This edition covers a number of important tax issues, including tax breaks for military personnel, college education saving tips, healthcare subsidies, charitable contribution rules, and upcoming tax deadlines.
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Tax Breaks for Military Personnel
Residence or Domicile
Combat Pay Exclusion
Home Mortgage Interest and Taxes
Home Sale Gain Exclusion
Reservist Travel Expenses
Reservist Early Withdrawal Exception
Extension of Deadlines
Uniform Costs and Upkeep
Joint Returns o Tax Forgiveness
ROTC Students o Transitioning Back to Civilian Life
Military service members have special obligations and take risks while performing their service to our country, which impact their tax situation. As a result, they are entitled to a number of special tax breaks. The following are the predominant tax breaks available to military personnel:
Residence or Domicile — A military service member does not lose or acquire a residence or domicile for tax purposes due to being absent or present in any tax jurisdiction in the U.S. solely to comply with military orders. Thus, for example, a member of the military who is a resident of Texas and is assigned under military orders to a duty station in California continues to be treated as a Texas resident and is not subject to California state income tax.
Another special rule exempts any personal service income of a military spouse from being taxed by any state other than the military spouse's resident state. For the income to be exempt from the nonresident state's taxes, the couple must have relocated to another state under military orders. They must also share the same "domicile" or true home outside the duty station state where they intend to return and relocate permanently.
Moving Expenses — A member of the Armed Forces on active duty who is required to move because of a permanent change of station can deduct the reasonable unreimbursed expenses of moving themselves and members of their household. They are not subject to the 50-mile distance test or 39-week employment test that civilians are subject to for claiming a moving expense deduction. Reasonable expenses include shipping, a moving van, truck rental, travel expenses (not meals), packing, insurance and storage en route, moving pets, and utility connect/disconnect charges.
Combat Pay Exclusion — If a member of the Armed Forces serves in a combat zone as an enlisted person or as a warrant officer for any part of a month, all of the military pay that he or she receives for military service that month is excluded from taxation. For officers, the monthly exclusion is capped at the highest enlisted pay plus any hostile fire or imminent danger pay received.
Living Allowances — The basic housing allowance and both housing and cost-of-living allowances abroad, whether paid by the U.S. Government or by a foreign government, are excluded from taxation.
Home Mortgage Interest and Taxes — A military taxpayer can deduct mortgage interest and real estate taxes on his or her tax return as an itemized deduction, even if they are paid with nontaxable military housing allowance pay.
Home Sale Gain Exclusion — In order to claim the $250,000 ($500,000 for qualifying married taxpayers) home gain exclusion, taxpayers must generally own and use the home for 2 of the 5 years immediately prior to the home's sale. A military taxpayer may choose to suspend the 5-year look-back period for up to 10 years when on qualified official extended duty.
A military taxpayer who sells his or her primary residence and does not meet the 2- of-5-years ownership and use tests due to a move to a new permanent duty station may qualify for a reduced maximum exclusion amount.
Reservist Travel Expenses — Armed Forces reservists who travel more than 100 miles away from home and stay overnight in connection with service as a member of a reserve component can deduct travel expenses as an adjustment to their gross income. This differs from the rules for other employees, who may only deduct job-related travel expenses as a miscellaneous itemized deduction (subject to the 2% of AGI limitation). Thus, this deduction can be taken even if the reservist does not itemize his or her deductions.
Reservist Early Withdrawal Exception — Qualified reservists are permitted penalty-free withdrawal from IRAs, 401(k)s, and other arrangements if ordered or called to active duty for a period in excess of 179 days and if the distribution is taken during the active duty period.
Extension of Deadlines — The time limit for taking care of certain tax matters can be postponed. The deadlines for filing tax returns, paying taxes, filing claims for refund, and taking other actions with the IRS are automatically extended for qualifying members of the military.
Uniform Cost and Upkeep — If military regulations prohibit you from wearing certain uniforms when off duty, the costs and upkeep of those uniforms can be deducted, but the deductible expense must be reduced by any allowance or reimbursement that is received.
Joint Returns — Generally, a joint return must be signed by both spouses. However, when one spouse may not be available due to military duty, a power of attorney may be used to file a joint return.
Tax Forgiveness — When members of the military lose their life in a combat zone or as the result of a terrorist action, their income taxes are forgiven for the year of their death and for any prior year that ends on or after the first day of service in a combat zone.
ROTC Students — Subsistence allowances paid to ROTC students participating in advanced training are not taxable. However, active duty pay — such as pay received during summer advanced camp — is taxable.
Transitioning Back to Civilian Life — You may be able to deduct some costs that are incurred while looking for a new job. Such expenses may include travel, resume preparation fees, and outplacement agency fees. Moving expenses may be deductible if your move is closely related to starting work at a new job location and if you meet certain tests.
If you or your spouse have questions about any of the above or questions related to your designated state of residence for state tax-filing purposes, please give this office a call.
Preparing for Your Child's Future Education
Sec. 529 plans
Coverdell Education Savings Accounts
American Opportunity Tax Credit
The Lifetime Learning Credit
Qualified Education Loan Interest
Figuring out how to pay for your child's trade school or college education can be challenging, and the earlier you create your plan and begin executing it, the greater your chances are of having the needed money set aside to pay for it. The government provides a variety of tax incentives to help defray the cost of education. Some require long-term planning to provide the most benefit, while others provide current tax deductions or credits. The benefits generally apply to both vocational schools and colleges.
Tax-Advantaged Savings Plans - There are tax-advantaged plans that allow you to save for the cost of college. Although they provide no tax benefit when contributing to the plans, they do provide tax-free accumulation and withdrawals if the distributions are used for qualified education expenses. The earlier they are established, the more you benefit from these plans.
Section 529 Plans - Section 529 plans (named after the section of the IRS Code that created them) are plans established to help families save and pay for college in a tax-advantaged way and are available to everyone, regardless of income. These state-sponsored plans allow you to gift large sums of money for a family member's college education while maintaining control over the funds. The earnings from these accounts grow tax-deferred and are tax-free, if used to pay for qualified higher education expenses. The accounts can be used as an estate-planning tool as well, providing a means of transferring large amounts of money without gift tax. With all of these tax benefits, 529 plans are an excellent vehicle for college funding. Section 529 plans come in two types, allowing you to either save funds in a tax-free account to be used later for higher education costs or to prepay tuition for qualified universities. For 2017, you can contribute $14,000 without gift tax implications (or $28,000 for married couples who agree to split their gift). The annual amount is subject to inflation adjustment. There is also a special gift provision allowing the donor to prepay five years of Sec. 529 gifts up front without gift tax.
One nice feature of a Sec. 529 plan is that parents, grandparents, a rich uncle, or anyone else, for that matter, can each make annual contributions to the plan, allowing substantial amounts to be contributed each year.
Coverdell Education Savings Account - These accounts are actually education trusts that allow nondeductible contributions to be invested for a child's education. Tax on earnings from these accounts is deferred until the funds are withdrawn, and if used for qualified education purposes, the entire withdrawal can be tax-free. Qualified use of these funds includes elementary and secondary education expenses in addition to post-secondary schools. This is the only one of the educational tax benefits that allows tax-free use of the funds for below post-secondary or college-level expenses. A total of $2,000 per year can be contributed for each beneficiary under the age of 18. The ability to contribute to these plans phases out when the modified adjusted gross income of married taxpayers filing jointly is between $190,000 and $220,000, or between $95,000 and $110,000 for all others.
A Coverdell account is beneficial if there are plans for your child(ren) to attend a private elementary and/or high school.
Education Tax Credits - Two tax credits, the American Opportunity Credit (partially refundable) and the Lifetime Learning Credit (nonrefundable), are available for qualified post-secondary education expenses for a taxpayer, spouse, and eligible dependents. Both credits will reduce one's tax liability dollar for dollar until the tax reaches zero. The credit is not allowed for taxpayers who file married separate returns.
The American Opportunity Credit (AOTC) is a credit of up to $2,500 per student per year that covers the first four years of that student's qualified post-secondary education. The student must be enrolled in a program leading to a degree, certificate, or other recognized postsecondary educational credential for at least one academic period beginning in that tax year. The credit is 100% of the first $2,000 of qualifying expenses plus 25% of the next $2,000 for a student attending a trade school or college on at least a half-time basis. Forty percent of the American Opportunity Credit is refundable (if the tax liability is reduced to zero). This credit phases out for jointly filing taxpayers with modified adjusted gross income between $160,000 and $180,000, and between $80,000 and $90,000 for others.
The Lifetime Learning Credit is a credit of up to 20% of the first $10,000 of qualifying higher education expenses. Unlike the American Opportunity Credit, which is on a per-student basis, this credit covers the whole family, i.e., it is per return, not per student. In addition to post-secondary education, the Lifetime Credit applies to any course of instruction at an eligible institution taken to acquire or improve job skills. For 2017, this credit phases out for jointly filing taxpayers with a modified adjusted gross income between $112,000 and $132,000, and between $56,000 and $66,000 for others. The credit is not allowed for taxpayers who file married separate returns.
The qualifying expenses for these credits are generally limited to tuition. However, student activity fees qualify if they are paid directly to the educational institution for the student's enrollment or attendance. For the Lifetime Learning Credit, fees for course-related books, supplies, and equipment only qualify if they are paid directly to the school, while for the AOTC, if these types of expenses are needed for a course of study, they qualify whether or not the materials are purchased from the educational institution. Otherwise, eligible expenses paid for with a tax-free scholarship won't qualify.
You may qualify for either of these credits even if you did not pay the tuition. (However, otherwise eligible expenses paid for with a tax-free scholarship won't qualify.) The tax law says that if a third party (someone other than the taxpayer or a claimed dependent) makes a payment directly to an eligible educational institution for a student's qualified tuition and related expenses, the student will be treated as having received the payment from the third party and, in turn, paying the qualified tuition and related expenses. Furthermore, qualified tuition and related expenses paid by a student would be treated as having been paid by the taxpayer if the student is claimed as the taxpayer's dependent.
Education Loan Interest - You can deduct qualified education loan interest of $2,500 per year in computing your AGI. This is not limited to government student loans and could include home equity loans, credit card debt, etc., if the debt was incurred solely to pay for qualified higher education expenses. For 2017, this deduction phases out for married taxpayers with an AGI between $135,000 and $165,000 and for unmarried taxpayers between $65,000 and $80,000. This deduction is not allowed for taxpayers who file married separate returns.
We all know that a child's success in life has a great deal to do with the education they receive. It's never too early to start the planning process for how you'll finance the higher education of your child(ren). Please call this office if you would like assistance in planning for your children's future education.
When is a Charitable Contribution Appraisal Required?
Substantiation and Documentation Requirements
Deductions of less than $250
Deductions of $250 to $500
Deductions over $500 but not over $5,000
Deductions over $5,000
A commonly overlooked requirement of taking a tax deduction for donating clothing and household goods to charity is the substantiation requirement, for both what is donated and the value placed on the donation. Because the IRS has encountered so much abuse in this area, it has increased the donation verification requirements over the years, and taxpayers risk losing the deduction if their donations are not correctly documented and reasonably valued.
Fair Market Value – Generally, it is up to you, the donor, to reasonably determine the fair market value (FMV) of the items you donate. If your return is reviewed, the values you claimed can be challenged. A deduction for household goods or clothing is not allowed unless they are in good used condition or better. The FMV of used household goods, furniture, appliances, linens, used clothing and other personal items are usually worth far less than the price they sold for new. Valuing these items as an arbitrary percentage of the original cost or by using another fixed formula is not appropriate – the condition of each item, whether it is still in style and other factors need to be considered. The value of the donated item(s) will determine the type of verification needed. The documentation and verification requirements are broken down into four categories:
Deductions of less than $250 – These donations require a receipt from the charity that includes the date and location of the contribution and a reasonably detailed description of the donated property.
CAUTION – Don't always rely on door hangers as a valid acknowledgment, since they generally do not include all of the required information (especially the reasonably detailed description of the donated item), and their use as documentation has been denied in tax court.
Deductions of $250 to $500 – Such deductions require a written acknowledgement from the charity that includes the date and location of the contribution and a reasonably detailed description of the donated property, whether the qualified organization gave you any goods or services as a result of the contribution, and if goods and/or services were provided to you, a description of the goods/services and an estimate of their value.
Deductions of over $500 but not over $5,000 – You must have the same acknowledgement and written records as for contributions of at least $250 but not more than $500, as described above. In determining whether your deduction is worth $500 or more, combine your claimed deductions for all similar property items donated to any charitable organization during the year. In addition, the records must also include:
o How the property was obtained – for example, by purchase, gift, bequest, inheritance, or exchange.
o The approximate date when the property was obtained or, if you created, produced, or manufactured it, the approximate date when the property was substantially completed.
o The cost or other basis, and any adjustments to the basis, of property held for less than 12 months and, if available, the cost or other basis of property held for 12 months or more. However, this requirement does not apply to publicly traded securities. If you are unable to provide either the date the property was obtained or the cost basis of the property and there is reasonable cause for not being able to do so, you need to attach a statement to your return with an explanation.
When your total deduction for all noncash contributions for the year is over $500, Form 8283 must be completed and attached to your Form 1040.
Deductions over $5,000 – You must have the same acknowledgement and written records as for contributions of at least $250 but not more than $500, as described above. In addition, if the contribution exceeds $5,000 for a single property item or group of similar items, then a qualified appraisal is required, and IRS Form 8283 must be completed, signed by the qualified appraiser and attached to the return. The exception to this rule is publicly traded securities.
Example: Jay and Emily made three donations of used clothing during the year: $2,500 worth to the Salvation Army, $1,500 worth to the Vietnam Veterans of America and $2,000 to Goodwill, for a total of $6,000. Because the items were all similar in nature (clothing) and because the total exceeded $5,000, Jay and Emily will need to obtain a qualified appraisal.
Qualified Appraisal – A qualified appraisal of any property is an appraisal that's treated as qualified under IRS regulations. This means that the person doing the appraisal is generally someone who earned an appraisal designation from a recognized professional appraiser organization, has met certain education or experience requirements relative to the type of property being appraised, regularly prepares appraisals for a fee and has not been prohibited from practicing before the IRS.
Appraisal Timing– You must obtain the appraisal no earlier than 60 days before the appraisal property's contribution date and no later than the extended due date of your tax return.
CAUTION – If you don’t bother to obtain an appraisal and the IRS later challenges your deduction, it will be too late to get the appraisal, and the deduction will most likely be denied.
Donations of vehicles, boats and airplanes have a special set of rules not covered in this article if the claimed deduction exceeds $500. Please give this office a call about the documentation requirements for vehicle donations and any questions you might have related to any charitable contribution. Click here to download a special non-cash contribution form.
Did You Have to Repay Part of Your Obamacare Subsidy and Don't Know Why?
Premium Tax Credit
Basis for the Credit
Advance Premium Tax Credit
As part of Obamacare, most everyone is required to be insured or pay a penalty. However, this created a substantial financial burden for lower-income families. To alleviate this situation, Obamacare included a subsidy, referred to as the premium tax credit (PTC), to help them pay the cost of the insurance.
That credit is based on family size, household income, household income in relationship to the federal poverty line tables and the cost of the family's insurance.
The primary variable in determining the actual credit is the family's household income, so the exact amount of the PTC cannot be determined until after the close of the tax year. Providing the credit after the fact on the tax return for the year does not help families to pay their premiums during the year, so to alleviate that problem, Obamacare allows families to estimate their family income when they apply for their insurance, and the government insurance marketplaces will estimate the PTC and allow it as a subsidy in advance. That subsidy is called the advance premium tax credit (APTC) and reduces the amount of the insurance premiums that the family must pay during the year.
Then, when the tax return for the year is prepared, the actual household income is known, and the actual PTC to which the family is entitled is determined. If the PTC is greater than the APTC, then the difference is credited on the tax return. However, if the APTC — the subsidy paid in advance — is greater than the actual PTC the family is entitled to, then the difference must be repaid.
So, if you had to repay some amount of the credit, it was generally due to your household income being underestimated when you signed up for the insurance, thus causing the APTC to be larger than the PTC. This is one of the hazards of estimating your household income in advance because you may receive unexpected income during the year, such as a raise, a bonus, a spouse starting to work, selling some stocks for a gain...the list goes on.
There are other reasons for a mismatch between the APTC and PTC. For instance, if your employer offered you affordable, compliant insurance for any month during the year, then you were not eligible for the PTC that month. (The IRS knows when this occurred based on a report that employers have to file.) Other things that can change the PTC include changes in family size created by marriage, divorce, children getting married, deaths, etc. Another reason is when a married couple is receiving APTC from the marketplace and files married filing separate (MFS) returns instead of filing jointly. The MFS filing status does not allow them to claim the PTC.
You can mitigate the repayments by keeping the insurance marketplace updated on your estimated family income and family size and allowing it to make appropriate adjustments to the APTC.
If you have questions related to the premium tax credit or the repayments, please give this office a call.
September 2017 Individual Due Dates
September 1 - 2017 Fall and 2018
Tax Planning Contact this office to schedule a consultation appointment.
September 11 - Report Tips to Employer
If you are an employee who works for tips and received more than $20 in tips during August, you are required to report them to your employer on IRS Form 4070 no later than September 11. Your employer is required to withhold FICA taxes and income tax withholding for these tips from your regular wages. If your regular wages are insufficient to cover the FICA and tax withholding, the employer will report the amount of the uncollected withholding in box 12 of your W-2 for the year. You will be required to pay the uncollected withholding when your return for the year is filed.
September 15 - Estimated Tax Payment Due
The third installment of 2017 individual estimated taxes is due. Our tax system is a "pay-as-you-go" system. To facilitate that concept, the government has provided several means of assisting taxpayers in meeting the "pay-as-you-go" requirement. These include:
Payroll withholding for employees;
Pension withholding for retirees; and
Estimated tax payments for self-employed individuals and those with other sources of income not covered by withholding.
When a taxpayer fails to prepay a safe harbor (minimum) amount, they can be subject to the underpayment penalty. This penalty is equal to the federal short-term rate plus 3 percentage points, and the penalty is computed on a quarter-by-quarter basis.
Federal tax law does provide ways to avoid the underpayment penalty. If the underpayment is less than $1,000 (the de minimis amount), no penalty is assessed. In addition, the law provides "safe harbor" prepayments. There are two safe harbors:
The first safe harbor is based on the tax owed in the current year. If your payments equal or exceed 90% of what is owed in the current year, you can escape a penalty.
The second safe harbor is based on the tax owed in the immediately preceding tax year. This safe harbor is generally 100% of the prior year's tax liability. However, for taxpayers whose AGI exceeds $150,000 ($75,000 for married taxpayers filing separately), the prior year's safe harbor is 110%.
Example: Suppose your tax for the year is $10,000 and your prepayments total $5,600. The result is that you owe an additional $4,400 on your tax return. To find out if you owe a penalty, see if you meet the first safe harbor exception. Since 90% of $10,000 is $9,000, your prepayments fell short of the mark. You can't avoid the penalty under this exception.
However, in the above example, the safe harbor may still apply. Assume your prior year's tax was $5,000. Since you prepaid $5,600, which is greater than 110% of the prior year's tax (110% = $5,500), you qualify for this safe harbor and can escape the penalty.
This example underscores the importance of making sure your prepayments are adequate, especially if you have a large increase in income. This is common when there is a large gain from the sale of stocks, sale of property, when large bonuses are paid, when a taxpayer retires, etc. Timely payment of each required estimated tax installment is also a requirement to meet the safe harbor exception to the penalty. If you have questions regarding your safe harbor estimates, please call this office as soon as possible.
CAUTION: Some state de minimis amounts and safe harbor estimate rules are different than those for the Federal estimates. Please call this office for particular state safe harbor rules.