Personal Tax

Personal Tax

Standard Mileage Rates for 2019

Beginning on Jan. 1, 2019, the standard mileage rates for the use of a car (also vans, pickups or panel trucks) will be:

  • 58 cents per mile for business miles driven
  • 20 cents per mile driven for medical or moving purposes
  • 14 cents per mile driven in service of charitable organizations

Disaster Loss Election Carryback

If you suffer a casualty loss in a presidentially declared disaster area, you can either deduct the loss in the year it occurs, or carry the loss back to the prior year.  Deducting the loss in the prior year can make sense if you were in a higher bracket (often the case).  The deadline for making the election is the due date of your return, without extensions, for the year the loss occurs.  For example, you had a $26,000 loss in 2018 from a fire or natural disaster.  You can take the loss on your 2017 return or on your 2016 return by filing an amended return.  However, you must make the decision by the due date of your 2018 return, April 15, 2019.

Employee Stock Purchase Plan (ESPP)

An ESPP allows employees to purchase public or privately held stock at a discounted subscription price – typically 15% below the stock’s market value.  To participate the employer withholds after-tax funds from an employee’s pay usually across six month intervals.  At the end of each interval, shares of stock are purchased on behalf of the employee using the after-tax funds.  If the employee sells the stock at least eighteen months beyond the purchase date and two years beyond the initial offering date (aka a qualifying sale), the tax bite may be narrowed by as much as 20%.  Satisfying the holding periods will limit ordinary income (subject to higher tax rates) to the initial discount given on the offering date.  Selling sooner (disqualifying sale) will trigger ordinary income equal to the stock’s fair market value on the date of purchase less the purchase price; in other words, the total discount received on the date of purchase.  A qualifying sale allows all appreciation after the purchase date to be taxed as a long term capital gain.  The current federal capital gains tax rate is 20%.  An additional 3.8% ObamaCare tax applies beginning January 1, 2013 for single taxpayers with AGI above $200,000 and married taxpayers with AGI above $250,000.

Incentive Stock Options

ISOs work similarly to an ESPPs, except they are not issued at a discount.  The offering or grant price must equal the stock’s fair market value on the grant date.  If you don’t meet the holding period (defined above under ESPP), the ordinary income is reported in the same fashion as the ESPP disqualifying disposition.  Satisfying the holding period converts all your profit into capital gain income.  This latter scenario makes ISOs more favorable in comparison to the ESPP.  Keep in mind – if you exercise and hold your shares beyond December you may be required to prepay a portion of the tax if the stock price on the exercise date is greater than the grant price.  This tax is referred to as alternative minimum tax.

Deduction for Higher Education Expenses

This deduction allows you to deduct $2,000 or $4,000 of qualifying tuition expenses to help subsidize college and post-high-school education expenses for you, your spouse or your dependents.

The deduction is available for qualifying expenses paid in 2018 and is based on:

  • Enrollment that begins the first three months of the following year. In other words, if you paid tuition in December of 2018 for a class that begins in January, February or March of 2019, the cost is included when figuring your 2018 deduction.

If you qualify for the American Opportunity (AO) or Lifetime Learning Tax Credit you cannot deduct the tuition expense.  Generally, if your tax bracket is above 20%, you are better-off claiming the interest deduction.  If your income level prevents you from claiming a tuition deduction, consider the AO Tax Credit.  The maximum credit is $2,500 and applies to four years of higher education: (100% of first $2,000 of tuition and materials and 25% of next $2,000).  The The credit begins to phase-out for single filers with income between $80,000 and $90,000 and for joint filers between $160,000 and $180,000.  A benefit of the AO credit is that up to 40% of the credit is refundable when taxpayers have no tax liability.  In other words, if a taxpayer has no reason to file a tax return, they should file to collect up to $1,000 from the federal government.  If you are attending post graduate school you may qualify for the Lifetime Learning Credit.  There is no limitation on the number of years this credit can be claimed.  It provides a tax credit up to $2,000 on the first $10,000 of college tuition and fees.  Unlike the AO Tax Credit, you need not be enrolled at least half-time to qualify.

  • If your Adjusted Gross Income is $54,000 or less ($108,000 or less with a joint return), your maximum deduction is $2,000.
  • If your Adjusted Gross Income is between $54,001 and $64,000 (between $108,001 and $128,000 with a joint return), you receive a reduced amount of  the credit.
  • If your Adjusted Gross Income exceeds these limits, you cannot take a deduction.
  • You must be enrolled at least 5 months as a full-time student for the year.
  • You must be enrolled for an academic term that begins during the year.

Appreciated Property Donation

If you donate appreciated stock (held for more than a year) to a qualified charity you may take a deduction for the asset’s fair market value.  You receive a substantial deduction and avoid taxes on the appreciated value.  In contrast, selling the shares and contributing the cash creates a tax liability and limits the deduction to your after-tax proceeds.  Caution – if the stock is not publicly traded on an established exchange, special appraisal requirements will apply.  Donating appreciated patents fall under more restrictive rules.  The donor may only deduct patent expenses (cost basis) if less than market value and a percentage of subsequent royalties (to the extent they exceed the cost basis).

How You Can Deduct Commuting

Expenses you have for driving between your home and your job everyday generally are not deductible… EXCEPT the IRS and the courts have allowed them in certain cases…

    A taxpayer got a favorable decision because he had an office at home which was the principal (main) location of his particular business. The costs he incurred for transportation to other locations to handle dealings for the business were deductible.
    A self employed tree cutter got to deduct his costs for travel from home to timber sites though his home was used only “regularly” for his business (but was not his principal place of business). The court, in its favorable decision for the taxpayer, cited an IRS ruling made several years ago which said that taxpayers can deduct transportation costs for traveling from home to temporary work sites.

Now the IRS has “clarified” the commuting issue with a new ruling – they have also indicated they won’t follow the court’s determination in the tree cutter’s case.  The new ruling describes the circumstances that can produce deductible commuting mileage:

  1. Driving from home to a local temporary work site when your regular work location is a place other than your home.  You must have one or more regular work locations away from home.
  2. When your home office is your principal business place, driving between home and other business locations (regardless of whether or not you go to these other business locations regularly or just once or twice).
  3. Transportation from home to temporary work locations outside the area where you normally live and work (e.g. a temporary job 60 miles from home).

Terms like “temporary”, “regular” and “principal” will not help to change commuting from the confusing and touchy issue it has always been.  However, beginning January 1999 taxpayers have been allowed a much friendlier definition of “home office”; this change will expand the number of sole proprietors qualifying for mileage deductions beginning from home.  If you use your car for business, you may need to do a little extra planning when considering deductions for car expenses.  If you have questions about the latest rules, be sure to consult your tax advisor.  It’s best to act soon to make sure your transportation deductions are not jeopardized.

Rolling Company Stock Into an IRA

You will owe taxes – but only on the value of the shares at the time you purchased them, or whenever the company added them to your account.  If your company’s stock has performed well, the “cost basis” is usually much less than the stock’s current price.  You will continue to defer taxes on all the share-price gains since the stock was initially purchased – until you sell the stock.  When the shares are ultimately sold, you will pay taxes on the appreciated value at long-term capital gains rates, usually 15%, rather than at income tax rates of as much as 35% if the stock was sitting in your IRA.  Many do not realize that all taxable distributions from IRAs or other qualified plans do not qualify for capital gains tax rates – they must be taxed as if the income were wages.  Your heirs will also benefit from this tax planning strategy.  They will receive a step-up in cost basis, relieving them of a tax bill based on the difference between the stock’s purchase price and share value at the time of death.  If the stock was rolled into an IRA, the heirs will owe tax on all of the stock’s value at ordinary income tax rates.

Dealing With an Audit

The United States’ voluntary compliance system of taxation means individuals each report to the government their income and deductions and compute their amount of tax due.  To insure that the tax laws are followed and the deductions on a return are legitimate, the Internal Revenue Service has the authority to audit tax returns.

There are generally three types of audits.  Each begins with the taxpayer receiving a letter from the Internal Revenue Service.

    The IRS requests that certain information be provided by mail.  If it is necessary for you to provide any documentation, be sure that you mail only copies (never originals).  If the IRS finds that you owe tax and you don’t agree, you may request an office-audit.
    The letter you receive from the IRS will ask you to call for an appointment.  The items the IRS is questioning will be listed in the letter.  You or your representative will call for an appointment by the date indicated and take the documents supporting your income and deductions to that appointment.  At the IRS office, a tax auditor will review these documents and discuss points of law that are relevant to your tax return.  If an agreement is reached with the auditor, your case will be closed.  If you don’t reach an agreement you may appeal.
    This type of audit is normally used to audit business returns.  The auditor may come to your home or business to examine all the books and records for that business.  A field audit may also be conducted in your Enrolled Agent’s (EA’s) office, an especially good idea if your bookkeeping was done there as well.

Normally, a tax return is selected for an audit based on a combination of factors including the amount and type of income and deductions. For example, if you operate a business or have rental property, your chances of being audited are slightly higher.  In addition, taxpayers with large casualty losses, medical expenses, charitable contributions, or employee business expenses have a greater chance of being audited.

You should never omit legitimate deductions simply because you’re afraid of being audited. First, only about two percent of tax returns are audited and, second, you could still be audited even if you don’t take advantage of all the deductions to which you are entitled.

If you get a letter from the Internal Revenue Service about an audit, the first thing you should do is to inform your tax advisor. He or she can advise you on the things that need to be done and the procedures for any type of audit.

For an Office Audit, you will need to gather all the documentation to prove the amount of income you received and the amount and legitimacy of your deductions. You will need to put the receipts and related documents into categories so they can be presented in an organized manner to the auditor. It will not be to your benefit to simply take a large bag of receipts and dump them on the auditor’s desk.

If you don’t agree with the auditor, you have the right to appeal your case using the following procedures. First, you may appeal to the auditor’s supervisor.  If you do not reach agreement with the supervisor, you may take your case to the Appeals Division of the IRS.  An agreement can often be reached at this level.  Appeals officers are often more knowledgeable of tax law than auditors and, if appropriate, want to avoid unnecessary litigation.  If you don’t agree with the appeals officer, the IRS will issue a Statutory Notice of Deficiency.  You have 90 days from the date this notice is issued to file a Tax Court petition and have your case heard.  To do this you do not need to pay the tax in question.  Depending upon the amount owed, you may elect to file your case in Small Case Tax Court where an attorney is not needed.  Otherwise, you would file your case in regular Tax Court.  As an alternative to Tax Court, you may pay the amount of tax in question and file a suit for refund in either a U.S. District Court or U.S. Claims Court. Most cases are settled before they reach the Tax Court.  An EA or CPA can handle your case from the audit through the appeals process, up to the point where you elect to file in Tax Court, the U. S. District Court or U. S. Claims Court.

Remember: It isn’t necessary that you go to the IRS office yourself.  With a properly executed power of attorney, Enrolled Agents, Certified Public Accountants, or Attorneys can represent you at an audit.  Any of these three types of professionals may present your records and argue points of law with the Internal Revenue Service.  These individuals are familiar with tax law and IRS procedures and can often do a better job of defending your position than you would be able to do alone.  If you choose to go to an audit alone and become uncomfortable, you may stop the audit at any time by telling the revenue agent you want to get representation.

Avoiding Tax Traps In A Divorce

Tax law changes have made significant modifications to the tax treatment of dependents, alimony, child support, property settlements, and other divorce related issues which can produce unintended results for divorced individuals.  Failure to understand these rules can be very costly.

The custodial spouse is entitled to the outright exemption for the dependent child for any divorce or separation agreement granted since 1985.  There are certain exceptions that allow the non-custodial spouse to claim the child exemption:

  1. A multiple support agreement which designates the non-custodial parent to take the exemption.
  2. The custodial parent releases the exemption of the child(ren) to the non-custodial spouse.
  3. There is a pre-1985 divorce agreement, whereby a completely different set of rules and regulations are in effect.
  4. The Internal Revenue Service has taken the position that the custodial parent may release the exemption(s) in the divorce or separation agreement.  As a result, custodial parents should take care to include in the agreement some protections against default or other limitations if they plan to agree to such a condition.

Beginning in 2005 non-custodial parents are entitled to the (child) dependency deduction as long as the couple’s separation agreement stipulates the noncustodial parent entitlement.  Prior law required the custodial parent to waive the deduction irrespective of settlement agreement terms.

If, under the terms of the divorce or separation agreement, you may not claim your child as a dependent, you are nevertheless entitled to the childcare tax credit.  To be able to claim this credit these criteria must be met:

  1. You must file a separate return.
  2. Provide your home as the home of the qualifying child for more than half the year.
  3. Pay more than half the cost of keeping up your home for the year.
  4. Your spouse may not live in your house for the last six-months of the year.

Payments of alimony made under a decree of divorce or separation are deductible by the payor spouse and taxable to the payee spouse.  In order to qualify as alimony, the payment must be in cash and cannot be a transfer of property or assets.  There must also be a requirement that these payments will cease upon the death of the payee.  If the individuals are either divorced or separated, they must not be living together when the cash payments are made.  Single payments of cash may qualify as alimony if the amount is $15,000 or less.  Payments exceeding $15,000 per year are subject to a recapture rule if they do not continue for 3 years or more unless ended because of the death of either spouse or the remarriage of the payee.

Any cash payments made to a third party, if required by the agreement on behalf of the payee spouse, will still qualify as alimony payments.  Thus, payments made for rent, mortgage, tuition, or living expenses of the payee spouse under the terms of the divorce or separation instrument can qualify as alimony payments.

The agreement may also call for alimony (or property settlement) payments to be made from pension or retirement funds under a Qualified Domestic Relations Order (QUADRO).  Payments made under a QUADRO are exempt from the 10% penalty on premature distributions from qualified retirement plans.

What happens to a jointly owned principal residence is usually a key item in a divorce agreement.  The three most frequent provisions chosen are:

  1. Sell the house and divide the proceeds with each spouse reporting his or her share of the sale on separate returns.
  2. Transfer the house to one spouse or the other.
  3. Retain joint ownership allowing the custodial parent to live in the home until the child(ren) reach(es) a specific age, etc.

Recent tax changes make option two or three more favorable in view of the home sale capital gain exclusion rules.

Child support is neither taxable to the recipient nor deductible by the payor.  If part of an alimony payment is based on a child’s situation (such as coming of age, marriage, and college), that portion of the payment is presumed to be non-deductible child support.

Alimony payments received by a payee are considered to be “earned income” for the purpose of allowing alimony recipients to contribute to an Individual Retirement Account.  This is true even if the alimony recipient is not employed and, therefore, not earning wages.

Legal fees paid in connection with obtaining a divorce are not deductible.  Fees paid for obtaining and maintaining alimony, income producing property, and for tax advice are deductible.  In order to qualify as deductible legal fees, the attorney must stipulate on the invoice the amount or percentage of fees attributable to tax matters.  Legal fees are miscellaneous itemized deductions subject to the 2% of AGI limitation.  Fees allocated to capital assets increase the asset’s cost basis and are recovered upon the sale of the asset.

Quarterly Tax Payments

Estimated taxes are the pay-as-you-go levy on income that escapes withholding.  Many unsuspecting taxpayers trigger this liability by selling stock for a taxable capital gain or starting to earn freelance dollars subject to income and self-employment taxes.  Most of the public believe they can make up the difference with their tax return, without late payment penalties.

Other income subject to estimated taxes includes dividends, interest, alimony, gambling winnings and children’s income reported on the parents’ return.  Bonuses and stock options may be under withheld.  Unemployment compensation, pensions, retirement-account withdrawals and, for some, Social Security benefits may also require estimated tax payments.

Not one penalty, but four?  The hidden stinger is that a penalty doesn’t depend just on your total tax payments.  That is, you must pay the right prorated share of tax for each of four payment periods.  Otherwise, you could end up paying enough tax in total and still be penalized for an underpayment.

The payment periods are commonly referred to as “quarters,” even though only the first period corresponds to a calendar quarter: Jan. 1 through March 31.  The other three periods are April 1 through May 31, June 1 through Aug. 31 and Sept. 1 through Dec. 31.  Payments are due 15 days after the end of each period, unless a weekend or holiday delays the due date.

The IRS’ own taxpayer advocate told Congress that the penalty rules are “extraordinarily complex” and frustrating for taxpayers and “very difficult for the IRS to administer.”  Many people can avoid estimated taxes by increasing paycheck withholding or by having tax withheld from unemployment compensation or retirement income.

Generally, you must make estimated payments if you expect your tax bill each April to be at least $1,000 and you expect your withholding plus credits to fall below a minimum level.  The minimum is either 90% of the tax you will report this year or 100% of your prior tax liability – whichever is less (110% if your prior year adjusted gross income exceeded $150,000).

A Penalty-Free Way To Tap Your IRA

The IRA is intended as a long-term investment vehicle, which is why Federal law ordinarily slaps a 10% tax penalty on money withdrawn before reaching age 59 1/2.  However, there are exceptions including an “escape hatch”, or annual withdrawals taken as a series of substantially equal periodic payments over life expectancy.  In essence, this converts the investment into an annuity.  Of course, regular income taxes are due on the withdrawals.

The annual withdrawals must represent a series of substantially equal payments of at least one per year; withdrawals must continue for five years or until you reach age 59 1/2, whichever is later.  So, a 55-year-old must take withdrawals for five years, while a 51-year-old must take them for eight-and-a-half years.  Like many taxpayers, you may own several IRAs; in this instance you may select the IRA or IRAs earmarked for the periodic distributions.

In order to maximize your withdrawals, you should utilize the annuity factor method for determining periodic withdrawals.  This involves dividing the IRA balance by an annuity factor or the present value of $1 per year for your life expectancy, based on reasonable mortality tables and interest rates.  It is important to consult with your tax advisor for specific details. Mistakes are costly; any change in the payment schedule after you’ve begun making withdrawals creates a 10% tax penalty – applied retroactively to all previous withdrawals.

Performing Artists

Performing artists may be entitled to deduct their business expenses to arrive at adjusted gross income.  That’s much better than taking the expense as an itemized deduction.  However, in order to do so, they must work for at least two employers, have total business deductions that exceed 10% of the income, and have adjusted gross income of $16,000 or less. In Jack A. Fleischli, a.k.a. Jack Forbes (123 TC–, No. 3) the Court held that the income from all sources had to be included when determining the $16,000 AGI threshold. The Court dismissed the taxpayer’s arguments that the law was flawed for a number of reasons.