You, Me and Uncle Sam

If you’re like most taxpayers, you find yourself with an ominous stack of “homework” around TAX TIME! Unfortunately, the job of pulling together the records for your tax appointment is never easy, but the effort usually pays off when it comes to the extra tax money you save! When you arrive at your appointment fully prepared, you’ll have more time to: 

• Consider every possible legal deduction;
• Better evaluate your options for reporting income and deductions to choose those best suited to your situation;
• Explore current law changes that affect your tax status;
• Talk about possible law changes and discuss tax planning alternatives that could reduce your future tax liability. 

Choosing Your Best Alternatives 

The tax law allows a variety of methods for handling income and deductions on your return. Choices made at the time you prepare your return often affect not only the current year, but later year returns as well. When you’re fully prepared for your appointment, you will have more time to explore all avenues available for lowering your taxes. 

For example, the law allows choices in transactions such as: 

Sales of property 

If you’re receiving payments on a sales contract over a period of years, you are sometimes able to choose between reporting the whole gain in the year you sell or over a period of time, as you receive payments from the buyer. 

Depreciation 

You’re able to deduct the cost of your investment in certain business property using different methods. You can either depreciate the cost over a number of years, or in certain cases, you can deduct them all in one year. 

Higher Education Expenses 

If you are paying college expenses for yourself, your spouse, or your dependent(s), you may qualify for a tax benefit of either an above-the-line tax deduction or a tax credit. 

Where to Begin? 

Ideally, preparation for your tax appointment should begin in January of the tax year with which you’re working. Right after the New Year, set up a safe storage location—a file drawer, a cupboard, a safe, etc. As you receive pertinent records, file them right away, before they’re forgotten or lost. By making the practice a habit, you’ll find your job a lot easier when your actual appointment date rolls around. 

Other general suggestions to consider for your appointment preparation include… 

• Segregate your records according to income and expense categories. For instance, file medical expense receipts in an envelope or folder, interest payments in another, charitable donations in a third, etc. If you receive an organizer or questionnaire to complete before your appointment, make certain you fill out every section that applies to you. (Important: Read all explanations and follow instructions carefully to be sure you don’t miss important data. Organizers are designed to remind you of transactions you may miss otherwise.) 
• Keep your annual income statements (e.g., W-2s from employers, 1099s from banks, stockbrokers, etc., and K-1s from partnerships, etc.) separate from your other documents. Be sure to take these documents to your appointment, including the instructions for K-1s! 
• Write down questions you may have so you don’t forget to ask them at the appointment. Review last year’s return. Compare your income on that return to the income for the current year. For instance, a dividend from ABC stock on your prior-year return may remind you that you sold ABC this year and need to report the sale.
• Make certain that you have social security numbers for all your dependents. The IRS checks these carefully and can deny deductions for returns filed without them.
• Compare deductions from last year with your records for this year. Did you forget anything?
• Collect any other documents and financial papers that you’re puzzled about. Prepare to bring these to your appointment so you can ask about them. 

Accuracy Even for Basic Details  

To ensure the greatest accuracy possible in all details on your return, make sure you review personal data. Check name(s), address, social security number(s), and occupation(s) on last year’s return. Note any changes for this year. Although your telephone number isn’t required on your return, current home and work numbers are always helpful should questions occur during return preparation. 

Marital Status Change 

If your marital status changed during the year, if you lived apart from your spouse, or if your spouse died during the year, list dates and details. Bring copies of prenuptial, legal separation, divorce, or property settlement agreements, if any, to your appointment. 

Dependents 

If you have qualifying dependents, you will need to provide the following for each: 

• First and last name
• Social security number
• Birth date
• Number of months living in your home
• Their income amount (both taxable and nontaxable) 

If you have dependent children over age 18, note how long they were full-time students during the year. To qualify as your dependent, an individual who is not a qualifying child must pass several strict dependency tests. If you think a person qualifies as your dependent (but you aren’t sure), tally the amounts you provided toward his/her support vs. the amounts he/she provided. This will simplify making a final decision about whether you really qualify for the dependency deduction. 

Some Transactions Deserve Special Treatment 

Certain transactions require special treatment on your tax return. It’s a good idea to invest a little extra preparation effort when you have had the following transactions: 

Sales of Stock or Other Property:  All sales of stocks, bonds, securities, real estate, and any other type of property need to be reported on your return, even if you had no profit or loss. List each sale and have the purchase and sale documents available for each transaction.  New for 2011, when a broker knows the purchase price of the stock that was sold during the year, the brokerage firm is required to show that amount on the broker transaction report, Form 1099-B. 

Purchase date, sale date, cost, and selling price must all be noted on your return. Make sure this information is contained on the documents you bring to your appointment. 

Gifted or Inherited Property: If you sell property that was given to you, you need to determine when and for how much the original owner purchased it and its value when you received it. If you sell property you inherited, you need to know the date of the decedent’s death and the property’s value at that time. You may be able to find this information on estate tax returns or in probate documents. If the property was inherited from someone who died in 2010, special complicated rules may apply in determining your inherited basis. Please call for further details. 

Reinvested Dividends: You may have sold stock or a mutual fund in which you participated in a dividend reinvestment program. If so, you will need to have records of each stock purchase made with the reinvested dividends. If you sold mutual fund shares, you may have received a statement from the fund that shows your average cost basis for the shares sold and any “wash sale” adjustments. Be sure to bring this statement to your appointment along with the purchase and reinvestment records you have. 

Sale of Home: The tax law provides special breaks for home sale gains, and you may be able to exclude all (or a part) of a gain on a home if you meet certain ownership, occupancy, and holding period requirements. If you file a joint return with your spouse and your gain from the sale of the home exceeds $500,000 ($250,000 for other individuals), record the amounts you spent on improvements to the property. Remember too, possible exclusion of gain applies only to a primary residence, and the amount of improvements made to other homes is required regardless of the gain amount. Be sure to bring a copy of the sale documents (usually the closing escrow statement) with you to the appointment. 

Home Energy-Related Expenditures: If you made home modifications to conserve energy (such as special windows, roofing, doors, etc.) or installed solar, geothermal, or wind power generating systems, please bring the details of those purchases and the manufacturer’s credit qualification certification to your appointment. You may qualify for a substantial energy-related tax credit. 

Car Expenses: Where you have used one or more automobiles for business, list the expenses of each separately. To claim auto-related business expenses, the government requires that you provide your total mileage, business miles, and commuting miles for each car on your return, so be prepared to have that information available. If you were reimbursed for mileage through an employer, know the reimbursement amount and whether the reimbursement is included in your W-2. 

Charitable Donations: Cash contributions (regardless of amount) must be substantiated with a bank record or written communication from the charity showing the name of the charitable organization, date, and amount of the contribution. Cash donations put into a “Christmas kettle,” church collection plate, etc., are not deductible unless verified by receipt from the charitable organization. 

For clothing and household contributions, the items donated must generally be in good or better condition, and items such as undergarments and socks are not deductible. A record of each item contributed must be kept, indicating the name and address of the charity, date and location of the contribution, and a reasonable description of the property. Contributions valued less than $250 and dropped off at an unattended location do not require a receipt. For contributions of $500 or more, the record must also include when and how the property was acquired and your cost basis in the property. For contributions valued at $5,000 or more and other types of contributions, please call this office for additional requirements. 

Foreclosure or Cancellation of Debt: If you lost your home to a foreclosure, short sale, or voluntary reconveyance, you will have to report both the sale of the home and cancellation of debt (COD) income. However, you may be able to exclude the gain and the COD income under provisions of the tax code. The lender may issue either a Form 1099-A or 1099-C or both. These forms should be retained as they include valuable information needed to report the transaction and exclude debt relief income. It may also be appropriate to contact this office in advance to determine exactly what additional information must be assembled in order to complete your return. 

If you had credit card debt discharged, the amount discharged is taxable income and you will receive a 1009-C. If, at the time the debt was forgiven, you were insolvent (where your liabilities were more than your assets), you will be able to exclude the debt relief income to the extent your liabilities exceeded your assets. Please call the office in advance of your appointment to determine what information will be needed.

January 3 – Time to Call For Your Tax Appointment

January is the beginning of tax season. If you have not made an appointment to have your taxes prepared, we encourage you do so before the calendar becomes too crowded.

January 10 – Report Tips to Employer

If you are an employee who works for tips and received more than $20 in tips during December, you are required to report them to your employer on IRS Form 4070 no later than January 10.

January 17 – Individual Estimated Tax Payment Due

It’s time to make your fourth quarter estimated tax installment payment for the 2011 tax year. Generally, this due date is January 15, but when the due date falls on a Saturday, Sunday or federal legal holiday, it is not due until the next business day.

January 17 – Farmers & Fishermen Estimated Tax Payment Due

If you are a farmer or fisherman whose gross income for 2010 or 2011 is two-thirds from farming or fishing, it is time to pay your estimated tax for 2011 using Form 1040-ES. You have until April 17, 2012 to file your 2011 income tax return (Form 1040). Generally, this due date is January 15, but when the due date falls on a Saturday, Sunday or federal legal holiday, it is not due until the next business day. If you do not pay your estimated tax by January 17, you must file your 2011 return and pay any tax due by March 1, 2012 to avoid an estimated tax penalty.

January 31 – File 2011 Return to Avoid Penalty for Not Making 4th Quarter Estimated Payments File 2011

Return to Avoid Penalty for Not Making 4th Quarter Estimated Payment If you file your prior year’s return and pay any tax due by this date, you need not make the 4th Quarter Estimated Tax Payment (January calendar).

If you like to watch game shows and enjoy all the excitement that goes with watching contestants win prizes, then you can add another element to your viewing pleasure by considering how the contestants will handle the IRS Form 1099 they receive for the value of the items they won. You may not have thought much about it, but the contestants must pay federal and applicable state income tax on the cash and the value of the goods they win on game shows.

The lucky ones are those who simply win cash. They will have money to pay the taxes— unless, of course, they overlook the tax issue and spend all the winnings and end up with a tax liability they cannot pay. All that winning excitement turns into a stressful financial problem, and they probably end up wishing they hadn’t won.

The winners of non-cash prizes have more complex issues. They are required to pay taxes on the fair market value of the prize. The problem here is that game shows generally report prizes at full retail value and not the price the items would fetch on the open market. Take for example a contestant who wins a trip. Typically, hotel packages are valued by the game shows at their top retail value, not the discounted rates that can be obtained online or through a travel agent. Thus, those who accept the trip may not be able to afford the taxes on the trip, and after a week in paradise, they find themselves in tax purgatory.

The issue becomes a real financial drag for the taxpayer who is unable to pay the tax liability because they end up with failure-to-pay (and perhaps underpayment of estimated tax) penalties and interest that the IRS keeps tacking on until the liability is finally paid in full.

The tax issues can be avoided by refusing the non-cash prize, especially if the prize is something of no use to the winner. Another option for easy-to-sell items is to accept the prize and then sell it (not to a relative or friend). The gap between retail and real value can be especially harmful for winners who accept a prize with the intent to resell it: They’re paying taxes on a value they have no hope of recouping, which eats into the profits.

Remember back in 2004 when Oprah Winfrey gave away to everyone in the audience aPontiac? The sticker price of those cars was $28,500, and that amount had to be claimed as income by the audience members. If the person who received a car was in the 25% tax bracket, they were looking at a tax bill of $7,125. So the free car wasn’t free and could have ended up as a tax headache for some.

One famous contestant on “Survivor” did not report his $1 million winnings, claiming that CBS had told him the network was responsible for the taxes. It turns out that the contract he signed with CBS specifically stated that he was responsible for the taxes, and as a result, Richard Hatch ended up in federal court, where he was convicted of tax evasion and sentenced to a 51-month prison term.

When watching “Extreme Makeover: Home Edition,” you probably never thought about the tax implications to the beneficiaries of the home makeover. The makeover is classified as winnings and subject to income tax, as is the trip the homeowners took while the makeover was in progress. Then there is the real property tax issue; in most jurisdictions, the property taxes are based on the value of the home. Once the improvements are made, the homeowner’s property taxes will substantially increase. 

As you can see, there is a down side to being a game show winner! If you have more questions related to prize winnings, please give this office a call.

After 2012, the limitation on deductible medical expenses increases for most taxpayers from the current 7.5% of AGI to 10% (it remains at 7.5% for taxpayers age 65 and over through 2016). So if you need some dental work, laser eye surgery, or other elective but deductible medical procedures, you might consider doing so sooner than later to take advantage of the current lower AGI limit. (But forget that face lift or other nip and tuck procedure you’ve been thinking about?cosmetic surgery costs aren’t deductible unless related to a physical injury or disfiguring disease.) Also, if you are paying for a procedure over time, it might be appropriate to pay it all at once to increase your currently deductible medical expenses. Determining whether the tax benefits after the AGI limit is applied warrant the current expenditure can be complicated, and you may wish to call this office for assistance. The following is a checklist of deductible medical expenses. The list is by no means all-inclusive, and some of the deductions listed may have additional restrictions not included here.

 Please call this office with questions regarding these or other potential medical deductions.

Taxpayers with disabilities and parents of children with disabilities may qualify for a number of IRS tax credits and benefits.  Listed below are several benefits which are available if you or someone else listed on your federal tax return is disabled.

Child or Dependent Care Credit – Taxpayers who pay someone to care for their disabled dependent or spouse, regardless of the spouse’s or dependent’s age, can claim the child or dependent care credit.  The credit is based upon the lower-earning spouse’s income.  So when a disabled spouse does not work, the disabled spouse is treated as having a monthly income of $250 ($500 if more than one qualifying person was cared for during the year).  The expenses used to compute the credit are limited to $3,000 where there is one qualifying person and $6,000 where there are two or more.  The credit ranges from 20 to 35% of the expenses based on the taxpayers’ income. The higher the income, the smaller the percentage!

Medical Deductions – In addition to the normal medical expense deductions, a taxpayer may also be able to deduct:

• Nursing Homes – The entire cost of nursing homes and assisted living facilities is deductible as a medical expense, if the primary reason for the individual being there is for medical care or the individual is incapable of self-care. This would include the entire cost of meals and lodging at the facility. 
• In-Home Care – As an alternative to nursing homes, many care providers are hiring day help or live-in employees to provide the needed care at home. When this is the case, the services provided by the employees must be allocated between household chores and deductible nursing services. To be deductible, the nursing services need not be provided by a nurse as long as the services are the same services that would normally be provided by a nurse, such as administering medication, bathing, feeding, dressing, etc. If the employee also provides general housekeeping services, then the portion of the employee’s pay attributable to household chores would not be a deductible medical expense.  Caution: household employees are subject to certain federal and state payroll taxes.
• Impairment-related Expenses- Amounts paid for special equipment installed in the home or for modifications needed to accommodate a taxpayer’s disabled condition, or that of the spouse or dependents who live with the taxpayer, are generally treated as deductible medical expenses.  Any portion of an expense that increases the value of the home would not be deductible.   The following are examples of deductible improvements:
  • Constructing entrance or exit ramps for the home,
  • Widening doorways at entrances or exits to the home,
  • Widening or otherwise modifying hallways and interior doorways,
  • Installing railings, support bars, or other modifications,
  • Lowering or modifying kitchen cabinets and equipment,
  • Moving or modifying electrical outlets and fixtures,
  • Installing porch lifts and other forms of lifts but generally not elevators,
  • Modifying fire alarms, smoke detectors, and other warning systems,
  • Modifying stairways,
  • Adding handrails or grab bars anywhere (whether or not in bathrooms).
• Education - Expenses that you incur in order to enable your child to compensate for or overcome disabilities or to prepare your child for future normal education or normal living are deductible medical expenses. Thus, any expenses for therapy that helps your child’s adaptation are deductible medical expenses. In addition, the expenses of your child’s schooling at a “special school” for mentally or physically disabled individuals are deductible (including the cost of an ordinary education) if the resources of the school are the reason for your child’s presence and the educational services provided are rendered only as an incident to the medical care provided.

Earned Income Tax Credit – EITC is available to disabled taxpayers as well as to the parents of a child with a disability. If you retired on disability, the taxable benefits you receive under your employer’s disability retirement plan are considered earned income until you reach minimum retirement age. The EITC is a tax credit that not only reduces a taxpayer’s tax liability but may also result in a refund. Many working individuals with a disability who have no qualifying children, but are older than 25 and younger than 65, qualify for EITC! Additionally, if the taxpayer’s child is disabled, the age limitation for the EITC is waived. The EITC has no effect on certain public benefits. Any refund you receive because of the EITC will not be considered income when determining whether you are eligible for benefit programs such as Supplemental Security Income and Medicaid.

Impairment-related Work Expenses – Employees who have a physical or mental disability limiting their employment may be able to claim business expenses in connection with their workplace. They are ordinary and necessary expenses, including attendant care services (e.g., a blind taxpayer’s use of a reader) at the place of employment, to enable an individual who has a handicap to work. Impairment-related work expenses are itemized deductions but aren’t subject to the 2%-of-AGI floor. 

Standard Deduction – Taxpayers who are legally blind are entitled to an extra amount of standard deduction.  For 2011, the additional amount is $1,150 for a married individual and $1,450 for others.

Gross Income – Certain disability-related payments, Dept. of Veterans Affairs disability benefits, and Supplemental Security Income are excluded from gross income.

Waiver of Early Pension Plan Withdrawals – Generally, if a taxpayer is under age 59-1/2 and withdraws assets (money or other property) from a qualified plan including traditional IRAs, the taxpayer must pay a 10% additional tax, commonly referred to as the early withdrawal penalty. This tax is 10% of the part of the distribution that the taxpayer was required to include in gross income.  If a taxpayer becomes disabled before reaching age 59-1/2, any amounts withdrawn because of the disability are not subject to the 10% additional tax.  A taxpayer is considered disabled if the taxpayer can furnish proof that he/she cannot perform any substantial gainful activity because of the physical or mental condition. A physician must determine that the taxpayer’s condition can be expected to result in death, or is expected to be of a long, continued and indefinite duration.

Moving Deduction Qualification Period Waived – One of the qualifications for the job- related moving deduction is that an individual must work in the general area of the new workplace full-time for 39 weeks during the 12-month period right after the move (78 weeks out of a 24-month period for a self-employed individual).  These time periods are waived in the case of death or disability.

Credit for the Elderly or Disabled – This credit is generally available to certain taxpayers who are 65 and older as well as to certain disabled taxpayers who are younger than 65 and are retired on permanent and total disability. However, due to limitations of the credit, only very low-income taxpayers generally qualify for it.

If you have any questions related to these tax benefits, please give this office a call.

As the end of the year approaches, there are still things you can do to increase and properly document your charitable contributions for 2011.  Here is a brief rundown:

Non-cash contributions– If you have used clothing or household goods that are in good or better condition that you don’t use any longer, contribute them to a charity thrift shop before the end of the year.  Don’t forget: a receipt from the charity is required to document the gift.  If the gift’s fair market value (FMV) is more than $500, you will also need an itemized list of the items contributed, how and when each was acquired, and the cost.  If the FMV of what you’ve donated is greater than $5,000, or you contributed a vehicle, call this office for additional documentation requirements.  A receipt from the charity is not required if the gift’s value is less than $250 and the donation was made at an unattended drop site.  However, you will need to document the donation yourself.

Cash Donations – All cash donations must be documented either by a receipt from the charity or by a bank record such as a check, bank statement, or credit card payment.  You can no longer claim contributions of cash dropped into the offering plate or Christmas kettle.  So, be wise and drop a check instead.  If you regularly tithe at a house of worship, you might consider pre-paying your 2012 tithing and moving the deduction into 2011.  In doing so, some taxpayers that marginally itemize may be able to itemize every other year and take the standard deduction in alternate years.

Charity Volunteer Expenses – If you volunteer your time for a charity, you may qualify for some tax breaks.  Although no tax deduction is allowed for the value of services performed for a charity, there are deductions permitted for out-of-pocket costs incurred while performing the services.  Possible expenses might include:

• Away-from-home travel expenses while performing services for a charity, plus lodging and meals at 100 percent, provided there is no significant element of personal pleasure associated with the trip.
• Use of your personal vehicle while performing services for the charity, generally at 14 cents per mile.  Be sure to keep a written record of the name of the charity, the date the vehicle was used for charitable purposes, and the number of miles driven.
• Upkeep and cost of uniforms that aren’t suitable for everyday use and if worn while performing the charitable service.

No charitable deduction is allowed unless the contribution is substantiated with a written acknowledgment from the charitable organization.  The documentation must specify the need for your services and include an acknowledgement by the charity that the expenses claimed were required; be sure to maintain the receipts for the expenses.

Vehicle Donations – Generally, the deduction for used cars, boats, planes, etc. is limited to $500.  More than $500 can be claimed based upon the charity’s use of the vehicle or the actual amount the charity received from the sale of the vehicle.  You will need Form 1098-C from the organization to claim the deduction and attach it to your return.  Call for further details related to claiming more than $500.

Timing of Acknowledgments – Whenever you are required to have an acknowledgment from a charity for donations you’ve made, you must have that letter or statement in your hands by the earlier of the date you file the return for the year of the donation or the extended due date of that return.

If you have additional questions or would like to determine how a specific donation will impact your tax return, please give this office a call.