Answers to Tax Questions in Jefferson City and Central MO

Question: How do I defend my Fair Market Value determination?

Answer: This question can get complicated AND expensive. First start with a definition per the IRS;

“Fair market value (FMV) is the price that property would sell for on the open market. It is the price that would be agreed on between a willing buyer and a willing seller, with neither being required to act, and both having reasonable knowledge of the relevant facts.”

Source: IRS Publication 561

This is the standard the IRS uses to determine if an item sold or donated by you is valued correctly for income tax purposes. It is also a definition that is so broad that it is wide open to interpretation. The difficulty here, is if the IRS decides your FMV opinion is wrong, you are not only subject to more tax, but penalties to boot. Here are some tips to help defend your FMV in case of an audit.

Understand when it is used

Fair Market Value or FMV is used whenever an item is bought, sold, or donated that has tax consequences. The most common examples are:

Buying or selling your home or other real estate

Buying or selling personal property

Buying or selling business property

Establishing values of other business assets like inventory

Valuing charitable donations of personal goods and property like automobiles

Valuing bartering of services

Valuing transfer of business ownership

Valuing the assets in an estate of a deceased taxpayer

Ideas to defend your FMV determination

Here are some suggestions to help you defend your FMV determinations.

Properly document donations. FMV of non-cash charitable donations is an area that can easily be challenged by the IRS. Ensure your donated items are in good or better condition. Properly document the items donated and keep copies of published valuations from charities like the Salvation Army. Don’t forget to ask for a receipt (confirmation) of your donations.

Donate capital items like automobiles to the correct places. You may use the FMV of a donated automobile but only if the charity you donate the item to will use it themselves, or will provide it to someone who will use it. Websites like Kelley blue book (kbb.com) can help establish the value of your vehicle when you donate it. Otherwise, the FMV of the donated vehicle will be limited to the amount the charity receives when they re-sell it.

Get an appraisal. If you sell a small business, collection, art, or capital asset make sure you have an independent appraisal of the property prior to selling it. While still open to interpretation by the IRS, this appraisal can be a solid basis for defending any differences between your valuation and the IRS.

Keep copies of similar items and transactions. This is especially important if you barter goods and services. If you have a copy of an advertisement for a similar item to the one you sold, it can readily support your FMV claim.

Take photos. The condition of an item is often a key determinate in establishing FMV. It is fair to assume an item has wear and tear when you sell or donate it. Visual documentation can be used to support your claimed amount.

Keep good records. Keep copies of invoices for major purchases. Retain bills for any improvements. Make sure your sale of property includes a dated bill of sale that clearly states transfer of ownership and amount paid for the item.

With proper planning, establishing the fair market value of an item sold or donated, can be done in a reasonably defendable way if ever challenged.

Cash versus Accrual

When you start a business, you have many decisions to make. One of those is the method of accounting your business will use for reporting income and expenses on your tax return. It is an extremely important decision. With few exceptions, the method you choose can only be changed in the future with the IRS's permission.

The two methods generally used are the cash method and the accrual method. The cash method is probably the easiest for most people to understand and the easiest for small business owners to use. This method recognizes income when you receive a payment from a customer, and a deduction is taken when you pay cash or write out a check for a bill you have to pay.

The accrual method recognizes income when the services are rendered or the product is sold, despite the fact that you may not get paid for several months. You have "accounts receivable" in the form of money customers owe you. Expenses are handled the same way. If you buy something today, but don't pay for it until later, maybe even next year, you would deduct the cost now. What you owe for purchases you've made constitutes your "accounts payable."

The cash method is easier to understand and more closely reflects how money is coming in and out of the business. However, it doesn't tell you how much people owe you or how much debt the business owes. The accrual method better reflects how the business is actually doing, but it is more complex and, for most business owners, more difficult to understand.

All new business owners should sit down with their accountants to discuss the pros and cons of each method and to decide what works best for their business. Many businesses are required by tax law to use the accrual method for tax reporting.

Question: I pay someone to care for my child while I work? Can I deduct this expense?

Answer: No, but you may be able to claim a tax credit, which is more valuable than a tax deduction because it reduces your tax liability dollar for dollar.

You can take the child care credit if you pay someone to care for your child who is under the age of 13, or for a child or other dependent (any age) who is physically or mentally incapable of caring for themselves. You must have earned income in order to claim the credit, and you must need the child care to allow you to work.

The maximum credit is 35%. Eligible expenses are $3,000 for one child and $6,000 for two or more children.

Question: Who can I claim as my dependent?

Answer: You must generally pass five tests in order to claim someone as a dependent, including;

1. the member of household/relationship test,

2. the support test,

3. the gross income test,

4. the joint return test, and

5. the citizenship test.

Question: Who can I claim as my dependent?

Answer: You must generally pass five tests in order to claim someone as a dependent, including;

1. the member of household/relationship test,

2. the support test,

3. the gross income test,

4. the joint return test, and

5. the citizenship test.

The rules are complicated. Also, just because you can claim someone as your dependent, you may not find it beneficial to do so. This determination is not for the uninformed. Please call for help and clarification of the tax rules!

Question: Is my disability income taxable?

Answer: Money received from worker's compensation for sickness or illness is not subject to income tax. Amounts received under a private accident policy for which you pay the premiums are also nontaxable. To the extent your employer pays the insurance premiums, your benefits will be subject to tax.

The punitive damage amount in any legal settlement, if any, is generally includible in taxable income as is any interest included in the damage award.

Question: What tax breaks are available if I suffer a loss due to a natural disaster?

Answer: If the federal government declares your area to be a major disaster area, the tax law allows individuals and businesses to get a faster refund by claiming disaster losses on their prior years' return. This is done by filing an amended return for the prior year.

Also, in some disaster situations, the IRS might allow additional time to file current year returns and pay any tax due.

It is important to check as soon as possible to note any approved filing delays or tax benefits due to your unfortunate circumstance.

Question: What if I can't file my return on time?

Answer: April 15* is the tax filing deadline for most individual income tax returns. If you can't complete your tax return by then, file Form 4868 with the IRS to give yourself up to six additional months to complete your return.

Caution: Form 4868 only extends your filing deadline; it does not extend your tax payment deadline. If your tax is not paid in full by April 15, you'll face interest and penalties on the balance owed.

* When April 15 falls on a Sunday or legal holiday, the deadline for filing is moved to the next business day.

Question: Do I need to file a tax return after I retire?

Answer: You may need to file a return even after you retire. You're required to file a return if your income is over certain levels. Generally, you must file a 2020 federal income tax return, even if you don’t owe tax, when your gross income exceeds the following limits:

Single 

$12,400

Head of household 

$18,650

Married filing jointly 

$24,800

Married filing separately 

$12,400

If you are 65 or older or legally blind, you are allowed to make more money before you have to file a return. Single taxpayers who are legally blind or over age 65 can take another $1,650 ($1,300 for each married taxpayer).

If your total income is less than these amounts, you’ll still have to file a return if you are self-employed and your business net income is $400 or more.

Even if you do not have to file a return, you might still want to do so. For example, if you paid taxes to the IRS or had taxes withheld from your wages or pension, the only way you can get your money back is to file a tax return.

Question: Does my child have to file a tax return?

Answer: If you or someone else claims your child as a dependent, your child will need to file a 2019 return if he or she has:

1) Earned income from wages of more than $12,400.

2) Earned net income from self-employment (from a paper route, for example) of $400 or more.

3) Investment income only (such as interest and dividends) of more than $1,100.

4) Both earned and investment income totaling more than the larger of: (a) $1,100 or (b) $350 plus earned income, not to exceed $12,400.

If no one claims your child as a dependent, your child has the same filing requirements as any other taxpayer. Also remember, if your child has any withholdings, the only way to get them refunded is to file a tax return!

Question: What's the best filing status?

Answer: The best filing status for you depends upon which status you can qualify for and your particular circumstances. Tax savings are only one consideration when selecting your filing status. For example, you might not want to file a joint return with your spouse for personal reasons. Here are the five filing statuses and the qualifications you must meet to use them.

Single - You can use this status if you are unmarried at the end of the year or legally separated according to state law.

Head of household - You can choose this status if you are single at the end of the year, and you have a dependent and meet certain requirements. In some cases, married, but separated individuals can also use this status. If you're eligible to claim head of household status, you'll probably pay less tax than filing as a single taxpayer.

Married filing joint - You can use this status if you are married at the end of the year. However, you cannot use this status if you are legally separated on the last day of the year.

Married filing separate - You can use this status if you are married, but choose not to file a joint return with your spouse. When legally separated, you cannot use "married filing separate" filing status.

Qualifying widow(er) - You can choose this status if your spouse died in the last two years, you claim a dependent, and you meet certain other requirements. You then can use the more favorable tax rates for married filing jointly rather than the rates for single taxpayers.

Question: When are gift taxes due and who pays them?

Answer: Gift taxes are due on certain transfers of wealth. If and when gift taxes are due, the donor is liable for them. The recipient of the gift is not taxed. (Note that gifts to charity are not subject to gift taxes.)

The combined estate and gift exclusion is $11.58 million. In addition, you're entitled to make annual gifts of up to $15,000 in 2018, 2019 and 2020 to as many individuals as you like without incurring a gift tax. The tax law lets you give away more than this annual limit in certain cases. For example, you can generally make unlimited gifts to your spouse. You can also pay an unlimited amount of medical or tuition expenses for another person as long as your payments are made directly to the institution.

Gifts beyond the limits indicated are subject to tax at a maximum rate of 40%. If this occurs, ask for clarification on how this should be reported.

Question: When is my hobby considered a business?

Answer: The IRS is suspicious of any business activity that looks like it provides personal enjoyment, such as antiques, photography, horse racing, etc. If you make a profit in any three out of five consecutive years (two out of seven years for horse activities), your activity is presumed to be a business, and any business losses are deductible.

If you fail to show a profit, you may still qualify to deduct your losses if you are running your business with the intent of making a profit. For example, the way you keep records, the amount of time you spend in the business, and your financial risk in connection with the activity are some of the factors the IRS will consider.

Even if your hobby doesn’t qualify as a business, your hobby income must still be reported on your income tax return

Question: Is the sale of my residence taxable?

Answer: That depends on the amount of profit from the sale. Single taxpayers can exclude from tax up to $250,000 of profit on a home sale and married couples can exclude up to $500,000. To take the full exclusion, you must generally have owned and used the home as your principal residence at least two of the five years prior to its sale. Also, you can't use the exclusion more than once every two years. A reduced exclusion may apply in some cases. Prior to selling your home, it is important to review your situation.

Question: When I sell my home, do I have to replace it with a more expensive home to postpone taxes on the sale?

Answer: No. In fact, you don’t have to reinvest in another house at all. If you meet certain qualifications, you can use your sale proceeds for whatever purpose you choose - without having to pay tax on your profit in the sale.

The Taxpayer Relief Act of 1997 eliminated two longtime provisions in the tax law. Under the old rules, taxpayers age 55 and older had a once-in-a-lifetime opportunity to exclude $125,000 of gain on the sale of their principal residence. In addition, once every two years, you were allowed to roll over the gain from one house to the next as long as you purchased a replacement house of equal or greater value. Doing so allowed you to postpone tax on the gain.

Now, you can no longer roll over the gain from one home to another, even if you want to. And the gain exclusion for those age 55 and older no longer exists. However, individuals can exclude up to $250,000 of profit ($500,000 for married couples) if you meet certain requirements

Question: I refinanced my home mortgage this year. Can I write off the loan costs?

Answer: If you refinanced to consolidate your debts or to obtain a lower interest rate, you must amortize (write off) the points over the term of your loan. However, to the extent you used the loan proceeds to make improvements to your home, you can write off that portion of points this year.

If you've been amortizing points on a previous mortgage, you can write off the remaining balance of points in the year the loan is paid off.

Question: Can my child set up an IRA?

Answer: If your child has wages or self-employment income, he or she can contribute to an IRA. However, in 2020 the contribution cannot exceed the child's earned income or $6,000, whichever is lower.

Your child can choose between making a deductible IRA contribution and a nondeductible Roth IRA contribution. In most cases, a Roth IRA will have the greatest long-term benefit for your child.

Question: Can I make penalty-free IRA withdrawals?

Answer: The tax law generally makes you pay a 10% penalty if you take money out of an IRA before you reach age 59½. However, there are several ways to tap your IRA earlier without incurring the 10% penalty.

Equal withdrawals. One way is to elect to take substantially equal withdrawals based on your life expectancy or the joint life expectancies of you and your designated beneficiary.

Home and education. You may also take money from your IRA to help cover certain expenses. For example, if you, your child, or grandchild is purchasing a home and the purchaser hasn’t owned a home within the last two years, you can withdraw, penalty-free, up to $10,000 to use towards this transaction. Likewise, if you, your spouse, child, or grandchild attends college or graduate school, you can take penalty-free distributions to cover eligible higher education costs.

Medical expenses. The IRS also allows penalty-free access to IRAs when taxpayers face certain difficulties. For example, if your medical expenses exceed 10% of your adjusted gross income, you may make a penalty-free withdrawal of up to the amount by which these expenses exceed the 10% floor. Similarly, if you have been unemployed for at least 12 consecutive weeks, you can take a penalty-free distribution to cover medical insurance premiums. Also, you are exempt from the early withdrawal penalty if you become disabled.

Military and public service personnel. Special rules apply to those on active military duty and to certain public safety employees.

Remember that you will most likely owe regular income tax on the money withdrawn even if the withdrawal is penalty-free.

Question: Should I convert my IRA to a Roth IRA?

Answer: Roth IRAs are very attractive because once money is inside a Roth, it may never be taxed again. However, before you rush to convert your traditional IRA to a Roth, there are a number of factors you should consider.

How much after-tax money will you end up with for retirement? You’ll need to make some assumptions about your future tax rate, your retirement age, and your investment return. Then you’ll have to run the numbers to see whether you’d end up with more money, after taxes, if you left it in your traditional IRA or if you converted to a Roth.

Do you have enough cash to pay conversion taxes? When you convert, you'll owe regular income taxes on the amount you roll over to your Roth. If you have to sell outside investments to pay taxes on the rollover, you’ll owe taxes on any gains from those sales as well. If you have to cash out part of your IRA to pay taxes, you’ll be socked with a 10% penalty unless you are over 59½.

How soon will you need the money? Generally, you cannot withdraw the earnings on the money within five years of the conversion without a penalty.

Will the conversion income push your adjusted gross income to the point where it will cost you valuable tax benefits, such as certain deductions and tax credits?

Will it push you into a higher tax bracket?

As you can see, deciding whether a Roth conversion is right for you involves careful planning.

Question: What if I fail to take my required IRA distribution on time?

Answer: You'll face a 50% penalty on the amount that should have been withdrawn. Fortunately your investment firm will typically send reminders and you can often ask for an abatement of the penalty. But why put yourself in that position. Develop a reminder system at the beginning of each year to ensure this does not happen to you.

Question: When must I start withdrawing money from my IRA?

Answer: Upon turning age 72 (or age 70 1/2 if you reach 70 1/2 before January 1, 2020), you must begin withdrawing money from your traditional IRA as follows:

Your first withdrawal can either be taken by December 31 of the year you turn age 72, or it can be postponed up until April 1 of the following year.

Your second withdrawal must be taken by December 31 of the year after you turn age 72.

In each subsequent year, you must withdraw at least the required minimum amount by December 31.

If you fail to take your required distribution on time, you'll face a 50% penalty on the amount that should have been withdrawn.

Note: There is no requirement to make withdrawals from a Roth IRA at age 72.

Question: What investment choices do I have for my IRA?

Answer: The tax law only tells you what investments can't be held inside your IRA. You may not use IRA funds to invest in collectibles such as artwork, rugs, antiques, coins, stamps, and gems. The law also prohibits IRA investments in life insurance, tangible personal property (such as a car), and non-U.S. property.

Clearly, that leaves you with a lot of investment choices. Conventional IRA investments include publicly traded stocks, bonds, mutual funds, Treasuries, or cash. More unconventional, yet acceptable, investment options include:

Certain gold, silver, and platinum coins and bullion

Commodities and futures

Real estate Mortgages/deeds of trust

Promissory notes

Limited partnerships

Joint ventures

Private stock offerings

Foreign stocks

Limited liability corporations

Tax lien certificates Accounts receivable

Commercial paper Leases

Question: CanI itemize my deductions this year?

Answer: If you have enough personal expenses, you may save income taxes if you itemize your deductions. Compare your itemized deductions with the standard deduction for your filing status, and use the larger of the two.

Itemized deductions include the following:

Medical expenses - only to the extent they exceed 10% of your adjusted gross income. Different rules apply for age 65 and older.

Taxes - this includes state and local taxes, real estate taxes, and personal property taxes.

Interest you pay - such as home mortgage interest, certain points, and investment interest. Tish is limited to $10,000.

Charitable gifts - this includes gifts of both cash and property.

Casualty and theft losses in federally declared disaster areas - above certain thresholds.

The standard deduction is indexed annually for inflation. Here are the standard deduction amounts for 2018 and 2019.

Filing

Status 

2019

2020

Single 

$12,200

$12,400

Joint returns & surviving spouses 

$24,400

$24,800

Married filing separately 

$12,200

$12,400

Head of household 

$18,350

$18,650

In 2020, each married taxpayer over age 65 or legally blind receives an additional $1,300 deduction. Singles receive an additional $1,650 deduction.

So will you itemize? Probably yes if you are:

• Own a home
• Single
• Have high medical bills
• Donate a lot to charity

Question: What if I owe more money to the IRS than I can pay?

Answer: The IRS offers several options to taxpayers who cannot pay their taxes in full when they file their return.

You can charge your taxes on a credit card. The IRS's credit card service providers charge a convenience fee of about 2.5% in addition to the interest rate your credit card company charges on your balance.

You can request to pay your taxes to the IRS in installments. If you owe $50,000 or less and agree to pay off the balance within a six-year period, the approval process is pretty straightforward. Larger balances can be set up on an installment plan too, but they won’t be automatically approved. The IRS will continue to add interest and penalties to your account until you pay off the balance.

You can enter into an offer-in-compromise"agreement with the IRS to settle your tax bill and get off to a fresh start. Under this arrangement, the IRS will settle your account for a portion of the tax you owe if you agree to file and pay your future taxes on time. You'll have to submit financial information to the IRS to prove that you don't have the money or ability to pay off the entire balance.

Question: What kind of penalties will I be charged if I pay my taxes late?

Answer: If you fail to pay all your taxes by the April 15* deadline, you'll have to pay the IRS interest and penalties on your underpayment. The IRS charges interest at its prevailing rate, which it publishes quarterly. The late payment penalty is generally .5% for each month there is an unpaid balance, up to a maximum 25% penalty.

When you file a late return with a balance due, another nasty penalty kicks in - the late filing penalty. This penalty amounts to 5% per month, for a maximum of five months. For example, if you owe $5,000 in taxes and failed to file a return or an extension by April 15, the failure-to-file penalty could build up to as much as 25% or $1,250.

*When April 15 falls on a Saturday, Sunday, or legal holiday, the deadline for filing is generally moved to the next business day.

Question: Why do I need a tax professional when I can buy tax preparation software?

Answer: Tax software producers claim their products can prepare complex returns, but you may want to think twice before relying on software for all your tax and financial guidance. Although software may help you make choices on your tax return that result in the lowest tax this year, you should consider the long-term effect of your choices in order to pay the lowest tax over a number of years.

With a professional tax preparer you get more than just a tax return. An established relationship with a tax professional who is familiar with your finances, your family, and your goals can prove to be invaluable.

If you prepare your own returns, it's a good idea to let a professional preparer review your returns at least every three years. That's because you only have three years to amend a return to change any items of income, deductions, or credits that were reported in error or omitted on your original return.

Question: Should my corporation own our business building or should I own it personally?

Answer: If your business is incorporated, it is often a good idea to personally own the real estate occupied by your corporation.

If appreciated real estate is sold by a regular corporation, the gain will be subject to double taxation if the corporation distributes the money to you. However, if you own the real estate personally, there is no double taxation. Though the double taxation does not apply to S corporations, there can be problems when an S corporation sells its operating business and its real estate.

If you personally own the property, you can lease it to the corporation.

There are non-tax advantages of personal ownership of business real estate as well. Discuss the facts with us and your attorney before you buy business real estate or change the form of ownership on real estate you already have.

Question: What is the best way to assemble records for you to prepare my tax return?

Answer: First, don’t wait until the last minute to sort through your records. Set up a filing system early in the year and stay on top of your filing.

Second, realize that there's not one particular system that works for everyone. If you use a tax organizer, you may want to set up your files in the same order, so you can easily locate the items you'll need to complete it. Otherwise, you might want to use last year’s return as a guide, and organize your files in the same order they were reported on your prior-year income tax return.

Third, when you receive important tax documents, such as your W-2, 1099s, mortgage interest statements, retirement account statements, etc., verify that the information is accurate before filing the documents with your other records.Describe the item or answer the question so that site visitors who are interested get more information. You can emphasize this text with bullets, italics or bold, and add links.

Question: Are my Social Security benefits taxable?

Answer: Up to 85% of Social Security benefits can be taxed. Whether your benefits will be taxed depends upon your total income from both taxable and tax-exempt sources. Once your total income reaches $25,000 ($32,000 for married couples), a portion of your benefits will be subject to income tax.

This is important to know as you start receiving benefits. It may impact how much you are willing to work in a part-time job and it may impact the amounts you withdraw from retirement accounts.

Question: Is there anything wrong with getting a big income tax refund every year?

Answer: Yes, it means you're giving the IRS an interest-free loan when you could have the use of that money during the year to invest for yourself.

Steps to take. As early as possible each year;

Take the time to estimate your total tax bill for that year.

Consider adjusting your withholding so that the amount your employer withholds comes closer to what you will actually owe on your tax return.

Change your withholding at any time during the year by giving a new Form W-4 to your employer to make mid year corrections.

Question: What is a capital gain distribution? I didn't sell any shares of my mutual fund, but I received a year-end statement from the company reporting a capital gain distribution.

Answer: Typically mutual funds buy and sell stocks or bonds throughout the year. Each time the fund sells an investment, its owners owe tax on their share of any gain. At the end of each year, the mutual fund company reports the total gains to its owners for income tax reporting purposes.

Many investors are surprised to learn they owe tax when they didn't receive any cash from the company. Instead of distributing the proceeds to you when an investment is sold, the fund manager reinvests the cash in another investment. However, you are still responsible for the tax.

Question: After I filed my tax return, I discovered an error. How do I fix it?

Answer: Oversights and errors are not uncommon, so the IRS provides a way for you to correct them. You can correct your return for up to three years after you file your original return by filing an amended return with the IRS.

You need to tell the IRS why you are correcting the return, and include the appropriate documentation with your amended return.

If you've discovered income or deductions that you should have reported on your income tax return, give us a call. We can help you set the record straight and pay only the tax actually due.

Question: Is bond interest taxable?

Answer: That depends on the type of bond. For example:

Corporate bond interest is taxable.

Municipal bond interest is generally not subject to federal income tax.

Treasury bond interest is free from state and local income taxes.

Savings bond interest may or may not be taxable depending on the issue and what you use the bond interest for. For example, the interest on certain Series EE and Series I bonds is nontaxable if it is used for qualified education expenses.

Question: How does "adjusted gross income" differ from "gross income"?

Answer: For income tax purposes, there are three levels of income: gross income, adjusted gross income, and taxable income.

Gross Income. Gross income includes income from all sources whatsoever unless specifically excluded by tax law. Gifts and inheritances, for example, are specifically excluded from income.

Adjusted Gross Income. To arrive at adjusted gross income (AGI), you are allowed a long list of deductions from gross income including such things as business expenses, certain losses, and retirement account contributions. These deductions, also called above-the-line deductions, are allowed even if you don't itemize your personal deductions (if you choose instead to use the standard deduction). AGI is an important number because it is used to determine certain other tax benefits.

Taxable Income. Taxable income is AGI minus your itemized deductions (or standard deduction) and your personal and dependency exemptions. Taxable income is used to determine your tax bracket, your tax rate, and your ultimate tax liability.

Question: I made a loan to a relative that will never be repaid. Can I take a deduction for this bad debt on my tax return?

Answer: Your loss might qualify as a nonbusiness (personal) bad debt deduction.

You can take a tax deduction for a nonbusiness bad debt only in the year it becomes worthless and only as a short-term capital loss. In addition, you must be able to prove that a bona fide debt existed and that you've made efforts to collect the debt.

Question: The social security number reported on my Form W-2 is incorrect. What should I do?

Answer: Immediately contact your employer and correct your Social Security number. Ask your employer for a corrected W-2 (Form W-2C, Corrected Wage and Tax Statement). If the W-2 information is not corrected, you will not get social security credit for the wages you earned. If this happens to you make sure your employee record is corrected as soon as possible. The same process holds true with other common errors including a name change when you get married or divorced.

Question: I disagree with the amount of wages reported on my Form W-2? What should I do?

Answer: Contact your employer and ask for a corrected W-2 (Form W-2C, Corrected Wage and Tax Statement). If you do not receive the corrected W-2, you should report the incorrect amount as noted on the W-2 to avoid an IRS correspondence audit AND then correct the amount on your tax return.

Question: My employer went out of business and I didn't receive a Form W-2. I can't locate the owner. What should I do?

Answer: You are required to report all your income, whether or not you receive information forms (W-2s or 1099s) from the parties who paid you. You'll have to reconstruct your income and income tax withholding based on your paycheck stubs or other documents. Make sure your income is also properly reported on your account with the Social Security Administration as your future benefits could be negatively impacted if not properly reported by your employer.

According to the IRS, you should contact the IRS and a representative will take a W-2 complaint.

Question: Are unemployment benefits subject to federal income tax?

Answer: Yes, unemployment benefits are subject to federal income tax. The government unit that paid you should provide you with a year-end statement (Form 1099-G) showing the amount that is to be included as income on your tax return.

To avoid having a large tax balance due at filing time, you should consider filling out Form W4-V to have the proper amount of income tax withheld from each unemployment check

Question: How do I keep track of the business use of my vehicle?

Answer: You can use either of two methods to account for your deductible business use of a vehicle.

1. Actual expenses. The first and most cumbersome is to keep track of all your expenses, such as gas and oil, license, insurance, and repair bills. You total all your expenses and take a percentage of that total based on the business miles driven in relation to the nonbusiness miles driven.

2. Standard mileage. Your other choice is to use the standard business mileage rate announced by the IRS each year. This is a flat rate that is multiplied by the total business miles driven for the year. In addition you can deduct your business-related parking fees and tolls paid.

If you are an employee and use your personal vehicle for business purposes, special rules apply. Check with your employer to determine whether they will reimburse you for the use of your vehicle.

You might be surprised by the answer.

Question: If a debt I owe is cancelled, is that income to me?

Answer: Cancelled debt is included in income unless it is specifically excluded by some provision in the tax code. Thankfully, certain types of debt forgiveness are generally excluded from income (e.g., discharge in bankruptcy under Title 11, a discharge when the taxpayer is insolvent outside of bankruptcy, qualified farm indebtedness, and qualified real property business debt).

Under special circumstances, some types of student loan cancellations are also excluded from income. A common example of this is student loan debt forgiveness when you work in an approved government incentive program.

Before accepting a debt forgiveness offer from a bank or other source, please understand the tax ramification of accepting the terms before you sign.

Question: What is the difference between a tax deduction and a tax credit?

Answer: A deduction reduces your taxable income, and a credit is a dollar for dollar offset against your computed tax liability. Some credits are refundable, meaning that if your credit is larger than your tax liability, the IRS will pay you the difference.

This example may help. A $100 deduction will reduce your taxes by $24 if you are in the 24% tax bracket. A $100 credit will reduce your taxes by $100.

There are many ways to save for college, but one thing is certain: it is never too early to start. One way to save for college is with a "Section 529" plan. These plans offer a way to pay for college expenses with some nice tax advantages.

What are they?

Section 529 plans allow you to set up a tax-advantaged account to pay for your child's college education. There are two types of Section 529 plans: prepaid tuition programs and college savings plans.

Prepaid tuition programs let you lock in today's tuition costs by purchasing tuition credits or certificates that a student redeems when he or she starts college.

College savings plans let you make contributions to a state-sponsored savings account to build a fund for your child's college expenses. These accounts are generally managed by a private mutual fund company. This is the Section 529 plan you've probably been hearing about, and it is this type of college plan that is the focus of this article.

How do Section 529 college savings plans work?

Make a gift to set up an account.You start by setting up an account and naming your child (or anyone else) as the beneficiary. Your contribution is considered a gift. Your contributions qualify for the $14,000 annual tax-free gift exclusion ($28,000 for married couples making a joint gift).

Special rules for 529 plans let you average your gift over five years. This means married couples can make a $140,000 joint gift and individuals can make a $70,000 gift in a single year, without incurring gift tax. However, you cannot make additional gifts to your child for five years, or you may owe gift tax.

Your contribution is limited.You aren't permitted to make contributions to a 529 plan beyond what is necessary to pay for your child's college expenses. Each plan sets its own limit.

Most plans allow you to make either a lump sum contribution or a series of monthly contributions. All contributions must be made in cash; you can't contribute shares of stock or other property to these plans.

You remain in control. You cannot choose the investments in the fund - you must choose one of the plan's investment options. However, you do remain in charge of all withdrawal decisions. You can allow your child to make withdrawals to pay for college expenses. If your plan permits it, you can change the beneficiary to one of your other children. If you change your mind about maintaining the account, you can even request a refund (tax and penalties will apply).

Your child can withdraw money to pay for college expenses.Section 529 funds must be used for qualified higher education expenses, such as tuition, fees, books, and supplies. They can also be used to cover certain room and board expenses, as long as your child attends school at least half-time. If your child receives a scholarship, you can request a penalty-free refund up to the amount of the scholarship. In addition, you can withdraw the funds if your child becomes disabled or dies.

If the funds are withdrawn for any other purpose, you (not your child) pay tax on the earnings that have accumulated in the fund.

You can change plans. You can make a tax-free rollover to another plan with the same beneficiary. That allows you to move your child's plan to another state's plan without losing the tax benefits. This tax-free rollover treatment only applies to one transfer within any 12-month period.

What are the benefits?

Section 529 plans offer tax benefits. Your contribution is not tax-deductible, but your investment grows tax-deferred. That allows your money to grow faster than a similar investment in a taxable account. Qualified distributions from Section 529 college savings plans are tax-free.

Section 529 plans offer an estate planning opportunity. Section 529 plans let wealthy parents or grandparents transfer wealth out of an estate and into an account a child can use to pay for college expenses.

What are the disadvantages?

While these plans offer an attractive alternative to other college funding plans, they are not without drawbacks. There are a number of factors you should consider before you invest in a Section 529 college savings plan.

Substantial penalties apply to nonqualified withdrawals. Any nonqualified distributions will be subject to withdrawal fees and penalties. You'll also owe income tax on the distribution.

Your state plan may not meet your investment expectations. You should choose from among the available plans the one that meets your risk tolerance and performance expectations. But what if you are unhappy with a plan's investment performance? If your plan allows rollovers, you can move the funds into another plan. If you simply request a refund, you'll have to pay income tax and penalties on the distribution.

Do your homework.

The same federal income tax rules apply to all Section 529 college savings plans. However, each plan has unique features. Here are some items you should compare when you evaluate different plans.

State income taxes.

Investment return.

Enrollment fees.

Maximum contributions.

Flexibility in making contributions.

Withdrawal fees and penalties.

Transferability to another beneficiary or another qualified plan.

Choice of schools.

Participation by nonresidents.

Beneficiary age restrictions.

Covered education expenses, including restrictions on room and board.

Section 529 plans provide an attractive, tax-favored way to save for college. However, they are not the right choice for everyone.

What happens when an ex-spouse files a joint tax return with errors in it that you did not know about? You learn that the tax obligation on a jointly filed tax return can be collected in its entirety from either filer. The IRS refers to this as joint and severable liability. Fortunately, there is some protection for the unsuspecting spouse through Innocent Spouse Relief provisions in the tax code.

Example: Jane and John Doe are married. John files the couple's tax returns. Jane signs the returns without knowledge of significant errors in the tax returns relating to John's business. John has lied on the tax return, under-reporting income and does not pay all the tax. John and Jane separate and ultimately divorce. Two years later, Jane receives a tax bill from the IRS for past taxes owed while married to John.

Innocent Spouse Relief defined

Generally, innocent spouse relief refers to a petition by a taxpayer to be relieved of a tax obligation due to a spouse or ex-spouse’s actions. These actions are typically under-reporting income, claiming unsupported deductions or credits, or simply not paying the taxes owed.

In tax code speak, however, there are three main tax obligation relief provisions that are under the “Request for Innocent Spouse Relief” umbrella.

Innocent spouse relief. When granted, the innocent spouse is relieved of the joint and severable tax liability of additional taxes due to unreported income or mis-reported credits and deductions.

Separation of liability relief. In this case, the IRS divides (allocates) the additional tax owed between the two spouses who are divorced or legally separated. The person who receives the tax relief of understated tax from their spouse’s wrong-doing still probably owes some tax, but not for the unknown obligation.

Equitable relief. If the innocent spouse does not receive innocent spouse relief or separation of liability relief, he/she may still be entitled to equitable relief. This often applies to correctly filed tax returns that have unpaid taxes.

Judgment is involved

As you can imagine, there is significant judgment involved in granting this relief by the IRS. To receive innocent spouse relief of tax, interest, and penalties the following conditions apply;

The couple files a joint tax return.

The tax return has tax owed due to erroneous items from a spouse (or former spouse).

When signing the tax return you did not know or have reason to know that the tax understatement existed.

It would be unfair to hold you liable for the obligation.

The request for Innocent Spouse Relief is a detailed seven page tax form. Please ask for assistance if you think you need help in this area.

The Basics: FAQ articles summary View all categories 

Tax credits are one of the most powerful ways to lower your income taxes. A tax credit reduces your tax bill dollar for dollar. A tax deduction, on the other hand, only reduces your taxable income, so your benefit is determined by your tax bracket.

For example, a tax deduction of $1,000 will lower your tax bill by $320 if you are in the 32% tax bracket. A $1,000 tax credit will lower your tax bill by $1,000.

Here are some of the most common tax credits; most are subject to income limits.

Child credit. Taxpayers who have dependent children under age 17 may be eligible for a child tax credit of $2,000 per child.

Dependent care credit. Expenses paid for the care of dependent children under 13 and certain other dependents may qualify for a tax credit.

Education credits. Qualified college and vocational school expenses for eligible students may qualify for a credit. Under the American Opportunity Tax Credit, up to $2,500 per student can be claimed for tuition and fees paid during four years of post-secondary education. Under the Lifetime Learning Credit, up to $2,000 per family is available for post-secondary education expenses and for education expenses to acquire or improve job skills.

Earned income credit. This credit is intended for low-income taxpayers. The size of the credit depends on the amount of your earned income (wages and self-employment income), investment income, and your filing status. Qualifying children can increase the credit.

Business credits. There are a number of credits available to businesses. They include the research credit the work opportunity credit, the disabled access credit, and the low-income housing credit.

Don't overlook valuable credits that could reduce your taxes. For details on the credits for which you might qualify, call for a review of your situation.

The "tax gap" is a concept developed by the Internal Revenue Service to measure voluntary compliance with the tax laws by taxpayers. The tax gap is the difference between what taxpayers should have paid and the amount that is actually paid voluntarily and timely.

According to the latest tax gap figures, about 83% of all taxes owed are paid as due. That leaves a 17% noncompliance rate for a tax gap of about $450 billion. IRS enforcement activities, including tax return audits, collect about $65 billion of this tax revenue shortage.

There are three components to the tax gap: nonfiling, underreporting, and underpayment. The tax gap does not include taxes that should have been paid on income from illegal activities.

Underreporting accounts for about 84% of the tax gap. The largest sub-component for underreporting involves individual taxpayers understating their income, taking improper deductions, and overstating business expenses. Noncompliance is highest where there is no third-party reporting and/or withholding such as there is with W-2s and 1099 information slips.

The current IRS measurement of the tax gap was done using tax returns from a few years ago. The information on the tax gap assists the IRS in selecting tax returns for audit. The intent is to select those tax returns that will lead to the greatest amount of additional tax. This not only improves IRS efficiency, but it also demonstrates to taxpayers that others will be paying according to the tax laws.

What does all this mean to you? If a large portion of your income is not subject to third-party reporting, you may be in a group that is on a potential tax return audit list this year.

Every industry and profession has common terms that are used so often those of us in the business often forget that most people do not have the depth of understanding that a person working within the tax code might have. One of these areas is understanding the differences between the tax terms "deductions" and "credits". Is one better than the other?

Top line. Dollar for dollar, a credit is worth more to you than a deduction. Why? A credit is a direct reduction in tax, while a deduction reduces the amount of income that gets taxed. Here is a simple chart showing the difference.

Assuming you have a $2,000 tax credit, how large a deduction would you need to be indifferent?

Your marginal tax rate Deduction required to equal $2,000 tax credit

10% 20,000

15% 13,333

25% 8,000

28% 7,143

33% 6,061

35% 5,714

Note: This example does not account for the possibility that the deduction could move you into a lower tax rate nor does it consider other tax factors.

So on the surface it appears that a credit is worth more than a deduction to you. But the real answer is….it all depends. Here are some things to consider:

Your marginal tax rate. A similar deduction is worth more to someone in the 35% tax range than it is to someone being taxed at 10%.

How much is it? A large deduction could be worth more to you than a small credit. In combination with your marginal tax rate, a deduction could be worth a lot more to you than a credit.

Are there phase-outs? Most credits and deductions phase out when your income is over certain amounts. You must consider this when determining the true tax benefit. Consider that a deduction that reduces your income could make other credits and deductions that were previously phased out now available to you.

Is the credit refundable? Some credits get a “bonus”. While you cannot deduct your income below zero, you can sometimes receive credits that create a refund even if you owe no tax. Credits that have this “bonus” feature are called “refundable” credits.

When does any of this matter?

Educational Expenses. A common area in which understanding credits and deductions is important is in the use of educational tax benefits. If you paid tax-deductible tuition for undergraduate studies you must decide what tax alternative is best for you. Among the many alternatives that need to be evaluated are the American Opportunity Credit and the Lifetime Learning Credit (Assuming all of these options remain available to taxpayers.).

Understanding the Cost. When proposals come through Washington, understanding the difference between credits and deductions can help you understand how the proposed changes impact your tax situation. Remember the value of a deduction to you needs to be filtered with your marginal tax rate to see the true tax benefit. Here is a simple formula.

Deduction Amount x Your Tax Rate = Your Tax Benefit

Included for your reference are some of the more common deductions and credits. Thankfully, professional tax software allows for quick analysis of the choices.

Common Credits Common Deductions

Earned Income Tax Credit

Child Tax Credit

Adoption Credit

American Opportunity Credit

Lifetime Learning Credit

Dependent Care Credit

Retirement Saving Credit

Elderly Disabled Credit

Foreign Tax Credit

General Business Credits

Medical Expenses

Charitable Contributions

Property Taxes

State Income Taxes

Mortgage Interest

Standard Deductions

Alimony paid (through 2018)

IRA and HSA contributions

Qualified Education Expenses

Note: Many of these credits and deductions are not a permanent part of the tax code. Some have been repeatedly extended while others have or will expire without congressional action.

The tax code is filled with terms we rarely use in everyday conversation. Two of the more common are Marginal Tax Rates and Effective Tax Rates. Knowing what they mean can help you think differently about your potential tax obligation.

Definitions

Marginal Tax Rate: This is the tax rate applied to the “next” dollar you earn. Since our income tax rates are progressive, the next dollar you earn could be taxed at as little as zero or as high as 37%!

Effective Tax Rate: This is the tax rate you actually pay. This is simply taxes you pay divided by your total taxable income. Said another way, after taking your income and then applying taxes, deductions, credits, exemptions, and other adjustments you are left with your true tax obligation. This obligation is a percent of your income.

A Simple Example

Consider two people; Joe Cool who earns $50,000 and Chuck Browne who earns $500,000. If we had a flat tax of 10%, Mr. Cool would pay $5,000 in tax and Mr. Browne would pay $50,000 in tax. Both of their Effective Tax Rates would be 10% AND their Marginal Tax Rates would also be 10% because each additional dollar they earn would be taxed at the same 10%. However it is a different picture when you apply our progressive tax rates:

If we use the 2019 U.S. tax table for a single filer, Joe Cool pays $6,859 and Chuck Browne pays $150,194 in federal tax. This is because tax rates applied to Joe Cool’s income are (10 – 22%) while Chuck's income over $50,000 gets Marginal Tax Rates of (22 – 35%). Ignoring other tax factors, our two taxpayers’ tax rates are:

Joe Cool Chuck Browne Diff +/- Comment

Effective Tax Rate 13.7% 30.0% +16.3 Chuck pays 30.0% of his income in tax; Joe 13.7%

Marginal Tax Rate 22% 35% +13.0 The next dollar each earns will be taxed at this rate.

Why Care?

Calculating Returns. The true return you receive on any taxable investment will be determined by your Marginal Tax Rate. A $500 profit from a new investment could cost Joe Cool 22% in federal tax, but it could cost Chuck Browne 35% in federal tax.

Phase-outs can provide a dramatic impact on Effective Tax Rates. The simple examples above do not account for income limits applied to many tax benefits. Additional income could have a very dramatic impact on Joe Cool if it triggers losing things like an Earned Income Credit, or Child Tax Credit. This could increase your Effective Tax Rate while not touching your Marginal Tax Rate.

Extra work can help the taxman more than you. There have been cases where adding a second job can actually cost you money by not understanding the impact of the income on your Effective Tax Rate. This is especially true for retired workers receiving Social Security Retirement Benefits. That extra job may make your Social Security benefits taxable.

It’s not that simple. In addition to all the different income phase-outs for credits and deductions, your Effective Tax Rate could be impacted by the elimination of itemized deductions, reduction of exemptions, the Alternative Minimum Tax, and the marriage penalty.

It is a good idea to understand your Effective Tax Rate and your Marginal Tax Rate. Look at last year’s tax return and calculate your Effective Tax Rate. Then look at your income and determine what your Marginal Tax Rate is if you earn additional income. If you anticipate an increase in earnings, consider forecasting the impact on your Effective Tax Rate. You may be surprised by the result.

The term "kiddie tax" was introduced by the Tax Reform Act of 1986. The IRS introduced this rule to keep parents from shifting their investment income to their children and have this income taxed at their child's lower tax rate. The law requires a child's unearned income (generally dividends, interest, and capital gains) above a certain amount to be taxed using the estate and trust tax tables. Here is what you need to know.

Who it applies to

Children under the age of 19

Children under the age of 24 if a full-time student and providing less than ½ of their own financial support

Children with unearned income above $2,100 ($2,200 in 2019)

Who/What it does NOT apply to

Earned income (wages and self-employed income from things like babysitting or paper routes).

Children that are over age 18 and have earnings providing more than ½ of their support.

Older children married and filing jointly

Children over age 19 that are not full-time students

Gifts received by your child during the year

How it works

The first $1,050 of unearned income is generally tax-free

The next $1,050 of unearned income is taxed at the child's (usually lower) tax rate

The excess over $2,100 is taxed using the estate and trust tax table

What to know/do now

Maximize your low tax investment options. Look to generate gains on your child's investment accounts to maximize the use of your child's kiddie tax threshold each year. You could consider selling stocks to capture your child's investment gains and then buy the stock back later to establish a higher-cost basis.

Be careful to plan your child's level of unearned income. It might inadvertently raise taxes in surprising ways by exposing more income to tax rates that could be higher than yours. With new tax rules, the risk of this occurring is reduced, but not fully eliminated.

Leverage gifts. If your children are not maximizing their tax-free investment income each year consider gifting funds to allow for unearned income up to the kiddie tax thresholds. Just be careful, as these assets can have an impact on a child's financial aid when approaching college age years.

Properly managed, the "kiddie tax" rules can be used to your advantage. But if not properly managed, this part of the tax code can create an unwelcome surprise at tax time.

Surprise! Your stock loss is not deductible.

As you look for year-end tax moves to save on your bill from Uncle Sam, you may consider selling stocks that have lost value. This can be a great strategy when up to $3,000 in stock losses can offset your ordinary income. However, there is a little known rule called the Wash Sale rule that could surprise the unwary taxpayer.

Wash Sales

If the Wash Sale rule applies, you cannot report a loss you take when you sell a security. Per the IRS,

A wash sale occurs when you sell or trade stock or securities at a loss and within 30 days before or after the sale you:

Buy substantially identical stock or securities,

Acquire substantially identical stock or securities in a fully taxable trade,

Acquire a contract or option to buy substantially identical stock or securities, or

Acquire substantially identical stock for your individual retirement account (IRA) or Roth IRA.

Why the rule?

Many investors were selling stock they liked simply to book the loss for tax reasons. They then turned around and immediately re-purchased shares of the same company or mutual fund. If done repeatedly, shareholders could constantly be booking short-term losses on a desired company while still owning the shares in a chosen company’s stock indefinitely. Clever shareholders would even purchase the replacement shares prior to selling other shares in the same company to book the loss.

Some ideas

How does one take action to ensure the Wash Sales rule works to your advantage?

Check the dates. If you decide to sell a stock to book a loss this year, make sure you haven’t inadvertently acquired the same company’s shares 30 days prior to or after the sale date.

Dividend reinvestment. If you automatically re-invest dividends you will want to make sure this doesn’t inadvertently trigger the Wash Sale rule.

It is only losses. Remember the Wash Sale only applies to investments sold at a loss. If you are selling stock to capture gains, the rule does not apply.

Consider similar transactions. The Wash Sale rule applies to buying and selling ownership in the same company or mutual fund. With the exception of some common versus preferred stocks in the same company, buying and selling similar (but not identical) shares does not apply to the Wash Sale rule.

If your loss is ever disallowed because of the Wash Sale rule you can add the disallowed loss on to the cost of the new security. When the security is eventually sold in the future, the forfeited loss will be part of the calculation of future gain or loss. This also includes the original stock's holding period to help define the transaction as a short-term or long-term sale.

Small business owners have a number of options on how to organize their business for tax purposes. Many small, single owner, businesses are not incorporated, and are deemed "sole proprietors", in the eyes of the IRS. Other business entities, like C-Corporations, are taxed as a separate entity with distributions to owners taxed a second time as dividends. Still others are deemed "flow-through" entities like S-Corporations and Limited Liability Companies (LLC).

Flow-through entities

Flow-through entities do not pay taxes at the company level. Instead, the business tax return reports the net income to the IRS, but then distributes the taxable income to their respective owners via a K-1 tax form. Each individual owner then reports their share of the K-1 net income on their individual tax return and pays the tax on this and any other personal income.

Generally, business owners like flow-through entities because:

The business income is taxed once instead of twice as in the case of C-Corporations.

The business format provides owners a level of legal protection that is not available by doing business as a sole proprietor.

What you should know

Individual tax rates. Increases in individual tax rates have an impact on the amount of tax paid by all small businesses that are organized as flow-through entities.

Can you pay the tax? Small "flow-through" businesses must pay income tax on all their business profits. However the business entity is NOT required to distribute cash from the company to help pay the tax. So "flow-through" owners could see a tax bill without money to pay the tax.

Seasonality challenge. Seasonal "flow-through" businesses with high sales volumes in the summer often have a hardship to pay their taxes. This is because cash for these businesses is typically used to build inventory at the same time taxes are due.

Minority shareholder caution. Minority Shareholders in "flow-through" entities are doubly cursed. They not only may not receive distributions to pay taxes due, but they are often precluded from selling their shares, and they do not have enough ownership to require distribution of funds through shareholder voting.

The marriage penalty. Taxes on your business income can be higher for a married couple versus a single business owner. This is due to the pre-built tax rate penalty for married couples in the current tax code.

Very popular business entity type. According to the IRS the S-Corporation formation is a popular business entity type with over 4.2 million S-Corporations on record. LLC's are quickly becoming the new entity of choice with growth from 250,000 entities to over 1 million entities today.

One of the more unpleasant surprises that can hit a taxpayer occurs when you sell personal property, rental property or assets from your small business. This tax surprise is often associated with depreciation recapture rules.

Defined

Depreciation recapture refers to reducing the cost of an asset sold by prior period’s depreciation expense to determine whether taxes are owed on the sale of an asset and to determine the type of tax that must be paid on the sale of the asset.

When you have business property with a useful life of over one year, you often have the ability to deduct part of the cost of that property over the estimated useful life (recovery period) of that property. The most common users of these depreciation rules are small businesses and rental property owners.

When the asset is later sold the IRS wants you to determine if any tax is due as either ordinary income or as a capital gain.

A simplified example: Assume you run a small business out of your home. You purchase a new computer used 100% by your small business. The cost of the computer is $3,500. IRS rules determine you may recover the cost of this type of asset over five years. So each year you can deduct $700 as depreciation (1/5 of the cost of the computer assuming straight-line depreciation is used) on your business tax return.

Next assume the computer was sold at the end of year three for $2,000. This will result in a taxable event that includes depreciation recapture.

This example is simplified for clarity. Actual depreciation methods used will vary from this example. The ordinary income must be claimed on your tax return and is caused because of the depreciation taken in prior years. This illustrates the recapture of prior period depreciation.

When does it occur?

Look for the possibility of depreciation recapture when:

You sell rental property

You sell your home that you have used as a home office

You sell any property used within a small business

Warning: Understand the allowed or allowable trap

One of the land mines surrounding depreciation recapture rules is the concept of “allowed or allowable.” When calculating whether you owe deprecation recapture related taxes, the tax code requires that you adjust for depreciation whether or not you actually took the depreciation expense in prior years. So if you have assets that should be depreciated on your tax return, but are not, please call for a review of your situation.

What you should know

First and foremost, many unsuspecting landlords forget that years of depreciation on their property can impact their tax obligation when the property is sold. This can occur even if the sales price is less than what they paid for the property.

Secondly, the tax code applies different tax rates on ordinary income versus depreciation recapture versus long-term capital gains. The maximum tax rates on each are noted here:

Personal income tax: 37%

Depreciation recapture: 25.0%

Long-term capital gains: 20.0%

(excludes the impact of possible Affordable Care Act surtax)

Unfortunately, the tax laws in this area are fairly complex. The amount due can be impacted by;

Different depreciation methods

Use of Section 179 and bonus depreciation rules

Improvements made to property

Like-kind exchange rules

Asset class designations

Thankfully, you do not need to understand the complexities surrounding depreciation recapture rules. You simply need to know they exist and ask for assistance.

A timely knowledge of this definition is pretty important

If you have problems getting to sleep at night and you turn to the IRS tax code for help, you might find some vocabulary that is very foreign to words you use every day. One of the more common words used by the IRS is the term "contemporaneous". So what does it mean and why should you care?

Contemporaneous Defined

According to the IRS it means the records used to support a claim on your tax return were created and originated at the same time as your claimed deduction. In other words, if you realize that you forgot to get a receipt for something, you are out of luck if you try to get one at a later date.

Not Fair!

Perhaps you know you had the expense, but you simply forgot to get a receipt. You can cry foul, but time and again the IRS has had tax courts uphold their elimination of a taxpayer's deduction for lack of contemporaneous documentation. Here are some areas where contemporaneous documentation is especially important:

Charitable contributions

Business deductions for expenses and capital purchases

Mileage logs

Tip records

Gambling losses

Traveling and entertainment expenses

Hobby losses

The donation of vehicles, boats, and planes is often the most cited area where lack of contemporaneous documentation is a problem. This is because the value of this type of donation can be high and the estimated market value could change each month. But timely, written acknowledgement from the charitable organization is also required for any donation of $250 or more.

What you need to know

Always get a receipt. Before you leave a donated item, always ask for a receipt. In the case of a vehicle, make sure the charitable organization gives you a 1098-C fully filled out. In addition, make sure the organization uses your vehicle or is a qualified charitable group that allows you to take the full market value of your donation.

If you forget, call right away. As soon as you realize a confirmation or receipt is missing, call to get one sent to you. Request that the receipt be dated as of the date of the service or activity.

Think tax year. Understanding the definition of contemporaneous is important, because it is not always "precisely" defined. If the documentation is received in the same year as the donation or transaction, you are usually in good shape.

Keep a log. Many expenses require the correct documentation at the time the activity occurred. This is true with deductible mileage, gambling loses, and documenting your tip income. So keep a log of your activities when they occur.

Wait to file. Often, to meet the IRS definition of contemporaneous, the receipt or acknowledgment must be received the earlier of either; when you file your tax return OR the due date (including extensions) of your tax return. This is particularly true with charitable contributions. So if you want to play it safe, do not file until all documentation is in hand.

Adjusted Gross Income (AGI) is one of the core tax terms used by Federal and many State taxing authorities. So what is it and why is it important?

The Federal formula for AGI is:

AGI = Gross Income - Adjustments from Gross Income

Gross Income. For most of us, Gross Income is our wages as shown on a W-2 at the end of the year. It also includes taxable interest income, retirement income (including Social Security benefits), and dividends. But there are many other components to Gross Income. Here is a list of the most common;

Alimony received

Annuities and pensions

Commissions, tips, bonuses

Dividends

Farm income (net)

Gains on sales and exchanges

Business income (loss)

Illegal gains

Interest income

Net rental and royalty activity

Prizes and awards

Rents and royalty income (net)

Retirement plan distributions

S Corp and partnership income

Social Security income

State and local tax refunds

Trust and estate distributions

Unemployment compensation

Wages and salaries

Loss from sale or exchange

Common Deductions from Gross Income. To get to AGI a number of reductions are allowed. Some are very common, such as alimony paid to someone else, while others are less common. Here is a brief list of the most likely adjustments you may experience.

Alimony paid

Contributions to IRAs

Domestic Production Activities Deduction

Educator expense

Medical/Health Savings Account contributions

Moving expense

Qualified educational expense

Qualified student loan interest

Repayments: Unemployment compensation and jury duty pay

Savings early withdrawal penalties

Self-employed health insurance

Self-employed retirement plan contributions

Trade and business expense

What you should know

AGI is not Taxable Income. Before you can determine the tax you will pay, you need to subtract deductions (either the Standard Deduction or Itemized Deductions) and Personal Exemptions for you and your family members. So do not confuse the term AGI with Taxable Income, they are not the same thing.

AGI is the starting point. On the other hand, AGI is an important figure in the world of taxes.

State income taxes. Most states use AGI as the starting point to determine your tax obligation to them. They will use this figure and then make adjustments to get to their state basis taxable income.

Phase-outs. Federal tax legislation reintroduced tax code that reduces your Deductions and Exemptions. This reduction raises your Taxable Income and is based upon your AGI. Understanding and managing your AGI can have a real impact on how much of your Exemptions and Deductions you will be able to use.

Modified AGI. The IRS and writers of tax code like to use AGI as the starting point for other tax provisions. You might see the term “Modified AGI” when this occurs. The actual definition of Modified AGI will vary depending on the tax calculation being constructed. Typical add backs to AGI are tax exempt interest, excluded portions of Social Security benefits and other tax-free income.

While you do not need to fully understand the details behind the calculation, it is helpful to be aware of this important tax term. It is often the starting point for effective tax planning.

Your grandson needs a car, but cannot afford the payments. As a favor, you provide the $25,000 to purchase the car. You tell your grandson to pay you back when he can, but there is no loan document. The IRS sees this payment during an audit and asks you where your interest income is for this loan. Should this happen, you will quickly understand the meaning of AFRs.

Each month the IRS publishes a series of tables known as AFRs. So what are they and why should you care?

AFRs Defined

AFRs stand for Applicable Federal Rates. They are minimum interest rates that the IRS applies to a transaction when no rate is stated or implied. In other words, you may have a transaction that the IRS believes has an interest income/expense element to it, but none has been claimed by the taxpayer. These minimum interest rates are published each month by the IRS for three loan terms; short-term (0 – 3 years), mid-term (4 to 9 years) and long-term (over 9 years).

When does the AFR apply?

You may think that money you gave to a friend or that car sale to your cousin with repayment over time has no interest rate, but the IRS often sees it differently. So if no interest rate is stated, the IRS will apply the applicable AFR and you could be in for a tax surprise. Here are some common examples when the AFR rates can come into play:

Loans to family and friends.

Buying anything over time. If you take possession of an item, but can pay for it over a length of time, imputed interest is involved.

Employee advances. This can include giving an employee the rights of stock ownership, but not expecting payment for the stock right away.

How to use the AFR knowledge to your advantage

Create a loan document. Whenever you establish a transaction that has the expectation of repayment, write up a simple loan agreement. Not only will it clarify your repayment expectation, it also establishes the repayment terms. Please ensure both parties sign and date the document.

Establish a safe interest rate. Use the AFR tables to establish an audit-safe interest rate. Remember, AFRs are also used if the IRS believes your stated interest rate is too low.

Leverage gift rules. Remember you (and your spouse) can each gift up to $14,000 to an individual. If you stay under this threshold, you could defend your money transfer as a non-interest bearing gift and not a loan.

Caution with housing transactions. Banks are asking buyers to document where they receive their money for their down payment. If the money comes from you, it could establish a potential implied loan document that you might need to defend. If you plan to help with a down payment in the future, try to understand the bank’s look back rules for this disclosure reporting and use this knowledge in conjunction with the IRS gift rules to avoid creating implied interest.

Should you wish to see the published AFR rates, they are available on the IRS website at www.irs.gov.

Are you Eligible?

Since 1975, the Earned Income Tax Credit (EITC) has provided a tax break to millions of Americans each year. The credit was originally established to give low and medium income taxpayers a break on their Social Security taxes while providing an incentive to work. The EITC is often the subject of missed opportunity as the IRS estimates as many as 20% of taxpayers that qualify for the credit do not include it on their tax return. Here are some things to consider:

Q. Do I have to have children to qualify? Do I have to be married?

A. No. One of the most common errors is thinking the EITC is only for married couples with children. Both single and married taxpayers can qualify for the EITC. Even taxpayers without children may qualify for the credit if they meet certain age and residency requirements. You may NOT, however, file your tax return as "married filing separate" and still receive the credit.

Q. How much can I earn and still qualify for the EITC?

A. If you earned $54,884 or less in 2018 you could qualify ($49,194 if you are unmarried).

Q. If I did not earn income can I still get the credit?

A. No, you must have “earned” income to qualify for the credit. You have earned income if you worked for someone else (wages), are self-employed, or have income from farming. Nontaxable combat pay for military members qualifies as does some cases of disability income.

Q. How much is the credit?

A. The maximum credit could be worth $6,431 to you in 2018 ($6,557 in 2019). The amount of the credit depends on your filing status (married filing jointly, single, widow, or head of household), your income, and how many qualifying children you have.

Q. What else should I know?

A. A valid social security number is required for you, your spouse, and any qualifying children to receive the credit. It is also important to save information to support your claim for the credit. If the IRS thinks you recklessly disregarded the rules and claimed the credit in error, they could prohibit you from receiving the credit for two more years. If the filing was deemed fraudulent, you could be barred from using the credit for 10 years!

Remember to check for your EITC every year. Just because you did not qualify in the past does not mean you can't qualify for the credit in the future. Many other rules apply but thankfully professional tax preparation software does a good job evaluating your qualifications.

Originally named education IRAs, these accounts are now called Coverdell education savings accounts.

An education savings account is a custodial savings account created to pay for a child’s school expenses at any accredited college, university, or vocational school. The funds can also be used for elementary and secondary (K-12) school expenses at public, private, or religious schools.

Education savings accounts allow anyone, not just parents, to contribute to an account for any child under age 18. The total contributions made for a child cannot exceed $2,000 per year. To contribute the full amount, your income must be under a certain level.

Contributions are not deductible, but the earnings in the account are never taxed if the money is used to pay for qualifying education expenses, such as tuition, fees, supplies, required equipment, and certain room and board expenses.

Education savings account funds must be used by age 30. If the money is not spent on college by the time the beneficiary is 30 years old, the unspent money must be withdrawn (subject to income tax and a 10% penalty) or rolled over into another family member's education IRA.

There are two education-related tax credits that can be claimed to reduce your income tax liability dollar for dollar.

American Opportunity Tax Credit. The Hope scholarship credit, permanently modified and renamed the American Opportunity Tax Credit, can be claimed for tuition, fees, and course materials during four years of post-secondary education. It's worth a maximum of $2,500 in tax savings per student, per year. The student must be enrolled in an accredited school at least half-time during the year.

Lifetime Learning Credit. The lifetime learning credit can be claimed for tuition and fees relating to any year of post-secondary education and for job-related courses as well. The credit is worth a maximum of $2,000 in tax savings per family (rather than per student).

Both credits cannot be claimed for the same student in a given year. But it is possible to use both credits in the same year. Also, the credits cannot be claimed for the same expenses for which another tax benefit is received.

Section 529 plans (named after the IRS Code Section) allow individuals to set up an account on behalf of another individual (typically a child or grandchild) that can be used to pay college expenses. A recent law change has also allowed up to $10,000 to be used for tuition expenses for elementary and secondary public, private and religious schools.

The funds used as contributions are after tax, but any earnings within the account are tax-free as long as they are used for qualified educational expense. Even better, anyone can contribute to an account.

There are two types of plans:

Prepaid tuition programs are designed to hedge against inflation. You can purchase tuition credits, at today's rates, that your child can redeem when he or she attends college. Both state and private institutions can offer prepaid tuition programs. Using tuition credits from prepaid tuition programs is tax-free.

College savings accounts let you build a fund for your child's college expenses. Once in the plan, your money grows tax-free. Provided the funds are used to pay for qualified college expenses, withdrawals are tax-free. Qualified expenses include tuition, fees, books, supplies, and certain room and board costs. Private institutions are not allowed to set up college savings accounts, so each state sets up their own 529 plan in conjunction with a third part administrator.

Head of household tax filing status is available for unmarried taxpayers and certain separated taxpayers who provide a home for a qualifying person, such as a child or a parent.

If you qualify, you'll generally pay less tax as a head of the household filer than as married filing separately or a single taxpayer.

The head of household rules are fairly specific, so if you think you might qualify please ask for a review of your situation.

Health savings accounts (HSAs) are similar to IRAs, except they're intended for medical expenses rather than for retirement. You can make a tax-deductible contribution to an individual HSA or to a family HSA. If you’re 55 or older, your annual contribution can be larger. If your employer makes the contribution as part of a cafeteria benefits plan, it isn’t taxable to you. Earnings on investments made with your contributions won’t be taxed currently, and withdrawals are also tax-free if they are used for a broad range of medical expenses.

Of course, there are restrictions. To be eligible for an HSA, you must be covered by a health plan with a high deductible. These high deductible health plans can save you money, since they should have lower premiums. You must be under 65, and therefore not eligible for Medicare, when opening an HSA. If you withdraw HSA funds for non-health expenses, you’ll pay taxes, plus be subject to a penalty if you do it before age 65.

Do you qualify for a home office deduction?

If you run a business from home, you may be entitled to a home office deduction. This is only if you claim your home office as a business write-off on Schedule C as miscellaneous deductions have been eliminated for tax years 2018-2025.

Your business space doesn't have to take up an entire room, but you have to use that space exclusively for business purposes.

You must also meet at least one of the following conditions:

1) Your home must be your principal place of business. In other words, it's the only place you have to conduct administrative and management activities, such as billing customers, keeping the books, setting up appointments, or placing orders.

2) You use the space to meet with your customers, clients, or patients.

3) You use a space in a separate structure not attached to your home; for example, a detached garage.

4) You use the space to store inventory or product samples, and your home is the only fixed location of your business. For example, you are an outside salesman, and you store product samples in your basement.

5) You use the space as a licensed day-care facility.

Caution: Taking the home office deduction can limit the tax-free gain on the future sale of your home.

Optional square foot deduction. Taxpayers can use an optional per square foot deduction for a home office. This optional method does not change the criteria of who may take a home office deduction. The deduction is $5 per square foot of home office up to a maximum of 300 square feet (a maximum deduction of $1,500). Your home mortgage interest and real estate taxes can still be taken as itemized deductions. There is no recapture of depreciation in later years for years when this optional method is used.

According to the IRS, Interest is generally grouped into the following categories: business, mortgage, education, investment, or personal. Except for personal interest, all the other categories may be tax-deductible. Your record keeping and your individual situation will determine what category your interest falls into and whether it is deductible. Here are some general guidelines:

Business interest - Interest paid in your trade or business is fully deductible.

Student loan interest - You can deduct up to $2,500 a year for interest paid on certain student loans. You don't have to itemize to claim this deduction, but the deduction is phased out if your income exceeds certain levels.

Investment interest - If you itemize, you can deduct investment interest to the extent you have investment income, such as interest and dividend income. You must itemize your deductions to claim this expense. If you borrow money to make tax-exempt investments, the interest expense is not deductible.

Mortgage interest - Within certain limits, interest on your first and second residence and on home equity loans is tax-deductible if you itemize.

Personal interest - Interest paid on credit cards, personal vehicles, consumer loans, etc., is not deductible.

Question: What is the marriage penalty?

Answer: The marriage penalty occurs when a married couple pays more federal income tax than two single taxpayers with the same total amount of income.

This phenomena occurs whenever there is a tax benefit for a married couple that is not twice the amount of two single taxpayers with the same amount of income. This occurs because:

Tax rates are progressive with rates ranging from 0 to 37 percent. So unless the tax tables are always double for a married couple versus two singles, there will be a penalty.

Phase out ranges. If a tax benefit for a married couple phases out at less than double two single taxpayers, the couple loses the benefit sooner.

Itemized deductions. The itemized deduction for taxes is limited to $10,000 for a married couple. However two single taxpayers get a $20,000 tax deduction limit!

While married taxpayers have the choice of filing jointly or as married filing separate, the married filing separate status does not provide the same tax benefit as does filing as two single taxpayers. As a result, these two taxpayers are being penalized for being married.

While most of us know this area of the tax code as the nanny tax, the IRS refers to this as household employees.

Definition. Basically the IRS believes individuals may unknowingly have employees that help them around their home. The nanny tax refers to three federal employment taxes (Social Security, Medicare, and federal unemployment tax) that employers must pay if the wages of certain household workers exceed a threshold amount.

The nanny tax only applies to your employees. A worker is generally considered to be your employee if you directly supervise the work and you supply the tools or supplies necessary to do the job. If your worker came from an agency or runs his or her own business, the nanny tax may not apply.

Who is included. Employees can include baby sitters, nannies, housekeepers, gardeners, health aides, and other household workers.

If you have any of these workers, it is always best to review your situation.

A passive activity is a business activity in which a taxpayer does not materially participate.

Material participation defined. So just what is material participation? In general, material participation requires you to be involved in the operation of the activity on a regular, continuous, and substantial basis. If you do not meet this threshold, the activity is deemed passive in the eyes of the IRS.

Rental activity is generally passive. Any rental activity is generally a passive activity except for some very specific ones defined by a complicated calculation of hours spent in the activity. A limited partnership is generally considered to be a passive activity unless personal involvement meets a specified number of hours.

The passive activity rules. The complicated passive activity rules are in place to curb abuse by taxpayers who use tax-shelter losses to offset against their ordinary income (wages, interest, dividends, etc.). The rules create a separate tax basket for passive activities. The gains and losses from various passive activities are netted against each other within this basket. If the net result is a loss, the loss is generally suspended or carried forward to the next year where the process is repeated. In other words, the law generally eliminates the ability to offset ordinary income with passive losses until you dispose of an investment.

Proper tax planning dictates that you determine early on how your business activities will be viewed by the IRS. Thankfully, there are some exceptions when your income is low, but it require planning and review.

What is backup withholding?

This occurs when someone makes payments to you and they are required by the IRS to withhold some of it and send it to them as an estimated payment of your taxes. This often is done by banks and other businesses that pay you interest, dividends, rent, or for services you render as an independent contractor.

When does it happen?

You will be subject to backup withholding if:

You fail to provide the business paying you with your correct taxpayer identification number when they request it.

The IRS notifies the payer to start backup withholding because you failed to report all of your interest and dividend income on your tax return.

Federal and state authorities request withholding for back taxes or there is a request from an agency for underpayment of child support or similar shortfall.

The alternative minimum tax (or AMT) was created many years ago to insure that higher-income taxpayers with lots of deductions and credits pay at least a minimum amount of tax.

The AMT is a separate tax calculation that disallows many of the deductions and credits used to calculate regular income tax. It also adds back certain income that is not normally taxed. The most common AMT adjustments are for certain itemized deductions and adjustments, such as state and local taxes. Also, if you exercise incentive stock options, sell investments with large long-term capital gains, or take depreciation on business property, you may be hit with the AMT.

You're required to calculate your tax under both the regular and AMT method. You then pay whichever tax is higher.

If the IRS has determined that you are unable to pay the full amount due to them either with your current assets or with your future income stream less certain living allowances, they may enter into an Offer in Compromise. This will allow you to settle your debt to the IRS for less than the full amount you actually owe. Be leery of those who promise to settle your IRS debts for pennies on the dollar. They may be promising more than they can deliver.

A capital gain is what results when you sell certain property at a profit. In general, everything you own for personal or investment purposes is a capital asset, including your home, stocks, bonds, and collectibles. Capital assets do not include business property, such as inventories, notes, and accounts receivable.

Short-term capital gains occur when you sell property you have owned for less than one year. Any gains from these sales are treated as ordinary income, just like wages.

Long-term capital gains (generally gains on the sale of assets held more than one year) receive more favorable tax treatment than ordinary income. For example, the maximum long-term capital gain rate is currently 20%, whereas the maximum ordinary income tax rate is 37%.

Other capital gains tax rates exist for specific classes of assets like collectibles (e.g. stamps, artwork and coins.)

Basis is a common IRS term, but probably does not enter into your everyday conversation. This IRS term is important because it impacts the taxes you pay when you sell, exchange or give away property.

What basis is

The IRS describes basis as:

The amount of your capital investment in a property for tax purposes. Use your basis to figure depreciation, amortization, depletion, casualty losses, and any gain or loss on the sale, exchange or other disposition of the property.

In plain language, basis is the cost of your property as defined by the tax code.

There are a few different types of basis that apply to different situations, including "cost basis," "adjusted basis," and "basis other than cost."

Types of basis

Cost basis. Your basis usually starts with what the item cost. Cost basis also includes sales tax paid, freight, installation, testing, legal fees and other fees to purchase the property. If you acquire a business you must often allocate the purchase price to each of the assets to establish their basis.

Tip: Retain records of any major transaction. Ensure the documentation includes all allowable costs that could be applied to your basis. This will help reduce taxes when you sell or dispose of the property.

Adjusted basis. When you sell, exchange or dispose of property you may have to adjust its basis to account for changes to the property since you acquired it. This is known as its adjusted basis. A common example of adjusted basis is when you add the costs of capital improvements to property that have a useful life for more than one year.

Adjusted basis can decrease the value of property as well. This is the case when property is affected by things such as casualty or theft losses, depreciation and other deductions.

Home tax tip: Adjusted basis applies to many home improvements. These could include a full roof replacement, adding a room to your home, or even special assessments for local improvements. Create a folder and retain all documentation that could add to your home’s basis. It may lower your capital gain when you sell your home.

Basis other than cost. What is the basis when you inherit property, receive property for services or receive property as a gift? In most cases, the basis is the fair market value of the item. This is the price a willing buyer would pay for the item and a willing seller would be willing to receive for that item. But there are also special basis rules for:

Inherited property

Like-kind exchange of property

Involuntary conversions

Property transferred to a spouse

Should any of these situations apply to you, please ask for a review of your circumstances, as establishing a basis can become fairly complex.

The IRS is clear on their point of view. If you barter you must include the barter activity's fair market value as income on your tax return in the year the barter activity is performed. But is it really that simple? Here are some things to consider if you barter.

What is fair market value? The classic definition is the price someone is willing to pay and someone is willing to receive for the exchange of goods or services. But we all know this requires a level of judgement. What if an item is on sale when the barter activity is performed? Are prices always the same for a similar item or service? Prior to establishing the value of a barter item, shop around and take the lowest defendable value possible for your bartered item.

Example: You barter dog grooming for lawncare work. If you offer a range of prices from $20 to $60 for your grooming service what rate do you use? You must be prepared to defend your barter value. Perhaps shopping competitors can help establish a lower value.

What about your costs? The IRS barter documentation is so focused on capturing and taxing your barter income it under informs taxpayers on the reasonable reporting of costs associated with that income.

Example: If two retailers exchange wholesale goods of equal value for resale, the cost of goods could logically eliminate much of the fair market value of the barter income. What if the fair market value of the goods received is worth less because you discover it is distressed? Then you could actually have a barter based loss on your books.

Is the barter fair? If you are bartering with another firm, look at the “tax value” of the barter. This can change the true value of the barter depending on the “hard costs” associated with the barter activity.

Example: A painter exchanges $3,000 house painting with a law firm for legal services.

If both firms are sole proprietors, the salary of the owners is reflected in their net income. Self-employment taxes, sales taxes, and other taxes would also need to be applied to the net income number of each barter participant. In this case, the barter does not appear equal.

Caution with barter exchanges. With barter exchanges you receive credits (vouchers) for your provided services prior to using those credits on another service. Since you are required to report income when your service is provided, you could potentially have barter income without receiving the benefits for your barter activity until later years.

Clear reporting. If you use bartering in your business, you generally report the activity on 1099-B's each year, separate from other informational reporting.

You’ve loved dogs all your life so you decide to start a dog breeding and training business. Turning your hobby into a business can provide tax benefits if you do it right. But it can create a big tax headache if you do it wrong.

One of the main benefits of turning your hobby into a business is deducting all your qualified business expenses, even if it results in a loss. However, if you don’t properly transition your hobby into a business in the eyes of the IRS, you could be waving a red flag that reads, “Audit Me!” The agency uses several criteria to distinguish whether an activity is a hobby or a business.

The business-versus-hobby test

Honest assessment

If your dog breeding business (or any other activity) falls under any of the “hobby” categories on the right side of the chart, consider what you can do to meet the businesslike criteria on the left side. The more your activity resembles the left side, the less likely you are to be challenged by the IRS.

If you need help to ensure you meet the IRS’s criteria for businesslike activity, reach out to schedule an appointment

If you're going through a divorce, taxes may be the last thing on your mind. But divorce involves many potential tax traps and pitfalls. Here are some things to know.

Alimony and child support. Through 2018, alimony is taxable income to the person who receives it and deductible by the person who pays it, as long as it meets certain specific tax requirements. Child support is neither taxable nor deductible. A divorce agreement should clearly spell out the difference between alimony and child support. After 2018, alimony is no longer a taxable event for either party so plan accordingly.

Property settlement. When a divorcing couple agrees to a property settlement, there are no immediate tax consequences. But when it comes time to sell the property, one of the parties could be in for a nasty tax surprise. That's because each spouse receives property with its original tax basis, and a low tax basis may trigger a large capital gain down the road. A truly equitable property settlement should consider the tax basis of assets, not just current market value.

Children. After divorce, the parent who has custody of a child for the greater part of a year generally has the right to claim that child as a dependent. However, the custodial parent may transfer the dependency exemption to the other parent by signing the appropriate IRS form. Why would you ever give away a deduction? Because it may be worth more to your ex-spouse. In exchange for the dependency deduction, you may be able to bargain for more alimony or a larger property settlement.

Tax filing. As a married couple, you probably have been filing a joint tax return. But during divorce proceedings, you may be better off filing separately or, if you qualify, as head of household. Once the divorce is final, your filing status will be either single or head of household. To qualify as head of household, certain requirements for dependents must be met.

Marital status is an important factor in the amount of taxes you will pay. Be aware that in divorce situations some planning might cut your taxes significantly.

You can check your credit rating from all three of the major credit reporting agencies for free to insure the accuracy of your report. Simply log onto the Internet and go to www.annualcreditreport.com. Alternatively, you can receive your free report if you call 1-877-322-8228. You are allowed to obtain one free report from each agency annually.

Why bother to get a credit report? Identity theft is a multi-billion dollar industry, and checking your credit rating is one of the best ways to protect yourself. You might also be surprised at the number of mistakes that can be found on credit reports. Relatives or even non-relatives with the same (or similar) last name could have their credit information jumbled with yours. Individual companies could have incorrectly reported a negative credit occurrence (in the form of a delinquent payment or nonpayment) to the reporting agencies. Reviewing your credit report is a way to find and fix those negative credit issues.

What if there's an error? If you find an error, it might take some time to fix, but all of the agencies will provide you with instructions on how to correct errors. It's possible that you'll also have to contact the company that gave the incorrect information to the credit reporting agency. All of this communication should be done in writing.

One thing you can't get for free is your credit (or FICO) score. This is the number that companies use to determine how well you manage your credit. You will still be required to contact the three agencies individually in order to, for a fee, obtain your FICO score. However, watch for the "free" credit rating come-ons. If you use another service, either by e-mail or telephone solicitation, you will likely be charged for something that you can get for free.

The Tax Torpedo

When you reach age 70 ½, the trigger requiring distributions from qualified retirement accounts is pulled. This annual Required Minimum Distribution (RMD) applies to Traditional IRAs, SEP IRAs, SIMPLE IRAs, 401(k), 403(b) and other defined contribution plans. Amounts not distributed on a timely basis could be subject to a 50% penalty. Thankfully, the RMD rules do not apply to Roth IRAs.

The RMD rules are established to ensure the deferred tax benefit for certain retirement accounts does not go indefinitely into the future. In other words, the IRS now wants their cut of your tax-deferred savings accounts. The amount you must take out each year is based upon your age, your spouse’s age and your filing status.

The Tax Torpedo

The Tax Torpedo refers to the surprising event of having your Social Security Income taxed. Depending on your income and filing status, up to 85% of your Social Security Benefit could be subject to income tax.

RMD causes Tax Torpedo

If you continue to wait to start taking money out of your retirement accounts, the balance in your accounts may be very high when you reach age 70 ½. These higher balances mean a higher annual withdrawal amount. If your required retirement plan distribution is large enough it may put you into a higher marginal tax bracket as well as trigger taxes on your Social Security.

Some Tips

Plan withdrawals. Once you hit age 59 ½ you may withdraw money from qualified tax-deferred retirement accounts without experiencing an early withdrawal penalty. To reduce the tax risk on your Social Security, manage annual disbursements from your retirement account(s) to be more tax efficient when you reach age 70½.

Starting Social Security. You may begin full Social Security Benefits after you reach your minimum retirement age. However, your benefit amount can increase if you delay your start date up until age 70. Consider this as part of your plan to manage a potential Tax Torpedo.

See an advisor. There are many moving parts in planning for retirement. These include Social Security Benefits, pension plans, savings, and retirement accounts. Ask for help to create the proper plan for you and your family. One element of the plan should include being tax efficient

The IRS is reporting that it will be comparing filed 1099-Ks against income reported on business tax returns (including those reported on 1040 Schedule C tax returns). Knowing how this impacts you can save you an unwanted IRS correspondence audit.

Background

A couple of years ago the IRS introduced the 1099-K. This new informational tax return is meant to capture sales activity of previously unreported credit card transactions from places like e-bay and Amazon. Credit card processors are now required to report these transactions to you and the government if you have 200 or more transactions and over $20,000 in billing activity.

What is happening now

The IRS is now going to be comparing these filed 1099-Ks with the income reported by those receiving the form. If their computer audit shows you have not reported income sufficient enough to cover the activity on the 1099-K you will receive a letter asking for an explanation.

What you need to know

1099-Ks could include more than income. Since your 1099-K comes from a credit card merchant processor, whatever is on that credit card transaction is included on the tax form. This means it can often include sales tax receipts that have been passed on to your state. If you only record the income portion of the 1099-K, you may run the risk of under-reporting your 1099-K causing an underreporting audit.

Sole proprietors using a Schedule C do not have a place to report 1099-K activity. If you are a sole proprietor, your business activity is reported on a Schedule C. There is not a separate line to report 1099-K activity. Given this, the problem with sales tax previously mentioned can become even more complicated.

Make sure you do not double count. Remember 1099-K is credit card transaction activity that may also be reported within other types of 1099 reporting. You must make sure that Gross Revenue on your tax return matches the revenue on your business books.

Leverage the IRS matching knowledge.Knowing that the IRS is going to run an automated underreporting match using 1099-K information, here are some suggestions;

Make sure your Gross Income (gross receipts) surpasses the amounts shown on all related 1099 transactions. Focus on your 1099-MISC and 1099-K activity.

Reduce your gross 1099-K activity to account for non-revenue transactions on a separate line and note what the activity represents. Do not net out the non-revenue portion of 1099-K activity as this may cause a mismatch for the IRS comparison program.

Double check your book income against your tax return and make sure you can tie them to each other. Pay special attention to ensure your 1099-K activity is not over-stating your revenue.

Should you receive a correspondence audit from the IRS concerning a 1099-K call for help. Remember, this process will be new for them as well as for you.

Although the child tax credit is simple in concept, it's actually quite complicated in application. On their tax returns, taxpayers are entitled to a tax credit of $2,000 for each dependent child under age 17. That seems simple enough, but a look at the details reveals how complex the child tax credit really is.

Credit phases out. The credit begins phasing out at the rate of $50 for each $1,000 of modified adjusted gross income in excess of $400,000 for joint tax filers ($200,000 for single taxpayers). The length of the phase-out range varies depending on the number of children a taxpayer has who qualify for the credit.

Refundable - with exceptions. Some lower-income families who qualify for the child tax credit, but who don't earn enough to pay income tax, may be entitled to a check from the government through what is called a "refundable credit." A refundable credit means you get the benefit of the credit even when you don't pay enough in taxes to use the credit. The government sends you a check for the amount of credit that exceeds your tax liability.

What about divorce? In the case of divorced or separated couples, the spouse who is entitled to the dependency exemption is entitled to take the child tax credit.

Withholding adjustments. If you will be eligible to claim more (or fewer) dependent children under age 17 on your tax return this year than you claimed last year, consider adjusting your withholding. You can adjust your withholding at any point in the year by giving your employer a revised Form W-4.

Credit protected from the AMT. The current law protects the child credit from being reduced by the alternative minimum tax (AMT). This tax hits taxpayers with a large number of deductions and exemptions.

Having a good accountant can do more than just prepare your tax return. He or she can assist you with -

accounting and recordkeeping

income tax planning

business planning and problem solving

computer selection and use

estate tax planning

bank loan assistance

your other tax, business, and financial concerns

An accountant can provide you with year-round planning for your tax, financial, and business affairs. Such planning is essential if you want to realize your financial goals.

Understanding the Home Gain Exclusion

One of the largest tax breaks available to most individuals is the ability to exclude up to $250,000 ($500,000 married) in capital gains on the sale of your personal residence. Making the assumption that this gain exclusion will always keep you safe from tax can be a big mistake. Here is what you need to know.

The rule’s basics

As long as you own and live in your home for two of the five years before selling your home, you qualify for this capital gain tax exclusion. In tax-speak you need to pass three hurdles:

Main home. This tax term defines what a main home is. It can be a traditional home, a condo, a houseboat, or mobile home. Main home also means the place of primary residence when you own two or more homes.

Ownership test. You must own your home during two of the past five years.

Residence test. You must live in the home for two of the past five years.

Some quirks.

You can pass the ownership test and the residence test at different times.

You may only use the home gain exclusion once every two years.

You and your spouse can be treated jointly OR separately depending on the circumstances.

When to pay attention

You have been in your home for a long time. The longer you live in your home the more likely you will have a large capital gain. Long-time homeowners should check to see if they have a capital gains tax problem prior to selling their home.

You have old home gain deferrals. Prior to the current rules, home-gains could be rolled into the next home purchased. These old deferred gains reduce the cost of your current home and can result in capital gain exposure.

Two homes into one. Often newly married couples with two homes have potential tax liability as both individuals may pass the required tests on their own property but not on their new spouse’s property. Prior to selling these individual homes, you may wish to create a plan of action that reduces your tax exposure.

Selling a home after divorce. Property transferred as a result of a divorce is not deemed a sale of your home. However, if the ex-spouse that retains the home later sells the home, it may have an impact on the amount of gain exemption available.

You are helping an older family member. Special rules apply to the elderly who move out of a home and move into assisted living and nursing homes. Prior to selling property it is best to review options and their related tax implications.

You do not meet the five-year rule. In some cases you may be eligible for a partial gain exclusion if you are required to move for work, disability, or unforeseen circumstances.

Other situations. There are a number of other exceptions to the home gain exclusion rules. This includes foreclosure, debt forgiveness, inheritance, and partial ownership.

A final thought

The key to obtaining the full benefit of this tax exclusion is in retaining good records. You must be able to prove both the sales price of your home and the associated costs you are using to determine any gain on your property. Keep all sales records, purchase records, improvement costs, and other documents that support your home’s capital gain calculation.