Home Office Deductions
When you qualify to take a home office deduction, the business
portion of the following expenses (which are usually not deductible) become deductible:
- utility costs
- home insurance premiums
- repairs
- the lower of the cost of your home or its fair market value (this is done through depreciation deductions)
A couple of caveats:
- the home office deduction is limited to the income from the business (or job) for which you are using the home office
- home office deductions for employees are only allowed if the employee’s home office is used for the convenience of the employer
- So if your employer provides you with an office at work, but you choose to work at home, you can’t take a home office deduction because you are working at home for your own convenience.
- If your employer does not provide you with an office at work (or the availability of the employer’s office is too restrictive), your home office is more likely to be for the convenience of your employer and be deductible.
Requirements of the Home Office Deduction
A home office must be used REGULARLY and ***EXCLUSIVELY***as:
- your principal place of business
- a place where you meet with customers or clients
- connected with your business if your home office is in a separate structure
If there is any personal use of your home office, it is not being used exclusively for business and the home office deduction is not allowed. There are only two exceptions to the exclusivity rule:
- you are running a daycare out of your home
- the home office is being used to store inventory
If you are running a daycare or using your home office to store inventory, you can take a home office deduction even if the home office is not being used exclusively for business (but the home office deduction is reduced by the percentage that it is being used for personal reasons).
Principal Place of Business Requirement
There are two ways to meet the principal place of business requirement:
- You meet the facts and circumstances test
- the nature of the work performed at each location
- the amount of time you spend at each location is considered.
- You perform managerial or administrative work out of your home office, and you do not perform substantial administrative or managerial work at another fixed location.
Example: Doc is a cardiologist who has a home office where he:
- does billing work
- reads medical journals
- schedules appointments
- does some bookkeeping work for his business
Under the facts and circumstances test, the IRS looks to Doc’s business and the nature of the work he performs at each location. Doc is a cardiologist and performs surgery and consults at hospitals. Since the work of a cardiologist is primarily surgical and consultative, Doc cannot take a home office deduction because his primary work is done at hospitals.
However, Doc can take a home office deduction because he performs managerial and administrative work out of his home office (and doesn’t do such work at other locations).
This fact scenario is based on the Solimon v. Commissioner case. In this case, the Supreme Court agreed with the IRS and disallowed a home office deduction under the facts and circumstances test. Congress responded by changing the law to allow home office deductions for administrative and managerial work done in a home office.
A very important advantage of having your home as your principal place of business is that commuting expenses become deductible. Normally, your commute to your first business stop (and from your last business stop to your home) are nondeductible. When your home is your principal place of business, commuting expenses from your home office to your first business stop (and from your last business stop to your home office) become deductible.
A Place where You Meet with Customers/Clients
You must actually meet with customers/clients at your home (i.e., teleconferencing or videoconferencing does not count). Not much more to say here.
Connected with Your Business if the Home Office is in a Separate Structure
The “connected with” requirement is a much less stringent requirement to meet than the principal place of business requirement. A separate structure can include a detached garage or barn. The reasoning for the less stringent standard is because a separate structure is less likely to be used for personal reasons (e.g., you are more likely to watch TV or have company in your den than you are to watch TV or invite company to your detached garage).
Simplified Home Office Deduction
There is a simplified method of computing the home office deduction. The home office deduction can be calculated by multiplying $5 by the square footage of the home 
office. The maximum square footage of the home office under this method is 300 square feet, and the maximum home office deduction will therefore be $1,500. Of course, taxpayers still have the option of calculating the home office deduction under the actual expenses method if it results in a larger deduction.
Taxpayers who use the simplified method may still fully deduct mortgage interest, real estate taxes, and casualty losses as itemized deductions. Additionally, businesses expenses such as advertising, wages, and supplies are still deductible. Depreciation may not be claimed.
If you need help with small business taxes,
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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.
Use the Power of Positive Mental Attitude to Lower Your Taxes (2017 Top Tax Scams)
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The IRS is in the process of releasing its 2017 Dirty Dozen list of tax scams. It updates this list each tax season to alert taxpayers of tax scams they may encounter during the filing season. Tax scams making the list this year include:
Falsely Padding Deductions
The majority of taxpayers file honest and accurate tax returns each year. However, each year some taxpayers “fudge” their information. This is why falsely claiming deductions, expenses or credits on tax returns remains on the “Dirty Dozen” list of tax scams.
Significant penalties may apply for taxpayers who file incorrect returns including:
- 20 percent of the disallowed amount for filing an erroneous claim for a refund or credit.
- $5,000 if the IRS determines a taxpayer has filed a “frivolous tax return.” A frivolous tax return is one that does not include enough information to figure the correct tax or that contains information clearly showing that the tax reported is substantially incorrect.
- In addition to the full amount of tax owed, a taxpayer could be assessed a penalty of 75 percent of the amount owed if the underpayment on the return resulted from tax fraud.
Taxpayers may be subject to criminal prosecution and be brought to trial for actions such as:
- Tax evasion
- Willful failure to file a return, supply information, or pay any tax due
- Fraud and false statements
- Preparing and filing a fraudulent return, or
- Identity theft.
Criminal prosecution could lead to additional penalties and even prison time.
Excessive Claims for Business Credits
Avoid improperly claiming the fuel tax credit, a tax benefit generally not available to most taxpayers. The credit is generally limited to off-highway business use, including use in farming. Taxpayers should also avoid misuse of the research credit. Improper claims generally involve failures to participate in or substantiate qualified research activities and/or satisfy the requirements related to qualified research expenses.
Inflated Refunds
“Exercise caution when a return preparer promises an extremely large refund or one based on credits or benefits you’ve never been able to claim before,” said IRS Commissioner John Koskinen. “If it sounds too good to be true, it probably is.”
Watch Out for Fake Charities
Be on guard against groups masquerading as charitable organizations to attract donations from unsuspecting contributors. Be wary of charities with names similar to familiar or nationally-known organizations. Contributors should take a few extra minutes to ensure their hard-earned money goes to legitimate and currently eligible charities. IRS.gov has the tools taxpayers need to check out the status of charitable organizations.
Watch Out for Crooked Tax Preparers
Be on the lookout for unscrupulous return preparers. The vast majority of tax professionals provide honest high-quality service. But there are some dishonest preparers who set up shop each filing season to perpetrate refund fraud, identity theft and other scams that hurt taxpayers. Legitimate tax professionals are a vital part of the U.S. tax system.
Be Vigilant Against Criminals
Tax-related Identity theft – with its related scams to steal personal and financial data from taxpayers or data held by tax professionals – remains a top item on the Dirty Dozen list because it remains an ongoing concern even though progress is being made.
The IRS and its partners remind taxpayers they can do their part to help in this effort. Taxpayers and tax professionals should:
- Always use security software with firewall and anti-virus protections.
- Make sure the security software is always turned on and can automatically update.
- Encrypt sensitive files such as tax records stored on the computer.
- Use strong passwords.
- Learn to recognize and avoid phishing emails, threatening phone calls and texts from thieves posing as legitimate organizations such as a bank, credit card company and government organizations, including the IRS. Do not click on links or download attachments from unknown or suspicious emails.
- Protect personal data. Don’t routinely carry a Social Security card, and make sure tax records are secure. Treat personal information like cash; don’t leave it lying around.
Phone Scams
Phone calls from criminals impersonating IRS agents remain an ongoing threat to taxpayers. The IRS has seen a surge of these phone scams in recent years as scam artists threaten taxpayers with police arrest, deportation and license revocation, among other things.
Phishing
Taxpayers need to be on guard against fake emails or websites looking to steal personal information. The IRS will never send taxpayers an email about a bill or refund out of the blue. Don’t click on one claiming to be from the IRS. Be wary of strange emails and websites that may be nothing more than scams to steal personal information.
If you have any questions on how this applies to you, please feel free to give us a call at 248-538-5331.
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.
Before You Start Development on that Land Investment…
Land prices have been recovering since the Great Recession. People who hold land for investment may be interested in developing then selling the land. If held for more than 12 months, gains from sales of investment real estate are subject to favorable capital gain rates (generally 15%, but up to 23.8% for high income individuals). However, people who do any development of the land generally will not qualify for capital gain treatment; they will be subject to ordinary income rates (up to 43.4%) on their entire gain from the sale of developed land.
Example: Jane owns a parcel of land she bought as an investment 20 years ago. She originally paid $200,000 for the parcel and it is now worth $300,000. Jane has not performed any development activity on the land. If she sells the land, her gain of $100,000 will be subject to the favorable capital gain tax rate of 15%. Her tax on the sale will be $15,000.
Example 2: Same as above, except that Jane spent $20,000 improving and developing the lane. She sells the parcel for $350,000. Her cost basis in the land is the $200,000 purchase price plus the $20,000 she spent on improvements–$220,000. If she sells the land for $350,000 her gain will be $130,000. Since she began developing the land, the gain of $130,000 no longer qualifies for capital gain treatment. The gain will be taxed at ordinary income rates. If Jane is in the 28% tax bracket, the tax on her gain will be $36,400.
Tax Strategy: Sell the Undeveloped Land to Your S Corporation
Through a tax-saving strategy, it is possible to have pre-development gains subject to the capital gain tax rate, and only gains from development will be subject to ordinary income rates. This is done by selling the investment land to an S corporation that the real estate investor owns before performing any development activity.
Example: Carrying on with the same fact scenario as above. Instead of developing the land herself, Jane first sells her investment property that she purchased for $200,000 to her 100% owned S corporation. The purchase price is the $300,000 market value of the land. She recognizes a $100,000 gain that is taxed at the 15% capital gain tax rate. Her tax on the pre-development gain is $15,000.
Her S corporation will now develop the land. The S corporation spends $20,000 to develop the land and the land is now worth $350,000. The S corporation’s cost basis in the land is the $300,000 purchase price plus $20,000 development costs–$320,000. When the S corporation sells the developed land for $350,000, it recognizes a $30,000 gain that is taxed at Joan’s ordinary tax rate of 28%. The tax on the $30,000 gain is $8,400. Her and her S corporation’s total tax is $23,400.
The Tax Savings
If she developed the land herself, her total tax would be $36,400 on $130,000 of total gain. By first selling the land to her S corporation, she is able to preserve capital gain treatment on the pre-development gain ($100,000) and only pays ordinary income tax rates on the gain allocable to development ($30,000). Her total tax with the S corporation strategy is $23,400. She saved $13,000.
Strategy Does NOT Work with an LLC
This strategy will generally only work with an S corporation. It will not work with LLCs because there is a rule denying capital gain treatment when an LLC owner sells property to his LLC and the property is ordinary income property of the LLC. Since the property held by the LLC will be sold at ordinary income rates, the LLC owner’s gain on the sale to the LLC will also be ordinary income.
Make Sure It’s a Bona Fide Sale for Fair Market Value
For this strategy to work, the sale to the S corporation must be a bona fide sale for fair market value. There should be a sales agreement, and if the sale is on an installment agreement, regular payments should be made and interest to the S corporation should be charged.
If you have any questions on how this applies to you, please feel free to give us a call at 248-538-5331.
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.
IRS Taxes Sweat Equity
When a taxpayer forms an LLC and contributes appreciated property to the LLC, the taxpayer generally does not recognize gain on the transfer. The IRS does not force taxpayers to recognize gain on property contributions to LLCs because taxpayers didn’t sell or exchange the property; they continue to own an interest in the contributed property, albeit through a business entity. Naturally, there are exceptions to this rule where gain can be recognized such as where debt encumbered property is transferred to the LLC or investments are transferred to an investment LLC.
On the other hand, when a taxpayer performs services (i.e., sweat equity) in exchange for an interest in an LLC, the taxpayer will usually recognize compensation income equal to the fair market value of the LLC interest received. The IRS treats the transaction as if the taxpayer received cash compensation (which is taxable), and then used the cash to purchase the LLC interest at fair market value.
There are two forms of ownership interests in an LLC—a capital interest and a profits interest. A capital interest gives the owner a claim to assets when the LLC is dissolved. A profits interest is defined as an interest other than a capital interest. Helpful. Basically, a profits interest does not entitle the owner to assets upon the LLC’s liquidation, but instead entitles the owner to a share of the LLC’s profits (if any).
A taxpayer who performs services in exchange for a capital interest recognizes income in the amount of the fair market value of the capital interest. However, a taxpayer who performs services in exchange for a profits interest will not recognize income on receipt of the profits interest. This is because the profits interest holder is not entitled to liquidation proceeds of the LLC, but is instead entitled solely to LLC profits (if any). Profits interests holders therefore have an speculative value in their interests and will not recognize income upon receipt of the interest, but will instead pay tax on any profits that are allocated to them.
Example 1: Thelma and Louise form an LLC. Thelma contributes land that is currently worth $50,000 and was originally purchased for $20,000 for a 50% capital interest. Louise will perform real estate advisory services for a 50% capital interest. Since both parties own a 50% capital interest, each would be entitled to 50% of the assets upon liquidation—Thelma and Louise would each own 50% of the land upon liquidation. Thelma does not recognize income upon her contribution because it is a contribution of property. Louise will recognize income of $25,000 because she contributed services in exchange for a capital interest.
Example 2: Same as above except that Louise received a profits interest instead of a capital interest. If the LLC liquidates, Louise will not share in the liquidation assets. Instead, Thelma will receive 100% of the land. Louise will not be taxed on her contribution of services because she received only a profits interest. However, Louise will recognize income for any profits that are allocated to her in the future.
While a profits interest is generally not subject to tax because of their unascertainable value, there are circumstances where their value is ascertainable. In these circumstances, the profits interests will be taxable upon receipt. These circumstances include:
- the profits interest relates to a substantially certain and predictable stream of income from the partnership assets (such as a net lease);
- the partner disposes of the profits interest within two years of receipt; or
- the profits interest is a limited partner interest in a publicly traded partnership.
While a capital interest received in exchange for services usually is taxable, it is not immediately taxable if the capital interest is subject to a substantial risk of forfeiture. Property is subject to a substantial risk of forfeiture if the rights to its full enjoyment are conditioned (directly or indirectly) upon either of the following:
- Future Performance of Substantial Services. A requirement of future performance (or refraining from performance) of substantial services by the recipient is a substantial risk of forfeiture. The regularity of the performance of services and the time spent in performing them tend to indicate whether the required services are substantial.
- Occurrence of a Condition Related to a Purpose of the Transfer. For example, a requirement that the recipient complete an advanced educational degree, obtain a professional designation, or attain a certain job position within the company to receive unrestricted access to the property would likely be a substantial risk of forfeiture, which would exist until that condition was met.
When the capital interest is subject to a substantial risk of forfeiture, the service provider will not recognize gain until the substantial risk of forfeiture is eliminated.
Example: Same as Example 1 above except that Louise’s capital interest will be forfeited if Louise does not provide 5 years of services to the LLC. Since Louise’s capital interest is subject to a substantial risk of forfeiture, it is not taxable in the year of receipt. Instead, it will be taxable after Louise completes 5 years of service and her capital interest is fully vested.
If you need help with small business taxes,
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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.
Michigan’s New Minimum Wage
A little over two years ago, Governor Snyder signed a law that increased the minimum wage. Under this law, the minimum wage for 2017 will be $8.90. It will again increase in 2018 to $9.25 per hour. Beginning in January 2019, the minimum wage will be indexed for inflation. The minimum wage increase for each year will not take effect if the unemployment rate in Michigan is 8.5% or more in the year prior to the year of the minimum wage increase.
Training Wage is Still Available
As existed under prior law, an employer may pay a new employee who is under age 20 an hourly training wage of $4.25 for the first 90 days of that employee’s employment. After 90 days has passed, the employee must be paid at least minimum wage.
Minor Minimum Wage is Still Available
The minimum wage for an employee who is less than 18 years of age is 85% of the general minimum wage listed above. This is not a new rule.
Minimum Wage for Tipped Employees
The current minimum wage for tipped employees is $3.23 per hour. It will increase to $3.38 per hour in 2017. To qualify for this lower rate, the following must occur:
- the employee receives gratuities in the course of employment
- the tipped minimum wage plus the gratuities received must be at least equal to the general minimum wage (i.e., in 2016 the tips received per hour plus the tipped minimum wage of $3.23 must be at least equal to the general minimum wage of $8.50). If there is a shortfall, the employer must pay the shortfall to the employee.
Overview of Minimum Wage Rates
The schedule of minimum wage increases under the law signed two years ago is:
|
Minimum Wage |
Minimum Wage for Tipped Employees | Minimum Wage
for Minors |
Training Wage (first 90 days only) |
|
| Prior to September 1, 2014 |
$7.40 |
$2.65 | $6.29 | $4.25 |
| September 1, 2014 |
$8.15 |
$3.10 |
$6.93 |
$4.25 |
| January 1, 2016 |
$8.50 |
$3.23 |
$7.23 |
$4.25 |
|
January 1, 2017 |
$8.90 | $3.38 | $7.57 |
$4.25 |
| January 1, 2018 |
$9.25 |
$3.52 |
$7.86 |
$4.25 |
If you have any questions on how this applies to you, please feel free to give us a call.
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.
New Deadlines for 2016 Tax Forms–Avoid Late Penalties!
As you know, the tax system is made up of all types of deadlines. This year, deadlines that we have long been accustomed to are changing. These changing deadlines apply to Forms W-2 and 1099-MISC as well as to income tax forms such as the Form 1065 for entities taxed as partnerships and the Form 1120 for C corporations. This post will describe the new deadlines for each of these items.
Forms W-2 and 1099-MISC
When a business pays a worker who is not an employee $600 or more in a year, the business must file an information return using Form 1099-MISC (miscellaneous income) to report the payments. Likewise, an employer must report wages paid to employees on Form W-2. In prior years, these forms had to be provided to the worker by January 31 of the following year and copies were required to be filed with the IRS (Form 1099-MISC) and the Social Security Administration (Form W-2) by the last day of February, or by March 31 if filing electronically.
Starting with 2016 forms (due in 2017), the due dates for IRS and Social Security Administration have been accelerated to January 31 of the following year (no longer the last day of February, or March 31 for electronic filers). So, 2016 Forms W-2 and 1099-MISC will need to be filed with the government by January 31, 2017–the same date that the forms have to be provided to workers.
Failing to file these returns timely can result in significant penalties–beginning at $50 per 1099-MISC or W-2 filed late.
Form 1065 (U.S. Return of Partnership Income)
Under prior law, partnership tax returns were due three and a half months after the end of the year (i.e., April 15). Since the partnership tax return was due on the same day as personal income tax returns, many owners of partnerships (or LLCs taxed as partnerships) did not receive their Form K-1 from the partnership in time to file their personal returns by the April 15 personal income tax deadline.
Beginning with 2016 partnership tax returns, the deadline has been moved up to two and a half months after the end of the partnership tax year (i.e., March 15). Six month extensions to September 15 are available.
It is important to either timely file the partnership tax return or to request an extension. If the return is filed late, the penalty is $195 per owner per month! So if a five member LLC unaware of the new deadline files a partnership tax return on April 15, the return is one month late and the penalty is $975.
Form 1120 (U.S. Corporation Income tax Return)
The deadline for C CORPORATION tax returns has been two and a half months after the end of the corporate year (generally March 15). Beginning with 2016 C corporation tax returns, the deadline has been moved back to three and a half months after the end of the corporate tax year (generally April 15). Since C corporations are not flow-through tax entities, the owner’s personal tax return is not dependent on the filing of the C corporation tax return. Delaying the C corporation deadline and accelerating the partnership tax return deadline therefore makes some sense.
Form 1120S (U.S. Return of S Corporation Income)
No changes here–the deadline is still March 15.
FinCen Form 114 (FBAR)
In prior years, foreign bank accounts had to be reported to the IRS by June 30, and no extensions were allowed. Beginning this year, the due date for FinCen 114 will be April 15 of the following year, but a six month extension will now be allowed. The extension will last to October 15.
Under the Internal Revenue Code, if a due date falls on a holiday or weekend, the return is due on the next business day. Unfortunately, the FinCen 114 form is required under the Bank Secrecy Act of 1970 and not under the Internal Revenue Code–so if the April 15 deadline for FinCen 114 falls on a holiday or weekend, the due date will not be delayed to the next business day (even though the Form 1040 will be delayed to the next working day).
So this tax season, April 15 is on a Saturday and Monday, April 17 is Emancipation Day, so the Form 1040 due date will be April 18. Since the FinCen 114 is outside of the Internal Revenue Code, its due date remains April 15.
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.
IRS Scrutinizing Aggressive Tax Strategy
I always get a kick when I see a book or an article with “what your CPA doesn’t want you to know” in the title. The strategy that is being pushed is either a well established strategy that most competent CPAs already know about or the strategy is a sham. One strategy that fits more closely into the latter category is the captive insurance company.
The Basics of a Captive Insurance Company
Basically this strategy involves a profitable business that sets up a related captive insurance company. The business enters into an insurance agreement with the related insurance company to cover risk the likelihood of which is almost certain never to occur. The business will take a deduction for the insurance premiums. The captive insurance company files an election under IRC Section 831(b) to only pay tax on investment income–basically the captive insurance company does not pay tax on the premiums it receives–it only pays tax on the investment income it earns on the premiums.
Example: Sham-How Corp is expecting profit of $200,000 this year. To shelter some of its income, it forms a captive insurance company. It then takes out a policy covering risk of a Godzilla attack. It pays the captive insurance company $100,000 in premiums. Sham-How Corp takes a $100,000 deduction. The captive insurance company does not pay tax on the $100,000 of premiums it receives–it only pays tax on the investment income it earns on the $100,000. Wanting to push its luck even more, Sham-How Corp then borrows $100,000 from the insurance company (loans are tax-free).
The Party is Ending
While these transactions have worked, they are very aggressive. The IRS is classifying captive insurance arrangements as a transaction of interest. This classification requires businesses entering into these transactions to disclose the transaction to the IRS. This will subject the transaction to close scrutiny–someone just called the cops and the party is winding down.
Why the Scrutiny?
The IRS is scrutinizing captive insurance arrangements because these arrangements tend to have the following characteristics:
- the coverage involves an implausible risk
- the coverage does not match a business need or risk of the business
- the description of the coverage in the insurance policy is vague, ambiguous, or illusory
- the coverage duplicates coverage provided to the business by an unrelated, commercial insurance company, and the policy with the commercial insurer often has a far smaller premium.
The premiums paid to the captive insurance company have one or more of the following characteristics:
- the insurance premiums are designed to be deductible
- the payments are determined without an underwriting or actuarial analysis that conforms to insurance industry standards
- the premium payments are not made consistently with the schedule in the policy
- the premiums are set without comparing the amounts of the premiums to premiums that would be made under policies with unrelated insurance companies
The management of the captive insurance company has one or more of the following characteristics:
- the insurance company fails to comply with some or all of the laws applicable to insurance companies in the jurisdiction where it is organized
- the insurance company does not issue policies or binders in a timely manner consistent with industry standards
- the insurance company does not have defined claims administration procedures that are consistent with industry standards
- the insured does not file claims for each loss that is covered by the policy
- the insurance company does not have adequate capital
- the insurance company invests its capital in illiquid or speculative assets usually not held by insurance companies
- the insurance company loans or otherwise transfers its capital to the business, related businesses, or owners of the business.
For tax strategies that work, give us a call at 248-538-5331.
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.
Deducting Investment Interest
Investors are allowed to deduct interest expense they pay on debt incurred to purchase or carry property held for investment. Property held for investment includes any property producing interest, dividends, annuities, royalties, and gain-generating property other than that used in a business.
How the Investment Interest Expense Deduction Works
Investment interest is deductible as an itemized deduction. It is limited to net investment income. Net investment income is defined as investment income that exceeds investment expenses. Investment income includes interest and includes gains that are not subject to the reduced capital gains tax rate (e.g., short term capital gain taxed at ordinary rate is qualifying investment income while long term capital gain taxed at 15% is not qualifying investment income). Also excluded from qualifying investment income are qualified dividends subject to the lower capital gains tax rates. An election exists whereby a taxpayer can treat qualifying dividends and capital gains as ordinary income and treat such income as qualifying investment income in order to deduct investment interest expense, but this election generally won’t be beneficial.
Watch Out for Tax Exempt Securities
Investment interest does not include interest expense incurred to purchase tax-exempt securities, so such interest expense is not deductible. This rule also applies to mutual funds so if a fund invests in both taxable and tax-exempt securities, the interest expense must be allocated proportionally based on the income in the fund.
Because expenses allocated to tax-exempt securities are not deductible, the allocation of expenses to tax-exempt income should be minimized. While it is common to allocate investment expenses to taxable and non-taxable income based on the amount of income in each category, allocating the interest expense in a different manner (such as the number of transactions or the amount of time spent on each class of income) may provide larger allocations to taxable income and therefore increase the amount of deductible investment interest expense.
Example: Danny manages his own investments. He trades very frequently, but hasn’t been successful this year. His taxable investment income is $5,000 and his tax-exempt investment income is also $5,000. If he allocated investment interest expense based on the relative amount of income from each class, only half of his investment interest expense would be deductible. However, if 90% of his time in his investment activities is managing his taxable investments and 10% of his time is spent managing his tax-exempt investments, then he has a strong case that 90% of his investment interest should be deductible.
Taxpayers who receive tax exempt income must submit with their returns an itemized statement showing the amount of each class of exempt income and the expenses allocated to each class. If an item is allocated between tax-exempt and taxable income, the basis of the allocation must be shown on the statement.
To see how this applies to you, give us a call at 248-538-5331.
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 Scammers Sending Affordable Care Act Penalty Notices
Tax scammers are at it again. The IRS has just issued an alert to taxpayers to be on guard against fake emails containing a fraudulent IRS tax bill related to the Affordable Care Act. The fraudulent tax bill uses the same formatting and very similar language to the actual IRS Form CP2000.
The Real Form 2000CP
The IRS sends Form 2000CP when income reported from third-party sources (such as an employer) does not match the income reported by the taxpayer on his return. The form provides instructions to taxpayers about what to do if they agree or disagree with the proposed additional tax. If the taxpayer will send payment, the form instructs that payment be made out to “United States Treasury.” The Form 2000CP is mailed to taxpayers—it is never emailed.
The Fake Form 2000CP
The IRS has received numerous reports of a fake Form 2000CP being emailed to taxpayers around the country. The fake forms have the following characteristics:
- An email that contains the fake CP2000 as an attachment
- The notice appears to be issued from Austin, Texas
- The underreported issue is related to the Affordable Care Act requesting information regarding 2014 coverage
- The payment voucher lists the letter number as 105C
- The notice includes a payment request that taxpayers mail a check made out to “I.R.S.” to the “Austin Processing Center” at a PO Box. This is in addition to a payment link within the email itself.
The American Institute of Tax Problem Solvers (of which we are members) obtained a copy of the fake tax notice. It can be viewed here.
What to Do if You Receive a Fake Notice
Taxpayers who receive this scam email should not open the attachment, but forward it to phishing@irs.gov and then delete it from their email account. Taxpayers should be wary of any unsolicited email purported to be from the IRS. They should never open an attachment or click on a link within an email sent by an unknown source.
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 Credits for Energy-Efficient Homes
Over the past several years, Congress has provided taxpayers with a nonrefundable tax credit for energy efficient home improvements. These tax credits were scheduled to expire in the past, but Congress continues to extend them. Once again, these credits have been extended through 2016. This post is a summary of the current rules regarding these credits.
The Credit for Nonbusiness Energy Property
Individuals can claim a nonrefundable tax credit for certain expenditures during 2016 to increase the energy efficiency of their primary residences (not for vacation or second homes) in the United States.
The credit equals the sum of:
- 10% of certain costs for property installed during the year to improve the energy efficiency of existing homes (these costs are referred to as building envelope components)
- amounts paid for residential qualified energy property expenditures
Building envelope components are:
- insulation systems that reduce heat gain/loss
- exterior windows (including skylights)
- exterior doors
- certain metal and asphalt roofs designed to reduce heat gain
For building envelope components, the credit is allowed only for amounts paid to purchase the components. The credit is not available for amounts paid for onsite preparation, assembly, or original installation of the component. The component must meet or exceed certain energy efficiency criteria (the manufacturer will certify whether a component meets the criteria).
Qualified energy property is property that meets certain energy efficiency criteria (once again, the manufacturer will certify whether a product meets the criteria). The credit equals 100% of the cost of the property (up to the limits below). Qualified energy property includes:
- electric heat pump water heaters (up to $300)
- electric heat pumps (up to $300)
- biomass fuel stoves (up to $300)
- high-efficiency central air conditioners (up to $300)
- natural gas, propane, or oil water heaters (up to $300)
- natural gas, propane, or oil furnaces or hot water boilers (up to $150)
- advanced circulating air fans (credit limited to $50)
For qualified energy property, the credit is available for amounts paid to purchase the property as well as for costs for onsite preparation, assembly, or original installation.
For building envelope components and qualified energy property, there is a taxpayer lifetime tax credit limit of $500 ($200 for exterior windows and skylights), taking into account all such credits allowed to the taxpayer after 2005.
The Credit for Residential Energy Efficiency Property
This is an entirely separate tax credit and is generally available for installation of alternative energy equipment through at least 2016. Taxpayers can claim a tax credit for 30% of the cost of eligible solar water heaters, solar electricity property, fuel cell property, small wind energy property, and geothermal heat pump property. The 2016 Consolidated Appropriations Act extends the Residential Energy Efficient Property credit for five years so it applies to property placed in service through 2021, but ONLY for qualified solar electric property expenditures and qualified solar water heating property expenditures. The credit will decrease to 26% for 2020 and 22% for 2021 (down from the current 30%).
Expenditures for labor costs for onsite preparation, preparation, assembly, or original installation of qualified property and for piping or wiring to interconnect such property to the dwelling unit also qualify for the credit.
The principal residence requirement does not exist for qualified solar water heating, solar electric, small wind energy, or geothermal heat pump expenditures.
To see how this applies to you, give us a call at 248-538-5331.
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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