Household Help: Employee or Contractor?

Article Highlights:

  • Household Employee Definition
  • Employee Control Factors
  • Self-employed or Employee
  • Withholding Requirements
  • Reporting Requirements

Taxpayers often will hire an individual or firm to provide services at the taxpayer’s home. Because the IRS requires employers to withhold taxes for employees and issue them W-2s at the end of the year, the big question is whether or not that individual is a household employee.

Determining whether a household worker is considered an employee depends a great deal on circumstances and the amount of control the hiring person has over the job and the worker they hire. Ordinarily, when someone has the last word about telling a worker what needs to be done and how the job should be done, then that worker is an employee. Having a right to discharge the worker and supplying tools and the place to perform a job are primary factors that show control.

Not all those hired to work in a taxpayer’s home are considered household employees. For example, an individual may hire a self-employed gardener who handles the yard work for that individual as well as some of the individual’s neighbors. The gardener supplies all tools and brings in other helpers needed to do the job. Under these circumstances, the gardener isn’t an employee and the person hiring him/her isn’t responsible for paying employment taxes. The same would apply to the person hired to maintain an individual’s swimming pool or to contractors making repairs or improvements on the home.

Contrast the following example to the self-employed gardener described above: The Johnson family hired Maclovia to clean their home and care for their 3-year old daughter, Kim, while they are at work. Mrs. Johnson gave Maclovia instructions about the job to be done, explained how the various tasks should be done, and provided the tools and supplies; Mrs. Johnson, and not Maclovia, had control over the job. Under these circumstances, Maclovia is a household employee, and the Johnsons are responsible for withholding and paying certain employment taxes for her and issuing her a W-2 for the year.

W-2 forms are to be provided to the employee by January 31 of the year following the year when the wages were paid and the government’s copy of the form – sent to the Social Security Administration – is also due by January 31.

If an individual you hire is considered an employee, then you must withhold both Social Security and Medicare taxes (collectively often referred to as FICA tax) from the household employee’s cash wages if they equal or exceed the $2,100 threshold for 2019.

The employer must match from his/her own funds the FICA amounts withheld from the employee’s wages. Wages paid to a household employee who is under age 18 at any time during the year are exempt from Social Security and Medicare taxes unless household work is the employee’s principal occupation.

Although the value of food, lodging, clothing or other noncash items given to household employees is generally treated as wages, it is not subject to FICA taxes. However, cash given in place of these items is subject to such taxes.

A household employer doesn’t have to withhold income taxes on wages paid to a household employee, but if the employee asks to have withholding, the employer can agree to it. When income taxes are to be withheld, the employer should have the employee complete IRS Form W-4 and base the withholding amount upon the federal income tax and FICA withholding tables.

The wage amount subject to income tax withholding includes salary, vacation and holiday pay, bonuses, clothing and other noncash items, meals and lodging. However, if furnished for the employer’s convenience and on the employer’s premises, meals are not taxable, and therefore they are not subject to income tax withholding. The same goes for lodging if the employee lives on the employer’s premises. In lieu of withholding the employee’s share of FICA taxes from the employee’s wages, some employers prefer to pay the employee’s share themselves. In that case, the FICA taxes paid on behalf of the employee are treated as additional wages for income tax purposes.

A household employer who pays more than $1,000 in cash wages to household employees in any calendar quarter of either the current or the prior year is also liable for unemployment tax under the Federal Unemployment Tax Act (FUTA).”

Although this may seem quite complicated, the IRS provides a single form (Schedule H) that generally allows a household employer to report and pay employment taxes on household employees’ wages as part of the employer’s Form 1040 filing. This includes Social Security, Medicare, and income tax withholdings and FUTA taxes.

If the employer runs a sole proprietorship with employees, the household employees’ Social Security and Medicare taxes and income tax withholding may be included as part of the individual’s business employee payroll reporting but are not deductible as a business expense.

Although the federal requirements can generally be handled on an individual’s 1040 tax return, there may also be state reporting requirements for your state that entail separate filings.

Another form that is required to be completed when hiring a household employee who works for an employer on a regular basis, is the U.S. Citizenship and Immigration Services (USCIS) Form I-9, Employment Eligibility Verification. By the first day of work, the employee must complete the employee section of the form by providing certain required information and attesting to his or her current work eligibility status in the United States. The employer must complete the employer section by examining documents (acceptable documents are listed on the I-9) presented by the employee as evidence of his or her identity and employment eligibility. The employer should keep the completed Form I-9 in his or her records and make it available upon request of the U.S. government. It is unlawful to knowingly to hire or continue to employ an alien who can’t legally work in the United States.

If the individual providing household services is determined to be an independent contractor, there is currently no requirement that the person who hired the contractor file an information return such as Form 1099-MISC. This is so even if the services performed are eligible for a tax deduction or credit (such as for medical services or child care). The 1099-MISC is used only by businesses to report their payments of $600 or more to independent contractors. Most individuals who hire other individuals to provide services in or around their homes are not doing so as a business owner.

Please call this office if you need assistance with your household employee reporting requirements or need information related to the reporting requirements for your state.

How Does Combining a Vacation with a Foreign Business Trip Affect the Tax Deduction for Travel Expenses of a Self-Employed Individual?

Article Highlights:

  • Primarily Business
  • Primarily Vacation
  • Special Circumstances
  • Foreign Conventions, Seminars and Meetings
  • Cruise Ships
  • Spousal Travel Expenses

Note: effective for years 2018 through 2025, the Tax Cuts and Jobs Act of 2017 suspended the deduction of miscellaneous itemized expenses that must be reduced by 2% of the taxpayer’s adjusted gross income. Employee business expenses, including travel expenses, fall into this category. Therefore, this discussion only applies to self-employed individuals for years 2018-2025.

When a self-employed individual makes a business trip outside of the U.S. and the trip is 100% devoted to business, all of the ordinary and necessary business travel expenses are deductible, just as if the business trip were within the U.S. On the other hand, if the trip also incorporates a vacation, special rules determine the deductibility of the travel expenses to and from the destination; when the other business travel expenses, such as lodging, meals, local travel and incidentals, can be deducted; and when they must be allocated. So, whether you are just visiting one of our neighboring countries or traveling to Europe or even more exotic locales, here are some travel tax pointers:

Primarily Vacation – If the travel is primarily for vacation and only a few hours are spent attending professional seminars or meeting with foreign business colleagues, none of the expenses incurred in traveling to and from the general business location are deductible. Other travel expenses must be allocated on a day-by-day basis, and only the business portion is deductible.

Primarily Business – If the trip is primarily for business and meets one of the conditions listed below, the expenses incurred in traveling to and from the business destination are deductible in full (same as for travel within the U.S.).

(1) The travel outside the U.S. is for a period of one week or less (seven consecutive days, excluding the departure day but including the day of return). In addition, all other ordinary and necessary travel expenses are fully deductible.

(2) Less than 25% of the total time outside the U.S. is spent on non-business activities. In addition, all other ordinary and necessary travel expenses are fully deductible. (If 25% of more of the total time is spent on non-business activities, a day-by-day allocation of all travel expenses between personal and business activities is necessary and only the business portion is deductible.)

(3) The individual incurring the travel expenses can establish that a personal vacation or holiday was not a major consideration. In addition, all other ordinary and necessary travel expenses are fully deductible.

(4) The taxpayer did not have “substantial control” over arranging the trip. (For self-employed taxpayers, who would generally have substantial control over the trip arrangements, this provision likely won’t apply.) In addition, all other ordinary and necessary travel expenses are fully deductible.

When determining what constitutes business and non-business time, business days include: days en route to or from the business destination by a reasonably direct route without interruption; days when actual business is transacted; weekends or standby days that fall between business days; and days when business was to have been transacted but was canceled due to unforeseen circumstances.

Nonbusiness days are days spent on nonbusiness activities as well as weekends, holidays and other standby days that fall at the end of the business activity, if the taxpayer remains at the business destination for personal reasons.

Foreign Conventions, Seminars or Meetings – Tax law does not permit a deduction for travel expenses to attend a convention, seminar or similar meeting held outside of the North American area unless the taxpayer establishes that:

(1) The meeting is directly related to the active conduct of the taxpayer’s trade or business, and
(2) It is “as reasonable” for the meeting to be held outside of the North American area as it is within the North American area.

The IRS defines “North American area” quite broadly and includes not just the U.S., Canada and Mexico, as you would expect, but also Bermuda, several countries in the Caribbean basin, U.S. possessions such as American Samoa and other Pacific island nations, and some Central American countries as well.

Cruise Ship Conventions – In order for a taxpayer to deduct the cost of attending a convention related to his or her trade or business on a cruise ship, the ship must be a U.S. flagship, and all the ports of call must be within the U.S. or its possessions. In addition, the maximum deduction is limited to $2,000 per attendee. Substantiation requirements include certain signed statements by both the taxpayer and an officer of the convention sponsor.

Spousal* Travel Expenses – Generally, deductions are denied for travel expenses for a spouse, dependent or employee of the taxpayer on a business trip unless:

  1. The spouse is an employee of the taxpayer, and
  2. The travel of the spouse, etc., is for a bona fide business purpose, and
  3. The expenses would otherwise be a deductible business travel expense for the spouse.*These rules also apply to a dependent or employee of the taxpayer.

Since a spouse, dependent or other individual who is an employee will be denied a deduction for business travel expenses in years 2018 through 2025, condition #3 can’t be met. This means that “spousal” travel expenses won’t be deductible for years 2018 through 2025.

However, the law allows a deduction for the single rate for lodging on qualified business trips, and frequently, there is no rate difference between one and two occupants. Thus, virtually the entire lodging expense for an accompanying spouse will be deductible. When traveling by car, the law does not require any allocation because the spouse is also traveling in the vehicle. Thus, if traveling by vehicle, the entire cost of the business-related transportation would be deductible. This would generally also apply to taxis at the destination.

As you can see, determining the tax deduction for a foreign business trip of a self-employed individual that is combined with a vacation can be complicated. If you need additional tax guidance or help planning such a trip, please give this office a call.

Electric Vehicle Credit on the Decline

Article Highlights:

  • Tax Credit
  • Credit Phase-Out
  • Tesla
  • General Motors
  • Determining the Credit
  • Off-Road Vehicles and Golf Carts
  • Allocation Between Business and Personal Use
  • Credit Reduces Basis
  • Business Standard Mileage

Back in 2009 Congress created a tax credit for the purchase of electric vehicles as a stimulus for car companies to manufacture “green” vehicles and as an incentive for consumers to purchase electric vehicles. Although there is no specific date in the future when this credit will expire, there is a limit to the number of vehicles each manufacturer can sell that can qualify for the credit.

That limit is not a set number of vehicles, but rather a credit phaseout by manufacturer that is triggered when the manufacturer sells the 200,000th electric vehicle. Here is how the credit phase-out works:

Credit Phase-Out – The credit phases out beginning in the second calendar quarter following that in which a manufacturer sells its 200,000th plug-in electric drive motor vehicle for use in the U.S. The applicable percentage phase-out is:

  • 50% for the first two calendar quarters of the phaseout period,
  • 25% for the third and fourth calendar quarters of the phaseout period, and
  • 0% for each later calendar quarter.Example: Tesla, Inc., sold more than 200,000 vehicles eligible for the plug-in electric drive motor vehicle credit, reaching this sales level during the third quarter of 2018. Thus, a phase out of the tax credit available for purchasers of new Tesla plug-in electric vehicles was triggered beginning Jan. 1, 2019. This means the maximum credit available for the purchase of a Tesla, which was $7,500 before 2019, has begun to phase out and the maximum credits for 2019 are as follows for vehicles purchased:
  • Jan 1, 2019 through June 30, 2019: $3,750 (50% of $7,500).
  • July 1, 2019 through Dec 31, 2019: $1,875 (25% of $7,500).
  • After 2019, Tesla vehicles will no longer qualify for the credit.

During the fourth quarter of 2018, General Motors (GM) also reached a total of more than 200,000 sales of vehicles eligible for the plug-in electric drive motor vehicle credit and accordingly, the credit for all new qualified plug-in electric drive motor vehicles sold by GM have begun to phase out beginning April 1, 2019. Thus, the maximum credit for a GM plug-in electric drive motor vehicle is $3,750 for purchases in April through September of 2019, then dropping to $1,875 for purchases in October 2019 through March 2020, after which GM vehicles will not qualify for the credit.

If you are considering purchasing an electric vehicle, you may need to make that decision sooner than later since the credit for many popular models is beginning to phase out. Here are some things you should be aware of before making your decision to purchase an electric vehicle.

Not All Electric Vehicles Qualify for the Full Credit – The credit is not a flat $7,500; it is actually made up of two elements, a $2,500 per vehicle credit plus an additional $417 for each kilowatt hour of capacity in excess of 5 kilowatt hours, but not in excess of $5,000, resulting in an overall credit of up to $7,500.

The amount of credit available for any qualifying vehicle, listed by manufacturer is available on the IRS website. Although most salespeople will know the amount of credit that is available for the vehicle you are interested in purchasing, you sometimes run into an overzealous one that might mislead you a bit. So, it is good practice to double check for yourself and that is quite easy to do on the IRS Website.

The following requirements must be met to qualify for the credit.

  • You are the owner of the vehicle. If the vehicle is leased, only the lessor and not the lessee, is entitled to the credit. 
  • You placed the vehicle in service during your tax year.
  • The vehicle is manufactured primarily for use on public streets, roads, and highways.
  • The original use of the vehicle began with you.
  • You acquired the vehicle for use or to lease to others, and not for resale.
  • You use the vehicle primarily in the United States.

Credit for Multiple Vehicles – The credit is a per vehicle credit, thus if a taxpayer purchases multiple plug-in electric drive motor vehicles the taxpayer can claim the credit for each one.

Off-Road Vehicles & Golf Carts – Vehicles manufactured primarily for off-road use, such as for use on a golf course, do not qualify for the credit.

Allocation Between Business and Personal Use – When a taxpayer uses a qualified plug-in electric drive motor vehicle both personally and in the taxpayer’s business, the credit is divided (allocated) between personal use and business use and creates two separate credits, with the tax treatment of the two being quite different.

  • Personal Credit – The personal portion of the credit is non-refundable, meaning the personal portion of the credit can only offset a taxpayer’s tax liability and any excess not used in the year of purchase is lost. Thus, taxpayers need to be mindful of just how much benefit the credit provides and not necessarily expect to benefit from the full amount of credit for the vehicle.
  • Business Credit – The business use portion of the credit, on the other hand, becomes a business credit and any unused portion for the current year can be carried back to the prior tax year where it can offset tax liability in that year and result in a refund. If there is still unused credit it can carry forward for up to 20 years to offset future tax liabilities.

Credit Reduces Basis – For both the personal and business credit, the basis of the vehicle is reduced dollar for dollar by the amount of the credit. For a taxpayer claiming only the personal credit, this only becomes an issue when the vehicle is subsequently sold, since when determining the gain or loss on the sale the cost of the vehicle is reduced by the amount of any credit claimed. This is rarely an issue since vehicles are seldom subsequently sold for a profit. However, for a vehicle used for business, the credit reduces the depreciable basis of the vehicle. Also, no credit is allowed for any portion of a business vehicle expensed under Sec 179.

Business Standard Mileage – If a taxpayer uses a vehicle for business, they can choose between deducting actual expenses such as fuel, repairs, insurance, etc., or deducting a standard amount for each business mile driven. The standard mileage rate is determined periodically by the IRS using average costs of operating a vehicle. The IRS does not distinguish between fuel powered cars and electric cars, and both are allowed to use the same standard amount, even though the rate includes fuel costs. The business mileage rate for 2019 is 58 cents per mile, up from 54.5 cents per mile for 2018.

Call this office to determine how much benefit you will derive from the plug-in electric drive motor vehicle credit based upon your specific use of the vehicle, whether it is personal, business or a combination of the two.

Tax Reform Muted the AMT: Holders of Incentive Stock Options, Take Note

Article Highlights

  • Alternative Minimum Tax
  • Deterrent to Tax Shelters
  • Tax Reform Changes
  • Tax Deductions and Preferences
  • Incentive Stock Options
  • Tax Planning Opportunity

Although Congress, as part of the recent tax reform, promised to do away with the alternative minimum tax (AMT), it only did so for C corporations; as a result, the AMT still applies to individuals.

Congress originally developed the AMT in 1969 as a means to prevent high-income individuals from using tax shelters to reduce their taxes. For the AMT, federal income tax is calculated without certain deductions and tax preferences. This tax applies if it is greater than the regularly computed income tax. Although it has since been indexed to inflation, the AMT at one point began to apply to middle-income taxpayers, who are not the intended targets of this punitive tax.

The AMT computation includes a tax-exempt amount, but this amount begins to phase out for taxpayers whose adjusted gross income (AGI) exceeds a certain threshold (depending on their filing status). Although the tax reform did not eliminate the AMT, it did mute that tax considerably by increasing the AMT exemptions and by substantially raising the exemption-phaseout thresholds, as illustrated below. The exemptions and AGI phaseout thresholds will be inflation-adjusted in future years.

AMT EXEMPTIONS ($)
Status20172018
Married Filing Jointly or Surviving Spouse84,500109,400
Single or Head of Household54,30070,300
Married Filing Separately42,25054,700

 

EXEMPTION-PHASEOUT AGI THESHOLDS
Status20172018
Married Filing Jointly or Surviving Spouse160,9001,000,000
Single or Head of Household120,700500,000
Married Filing Separately80,450500,000

These are the tax deductions and preferences that most often affect the average taxpayer:

  • Some itemized deductions are allowed for the regular tax computation but not for the AMT computation.
  • Tier II miscellaneous itemized tax deductions are not allowed for the AMT computation; in addition, for the years 2018 through 2025, they are also not allowed for the regular tax computation. This category primarily includes employee business expenses, investment expenses, and legal fees. As these expenses aren’t currently deductible in either tax calculation, there is no adjustment for the AMT calculation.
  • The AMT computation does not allow the itemized deduction for interest on home-equity debt; such debt also is not deductible in the regular computation through 2025, which eliminates another difference in the two computations.
  • Employee incentive stock option tax preferences are also handled differently in the two computations, as is discussed in more detail later in the post.

As a result of the increased exemptions, the higher AGI thresholds for the exemption phaseout, and the reduction or elimination of differences in deductions, the AMT typically no longer affects average taxpayers.

Incentive stock options – Employers sometimes grant employees qualified stock options (i.e., incentive stock options), as motivation to become more involved in the company’s success and to share in the company’s stock appreciation.

For these options, the employer grants the employee an opportunity to purchase the company’s stock at a preset price on a future date. An option is usually accompanied by a vesting schedule that details the date when the options can be exercised (i.e., when the stock can be purchased). Once the employees has held these shares for more than a year—and for at least two years after the option was granted—any subsequent gains from sales of the stock are subject to the capital-gains tax instead of the ordinary (less favorable) income tax.

The Catch – The catch for incentive stock options is that, in the year when the employee exercises the option and purchases the stock, the difference (often referred to as the “bargain element”) between the stock’s current market value and the price that the employee paid as part of the option is treated as a tax preference. Thus, this difference is added to the employee’s AMT income but is not included in the regular tax income. In the past, this usually triggered the AMT, which meant that the employee had to pay tax on the phantom income in the year of the option, even though there was no actual stock sale. As a result, many employees have shied away from taking full advantage of incentive stock options; rather than holding the stock for the required qualifying period, they have been selling the stock in the year when they exercised the option, resulting in the profit being classified as ordinary income.

(Note that nonqualified stock options are not eligible for the beneficial tax treatment that incentive stock options are afforded. When a nonqualified option is exercised, the bargain element is included in the employee’s wages as ordinary income for the year when the option is exercised. However, this ordinary income is not a preference item for AMT purposes. Most employees who exercise nonqualified stock options immediately sell the stock so that they have money to pay the payroll taxes related to the resulting ordinary income. The paperwork that the employer provides when awarding the option states whether the option is qualified or nonqualified.)

Opportunity – The changes in the AMT present low- to moderate-income taxpayers with an opportunity to exercise incentive stock options without triggering the AMT.

If you hold incentive stock options, it may be possible to develop a plan—perhaps a multiyear plan—that will allow you to exercise your options without incurring phantom income in the AMT calculation. Please call this office for assistance in developing such a plan.

Will Gifts Now Using the Temporarily Increased Gift-Estate Exclusion Harm Estates after 2025?

Article Highlights:

  • Annual Gift Exclusion
  • Unified Gift-Estate Exclusion
  • Tax Reform’s Temporary Exclusion Increase
  • Taxpayer-Friendly Regulations

Individuals with large estates generally want to gift portions of their estate to beneficiaries while they are still living, to avoid or lessen the estate tax when they pass away. That can be done through annual gifts (up to the inflation-adjusted annual limit for each gift recipient each year – $15,000 for 2019) and/or by utilizing the unified gift-estate exclusion for gifts in excess of the annual exclusion amount. The tax reform virtually doubled the unified gift-estate exclusion for years 2018 through 2025, after which – unless further extended by Congress – it will return to its inflation-adjusted former amount. This has caused concerns related to what the tax consequences will be for post-2025 estates if the decedent, while alive, had made gifts during the 2018-through-2025 period utilizing the higher unified gift-estate exclusion. Would that cause a claw back due to the reduced exclusion?

The Treasury Department has proposed taxpayer-friendly regulations to implement changes made by the tax reform, the 2017 Tax Cuts and Jobs Act (TCJA). As a result, individuals planning to make large gifts between 2018 and 2025 can do so without concern that they will lose the tax benefit of the higher exclusion level for those gifts once the exclusion decreases after 2025.

In general, gift and estate taxes are calculated using a unified rate schedule on taxable transfers of money, property, and other assets. Any tax due is determined after applying a credit based on an applicable exclusion amount.

The applicable exclusion amount is the sum of the basic exclusion amount established in the statute plus other elements (if applicable) described in the proposed regulations. The credit is first used during life to offset gift tax, and any remaining credit is available to reduce or eliminate estate tax.

The TCJA temporarily increased the basic exclusion amount from $5 million to $10 million for tax years 2018 through 2025, with both dollar amounts adjusted for inflation. For 2018, the inflation-adjusted basic exclusion amount is $11.18 million; for 2019, it is $11.4 million. In 2026, the basic exclusion amount will revert to the 2017 level of $5 million, adjusted for inflation.

To address concerns that an estate tax could apply to gifts exempt from gift tax through the increased basic exclusion amount, the proposed regulations provide a special rule that allows the estate to compute its estate tax credit using the higher of the basic exclusion amount applicable to gifts made during life or the basic exclusion amount applicable on the date of death.

If you have any questions related to gifting and estate planning, please give this office a call.

When To Claim a Disaster Loss

Article Highlights:

  • Disaster Losses
  • Elections
  • Net Operating Loss
  • AGI Limitations
  • Possible Gain

Tax reform eliminated the deduction for casualty losses but did retain a deduction for losses within a disaster area. With the wild fires in the west, hurricanes and flooding in the southeast and eastern seaboard we have had a number of presidentially declared disaster areas this year. If you were an unlucky victim and suffered a loss as a result of a disaster, you may be able to recoup a portion of that loss through a tax deduction. If the casualty occurred within a federally declared disaster area, you can elect to claim the loss in one of two years: the tax year in which the loss occurred or the immediately preceding year.

By taking the deduction for a 2018 disaster area loss on the prior year (2017) return, you may be able to get a refund from the IRS before you even file your tax return for 2018, the loss year. You have until the unextended due date of the 2018 return to file an amended 2017 return to claim the disaster loss. Before making the decision to claim the loss in 2017, you should consider which year’s return would produce the greater tax benefit, as opposed to your desire for a quicker refund.

If you elect to claim the loss on either your 2017 original or amended return, you can generally expect to receive the refund within a matter of weeks, which can help to pay some of your repair costs.

If the casualty loss, net of insurance reimbursement, is extensive enough to offset all of the income on the return, and results in negative income, you may have what is referred to as a net operating loss (NOL). Because tax reform changed how NOLs are treated after 2017 your decision whether to claim the loss in the current year or the prior year will have significant tax ramifications.

  • Claimed in 2017 – If the loss is claimed in 2017 and results in an NOL, that NOL is carried back two years and the forward 20. Meaning if the loss results in a negative 2017 income the NOL can be carried back to your 2015 return before being carried forward.
  • Claimed in 2018 – Tax reform changed the treatment of NOLs and as a result no longer be carried back to prior years. In addition, NOL occurring in 2018 and subsequent years can only offset 80% of a subsequent years taxable income. Determining the more beneficial year in which to claim the loss requires a careful evaluation of your entire tax picture for both years, including filing status, amount of income and other deductions, and the applicable tax rates. The analysis should also consider the effect of a potential NOL.

Casualty losses are deductible only to the extent they exceed $100 plus 10% of your adjusted gross income (AGI). Thus, a year with a larger amount of AGI will cut into your allowable loss deduction and can be a factor when choosing which year to claim the loss.

For verification purposes, keep copies of local newspaper articles and/or photos that will help prove that your loss was caused by the specific disaster.

As strange as it may seem, a casualty might actually result in a gain. This sometimes occurs when insurance proceeds exceed the tax basis of the destroyed property. When a gain materializes, there are ways to exclude or postpone the tax on the gain.

If you need further information on disaster losses, your particular options for claiming the loss, or if you wish to amend your 2017 return to claim your loss, please give this office a call.

2019 Standard Mileage Rates Announced

Article Highlights:

  • Standard Mileage Rates for 2019
  • Business, Charitable, Medical and Moving Rates
  • Important Considerations for 2019
  • Switching between the Actual Expense and Standard Mileage Rate Methods
  • Employer Reimbursements
  • Employee Deductions Suspended
  • Special Allowances for SUVs

The Internal Revenue Service (IRS) computes standard mileage rates for business, medical and moving each year, based on a number of factors, to determine the standard mileage rates for the following year.

As it does annually around the end of the year, the IRS has announced the 2019 optional standard mileage rates. Thus, beginning on Jan. 1, 2019, the standard mileage rates for the use of a car (or a van, pickup or panel truck) are:

  • 58 cents per mile for business miles driven (including a 26-cent-per-mile allocation for depreciation). This is up from 54.5 cents in 2018;
  • 20 cents per mile driven for medical or moving* purposes. This is up from 18 cents in 2018; and
  • 14 cents per mile driven in service of charitable organizations.* For years 2018 through 2025, the deduction for moving is only allowed for members of the armed forces on active duty who move pursuant to a military order. 

The business standard mileage rate is based on an annual study of the fixed and variable costs of operating an automobile. The rate for medical and moving purposes is based on the variable costs determined by the same study. The rate for using an automobile while performing services for a charitable organization is statutorily set (it can only be changed by Congressional action) and has been 14 cents per mile for 20 years).

Important Consideration: The 2019 rates are based on 2018 fuel costs. Based on the potential for substantially higher gas prices in 2019, it may be appropriate to consider switching to the actual expense method for 2019 or at least to keep track of the actual expenses, including fuel costs, repairs and maintenance, so that the option is available for 2019.

Taxpayers always have the choice of calculating the actual costs of using their vehicle for business rather than using the standard mileage rates. In addition to the potential for higher fuel prices, the extension and expansion of the bonus depreciation as well as increased depreciation limitations for passenger autos in the Tax Cuts and Jobs Act may make using the actual expense method worthwhile during the first year when a vehicle is placed into business service.

However, the standard mileage rates cannot be used if you used the actual method (using Section 179, bonus depreciation and/or MACRS depreciation) in previous years. This rule is applied on a vehicle-by-vehicle basis. In addition, the business standard mileage rate cannot be used for any vehicle used for hire or for more than four vehicles simultaneously.

Employer Reimbursement – When employers reimburse employees for business-related car expenses using the standard mileage allowance method for each substantiated employment-connected business mile, the reimbursement is tax-free if the employee substantiates to the employer the time, place, mileage and purpose of the employment-connected business travel.

The Tax Cuts and Jobs Act eliminated employee business expenses as an itemized deduction, effective for 2018 through 2025. Therefore, employees may no longer take a deduction on their federal returns for unreimbursed employment-related use of their autos, light trucks or vans. Members of a reserve component of the U.S. Armed Forces, state and local government officials paid on a fee basis and certain performing artists continue to be allowed to deduct unreimbursed employee travel expenses, including the business standard mileage rate, because they are deductible from gross income rather than as an itemized deduction.

Faster Write-Offs for Heavy Sport Utility Vehicles (SUVs) – Many of today’s SUVs weigh more than 6,000 pounds and are therefore not subject to the limit rules on luxury auto depreciation. Taxpayers who purchase a heavy SUV and put it into business use in 2019 can utilize both the Section 179 expense deduction (up to a maximum of $25,500) and the bonus depreciation (if the Section 179 deduction is claimed, it must be applied before the bonus depreciation) to produce a sizable first-year tax deduction. However, the vehicle cannot exceed a gross unloaded vehicle weight of 14,000 pounds. Caution: Business autos are 5-year class life property. If the taxpayer subsequently disposes of the vehicle before the end of the 5-year period, as many do, a portion of the Section 179 expense deduction will be recaptured and must be added back to the taxpayer’s income (self-employment income for self-employed individuals). The future ramifications of deducting all or a significant portion of the vehicle’s cost using Section 179 should be considered.

If you have questions related to the best methods of deducting the business use of your vehicle or the documentation required, please give this office a call.

Don’t Overlook Tax Credits

Article Highlights:

  • Non-refundable vs. Refundable Credit
  • Childcare Credit
  • Earned Income Tax Credit
  • Child & Dependent Tax Credit
  • Saver’s Credit
  • Vehicle Tax Credits
  • Adoption Credit
  • Residential Energy-Efficient Property Credit

Tax credits are a tax benefit that offsets your actual tax liability, as opposed to a tax deduction, which reduces your income. Congress provides tax credits to individual taxpayers for a number of reasons, including as a form of assistance for lower-income taxpayers, to stimulate employment, and to stimulate certain investments, among other things.

Tax credits come in two types: non-refundable and refundable. A non-refundable credit can only reduce your tax liability to zero; any excess is either carried forward or is simply lost. In the case of a refundable credit, if there is excess after reducing your tax liability to zero, the excess is refundable. The following is a summary of some of the tax credits available to individual taxpayers:

Childcare Credit – Parents who work or are looking for work often must arrange for care of their children during working hours or while searching for work. If this describes your situation and your children requiring care are under 13 years of age, you may qualify for a childcare tax credit.

The credit ranges from 20% to 35% of non-reimbursed expenses, based upon your income, with the higher percentages applying to lower-income taxpayers and the lower percentages applying to higher-income taxpayers.

Applicable Percentage of AGI for the Childcare Credit

 

AGI OverBut Not OverApplicable PercentAGI OverBut Not OverApplicable Percent
015,0003529,00031,00027
15,00017,0003431,00033,00026
17,00019,0003333,00035,00025
19,00021,0003235,00037,00024
21,00023,0003137,00039,00023
23,00025,0003039,00041,00022
25,00027,0002941,00043,00021
27,00029,0002843,000No Limit20

The maximum expense amount allowed is $3,000 for one child and $6,000 for two or more, and the credit is non-refundable, which means it can only reduce your tax to zero, and the excess is lost.

As an example, say your adjusted gross income (AGI) is between $33,000 and $35,000. Your credit percentage would be 25%. If you paid childcare expenses of $4,000 for two children under the age of 13, your tax credit would be $1,000 ($4,000 x 25%). If your tax for the year was $5,000, the credit would reduce that tax to $4,000. On the other hand, if your tax for the year was $800, the credit would reduce your tax to zero, and the $200 excess credit would be lost.

This credit also applies when a taxpayer or spouse is disabled or a full-time student, in which case special “earned income” allowances are provided for months when the taxpayer or spouse is disabled or a full-time student. Please call this office for additional details if this situation applies in your case.

Earned Income Tax Credit (EITC) – Congress established the EITC as an income supplement for working individuals in lower-paying employment. If you qualify, it could be worth as much as $6,431 in 2018. It is a refundable credit.

The EITC is based on the amount of your earned income (income from work for wages and/or self-employment) and whether there are qualifying children in your household. Qualifying children are those who live with you for over half the year, are related, and are under the age of 19 or a full-time student under the age of 24. The credit increases as your earned income increases. The table below shows the earned income at which the maximum credit is achieved for 2018.

Qualifying ChildrenEarned Income Maximum Credit
None6,780$519
1$10,180$3,461
2$14,290$5,716
3 or more$14,290$6,431

The credit amount phases out after reaching the maximum based on filing status and number of qualifying children. The 2018 phase-out ranges are shown in the table below.

Qualifying Children

Filing StatusPhase-out Range
NoneMarried Filing Joint$14,170–20,950
Others$8,490–15,270
1Married Filing Joint$24,350–46,010
Others$18,660–40,320
2Married Filing Joint$24,350–51,492
Others$18,660–45,802
3 or moreMarried Filing Joint$24,350–54,884
Others$18,660–49,194

In addition, there are some qualification requirements: you, your spouse (if married and filing jointly), and each qualifying child must have a valid Social Security number, and you cannot use the filing status married filing separately. You cannot be a qualifying child of another person, your investment income for the year cannot exceed $3,500 (2018), and you cannot exclude earned income from working abroad. If you do not have a qualifying child, you must be at least age 25 but under 65 at the end of the year.

Even though this credit can be worth thousands of dollars to a low-income family, the IRS estimates as many as 25 percent of people who qualify for the credit do not claim it, simply because they don’t understand the criteria. If you qualified for but failed to claim the credit on your return for 2015, 2016, and/or 2017, you can still claim it for those years by filing an amended return or an original return, if you have not previously filed. Please call for assistance.

Members of the military can elect to include their nontaxable combat pay in their earned income for the earned income credit. If that election is made, the military member must include in their earned income all nontaxable combat pay they received for the year.

Child & Dependent Tax Credit – As an aid to families with children, the tax reform increased the child tax credit from $1,000 to $2,000 for each qualified child. A qualified child for this tax credit is one who is under age 17 at the end of the year, is related, is not self-supporting, lived with you over half the year, has a Social Security number, and is claimed as your dependent. The refundable portion of this credit is equal to 15% of your earned income but limited to $1,400.

Beginning in 2018, you are also able to claim a non-refundable credit of $500 for each of your dependents who do not qualify for the child credit.

For both the child and dependent credits, the credit begins to phase out for married taxpayers with an AGI of $400,000 ($200,000 for others).

Saver’s Credit – Congress created the non-refundable saver’s credit as a means of stimulating retirement savings among lower-income individuals. It helps to offset part of the first $2,000 that workers voluntarily contribute to traditional or Roth individual retirement arrangements (IRAs), SIMPLE-IRAs, SEPs, 401(k) plans, 403(b) plans for employees of public schools and certain tax-exempt organizations, 457 plans for state or local government employees, and the Thrift Savings Plan for federal employees. The saver’s credit is available in addition to any other tax savings that apply as a result of contributing to retirement plans. The credit is a percentage of the first $2,000 contributed to an eligible retirement plan. The following table illustrates the percentage based upon filing status and AGI for 2018.

Adjusted Gross Income Range Credit 
Married Filing JointHead of HouseholdOthersPercentage
$0–$38,000$0–$28,500$0–$19,00050
$38,001–$41,000$28,501–$30,750$19,001–$20,50020
$41,001–$63,000$30,751–$47,250$20,501–$31,50010
$63,001 & Over$47,251 & Over$31,501 & OverNo Credit

Example – Eric and Heather are married, both age 25, and filing a joint return. Eric contributed $3,000 through his 401(k) plan at work, and Heather contributed $500 to her IRA account. Their modified AGI for 2018 was $28,000. The credit is computed as follows:

Eric’s 401(k) contribution was $3,000, but only the
first $2,000 can be used………………………………………………………………….. $2,000
Heather’s IRA contribution was $500, so it can all be used……………. 500
Total qualifying contributions…………………………………………………………… $2,500
Credit percentage for a MFJ AGI of $28,000 from the table……………. X .50
Non-refundable saver’s credit…………………………………………………………….$1,250

Vehicle Tax Credits – If you are considering purchasing a new car or light truck (less than 14,000 pounds), don’t overlook the fact that Congress included a substantial tax credit for the purchase of the many electric vehicles currently being offered for sale, providing a tax credit worth as much as $7,500.

To be eligible for the credit, you must acquire the vehicle for use or lease and not for resale. Additionally, the vehicle’s original use must commence with you, and you must use the vehicle predominantly in the United States.

Congress did include a phase-out provision for this credit that applies by vehicle manufacturer. The credit begins to phase out once the manufacturer sells 200,000 electric vehicles. To see if the make and model you are considering qualify, visit the IRS website.

The credit is available whether you use the vehicle for business, personally, or a combination of both. The prorated portion of the credit that applies to business use becomes part of the general business credit, and any amount not used on your return for the year when you purchase the vehicle can be carried back to the previous year and then carried forward until used up, but for no more than 20 years. The personal portion is non-refundable.

Adoption Credit – If you are an adoptive parent or are planning to adopt a child, you may qualify for the adoption credit. The amount of the credit is based on the expenses incurred that are directly related to the adoption of a child under the age of 18 or a person who is physically or mentally incapable of self-care.

This is a 1:1 credit for each dollar of qualified expenses up to the maximum for the year, which is $13,810 for 2018. The credit is non-refundable, which means it can only reduce your tax liability to zero (as opposed to potentially resulting in a cash refund). But the good news is that any unused credit can be carried forward for up to five years to reduce your future tax liability.

Qualified expenses generally include adoption fees, court costs, attorney fees, and travel expenses that are reasonable, necessary and directly related to the child’s adoption, and they may be for both domestic and foreign adoptions; however, expenses related to adopting a spouse’s child are not eligible for this credit. When adopting a child with special needs, the full credit is allowed, whether or not any qualified expenses were incurred.

The credit is phased out for higher-income taxpayers. For 2018, the AGI (computed without foreign-income exclusions) phase-out threshold is $207,140, and the credit is completely phased out at the AGI of $247,140. Unlike most phase-outs, this one is the same regardless of filing status. However, taxpayers filing as married filing separately cannot claim the credit.

Residential Energy Efficient Property Credit – This tax credit was created to reward individuals for investing in equipment that uses alternative energy sources to create electrical power for use in a taxpayer’s home or second home. It includes alternative power sources such as fuel cells, wind energy, and geothermal heat pumps, for which the credit expires after 2021.

However, the credit is most commonly associated with the home solar credit, which is equal to 30% of the cost of the solar electric system for an individual’s primary and second homes, with no limit on the cost of the solar system. Even though the credit is non-refundable, any amount not used in the first year carries over to subsequent years.

The credit percentage is phased-out as shown in the table.

Home Energy Credit Percentage
Year2018–2019202020212021
Percentage302622None

Before deciding to add a solar electric system to your home, you need to consider if you can actually afford the system and whether it is worth having one, after taking into account the system’s cost, the financing interest, the reduced electricity costs, and the tax credit. You should make an objective analysis without pressure from a salesperson. These credits are substantial, but the one thing salespeople and contractors typically fail to mention is that the credit is not refundable, and even though it carries over through 2021, there is a good chance you will never use it all. It may be appropriate for you to consult with this office before entering into a contract for a home solar system.

If you have questions or would like additional details related to any of these credits, please give the office a call.

Wonder What a Tax Deduction Is Worth?

Article Highlights:

  • Non-business deductions
  • Tax bracket
  • Above-the-line deductions
  • Business deductions

Individuals are always looking for tax deductions that can reduce their tax liability. But what is the actual tax benefit derived from a tax deduction? There is no straightforward answer because some deductions are above the line, others must be itemized, some must exceed a threshold amount before being deductible, and certain ones are not deductible for alternative minimum tax purposes, while business deductions can offset both income and self-employment tax. In other words, there are many factors to consider, and the tax benefits differ for each individual, depending on his or her particular situation and tax bracket.

For most non-business deductions, the savings are based upon your tax bracket. For example, if you are in the 12% tax bracket, a $1,000 deduction would save you $120 in taxes. On the other hand, if you are in the 32% tax bracket, the $1,000 deduction will save you $320 in taxes. Even so, if your taxable income is close to transitioning into the next-lower tax bracket, the benefit will be lower. You also need to consider whether the particular deduction is allowed on your state return and what your state tax bracket is to determine the total tax savings. Currently, the maximum federal tax bracket is 37%, meaning the most benefit that can be derived from a $1,000 income tax deduction is $370. Some individuals justify making discretionary purchases just because they are tax-deductible. Even in the highest tax bracket, you are still paying $630 out of pocket ($1,000 − $370), so it does not make sense to incur a tax-deductible expense just for the tax deduction.

Some deductions, such as IRA and self-employed retirement plan contributions, alimony, and student loan interest, are adjustments to income or what we call above-the-line deductions. These deductions, to the extent permitted by law, provide a dollar deduction for every dollar claimed. Deductions that fall into the itemized category must exceed the standard deduction for your filing status before any benefit can be derived. In addition, medical deductions are reduced by 7.5% of your adjusted gross income (AGI) in 2018, and most cash charitable deductions are limited to a maximum of 60% of your AGI. Under the tax reform, the deduction for state and local taxes has been capped at $10,000.

The most beneficial deductions are business deductions that offset both income tax and, depending upon the circumstances, self-employment tax. For 2018, the self-employment tax rate is 12.4% of the first $128,400 of net self-employment income plus 2.9% for the Medicare tax, with no cap. Some high-income taxpayers may pay an additional 0.9% Medicare tax. For self-employed businesses with less than $128,400 of net income, the self-employment tax rate is 15.3%. Thus, for small businesses with profits of less than $128,400, the benefit derived from deductions generally will include the taxpayer’s tax bracket plus 15.3%. For example, for a taxpayer in the 24% tax bracket, the benefit could be as much as 39.3% (24% + 15.3%) of the deduction. If the deduction were $2,000, the tax savings could be as much as $806 or more, when the taxpayer’s state income tax bracket is included.

If you are planning an expenditure and expect the tax deduction to help cover the cost, please call in advance to ensure that the tax benefit will be what you anticipate.

Expecting Your Taxable Income to Be Low This Year? You Can Take Advantage of It

Article Highlights:

  • Adjusted Gross Income
  • Taxable Income
  • Graduated Individual Tax Rates
  • Take IRA Distributions
  • Redeem Government Bonds
  • Defer Deductions
  • Convert Traditional IRA Funds into a Roth IRA
  • Zero Capital Gains Rate
  • Business Expenses
  • Affordable Care Act

If your taxable income is exceptionally low this year, or even if you expect not to be required to file a tax return this year, a number of tax opportunities may be available to you. But time is running short, since these opportunities will require action on your part before year’s end.

However, before we consider actual strategies, let’s look at key elements that govern tax rates and taxable income.

Adjusted Gross Income (AGI) – This is the sum of all of your income that’s subject to tax, such as wages, interest, dividends, gains from sales, net self-employment income, retirement income, minus items that are specifically deductible without having to itemize your deductions, including contributions to traditional IRAs and self-employed retirement plans, interest paid on student loans, contributions to health savings plans, and a limited number of others.

Taxable Income – To be simplistic, taxable income is your AGI less the greater of the standard deduction for your filing status or your itemized deductions:

AGI
XXXX
Deductions– XXXX
Taxable Income
XXXX

If the deductions exceed your AGI, then you can end up with a negative taxable income, which means that to the extent it is negative, you can actually add income or reduce your deductions without incurring any tax.

Graduated Individual Tax Rates – Ordinary individual tax rates are graduated. So as your taxable income increases, so does your tax rate. Thus, the lower your taxable income, the lower your tax rate will be. Your income tax is the result of multiplying your tax rate by your taxable income (but to simplify the computation for those with taxable income up to $100,000, the IRS figures the tax by income range and provides look-up tables, so for most taxpayers, their tax rate is not apparent). Individual ordinary tax rates range from 10% to as high as 37%. For 2018, the taxable income amounts for the three lowest tax rates – 10%, 12%, and 22% – are:

Filing Status
Single
Married Filing Jointly
Head of Household
Married Filing Separate
10%
$0–9,525
$0–19,050
$0–13,600
$0–9,525
12%
$9,526–38,700
$19,051–77,400
$13,601–51,800
$9,526–38,700
22%
$38,701–82,500
$77,401–165,000
$51,801–82,500
$38,701–82,500

So for instance, if you are single, your first $9,525 of taxable income is taxed at 10%. The next $29,174 ($9,526 to $38,700) is taxed at 12%, and the next $43,799 ($38,701 to $82,500) is taxed at 22%.

Here are some strategies you can employ for your tax benefit. However, these strategies may be interdependent on one another and your particular tax circumstances.

Take IRA Distributions – Depending upon your projected taxable income, you might consider taking an IRA distribution to add income for the year. For instance, if your projected taxable income is negative, then you can actually take a withdrawal of up to the negative amount without incurring any tax. Even if your projected taxable income is not negative and your normal taxable income would put you in the 22% or higher bracket, you might want to take out just enough to be taxed at the 10% or even the 12% tax rate. Of course, those are retirement dollars; consider moving them into a regular financial account set aside for your retirement. Also, be aware that distributions before age 59½ are subject to a 10% early-withdrawal penalty even if there is no tax liability, so this strategy isn’t recommended for those younger than 59½.

Redeem Government Bonds – If you have invested in U.S. government bonds, such as Series EE or I bonds, and you’ve been deferring paying tax on the interest from these bonds until they mature, you may want to cash in the bonds prior to the year when they mature, if that maturity date is within the next few years and to the extent that adding the bond interest to your other income for the year won’t push you out of the zero or 10% tax bracket and into a higher bracket. This strategy isn’t advisable if the interest you would earn on the bonds if you held them to maturity would be more than the tax you can save by cashing in the bonds during a low-income year.

Defer Deductions – When you itemize your deductions, you may claim only the deductions you actually pay during the tax year (the calendar year, for most folks). If your projected taxable income will be negative and you are planning on itemizing your deductions, you might consider putting off some of those year-end deductible payments until after the first of the year and preserving the deductions for next year. Such payments might include house of worship tithing, year-end charitable giving, tax payments (but not those incurring late payment penalties), estimated state income tax payments, and medical expenses.

Convert Traditional IRA Funds into a Roth IRA – Roth IRAs provide tax-free accumulation and tax-free retirement distributions. So to the extent of any negative taxable income or even just for the lower tax rates, you may wish to consider converting some or all of your traditional IRA into a Roth IRA. The lower income results in a lower tax rate, which will provide you with an opportunity to convert to a Roth IRA at a lower tax amount.

Zero Capital Gains Rate – There are three capital gains rates depending upon your taxable income. When your taxable income is in the lowest range, as shown in the table below, you will actually pay no tax on your long-term capital gains. Thus, if your taxable income is within the zero percent long-term capital gains rate bracket, this is an opportunity for you to sell some appreciated securities that you have owned for more than a year and pay no tax on the gains.

Long-Term Capital Gains Rates (2018)
Filing Status
0%
15%
20%
Single
$0–38,600
$38,601–425,800
$425,801 & Above
Head of Household
$0–51,700
$51,701–452,400
$452,401 & Above
Married Joint
$0–77,200
$77,201–479,000
$479,001 & Above
Married Separate
$0–38,600
$38,601–239,500
$239,501 & Above

Business Expenses – The tax code has some very liberal provisions that allow a business to currently expense, rather than capitalize and slowly depreciate, the purchase costs of certain property. In a low-income year, it may be appropriate to capitalize rather than expense these current-year purchases and preserve the depreciation deduction for higher-income years. This is especially true when taxable income is negative in the current year.

Affordable Care Act – On the negative side, if you have obtained your medical insurance through a government marketplace, employing any of the strategies mentioned above will increase your taxable income and could impact the amount of your allowable premium tax credit. As a result, you would likely have to repay some or all of any advance premium tax credit that was used to reduce your health insurance premiums; the credit is reconciled on your tax return.

If you would like to discuss how these strategies might provide you with tax benefits based upon your particular tax circumstances or would like to schedule a tax-planning appointment, please give the office a call.