Monthly Archives: September 2015

New Court Case Makes it Easier to Deduct Interest on Large Mortgages

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mortgage interest deductionVirtually all personal interest expense is not deductible. Fortunately, there is an exception for mortgage interest expense. Mortgage interest expense is deductible as an itemized deduction.

Categories of Mortgage Interest Deductions

There are two categories of mortgage interest:
• Home Acquisition Debt which is (1) incurred to acquire, construct, or substantially improve a residence and is (2) secured by such residence
• Home Equity Debt which is secured by a residence and, unlike home acquisition debt, can be used for any purpose without affecting its deductibility

Mortgage debt must be on a qualified residence which includes the taxpayer’s principal residence and up to one additional personal residence owned by the taxpayer. If the taxpayer owns two or more additional residences, the taxpayer can choose which house is treated as the second residence. The taxpayer can alternate which house is considered the second house each year (the one with the higher interest expense should be the second residence).

Limits on Deductibility

Home acquisition debt is limited to $1 million dollars and home equity debt is limited to $100,000. A recent 9th Circuit case answered the question: Are the $1 million and the $100,000 limits applied on a per taxpayer basis or on a per residence basis for unmarried joint owners of property? For married couples, the above limits are halved so a married couple’s total acquisition debt limit is $1 million and the total home equity debt limit is $100,000.

Examples

Example: John and Suzy are brother and sister. They purchase a $2.5 million dollar home with a $2.2 million mortgage. If the mortgage debt limits are on a per residence basis, the total amount of qualifying mortgage debt is $1.1 million*. Since the total mortgage is $2.2 million, only half of John and Suzy’s mortgage interest will be deductible.

• In prior case law, it was held that the $100,000 home equity debt limit could be applied to an acquisition of a home. This, in a way, increases the home acquisition indebtedness limit to $1.1 million.

If the mortgage debt limits are on a per taxpayer basis, John and Suzy each have $1 million of acquisition debt and $100,000 of home equity debt on which interest will be deductible. Since the sum of their limits is $2.2 million, all of their interest expense is deductible.

If John and Suzy were married, their total home acquisition debt limit is $1 million and their total home equity debt limit is $100,000. Since the total mortgage is $2.2 million, only half of their mortgage interest is deductible.

This recent court case affects unmarried joint owners of mortgaged property. The per residence limit continues to apply to married people.

Taxpayers now have substantial authority for taking the position that the qualified residence interest debt limits can be applied on a per taxpayer basis in situations where qualified residences are co-owned by unmarried individuals.

To see how this applies to you, give us a call at 248-538-5331.

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Buzzkill Disclaimer:  This post contains general tax information that may or may not apply in your specific tax situation. Please consult a tax professional before relying on any information contained in this post.

How IRAs Can Invest in Precious Metals

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IRA Precious MetalsWith the recent volatility in the stock market, some IRA owners may be concerned that their retirement funds are overexposed
to equity investments.  Some IRA owners are looking into precious metal investments.

IRAs Cannot Invest in Collectibles

As a general rule, the IRS throws cold water on the idea.  The IRS will treat an IRA investment in precious metals as a disallowed investment in collectibles.  As such, the transaction will be treated as an IRA distribution and will be subject to income tax and, possibly, the 10% penalty.

The Exception that Swallows the Rule

Fortunately, an exception allows IRAs to investment in certain gold, silver, and platinum coins and in gold, silver, platinum, and palladium bullion that meets purity standards.  For example, gold bars must be at least 99.5% pure and silver bars must be at least 99.9% pure.

Coins or bullion must be held by the IRA trustee or custodian rather than by the IRA owner directly.

The above rules apply equally to traditional IRAs, Roth IRAs, SEPs and SIMPLE-IRAs.

The big practical issue is finding an IRA trustee that is willing to set up a self-directed IRA and facilitate the physical transfer and storage of precious metal assets.  A precious metal IRA trustee will usually charge a one-time account fee (maybe $50), an annual account administrative or maintenance fee for sending account statements and so forth (about $150 or an amount based on asset value), and an annual storage and insurance fee (about $125 to $250 or an amount based on asset value).

Don’t Want to Arrange Storage?

For those who don’t want to deal with the issue of physical storage of precious metal coins or bullion, buying shares of an ETF that tracks the value of a particular precious metal is an option.  The IRS has held that IRAs can buy shares in precious metal ETFs that are classified as grantor investments trusts without any tax problem.

An even more indirect way to invest in precious metals through an IRA is for the IRA to invest in mining companies.  There is absolutely no tax law problem in this type of investment.

Issue When Retirement is Approaching

Traditional IRA owners must consider what happens once they reach age 70½ when minimum required distributions are required.  The IRA account must have sufficient liquidity to pay the required distribution to the IRA owner.  That said, required distributions are not required to be taken from each IRA; all that is required is for a distribution to be taken from any IRA based on the aggregate value of all IRAs.  Therefore, while the value of a precious metal IRA must be taken into account in determining the amount of the required distribution, the actual distribution can come out of an IRA that is invested in liquid assets such as CDs, money market accounts, marketable securities, etc.

To see how this applies to you, give us a call at 248-538-5331.

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Buzzkill Disclaimer:  This post contains general tax information that may or may not apply in your specific tax situation. Please consult a tax professional before relying on any information contained in this post.

 

Tax Issues When Non-Profits Reimburse Volunteers

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tax exemptVolunteers are the life blood of many tax exempt organizations. To keep volunteers volunteering, it is important for an exempt organization to follow the proper tax rules or they could create very unpleasant tax surprises.

Reimbursing Volunteers the Right Way

If the organization reimburses volunteers for out-of-pocket expenses, it is important to use an accountable plan to do so. Otherwise, the reimbursement will be taxable compensation to the volunteer. Even worse, if the volunteer does not report the compensation on her tax return, there could be a 25% excise tax on the compensation if the volunteer is a disqualified person (discussed later).

Accountable plans are reimbursement plans that meet three requirements:

  • Business Connection: the plan should pay reimbursements only for reasonable expenses incurred on behalf of the exempt organization that would be deductible as a business expense if the volunteer were an employee. These include lodging and meal expenses while away from home overnight, mileage, travel expenses, supplies, etc.
  • Adequate Substantiation: the volunteer must substantiate the expenses being reimbursed within a reasonable time. Substantiation can include completing the exempt organization’s reimbursement form or submitting to the exempt organization a detailed written record indicating the expense amount, when and where incurred, and the relationship of the expense to the exempt organization’s activities.
  • Excess Advances: Advances in excess of the substantiated expenses must be returned to the exempt organization. Any excess advance not returned is treated as taxable compensation to the volunteer.

25% Excise Tax on Disqualified Persons

Disqualified persons who receive an excess benefit from a Section 501(c)(3) or (c)(4) organization are subject to a 25% excise tax on the excess amount. Disqualified persons include voting directors, certain key officers, and other employees who have a substantial influence over the affairs of the organization.

An excess benefit is normally defined as the amount by which the economic benefit received by a disqualified person exceeds the value of the consideration given by the disqualified person. Normally, a reimbursement should not be an excess benefit. However, an economic benefit that should be treated as compensation, but is not is an automatic excess benefit transaction. Thus, if reimbursements not made under an accountable plan are not reported as income, they are subject to the 25% excise tax.

Providing Information So Volunteers Can Deduct Unreimbursed Expenses

On the flip side, if the organization does not reimburse the volunteer’s out-of-pocket expenses, it is important to provide volunteers with required documentation so that volunteers can deduct the out-of-pocket expenses as charitable contributions.

Out-of-pocket expenses are subject to the same substantiation rules that apply when contributing money. The volunteer must produce one of the following:

  • a cancelled check
  • a receipt showing the volunteer’s name, contribution date, and contribution amount
  • when neither of the above two items is available, other reliable written records showing the previous data

In addition to meeting the above recordkeeping requirements, an unreimbursed expense of $250 or more must be supported by a written acknowledgment from the exempt organization.

To see how this applies to you, give us a call at 248-538-5331.

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Buzzkill Disclaimer:  This post contains general tax information that may or may not apply in your specific tax situation. Please consult a tax professional before relying on any information contained in this post.

How to Reimburse Employees for Business Use of Their Cars

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mileage allowanceMany employees use their personal vehicles for company business, and many businesses reimburse employees for auto expenses the employees incur while on company business.  If done the right way, employers receive a tax deduction for the reimbursement, and the reimbursement is tax-free to the employee.

Employers can reimburse the actual auto expenses of employees under an accountable plan to be subject to the favorable tax rules above.  Instead of reimbursing actual auto expenses, employers may also reimburse employees through a mileage allowance regardless of the actual amount spent for auto expenses and still be subject to the favorable tax rules above.

Reimbursing Employees With a Mileage Allowance

A mileage allowance is an allowance paid under an accountable plan that meets the following requirements:

  • the allowance is paid for ordinary and necessary business expenses incurred by an employee for auto expenses in connection with the performance of services for the employer
  • the allowance is paid at the applicable business standard mileage rate, under a flat rate, or stated schedule, or in accordance with any other IRS-specified rate or schedule

Employers may reimburse an employee at a higher rate than the standard mileage rate of 57½ cents (for 2015) if the reimbursement rate is reasonably calculated not to exceed the amount of expenses incurred by the employee.  However, only the portion of the reimbursement rate equal to the standard mileage rate is treated as under an accountable plan and qualifies for the favorable tax treatment.

Example:

ABC Corp reimburses its employee, John, at a rate of 60 cents per mile even though the standard mileage rate is 57½ cents per mile.  John drives 300 miles on employer business.  The tax treatment is as follows:

 

Total reimbursement                                       $180.00 (60 cents times 300 miles)

Reimbursement at Standard Mileage Rate        $172.50 (57½ cents times 300 miles)

Excess Reimbursement                                      $7.50

The $172.50 reimbursement is deducted by ABC Corp and is tax-free to John.  The $7.50 excess reimbursement is deducted as payroll by ABC Corp and is taxable income to John.  The excess reimbursement is subject to payroll taxes to ABC Corp and is subject to FICA tax to John.

Advantages of Using a Mileage Allowance

Reimbursing an employee under a mileage allowance has the following benefits over reimbursing actual expenses:

  • Reduced substantiation: mileage allowances eliminate the need for employees to gather documentation supporting the amount spent for automobile expenses.  While employees don’t have to substantiate the amount of auto expenses, they must still substantiate the other elements of the auto expenses such as dates, locations, miles, and business purposes of the trips.
  • Retaining excess reimbursements: if the mileage allowance at the standard mileage rate exceeds the actual expenses of the employee, the employee may keep the excess reimbursement tax-free.  Normally, excess reimbursements under an accountable plan must be returned to the employer.

To see how this applies to you, give us a call at 248-538-5331.

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Buzzkill Disclaimer:  This post contains general tax information that may or may not apply in your specific tax situation. Please consult a tax professional before relying on any information contained in this post.

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