Category: Taxes

Posted on by Jan Roberg

Let the IRS Help You Pay for Your Vacation

Saving with the IRS.

If you have trouble saving money, then withholding extra in your taxes might be the way to put money away for a vacation. (Or whatever else you want to save for!)

 

 

Okay I can hear you now, “How can you get the IRS to pay for your vacation?”  That’s not what the title said; it says “help pay” for your vacation.  If I had a way for the IRS folks to pay for my vacation, I’d be blogging this from London instead of my living room.  (Olympics are on, I’m an Olympics junkie.  I’m working in front of the TV set today.)

 

But how can the IRS help you pay for your vacation?  By helping you save for it!

 

Face it; some people are great at putting money away and saving up for whatever they need.  This blog post isn’t for them.  This is for the folks that have trouble saving up for the things they want—like a vacation.  If you’re not a good saver, then this plan might work for you.

 

First, you need to figure out how much money you need for your trip.  I was looking at a little trip to Disney World, with my husband, Mark.   I think we can do it for $3,000.  Mark gets paid twice a month—so over the course of the year, he’ll get 24 paychecks.

 

(Yes, I’m using his paycheck for this example.  I’m self employed.  If I’m thinking about buying something with my own money I use “How many tax returns to I have to prepare to go to Disney World?”  But I don’t have withholding—I have to pay estimated taxes so this program will not work for me.)

 

So to save up $3,000 first we’ll have to figure out how much of a refund we’ve got coming (or how much we’ll owe) if we don’t make any adjustments.  So how do you figure that out?  You use the IRS withholding calculator.  Here’s a link:  http://www.irs.gov/individuals/page/0,,id=14806,00.html

 

You’ll want to have a copy of your latest pay stub and your last tax return with you when you do it.  Just go to the site, answer the questions, and it will tell you what your expected refund (or what you’ll owe) will be.

 

I did this back in February and it looks like we can expect a refund of just about $1,000 next year.  We will need to save another $2,000 for our Disney vacation.  Since we did this in February, that gave us 10 months to save up.  Let’s do the math:

10 months times 2 paychecks per month = 20 paychecks

$2,000 divided by 20 paychecks = $100 per paycheck

 

So for us to have adequate savings for Disney World, Mark would need to withhold an additional $100 per paycheck to give us a $3,000 income tax refund.

 

If you want to change your withholding, you’ll need to go to your human resources department and complete a new W4 form.  If you know exactly how much extra money you want to save, just put that dollar amount on line 6 of your W4:  http://www.irs.gov/pub/irs-pdf/fw4.pdf

 

If you’re just interested in getting a bigger refund, but don’t know who much extra you want to save, you can change the number of allowances you’re claiming on line 5.  For example, if you’re currently claiming 3 exemptions and your refund is very small, change your withholding to 2 exemptions and your refund will be larger (assuming that everything else on your tax return stays the same.)

 

Realize that if you do this, you will have less money to spend from every paycheck.  What you’re doing is making a trade off.  Money later versus money now.

 

I’m going to be perfectly honest with you—most tax professionals would never, NEVER, recommend saving money by letting the IRS hold it for you.  Two reasons:  the first argument is that you can save the money yourself and earn interest on it in a savings account.  My answer to that is—the interest rate on my savings account right now is .2491%.   If I had the whole $3,000 in the bank for the whole year, I would earn $7.47.  I think actually being able to save $3,000 is worth that price.  This isn’t such a good argument these days.

 

The second issue is a little more serious:  If the IRS is holding your money—you cannot access it until you file your tax return next year.  If you have a financial emergency, there’s no way for you to get your hands on that cash.  It’s important that you understand that.  The whole point in having the IRS hold your money is so that you can’t spend it, it’s a good idea to have a little savings cushion—but this is a strategy for people who aren’t good at saving, so there’s a bit of a catch 22.

 

Like I said, this strategy isn’t for everyone—but there are lots of people who use it and they use it successfully if saving money is a problem for you.

Posted on by Jan Roberg

Does the New Health Care Bill Have a 3.8% Sales Tax on Selling Your Home?

Boardwalk

Photo by therichbrooks at Flickr.com

I received a question from Laura who asked:

 

“I just received an email from a friend that said that there will be a 3.8% tax on all home sales after 2012 and that this tax is part of the Health Care bill. Do you know anything about this and can you clarify it?  Thanks.”

 

I’ve heard that one too, but it’s not exactly true.  Last week I wrote about a 3.8% Medicare tax on investment income which includes long term capital gain transactions of real estate—and that’s the rule that people are referring to when they talk about a sales tax on selling your home.

 

Let’s sort this out so you know exactly what’s going on.

 

Bottom line: if you sell your house after you’ve lived in it for at least two years, $250,000 of the profit is excluded from capital gains tax. ($500,000 if you’re married.) Let’s say your house cost $200,000 (this is usually referred to as “basis” in the tax prep world) when you bought it and you sell it for $400,000, that’s a gain of $200,000.  You’re not even in the running for paying the 3.8% Medicare tax because all of that gain was excluded from your income.  For you, this Medicare tax would not be an issue at all.  None of the proceeds from the sale of your home in this instance would even show up on your tax return.

 

Now let’s say you live someplace where the property values have gone up astronomically.  (Clearly you don’t live in my neighborhood if they did.  Our values just seem to drop while our property taxes go up.  Sorry, I’m whining.)  Okay, let’s say you live someplace where real estate values have increased way more than they have here in Missouri—then you could have an issue.

 

Let’s say you bought your house for $100,000 and sold it for $800,000 so that you’ve got a profit of $700,000. A $700,000 profit is a good thing!  Assuming that you’re married, you get to exclude $500,000 of that gain from the capital gains tax so you would only pay tax on the extra $200,000.

 

Let’s do the math:  $800,000 sales price – $100,000 purchase price = $700,000 capital gain.

 

$700,000 capital gain – $500,000 capital gain exclusion = $200,000 that you have to pay capital gains tax on.

 

A transaction like that will kick you into a high enough tax bracket to pay that extra Medicare tax in addition to the capital gains.

 

For most normal folks—we’ll never have to pay the Medicare tax on the sale of our homes.

 

If the value of your home has increased so much that you have to pay that tax—then to quote Charlie Sheen, “Winning!”   Seriously, you’d have gained $700,000 on the sale of your home.  That would be awesome.  And you’d only have to pay capital gains tax on $200,000 of it.

 

Right now—the capital gains tax for 2013 is scheduled to be 20% (who knows what Congress will say before the year is out but that’s what it’s scheduled to be.)  And the extra Medicare tax will be 3.8%.    So—let’s do the math on that:

 

200,000 taxable gain x .2 capital gains tax = $40,000

 

200,000 taxable gain x .038 Medicare tax = $7,600

 

So the total tax on that gain would be $47,600.  As bad as that sounds, remember we’re looking at a $700,000 gain to begin with so you’re really only paying 6.8% (or 47,600/700,000 * 100) tax on that amount.  Granted, we’re talking about one little example with crazy numbers—but remember—that’s for someone who has enough gain to have to pay in the first place.  Like I said earlier, for most of us—we’re looking at zero tax money spent on the sale of our homes.

 

(Note from editor:  So I checked the web and saw that many people were receiving emails claiming that there was this 3.8% sales tax on the sale of your home.  However, what these emails failed to explain was the exclusion amounts (250k single or 500k married) that are shielded from tax.  They later went on to criticize the health care bill and our current president.  Since it is an election year, you are probably more susceptible to emails or messages like this to try to get you to vote a certain way.  Do your research and keep checking in with this blog for the most recent and accurate information.)

Posted on by Jan Roberg

The Government Imposes Taxes to Make Us Behave the Way it Wants Us To (An Editorial)

White House

Photo by Tom Lohdan on Flickr.com

The Government imposes taxes to make us behave the way it wants us to.  Whew!  That sounds like something one of my “nutjob government conspiracy type” friends would say, not me.  Except that it’s true.  If you don’t believe me, just take a look at the so called “sin taxes”.  You know, the extra taxes imposed on cigarettes and liquor.

 

The federal government taxes each pack of cigarettes by a $1.01.  Add to that the state taxes, here in Missouri, we have the lowest cigarette tax in the country at 17 cents a pack, but Washington State has a tax of $3.20 per one single pack of 20 cigarettes.  You really gotta want a cigarette to smoke in Washington.

 

Beer, on the other hand, only brings in 5 cents per 12 ounce can to the feds.  But a bottle of tequila will fetch $2.14 cents in taxes.  And that’s before adding in the state taxes!

 

So maybe you don’t smoke or drink, you might think these taxes don’t apply to you.  But it’s not just our sins that the government is trying to control; it’s our shopping behavior as well.  Think about the First Time Home Buyer Tax Credit–a nice chunk of change of up to $8,000 for buying a new home.  The energy tax credit–for making our homes more energy efficient.  And of course the energy efficient vehicle tax credit–for buying an electric or fuel efficient car.  All of these tax credits were intended to help various industries.

 

So maybe these programs didn’t apply to you either, but here’s one that probably did:  The Economic Stimulus Act of 2008.  Maybe you remember that’s the year that everybody got an extra $300 check in the mail.  The idea was that if everyone in America got an extra $300, they’d go out and spend it and that would jump start the economy again.  Unfortunately, that didn’t work.  A large percentage of the population used that money to either pay down their credit cards or add to their savings accounts–we didn’t get the consumer bang that the government wanted.  You might remember we later got the “Making Work Pay” credit, which basically gave us an extra $400 but it was doled out in our paychecks in tiny increments over the course of the year. People hardly noticed the increase in their paychecks, so the money just got spent.

 

The analogy that I think of here is that it’s kind of like having a $50 bill in your wallet.  I don’t get 50 dollar bills very often, so when I do get one I tend to hang onto it for awhile.  “I’ve got a $50 dollar bill, it’s special, and I don’t want to spend it!”  Now give me a $5 or a $1 bill and it’s gone.  My nephew calls it “blowing your money away.”  (He actually uses a slightly different phrase but I’ve been edited for my G rating.)    You understand though, it’s much easier to let small amounts of money slip through your hands than larger amounts.  So these little tax games have made us spend more money–without us even being aware of it.

 

And I have a problem with that.  I don’t like the idea of being manipulated for one thing.  But more importantly, I think our tax code sends a message about American values that I don’t think we as a country should be sending.  As a nation we talk about the importance of marriage and of children being raised in a two parent family–and then we pay a premium to unmarried parents through the Earned Income Tax Credit.  I don’t think it was intentional, but that’s what happens.  Young married families with two incomes get phased out of that tax credit, but if you don’t get married–then you get the money.  And it’s huge!  We’re talking thousands of dollars a year.  That’s a big incentive for not getting married.  Why are we doing that?

 

There’s already been lots of talk from the politicians about changing the tax code.  “Tax the rich”, “don’t tax the rich” those arguments can go on for hours.  But what I’m not hearing, and what I’d really like to hear, is where should our country be headed?  How do we get there?  How much is it going to cost?  And how are we going to pay for it over the long haul?  These quick-fix one-year only tax incentives aren’t the way to run a country.  And while the rich are very concerned about their taxes (and rightly so, they seem to have the most to gain or lose during this election) the tax code affects everyone; rich, poor, and middle class. We need long range planning, long range goals, and a long term tax plan.  Let’s bring the grownups to the table, drop the manipulation games, and get to work on a real solution.

Posted on by Jan Roberg

Tax Reporting of Insurance Premiums for Retired Public Safety Officers

Fire fighters in station prepare for next emergency call

 

Retired public safety officers may be eligible to exclude up to $3,000 from their pension distributions for money that was used to pay the premiums for accident or health insurance or long-term care insurance. Public safety officers include law enforcement officers, firefighters, chaplains, and members of a rescue squad or ambulance crew. In order to qualify for this deduction, the payment for the insurance must be made directly from the pension plan to the insurance provider. Basically you exclude the smaller of the amount of your insurance or the $3,000. If you’re excluding the insurance from your pension income, then you can’t include it as a Schedule A deduction.

 

So if you’re making this deduction, how do you show it on your tax return? First, I guess I should be using the right words. It’s not really a deduction – you are “making an election to exclude the insurance premiums from your income.” Now you’ve just had a lesson in tax geek semantics. I know you don’t care, but I’m supposed to use the right words. For what it’s worth, a reduction in income is better than a deduction.

 

Anyway, if you look at your 1099R, which shows your pension distribution, the box 2a which shows what part of your pension is taxable doesn’t show your insurance payment, so the exclusion isn’t automatic. Here’s what I mean – let’s say that you receive a public pension for $25,000 a year. $5,000 of it isn’t taxable so your 1099 shows $25,000 in box one (your gross distribution) and $20,000 in box 2a (the taxable amount). But if you paid $4,000 for your health insurance, you’re allowed to exclude $3,000 of that money from your income. So really your true taxable amount is $17,000.

 

If you are doing this by hand, you’d just write it on the 1040 like this: On line 16a you’d write $25,000 for the total amount of the pension, and on line 16b you’d write $17,000 for the taxable portion. You’d write PSO next to it so that the IRS would know why the number on line 16B didn’t match the number in box 2a of your 1099.

 

It’s really important that the numbers on your tax return match the numbers in the boxes on your 1099. When they don’t, you get little letters from your friends at the IRS. Writing PSO on your tax return basically tells them that you’re not just arbitrarily changing their tax figures for them.

 

So how do you do this if you’re using a computerized tax program? That’s a little trickier because you can’t just go and change the numbers without somehow notating it. If you just type in $17,000 in box 2a instead of the $20,000 number, I guarantee you you’ll be hearing from the IRS. And we don’t want that do we?

 

If you’re using the 1040.com program, it’s really easy. When you’re in the 1099 input screen, you’ll see at the top there’s a little phrase in blue letters: “Special Tax Treatments.” You’re going to want to click on that button. It will take you to a new page with other items that also require special tax treatment. The “public safety officer” insurance is at the very bottom. All you have to do it type in how much you paid into the little box and the program will handle the rest.

 

Other tax programs should have something similar. If you can’t find a “special tax treatments” page, call the phone number listed with your program and they should be able to tell you how to get there. And if they can’t, come back here and use my 1040.com site (sorry for the shameless plug but a girl’s gotta eat.)

 

Special thanks go out to Mr. A—– in California for the idea for this post.

Posted on by Jan Roberg

Can I Claim My Indian Parents on My US Tax Return?

 

It's difficult to claim foreign parents on a US tax return.

Make sure you meet all of the requirements before you try to claim your parents as dependents on your U.S. income tax return.

 

Claiming parents is difficult, but it can be done if you pass the “Qualifying Relative” tests. But first, here are the two biggies that tend to get in the way:

  1. You cannot claim a married person who files a joint return with his or her spouse. So if your parents file a joint tax return in the United States, then you won’t be able to claim them. (I’m guessing they don’t, but I wanted to make sure that I told you about that.)
  2. To claim someone as a dependent, the person must be a US citizen, US resident alien, US national or resident of Canada or Mexico. Where my clients have had trouble before is when their parents visit the US, but their visas are only for 6 months, no longer. Then they don’t qualify as US residents. I just wanted to make sure you knew about the 6 month rule because that’s the issue most likely to cause Indian families trouble with claiming their parents.  After that, the rules are the same for anyone else in America who wants to claim their parents on their US income tax return.  You need to pass the qualifying relative test.

 

 

The Qualifying Relative Test has 4 parts:

  1. They cannot be considered a qualifying child of anyone else. No problem! As your parents, I’m guessing they’re both over the age of 24. Easy pass.
  2. Member of household or relationship test. As your parents, they do not have to live with you. Also, since they are your parents, they automatically pass the relationship test. Easy pass.
  3. Gross income test. This one is harder. They cannot have more than than $4,050 in gross income for the year. If they are retired, they might qualify, but if they are receiving a taxable pension, that could kick them out of being a dependent. In the US, for example, my mother in law receives Social Security income which isn’t taxable and it doesn’t count as gross income. Her other income is less than $4,050 so she would pass the gross income test for me to claim her as a dependent. Remember, once your parents become US residents, they will be taxed on their “world wide income.”
  4. Support Test. In order to claim your parents as dependents, you must provide more than 1/2 of their support. Let’s say that your parents each earn $3,000 a year in some type of pension. For you to be able to claim them as dependents, you would have to pay more than $3,000 for support for each of them. For example, if they live with you, then you would consider part of your rent or mortgage to be towards their support. Also food, clothing, medical expenses, etc. If they don’t live with you, who is paying for their rent, food, clothing, etc.? Using my mother-in-law as an example again: although I pay some of her bills, I definitely don’t pay over 1/2 of her support. She pays for her food and rent with her Social Security money so I don’t come close to the 50% of her support.

 

If you do find that you qualify to claim your parents, then you would complete the W7 forms for them, so that they have an ITIN number, and submit them with your next tax return.  I find that the best way to handle the W7 form is to take your tax return in to the nearest IRS office with your supporting documents (like passports) and submit them there.  Although it might be inconvenient making the trip, it will save you a lot of hassle in the long run.

 

 

Posted on by Jan Roberg

Sub-S Corp Year End Tax Tips

Tax tips for Sub-chapter S Corporations

        As the year comes to a close, make sure you do everything you can to reduce your tax liability.

 

 

Updated for 2016

 

You read a lot of news stories about year-end tax tips, but you don’t see a lot of things specifically targeted at Sub-S Corporations, and there’s nothing out there for the single owner S Corporation. It’s kind of sad because most people with Sub-S Corps are set up that way for the tax advantage.  If you own a Sub-Chapter S Corporation, then you need to make sure that you maximize your deductions. These tips are especially for you:

 

First, and most importantly, if you’ve got a profit this year, you want to make sure that you are paying yourself some type of payroll. This is one of the most common mistakes that S Corps make. The point of having an S Corp is to protect some of your income from self employment taxes. (Notice I said some, you can’t protect yourself from all self employment tax.)  S-Corporaton owners need to pay themselves a salary. In the early years of a business, there’s often a loss and the salary isn’t important, but once the business is in the profit side, the owner should be paying a wage that is commensurate with what he or she’d be earning if he worked the same job for someone else. If you don’t do this, the IRS can come back and assess self-employment tax on 100% of your S corp profit. That would completely defeat the whole purpose of being an S Corp, so that’s the first thing you want to handle.

 

Reimburse yourself for your employee expenses: Write yourself an expense report and have the S Corp write you a check. For example: let’s say you took a business trip for a convention and your travel expenses cost $1000. You paid it out of your own pocket because it was easier at the time and you just figured that you’d write it off on your taxes later.  But that’s a stinky idea.  Here’s why:

 

Even though you are the owner of the business, you are also an employee.  As an employee of the S corp, you would put the $1000 travel cost on your schedule A as an employee business expense.  When you do it that way, the expense would be subject to the 2% limitation rules.   Meaning, you can only deduct expenses that are over 2% of your adjusted gross income.  The higher your income, the smaller the deduction you get to claim.   If you pay Alternative Minimum Tax, or don’t itemize your deductions, you could even get a zero tax benefit from putting it on your schedule A.  So putting the expense on your schedule A gives you a much smaller tax benefit than if it’s on your S Corp return.

 

When you do an expense report, and reimburse yourself through the business you get  100% of the allowable business deduction.  Isn’t that much better?

 

Next up:  Pay your health insurance through your S Corp: This is a little convoluted, but stick with me.   If you claim this deduction, you want to do it right.  As an employee of your S Corp, you can’t claim the self-employed health insurance deduction like you could as a sole proprietor. Your health insurance would go on your schedule A subject to a 10% limitation before anything could be deducted (for most people that’s a zero deduction.)  We don’t like zero deductions!  So you have to do the S-Corp health insurance dance.  It goes like this:

 

Your S Corp pays your health insurance, then it comes to you as a taxable fringe benefit.  When you do it this way you get to deduct the cost of your health insurance on page 1 of your tax return (just like a sole proprietor)—a much better place to put a deduction.  You do not pay FICA on your health insurance.

 

So let’s say your wages from your S corp are $10,000 and your health insurance is $5,000.  In box 1 of your W2, it would say wages $15,000.  In boxes 3 and 5 – the Social security and medicare wages, it would say $10,000.   You would then deduct the $5,000 that you paid in health insurance under the self employed health insurance line.  (Line 29 in the 2015 return.)    Yes, I realize that this sounds like a cockamamie way to do the accounting for your health insurance–but those are the IRS rules.  ‘Nuf said, right?  And while I realize that this sounds crazy, that’s really how you do it.

 

Another expense you don’t want to miss out on is to reimburse yourself for your home office deduction: It’s hard to claim a home office deduction on a Sub-S corporation. Like other employee expenses, it would go on your Schedule A and be subject to the 2% limitation rules like any other employee business expense. Many accountants won’t even touch a home office for a Sub-S Corporation.

 

Some people try to charge rent to their S Corps for their home office, but that’s just moving your income from one taxable entity to another so you don’t really save anything on you taxes that way either..

 

What you want to do is reimburse yourself for your home office deduction in a fully accountable plan. That’s a phrase that you want to remember: fully accountable plan. Prepare a form 8829 Home Office form like you were doing it for a sole proprietorship and use that report to determine how much you should reimburse yourself for your home office. Remember, it’s a reimbursement, not a rent payment. It reduces taxable income to the company, but it is not taxable to you because you have “accounted” for the expenses. For more information about home office deductions, you might want to read this post: How to Boost Your Home Office Deduction

 

If you’re interest in more year end tax tips, you might also want to check out: Year End Tax Tips for Tiny Business Owners.

Posted on by Jan Roberg

Year End Tax Tips for Tiny Business Owners

 

Taxes for small business owners

Planning ahead on your taxes could save you money!

 

Updated for 2016!

 

Tiny business owners, you know who you are: you’re a single member LLC or sole proprietor, or maybe you’re in business with your spouse. You might even have an employee or two, but that’s about it. When Congress passes laws to help “small business” they don’t mean us. This post is for you. If you have a Sub-chapter S corporation, I’ve got some different tips here:  Tax Tips for Sub-chapter S Corporations

 

Number 1: If you’re going to be in the red for this year, you don’t really need to worry about reducing your business tax, right? Your negative business income will help offset your other income (if you’re lucky enough to have some). You can devote your energy to being profitable next year.

 

Number 2: If your business is in the black, congratulations! You’re going to want to look at cash flow and make sure you’re got enough cash to pay your upcoming expenses (like payroll and payroll tax if you’ve got it), but let’s look at some ways to reduce your excess income before the year is out.

 

Hire your kids: If you’ve got kids under the age of 18, you can hire then without having to pay FICA.  It used to be if you had an LLC, you paid FICA for your kids but that changed in 2011 so even if you have an LLC, you don’t pay FICA on your children’s wages.     There are rules that have to be followed, but if you could use a little help at work this time of year you’d at least be keeping the money in the family. For more information check this: Hire Your Kids

 

Pre-pay business expenses: Most tiny business owners use something called “cash basis accounting”, basically, you’re taxed on what comes in versus what goes out. If you are cash heavy, you can pre-pay some of your business expenses for up to twelve months. For example: I lease my office space, I’ve got a one year contract so I know that I’m going to have that monthly expense for the rest of the year. If I were cash heavy (in my dreams) I could prepay my rent for the next year and write it off on this year’s taxes. But you see how you can play with that? While I won’t be paying a full year of rent in advance, I did pay a few January bills early.

 

Delay invoices: Remember, this only works if you’re cash flush. Let’s say you did a job and a client owes you $1000 and you normally would send out the bill with a due date of December 30th. Change to due date to January 15th—you’re pushing that income ahead to next year. Besides, your client might just appreciate the break at Christmastime. I set up a billing schedule for a client that didn’t start until January and I used “I thought you could use a little Christmas break.” She was thrilled and I delayed the income—talk about a perfect win/win situation.

 

Credit card purchases:     According to IRS rules, if you buy something with a credit card, you’ve bought it now. So, let’s say you’re a little cash poor right now but you’ll have the revenues next month to cover your expenses. Pay expenses with your credit card and it will count as having been paid when charged.  I always like to be cautious about credit card spending–hate those bills, but it’s a good solution for some businesses.

 

This one I don’t like to say, but buy equipment: If you need it. I almost hate to list this as advice because it’s the standard that everybody says every year. One of my clients fired his old accountant for saying it. Like he said, “I know what I do need and don’t need to run my business and I don’t need any more equipment. What other ideas you got?”  Here’s my advice, “Don’t buy crap you don’t need.” If you do need equipment, and you’re profit heavy, it’s better to buy in December than in January. But buy what makes sense for the business.

 

Get your retirement plan in place: If you’re just investing in an IRA, you don’t need to worry about that yet, you’ve got until April to do that. If you’ve been wanting to set up a SEP or a 401(k), you need to get that done by December 31st. Contact your financial advisor about setting up your business retirement plan.

 

Last, because this isn’t really business: charitable contributions. If you’re a sole proprietor, your charitable contributions do not count as business expenses. So if you give money to the Salvation Army, that’s a personal deduction, not a business deduction. Every year, I see a lot of people trying to claim their charitable contributions as business expenses and it won’t fly with the IRS. Even if you pay a charity from your business bank account, it’s not allowed as a business expense. Charitable contributions won’t help reduce your self-employment taxes. Please give to charities and give generously, but know that it’s a personal deduction, not a business one.

Posted on by Jan Roberg

Split Exemption: Claiming One Child on Two Tax Returns — The Legal Way

IRS rules allow for divorced parents to split a child's exemption

Splitting an exemption is not illegal if you follow the proper rules. Learn how here.

 

 

Sometimes when I’m working with a divorced couple, it seems that the most beneficial way to prepare the tax return is to split the exemption for their child. When I say that, they always tell me, “But I heard that was against the law!” No—that’s not exactly true. But let me tell you, there is a right way and a wrong way to do it. If you follow the rules and do it correctly, it’s not only legal, it’s the right thing to do. Warning: if you don’t follow the rules, you could be breaking the law. I give a lot of advice to do-it-yourselfers, but if you’re planning to split an exemption, I recommend you go to a professional for it. (And if she tells you it can’t be done—hire somebody who knows what she’s talking about.)

 

With most divorced couples (I’m including here couples who were never married but have split apart and have lived apart for at least 6 months of the past tax year), one parent (usually the mother) has custody and the other parent (usually the father) has visitation rights. A lot of couples say that they have “joint” custody – for example, the kids stay with the dad every Wednesday night and every other weekend and with the mom the rest of the time. If you count the days, under IRS rules, the mother wins on the custody status. According to the IRS, wherever the child spends the most nights is where the child lives—if you’ve got one of those every other weekend and every Wednesday night agreements, the IRS doesn’t count that as being equal.

 

In my example, I’m saying the child lives with the mother. In IRS lingo, the mother in this example is the “custodial” parent and the father is the “non-custodial” parent.

 

In this case, the mom has all the power—she’s the custodial parent. The mom can claim all the benefits of having a child on the tax return. Those benefits include:

  • Head of Household filing status-a lower tax rate
  • Childcare tax credit-credit for money you spend on daycare
  • Childcare exclusion-so you don’t get taxed if your company pays for daycare
  • Earned Income Credit-this can be worth up to $3,094 for one child
  • Exemption for the child-a deduction of $3,600 off your income
  • Child Tax Credit-worth up to $1,000

 

When tax professionals tell you that you can’t split exemptions, what they’re reading is the section of Pub. 17 (that’s like our Bible for tax stuff) that says these things always go to the same person. What they’re not reading is page 31—the part that tells you about the special rules for divorced or separated parents. Under the special rules section, it says that the mom (our custodial parent) can release the exemption for the child to the father (the non-custodial parent). This lets him claim the exemption and the child tax credit on his return, while the mom keeps the head of household status, the dependent care credit, and the EIC on her return.

 

Why would anyone want to do this? Lots of reasons! Number one, of course, is to maximize the amount of money you get back from the government. A lot of times, after a divorce, the mom doesn’t have a very high taxable income. Remember, child support isn’t taxable. The dad has lost a lot of his deductions so his tax bill could be pretty high. He’d probably never qualify for an earned income credit anyway, but the $1000 child tax credit would really help him out. If the mom’s taxable income is really low, she wouldn’t even qualify for the $1000 child tax credit. In some cases she could give it away without it hurting her at all. Or maybe the father is behind on child support, she could negotiate: if he catches up on the child support by December 31st, she’ll sign the form to allow the father to claim the child’s exemption. Remember, when claiming the exemption for a child, the custodial parent has all the power. If the dad claims the child without permission, the mom can just file her own return fully claiming the child and sending the dad’s return to the IRS audit division. You don’t want that to happen.

 

Splitting an exemption isn’t the best choice for everybody. You have to look at both returns and see if it’s going to work. It also helps to be on good terms with the ex—this certainly doesn’t work well with people who are fighting.

 

There are a lot of other rules that I haven’t even touched. (That Pub. 17 book is 295 pages long!) But if you are divorced or separated, you need to know that splitting an exemption might be an option for you to use on your income tax return.

 

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Here are some links that might help:

EIC questions of any kind:  EITC Assistant

 

How to find free tax preparers:  Free Tax Help

 

How to find your local IRS office:  Find an IRS Office

 

Posted on by Jan Roberg

Hiring Grandma to be a Nanny

Hiring grandparents.

Usually you must withhold Social Security and Medicare taxes for household employees. But if you hire your parent to watch your kids, they may be exempt.

 

 

I was recently asked, “How do I go about hiring my Mom to be a nanny?”  Unlike me, who would just try to pawn my kids off on my Mom whenever I got the chance, this person wanted to make it official: 1. She wanted to pay her mother for the work, and 2. She wanted to make sure all the tax stuff was handled properly.  If you’re thinking about hiring your Mom (or your Dad) here’s what you should know.

First, when you hire your parent for domestic work (including child care, housekeeping, etc.) your parent is exempt from social security and medicare withholding.  This makes the whole “hiring your parent” thing a lot easier.  There is an exception though, and I think a lot of families might fall into this category:

If you meet both of these conditions:  1. Your parent cares for your child who is under 18 or is disabled and 2. You are either divorced or widowed and not remarried, or your spouse is permanently disabled.  Note:  the rules don’t say anything about if you were never married, just divorced or widowed.  So, if you meet these conditions, then you do pay the payroll taxes.  Otherwise, just pay your mom every week.  She can report the income on her tax return and you can report that you paid her and claim the child care credit. Super easy, right?

If you do have to do the payroll withholding, it’s not that hard.  For 2011, you’ll want to withhold 5.65% to cover the employee’s share of payroll taxes.  You’ll wind up matching that amount when you file the Schedule H with your tax return (the household employee tax.)  You have the option of paying your Mom’s share of the employee tax and not withholding it from her pay. (You just don’t withhold and you pay double the employer’s tax, still pretty easy.)

You do not pay FUTA (federal unemployment taxes) on your parent no matter what the circumstance.

You may be required to pay state unemployment insurance, you’ll have to check with your state.  Here in Missouri, you’ll pay unemployment insurance if you pay your parent over $1,000 per quarter.

You will need to provide your parent with a W2 after the year is over showing the income paid, whether you withhold the payroll taxes or not.

For more information of household employees, check out IRS publication 926.

To check out the Schedule H, click on this link:    Schedule H.

Addendum:  shortly after I posted this blog, I read an article about nanny’s that get paid over $150,000 a year.  If you pay your nanny over $106,800, then you don’t need to withhold the social security tax on any amount over that.  (You still withhold the medicare.)  If you do pay your nanny that amount, I’d just like to point out that not only am I really good with children, but I can also prepare my own payroll and do all the associated tax forms that go with it.  (Just saying.)

Posted on by Jan Roberg

Multi-State Tax Returns

Preparing multi-state tax returns is tough.

It isn’t always easy preparing your taxes when you’ve worked in more than one state. We can help you get it right!

 

 

I get many calls from people who prepared their own returns with two or more states and they all say something pretty similar, “I did the return, the federal is okay but the state just doesn’t seem right.”  Then I ask, “Do you owe way more than you think you should?”  “Yes, how did you know?”  I do this for a living.  The quick answer is to check to see if you took a “credit for taxes paid to another state”, that’s usually where the problem is.

 

Normally, I would have put that at the end of the blog post, but it’s such a common problem that I figured it needed to go first.  Quick answer and you’re done.  If you need more information, I’ll start from the beginning.

 

Two states can usually be handled by most of the major tax software companies with no problem.  Remember the credit for taxes paid to another state and you should be good.  On the other hand, three or more states can send your software into a tizzy.  Even with my professional grade software, I still have to compute numbers by hand and manually input them into the program.  If you’re dealing with three or more states, spend the money on a professional.  It’s a good idea to ask, “Have you ever done a California return before?”  (Or Ohio, or North Carolina, or whatever.)  Experience helps.

 

Back to the two states:  There are two situations where you could have two state returns.  One would be you moved from one state to another, for example moving from Indianapolis to Chicago for a job.   The other would be where you live in one state but work in a different state, for example living in St. Louis, Missouri but working across the river in Alton, Illinois.  These two types of situations use different forms.

 

Moving:  When you move from one state to another, you’ll be filing your two state returns as a “part-year resident”.  You’ll be completing paperwork that says how long you lived in the state, what your earnings were for the state, etc.  You should only be taxed on the income that you earned while you lived and work in the state.  If you withheld properly, your taxes should come out normal, no big refunds, nor big balance dues.  Most of the time in a case like this, you won’t be filing a “credit for taxes paid to another state” because the “part year resident” return will handle you income allocations.  (Most of the time—there’s 50 states and they all have different rules, so in some cases you’ll still be doing the credit for taxes paid to another state.)

 

Living in one state and working in another:  this situation is a little different.  You will be a “resident” of the state you live in and a “non-resident” of the state you work in.  The state you work in is the state your company is going to withhold taxes from.  But the state you live in is going to tax your income too.  This is where it’s really important to remember the credit for taxes paid to another state, because if you miss taking that credit your tax bill could be enormous.  Sometimes, the tax bill is still pretty large even when you’ve done everything right.  For example, here in Missouri our state income tax rate is 6%.  Next door in Illinois it’s 3% (although it’s moving up to 5% this year.)  If you live in Missouri and work in Illinois, you’re going to get hit with a pretty harsh state tax bill unless you had Missouri taxes withheld or paid estimated taxes.

 

Here’s some other tips that will help you with your multi-state return:

1.  Always do the federal return first.  Don’t start the state returns until the federal is done and you feel that it’s correct.  If you have to go back and make changes to the federal, your state numbers will be off.

2.  Non-resident income:  that’s wages that you were paid in a state you didn’t live in.  It also includes self-employment performed in the state.

3.  Resident income:  the state you live in will tax everything, in addition to your wages, it will tax your pension, interest, investment income, everything.

4.  Moving expense deduction-always goes to the state that you moved to, not the state that you moved from.

This is a pretty quick and dirty summary of multi-state tax returns.  If these tips don’t solve your problem, do call us and get some help.  They’re not always easy to handle and we do this for a living.