxable gift reduces your lifetime exclusion of $5.12 million (2012). No gift tax is due unless you exceed this amount so it is generally just a reporting  exercise with no tax payments required.

Estate Tax Return

There are some expenses only deductible on an estate tax return form 706. You can't deduct them on the final form 1040 or the estate income tax return form 1041. They include funeral expenses, claims against the estate, and the tax due on the final form 1040.

LLC's and the Self Employment Tax

The answer is clear if you are a passive member, your share of the profit is not subject to self employment tax. Otherwise, there is uncertainty in the tax code, and as a managing member of an LLC you may be subject to the tax. You may want to pay yourself a reasonable guaranteed payment subject to the tax for your services in that situation.

LLC or SUB S

An LLC is more flexible than a Sub S corporation because any entity can be a member, there can be different classes of stock, there can be any number of members, and the profits can be allocated to the members in any way. A Sub S corporation has one great advantage though. You can save on payroll taxes because any profits above a reasonable salary for the owner escapes self employment taxes. Not so in an LLC where all profits are generally subject to self employment taxes.

Business Gifts

Deductions for business gifts are limited to $25 per person per year. The costs of engraving, mailing, and gift wrapping are not included in the limit. This is a very low limit and has not been updated for inflation for a very long time. Sometimes it is more appropriate to deduct a gift as entertainment such as tickets to a sporting event, but then you can only deduct 50%.

50% Limit on Meals

The 50% limit only only applies to meals associated with a business such as business travel or income producing property (rental). However, medical or charitable meals are 100% deductible if they otherwise qualify.

Medicare Part B

This is the part you pay for each month which is withheld from your social security payment. If your income is less than $85,000 and you file a single return, or if your income is less than $170,000 and you file a joint return, then the monthly premium is $99.90. If you make over those amounts, then your monthly premium increases from $139.90 to a maximum of $319.70 for 2012. It is like a little mini tax return.

Can you deduct the cost of an MBA degree?

Maybe. If you are already in business, and go back to school to get an MBA that is related to what you are already doing, then you should be able to deduct the costs. Also your company can't require you to get the MBA to keep your job. The IRS doesn't like this deduction one bit and will argue it qualifies you for a new business or profession. You will have to be able to refute that with the facts and circumstances of your situation. If you immediately leave your company upon graduation, and take a new job in a different industry, that will hurt your case. The MBA has to maintain or improve your skills used in your current job. An employee would take the deduction as a miscellaneous itemized deduction subject to the 2% of adjusted gross income threshold.

IRS Tax Notices

It is never pleasant to receive one of these in the mail. What should you do? The first thing you don't do is ignore it. It won't go away on its own, and it will likely escalate to even more unpleasantness if left unanswered. Don't panic either. Many times the notices are incorrect and have an easy fix with a simple explanation. The best approach is to notify your tax preparer and have them respond. Usually you have 30 days from the date of the notice before more penalties and interest are added and the process escalates. A call to the IRS can usually get you more time to respond if the answer is complex and requires a lot of work. Also you have to be patient with getting closure on the notice. It might take six months or longer to receive a resolution from the IRS after you have responded to them.

Georgia Entertainment Tax Credit

Qualified production costs (movies, TV, commercials)  in Georgia are eligible for up to a 30% tax credit. The production company can take the credit against their GA taxes  or they can sell the credit to other GA taxpayers at a discount to their fair market value. You can buy tax credits for the last 3 years and apply them retroactively to offset your underpaid taxes, interest and penalties. The current market rate is 83-89 cents per dollar of credit. There is a risk of recapture from GA if the production company has not followed all of the rules so you have to be careful when dealing with small independent production companies. The risk should be lower with a major motion picture studio.

Georgia Tax Credit Scholarship Program

This program allows a couple to donate $2,500 to the participating private school of their choice and take a dollar for dollar tax credit on their Georgia return so it really costs  nothing. The private school uses the money to offer scholarships to public school students. You also can take a tax deduction for the contribution on your Federal return so you end up better off than you were before the contribution.

What Medicare Doesn't Pay For

Some of the items and services medicare doesn't cover include: dental care, hearing aids, eye exams, eyeglasses, assisted living care, long term care, chiropractic services, orthopedic shoes, routine foot care, and yearly physical exams.

How Long Should I Keep My Tax Return Records?

The answer is forever for the actual returns. However, you only need to keep the supporting records for the current and 3 previous years.

Personal vs Investment Asset

The distinction between personal and investment property is important in tax law. A loss on investment property can be deducted as a capital loss. A personal loss cannot. Expenses on investment property are deductible as itemized deductions subject to 2% of adjusted gross income. Expenses on personal use property such as your home, car, or furniture are not deductible. The key point to make a property investment property is whether the property was held for the production of income which is a facts and circumstances test. For example, a house purchased for your child to live in while in college is personal use property. However, if the same house is later rented to other students, then it is investment or rental property.

Final Form 1040

Any income received prior to death is reported on the decedent's final form 1040. Income earned on assets in the estate until distributed to the beneficiaries is taxed on form 1041 the estate income tax return. You need to apply for a Federal ID # for the estate because you can't use the decedent's social security number. You can also use a fiscal year other than the calendar year for the estate.

Estate and Gift Tax Exclusion for 2012

The estate and gift tax exclusion for 2012 is $5,120,000 the highest amount it has ever been. Now is the time to make that gift to your children or grandchildren. In 2013, the exclusion could drop back to $1,000,000.

Is your child living at home still a dependent?

If your child is over 23 and making under $3,700 and you provide more than half of their support, you can claim them as a dependent. The $3,700 rule is the one that usually disqualifies most dependents over 23.

Don't File Sub S and Partnership Returns Late!

Late returns are hit with a $195 penalty per shareholder or partner for every month late up to 12 months.

Self-Employed and on Medicare

You can deduct as self-employed health insurance the medicare premium you pay each month. You can't deduct your spouse's medicare too though.

Gambling Winnings

Gambling winnings are taxable but you can offset them with documented gambling losses. A great way to document your losses is to get a casino player's card which tracks all of your bets. At the end of the year you can request a report of all of your losses from the casino. The losses to the extent of winnings are deducted on schedule A (itemized deductions) of the the tax return.

Medicare Part B Premiums for 2012

Medicare part B monthly premiums are based on your 2010 adjusted gross income on your tax return and your filing status. The monthly premium for singles with less than or equal to $85,000 or for married filing jointly (MFJ) at $170,000 or below is $99.90. The highest monthly premium is $319.70 for singles over $214,000 and for MFJ over $428,000.

IRA Contributions for Seniors

If you will be age 70 1/2 by the end of the calendar year, you cannot make a regular IRA contribution anymore. However, you can still make a Roth contribution at any age as long as you have earned income and meet certain other requirements.

Start Up Costs

Costs that you have before you start operations in a new business can be deducted currently up to $5,000. Any amount over the $5,000 has to amortized over 15 years. Start up costs include such expenses as legal fees to incorporate, market surveys, consulting fees, market research, and advertising the business opening.

Mortgage Insurance

Mortgage insurance premiums on contracts issued after 2006 on your primary or second home qualify as deductible interest expense.  However if your income exceeds $109,000 you lose the deduction. The amount of the premium is reported in box 4 of form 1098 which should be mailed to you by your lender.

Alimony and Child Support

Alimony is taxable income to the recipient and tax deductible by the payer. Alimony must be paid in cash, checks or money orders and must be required by the divorce decree. Child support is not deductible by the payer, and it is also not taxable to the receiver.

Georgia Retirement Income Exclusion

Each taxpayer age 62 or older by the end of the year gets to exclude $35,000 of retirement income (only the first $4,000 in earned income) for 2011. Social security is already excluded 100% so is not part of the $35,000. In 2012, the amount goes to $65,000 and every year after the amount increases until all retirement income will be excluded. Georgia will become an even better place to retire.

Maximize Your Social Security

A good tool to increase your social security benefits if you are married and both at full retirement age is to take advantage of the file and suspend technique. The higher earning spouse applies for the benefit at full retirement age (age 66 for those born 1943 to 1954) and then asks that it be suspended and continue to earn delayed credits. The lower earning spouse can then file for a spousal benefit which gives them 50% of the other spouse's benefit. This does not reduce any future payment to the higher earning spouse. If the lower earning spouse's benefit is higher on their own account, they don't need to use this technique. The higher earning spouse can then claim their benefit at age 70 which will be 32% higher. When you apply for social security, remember the term "file and suspend" which may be a great strategy to maximize the family's social security.

Due Date of 2011 Individual Tax Returns

The due date for filing  individual income tax returns has been changed to Tuesday April 17th since there is a Washington DC holiday on the 16th.

Reporting on Stock Sales

For the first time, brokers will be required to report the customer's adjusted basis in stocks and bonds purchased after 2010 and whether or not the gain or loss is short-term or long-term for security sales. Before they only had to report the gross proceeds of the sales. This requirement doesn't cover mutual funds and stock acquired through reinvestment plans until after 2011.

Form 1099-K

Beginning for tax year 2011, banks that process credit cards and third party networks like paypal have to report payments to recipients on new form 1099-K, Merchant Card and Third Party Network Payments. The 2011 tax forms have line items on Schedules C, E, and F where the information from the 1099-K is to be reported. However, the IRS backed off of requiring compliance for 2011 due to possible problems with this new form.  I bet the reporting will fully be in place for 2012.