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If you have children, you will be happy to learn that the tax code favors you. Whether you are single or married, there are benefits for folks with offspring. The child tax credit gives you a nice break of $1,000 per child subtracted from your tax liability. The Dependent Care Credit and the Earned Income Tax Credit for low income filers, which was enhanced several years ago to cover three or more children rather than two, provides even more of a tax break.

Here are some other tips parents should know:

 

  1. Check your filing status. Years ago my masseuse asked me to look over her tax return. “It’s odd; I’ve never had to pay before. I’ve always gotten a refund. This year my CPA says I owe two grand; that’s how much I usually get as a refund. There’s not much difference between my income this year and last year.” After reviewing the return, I realized that the problem was filing status. She was listed as single rather than head of household. Not only is the tax bracket higher for single, but a single filing status blew her out of the water for enjoying the Earned Income Tax Credit. Correcting her filing status provided her with a refund of $2,600. That’s quite a swing. If you are a single parent and your child is away at college and you pay for more than 50% of her support, you may still take the head of household filing status because the child’s absence is considered temporary.

 

  1. File first. If you suspect your ex will try to take your kid(s) as dependent(s) when you are entitled to the deduction, file your taxes first. The IRS will not get in the middle of a domestic dispute. Whoever files first gets the deduction. If the later-filing party is entitled to the deduction, he or she will have to make a case for it.

 

  1. Proof of Dependency. In conjunction with #2 above, keep important information relating to the validity of deducting your dependent in your tax file. This includes paperwork such as school records which show the child lived at your address and records to prove that you provided more than 50% of the child’s support.

 

  1. Dependent Care Credit.  You may accumulate up to $3,000 in child care expenses for each child under the age of 13. The maximum credit has been increased from 30% to 35% of total expenses. At year end ask your child care provider for a statement showing how much you paid. You must have the provider’s federal ID number or social security number and address in order to take the Dependent Care Credit. This credit also applies to a spouse or other dependent over the age of 13 that is incapable of self-care.

 

  1. Track alimony payments. This is taxable income for the recipient and must be reported on your income tax return. By the same token, alimony you pay to a former spouse is a tax deduction as long as it is court ordered. Child support is not taxable income to the recipient nor is it deductible for the one who pays it. Keep that in mind if you are getting a divorce so that support issues are structured fairly in the marital dissolution agreement.

 

  1. Tuition. Tax credits are available if you pay tuition to a qualified higher learning institution. Payments for books, computers, and fees also qualify for the credit. Room and board do not. Naturally, there are income limitations. It often works out to this: if you can afford to pay for your kid’s college education, you don’t qualify for the credit. Tuition for private schools for K-12 does not qualify for the deduction.

 

  1. Tutoring. If your child is diagnosed with a learning disability and special schooling or tutoring is required, you may be able to deduct those fees as a medical expense. Check with your tax pro. You will need a letter from your doctor to substantiate the deduction.

 

  1. Adoption Credit. Taxpayers who incur qualified adoption expenses may be eligible for this credit or, in the case of employer-provided assistance, an exclusion from income. In other words, it can qualify as a nontaxable fringe benefit. The dollar limitation of the credit has been increased to $13,190 per child for 2014.

 

  1. Employer-Provided Child Care. Employers that provide child care facilities may be eligible for a tax credit equal to 25% of qualified expenses plus an amount equal to 10% of qualified expenses for child care resource and referral services. The credit caps at $150,000 of annual qualified costs.

 

Will it ever happen?

I’ve made taxation a career for more than thirty years. Over the years, my hopes have been raised by promises and proposals by Presidents and Congress of an end to the complicated maze of tax regulations that burden business and individuals. An end to complexity. The ushering in of simplification.

Milton Friedman introduced a flat tax in 1962. It didn’t take.

This concept was also proposed in 1994 when Congressman Dick Armey (R-TX) introduced a flat tax of 17% for individuals as well as businesses. Virtually all deductions, credits, exclusions, and exemptions would have been eliminated. Dividends, interest, and capital gains would have been excluded from taxable income in order to encourage savings, investments, and capital formation. The tax return would be the size of a post card. Businesses would be allowed to take deductions for certain expenses against income. Everyone was excited about it. But the legislation failed to pass.

Shortly after taking office President Obama organized an economic coalition to study tax reform and recommend a new tax system. Under discussion was the elimination of income tax deductions accompanied by a reduction across the board of income tax rates. What everyone had in mind was a flat tax. Did it happen? No, of course not.

In 2011, Paul Ryan (R-WI) was set to introduce remarkably similar legislation with a transition period in which taxpayers could choose the current system or his proposed system for the next ten years. Rather than an across-the-board 17% tax rate, Ryan proposed a rate of 10% for incomes up to $100,000 and 25% for incomes above that level. A generous standard deduction and personal exemption (totaling $39,000 for a family of four) would have replaced the deductions and tax credits formerly enjoyed. The alternative minimum tax and the death tax would be eliminated.

Ryan’s plan included reform for the corporate income tax, currently the second highest in the industrialized world. It would have been replaced with a border-adjustable business consumption tax of 8.5 percent. This new rate is roughly half that of the rest of the industrialized world.

Jim DeMint (R-SC) planned to introduce a flat tax in 2012 – pretty much the same principal – one rate and a postcard size tax return.

None of these proposals have received any serious consideration.

Let’s face it; the current system needs to be burned to the ground. We’ve got approximately 100,000 pages of confusing, unfair, and contradictory tax code mired in shades of gray with the word “generally” used way too many times. According to the IRS, 47% of Americans pay no income tax whatsoever. Many of these “non-taxpayers” claim the Earned Income Tax Credit (EITC) and receive refunds of upwards of $6,000 depending upon family size and income level. According to statistics gathered from 2009 income tax returns, more than 25 million people claimed more than $57 billion in EITC refunds. Are there really that many people entitled to what we call a “reverse-welfare system?”

We all recognize that behind tax legislation is a motivation for certain societal behaviors. For example, if the tax code allows a deduction for charitable contributions, then more Americans will donate to worthy causes. A deduction for property taxes and mortgage interest propel Americans into the American dream of home ownership. The IRA deduction encourages people to save for retirement.

Imagine what would happen if these deductions were suddenly removed. Many nonprofits would cease to exist for lack of funding. The housing market may experience another decline. Why not be a renter and let someone else repair the leaky roof and dripping faucets? And with society becoming more mobile – the necessity of moving for work, renting has become attractive. And if taxpayers did not make IRA contributions would they reach old age only to live in poverty, relying on Social Security and the generosity of family to survive?

And what has happened with the IRS over the years? Because of severe continuing budget cuts along with the added burden of administering Obamacare, customer service has become a joke. As a practitioner I had become accustomed to calling the practitioner hot line and getting an IRS agent on the second ring. Now there are layers of menus followed by hold times of usually more than one hour. And oftentimes after holding that long the IRS disconnects before I’m able to speak to anyone at all. And practitioners supposedly enjoy priority service. I feel bad for my fellow Americans who probably have to hold for even longer periods of time.

To effect change, please write your Congressman!

Life is complicated. And that’s probably one big reason tax law is complicated. So many “what if’s” make for more and more legislation. Below are situations that may arise once you become a landlord. It’s important to understand the tax consequences in order to maximize your tax savings and to be in compliance with tax law.

Must I file 1099s if I pay a workman? No you don’t have to do that. Congress actually passed that requirement for landlords in 2011 but rescinded the legislation later on. Anyone who is self-employed is required to file Form 1099-Misc for payment for services in the amount of $600 or more. But if you are reporting your rental income and expenses on Schedule E then you needn’t worry about this obligation.

What if I am renting out to a family member? Renting to relatives can be a sticky wicket. The IRS views all transactions between related parties as suspect especially if the activity results in a loss that reduces your tax liability. In order to take all of the deductions to which you are entitled, and not have the rental reclassified by the IRS as “personal use,” make sure the rent is charged at fair market value and that you are treating the rental in a professional manner. So we’re talking rental or lease agreements on file as well as a bona fide business relationship. It would be advisable to obtain a list of comps in your area to substantiate that the rent you charge to your relative is what you would charge to a stranger. Keep that list in your tenant file along with the rental agreement in case of audit.

Renting part of your home is an interesting topic expanded upon in IRS Publication 527. Many people rent out spare rooms. This should be reported on your tax return if you your activity falls within the guidelines outlined in this publication. Allocate your expenses between personal use and rental purposes and claim your rental income and expenses on Schedule E. The rules listed in this publication also apply to vacation homes that are used for personal purposes as well as for rental. Speak to your tax adviser to work out the amounts you can deduct.

Limits on deductions apply to rental properties. Rentals are considered passive activities. Unless you are a real estate professional, you can deduct losses from these activities only against other passive income. Any unused losses and credits may be carried forward to future tax years. There is an exception: if you actively participate in the activity, you may deduct $25,000 in losses in the current year. If your modified adjusted gross income exceeds $100,000 ($50,000 if married filing separately), the amount of deductible loss will phase out. There is no deduction allowed currently if your income is greater than $150,000.

Depreciation is a deduction for the cost of the property, the cost of improvements, furniture, furnishings, machinery and equipment, expensed over the useful life. You cannot deduct depreciation for land or for any equipment you purchase to make improvements to the property. For example, if you buy a table saw so you can cut baseboard and other lumber for a remodel to the property, you cannot take a deduction, depreciation or otherwise, for the cost of the saw. You also cannot take a Section 179 deduction, in which you expense the full cost of furniture, fixtures, machinery, and equipment in the year of purchase. This special allowance is allowed only for businesses and not for a rental activity listed on Schedule E.

These are only a few examples of special situations. Because the tax laws governing rental properties are so complex, I would urge you to sit down with a tax professional to learn more so that your activity will pass all tests if you are under audit.

As a rental property owner, you are entitled to write off “ordinary and necessary expenses for managing, conserving, or maintaining rental property from the time you make it available for rent.”

The IRS has no definitive list of deductions. As a landlord, you should visit the IRS website and take a good look at Schedule E. This is where you will report the income and expenses for your rental property. Almost every deduction, certainly the obvious ones are listed: advertising, auto and travel, cleaning and maintenance, commissions, insurance, legal and professional fees, management fees, mortgage interest, other interest, repairs, supplies, taxes, utilities, and depreciation. Beyond that are five lines for “Other Expenses,” which might include bank charges, telephone, security, equipment rental, homeowner association dues, gardening, eviction expenses, among others. Think in terms of whether or not you would have spent the money if you didn’t have the rental property. If it’s an ordinary and necessary expense, it is deductible.

Timing is everything. You can deduct your expenses as soon as the property becomes available for rent. If you own a rental property that is sitting idle and you are not looking for tenants then your expenses with the exception of depreciation, are not deductible. Perhaps you are performing a major remodel or you don’t need the money and just don’t want to deal with tenants right now or you are using the property personally then you cannot take deductions for your expenses. But if the property is available and you are attempting to secure a tenant, you may. Keep a file of your advertising and other efforts incurred to secure a tenant in the event of audit as you may be required to prove intent.

If the property is vacant and listed for sale, you may deduct the expenses until it is sold.

Here are some special rules, tips, and background on certain deductions you may consider:

1. Travel expenses: if the primary purpose of a trip is to collect rental income or to manage, conserve, or maintain your rental property, the expense is deductible. For example, if you own a condo in Hawaii and drive by to make sure it’s still there while you’re on vacation, you don’t have a bona fide deduction. Obviously, vacation was your primary purpose. But if your primary reason for traveling there is to collect back rent or paint the exterior or figure out why the roof keeps leaking, you are entitled to the deduction. Keep in mind though, that if you are visiting the property to make major capital improvements, like remodeling the bathroom and kitchen, the expense is not currently deductible. You must add the cost of the trip to the cost of the improvements and depreciate it. Make sure to keep all documentation to prove intent.

Local travel is also deductible. If you own a property 45 minutes from your home and you visit it once a month to pick up the rent and make sure the tenant hasn’t burned the place down, you should track your mileage and take a deduction.

2. Taxes: Property tax is the obvious expense listed here. However, if local ordinance requires that a landlord pay for a business license, you may deduct this expense. However, you cannot deduct charges for taxes or assessments that increase the value of your property, such as charges for putting in streets, sidewalks or water and sewer systems. You also cannot depreciate these expenditures. But they don’t disappear. You add the cost to the basis of the property. They are essentially deducted when you sell the property.

3. Points: Points, aka loan origination fees, are basically considered prepaid interest and as such are amortized over the life of the loan. You cannot write off the deduction all at one time. Take a copy of the settlement paper to your tax pro when preparing the tax return. Other deductions may be listed on that statement that may be currently deducted.

4. Repairs versus improvements: While repairs are currently deductible, improvements must be depreciated over their useful life. A repair keeps your property in good working condition. Things like unstopping a toilet, fixing rain gutters, replastering the hole in the wall left by the last tenant’s fist when you raised his rent, replacing a broken window are all examples of repairs. Improvements add value to the property and include things like remodeling the kitchen or adding a swimming pool. In 2014, new incredibly complex regulations were passed changing the parameters covering the topic of repairs versus improvements. They were so complex that the IRS disbanded with enforcement for 2014. Be sure to contact your tax pro to determine the deductible status of any repairs and improvements you perform on your property this year.

5. Tax Return Preparation Fees: A portion of the total fee you pay for tax return preparation can be allocated and deducted on Schedule E for preparation of Schedule E. Deduct tax planning/projection fees relating specifically to the rental property and any fee paid to resolve a tax underpayment issue related to your rental property on Schedule E. The full tax preparation fee is deductible on Schedule A, so why bother allocating to schedule E? Bear in mind that on Schedule A you do not benefit from the entire deduction. It is listed as a Miscellaneous itemized deduction and is reduced by 2% of your adjusted gross income.

Publication 527 is available at www.irs.gov and will provide you with complete information on the deductibility and treatment of your rental expenses.

If this is the year you become a landlord, you will want to pay attention to the tax rules governing this investment. If you already own income property, you may want to review these IRS regulations to ensure that you are in compliance.

Unless you are in a partnership, your rental income and expenses are listed on your individual tax return on Schedule E.

The profit or loss from the activity is included in income and taxed at your ordinary income tax rate. It sounds pretty straightforward, doesn’t it? Not so fast. Watch and see just how tricky it can get.

First of all, what is rental income? If a prospective tenant pays first, last, and  a security deposit when moving into the property, not all of that is included in current year taxable income. Or is it? Here’s how it breaks down:

  1. First and last month’s rent are included in the current year income even if the last month’s rent will be applied in a future year.
  2. Advance rent – e.g. payment of next year’s today – is all included in income for the current year, regardless of what year the payments are for.
  3. Non refundable deposits are included in current year rent, even if a fee, for example, a nonrefundable cleaning fee, won’t be used until the tenant moves out in a future year.
  4. Security deposits need not be claimed as income if you intend to return the deposit to the tenant at the end of the lease term.
  5. Barter is income. If, for example, as part of the rent, your tenant agrees to maintain the gardens and pool, you must show the value of these services as rental income. By the same token, you may also deduct the same amount as a rental expense. I know it’s a push, but the IRS wants us to sharpen our pencils and do extra paperwork.
  6. Expenses paid by your tenant. See barter income above. Say you’re jet setting through Europe and the pipes spring a leak. Your tenant pays the plumber then deducts it from his rent. You must include the full rent in income and write off the plumbing expense against it. And again, it’s a push.
  7. Lease cancellation. If your tenant pays you to cancel the lease, include the payment as rental income.
  8. Option payments. If your tenant signs a lease with an option to buy, the option payments are generally rental income. But once the tenant exercises the right to buy the property, all payments received after the sale are considered part of the selling price.
  9. Here’s a little tax break for you: if you rent out part of your personal residence for fewer than 15 days, you need not include the rent you receive in your income.
  10. If you are renting space in your personal residence (including a vacation home) for more than 15 days, you must declare the income. But you should consult with your tax pro to determine how to properly allocate your rental expenses against the income you receive.
  11. If the property is unoccupied but available for rent, it is still considered a rental activity and as such, you may take all rental expenses against zero income. Be ready to prove it was available for rent. That includes keeping copies of ads you’ve run, etc.

Also make sure you keep all lease/rental agreements and tenant applications. If you are audited, the IRS will review these documents as part of the verification that this is indeed a rental property. Also keep all cancelled checks and credit card receipts for all rental expenses deducted on your tax return.

I have encountered so many misconceptions about what is deductible when you purchase, own, and operate a rental property or a personal residence for that matter. Here’s the list of misconceptions and the correct answers:

  1. Misconception: You are allowed to write off the down payment. Wrong! This expense is part of the basis of the property and is not deductible on your tax return. You still get the write off, albeit indirectly, via depreciation. Here’s how that works: you buy a property for $100,000. You put down $20,000 and pay $5,000 in closing costs. Your basis in the property is $105,000. After deducting the value of the land, you write off the remainder over 27.5 years for residential property and 39 years for commercial property. Depreciation applies only if the property is a rental activity; you cannot depreciate your personal residence. You are allowed, however, to depreciate the portion of the home used as a home office in an active trade or business.
  2. Misconception:Closing costs are deductible. No they are not. They are added to the basis of the property and are deducted via depreciation over the useful life of the property as described above. But take a close look at the closing costs. There may be some expenses listed there that you paid for, e.g. insurance, points, and property taxes which may be currently deductible. Always give closing papers to your tax pro, whether it’s for a purchase, refinance, or sale of a rental property or your own personal residence. Insurance is not deductible for a personal residence but it is an valid write-off for a rental or home office.
  3. Misconception: Points are always currently deductible. Points are only deductible in the year of purchase of a personal residence. For a rental property, points may be deducted ratably over the life of the loan. If you refinance your personal residence and pay points, you may amortize those over the life of the loan as well. It’s taken as a deduction on Schedule A under mortgage interest.
  4. Misconception: When you sell a property, your mortgage balance is deducted from the selling price to determine your taxable gain or loss. No, no, no! Your mortgage balance is not a factor in the equation. The IRS couldn’t care less if you financed or paid cash for a property. The basic formula is: selling price less selling costs and the basis in the property. If you sold the $105,000 rental property purchased in #1 for $205,000 and paid out $19,000 in closing costs and sales commissions plus $1,000 for a roof repair, your taxable gain would be $80,000. $205,000 – $105,000 – ($19,000+$1,000) = $80,000. You may also have depreciation recapture which will be included as income on your tax return. Check with your tax pro.
  5. Misconception: Income received from rentals owned in foreign countries is not taxable. Check with Charles Rangel (D-Harlem) on this one. He was confused about the taxability of rents received on his villa in the Dominican Republic. Why was he confused? “Because,” he says, “I don’t speak Spanish.” Hah! This was one of the reasons he was censured by Congress. Don’t get yourself censured. It’s taxable income, okay?

 

 

If you play the stock market, it is wise to know about the tax consequences of your securities transactions.

Capital Gains Tax First of all, any profit you enjoy from the sale of a stock held for at least a full year is taxed at the long term capital gains rate, which is lower than the rate applied to your other taxable income.  If you are in the 10%-15% tax bracket your rate on capital gains is 0%.  That’s right, zero. The 15% capital gains rate applies to those in the 25% tax bracket. Capital gains peaks out at 20% for higher income taxpayers. If the stock was held for less than a year, ordinary income tax rates apply. It is therefore beneficial tax-wise to hold the investment for longer than a year.

Dividends. The capital gains rate applies to “qualified” dividends. For dividends to be classified as “qualified” they must be paid by a U.S. corporation or a qualified foreign corporation and the holding period of the stock must be more than 60 days. There are plenty of other exceptions and definitions so check with your broker or tax advisor to see if the dividends for your stock holdings are “qualified” or not. Dividends on stock held in a qualified retirement plan are not taxable income.

Congress enacted the lower capital gains rate to drive investment. After all, most tax laws are passed as a form of directing social behaviors.

 

The Wash Rule Many investors benefit from selling a stock in a losing position to offset a gain, then turn around and buy the stock right back.

Well, the IRS will not allow an investor to claim a capital loss if you sell a stock and buy it back within 30 days. It is called the “wash rule” and does not allow for a capital loss. If you sell a stock and buy it back within 30 days, the IRS will disallow the capital loss and you will lose the offset.

Capital Losses One of the big limitations in stock investing is the amount of losses you are allowed to deduct on your tax return. If you sell stocks at a loss, you may deduct only $3,000 in losses per year. The remainder of the loss is carried forward to future years. You may apply capital losses against capital gains in the current and future years to net out the overall profit or loss.

Deductible Investment Expenses A tax deduction often overlooked by investors is the cost of management fees paid to brokers, usually for management of mutual fund accounts or for advisory services. You may deduct these fees as an investment expense on Schedule A of your tax return.  Some brokerage 1099s or year-end statements will state the total paid for the year.  But many do not. You may have to call your broker to find out how much you paid. Be sure to provide this information to your tax pro.

Stock Sales When determining your profit from a stock sale, it’s important to understand not only the formula but the meaning of the variables in the formula. Certain circumstances applied to the variables can reduce your tax liability when you sell. Many taxpayers believe they must pay taxes on the full amount of the check they receive from the sale. That is not true. You can subtract your basis.

The formula is: Sales Proceeds – Basis = Taxable Profit or Deductible Loss.

Sales proceeds can be reduced by commissions paid to the broker.

Basis is the cost of the stock plus any reinvested dividends and commissions paid for acquisition.  If you inherited the stock, the basis is the fair market value of the stock on the date of the decedent’s death or the alternate valuation date. If the stock was received as a gift, the basis is the lower of the fair market value or the basis of the donor at the time the gift was made.

Audit Taxpayers oftentimes forget about a stock sale when compiling their income tax return. This results in a CP-2000 letter from the IRS. The letter is about eight pages long and somewhere in the middle is a listing of omitted items and a calculation of the tax liability on those items. If you receive one showing an omitted stock sale, don’t just pay the tax bill. The IRS only knows about the stock sale; they have no clue as to what your basis in the stock is. Remember the formula earlier? You may actually have taken a loss on the stock and that means no tax liability whatsoever. In fact, you may be entitled to a refund. So call the phone number on the front of the letter and let them know that you will amend that tax return. The IRS may instruct you to complete a Schedule D declaring the details of the stock sale and ask you to fax it to them. They will adjust the tax due (if any) accordingly.

However, beginning January 1, 2011 as a part of the Emergency Economic Stabilization Act of 2008, brokerage firms are required to report the cost basis and gain/loss information to the IRS on their form 1099. This streamlines the tax preparation process considerably.

 

For most folks, the only time you’ve had to deal with gift tax was when you drew that dreaded card while playing Monopoly and had to throw a piece of pink currency into the center of the board. But if you know a little about the tax law surrounding gift tax, you’ll find that a little planning can keep you from paying lots of green into the center of the gaping mouth of the IRS.

Over the years, I’ve fielded a number of questions relating to the taxability of gifts. They usually go like this: “My grandmother gave me twenty grand for Christmas. How much tax do I have to pay on that?”

The answer always surprises them. The answer is none. Zero. Nada. Grandma can give you twenty million bucks and you wouldn’t owe a dime in taxes. How can that be? Well, the first rule on gift taxes is that the recipient isn’t taxed. It’s the giver who winds up with the tax bill.

Of course, I always get a different question from the giver, namely, “I gave my grandson twenty grand for Christmas. Can I write that off?” They just hate it when I tell them that not only is it NOT a write-off, but they could be liable for gift tax.

First of all, what is a gift? According to the IRS, “It’s a transfer of property (including money), or the use of or income from property, without expecting to receive something of at least equal value in return.” If you sell something for less than its fair market value or if you make an interest-free loan or even a reduced-interest loan, you could be making a gift.

Just about anything you give away could be subject to gift tax. But there are exceptions:

  1. Bestow all you want on your spouse. Get lavish. No gift taxes for transfers to a husband or wife. But you will have to file a gift tax return if you give your spouse an interest in property that will be ended by some future event.
  2. Pay tuition or medical expenses for anyone – as long as you pay it directly to the medical or educational institution. No tax will be due.
  3. Be generous with bona fide charities – these gifts are deductible and not subject to gift tax.
  4. Gifts to political organizations are not subject to gift tax, nor are they tax deductible.
  5. Gifts, excluding gifts of future interests, that are less than the annual exclusion for the calendar year are not taxable transactions.

The annual exclusion for all tax years beginning January 1, 2014 is $14,000. This exclusion amount did not change for 2015. It’s still $14,000. You can give that much without incurring a tax liability or having to file a gift tax return. Anything above that amount may be subject to gift tax. Married couples can gift a total of $28,000 (twice the annual exclusion) to a single recipient without incurring a gift tax liability.

If you wish to give more than the annual exclusion, you may be able to defer taxes on the gift by applying the unified credit (from your future estate tax) to the gift. This reduces your unified credit in future years but is a good tool to legally avoid paying gift tax now. You are still required to file Form 709 to declare your gifts.

Business Gifts:

Some gifts, other than charitable contributions, are deductible. You may give business gifts up to $25 per year per recipient to clients, associates, and employees and deduct them on your income tax return. Wrapping paper, gift cards, engraving, insurance and mailing are considered incidental expenses and not included in the $25 cap.

The $25 limitation has been around since Day One and I find it aggravating. You’d think the IRS would have adjusted that amount for inflation.

And you can’t double this gift deduction by including your spouse or business partner as a giver to the same recipient. Under this definition, you and your spouse or you and your business partners are considered one giver.

If you wish to spend more than $25 – you know, like if you don’t want to appear cheap – and get the write-off – you may consider giving something that would fall under the category of meals and entertainment. These expenses are subject to a 50% hair cut but what the heck. It could be more advantageous and enjoyable to take your client to a $100 dinner and get a $50 write off than spend $50 on a gift but enjoy only a $25 deduction.

If you are planning to make gifts above the annual exclusion, especially this year with no estate tax to worry about, check with your tax pro to decide how to gift in the most economical and least taxable method possible.

I trust everyone had a safe and fun 4th of July weekend! I went to the plaza here in downtown Sonoma and enjoyed the parade. Talk about a Norman Rockwell setting and slice of life. Well, when my husband and I were setting up our chairs, who happened to be right next to me but a good business associate. Not a client but a networking buddy. We chatted, ran over to Steiner’s and had a bloody Mary together. Hung out at the BBQ in the plaza afterwards. Never did talk business but we cemented our relationship a little more. He’ll remember me when it’s time to refer clients.

So what do you think? Can I write off that Bloody Mary? Can I write off the hot dog and potato salad? Is this a deductible business entertainment expense?

Well, I hate to burst your bubble, but a smug IRS agent quizzing you about this scenario would joyfully proclaim, “Disallowed!”  There are rules. And essentially, the rules say, “If you’re having way too much fun, it’s not a deductible expense.” But let me quit mincing words here and give you the real lowdown.

Rule #1 – First of all, any entertaining you provide must be directly related to the active conduct of your business or associated with a directly related discussion that preceded or followed the meal or entertainment. This means that hanging out with a business associate or even a client simply to promote goodwill is not deductible nor is giving a party for the sake of establishing goodwill. In order to deduct the cost of entertainment, you must conduct business before, during, or after the event. So we’re talking product demonstration, reveal of a new product or service, or a sales pitch. And the environment must be conducive to conducting business. The IRS believes it is impossible to convince a table-dancing drunk with a lampshade on his head to try your new and improved product.

The IRS once disallowed the write-off of tickets to a baseball game because the loud atmosphere at a ball part does not allow for a comprehensive business discussion.

And giving a sales pitch at the end of a party is much like talking politics with sugar infused 5-year-olds. As a write-off, it’s not going to fly.

Rule #2 – The guest list determines the extent to which you can write off an event. Given you are following Rule #1, you have a 100% write off if:

  1. The party is open to the general public, or
  2.  The party is for employees and their spouses.

You follow the 50% limitation rules that apply in general to meals and entertainment and write off half the cost if:

  1. The party is for customers and prospective customers and/or
  2. Independent contractors associated with your firm (they cannot be classified as employees for this purpose).

There is no write off for attendance by family members even if they are employees or owners. The expense is considered personal and no deduction is allowed. If there is a mix of employees customers and family members, allocate the expense and deduct accordingly. For example, if 10 employees and 30 customers attend, and the party costs $400, you may deduct 100% of 25% of the cost (employees) and 50% of the remaining cost (customers). And you thought there’d be no math. Sorry about that. Your deduction works out to $100 (cost allocated to employees) + $150 (cost allocated to customers) for a total write off of $250.

Rule#3 The entertainment may not be “lavish or extravagant.” That’s another one of those subjective, gray areas that can be argued to death with an auditor, his manager, all the way up to tax court. But why go there? Keep it simple. If your company grosses $100k a year, you likely shouldn’t be helicoptering in your guests. You get the picture.

It’s fine that you follow the rules, but proving you did is another matter. You want to have documentation to prove your case in the event of audit. Here are some tips:

  1. Make sure the invitation announces a business purpose. Such as “Brunch on us! Test drive our new cholesterol-free egg beater omelets.”
  2. Keep a guest list. Have attendees sign a guest book or track RSVPs so you can prove an accurate allocation of the expense.
  3. Take pictures of guests looking at your new products or a video clip of your product demonstration; anything that proves the business purpose.
  4. Keep all receipts for all expenses incurred.
  5. Maintain all of the above documentation in your tax file.

And a final tip: When providing the expenses to your bookkeeper, separate the cost of the party that is 100% deductible to a different category from “Meals and Entertainment.” Track it under “Promotion” or “100% Entertainment” to ensure the full write-off at tax time. Otherwise, your accountant will likely apply the 50% rule to everything under “meals and entertainment” and you will have lost a valuable write-off.

Okay, ready now? Cool. Let’s party!

Bob, a longtime client, showed up at my office during tax season bringing all his receipts and organizer. “You don’t have much in the way of medical expense,” I told him as I perused his itemized deduction worksheet.

“Nah, just some co-pays.”

I looked up from his organizer, surprised he hadn’t said, “WHAT?” After all, Bob is deaf as a stone and has been for years. That’s when I noticed a hearing aid in each ear. “You just get those?” I asked.

“I got them last year.”

“Did Medicare cover them?”

“Nope, I paid for them out of my own pocket. I got top of the line too. These suckers cost me seven grand.”

“And you got them in 2014 – last year – right?” He nodded. “You didn’t list the expense in your organizer, Bob. What’s the matter? You don’t want to write them off?”

His jaw dropped. “I can write them off?”

“Yeah, it’s a valid deductible medical expense. Good thing I noticed because I just saved you $2500 in taxes. How about that Bob?”

And Bob’s not the only one who doesn’t realize what is and what isn’t allowable when it comes to medical expenses. Lots of folks have misconceptions about what can be deducted.

First of all, one must be able to itemize deductions in order to take the medical expense deduction. The IRS grants us an option of the standard deduction – generally taken by renters and lower income individuals or itemized deductions – generally available to homeowners and higher income individuals.  Either the standard deduction or the total of itemized deductions (reported on Schedule A) is subtracted from your income. Income tax liability is calculated on the remainder. So the more itemized deductions you can list, the more you will save in taxes.

Know this; you generally have to have an awful lot of medical expenses in order to take these expenses as an itemized deduction. You don’t just list your medical then deduct it. After totaling your medical expenses, the IRS requires that you subtract 10% (7.5% if you are 65 or older) of your adjusted gross income from the total of your medical expenses. You then write off the remainder.  So if you made $100,000 last year, you can write off the amount above $10,000 ($7,500 if 65 or older) in medical expenses. If you’re healthy, you might not have enough medical bills to enjoy the write-off. But don’t quit reading yet. You can deduct more than just doctor visits.

A complete list of deductible medical expenses is available in Publication 502. Most people track medical insurance, doctor visits, prescriptions, eye and dental care. You may be surprised to find the following are deductible medical expenses:

  1.  Capital improvements to your home or vehicle to accommodate a disability
  2. Transportation and lodging in another city if the primary purpose is medical care
  3. Medicare premiums deducted from your Social Security check
  4. Chiropractor, acupuncture, therapeutic massage, psychologist, psychiatrist, marriage counselor, naturopath
  5. Alcohol and drug addiction for inpatient treatment at a therapeutic center, including meals and lodging
  6. Dentures, birth control pills, and pregnancy test kits, fertility enhancement
  7. Cost of buying, training, and maintaining a guide dog or other service animal when required to assist you or your dependent with physical disabilities
  8. Unused sick leave to pay for your health insurance premiums
  9. Cost of medical conferences and transportation to same if the topic concerns the chronic illness of yourself, your spouse or your dependent
  10. Adapters to television sets and telephones for the hearing-impaired.
  11. Braille instruction, Braille books and magazines
  12. Bandages
  13. Health, dental and eye insurance, long term care insurance, HMO fees, disability insurance withheld from your paycheck
  14. Lead-based paint removal in your home
  15. Cost of weight loss clinic if prescribed by a doctor for treatment of obesity or hypertension
  16. Cost of medical care, lodging and meals in a nursing home if there for medical reasons
  17. Medical mileage – trips to see practitioners, pharmacy, etc
  18. Cosmetic surgery for breast reconstruction after a mastectomy for cancer or to correct a birth defect or other condition that interferes with one’s health.

Generally cosmetic surgery is not deductible.  However, a stripper won a court case several years ago and was allowed a deduction for breast enhancement. However, it was not allowed as a medical expense. Instead, she was able to write it off as an “ordinary and necessary” business expense.

Also not deductible are vitamins and supplements, gym membership, dance lessons and swimming lessons even if recommended by your physician, prescriptions for controlled substances (marijuana, laetrile, etc. that violate federal law) or prescription medicines from foreign countries, hair transplants and teeth whitening.

Taxpertise tip of the day: stack your medical expenses into one year. So for example, if you had a surgery this year and also need a root canal and new glasses, don’t wait until January to have that work done. Do it now so you can maximize the tax benefit. You cannot pay for them now and take the deduction unless you actually undergo the treatment or procedure.

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©2013 Taxpertise | Bonnie Lee, E.A. | Ph: 707.935.1755 Fax: 707.938.1891 | 453 2nd Street West, Sonoma, CA 95476