Archive for the ‘Tax Topics’ Category

Are You Caring for an Aging Parent or other Individual?

Thursday, December 9th, 2010

Are you now or do you foresee yourself caring for an aging loved one? More and more of us are finding ourselves facing the decision about what choices are our loved ones going to have to live out their final years. Following are some tax considerations relative to making the decision to bring your loved ones into your home and care for them.

1. Dependency exemption. You may be able to claim the cared-for individual as your dependent, thus qualifying for an exemption. To qualify, (a) you must provide more than 50% of the individual’s support costs, (b) must either live with you or be related, (c) must not have gross income in excess of the exemption amount, which is $3,650 for 2010, (d) must not file a joint return for the year, and (e) must be a U.S. citizen or a resident of the U.S., Canada, or Mexico. If the support test ((a), above) can only be met by a group (several children, for example, combining to support a parent), a “multiple support” form can be filed to grant one of the group the exemption, subject to certain conditions.

2. Medical expenses. If the individual qualifies as your dependent, you can include any medical expenses you incur for him/her along with your own when determining your medical deduction. If he/she doesn’t qualify as your dependent only because of the gross income or joint return test ((c) and (d), above), you can still include these medical costs with your own. The costs of qualified long-term care services required by a chronically ill individual and eligible long-term care insurance premiums are included in the definition of deductible medical expenses. There’s an annual cap on the amount of premiums that can be deducted. The cap is based on age, going as high as $4,110 for 2010 ($3,980 in 2009) for an individual over 70.

3. Filing status. If you aren’t married, you may qualify for “head of household” status by virtue of the individual you’re caring for. If the person you’re caring for (a) lives in your household, (b) you cover more than half the household costs, (c) he/she qualifies as your dependent, and (d) he/she is a relative, you can claim head of household filing status. If the person you’re caring for is your parent, he/she need not live with you, as long as you provide more than half of his household costs and he/she qualifies as your dependent.

4. Dependent care credit. If the cared-for individual qualifies as your dependent, lives with you, and physically or mentally cannot take care of himself, you may qualify for the dependent care credit for costs you incur for his/her care to enable you and your spouse to go to work.

5. Exclusion for payments under life insurance contracts. Any lifetime payments received under a life insurance contract on the life of a person who is either terminally or chronically ill are excluded from gross income. A similar exclusion applies to the sale or assignment of a life insurance contract to a person who regularly buys or takes assignments of such contracts and meets other qualifying standards.

If your situation qualifies you for any of the above tax benefits, or you wish to discuss your situation further, please call us at (781) 326-9966.

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Job-Search Expenses

Saturday, November 27th, 2010

If you or someone in your family is looking for a new job, you should be aware of the income tax deduction that may be available with respect to job-search costs. Qualifying expenses are deductible even if they don’t result in a new position being offered or accepted.

Job Hunting Expenses – Defined

Expenses of seeking new employment can encompass a broad range of items. Some of the more common expenses for which deductions have been allowed are:

  • the cost of resumes, including postage for sending them to prospective employers;
  • job counselling and referral fees;
  • employment agency fees;
  • telephone charges related to seeking new employment;
  • local as well as out-of-town travel for interviews, to the extent not reimbursed by the prospective employer.

For job-search expenses to be deductible, you must be looking for employment in the same trade or business in which you are engaged. For this purpose, a corporation’s secretary-treasurer seeking a position as assistant to the vice president of finance at another corporation was seeking employment in the same trade or business. But an artist seeking work in the business end of the art field was held to be looking for a job in a new trade or business. And IRS says any job in the private sector is a new trade or business for a retired military officer.

Accepting temporary employment in another line of work won’t affect your deduction for expenses in searching for permanent employment in your regular line of work. But job hunting costs aren’t deductible if you are looking for a job in a new trade or business, even if you find employment as a result of the search.

First time job seekers

IRS says that job hunting expenses incurred in seeking employment for the first time are not deductible. This rule can be tough on students and others entering the job market for the first time. But it may be possible to avoid the impact of this rule through an internship or other employment during the student’s senior year. In addition to looking good on a resume, this type of work experience can be a trade or business in which the student is engaged (thus avoiding the first time job seeking rule).

Reentry into job market

If an individual is temporarily unemployed, expenses of seeking employment in the field in which he or she was previously employed are deductible. But IRS takes the position that if there is a substantial time break between earlier employment and the current search, you cannot deduct the expenses of looking for a job. Thus, if there has been a gap of several years since the last employment, for example, to take care of small children or to return to school to pursue post-graduate studies, the cost of seeking employment is not deductible.

Other limitations on deductibility

Deductible expenses in seeking employment are claimed as miscellaneous itemized deductions. As a result, individuals who take the standard deduction cannot claim such expenses. In addition, miscellaneous itemized deductions are deductible only to the extent that, in the aggregate, they exceed 2% of your adjusted gross income. Thus, unless your job hunting costs are large or you have other significant miscellaneous deductions, you may not be able to derive any tax benefit from these expenses.

I hope that this overview of the tax treatment of job search expenses is helpful. If you have any specific questions, or need additional information regarding this or other tax related matters, please feel free to call us at (781) 326-9966.

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Paying College Expenses – The Later Years

Saturday, November 27th, 2010

As a parent with children enrolled or near-enrolled in college, your concern shifts to paying for current or imminent college bills. I’d like to address this by suggesting several approaches that seek to take maximum advantage of tax benefits to minimize your expenses. (Please note that the following suggestions are strictly related to tax benefits. You may have non-tax-related concerns that make the suggestions inappropriate.)

Tuition tax credits

You can take an American Opportunity tax credit of up to $2,500 for 2010, per student for the first four years of college. You can take a Lifetime Learning credit of up to $2,000 per family for every additional year of college or graduate school. The American Opportunity tax credit is a partially refundable tax credit, which means that you can get a refund if the amount of the credit is greater than your tax liability. Both credits are phased out for higher income taxpayers. Only one credit can be claimed for the same student in any given year. However, a taxpayer is allowed to claim an American Opportunity tax credit or a Lifetime Learning credit for a tax year and to exclude from gross income amounts distributed (both the principal and the earnings portions) from a Coverdell education savings account for the same student, as long as the distribution isn’t used for the same educational expenses for which a credit was claimed.

Scholarships

Scholarships (if your child qualifies for any) are exempt from income tax. For this exemption to apply, certain conditions must be satisfied. The most important are that the scholarship must not be compensation for services, and it must be used for tuition, fees, books, supplies and similar items (and not for room and board). (Although a scholarship is tax-free, it will reduce the amount of expenses that may be taken into account in computing the American Opportunity tax credit, and Lifetime Learning credits, above, and may therefore reduce or eliminate those credits.) Note also that in an exception to the rule that a scholarship must not be compensation for services, a scholarship received under a health professions scholarship program may be tax-free even if the recipient is required to provide medical services as a condition for the award.

Employer educational assistance programs

If your employer pays your child’s college expenses, the payment is a fringe benefit to you, and is taxable to you as compensation, unless the payment is part of a scholarship program that’s “outside of the pattern of employment.” Then the payment will be treated as a scholarship (if the other requirements for scholarships are satisfied).

Tuition reduction plans for employees of educational institutions

Tax-exempt educational institutions sometimes provide tuition reduction plans for the children of their employees—tuition reductions for those children who attend that educational institution, or cash tuition payments for children who attend other educational institutions. If certain requirements are satisfied, these tuition reductions are exempt from income tax.

College expense payments by grandparents and others

If someone other than you pays your child’s college expenses, the person making the payments is generally subject to the gift tax, to the extent the payments and other gifts to the child by that person exceed the regular annual (per donee) gift tax exclusion of $13,000 for 2010). Married donors who consent to split gifts may exclude gifts of up to $26,000 for 2010). If the other person pays your child’s school tuition directly to an educational institution, however, there’s an unlimited exclusion from the gift tax for the payment. The relationship between the person paying the tuition and the person on whose behalf the payments are made is irrelevant, but the payer would typically be a grandparent. The unlimited gift tax exclusion applies only to direct tuition costs. There’s no exclusion (beyond the normal annual exclusion) for dormitory fees, board, books, supplies, etc. Prepaid tuition payments may qualify for the unlimited gift tax exclusion under certain circumstances.

Student loans

You can deduct interest on loans used to pay for your child’s education at a post-secondary school, including some vocational and graduate schools. (This is an exception to the general rule that interest on student loans is personal interest and, therefore, not deductible.) The deduction is an above-the-line deduction (meaning that it’s available even to taxpayers who don’t itemize). The maximum deduction is $2,500. However, the deduction phases out for higher income taxpayers. Some student loans contain a provision that all or part of the loan will be cancelled if the student works for a certain period of time in certain professions for any of a broad class of employers—e.g., as a doctor for a public hospital in a rural area. The student won’t have to report any income if the loan is canceled and he performs the required services. This is an exception to the general rule that if a loan or other debt you owe is canceled, you must report the cancellation as income.

Bank loans

The interest on loans used to pay educational expenses is personal interest which is generally not deductible (unless you qualify for the deduction for education loan interest, described above). However, if the loan is “home equity indebtedness,” and interest on the loan is “qualified residence interest,” the interest is deductible for regular income tax purposes, although not for alternative minimum tax purposes. If interest is deductible as qualified residence interest, it can’t be deducted as education loan interest.

Borrowing against retirement plan accounts

Many company retirement plans permit participants to borrow cash. This option may be an attractive alternative to a bank loan, especially if your other debt burden is high. However, the loan must carry an interest rate equal to the prevailing commercial rate for similar loans, and, unless you qualify for the deduction for education loan interest (described above), there’s no deduction for the personal interest paid. Moreover, unless strict requirements are satisfied, a loan against a retirement account is treated as a premature distribution (withdrawal) that’s subject to regular income tax and an additional penalty tax.

Withdrawals from retirement plan accounts

IRAs and qualified retirement plans represent the largest cash resource of many taxpayers. You can pull money out of your IRA (including a Roth IRA) at any time to pay college costs without incurring the 10% early withdrawal penalty that usually applies to withdrawals from an IRA before age 591/2 . However, the distributions are subject to tax under the usual rules for IRA distributions.

Not all of the above breaks may be used in the same year, and use of some of them reduces the amounts that qualify for other breaks. So it takes planning to determine which should be used in any given situation. If you would like to discuss one or more of the above planning or payment possibilities, or any other alternatives, in more detail, please call us at (781) 326-9966.

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Planning for College Expenses – The Early Years

Tuesday, November 23rd, 2010

As parents, you are concerned with setting up a financial plan to fund future college costs.  I’d like to suggest several approaches that seek to take maximum advantage of tax benefits to minimize your expenses. (Please note that the following suggestions are strictly related to tax benefits. You may have non-tax-related concerns that make the suggestions inappropriate.)

Transferring assets into custodial arrangements or trusts

Note, it’s not enough just to transfer the income to them, e.g., dividend checks. The income would still be taxed to you. You must transfer the asset that generates the income into their names.  If Federal financial aid is a consideration, this may not be a wise strategy as these assets are counted significantly for purposes of determining the family expected contribution.

Tax-exempt bonds

Another way to achieve economic growth while avoiding tax is simply to invest in tax-exempt bonds or bond funds. Interest rates and degree of risk vary on these, so care must be taken in selecting your particular investment. Some tax-exempts are sold at a deep discount from face and don’t carry interest coupons. Many are marketed as college savings bonds. A small investment in these so-called zero coupon bonds can grow into a fairly sizable fund by the time your child reaches college age. “Stripped” municipal bonds (munis) carry similar advantages.

Series EE U.S. savings bonds

Series EE U.S. savings bonds offer two tax-savings opportunities when used to finance your child’s college expenses: first, you don’t have to report the interest on the bonds for federal tax purposes until the bonds are actually cashed in; and second, interest on “qualified” Series EE (and Series I) bonds may be exempt from federal tax if the bond proceeds are used for qualified college expenses. To qualify for the tax exemption for college use, you must purchase the bonds in your own name (not the child’s) or jointly with your spouse. The proceeds must be used for tuition, fees, etc. (not room and board). If only part of the proceeds are used for qualified expenses, then only that part of the interest is exempt. But if your adjusted gross income (AGI) exceeds certain amounts, the exemption is phased out.

Qualified tuition programs (529 Plans)

A qualified tuition program (known as a 529 plan) allows you to buy tuition credits for a child or make contributions to an account set up to meet a child’s future higher education expenses. Qualified tuition programs can be established by state governments or by private education institutions. Contributions to these programs aren’t deductible, and the contributions are treated as taxable gifts to the child but they are eligible for the annual gift tax exclusion ($13,000 for 2010), and a donor who contributes more than the annual exclusion limit for the year can elect to treat the gifts as if they were spread out over a 5-year period. The earnings on the contributions accumulate tax-free until the college costs are paid from the funds. And distributions from qualified tuition programs are tax-free to the extent the funds are used to pay qualified higher education expenses. Distributions of earnings that aren’t used for qualified higher education expenses will be subject to income tax plus a 10% penalty tax.

Coverdell education savings accounts

You can establish Coverdell ESAs (formerly called education IRAs) and make contributions of up to $2,000 for each child under age 18. (This age limitation doesn’t apply to a beneficiary with special needs, defined as an individual who because of a physical, mental or emotional condition, including learning disability, requires additional time to complete his or her education.) The right to make these contributions begins to phase out once your AGI is over $190,000 on a joint return ($95,000 for singles). If the income limitation is a problem, the child can make a contribution to his or her own account. Although the contributions aren’t deductible, funds in the account aren’t taxed, and distributions are tax-free if spent on qualified education expenses.

The above are just some of the tax-favored ways to build up a college fund for your children. If you wish to discuss any of them, or other alternatives, please call us at (781) 326-9966.

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Gifts, The Gift Tax & The Gift Tax Exclusion

Wednesday, November 17th, 2010

Taxpayers can transfer substantial amounts free of gift taxes to their children or other donees through the proper use of this exclusion. (You’re probably aware that the estate tax has been repealed for 2010, but is scheduled to return in 2011. However, the gift tax has not been repealed, but continues to remain in effect in 2010 as well as in later years.)

The amount that one person can give to another person in a tax-free manner for 2010 is $13,000.

The exclusion covers gifts an individual makes to each donee each year. Thus, a taxpayer with three children can transfer a total of $39,000 to them every year free of federal gift taxes. If the only gifts made during a year are excluded in this fashion, there is no need to file a federal gift tax return. If annual gifts exceed $13,000, the exclusion covers the first $13,000 and only the excess is taxable. Further, even taxable gifts may result in no gift tax liability thanks to the unified credit (discussed below). (Note, this discussion is not relevant to gifts made by a donor to his spouse because these gifts are gift tax-free under separate marital deduction rules.)

Gift-splitting by married taxpayers

If the donor of the gift is married, gifts to donees made during a year can be treated as split between the husband and wife, even if the cash or gift property is actually given to a donee by only one of them. By gift-splitting, therefore, up to $26,000 a year can be transferred to each donee by a married couple because their two annual exclusions are available. Thus, for example, a married couple with three married children can transfer a total of $156,000 each year to their children and the children’s spouses ($26,000 for each of six donees).

Where gift-splitting is involved, both spouses must consent to it. Consent should be indicated on the gift tax return (or returns) the spouses file. IRS prefers that both spouses indicate their consent on each return filed. (Because more than $13,000 is being transferred by a spouse, a gift tax return (or returns) will have to be filed, even if the $26,000 exclusion covers total gifts. Please contact me regarding the preparation of a gift tax return (or returns), if more than $13,000 is being given to a single donee in any year.)

The “present interest” requirement

For a gift to qualify for the annual exclusion, it must be a gift of a “present interest.” That is, the donee’s enjoyment of the gift can’t be postponed into the future. For example, if you put cash into a trust and provide that donee A is to receive the income from it while he’s alive and donee B is to receive the principal at A’s death, B’s interest is a “future interest.” Special valuation tables are consulted to determine the value of the separate interests you set up for each donee. The gift of the income interest qualifies for the annual exclusion because enjoyment of it is not deferred, so the first $13,000 of its total value will not be taxed. However, the gift of the other interest (called a “remainder” interest) is a taxable gift in its entirety.

Exception to present interest rule

If the donee of a gift is a minor and the terms of the trust provide that the income and property may be spent by or for the minor before he reaches age 21, and that any amount left is to go to the minor at age 21, then the annual exclusion is available (that is, the present interest rule will not apply). These arrangements (called Code Sec. 2503(c) trusts because of the section in the Internal Revenue Code that permits them) allow parents to set assets aside for future distribution to their children while taking advantage of the annual exclusion in the year the trust is set up.

“Unified” credit for taxable gifts

Even gifts that are not covered by the exclusion, and that are thus taxable, may not result in a tax liability. This is so because a tax credit wipes out the federal gift tax liability on the first taxable gifts that you make in your lifetime, up to $1 million. However, to the extent you use this credit against a gift tax liability, it reduces (or eliminates) the credit available for use against the federal estate tax at your death.

If you wish to discuss this area further or have questions about related topics, please call us at (781) 326-9966.

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Tax Audits

Wednesday, November 17th, 2010

IRS will audit hundreds of thousands of individual tax returns this year. Although that represents but a small percentage of all returns filed, this is little consolation if your return is among those selected for audit. But with proper preparation and planning, you should fare well.

The purpose of the audit is to verify items reported on a tax return. The easiest way to survive a tax audit is to prepare for one in advance. On an ongoing basis you should systematically maintain documentation—invoices, bills, cancelled checks, receipts or other proof—for all items to be reported on your tax return. Keep all your records in one place and hold on to your calculations.

The government normally has three years within which to conduct an audit, and often the audit won’t begin until a year or more after you file your return. So don’t trust your memory. Leave a good trail. If you have to go back to your records later, you should be able to backtrack all of the entries on your return.

The scope of an audit depends on the complexity of the return being examined. A return reflecting business or real estate income and expenses is likely to take longer to audit than a return reflecting only salary income. You can facilitate matters by having the necessary records arranged in an orderly and systematic fashion for presentation to the IRS agent. The typical IRS agent is experienced and knows his job. Trying to outsmart the agent or sidestepping questions is likely to create friction and raise suspicions in the agent’s mind.

Representation. Even if you prepared your own return, it is often advisable to have a tax professional represent you at an audit. Your representative knows what issues the IRS agent is likely to focus on and can prepare accordingly. More importantly, a tax professional knows that in many instances IRS agents will take a position (for example, to disallow deduction of a certain type of expense) even though courts and other authority have expressed a contrary opinion on the issue. Because the representative knows and can point to the proper authority, the IRS agent may be forced to throw in the towel.

If you are facing a tax audit or simply want to improve your recordkeeping, we stand ready to assist you. To set up an appointment to discuss this or any other aspect of your taxes, please call us at (781) 326-9966.

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