What Triggers the Alternative Minimum Tax (AMT)?

The AMT with rates of 26% and 28% is a particularly vicious tax that may hit you if you have any of the following circumstances during the year:

1. Large state and local tax deductions under itemized deductions which are not deductible for the AMT. I find this is the most common reason for AMT.
2. Large miscellaneous itemized deductions which are not allowed at all for AMT.
3. Many dependents. The standard deduction and the personal exemption deduction are not allowed for AMT.
4. Tax exempt income from private activity bonds.
5. Large long term capital gains or qualified dividends. Both are taxed at the same rate for the regular tax and the AMT. However if you have a large amount of such income, the regular effective tax rate is reduced and can bring AMT into play on the other taxable income.
6. Exercise of incentive stock options. If the stock is sold before year end in the same year of exercise, then there is no add back to alternative minimum taxable income.

You compare the regular tax to the AMT and pay the higher of the two. The AMT is calculated on form 6251.

Tax Extenders

On December 19, the President signed into law " the tax increase prevention act of 2014" which extended some 55 popular tax provisions which had expired 12/31/13 to 12/31/14. Businesses can take advantage of bonus depreciation which is available for new fixed assets and the max section 179 depreciation which has increased from $25,000 to $500,000. Individuals can deduct the larger of sales tax or state income tax. Teachers can deduct what they spend on supplies up to $250.

I hope everyone has a very merry Christmas.

Real Estate Taxes

Property tax is deductible on your tax return when paid out of escrow to the taxing authority not when you make your monthly payments to the escrow account. Penalties and interest paid on late payments are not deductible. Special assessments for sidewalks,sewer upgrades, etc. are generally not deductible because they may increase the value of your property. In the year of sale of property, the property tax is prorated between the buyer and seller on the closing statement and can be deducted for the period of ownership.

Tax Extenders

The House has passed a package of 55 tax breaks for businesses and individuals that had expired on 12/31/13. The tax breaks will be effective for 1 year through 12/31/14 only but may be extended for future years at the end of next year. The Senate will likely vote on the package this week and then it will go to Obama who could veto it. The package includes such popular provisions as bonus depreciation, increased section 179 expensing for fixed asset additions, and sales tax deductions. Stay tuned.

Top Ten Ways to Reduce Taxes Right Now

You still have some time in 2014 to take steps that will beneficially affect your tax situation. Here are my top ten.

1. Clean out your closet and basement and make donations to Goodwill. Keep the receipts and a record of items donated. You can value the items using the valuation guide at salvationarmyusa.org.
2. Organize your 2014 tax documents and receipts for deductions in one file folder. Summarize the receipts and give the totals to your tax preparer. In general, do not send the receipts to your tax preparer.
3. If you have a business on the cash basis, delay mailing bills until late December so that payments won't be received until 2015.
4. Write a check to your favorite charity or donate appreciated stock. Be sure to get an acknowledgement letter from the charity for donations of $250 or more.
5. Consider converting your regular IRA to a Roth if you can do so without increasing your taxes. This would apply if you have enough itemized deductions or net operating losses to offset your taxable income after the increase from the Roth conversion.
6. Invest in Georgia municipal bonds or other state and local bonds. The interest is tax free from both federal and state tax if you invest in bonds from your state of residence. Municipal interest is tax free from federal tax regardless.
7. Sell investments that will generate losses to offset any capital gains plus $3,000.
8. Buy supplies and equipment for your business before year end. Pay January rent in December.
9. Estimate your volunteer mileage for the year.
10. Increase your retirement plan contributions to the max.

Obamacare Tax Penalty

Line 61 on the 2014 income tax return is where the penalty ends up on your return. It is called the individual shared provision and you owe it if you do not have health insurance coverage for all 12 months of 2014. The maximum penalty is based on the bronze level health plan which is $2,448 per individual. The penalty is the greater of a family maximum of $285 or 1% of your household income above the tax return filing threshold for your filing status. I think most people will pay at the 1% of household income figure. For example, a married couple with 2 children and $70,000 of adjusted gross income would pay a penalty of $497 for 2014. The calculation would be as follows: $70,000 minus the filing threshold of  $20,300 equals $49,700. One percent of $49,700 is $497 which is greater than the flat amount of $285 but under the cap of $2,448 x 4 or $9,792.  The penalty doubles to 2% in 2015.

Transferring Wealth

If you have an estate significantly over $5,340,000, you should consider gifting assets and paying the gift tax of 40%. The assets, the 40% tax, and any future asset appreciation are removed from your estate. This would be more beneficial than leaving the assets in your estate to be taxed at death since the effective estate tax rate would be 40% vs 28.57%(40/140) with a taxable gift since the gift tax is deductible from the estate. Greater after tax family wealth can be transferred using gifts as long as you can survive for 3 years after the gift. The IRS recognizes this benefit to gifting and so to discourage death bed transfers all gift taxes paid within 3 years of death have to be added back to the taxable estate.

Cash Charitable Contributions of $250 or More

If you give $250 or more to any charity at one time, you should be given an acknowledgement letter from that charity documenting your donation and whether the charity provided you any goods or services in exchange for your contribution. These acknowledgement letters should be kept in a file and given to your tax preparer each year. Otherwise you may lose the deduction in case of an IRS audit even if you have a copy of the check to the charity. Charities are required to provide these letters, so if you have lost one make sure you ask for another copy.

Simplified Home Office Deduction

The IRS now allows you to calculate the home office deduction using $5 a square foot times the number of square foot used for the home office up to a maximum of 300 square feet so you can get a home office deduction up to $1,500 a year. You can still deduct 100% of your mortgage interest and property taxes as itemized deductions even if you use this method. The simplified method is still limited to net income from the business though. If you do the simplified method in one year, you can change to other comprehensive method the next.

Max and Min State Income Tax Rates

There are 7 states with no individual income tax which are Alaska, Florida, Nevada, South Dakota, Texas, Washington, and Wyoming. In three states the max rate is in the double digits with California being the highest at 12.3%. Hawaii is at 11% and Massachusetts is 12%. If you are thinking about moving, you should consider the state tax rates.

Zero Emission Vehicle (ZEV) Tax Credits

The Federal tax credit is $7,500 on a new zero emission vehicle like a Nissan Leaf which is a 100% electric vehicle. The credit is calculated on form 8936. The Georgia tax credit is 20% of the cost of the new or leased vehicle to a max of $5,000.  You have to attach a ZEV certification form which you get from the dealer to your GA tax return to claim the credit. There is no federal credit carryforward; you can only use the credit against the current year tax, but Georgia allows a five year carryforward.

One Person 401k Plans for the Self Employed

The annual maximum contribution limit for 2014 is $57,500 which is composed of a $52,000 limit on 20% of self employed income up to $260,000 plus $5,500 for individuals age 50 and over. A one person 401k plan should be considered for the owner of a profitable business (sole proprieitorship) with no employees. Such a plan is not subject to the complicated nondiscrimination rules for 401k plans with employees.

Unrecaptured Section 1250 Gain Tax Rate of 25%

If you sell depreciable real estate like rental property, you have to pay tax on any gain applicable to depreciation at a rate of 25% for the federal tax return. Any capital gains on appreciation above the original cost would be taxed at a maximum rate of 20%. For example, if you sold a rental property for $50,000 that you bought for $10,000 ten years ago and that you had deducted $3,000 in depreciation up to the date of the sale, then the unrecaptured section 1250 gain of $3,000 would be taxed at 25% and the remaining gain of $40,000 would be taxed at a maximum rate of 20%. The total gain is $43,000 which is the proceeds of $50,000 minus the adjusted basis of $7,000($10,000-$3,000).

Emergency Fund

I recommend that you have 6 months worth of liquid funds to cover life's uncertainties. This should be enough cash to cover at least 6 months of living expenses. Think of it as insurance, and I bet it will help you sleep better.

Writing off Business Equipment in 2014

In 2013 you could write off up to $500,000 of the cost of business equipment under section 179 of the internal revenue code. I think that was generally enough for every small business in America to write off 100% of all equipment purchases. That nice rule went away for 2014 and is now only a low $25,000. Congress could still change the law before the end of the year, but I wouldn't count on it for tax planning purposes.

Roth Conversion Strategy

If your taxable income for a given year is going to be very low due to various factors such as a net operating loss carryforward from a failed business, then it would be the right year to convert part of your regular IRA , 401(k) or any qualified retirement plan with pretax funds into a Roth IRA. The amount you convert is taxable income which can be offset by the net operating loss carryforward and still result in no tax for the year. You also then have a Roth that allows you a lot more flexibility in the timing and amount of distributions. There is no required minimum distribution and no required beginning date for distributions like in a regular IRA.  You do have to leave the funds in the Roth for at least 5 years before you start pulling the funds out or you are subject to a 10% penalty if you under age 59 1/2.

Georgia Likes Old People

Georgia has a nice retirement income exclusion for those aged 62 and over. Between ages 62 and 64 the amount is $35,000 per person and applies to most income except earned income like salaries and wages which is limited to a maximum of $4,000. If you are age 65 and up, you get a $65,000 exclusion. If you are filing a joint return with your spouse and both of you are 65, then the exclusion is a total of $130,000. Not bad. Business income from a Sub S corporation where you materially participate is considered earned income.

What is the Basis of Gift Property?

If your grandparents gave you some stock which you then sold, how would you determine if you had a gain or loss on the stock for tax purposes? In most cases the grandparents have had the stock for a long time so the current value is higher than their original cost so the basis for determining gain would be your grandparents' original cost of the stock. You would have to pay tax on the capital gain. However, to prevent taxpayers from moving capital losses to other taxpayers the IRS has a rule that if the fair market value of the gift property at the time of the gift is lower than the donor's basis and you sold at a loss, then your basis in the gifted property is the fair market value. This reduces any capital losses you can take. Your holding period starts on the day after the date of the gift if your basis is determined by the fair market value and you sold at a loss.  For example, you received 1 share of stock from your uncle that he bought for $10 a share which had an $8 value on the date you received it. If you sold the stock for $7, then your capital loss would be only $1 since your basis is the fair market value. If you sold the stock for $11, then you would have a capital gain of $1 a share since your basis is the uncle's basis of $10 a share.

Paying for College Tuition

One of the best ways to do this is set up a section 529 plan. In 2014, you can contribute up to $70,000 to an account established to pay college expenses for your child or grandchild without any gift tax consequences. The gift is considered made over a 5 year period by the IRS which keeps in within the $14,000 annual gift tax exemption. Georgia also has a very good 529 program, and you can deduct up to $2,000 per beneficiary on the Georgia return if you use the GA 529 plan.

Head of Household Filing Status

The head of household filing status is more favorable than the single status due to lower tax rates on the same level of income. To qualify though you have to meet 4 tests: not married or considered unmarried, pay more than half the cost of keeping up the home, the home has to be the principal residence of your qualifying child or your dependent qualifying relative for more than half the year, and you are a US citizen or resident.

Gifts and Inheritances

In general, everything you receive as a gift or inheritance is not taxable. However, if you receive certain income from an inheritance such as distributions from an IRA, tax deferred annuities, accrued interest and dividends, or US savings bond interest then it is taxable to you. The key is if the deceased would have had to include it in their taxable income if they received it before death then you do too when you inherit it.

Nontaxable Employer Payments

In most cases everything your employer gives you especially cash or its equivalent like gift certificates goes on your W-2 as taxable wages. The following are 11 exceptions which are not taxable:
1. Holiday turkey
2. Coffee and drinks in the break room
3. Cost of up to $50,000 in group term life insurance
4. Up to $5,250 of qualified educational assistance
5. Employee discounts on services/goods sold by the company
6. Qualified employee length of service and safety awards limited to $1,600 in value
7. Value of employer provided athletic facility on premises
8. Meals furnished on employer's premises for its convenience
9. Retirement planning services
10. Qualified adoption assistance up to a certain limit
11. Limited personal use of the company copier

Miscellaneous Itemized Deductions

The following are ten unusual deductions that are subject to the 2% of adjusted gross income threshold that you may not know about:
1. IRA fees paid with funds outside of the IRA account
2. Loss on deposits in an insolvent bank
3. Cost of installing a safe in your home
4. Appraisal fees for determining income taxes such as the value of charitable donations
5. Hobby expenses up to the amount of hobby income
6. Job related education expenses
7. Protective clothing such as safety boots, safety glasses, and hard hats
8. Special theatrical clothing if not suitable for everyday wear
9. Books, magazines , and newspapers dealing with investments and taxes
10. Trips to look after investment property not including shareholder meetings, seminars or conventions.

Repay Income Reported in the Previous year

For example, in 2014 you are required to pay back $2,000 of unemployment compensation that was reported as income on your 2013 tax return. What do you do on your 2014 tax return? You have to claim a miscellaneous itemized deduction subject to the 2% of adjusted gross limitation (AGI) for $2,000. This is the rule for repayments of $3,000 or less. If the amount you paid back was greater than $3,000, you have much better options of either claiming a miscellaneous itemized deduction not subject to the 2% AGI limitation or claiming a tax credit on the 2014 return equal to difference between the recomputed 2013 tax as if the income had not been reported and the original tax.

Mortgage Interest on a Third Home

Mortgage interest on a third home is nondeductible personal expense. If you are considering buying a third home, the best tax approach is to buy it without taking out a mortgage loan. Mortgage interest on investment property is deductible as investment interest to the extent of investment income. Any nondeductible excess is carried over to future years. However, the expectation of profit on the sale of a residence does not convert the property to investment property.

Nondeductible Miscellaneous Expenses

The following expenses are never deductible: country club dues, political contributions, parking tickets, speeding tickets, homeowner association fees for your personal residence (if no office in the home), life insurance, loss from the sale of your personal residence, and telephone expenses for residential service for the first landline into your home.

Mortgage Interest on a Qualified Residence

Mortgage interest on your main home and a second home is tax deductible subject to a debt limitation of $1.1 million. But what is a qualified residence according to the IRS? A qualified residence is property that has sleeping, cooking, and toilet facilities so a boat and a mobile home can qualify.

5 Unusual Deductible Medical Expenses

These are unusual deductions that you may not be aware of. You can deduct the cost of YMCA day camp designed for children with disabilities. Exercise programs are deductible as medical expenses if recommended by a doctor for treatment for a specific condition. Cost of guide dogs for physically disabled persons, acupuncture, and sex therapy at a hospital upon doctor's advice are also all deductible medical expenses.

Extensions

Individual tax returns for 2013 can be extended to 10/15/2014. You can't extend the time to pay your taxes which were due on April 15, 2014, only the time to file the return. Any unpaid tax is subject to interest and late payment penalties until you pay it. Georgia charges 1% a month on unpaid taxes. Estimated taxes for 2014 which are due quarterly on 4/15/14, 6/15/14, 9/15/14 and 1/15/15 are also difficult to calculate without having done the 2013 tax return. Partnership and corporate returns for calendar year 2013 can be extended to 9/15/2014. You will have to pay a small penalty on the Georgia net worth tax for Sub S corporate returns filed later than the original due date of 3/15/2014. To avoid surprises, it is a good idea in my opinion to file these returns as soon as possible. Don't wait until the last minute.

Inherited IRAs

If you inherit an IRA from a spouse, you can treat that IRA as your own and all the regular rules concerning IRAs apply. If you are a non spouse beneficiary, then you are under a whole new set of rules. You can't make contributions to an inherited IRA, you can't roll over any of the inherited IRA to your own IRA, and one good thing; you don't have to pay the 10% early withdrawal penalty on distributions. There are required minimum distributions for inherited IRAs for non spouse beneficiaries. If the original owner of the IRA died before their required beginning date of distributions (generally age 701/2), then the distributions have to be taken out over the beneficiary's life expectancy. If the original owner died after the required beginning date, then distributions have to be taken out over the longer of the remaining life expectancy of the deceased per the tables in IRS publication 590 or the beneficiary's life expectancy.

Gift Tax Exclusion

There are really two exclusions: the lifetime exclusion of $5,340,000 and the annual exclusion of $14,000. For example, you can give any number of $14,000 gifts to different individuals in a year and you would not affect your lifetime exclusion nor would you need to file a gift tax return form 709. If you give over $14,000 you reduce your lifetime exclusion and need a gift tax return prepared. For example, if you give a car costing $30,000 to your daughter in 2014, your reportable taxable gift would be $16,000 because you reduce the gift by the annual exclusion and your lifetime exclusion would then be $16,000 less. You would not owe a gift tax until you exceeded the lifetime exclusion amount. Taxable gifts also reduce your estate tax exclusion of $5,340,000 which equals the lifetime gift tax exclusion.

Self Rental

If you have a business and also own your own office, then you pay rent to yourself. Generally you never want to put property that may appreciate in value in a corporation because you would pay double tax upon the sale of the property so that is why it is a good strategy to rent to yourself. What rent to charge though becomes the question. I think the best outcome is a break even because net rent income is considered non passive income but a net loss is passive. The IRS is playing heads I win, tails you lose. Passive losses are only deductible against passive income. Passive rental losses are suspended until you sell the property.

Late Payment Penalty

The IRS charges you a late payment penalty along with interest if you owe tax after April 15 on individual returns. You can extend the time to file your return but not the time to pay the tax due. The late payment penalty is .5% of the unpaid balance for each month or part of a month up to a maximum of 25%. If you agree to an installment arrangement with the IRS, then the penalty is half the usual rate.

Does your child have to file a tax return?

The requirements for filing include the following rules for dependents. Returns must be filed if your child has unearned income such as interest and dividends of over $1,000 or earned income such as wages greater than $6,100.  You may still want to file if you want to recover any tax withholding on wages less than $6,100.

Nonbusiness Bad Debt

"Neither a borrower nor a lender be, for loan oft loses both itself and friend." William Shakespeare
Well what can you do if you have ignored Shakespeare's good advice and lent money to a friend who won't or can't pay you back. The IRS lets you take a short term capital loss on your tax return if the loss meets certain qualifications.  It has to be a legal obligation meaning a written document signed by both parties, and the loan has to be totally worthless not just partially worthless. Loans to relatives face much greater scrutiny by the IRS and should in most cases just be considered gifts and not deductible bad debts. You have to attach a statement to your tax return indicating the following: description of the debt, amount, and date due, debtor's name and relationship, efforts made to collect debt, and why you think it is worthless. Vigorous documented efforts to collect the debt and a letter from the debtor explaining why he can't repay are good ways to support your deduction.

Kiddie Tax

It might not be a good idea to transfer investment assets to your children age 23 or younger that generates more than $2,000 in income. If you do, the investment income over $2,000 is subject to Federal tax at the parent's rate so as a family you're not saving any tax dollars. The rules apply to children age 19 to 23 only if they are full time college students.

An IRA for Your Spouse

You have to have earned income or compensation to make an IRA contribution. However, even if your spouse does not have any earned income, they can still make an IRA contribution by using your compensation to the extent you have any left over after your IRA contribution. For example, if the husband age 49 has a W2 showing $10,000 in wages and the wife has no earned income, he can make an IRA contribution of $5,500 and she can make one for $4,500.

Efiling

Most CPAs including me efile every possible tax return now because it creates less paper to mail, performs diagnostics tests like checking social security numbers, and avoids keypunch errors at the IRS. Taxpayers expecting refunds get them weeks earlier especially if they allow direct deposit into their bank accounts. The tax return can be efiled when the return is ready, but the payment doesn't have to be sent in until the due date.

Recharacterization of Roth IRA Conversions

If you convert part of your regular IRA to a Roth, you are subject to income taxes on the amount of the conversion. The IRS allows you to change your mind up until the extended due date of the return which would be 10/15/2014 for a 2013 tax return. This recharacterization has to be done through a trustee to trustee transfer. If you transfer the entire amount back to a regular IRA regardless of the earnings or losses for the period of time it was a Roth then there is no tax liability. For example, if you converted $10,000 of your regular IRA to a Roth on June 1, 2013 and then on March 31, 2014 when the value was $12,000 you recharacterized the entire amount back to a regular IRA, then you have to report only the $10,000 on  line 15a on your form 1040. You also have to attached a statement to the 2013 return  indicating the details of the recharacterization.

Depreciating Vans and Trucks

If you purchase and place in service certain trucks and vans in 2013, you can depreciate them under section 179 up to a limit of $500,000. They have to be used more than 50% for business. Other conditions are required such as an open cargo area of at least 6 feet long , a loaded gross vehicle weight of at least 6,000 lbs., and seating of more than 9 passengers behind the driver seat. Some qualifying vehicles are Ford F-150s with a 6 ft. bed, Ford F250/F350s super duty, and Ford E-series cargo vans. Any truck or van with a loaded gross vehicle weight over 14,000 lbs. also qualifies. This $500,000 section 179 limit drops to $25,000 in 2014.

2014 IRS Tax Numbers

Every year the IRS updates various amounts for tax returns. The following are some of the more significant changes from 2013:


Business mileage drops to 56 cents a mile from 56.5 cents per mile in 2013.
The estate tax exemption increases from $5,250,000 to $5,340,000 in 2014.
The social security taxable wage limit increases to $117,000 from $113,700.
The HSA contribution for families increases to $6,550.
The Medicare Part B premium starts at $104.90 per month and $0 for Part D.
For higher income seniors, the Medicare Part D premium can be as high as $335.70 a month and $69.30 for Part D.
The standard deduction for married filing joint is $12,400 and the personal exemption is $3,950.

The IRS Fresh Start Initiative

The IRS has streamlined its offer in compromise process where a taxpayer can pay off his unpaid tax liability, penalties and interest for less than the full amount owed through a written agreement with the IRS. The new process called the Fresh Start Initiative requires less financial info and is more flexible in looking at the taxpayer's ability to pay. There is also greater flexibility in looking at allowable living expenses.

Volunteer Work

Can you deduct anything for the value of your time you spend helping charitable organizations? Unfortunately, the answer is no. You can however deduct any out of pocket costs and mileage of 14 cents per mile.

Commuting

In general, commuting costs are not tax deductible if you are a W2 employee. If you are self employed with your home being the principal place of business, then all of your travel relating to your business is deductible. If you are an employee with a job that is going to last one year or less and the job is outside of your metropolitan area, then commuting is deductible. Hauling tools, business calls in the car, or having a business meeting in the car will not convert commuting to deductible business travel.

Getting Social Security at Age 62

Age 62 is the earliest you qualify for social security in most cases. Should you take it at that time? I recommend that you do not if you are healthy and don't really need the additional funds. Why, because you will get a lot more if you wait. You will take a 25% cut from what you would get at your full retirement age which is age 66 for those born 1943-1954. If you can wait until age 70, you will get 8% more each year from age 66 to age 70 or a permanent increase of 32% more for life. Unfortunately, over 80% of those eligible at age 62 start taking social security benefits. Be in the other 20% if you can.

Medical Expenses Paid for Parents

Can you deduct any medical expenses you pay for your parents? The answer is yes if you provide over half their support for the year. Your parents do not have to be your dependent.

Moving Expenses for First Job

If your first job is at least 50 miles from your former home, you can deduct your moving expenses such as the costs of moving your household goods and your travel expenses. A recent college graduate can take advantage of this even without having to itemize since the deduction is an adjustment to income on page 1 of form 1040.