Category: Uncategorized

Posted on by Jan Roberg

The Alternative Minimum Tax for Dummies

AMT for Dummies Okay, first, if you’re paying Alternative Minimum Tax, you’re probably not a dummy.  Most people who have to pay the Alternative Minimum Tax (AMT) are highly paid employees.  If you were really a dummy, you wouldn’t have a job that makes you pay AMT.  That said, AMT taxes are really confusing and can make you feel like an idiot.  I’ll try to make some sense of it here.

Why do we even have the AMT?  Good question!  Our tax laws have benefits for certain kinds of income and special deductions and credits for certain expenses.  For example, you don’t pay tax on the interest from a munincipal bond and you get a tax deduction for paying mortgage interest on a house.  If a person plays his cards right, he could drastically reduce his tax by taking advantage of these deductions.  Congress created the AMT in 1969 so that high income taxpayers who claim lots of deductions still wind up paying income tax.  That was the intention of the law—to make things fair.

Why is AMT such a pain in the behind now?  For one thing, the AMT wasn’t indexed for inflation.  What was considered to be wealthy in 1969 is fairly middle-class in 2011.  People who were never originally targeted for the AMT are now subject to AMT taxes.  Congress passed legislation last December for an “AMT patch” to adjust for inflation.  The patch will be good for 2010 and 2011, but if they don’t make some type of permanent adjustment, we’ll be dealing with this over and over again starting in 2012.

Who has to pay AMT?  Using the IRS definition:  You may have to pay the AMT if your taxable income for regular tax purposes plus any adjustments and preference items that apply to you are more than the AMT exemption amount.

How’s that in plain English? For most people, if you don’t itemize your deductions, you probably won’t have to pay AMT.  If you do itemize, one big deduction people lose has to do with employee business expenses—like when sales people take a deduction for their mileage, those people get hit with AMT.  If you’re a salesperson who claims employee business expense deductions on your tax return, you’re much more likely to be hit with AMT than a person who doesn’t.

Other AMT hot spot issues are your state income taxes that you paid, and mortgage interest expense.  With your mortgage, you can deduct the interest on the money that you used to purchase your home or improve your home.  But if you refinanced your home to pay off a credit card, that part of your interest payment won’t be a deduction for you on the AMT form.  Also, if you had enough medical expenses to claim a deduction on your regular return, it will be reduced or eliminated when calculating the AMT.

There are lots of items that affect the AMT, but those are ones that I see regularly when I’m doing tax returns with AMT.  There are things like mining costs, intangible drilling costs, and research and experimental costs.  I’m sticking with the issues that are fairly common.

If you’re using tax software, it will calculate the AMT for you automatically.  You’ll notice that if your AMT is lower than your regular tax, you don’t get your taxes lowered.  You only get to see the AMT tax if you owe more.  (Doesn’t seem quite fair does it?)

If you’re still doing your return by hand, or just want to estimate of you will have to pay AMT for next year, you can use the AMT assistant on the IRS website.  http://www.irs.gov/businesses/small/article/0,,id=150703,00.html

Posted on by Jan Roberg

Babysitting as a Charitable Donation

If you’re a parent and you use a babysitter or daycare provider to care for your child while you are at work, that’s a deductible expense. In general, both parents must work, or one must be disabled or in college in order to qualify. But did you know that hiring a babysitter to care for your child while you are performing charity work counts as a charitable donation? I didn’t until recently. In fact, if you read the IRS regulations, it’s pretty clear that it’s not allowed.

But, according to Kiplinger.com—the IRS lost a case in Tax Court trying to uphold that rule. The difference is, in this instance, you claim the child care expenses as a charitable donation instead of as a child care expense.

Now, in order to make such a claim, I would recommend that you keep excellent records of the time spent volunteering, the type of work performed, and the charity you worked for. Of course, if you spend two hours a week volunteering, but your child is in daycare for 30 hours a week, you can only deduct for the two hours of time you volunteered.

Posted on by Jan Roberg

Hobby vs. Business: What About the Collector?

Honus Wagner Baseball Card

Honus Wagner Baseball Card sold for $262,000

If you’ve seen some of my other blog posts, you may have noticed some of my articles about hobbies and businesses.  Most of the time, people know if they own a business or not, but sometimes the category gets a little blurry.  Like the other day, I was reading a message board by a fellow you sold his baseball cards on E-Bay.  In his case, he only sells about $50 worth of cards a year, definitely a hobby, not a business at this point.  But he was thinking about increasing his sales and crossing out of the “hobby” mode and into the “business” mode. 

Now I have all sorts of advice about moving from a hobby to a business, but in this case, things might be a little different.  The reason I say that is because baseball cards are collector’s items.  It kind of depends what level the gentleman is at.  You can buy cards and sell them at retail of course, that would be a regular business.  But there are also the folks that buy and trade “collectibles”.    The recent auction price of a Honus Wagner card for $262,000 gives you a clue as to what I’m talking about. 

If your business or hobby involves selling collectible items, such as art, guns, coins, stamps, and things like that, you might be reporting your income on a schedule D form.  The same form that you use to report gains and losses from the sale of stocks, bonds, and mutual funds. 

I like reporting income that way because of the tax advantage, there’s no self employment tax and if you sell an item that you’ve held for over a year then you’re also taxed at the lower capital gains tax rate.  The downside to reporting this way is that you get no loss deduction for the sale of “capital assets held for personal use.”

There could be three possible ways to report the same income for a “hobby/business/capital gain” sale.  For example:  Let’s say you purchase a painting for $1,000.  You keep it in your living room for a few years and then you sell the painting for $2,000.  If you report the income as a hobby:  $2,000 goes on line 21 of your 1040 and you might be able to claim the $1000 you paid for the painting as a deduction on your Schedule A, (but because of the other rules involved, most like you won’t get to deduct that at all.)  If you’re in the 25% tax bracket, you’ll pay $500 more in income tax.  If you report the $2,000 as self employment income on Schedule C, you can deduct the $1000 as an inventory expense leaving you with a profit of $1,000.  Taxed at 25%, that’s $250.  Add to that the 15% self employment tax which adds another $150 making your tax bill $400.  As a sale of a capital asset, you report on schedule D the income of $2,000, the basis of $1,000 with a taxable long term capital gain of $1,000 which will be taxed at the capital gain rate of 15% costing you $150 of tax money.  In this example, I know I’d want to use the capital gain. 

Of course, there are other rules and issues you have to consider when determining if an activity is a hobby or business or collection, but the example above does let you see some of the differences in how you might want to structure your business/hobby/collection.

I’d have to ask the baseball card fellow some more questions about his business plan to determine exactly what category I’d place him in.  But with some collectors, it’s pretty obvious that you’d want to classify their collecting income as capital gain and not self employment.

Posted on by Jan Roberg

Why You Might Want to Let Your Spouse Own Your Business

Sunshine Boutique

Photo by Living in Monrovia at Flickr.com

First and foremost—this post will only apply to a limited number of people, so please don’t go changing your business ownership based on the title. 

One of the downsides of owning your own business is that you have to pay self employment tax.  Self employment tax is 15.3% of your profit, you pay it in addition to your regular tax rate.  So, if you’re in the 25% income tax bracket, you’re actually paying 40.3% in taxes on your self employment income.  That’s a lot of tax.

Social security makes up 12.4% of that.  (8.4% for 2011 only.)  The maximum amount of your earnings that are subject to Social Security taxes is $106,800.  Once you cross that threshold, you don’t pay Social Security tax anymore for the year.  If you’re in that situation, you know how great it is when your company quits withholding your Social Security, it’s like a temporary pay raise. 

So let’s say that you own a small business with a net profit of $50,000.  Your husband gross pay is $125,000 a year.  He’s already completely paid up for his Social Security.  After claiming all of your deductions, let’s say your taxable income is $135,000 – that’s still in the 25% tax bracket.  Your tax liability would be $33,765.  That would be $26,115 for your regular tax plus another $7,650 for your self employment tax.

But what if your husband owned the business instead of you?  He’s already maxed out his social security taxes.  In this case, your total tax liability would be $27,565.  That would be the same $26,115 for the regular tax, plus only $1450 for the self employment tax (it would be the Medicare portion.)  In this example, it’s a total tax savings of over $6,000. 

What are the downsides?  Obviously, you wouldn’t want to have your business in your spouse’s name if divorce were a possibility.  It wouldn’t make sense to do this if your spouse’s wage income wasn’t above or at least near the social security maximum threshold.  Also, by putting the business in your spouse’s name, then you’re not contributing to your social security pool for the future.  See that $6,000 saved in the scenario above?  The best thing to do with that money is to put it towards your retirement. 

Another issue is continuity.  If you’ve had your business in your name for 20 years, why would you change it now?  On the other hand, if you’re starting a new venture maybe it makes sense to set it up that way.  You may have other perfectly legitimate reasons for not doing this as well.  It’s an option for saving some money, certainly not a requirement.

Posted on by Jan Roberg

Crime and Taxes

Tax fraud in prison

Tim Robbins and Morgan Freeman in Shawshank Redemption

In the Shawshank Redemption, Tim Robbins plays Andy, a banker falsely imprisoned for a crime he didn’t commit.  While in prison, he begins preparing tax returns for the prison guards which leads him to maintaining illegal books for the warden.  As Andy says to Morgan Freemans’ character, Red, “I never commited a crime until I went to prison.”

One of the more interesting aspects of the US tax code is that according to our tax law, you are required to report all of your income, even if it is from an illegal activity.  Anyone who’s seen the Untouchables knows that they got Al Capone for income tax evasion and not for any of the murders and other crimes he committed.  (Or am I supposed to say allegedly committed like they do on TV?)    Anyway, and I’m not making this up, the IRS  requires all thieves to report the fair market value of the items they stole on their tax returns.   Really.

But seriously, the crime I want to talk about is tax fraud.  In 2010, the number of fraudulent income tax returns increased by 50%.  That’s huge!  It’s estimated that 50,000 of those fraudulent returns were filed by prison inmates.  The IRS was able to catch about 4,500 of those forms because of falsely claimed Earned Income Credits.  EIC fraud is usually the easiest type of fraud to discover quickly because the IRS gets a conflicting tax return pointing out the fraud.  

Currently, state and federal prisons are not required to report the status of inmates to the IRS.  This makes it tougher for the IRS to catch the fraudulent prison returns and that hurts taxpayers who bear the tax burden while the fraud continues.   Of course, not all tax returns filed by prison inmates are fraudulent.  There are many legitimate tax returns that should be filed by prisoners.  For example:  a man is incarcerated in January but he had a full year of working on the outside and caring for his family before going to prison, that’s a very legitimate tax return. 

If the IRS had access to inmate status though, it would be much easier to determine which returns were for legitimate work,  and which returns were fraudulent.  While I’m not inclined to make life easier for IRS agents, this is one case where I think they deserve to have access to the tools that they need to do their job properly.

Posted on by Jan Roberg

Tax Tips for Families with High School Aged Children

Planning for collegeIf you’ve got kids in high school, you know how expensive it can be—food, clothes, car insurance…  And of course, there’s that big expense coming up; college.   A little strategic planning right now could help you with your college expenses in the future.  Let’s take a look.

Senior year:  If your child is already a senior, you’ll be completing the FAFSA application soon.  You financial picture for the college process is already done so there’s not much you can do now.  Even if you don’t think that you’ll qualify for financial aid, you should complete the FAFSA anyway.  Should your financial situation dramatically change, you may be able to renegotiate your aid with the school.  You won’t be able to without a completed FAFSA application on file. 

Junior year:  This is the most important year for you as far as tax strategy.  If your child is a high school junior right now, then your 2011 income tax return is what will be used to determine your future financial aid.  It’s really important to think through any actions that may affect your income.  For example cashing out an IRA or 401(k) right now would increase your taxable income, and because of that would reduce your potential financial aid.  Cashing out stock for a capital gain—same thing.  On the other hand, cashing out stock for a capital loss would reduce your income.   Be sure to take advantage of any programs that would reduce your taxable income such as flexible spending accounts and adding to your 401(k) if possible.

Sophomore year:  This is the year before you’re working on the FAFSA.  If you anticipate that you’ll need to sell stocks, cash out 401(k)s or anything else that would raise your income, this is the year to do it in. While the parent of a junior would want to defer income, if your child’s a sophomore you’d rather claim the income during this year.  This is a little counter-intuitive.  A tax person is always going to advise deferring income, but this is the one year where that’s not the case because you really want to keep that junior year income down.

Freshman year:  Welcome to high school.  It’s hard to think about college when you’re still trying to adjust to Friday night football games and the concept of your child riding in a car with other kids.  In a perfect world, you’ve been saving for college since pre-school and you’re all set.  Unfortunately, the world isn’t perfect and life gets in the way.  Now’s the time to really think about money.  How are you going to pay for your child’s education.  While your student might not have a clue yet about what school to attend, you need to start thinking about it.  How much can you really expect to contribute to tuition?  How are you going to make up the difference?  You don’t need to solve all these issues now, but you need to do some serious thinking now, before you get to graduation without a plan.

Posted on by Jan Roberg

Senior Small Business Owners: A Nice Surprise from the IRS

 

medicare part B can be used for the self employed health insurance deduction.

No clowning around: Medicare Part B can be used for the self-employed health insurance deduction.

Let’s be real, how often do you get to hear the words “surprise” “IRS” and “nice” in the same sentence?  I know it’s rare, but a nice surprise is exactly what senior citizen small business owners are getting this year from the IRS.  For 2010, your Medicare payment counts towards the self-employed health insurance deduction.

This is brand new.  So new in fact, that people don’t seem to know where this new rule came from.  In the past, Medicare payments were never allowed to be used for the self-employed health insurance deduction.  The rule is not in the Small Business bill that was passed earlier this year, and it doesn’t seem to be hidden in the numerous pages of the health care bill either. 

So where can you find this new mystery tax ruling?  It’s right in the 2010 instruction book for the 1040 tax form.  It says: Medicare Part B premiums can be used to figure the deduction.  …For more details, see Pub. 535

 

Now if you go to Publication 535, you’ll find it says:  Medicare Part B premiums are not considered medical insurance premiums for purposes of the self-employed health insurance deduction.

 

Oopsies!  But according to the IRS, a new Publication 535 is being produced and it will say that you can make the deduction. 

So what’s it worth to you?  Depending upon your tax bracket – a few hundred dollars!  The average Medicare Part B premium is about $1200.   For 2010 only, you can use that $1200 to reduce your self-employment tax which would save you about $180.  Additionally, you’d reduce your regular taxable income by $1200 so you’d save even more.

Should you be worried about the conflicting rules?  No.  According to the IRS, the 1040 instructions are the rule to use. I don’t expect this rule to stick around for next year, but enjoy the gift while you’ve got it.

Posted on by Jan Roberg

Why Your Take Home Pay Looks Messed Up

Payroll check stub

Photo by Christopher Titzer

The number one question I’m getting these days (okay, besides how big will my refund be?) is “What happened to my take home pay?”  Hopefully, I’ve got some answers for you.

We’ve all heard that Congress voted not to increase our payroll taxes, but it looks like there’s more federal withholding being taken out of your paycheck.  What’s up with that?  Well, the income tax rate didn’t go up, but the “Making Work Pay” credit was taken out.  Because that credit it gone, your payroll withholding has gone up (somewhere between $400 and $800 per year depending on your filing status.)

The other change that we’ve heard about is that the Social Security withholding went down from 6.2% to 4.2%.  This makes your payroll withholding go down.  Depending upon how much you make, this might give you more take home pay than before, for others, it’s the opposite.  (Here’s a clue, the more money you make, the bigger this deduction will seem.)

If you get a pension, and not wages, the increase in the withholding will hit you harder because you don’t have social security withholding.

Now for many people, the payroll tax changes were not set up correctly for their first paychecks of the year.  Please don’t blame your payroll department; the changes came so late in the year, that computer programs were not programmed for the new rules.  This made for some crazy adjustments that showed up in later checks.  Hopefully, by now, your paycheck should be normal.

It’s always a good idea to check to make sure your payroll withholding is right.  The IRS has a withholding calculator that you can use to see if you’re on target for next tax season.  You might want to wait another week or so to make sure that all of the payroll adjustments are done and that you’ve got a “normal” check to look at before running the numbers through the calculator.  If you use a check with “adjustments” in it, the numbers will be crazy so make sure you’ve got at least two checks in a row that have the same withholding numbers in them.

Posted on by Jan Roberg

Sub-Chapter S Corporations: Paying Yourself Enough?

Are you paying yourself enough?

Owners of Sub-Chapter S Corporations often pay themselves a salary and take the rest of the company profit as passive income.  It’s a pretty popular tax reduction strategy.  You don’t reduce your overall income tax rate, but you do save some money on the payroll taxes which amount to around 15% of your income. 

But it’s really important to make sure that the salary you pay yourself in your Sub-S Corporation is relevant to what you really should be paid.  Recently, the IRS won a case against an accountant, with 20 years of experience, in Iowa for only paying himself a wage of $24,000 while receiving distributions amounting to over $200,000.  According the IRS, a first year accounting grad can be expected to receive a salary of around $40,000.  They determined that the accountant should have paid himself a salary of $91,044.  (Okay, I know you’re thinking $91,044?  I can understand the $91,000 but how’d they get the $44?  Don’t ask me, I haven’t a clue.)

You may be wondering, why bother paying a salary out of the S Corp and taking the rest of the profits as a distribution in the first place?  Isn’t it all just profit anyway?  Well yes, but there’s a difference.  In the Iowa case, the man paid himself a wage of $24,000 plus he had distributions of $200,000.  In essence, his company had a profit of $224,000.  (I’m rounding, okay?)  If he were to receive all of that income as self employment income, he’d pay regular income tax on the $224,000 (less his deductions of course)  plus he’d pay 12.4% social security tax on $106,800 of that income, plus another 2.9% on the whole $224,000.  That’s $19, 739 over and above his regular income tax.  By paying himself a wage of $24,000, his employment taxes are $3,672.  Although it doesn’t work out that cleanly, he basically saved himself about $16,000 in taxes.  That is until the IRS stepped in.

For Subchapter S owners, this issue of an appropriate wage for self employment tax isn’t going to go away.  Last year Congress tried to make all Sub-S income from personal service firms (lawyers, accountants, and consultants) taxable as self-employment income.  The issue failed, but I suspect it will return again. 

So how should you value what you pay yourself?  The IRS doesn’t give us any firm guidelines.  Although some accountants suggest that any personal service provider should claim 70% or more of his or her S-Corp income as wages, the IRS only revised the accountant’s self employment wage to about 40% of his income.  That leaves us open for some interpretation.

One guideline I like to use for people who remain in the same career, but start a new business is what did they make performing the same service at their old company?  What would you get paid if you were to be hired today at a different company for the same job?  It’s a good way to substantiate that what you’re paying yourself is a legitimate wage. 

To read more about the case of the accountant in Iowa, check out the Wall Street Journal link here:  http://online.wsj.com/article/SB10001424052748703951704576092371207903438.html?mod=sf2tw

Posted on by Jan Roberg

Is it Taxable?

Is it taxable?
Click here for more Late Show.

 Have you ever watched the David Letterman show when he does the “Will it float?” routine?  They pick some ridiculous item and drop it into a huge tub of water to see if it will float.  It’s probably the singularly most stupid thing on television, but I can’t turn it off.  I don’t think they do it anymore, but I loved it when they used to have it.   As a child, my best friend and I would fill up the sink and test all sorts of stuff to see if it would float or not.  I guess Dave was just doing the same thing (on a much bigger scale!) 

Anyway, that’s how I feel about taxable versus non-taxable income.  Will it float?  Do I gotta pay taxes on the money or not?  For me, most of the time, I already know the answer, it’s what I do for a living.  But there’s always some new challenge, something I haven’t seen before.  Figuing out if various types of income are taxable or not is my personal little “Will it Float?” contest.  And let’s face it; I always like to find money that you don’t have to pay taxes on.

Here’s a list of some of the things you do not have to pay taxes on:

  • Child support payments
  • Gifts, bequests and inheritances—you may have heard of estate taxes, but if Uncle Joe dies and leaves you cash money, you don’t pay tax on that.  If Uncle Joe dies and leaves you his IRA, those distributions are taxable, it’s different from just being left cash.
  • Workers’ compensation benefits
  • Meals and lodging for the convenience of your employer – let’s say your boss sends you to Chicago for a business trip and you put the trip on your credit card.  Your boss reimburses you for your hotel stay and your food, you don’t pay tax on that.
  • Compensatory Damages awarded in a lawsuit.  Compensatory damages are to “make you whole.”  Let’s say you sued your neighbor because he ran over you with his car.  If the damages awarded to you are to cover your hospital costs, that would be compensatory damages and they wouldn’t be taxed.  If you sued for lost wages because you couldn’t work, that would be a different type of damages and that part of your lawsuit award would be taxed.  I’ve worked on tax returns dealing with lawsuits that awarded several different types of income from damages.  We’d have to split them into the correct categories for tax purposes.
  • Welfare benefits are not taxed.
  • Cash rebates from a dealer or manufacturer.
  • Adoption expense reimbursements for qualifying expenses are not taxed either.

Some things are kind of iffy, they’re taxed in some cases and not in others.  Here are some examples of “maybe yes, and maybe no.”

  • Life insurance- if somebody dies and you are paid death benefits, that’s not taxable.  If you surrender a life insurance policy for case, any proceeds that are more than what you paid for the policy will be taxable.
  • Scholarship or Fellowship Grants- If you are a degree candidate, then you can exclude from your taxable income amounts that you receive as a qualified scholarship.  If you get one of those super scholarships where they pay for your room and board, that doesn’t qualify as tax free and you will be taxed on that part.

Most other items count as taxable:  wages, salaries, tips, unemployment, self employment, pensions, interest, stock sales, etc.

There’s an IRS publication that goes into complete detail of what is and isn’t taxable.  It’s 43 pages long and it goes into some serious detail over what is and isn’t taxable.  For example:  did you know that death payments for astronauts dying in the line of duty after 2002 are not taxable?  That one was new to me, I just learned it now trying to pick up the link to the website.  The alphabetical list of types of income and whether it’s taxable or not begins on page 31.  http://www.irs.gov/pub/irs-pdf/p525.pdf

When in doubt, it’s probably taxable.  There’s actually a line in the tax code that says, if something isn’t specifically listed in the tax code as being not taxed, then it is taxable.  (They don’t actually phrase it that way, to be honest, if you read the actual paragraph you may not even know what they’re saying.  I took some liberties with the language, but the meaning is head on.  If you discover a new type of income, and there’s no mention of it anywhere, then by default the IRS taxes it.