Top 10 Investment Tax Blunders to Avoid

Oakland Tax Attorneys 

If you can avoid the top ten investment blunders, you will save money on your taxes and perhaps even increase the returns on your investments. We realize that a mid-year review of your tax situation may not be at the top of your “to-do” list, but think of it this way: devoting a few minutes now could save you big bucks at tax time.

By following these tips, you can reduce your taxes for the year and even increase the after-tax return on some of your investments:

1. Anticipate distributions from declining funds – Since mutual funds are required to distribute capital gains to shareholders, you might receive a taxable distribution even though there was a decline in the share price of your fund this year. By preparing yourself and setting aside cash, you can avoid scrambling to pay taxes in April.

2. Purchase shares after the next scheduled distribution – Don’t buy a mutual fund shortly before a capital gains distribution since a portion of your investment will almost immediately be handed back to you. This will have you owing tax on the distribution with less money to reinvest.

3. Be prudent with “tax-exempt” investments – Although the income from “tax-exempt” investments is generally nontaxable, funds will sometimes throw off capital gains distributions. This happens when the fund managers sell bonds, which can produce a taxable capital gain, and then buy other bonds. This can aggravate fund investors who don’t expect to pay taxes on these types of investments.

In addition, if you want the income to be tax-exempt for state income tax purposes, you need to make sure the fund is invested in your resident state muni-bonds since most states treat as taxable muni-bond interest derived from other states. Another common mistake is failing to change funds when you move from one state to another.

If you are subject to the alternative minimum tax (AMT), be aware that interest from “private activity” muni-bonds is tax-exempt for regular tax purposes but not for AMT purposes.

As part of the Affordable Health Care Act, starting in 2013 the net investment income of higher income taxpayers will be subject to the unearned income Medicare contribution tax, which is a 3.8% surtax on their investment income less investment expenses. For surtax purposes, gross income doesn’t include excluded items, such as interest on tax-exempt bonds, which weighs in favor of owning tax-exempt bonds.

4. Time your fund transfers wisely – Frequently, people sell one bond fund to buy another as a way of rebalancing their portfolio. However, for tax purposes, that represents a sale of a security and the purchase of another. Thus, you will need to account for the gain or loss from the fund sold on your tax return. This is generally an unpleasant surprise to those unaware of this rule, especially if there is significant gain to report on the sale. If there is a loss, selling it during the current year will allow you to utilize the loss now. However, if there is a gain, consider waiting until just after the first of the year so that you can defer the gain—but this strategy may not be appropriate for someone who can take advantage of the 0% long-term capital gain tax rate.

5. Contribute the maximum – If you maximize your retirement plan contributions, it will help maintain your current lifestyle years from now. In addition, it may also reduce this year’s taxable income.

6. Say “no” to tax-free investments in tax-sheltered plans – Instead of concentrating on annuities or municipal bonds, you’ll do better with high-yielding income and growth-oriented investments.

7. Sell a loser – There probably isn’t a stock market investor who isn’t holding a stock that is worth less now than when it was bought. Selling a loser in a taxable account can save you money and free up cash for investments with more potential. This is because the IRS allows investors to offset realized gains with realized losses. In addition, $3,000 in additional losses can be used to reduce your taxable income. Don’t sell for tax reasons alone, especially if you are confident that your dogs will turn into dream stocks. Just keep in mind that if a stock has dropped in price by 50%, it will need to gain 100% in order to break even.

8. Be aware of the limit on losses – If you are thinking of cashing in all your dogs, consider that losses are limited to offsetting realized gains and up to $3,000 in ordinary income. Although losses higher than this amount can be carried over for use in the future, they would be of no benefit to you this year.

9. Stay away from wash sales – If you would like to offset gains with losses, try and avoid “wash sales” since the IRS doesn’t allow you to recognize the loss on such sales. A wash sale occurs when a security is sold at a loss and then repurchased within 30 days before or after the date it was sold.

Don’t fret. One way you can realize losses and keep your portfolio balanced is to sell and buy back a security 31 days after the sale. Individuals who cannot wait for that period of time should purchase a similar security (not identical) to the one that was sold.

10. Check your cost basis when you sell – Although most people remember to include commissions on trades or mutual fund transaction fees when calculating cost basis, many fail to consider the dividend money that has automatically been reinvested, which results in taxpayers overpaying on taxes. Most commonly dividend reinvestment occurs with mutual funds but some companies also have dividend reinvestment plans for individual stockholders. Reinvested capital gains and dividends can add quite a bit to cost basis and make gains much smaller.

Review all your purchases when it comes time to sell. You will have a smaller taxable gain and a much better idea of your actual return on a fund.

As an investor, you want what’s best for your money. Be prepared and avoid the unnecessary headache at tax time.

Planning for Pension Distributions?

San Jose Tax Lawyers 

An individual may begin withdrawing, without penalty, from his or her qualified pension plans at the age of 59-1/2. There are several exceptions that will allow earlier withdrawal without penalty. Upon reaching age 70-1/2, you are required to take distributions from your plans or face a substantial penalty for failing to do so.

  • Impact of Your Marginal Rate – If you are able to plan your withdrawals, you can save considerable tax dollars. This is not always possible, but the basic premise is to take distributions and pay the resulting tax in years when your marginal rate is low. Also watch for years when, for a variety of reasons, your taxable income is negative and some amount of distributions could be taken tax-free if age 59-1/2 and over. The penalty only applies to those under 59-1/2.
  • Impact on Social Security – For retired individuals receiving Social Security benefits, planning IRA distributions can also be beneficial. Social Security itself is only taxable when the total of one-half of the taxpayer’s Social Security benefits plus the taxpayer’s other income exceeds $25,000 ($32,000 for a married couple filing jointly). Once this threshold is reached, every additional dollar of other income will cause 50% to 85% of the Social Security benefits to also become taxable. Therefore, if a taxpayer’s other income is under the threshold, it is generally good practice to withdraw just enough taxable IRA funds to bring the income up to the threshold amount, even if the funds are not needed in that year. They can be set aside for a future year when they might be used for some unplanned need or large purchase. However, this strategy may not work if IRA distributions are required to be made (see next section).
  • Minimum Distribution Requirements – The IRS does not allow taxpayers to keep funds in qualified plans indefinitely. Eventually, assets must be distributed and taxes paid. If there are no distributions, or if the distributions are not large enough, the owner may have to pay a 50% penalty of the amount not distributed as required. Generally, distributions must begin in the year the plan owner reaches the age of 70-1/2.In most cases, the required minimum distribution can be figured using the “life” factor from the following table, which is divided into the value of the account as of the end of the preceding tax year. So, for example, an individual who reaches age 73 in 2011 and whose IRA had a value on December 31, 2010 of $50,000, would be required to withdraw $2,024.29 in 2011 ($50,000/24.7).

    UNIFORM LIFETIME TABLE
    Age
    Life
    Age
    Life
    Age
    Life
    Age
    Life
    Age
    Life
    70
    27.4
    80
    18.7
    90
    11.4
    100
    6.3
    110
    3.1
    71
    26.5
    81
    17.9
    91
    10.8
    101
    5.9
    111
    2.9
    72
    25.6
    82
    17.1
    92
    10.2
    102
    5.5
    112
    2.6
    73
    24.7
    83
    16.3
    93
    9.6
    103
    5.2
    113
    2.4
    74
    23.8
    84
    15.5
    94
    9.1
    104
    4.9
    114
    2.1
    75
    22.9
    85
    14.8
    95
    8.6
    105
    4.5
    115
    1.9
    76
    22.0
    86
    14.1
    96
    8.1
    106
    4.2
    77
    21.2
    87
    13.4
    97
    7.6
    107
    3.9
    78
    20.3
    88
    12.7
    98
    7.1
    108
    3.7
    79
    19.5
    89
    12.0
    99
    6.7
    109
    3.4

Want to Keep More of What You Make?

Oakland Tax Attorneys

The Johnson’s are college graduates with two healthy children, good jobs, a home worth about $160,000 and two relatively new cars. To the casual observer, they’re doing well. Yet anyone taking a close-up view would find a few flaws in their situation, especially when it comes to their finances . . .

You see, the Johnson’s have:

  • Virtually no savings;
  • Retirement plans available through employers but with contributions at a bare minimum;
  • A portfolio of several hundred shares of stock bought as a result of a tip from a friend – the investment has gone sour; and
  • Large debts on their home, cars and credit cards.

Obviously, Mr. and Mrs. Johnson could benefit from a course in financial fitness. Their greatest need is to take a long, objective look at their financial picture AND make some rather radical adjustments!

Unfortunately, the hypothetical Johnson’s aren’t a lot different from many Americans today. Statistics indicate that a large number are saving less than 5 percent of their disposable household income, far less than citizens in other countries. For example, Canadians and Germans save about 10 and 12 percent respectively.* In addition, American workers (similar to the Smiths) aren’t taking full advantage of their employer’s retirement plans, most making pension contributions of only about $2,700 each year.

Perhaps most ominous, however, is the amount of personal debt Americans have been incurring. Statistics show that there has been a $256 billion increase in consumer spending in recent years. And 44% of it is being paid for using installment plans!

Improve Your Own Financial Future

The Johnson scenario and previously cited statistics paint a gloomy picture, but there are steps you and your family can take to prevent similar results. Achievement of financial security comes from adjusting your current financial picture in light of future goals. Far from being easy, the whole process requires a good amount of self sacrifice and more than a few trade-offs along the way.

Check Your Spending Habits

The only way to objectively view your finances is to set down on paper what you’re currently spending. No one enjoys this job, but it’s necessary if you’re serious about a plan to ensure financial well-being.

Keep a log of what you spend your money on for a while (account for every cent, including all cash, check and credit purchases). Write down everything from house payments to dinners out, grocery purchases, haircuts, parking fees, entertainment expenses, doctor visits, etc. Try to list each item by category – e.g., amounts spent on movies out, video rentals, and cable TV could all be listed under a category called Entertainment Costs.

At the end of the period, total each expense category and get ready for a huge surprise – you’ll probably find that those “ little” extra miscellaneous items have made a sizable dent in your pocketbook. After you examine the totals carefully, you’ll begin to see a trend. It’s then that you need to ask yourself, “Where can I cut down?”

Once you have a feel for the expense side of the ledger, concentrate on your income – salaries, pensions and annuities, interest, dividends,etc.

Total everything you received for a given period (e.g., a month, a quarter, or a year) and subtract from it the grand total of all your expenditures for that same period. If your answer is positive, you’ve done all right – there’s a profit. If your answer is negative, you could be faced with a problem.

Debt Could Be the Culprit

One reason many people can’t seem to get ahead financially is that they have a lot of debt – mortgages, credit cards, etc. And it’s difficult to reduce debt unless spending habits change. Probably the best place to start cutting back is with the credit cards. Most people have a huge pile of them (the average is nine for most Americans).

Credit card spending is expensive. Assume, for example, that the balance on your Megabank card is $1,000 on which you’re charged an annual interest rate of 20 percent. If you pay the minimum $20 per month on your account, your total yearly payments will be $240 ($20 x 12). Yet by the end of one year, you will have only reduced your debt balance by $44, as shown in the following chart:

Month
Interest
Principal
Balance
1
2
3
4
5
6
7
8
9
10
11
12
$16.67
16.61
16.55
16.50
16.44
16.38
16.32
16.26
16.20
16.13
16.07
16.00
$3.33
3.39
3.45
3.50
3.56
3.62
3.68
3.74
3.80
3.87
3.93
4.00
$996.67
993.28
989.83
986.33
982.77
979.15
975.47
971.72
967.92
964.05
960.12
956.12

And what if you have eight other credit cards with balances similar to the Megabank card? You see how easy it is for debt to escalate?

To get and keep the upperhand on all that plastic, you may need to:

1. Quit making purchases by credit card. If the cash isn’t available,don’t make the purchase.

2. Carry only one card for emergencies and get rid of those with the highest balances.

3. Begin the search for a credit card with a low interest rate – there are some available, but it may take a little detective work to find them.

4. See if you can consolidate your credit card debt into the card carrying the lowest interest rate.

5. Start making the largest payment you can each month to pay off the debt. Once you’ve established an amount, keep at it EVERY month. You will be able to get it paid off faster than you think if you work at it consistently!

Home Equity – Savior or Trap?

Your home equity is a tempting source for money. Just keep in mind that you will never own the home if you continuously tap into that equity. Your reasons for using the equity may be legitimate, but were they necessary and paid back in a timely manner?

Using home equity loans is an often touted means of avoiding higher interest rates on consumer loans for automobiles, major appliances, etc. It also provides a way to convert nondeductible consumer interest to deductible interest, since the interest on home equity debt (up to $100,000) is deductible as home mortgage interest.This is a good strategy if you plan to pay off the equity debt in the same period of time the consumer debt would have been paid off. Trap#1: People tend to roll their equity debt into their long-term home debt and end up paying on that consumer purchase for years, long after the car or appliance has been carried off to the recycle yard. Trap#2: Interest on equity debt is not deductible for Alternative Minimum Tax (AMT) purposes. Thus, if you are being taxed by the AMT, your benefit from the equity debt interest deduction will be reduced or eliminated.

Savior: If used wisely, a home equity loan can provide you with a fresh start. If you are heavily burdened with consumer debt and have sufficient equity in your home, you can consolidate your debts into a new home loan and substantially reduce your monthly outlay. With the extra monthly cash from the reduced debt, begin saving for future cash purchases, children’s education and retirement. Trap: After restructuring your debt, you continue to run up additional consumer debt and could potentially overextend yourself again.The cycle repeats itself and leaves you with no equity in your home and a heavy mortgage debt at retirement.

Saving For the Future

After you’ve taken stock of your inflow and outgo and instituted measures to reduce debts, the next step is to begin developing a savings plan. Here again, consistency is the key. For instance, look at what happens when you put away $25 a week at an annual compounded interest rate of only 5 percent:

Term

10 years
20 years
30 years

Ending Balance$16,768
44,081
88,571

In addition to regular savings, if you participate in a retirement plan, either through an employer or your own self-employed plan, begin using it to the fullest. Contribute as much as you can! After all, most pension plans allow you to build savings and defer paying taxes on income until you begin making withdrawals. It’s hard to find a better deal than this anywhere.

Review Your Strategy and Adjust For Changes

Remember, you need to continually review the savings strategy you establish in light of your overall goals – someday you will retire, in 20 years the children will be going to college, eventually you may want a bigger house, etc. Your strategy shouldn’t simply take into account those KNOWNs; your plan must create a cushion to handle the UNKNOWNs as well.

Change is a certainty, and because of this, no plan for meeting financial objectives can remain static. As you go along, you’ll no doubt have to do a little “adjusting” here and there. Events like marriage, divorce, birth, death, retirement, job relocation, etc., can all complicate and force reevaluation of your original plan. Because of all the technicalities involved, you’ll probably want some outside help. It’s advisable to consult professional tax, legal and financial advisors before embarking on or changing your course of action.

* According to statistics from the Organization for Economic Cooperation and Development

Deductions for Medical Professionals

Ainer & Fraker, LLP

Supplies & Expenses:
Generally, to be deductible, items must be ordinary and necessary to your medical profession and not reimbursable by your employer. Record separately from other supplies the cost of business assets that are expected to last longer than one year and cost more than $100. Normally, the cost of such assets are recovered differently on your tax return than are other recurring, everyday business expenses such as business cards or medical supplies.

Other Expenses:
Expenses of looking for new employment in your present line of work are deductible – you do not have to actually obtain a new job in order to deduct the expenses. Out-of-town, job-seeking expenses are deductible only if the primary purpose of the trip is job seeking, not pursuing personal activities.

Communication Expenses:
The basic local telephone service costs of the first telephone line provided in your residence are not deductible. However, toll calls from that line are deductible if the calls are business-related. The costs (basic fee and toll calls) of a second line in your home are also deductible if the line is used exclusively for business.

Uniforms and Upkeep Expenses:
If you are required to wear a uniform in your medical profession, the cost and upkeep may be deductible. IRS rules specify that work clothing cost and the cost of its maintenance are deductible if: (1) the uniforms are required by your employer (if you’re an employee); and (2) the clothes are not adaptable to ordinary street wear. Normally, the employer’s emblem attached to the clothing indicates it is not for street wear. The cost of protective clothing (e.g., safety shoes or goggles) is also deductible.

Continuing Education:
Educational expenses are deductible under either of two conditions: (1) your employer requires the education in order for you to keep your job or rate of pay; or (2) The education maintains or improves skills as a medical professional. Costs of courses that are taken to meet the minimum requirements of a job, or that qualify you for a new trade or business, are NOT deductible.

Auto Travel:
Your auto expenses are based on the number of qualified business miles you drive. Expenses for travel between work locations or daily transportation expenses between your residence and temporary work sites are deductible; include them as business miles. Expenses for your trips between home and work each day, or between home and one or more regular places of work, are COMMUTING expenses and are NOT deductible.

Document business miles in a record book as follows: (1) give the date and business purpose of each trip; (2) note the place to which you traveled; (3) record the number of business miles; and (4) record your car’s odometer reading at both the beginning and end of the tax year. Keep receipts for all car operating expenses – gas, oil, repairs, insurance, etc. – and of any reimbursement you received for your expenses.

Out-of-Town Travel:

Expenses accrued when traveling away from “home” overnight on job-related and continuing-education trips are deductible. Your “home” is generally considered to be the entire city or general area where your principal place of employment is located. Out-of-town expenses include transportation, meals, lodging, tips and miscellaneous items like laundry, valet, etc.

Document away-from-home expenses by noting the date, destination and business purpose of your trip. Record business miles if you drove to the out-of-town location. In addition, keep a detailed record of your expenses – lodging, public transportation, meals, etc. Always list meals and lodging separately in your records. Receipts must be retained for each lodging expense. However, if any other business expense is less than $75, a receipt is not necessary if you record all of the information in a timely diary. You must keep track of the full amount of meal and entertainment expenses even though only a portion of the amount may be deductible.

Professional Fees and Dues:
Dues paid to professional societies related to your medical profession are deductible. However, the cost of initial admission fees paid for membership in certain organizations or social clubs are considered capital expenses.

Deductions are allowed for payments made to a union as a condition of initial or continued membership. Such payments include regular dues but not those which go toward defraying expenses of a personal nature. However, the portion of union dues that goes into a strike fund is deductible.

Deductions for Entertainers

Ainer and Fraker, LLP

Continuing Education:
Educational expenses are deductible under either of two conditions: (1) your employer requires the education in order for you to keep your job or rate of pay; or (2) the education maintains or improves your skills in the entertainment profession. The costs of courses that are taken to meet the minimum requirements of a job, or that qualify you for a new trade or business, are NOT deductible.

Promotional Expenses & Supplies:
Generally, to be deductible, items must be ordinary and necessary to your profession as an entertainer. Record separately from other supplies items costing more than $100 and having a useful life of more than one year. These items must be reported differently on your tax return than other recurring, everyday business expenses.

If you incur expenses while looking for a job in your entertainment field, they may be deductible. You do not actually have to obtain a new job in order to deduct the expenses. Out-of-town job-seeking expenses are deductible only if the main purpose of the trip is to job search, not pursue personal activities.

Telephone Expenses:
The basic local telephone service costs of the first telephone line provided in your home are not deductible. However, toll calls from that line are deductible if the calls are business-related. The costs (basic fee and toll calls) of a second line in your home are also deductible if the line is used exclusively for business.

Auto Travel:
Your auto expenses are based on the number of qualified business miles you drive. Expenses for travel between business locations are deductible; include them as business miles. Expenses for your trips between home and a permanent work location, or between one or more regular places of work, are COMMUTING expenses and are NOT deductible.

Document business miles in a record book by the following: (1) give the date and business purpose of each trip; (2) note the place to which you traveled; (3) record the number of business miles; and (4) record your car’s odometer reading at both the beginning and end of the year. Keep receipts for all car operating expenses – gas, oil, repairs, insurance etc. – and of any reimbursement you received for your expenses.

Out-of-Town Travel:
Unreimbursed expenses accrued when traveling away from “home” overnight on job-related trips are deductible. Your “home” is generally considered to be the entire city or general area where your principal place of employment is located. Out-of-town expenses include transportation, meals, lodging, tips and miscellaneous items like laundry, valet, etc.

Document away-from-home expenses by noting the date, destination and business purpose of your trip. Record business miles if you drove to the out-of-town location. In addition, keep a detailed record of your expenses – lodging, public transportation, meals etc. Always list meals and lodging separately in your records. Receipts must be retained for each lodging expense. However, if any other business expense is less than $75, a receipt is not necessary if you record all of the information in a timely diary. You must keep track of the full amount of meal and entertainment expenses even though only a portion of the amount may be deductible.

Equipment Purchases:
Equipment purchases such as musical instruments or telephone answering machines are shown differently on your tax return than are general job-related supplies. Keep documentation for these items separate from everyday expenses so that they may be easily identified when your return is prepared.

Deductions for Airline Flight Crew Personnel

Oakland Tax Attorneys

Professional Fees & Dues:
Dues paid to professional societies related to your occupation are deductible. However, the costs of initial admission fees paid for membership in certain organizations or social clubs are considered capital expenses.

Deductions are allowed for payments made to a union as a condition of initial or continued membership. Such payments include dues, but not those that go toward defraying expenses of a personal nature. However, the portion of union dues that goes into a strike fund is deductible.

Educational expenses are deductible under either of two conditions: (1) your employer requires the education in order for you to keep your job or rate of pay; or (2) the education maintains or improves skills. Costs of courses that are taken to meet the minimum requirements of a job, or that qualify you for a new trade or business, are NOT deductible.

Uniforms & Upkeep Expenses:
Generally, the costs of your uniforms are fully deductible. IRS rules specify that work clothing cost and the cost of maintenance are deductible if: (1) the uniforms are required by your employer (if you’re an employee); and (2) the clothes are not adaptable to ordinary street wear. Normally, the employer’s emblem attached to the clothing indicates it is not for street wear.

Auto Travel:
Your auto expenses are based on the number of qualified business miles you drive. Expenses for travel between business locations or daily transportation expenses between your residence and temporary work locations are deductible; include them as business miles. Expenses for your trips between home and work each day, or between home and one or more regular places of work, are COMMUTING expenses and are NOT deductible.

Document business miles in a record book as follows: (1) give the date and business purpose of each trip; (2) note the place to which you traveled; (3) record the number of business miles; and (4) record your car’s odometer reading at both the beginning and end of the tax year. Keep receipts for all car operating expenses – gas, oil, repairs, insurance etc. – and of any reimbursement you received for your expenses.

Out-of-Town Travel:
Expenses accrued when traveling away from “home” overnight on job-related or continuing-education trips are deductible. Your “home” is generally considered to be the entire city or general area where your principal place of employment is located. Out-of-town expenses include transportation, meals, lodging, tips and miscellaneous items like laundry, valet etc.

Document away-from-home expenses by noting the date, destination and business purpose of your trip. Record business miles if you drove to the out-of-town location. In addition, keep a detailed record of your expenses – lodging, public transportation, meals etc. Always list meals and lodging separately in your records. Receipts must be retained for each lodging expense. However, if any other business expense is less than $75, a receipt is not necessary if you record all of the information in a timely diary. You must keep track of the full amount of meal and entertainment expenses even though only a portion of the amount may be deductible.

Telephone Expenses:
The basic local telephone service costs of the first telephone line provided in your residence are not deductible. However, toll calls from that line are deductible if the calls are business-related. The costs (basic fee and toll calls) of a second line in your home are also deductible if the line is used exclusively for business.

Equipment, Supplies & Repair:
Generally, to be deductible, items must be ordinary and necessary to your job as airline flight crew personnel and not reimbursable by your employer. Record separately from other supplies, the costs of business assets that are expected to last longer than one year and cost more than $100. Normally, the costs of such assets are recovered differently on your tax return than are other recurring, everyday business expenses such as flashlights, batteries and other supplies.

Miscellaneous Expenses:
Expenses of looking for new employment in your present line of work are deductible – you do not have to actually obtain a new job in order to deduct the expenses. Out-of-town job-seeking expenses are deductible only if the primary purpose of the trip is job seeking, not pursuing personal activities.

Thinking of Renting Out Your Vacation Home?

Oakland Tax Attorneys

If you own a home in a vacation locale – whether it is your primary residence or a vacation home – and are considering renting it out to others, there are complicated tax rules, referred to as the “vacation home rental rules,” that you need to be aware of.

Generally, the tax code breaks a “vacation rental” into three categories, each with a different treatment for income and expenses:

  • Rented Less Than 15 Days – If you rent your home for less than 15 days during the tax year, the tax code says that you do not need to report the income and you can still deduct 100% of the property taxes and qualified mortgage interest as an itemized deduction. Yes, you heard me correctly: the government is actually allowing you to ignore the income, regardless of the amount, if you rent the home for less than 15 days during the year. This rule offers some opportunities for substantial tax-free income, especially for more expensive homes. Here are some examples:
    • Rental as a film location – typically, film production companies will pay substantial amounts (thousands per day) for the short-term use of homes as movie sets. Individuals with unique properties can register with a local film location company.
    • Home in a vacation locale – individuals with homes in a popular tourist or vacation locales can rent their homes out to vacationers in their area while they are on vacation themselves.
    • Home in the area of a special event – when a one-time or special event such as a major sports event (think the Super Bowl) or convention comes to town, hotel rooms may be scarce or even fill up. Homeowners in these locations may want to rent their homes short-term during the activity while getting out of town to avoid the crowds.

However, be careful; if the rental goes over 14 days, the income is no longer tax-free. When calculating the number of days, the definition of a day is generally “the 24-hour period” for which a day’s rental would be paid. Thus, a person using a dwelling unit from Saturday afternoon through the following Saturday morning would generally be treated as having used the unit for seven days even though the person was on the premises on eight calendar days.

  • Rented 15 Days or More – When the home is rented 15 days or more, the income must be reported. However the tax treatment depends upon how many days you used the home personally:
    • Personal Use More Than 10% of the Rental Days – If your personal use of the home totals more than 10% of the rental days, the expenses are allocated according to personal versus rental days. In figuring your rental profit, the expenses must be deducted in the following order: allocated taxes and interest first, then maintenance and other cash expenses, and, finally, depreciation. However, the net result is limited to zero; i.e., a loss cannot be claimed.
    • Personal Use 10% or Less of the Rental Days – If your personal use of the home totals 10% or less of the rental days, the expenses are allocated according to personal versus rental days in the same manner as when the personal use exceeds 10% except that a loss is allowed, but the loss cannot include any amount attributed to depreciation.

When figuring the personal use days, include days used by an owner, co-owner, or family member of the owner/co-owner and days used under a reciprocal arrangement. However, you can exclude “fix-up” days, which are days spent repairing and maintaining the property.

Understanding IRS Inquiries

San Jose Tax Attorney

Correspondence from the IRS has a tendency to escalate a taxpayer’s pulse rate. However, most of the letters received are not of the feared “come on down” type that requests an appearance for a face-to-face audit; they would be more likely to just require a written explanation. Generally, all types of income (wages, interest, dividends, etc.) are reported by the payer to the IRS, which, in turn, matches the reported income to the recipient’s tax return based on Social Security number (SSN). Over the past few years, the IRS has become very proficient in using its matching software to pick up unreported income and other discrepancies on tax returns. Discrepancies will generate an IRS inquiry, so in addition to income, take note of the following items which are frequently monitored by the IRS computer:

  • Dependent SSN – The IRS allows only one taxpayer to claim the exemption for a dependent. Frequently, a dependent will claim the exemption himself or herself, or in other cases, separated or divorced individuals will both attempt to claim the dependent. Expect correspondence when the exemption for any SSN has been claimed twice.
  • Gross Proceeds of Sale – All brokerage firms are required to report security sales to the IRS as “gross proceeds of sale” on Form 1099-B. The 1099-B copy provided to the account owner is generally combined with interest and dividend reporting requirements and included in a consolidated 1099 statement. These statements can be confusing, and the “gross proceeds of sale” line is frequently buried in the multi-page statements. If a taxpayer fails to report these security sales, the IRS will treat the gross proceeds as all profit, recompute the tax owed and send a bill.
  • Stock Basis – For stocks purchased beginning in 2011, the IRS requires the brokerage houses to track the cost of the stock and report that information on Form 1099-B when the stock is ultimately sold, so the IRS can then verify profit or loss.
  • Pension and IRA Rollovers – Unless it is a direct (trustee-to-trustee) rollover, the plan administrator is required to issue a Form 1099-R whenever a taxpayer withdraws funds from an IRA or other type of qualified plan. If the 1099-R income is not properly accounted for on the tax return, the IRS may treat it as unreported, taxable pension income and issue a revised tax bill. Even if it is directly rolled over, ALWAYS bring rollovers to our attention.
  • Alimony – The person paying alimony must include the recipient’s name and Social Security Number with the deduction claimed for alimony payments. The IRS will match the payments to income reported by the recipient. If the two amounts are not the same, the IRS will initiate correspondence to both parties.
  • Home Sales – Technically, escrow companies are not required to issue 1099-S forms to taxpayers who sell their primary residence for less than the home sale gain exclusion amount and certify that they meet the exclusion qualifications ($250,000 for a single taxpayer and $500,000 for married taxpayers). Despite this, many escrow companies choose to issue them, making it necessary to report the home sale on the seller’s tax return to avoid IRS correspondence.
  • Home Mortgage Interest – Since all lenders who are in the business of lending money are required to report home mortgage interest, the IRS can verify the amount claimed as deductible mortgage interest on Schedule A of a tax return, and any significant discrepancy can lead to IRS correspondence. If a private party holds the loan (not in the course of business), Form 1098 is not required to be filed, but the taxpayer claiming the mortgage interest as a deduction is required to include that party’s name, contact information and SSN on Schedule A. The IRS can then match the claimed interest deduction to the amount reported by the private party as interest income. However, if a third party lent money to the taxpayer to purchase the home, the third party’s information is not required.
  • Education Benefits – Colleges and universities are required to report the tuition payments that may qualify for the American Opportunity or Lifetime Learning tax credits on Form 1098-T. Educational lenders report the amount of student loan interest paid on Form 1098-E. Both are used to match against claimed deductions and credits on the tax return

Are You a Self-Employed Tax Payer?

Bay Area Tax Attorneys – Self-employed taxpayers should consider their options carefully when it comes to applying tax benefits for their own education tuition and expenses.

Tax law provides multiple ways to benefit from the educational expenses and one may provide more benefit to you than another based on your particular set of circumstances. In addition, your tuition may qualify for one tax benefit while other education expenses qualify for another. 

• As a Business Expense – Generally, if the education qualifies, it is better to take the cost as a business expense since as a business expense it will offset both income taxes and self-employment tax. The expenses can include tuition, books, supplies, and allowable travel for the education. To qualify as a business expense, the education must either be to maintain or improve your skills or be required in your business. You may, however, not wish to use the education’s costs as a business expense when doing so limits your net profit and consequently limits your retirement plan contribution. Another situation when you may not want to claim the education costs as a business expense is when your Schedule C only has a very small profit or shows a loss for the year.

• As an Adjustment to Income – If the education expense is tuition at an institution of higher education and you are under the AGI phase-out limit for this deduction, you have the option to deduct up to $4,000 as an adjustment to overall income for the year. You can take this above-the-line education deductionwhether or not the education maintains or improves your skills required in your business. Other expenses related to this education such as books, supplies, and travel can still be deducted on your Schedule C as long as the education maintains or improves your skills required in your business. The deduction is a maximum of $4,000 if AGI does not exceed $65,000 ($130,000 for married couples filing jointly) or a maximum of $2,000 if AGI doesn’t exceed $80,000 ($160,000 for married joint filers). This provision is scheduled to expire at the end of 2013, unless extended by Congress.

• As a Tax Credit – As with the adjustment to income above, if the education expense is tuition at an institution of higher education, you might qualify for the lifetime learning credit. It may be more beneficial than the business expense or AGI adjustment for the tuition portion of the expenses, especially if you are in a lower tax bracket or the business profits are low. The lifetime learning credit allows you a credit of 20% of the cost of your tuition (up to $10,000 of costs annually) as a tax credit. It, too, has an AGI phase-out limitation. For 2013, the credit for single taxpayers phases out between $53,000 and $63,000 and $107,000 to $127,000 for joint filers. The phase-out ranges are inflation adjusted each year. Please call this office for the phase-out ranges for years other than 2013. If you meet the full-time student requirement, you may qualify for the more beneficial American Opportunity credits.