Tax Tip Archive - 2004

January

Tax Rates for 2003

Now that 2003 has come and gone, it is time to gather all the paperwork you will need to file your tax return.  

Although your 1099’s have not arrived, it is a good idea to get your paperwork in one place and add the 1099’s to the pile when they do arrive.  Once you have everything, the following chart will help you determine your tax situation.

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Like Kind Exchange

If you trade a business asset for a similar asset, that is known as a Like-Kind Exchange.  There are special rules regarding the basis in the new asset and how it is depreciated.

Any book value remaining in the traded asset (cost less accumulated depreciation) is added to any cash down payments or new loans.  If you receive money in the exchange, you may need to recognize a gain.  The money received will lower your basis and any recognized gain will increase your basis.  Gain is only recognized up to the amount of money and the fair market value of “non like-kind exchange property” received.  If you realize a loss, it is not deductible.

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Tax Savings for Home Owners

If you are someone who owns their own home, there are incredible tax savings available when the time comes to sell that house. 

The amount of gain you realize from any sale of your home does not need to be recognized up to $250,000 for single filers or as much as $500,000 for those that are married filing jointly. So any realized gain below these limits ($250,000 or $500,000) will not be reported on your tax return. 

There are very limited preconditions to this non-recognition of gain: Any person wanting to take advantage of this savings must have lived in this home as their primary residence for at least two of the previous five years ending on the date of sale and also have been the house’s owner. Even if you fail to meet the two-year rule, you can usually make an exclusion of gain from the sale on a portion of the proceeds if your reasons for selling before the two-year period meet the regulations.

Related to this are a couple of other good tidbits, courtesy of the IRS: 

If you have a business that operates out of an office in your home, you are no longer required to allocate gain to the portion of your home that is residential and the portion that is business-related in order to determine what is excludible. The entire house can now be taken as one unit and the entire $250,000 or $500,000 taken accordingly. 

Lastly, even if you have sold your house as far back as the 2000 tax year, you may still take advantage of this savings retroactively (though for 2000 your time will expire this April 15) because that year, as well as 2001 and 2002, remain open tax years for the IRS- allowing you to still reap the benefit for any sale in those years. Of course, any sale made in 2003 should be taken advantage of in this year’s tax season.

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Relief for Child Care Expenses

Employer-sponsored plans or tax credits may help ease the burden of child care expenses.

If you have children that are still young, you know how expensive child care can be. But some of that burden can be eased through employer-sponsored plans, or through an otherwise available tax credit. 

Many employers offer a dependent-care flexible spending account that allows contribution of pre-taxed income for expenses related to child-care where both of the parents are working and the child is under age 13. If your expenses relate to elderly or disabled dependents, these would also qualify.

These plans are established when your employer asks you how much you would like to contribute. You are allowed $5,000 per family whether you are married or single parents and regardless of how many children you have. Your employer will deduct a proportionate amount from your income each pay period, so that the whole amount you are contributing will not be taken out until year’s end. Payments required at the beginning of the year will still be reimbursed to you by giving the bill to your employer, along with the social security number or taxpayer identification number of the child-care center or individual providing care on your tax return when the time comes to file.

If your employer does not provide this, there is always the child and dependent care tax credit. The amount you are credited, however, is reduced quickly for moderate income families. If your income is $15,000 or less, you can write off up to 35% of your child care expenses for a maximum benefit of $1,050 per child. The percentage allowable continues to fall as your income rises. If you make at least $43,000 in income, your credit will be only 20% of child care expenses.

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February

Home-Office Expense Deductions 

Useful for those who work out of their house either as a self-employed person or as an employee

To be able to deduct these, you first must clear some hurdles as to how much of your home is used for business: 

First, the part of your house that you call your office (which does not have to be its own room, but rather a space or area you conduct business) must be used wholly for business, and not anything else. 

And secondly, this office must be your principal place of business. This is easy enough if you don’t have to get out of the office in order to make your income. However, for those that must leave to work elsewhere (say a salesperson or independent contractor), you can still likely meet this threshold thanks to fairly recent changes in the law. This home office would still be deductible if you: 

• have no other place to call an office (such as at the hospital)

• use the office for meetings even if most work is conducted outside of the office

• have the office as a separate facility removed from the rest of your home

If you have met these thresholds, then the amount you will actually be allowed to deduct will depend on the source of the expense. 

If it is solely an office expense that is directly connected to the office with no connections to the rest of the house, then all of that expense may be used. 

If it is a divided-expense, where the office area is only a portion of the entire house’s expense, then only use the percentage of the office area to the entire house. Try to divide your office according to the number of rooms in the house if they are all of approximate size (and if you choose not to use square footage to measure the rooms).

If you are an employee deducting your home-office expenses, you will be more severely limited, because the amount you will be allowed to deduct must be over 2% of your adjusted gross income. More than likely, you will be required to have additional expenses that qualify as miscellaneous itemized deductions in order to qualify on Schedule A, in contrast to those self-employed persons (described above) that will use Schedule C. In addition, those employees using their office in their house must do so for the benefit of the employer and not simply for their own benefit.

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Missing Your 1099?

What to do if you don’t receive your Form 1099 by February 16.

According to the IRS, payers have until February 2, 2004, to mail these forms to you. If you have not received an expected 1099 by a few days after that, contact the payer. If you still do not get the form by February 16, call the IRS for help at the Tax Help Line for Individuals at 1-800-829-1040.

In some cases, you may obtain the information that would be on the 1099 from other sources. For example, your bank may put a summary of the interest paid during the year on the December or January statement for your savings or checking account. Or the bank may make the interest figure available through its customer service line or Web site. Some payers include cumulative figures for the year with their quarterly dividend statements. If you are able to get the accurate information needed to complete your tax return, you do not have to wait for the 1099 to arrive.

If you file your return and later receive a Form 1099 for income that you did not fully include on that return, you should report the income and take credit for any income tax withheld by filing Form 1040X, "Amended U.S. Individual Income Tax Return."

You will not usually attach a 1099 series form to your return, except when you receive a Form 1099-R that shows income tax withheld. You should keep all other 1099s for your records.

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Missing Your Form W-2?

There are optional ways to get the information you need.

If you have not received your Form W-2, contact your employer to find out if and when the W-2 was mailed. If it was mailed, it may have been returned to your employer because of an incorrect or incomplete address, so be sure to verify your address. After contacting your employer, allow a reasonable amount of time for your employer to re-mail or to issue the W-2.

By February 16th, if you still have not received your W-2, contact the IRS for assistance toll free at 1-800-829-1040. When you call, have the following information handy:

1. The employer's name and complete address, including zip code, the employer's identification number (if known), and telephone number, 

2. Your name, address, including zip code, Social Security number, and telephone number; and 

3. An estimate of the wages you earned, the federal income tax withheld, and the dates you began and ended employment.

Misplaced W-2

If you misplaced your W-2, contact your employer and be prepared with the information listed above. Your employer can replace the lost form with a "reissued statement."  Be aware that your employer is allowed to charge you a fee for providing you with a new W-2.

Still no W-2 by filing deadline?

You still must file your tax return on time even if you do not receive your Form W-2. If you cannot get a W-2 by your tax-filing deadline, you may use Form 4852, "Substitute for Form W-2, Wage and Tax Statement," but it will delay any refund due while the information is verified.

Corrected W-2

If you receive a corrected W-2 after your return is filed and the information it contains does not match the income or withheld tax you reported on your return, you must file an amended return on Form 1040X.

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Health Savings Accounts

The new wave for paying for health care expenses for many employees may have finally arrived.

The new Health Savings Accounts (HSA’s) were signed into law last December. These are aimed at replacing the less user-friendly Medical Savings Accounts that have not exactly taken off in popularity. These new HSA’s, however, could make a big splash. 

Starting this year you can make contributions to an HSA that will be tax deductible “above-the-line,” which means that anyone will be able to deduct these contributed amounts (not just itemisers). In this respect it is very much like an IRA contribution. But what is better than the IRA contribution is that these HSA’s are not phased out at the highest income levels.

To be eligible for the HSA you must have a high deductible health insurance plan at your work place of at least $1,000 for self-only coverage or $2,000 for family coverage annually. If you meet these amounts, you will be able to deduct the lesser of either: (1) the annual deductible amount, or (2) $2,600 for single coverage or $5,150 for family coverage.

Some benefits of setting up an HSA are:

• You can use tax-free withdrawals to pay for medical expenses that are not covered for yourself, your spouse, and your dependents. 

• Being able to roll over the unused amounts from year-to-year, and any amounts earned on this are tax-free. 

• Upon reaching age 65, you may make withdrawals for any reason, including non-medical ones (though you will have a tax hit if that is the case). You may even want to pay for other expenses with your HSA upon turning 65, such as the cost of other necessaries you might have like Medicare premiums. 

• The ability to pass on your HSA to your surviving spouse tax-free (if they are properly named as beneficiary). 

You may make even larger contributions to the HSA each year if you are at least age 55 at the end of the year you wish to contribute in. During 2004, the previously mentioned minimum amount ($1,000) would be increased by $400. It will increase $100 more each year for the next five years. Upon reaching age 65, you may no longer contribute to the HSA, but if your account has a remaining balance, you can still make withdrawals the same as stated previously (tax-free unless for non-medical purposes).

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March

Medical Expense Deductions

Not all medical expenses qualify for deductions.

Many people would like to be able to reduce their tax bill by claiming medical expense deductions. Many of us have medical expenses ranging from doctor’s visits to prescription medicine. However, only qualifying expenses may be used to claim a deduction.  In addition, the qualifying expenses must be greater than 7.5% of your adjusted gross income. 

Qualifying expenses include costs that arise from the prevention or alleviation of a physical or mental defect or illness. The expenses cannot be for simple general health. A couple of the more common forms of expenses include prescription medicine and health insurance.

You may also be able to save if you increase the value of your home through an addition that may have been required for medical reasons. The cost of the addition may be written off to the extent that the cost exceeds the increase in the fair market value of the house. This can apply to changes to the house that are for the benefit of handicapped people or for those that come by a doctor’s recommendation.

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Improve Your Chances for Itemizing Your Deductions

If you have lived in areas outside of Texas and paid state and local income taxes, you could improve your chances for itemizing your deductions by including these taxes.  You may also be able to deduct any personal and real estate taxes paid.  Keep in mind that any tax paid for a prior or future tax year may be deducted in the current year if you paid the tax in the current year.

If you deducted state and local income taxes on Schedule A in one year and received a state or local income tax refund the next year, you will need to include the income tax refund on your federal return.  If you did not deduct state and local taxes on Schedule A because you did not itemize your expenses, an income tax refund is not taxable.

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Qualifications for Claiming a Dependent

Follow these general points to help you determine if someone qualifies as your dependent. 

• The support provided to the dependent is over 50% (this may be determined in different ways)

• The dependent made less than $3,050 (in 2003) in income

• The dependent is not filing a joint return of their own

• The dependent is either a U.S. Citizen, or resides in the U.S., Canada, or Mexico

• The dependent must be a “relative,” which includes children, grandchildren, parents, grandparents, brothers, sisters, aunt, uncles, nieces, nephews

• If the person is a cousin, or a foster child, than the person must have lived with you the entire year in order to qualify as a dependent

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New rates for the 2003 tax filing season

Many rate and amount changes have been put in place largely due to congress (and inflation when it exists). Here are three of these changes:

1. Traveling by car: The amount that you can deduct business miles at this year is 36 cents a mile, which reduces the previous year’s amount by half-a-cent. Other deductible amounts while driving include: medical expenses and moving expenses at twelve cents a mile, as well as charity related expenses at 14 cents a mile. 

2. Across the border: Those people who have earned income in another country now have the opportunity to exclude up to $80,000 if the person paid taxes on the income in the host country. 

3. Earned Income Credit: This year if you have no children and earned less than $11,230, you can file for the earned income credit, which is refundable. If you have one child you are supporting and made less than $29,666 you would be eligible for the credit. Or if you made less than $33,692 and are supporting two children, you will be eligible. Add $1,000 to each of these amounts if you are married.

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More New Rates for 2003

Last week we pointed out new rate and amount changes put in place by congress.  Here are three more rate changes affecting the 2003 tax filing season.

1. FICA wage base: Wages and net self employment income are subject to Social Security and Medicare tax.  In 2003, the first $87,000 of wages is subject to social security tax and all wages are subject to Medicare tax.  For 2004, the first $87,900 of wages is subject to social security tax and the Medicare tax is taken out for all wages.

2. Exemption amount: Now every person on the return is worth more, as the amount of the exemption is increased $50 to $3,050. The exemptions include your dependents as well as you and your spouse.

3. Standard deduction: Last year many people filing as married filing jointly noticed the amount they could deduct was not twice the amount of the single rate, therefore, if they had filed as single separately, they would have gotten a bigger deduction- hence the marriage penalty. Now, the amount for MFJ filers is twice the amount that single filers get, making it a substantial increase: $9,500 in 2003 compared with $7,850 deducted last year. Married filing separately get the same $4,750 that single filers receive, while widows and widowers get the same amount to deduct as do the married filing jointly crowd.

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April

Tax Filing Status

Are you using the right one?

Single: If at the end of the year you are not married, you usually will file as single, with some exceptions noted below.

Married filing jointly: If you are married by the year’s end, you will use the married filing jointly designation.  But if you lived apart from your spouse for the last six months of the year you might want to consider filing as head of household. You would also retain this filing status if during the year your spouse died.

Married filing separately: This category requires you to split your income 50/50 with your spouse since Texas follows the community property laws.  So many advantages that could be received are not as effective in this state. There are times when it can be beneficial however, such as when you are estranged from your spouse. Also, separate filing does not allow the benefit of many credits available to other filers. If you and your spouse file "married filing separate" and one spouse itemizes their expenses on Schedule A, the other spouse must itemize their expenses as well, even if those expenses are less than the standard deduction.

Surviving Spouse or Qualifying Widow/er: You should use this category if for two tax years after the passing of a spouse, you maintained over half the cost of a dependent child. When these years are over you will become Head of Household status.

Head of Household: If you provide over half the support to a child or grandchild (grown or not) and you are not married you should file in this category. Head of Household (HOH) also applies to other scenarios. Providing over half the support for a parent who does or does not live with you would qualify you.  As mentioned above, if you lived apart from your spouse the last six months of the year and were supporting your child, you would qualify only if you are legally separated under a decree of divorce or separate maintenance. 

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May

Miscellaneous Itemized Deductions

They include a mixture of items, but are all subject to the 2% of Adjusted Gross Income (AGI) test. Therefore, if you don’t have a lot of them, don’t bother trying to deduct them. Included are things like unreimbursed employee business expenses, uniform expense, union dues, professional fees and others. 

The 2% of AGI limit means that you must have expenses greater than 2% of whatever your AGI amount is. For $100,000 in AGI you would have to have over $2,000 in these expenses. If your income begins reaching into the upper limits, the amounts will begin shrinking which will happen on many itemized deductions with higher AGI’s. 

If you are itemizing, you should always consider what is available on all of Schedule A, even though this category is not as prominent as some of the others.

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Name Changes

Be sure to correctly report any changes to avoid a penalty.

If you are recently married or divorced, make sure any name change you have is registered with the Social Security Administration. This simple oversight can result in an increased tax bill or a reduced tax refund. The new name after marriage or divorce will cause a disparity between the previous name and the social security number if your name is not re-registered.

You’ll need Form SS-5 if you need to make any changes.  The form may be obtained various ways.

• On the web at www.ssa.gov

•  Over the phone at 1-800-772-1213

•  At your local SSA office where it will then be filed

For any children claimed on the return, make sure you are providing a social security number for each of them as well. If you are a parent of adopted children, you will want to attain an adoption taxpayer identification number for them. This may be received by filing form W-7A with the IRS. Go to www.irs.gov, or call 1-800-TAX-FORM to have one provided for you.

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Tax Refunds

Are you getting an income tax refund this year?  Many taxpayers are getting a refund as a result of the new tax laws.  If you are getting a refund, consider depositing some or all of it in a retirement account.  Depending on your age, that extra money can result in a substantial increase in the amount available upon retirement.

Another alternative is to open a college savings plan if you have children.  There are many to choose from and with the ever increasing cost of tuition, saving now could certainly pay off when your child turns 18.

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Tax Basis

There are a variety of issues when it comes to the basis of an asset depending on the circumstances.  One particular issue involves assets that are inherited from someone.

Usually the basis is what someone pays for an asset.  However, the basis in an inherited asset is not what the decedent paid for it; it is the fair market value of the asset on the date of death of the decedent.  If you sell an item that you inherit, you will need this information to determine the gain or loss on the sale.  If you do not know what the fair market value of the asset was at the date of death, you will need to contact the person who prepared the estate tax return.  If no tax return was required to be filed, the fair market value will need to be established.

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June

Retirement Accounts

Distribution Requirements

A person must begin receiving distributions from retirement accounts when they reach age 70 ½ or when they retire, which ever is later.  When the second event occurs, they are required to begin taking distributions out of traditional IRA’s, 401(k)’s, SEP’s and SIMPLE retirement plans.  This rule, however, does not apply to Roth IRA’s.  A taxpayer is required to receive a minimum distribution no later than April 1 in the year following the year he or she reaches age 70 ½ or retires.  After the first required distribution, subsequent distributions must be received by December 31 of each year.

Example:  David reaches age 70 ½ on March 8, 2004.  He is required to receive his 2004 distribution by April 1, 2005.  His 2005 distribution must be received by December 31, 2005.  Each year’s distribution must be received by December 31.

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Investment Basis

Many people who own mutual funds have chosen the option of having their dividends and capital gain distributions automatically reinvested to purchase more shares.  When this occurs, the basis in the total number of shares owned is the original purchase price plus the dollar amounts reinvested.  Those reinvestments must be tracked to correctly calculate basis when the funds are sold.  This can turn into a very tedious calculation if the funds have been owned for a long period of time.  It can be much simpler to use the total dollar amount reinvested on the year end statement provided by the mutual fund company.  By doing this, you will lower the capital gain or increase the capital loss upon the sale of the investment.  This applies to stocks as well.

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Get your refund faster

E-Filing & Direct Deposit

The Internal Revenue Service says the fastest way to get your refund is to file your income tax return electronically.  You can receive your refund as quickly as 7 to 10 days.  Compare that to 6 to 8 weeks for returns filed with a paper return.  If you choose to have your refund sooner, you can have your refund deposited directly into your checking or savings account.

To avoid delays, file your return in February or March instead of waiting until mid April.  Also, be sure to sign your return, attach all documents that are required (W-2, any 1099’s with federal withholding, etc.) and make sure there are no mathematical errors in the return.

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Upcoming Marriage?

Tax issues to be addressed.

If you are engaged to be married, you and your fiancée should consult your tax professional to avoid headaches at tax time.

Combining two single individual’s income and deductions into one tax return can reveal such issues as whether or not you will be subject to the marriage penalty, if more withholding is needed, if you will be subject to the Alternative Minimum Tax and other important facts.

Other issues that need to be addressed include estate planning, retirement plans and insurance policies.  Prepare a will if you do not have one or update an existing will.  Also, you may need to change the beneficiary designations on retirement plans and insurance policies.  Information regarding bank accounts will need to be updated if the accounts will be joint accounts.

Also, contact the Social Security Administration to notify them of your new married name

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Asset Expensing

The recent coverage of the ability to write off (expense) assets had many taxpayers purchasing new equipment, vehicles and other assets.  The recent tax law change was very generous increasing the amount that could be expensed from $25,000 to $100,000.  Also, the limit of how much could be placed in service during the year increased from $200,000 to $400,000 before the expensing amount was limited.

There is a limitation as to how much you could expense (called “Section 179”) in the current year.  The amount of expensing your assets is limited to “business income.”  Some taxpayers who purchased assets during 2003 may have not realized that after the end of the year their business income was negative and were not able to take Section 179.

There are different definitions of “business income” depending on the type of entity the business is (corporation, partnership, sole proprietor).  For all three, business income is income from any trade or business actively conducted without regard to Section 179.  For individuals, also include taxable wages, salaries, tips and other compensation earned as an employee.

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July

Reduce Your Refund

Should you adjust your withholding?

Many taxpayers received a large refund on their taxes this year. The majority of those taxpayers intentionally paid extra taxes during the year so they did not have to come up with the extra money when they filed their taxes.  While this method works for some people, the fact is that this is an interest free loan to the government.

For employees who received a large refund, consider adjusting your withholding at work by completing a new Form W-4.  The form includes a worksheet to assist in figuring how many allowances you should claim.  Review your most recent tax return to allow for other types of taxable income, such as interest, dividends and gains from investments.

If you’re worried about underpaying tax, there are a couple of rules you should know. Generally, you’ll escape a penalty if you pay, through withholding or quarterly estimated payments, at least 100% of last year’s taxes (110% if your adjusted gross income is over $150,000), or if you pay at least 90% of what you owe for this year.

Reducing your withholding is going to give you additional take home pay.  What should you do with the extra money?  Consider contributing more to your employer’s retirement plan, pay down those high interest credit cards (pay down the highest interest rate debt first), pay additional principal on your home mortgage, contribute to a higher education plan for your children or contribute to an IRA account if you are eligible.

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Sale of Residence

Under the sale of residence rules, up to $250,000 for singles and $500,000 for married filing joint taxpayers of gain can be excluded from taxable income upon the sale of a personal residence.  The exclusion cannot be made more often than once every two years and the residence must have been the principal residence of the taxpayer for at least 2 of the last 5 years.  There are safe harbors, such as health, employment and hardship reasons if the 2 year test is not met.

For taxpayers who wish to keep there residences in the family, there are rules which can allow a taxpayer to sell the residence to a family member and exclude the gain amounts above.  To qualify, the sale must be an arm’s-length transaction so that it will not be deemed a gift or other type of transfer.  Also, the buyer must make use of the property and legal title must pass to the buyer.

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August

Dependent’s Tax Return

Dependents who are not blind and under age 65 must file a tax return depending on their income levels.  Returns are required under the following situations:

• Unearned income is greater than $750 for 2003 (projected to be $800 in 2004)

• Earned income is greater than $4,750

• Gross income is greater than the larger of 1) $750 or 2) earned income up to $4,500 plus $250

Unearned income includes interest, dividends and capital gains.  Earned income is wages, tips and taxable scholarships and fellowship grants.  Gross income is unearned and earned income.

A return may be filed if the income levels are not reached to claim a refund of federal income tax withheld.

Parents can elect to include income from a child under the age 14 on their tax return.  This applies if the child had no earned income, received unearned income under $7,500 (projected to be $8,000 for 2004), was not subject to backup withholding and no estimated tax payments were made under the child’s name and social security number.

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State Income Taxes

Are you going to move or have you already moved this year to a different state?  If so, there are tax issues that need to be addressed.  Although each state is different, there are some categories you will need to review before the end of the year.  The specific rules also vary based on your residency (nonresident, part year resident or full time resident during the tax year).

• What types of income are taxable in that state?  Sometimes you must include tax exempt bond interest in income, even though it is exempt from federal tax.

• What items are “additions” and “subtractions” in that particular state?

• Can you get a credit for income taxes paid to another state?  Some states have this available.

• State income taxes paid to the state of residency are not deductible.

• What are the amounts for the standard deduction and exemption?

• What tax credits are available?

• Do you need to make estimated tax payments to your state?  This one is very important during the year of a move to a different state.  If you were not a resident of a state for 12 months the year before the year you are filing an underpayment penalty may be assessed.

Consult your tax professional or the statutes of the states in which you live during the year for more information.

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Becoming Subject to the Alternative Minimum Tax

If your taxable income and deductions meet certain criteria, you could become subject to the “stealth tax,” better known as the Alternative Minimum Tax. This was enacted with the purpose of penalizing people who paid no tax and were very wealthy in the 1960’s.  It has now grown to become increasingly commonplace among average income taxpayers. 

According to some research studies, the hardest hit people in the near future (by 2010) will be taxpayers that are married and parents. Couples will be more than 20 times as likely as singles to face the AMT in 2010. The AMT prohibits deductions for dependents, so 85 percent of married couples with two or more children will face the AMT.

It is more difficult to plan for because the traditional tax system that most of us still are subject to does not resemble the AMT in the manner in which deductions and adjustments are allowed. Some examples of the way income tax calculated under the traditional tax system and under the AMT are calculated differently are shown below:

• Passive activity losses are added back, or recalculated

• Net operating losses must be recomputed

• Long-term construction contracts must be calculated as “percentage of completion” rather than “completed contract”

• Incentive stock options become taxable when you exercise your stock, not when the stock is sold

Itemized deductions are heavily affected from the AMT:

• Tax deductions (such as property, real estate, or state) are added back

• Mortgage interest from a home equity loan (not from purchasing a house) is added back

• Medical expenses must exceed 10% of adjusted gross income (AGI), not 7.5%

• Miscellaneous itemized deductions that must exceed 2% of AGI are not allowed

• In addition, no personal exemption or standard deduction is allowed under the AMT. 

Of course, many other items are subject to different tax treatment under the AMT. Because of the benefits many have received from the traditional tax system tax cuts, more people will end up seeing this shortage of government revenue made up for with increased numbers subject to AMT.

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Benefits of Adopting a Child

Many people may not be aware of the tax credit that is available for the adoption of a child. This credit can be used even if the adoption has not been finalized. The amount of expenses incurred in adoption that may be benefited from are over $11,000.

The tax credit is for expenses associated with each adopted child, instead of an annual limit. Higher income families, however, will have the amount of credit that may be taken phased out or reduced. Expenses that may be used under the umbrella of adoption include: reasonable and necessary adoption fees, necessary transportation, meals, and lodging, as well as attorney fees.

One thing you must be aware of when seeking this benefit from adoption is that expenses assumed in adopting a spouse’s child or in a surrogate parenting arrangement (e.g. a foster parent) do not qualify you to take the credit. In addition, the adoption credit does not apply to expenses reimbursed by the government or private programs, and those expenses for which an income tax deduction or credit is already allowed.

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Claiming Someone as a Dependent

Because someone depends on you doesn't necessarily make that person your tax dependent. To know whether someone qualifies to be your dependent there is a test using the  “SUPORT” mnemonic that needs to be met in order to claim someone on your return:

S- Support given must be over 50% (if multiple support, one must provide at least 10% of the support)

U- Person for whom exemption is claimed must have under an annually indexed amount of income for the year. For the 2003 tax year, this was $3,050 (exceptions to this exist if one is under age 19, or a full time student under age 24)

P- Precludes filing a joint return for the dependent

O- Only US citizens and residents of US, Canada or Mexico can be claimed

R- Must be a relative or

T- Taxpayer lives with the individual for the whole year (if they are not a relative)

For the R and T of the mnemonic above a person must either live with you for the entire year as a member of your household or, if not living with you, must be related to you in one of the following ways:

• Your child, grandchild, great grandchild, etc. (a legally adopted child is considered your child) 

• Your stepchild 

• Your brother, sister, half brother, half sister, stepbrother or stepsister 

• Your parent, grandparent or other direct ancestor, but not foster parent 

• Your stepfather or stepmother 

• A brother or sister of your father or mother 

• A son or daughter of your brother or sister 

• Your father-in-law, mother-in-law, son-in-law, daughter-in-law, brother-in-law or sister-in-law

• A cousin for these purposes is not considered your relative

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September

Income from an IRA

There are certain requirements that enable you to know whether income you receive from an IRA will be taxable or not. Generally, retirement money may not be withdrawn until you have reached age 59 ½ or you elect to receive equal periodic distributions over your life expectancy. You are required to start withdrawals by the age of 70 ½.

Any income that you obtain from a traditional IRA will be taxed as ordinary income when received. However, any qualified benefits received from a Roth IRA will be non-taxable. And any benefits received from a traditional non-deductible IRA will have the return of principal non-taxed, but the interest received on it taxable when withdrawn.

Generally, there will be a ten percent penalty tax on any distribution that does not meet the exceptions to penalties on withdraw. These exceptions include:

• A first time homebuyer that uses up to $10,000 in funds within 120 days of withdrawal.

• Medical insurance expenses if you are unemployed with up to twelve consecutive weeks of unemployment compensation, or self employed and not eligible for unemployment compensation.

• Medical expenses that exceed 7 ½ % of your adjusted gross income.

• Costs of college tuition, books, fees, etc.

• Expenses related to disability and death.

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Who Must File?

The general rule is that one must file a return if their income is at least equal to the sum of:

• The personal exemption plus

• The regular standard deduction (unless married filing separately) plus

• The additional standard deduction amount for taxpayers age 65 and over or blind (again, unless married filing separately)

Exceptions to this general rule require one to file even if their income is less than these amounts. These are:

• Individuals whose net earnings from self-employment are $400 or more

• Individuals who can be claimed as a dependent on someone else’s tax return, have unearned income, and gross income of $750 or more

• Individuals who receive advance payments of earned income credit

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Moving Expenses as a Deduction

Can you deduct the moving expenses you incur? Only if the expense was incurred in connection with the commencement of work as an employee or as a self-employed individual at a new principal place of work. And these hurdles must be met:

-    The new workplace must be at least 50 miles further from your old house than your previous workplace was.

-     You must work full-time in the new location for at least 39 weeks (75% of the year) during the 12-month period immediately following your arrival. Someone self-employed must work full time at least 78 weeks during the 24-month period after his or her arrival.

-     Only direct moving costs are allowable. These include travel and lodging for you and your family. These may be actual costs or 12 cents a mile (tolls and parking fees may be added to this rate). Also the cost of moving household goods and personal effects from the old to the new location may be included.

-     Non-deductible costs would include meals, house hunting before moving, a broken lease expense, as well as temporary living expenses.

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October

Sale of a Home

A taxpayer is allowed to exclude the gain on the sale of their house with some stipulations. There can be non-recognition of gain on up to $500,000 for married couples filing jointly. That amount is $250,000 for people that are single, married filing separately, and head of household.

In order to qualify for this full exclusion:

(1) The taxpayer must have owned and used the property as a principal residence for two years or more during the five-year period ending on the date of the sale.

(2) Either spouse (in a joint return) must meet the ownership requirement, but both spouses must meet the use requirement

In addition, keep in mind these points:

            -There is no age requirement to receive the exclusion

            -No rollover to another house is required

The exclusion is renewable, meaning the taxpayer may use the homeowner exclusion as often as available over his or her lifetime provided he or she meets the other requirements

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What Losses Are Non-Deductible?

Some of the losses you might receive are not always deductible. Remember these as your year-end tax planning draws closer:

• Wash Sales- a wash sale exists when a security is sold for a loss and is repurchased within thirty days before or after the sale date. The loss on the wash sale is disallowed for tax purposes. The basis of the repurchased security is equal to the purchase price of the new security plus the disallowed amount of the loss on the wash sale.

• Related party transactions- those between brothers and sisters, husbands and wives, lineal descendants (father, son, grandfather), as well as entities that are more than 50% owned by individuals, corporations, trusts, and/or partnerships. However, your in-laws are not considered related parties.

• Personal- No deduction will be allowed for the loss received on a non-business disposal or loss. If you itemize, you might be able to take a deduction for a personal loss as a casualty or theft.

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Educational Expenses as an Adjustment to AGI

If you are currently in college or in some form of higher education, it is nice to know you can receive some relief on your taxes for the expenses you incur taking classes.

For tax years 2002-2005, qualified higher education expenses are an above-the-line deduction, regardless of whether the education is work-related. Before 2002, these expenses were only deductible as education expenses (an itemized deduction subject to the 2% of AGI limitation.)

For 2004 and 2005, the maximum amount that may be used as expenses is $4,000. But be aware, there is no phase-out on this $4,000, but rather an immediate cut-off if your adjusted gross income is above these amounts: $65,000 if single and $130,000 if married filing jointly.

Additionally, you cannot claim the deduction if the expenses were applied to either:

a. The Hope Credit and/or Lifetime Learning Credit or

b. Any non-taxable Education IRA distributions

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November

Deductible Taxes

For cash–method taxpayers, deductible taxes are generally deductible in the year paid. For accrual-method taxpayers, taxes are generally deductible in the year in which they accrue. Deductible taxes on Schedule A include:

* Real Estate Taxes (State, Local and Foreign)

-The taxpayer must be legally obligated to pay in order to deduct the taxes

-Prorate the taxes in the year of sale/purchase

-Taxes paid under protest are deductible, with any subsequent recovery included in gross income

-Real estate taxes do not include street, sewer, and sidewalk assessment taxes

 * Income Taxes (State, Local, and Foreign)

-Estimated taxes paid during the year are deductible

-Withheld taxes from paychecks during the year are deductible

-Assessments paid during the year for prior year’s tax are deductible

* Personal Property Taxes (State and Local Taxes)

Remember that the following taxes are not deductible on Schedule A:

-Federal taxes (including social security)

-State Inheritance Taxes (aka “federal estate pick-up tax”)

-Business taxes and rental property taxes

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Home Mortgage Interest

For the next couple of tips we will identify those eligible interest deductions that may be taken if you itemize on your tax return. The first of these interest deductions is Home Mortgage Interest.

Deductions are allowed for “qualified residence interest” on a first or a second home (a taxpayer’s principal residence and one other residence). A home that is used for personal purposes for at least fourteen days in a tax year qualifies as a “second home.” Qualified residence interest is available in two forms: acquisition indebtedness and home equity indebtedness.

Acquisition Indebtedness:

This interest is available on up to $1,000,000 of indebtedness. This is debt that is incurred in buying, constructing, or substantially improving your principal home or second home. The points related to this are immediately deductible. But, refinancing points must be amortized over the life of the loan. 

Home Equity Indebtedness:

This interest is available on up to $100,000 of indebtedness. This is debt that is secured by the first or second house but is not acquisition indebtedness (described above). The $100,000 is limited to the FMV of the property (reduced by the amount of outstanding acquisition indebtedness). The proceeds from this loan may be used for any purpose, like a vacation or a medical expense.

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Investment Interest

Continuing interest expense deductions from last week, another one available is investment interest. An important item to know is that the investment interest deduction for individuals is limited to net (taxable) investment income.

The items you do include as investment income are:

(1)  Interest and dividends or “portfolio income”

(2)  Dividends that are portfolio or investment income

(3)  Rents

(4)  Royalties (in excess of expenses)

(5)  Net long-term and short-term capital gains (but only if the taxpayer elects not to claim the reduced capital gains tax rate)

You do not include as investment income the interest expense used to purchase tax-free bonds, because the interest earned on the bonds is not taxable.

We will finish investment interest deductibility in the next tip, as well as the deductibility of other interest expenses.

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Deductible Interest Expense

To finish our look at deductible interest expense, remember these last remaining points:

1. Consumer interest (personal interest) is not deductible. This includes interest on:

-         A personal note to a bank or person for borrowed funds

-         Life insurance loans

-         Bank credit cards

-         A purchase of personal property (e.g. autos)

-         Interest off of federal, state, or local tax underpayments

2. Prepaid interest must be allocated over the life of the loan, even for a cash basis taxpayer. However, prepaid interest received is taxable when received and is not allocated.

3. Educational Loan Interest is an adjustment to arrive at adjusted gross income and is not an itemized deduction.

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Casualty and Theft Losses

Have you considered casualty and theft losses as an itemized deduction?

Casualty and theft Losses of non-business property are deductible to the extent that each individual loss exceeds $100 and that the aggregate of these excess losses (the amount over $100) exceeds 10% of Adjusted Gross Income. The $100 floor applies to each separate casualty event. 

The amount you may classify as a casualty loss is the difference in the market value of the property immediately before the casualty and the market value immediately afterward. But, the loss cannot exceed the amount of your adjusted basis in the property, which is usually the amount you paid for it less any depreciation taken on the item. Then, whatever amount is used must be reduced by the amount of any insurance recovery.

 In addition:

- a casualty loss must be sudden or unexpected (i.e., not something that has occurred over a long period of time);

- a casualty loss for non-business property cannot be deducted unless, (1) an insurance claim was filed, or (2) the losses are not covered by insurance;

- no casualty loss deduction is allowed for lost, misplaced, or broken property.

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December

Miscellaneous Itemizations (Part I)

An employee can almost always deduct their reimbursed expenses (these reimbursed expenses are also included in your gross income). Among the unreimbursed expenses here is a starting list of what is available:

1.  The travel, meals, and lodging that is related to overnight business travel.

2.  Transportation expenses that are related to the furtherance of your business, including local and out-of-town driving, but not commuting (to and from work). The standard mileage rate for the 2004 tax year in computing this will be 37½ cents per mile.

3.  Meals and entertainment expenses are 50% deductible only if they “directly relate to” or “are associated with” the active conduct of a trade or business.

We will continue this topic next time...

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Miscellaneous Itemizations (Part II)

Educational expenses (if not deducted above AGI for 2004) may be one of these deductions. Those that qualify include expenses that either:

1. Maintain or improve the skills needed by the individual in his or her trade or business; or

2. Meet the express requirements of the individual’s employer for retention of his job.

Educational expenses that will not qualify include those that are incurred to meet minimum job requirements, or if they qualified him or her for a new trade or business.

We will continue this in the next tip.

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Miscellaneous Itemizations (Part III)

Completing our list of items that may be included as itemizations, here are additional areas you may or may not be aware of:

Uniforms- The purchase, cleaning, and repair of uniforms may be deducted. Make sure that you do not wear the uniform as streetwear off the job or the expenses are not deductible.

Business use of your home- A taxpayer may not expenses for the business use of part of his or her home unless that part of the home is used exclusively and on a regular basis for work purposes and for the convenience of the employer.

Employment Agency Fees (Job Hunting Expenses) - An individual may deduct employment agency fees for a new job in the same profession. These fees are not deductible for a first job or an entirely new profession.

We will finish looking at these miscellaneous items in the next tip.

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Miscellaneous Itemizations (Part IV)

To conclude the items that will fall under the miscellaneous itemizations category as deductions, here are the remaining items:

Expenses of Investors (Safe Deposit Box and Investment Advice)-

Rental expenses for a safe deposit box used to store investments are deductible, as is investment advice and investment newsletters.

Subscriptions to professional journals-

These expenses are deductible.

Tax Preparation Fee-

A deduction is allowed for the legal and accounting fees incurred in the preparation of the taxpayer’s return. No deduction is allowed for the legal and accounting fees incident to divorce.

Activities not engaged in for profit (Hobbies)-

No deduction is allowed for activities not engaged in for profit, with the only exceptions being:

1. Deductions already allowed irregardless of profit motive, like interest and taxes.

2. A deduction that is equal to the amount of gross income over allowable deductions if such activity were engaged in for profit (meaning no losses are allowed).

3. A profit was shown for three or more years during a consecutive five year period. If that happens, there is a presumption that the activity was engaged in for profit.

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