Copyright 1999 by A/N Group, Inc. This publication is designed to provide accurate and authoritative information in regard to the subject matter covered. It is distributed with the understanding that the publisher is not engaged in rendering legal, accounting, or other professional service. If legal advice or other expert assistance is required, the services of a competent professional should be sought. The information is not necessarily a complete summary of all materials on the subject.--ISSN 1089-1536
Individual Tax Return Tips--Part II--Here's our final installment of tax preparation tips for your 1998 return.
In Brief:--Tax, business, and personal finance tips.
What happens if you pay too much for a property? The IRS has a say in the matter. In Corbin West Limited Partnership (T.C. Memo. 1999-7) the Tax Court sided with the IRS in finding that the partnership paid more for a property than the fair market value. The Court disallowed from basis the amount of the purchase price that exceed the fair market value. The Court also found that, although the note was recourse to the partnership (but not to the partners), it was subordinated to other existing debts.
Want to know the tax consequences of a transaction before you do it? You can ask the IRS for a letter ruling on the transaction. It will cost you. The IRS charges for such rulings and you'll probably need professional assistance. Still, it may be well worth it. However, the IRS will not rule in certain areas. In Rev. Proc. 99-3 the IRS provided a revised list of those areas where it will not issue rulings.
In IR-1999-15 the Service announced that some individuals may have received a Form W-2 with an incorrect marking in Box 15, which contains checkboxes to indicate a statutory employee, a deceased person, pension plan coverage, a legal representative or deferred compensation. Those individuals may use the incorrect form when filing their tax returns. The problem arose from a change in the form by the IRS. The number of boxes was reduced from 7 to 5. Software problems by employers or other payers may cause the X to fall in the wrong checkbox. This problem only affects printed copies. Information filed on magnetic media aren't affected.
The failure to deposit penalties associated with withholding taxes can be the most expensive penalties in the tax area. In Rev. Proc. 99-10 the IRS provided guidance with respect to these penalties. The procedure describes how a taxpayer may designate the application of its federal tax deposits for a particular return period in order to minimize the failure-to- deposit penalty with respect to deposits required to be made after January 18, 1998.
It's always nice to be able to combine business with pleasure. The IRS is always on the lookout for such activities and tries to disallow deductions under the hobby loss rules. In Earl L. Miller and Nancy B. Miller (T.C. Memo. 1998-463) the taxpayer wrote travel articles. The Court noted that despite the fact that the taxpayer conducted the activity continuously and regularly, she had no profit motive. For the most part, the income from selling the articles didn't cover the cost of the trips.
One tax scheme making the rounds is 'split-dollar' life insurance used in conjunction with a charitable contribution. An individual makes a large contribution to a charity. The charity then purchases a life insurance policy or annuity contract in the name of the donor and pays most of the premiums. After the donor dies, the charity and the trustee split the tax- free proceeds of the insurance policy. One member of the House Ways and Means Committee has introduced a bill that would ban such practices.
Legal fees may or may not be deductible. Things become even cloudier when the legal fees are incurred in defending a stockholder in a corporation. In the case of Dennis W. Stark (T.C. Memo. 1999-1) legal fees were paid by an S corporation in the defense of its sole shareholder. The suit involved a former shareholder and the shares of the S corporation. The Court held that the fees were paid for the benefit of the shareholder, not the corporation. That meant they were not deductible business expenses.
What happens if a shareholder skims money from the corporation or pads his expense account? Can the corporation deduct the amounts as a theft or bad debt loss? Not according to the Tax Court. It ruled that where a shareholder has nearly complete control, the misappropriation of funds is not a theft loss. Dennis W. Stark (T.C. Memo. 1999-1).
Generally, if you cash in an annuity contract the total amount must be included in your income in the year you receive the funds. And, if you're not age 59-1/2 at the time, or don't qualify for one of the other exceptions to an early distribution penalty, you'll be liable for a 10% penalty tax. There's another exception to the rule. If you roll over the distribution into another annuity, you escape both the tax and the penalty. The idea is similar to a roll over of an IRA, but the exchange of funds must be done between the trustees. In Dona Elizabeth Conway (111 TC--, No. 20) the Tax Court sided with the taxpayer who transferred some of the funds in one annuity into another annuity. The funds were transferred directly between the insurance companies and the taxpayer indicated she wanted to take advantage of the tax-free treatment under Sec. 1035. By the way, much the same rules apply on life insurance contracts. You can exchange them. Be sure to get good advice. The dollar consequences can be substantial.
Regular corporations that have too much passive type income (rents, interest, dividends, capital gains, royalties, etc.) run the risk of being classified as a personal holding company. That can result in another tax at 39.6% on the corporation's undistributed personal holding company income. The rules are complex. Suffice it to say, you want to avoid being in this position. In Char-Lil Corporation (T.C. Memo. 1998-457) the taxpayer was near the threshold. The issue turned on how interest on property sales was treated. The Court held this was interest income. That put the company over the threshold.
The IRS has announced that the following publications are now available:
Limited liability companies (LLCs) have some unexpected complexities. In Rev. Rul. 99-6 the IRS a ruling on the federal income tax consequences where one person purchases all of the ownership interests in an LLC that is classified as a partnership. In this situation the LLC is considered terminated at the time of the sale. That situation can arise if one owner in a multi-owner LLC purchases the interest of all the other owners or an outsider purchases all the ownership interests.
In a another ruling (Rev. Rul. 99-5) the IRS discussed the tax consequences of converting a single-member LLC to a multi-owner entity. The deemed sale of the assets to the new member is considered a taxable transaction.
In Internal Revenue News Release IR-1999-09 the IRS announce the dates and locations of offices that will be open for walk-in tax assistance on personal tax issues through April 10, 1999. IRS representatives will be available at these offices from 8:30 a.m. to 12:30 p.m. on those days. To get a listing of the offices and the addresses go to the IRS website or call 1-800-829- 1040.
The projected budget surpluses are almost sure to generate some sort of tax legislation this year. President Clinton just submitted his budget and it includes a number of proposed changes. Small business should benefit from any changes. On the other hand, President Clinton is proposing a crackdown on tax shelters used by larger corporations.
In Rev. Proc. 99-14 the IRS announced the depreciation limits on passenger autos for 1999. They're virtually unchanged from last year. The limits are $3,060 for the first year; $5,000 for the second year; $2,950 for the third year and $1,775 for the fourth and all succeeding years. You can use the cents-per-mile valuation rule to value the personal use of a business car if the fair market value of the auto does not exceed $15,500. Finally, you're deduction for lease payments are limited if the fair market value of the auto at the beginning of the lease is greater than $15,500.
Individual Tax Return Tips--Part II
This is the second and last part of our tax preparation tips for your 1998 tax return. We'll return to our regular coverage in the next issue.
Individual Retirement Arrangements
In general. You've got many more choices this year than last, and a number of the rules have changed. Here are the most important points:
Nondeductible IRAs. These are the simplest. There are no restrictions on who can contribute as long as you or your spouse have enough earned income. You can contribute up to $2,000 (as can your spouse). The contribution is not deductible and the earnings are tax deferred until you withdraw the funds. If you can't make contributions to the other type of IRAs, it may still make sense to contribute to a nondeductible IRA. If you do so you must complete Form 8606. There are penalties for failing to do so.
Deductible IRAs. Now also known as traditional IRAs, these may still make sense. The advantage is an up-front deduction. If you're currently in a high tax bracket, the deduction may be worthwhile. The disadvantage is all the amounts withdrawn will be taxable at ordinary income rates.
There are a number of restrictions on deductible IRAs if you or your spouse are covered by a pension plan. If you're covered by a plan, contributions to a deductible IRA are restricted if your AGI is over $50,000 if married filing joint or $$30,000 if you're single or head of household.
New for 1998. If you're not covered by a plan but your spouse is, you can make a deductible contribution, but it's limited if your combined modified AGI is more than $150,000. If your modified AGI exceeds $160,000, no deduction is allowed. If neither of you are covered by pension plans, each of you can make and deduct $2,000 contributions.
Tax Tip--Business owners, or other individuals whose income can fluctuate widely, might benefit from a deductible IRA in years when your income is high. In the lean years, you could convert all or a portion of those IRAs to Roth IRAs, paying taxes on the income at a lower rate.
Roth IRAs. There's no deduction for a contribution to a Roth IRA, but any distributions (that meet the requirements) are tax free. You can make contributions to a Roth regardless of whether you or your spouse are covered by a pension plan. However, if your modified AGI exceeds $150,000 (married filing joint; $95,000 for taxpayers filing single or head of household), your contributions are limited. No contributions are allowed if your AGI exceeds $160,000 ($110,000 for single or head of household filers).
Spousal IRA. If you didn't have any earned income, but your spouse did, you may be able to make a total of $4,000 in deductible IRA contributions, if your earned income is at least that amount.
Withdrawals. Generally, distributions before age 59- 1/2 are subject to a 10% penalty tax (see From 5329 and the instructions). There are a number of exceptions to the penalty tax. For 1998 there are two new ones. The first is for distributions for qualified higher education expenses and the second is for first-time home buyers. The latter is limited to $10,000.
Publication 590. IRAs can be surprisingly complex. You can get more information from Publication 590.
Form 8606. You must file Form 8606 if you either made nondeductible contributions to a traditional IRA for 1998 or you received IRA distributions in 1998 and you have ever made nondeductible contributions to any of your traditional IRAs. If you overstate nondeductible contributions on your Form 8606 you'll be liable for a penalty of $100 for each overstatement. If you fail to file Form 8606 you'll be liable for a $50 penalty.
Excess contributions. If you make excess contributions to an IRA, you can be liable for a 6% excise tax. You can correct an excess contribution and avoid the penalty for 1998 by withdrawing the excess amount and paying the tax on the earnings by April 15.
Moving Expenses
In general. If your employer reimbursed you for qualified moving expenses the amount of the reimbursement will not be included in your income. If you received any reimbursement for moving expenses that were not qualified, they'll be reported on your W-2. Form 4782 is no longer in use.
You may be able to deduct some of your expenses for moving to a new home because you changed job locations or started a new job. You can qualify for the deduction whether you are self- employed or an employee, but you must meet certain requirements. You must generally satisfy two tests--the distance test and the time test.
You can deduct allowable moving expenses if your move is closely related to the start of work. You can generally consider moving expenses incurred within one year from the date you first reported to work at the new location as closely related. You may be able to extend the one-year period if you can show that circumstances existed that prevented the move within that time. For example, you delayed the move to a new location to allow your child to complete high school.
You can usually consider your move closely related in place to the start of work if the distance from your new home to the new job location is not more than the distance from your former home to the new job location. A move that does not meet this requirement can qualify if you can show that;
Distance test. Your move will meet this test if your new main job location is at least 50 miles farther from your former home than your old main job location was from your former home. For example, if your old job was 3 miles from your former home, your new job must be at least 53 miles from that former home. Measure the distance by the shortest of the more commonly traveled routes. The distance test considers only the location of your former home. It does not take into account the location of your new home.
Example--You move to a new home less than 50 miles from your former home because you changed job locations. Your old job was 3 miles from your former home. your new job is 60 miles from that home. Because your new job is 57 miles farther from your former home than the distance from your former home to your old job, you meet the 50-mile test.
If you go to work full time for the first time, your place of work must be at least 50 miles from your former home to meet the distance test.
If you go back to full-time work after a substantial period of part-time work or unemployment, your place of work must also be at least 50 miles from your former home.
If you have more than one job, it's your main job location that counts. Your main job location depends on the facts and circumstances. Important considerations are:
Time test. You've also got to meet a time test. That means you have to work a certain amount of time at the new job location. If you are an employee, you must work full time for at least 39 weeks during the first 12 months after you arrive in the general area of your new job location. You don't have to work for the same employer, but time as a self-employed person doesn't count.
If you are self-employed, you must work full time for at least 39 weeks during the first 12 months and for a total of at least 78 weeks during the first 24 months after you arrive at the new job location. You're not considered self-employed if you are semiretired, a part-time student, or work only a few hours a week.
Deductible moving expenses. If you meet the above tests, you can deduct the reasonable expenses of:
You can only deduct reasonable expenses. Thus, only the cost of traveling the most direct route counts. Side trips aren't deductible.
If you travel by car, you can deduct the actual expenses of operating the car or 10 cents per mile.
Moving costs. You can deduct the cost of packing, crating, and transporting your household goods and personal effects and those of the members of your household. You can deduct any costs of connecting or disconnecting utilities, shipping your car or pet, and the cost of moving your household goods and personal effects from a place other than your former home.
Nondeductible expenses. You can't deduct the following as moving expenses:
Time to deduct expenses. If you were not reimbursed, you can deduct the expenses either in the year you had them or in the year you paid them. If you where reimbursed, you can choose to deduct them in the year your employer reimburses you if:
Medical Expenses
Self-employed health insurance premiums. If you're self-employed, you can deduct 45% of any health insurance premiums on the first page of form 1040. The remaining 55% may be deductible as a medical expense on Schedule A. If you enter the information in a computer worksheet, the program should handle the details. You're considered self-employed if you operate as a sole proprietorship, are a partner in a partnership, owner in an LLC, or a shareholder in an S corporation. The rules with respect to an S corporation are more complicated.
Qualified long-term care insurance. Qualified long- term care insurance contracts are generally treated as accident and health insurance and are deductible as medical expenses on Schedule A. However, your deduction is limited. The limitation is based on your age. Check the table in our Fast Facts page.
Medical insurance premiums. You can deduct premiums for policies that provide payment for:
Cafeteria plans. You can't deduct insurance premiums paid by an employer-sponsored health insurance plan (cafeteria plan) unless the premiums are included in your income. In addition, you can't deduct any other medical and dental expenses paid by the plan unless the amount is included in your income.
Medicare. If you are covered under social security, you are enrolled in Medicare A. The payroll tax paid for Medicare A is not a medical expense. However, Medicare B is a supplemental medical insurance. Premiums you pay for Medicare B are a medical expense.
Meals and lodging. You can deduct as medical expenses the cost of meals and lodging at a hospital or similar institution if your main reason for being there is to receive medical care.
You may also be able to deduct the cost of lodging while away from home if you meet all of the following requirements:
The amount you include for lodging cannot exceed $50 for each night for each person. Lodging is included for a person for whom transportation expenses are a medical expense because that person is traveling with the person receiving the medical care. The maximum deduction for lodging expense for all parties is limited to $100 per night.
Example--You're receiving treatment in a medical facility 150 miles from your home. The treatments are daily and are provided on an outpatient basis. You can deduct up to $50 per night for your stay in a hotel.
Example--The facts are similar to the example above, but it's your 12-year old daughter who's ill and an outpatient. You accompany your daughter. You can deduct up to $100 per night of lodging.
Example--The facts are the same as in example 2, but this time your spouse accompanies you on the trip. Your lodging expense is still limited to $100 per night.
Meals are never deductible.
Car expenses. You can include out-of-pocket expenses such as gas, oil, etc. But you can't deduct insurance, repairs, etc. Alternatively, you can use the standard rate of 10 cents per mile.
Tax Tip--You might as well go with the 10 cents per mile. It's unlikely your actual expenses will be larger.
Deductible expenses. Here's a list of some deductible expenses:
Nondeductible items. You can't deduct:
Reimbursements. You must reduce your total medical expenses by all reimbursements you receive from insurance or other sources during the year. This includes payments from Medicare.
If you pay the entire premium for your medical insurance or all of the cost of a plan similar to medical insurance, generally you don't have to include an excess reimbursement in your income.
If your current or former employer pays the total cost of your medical insurance plan and your employer's contributions are not included in your income, you must report all excess reimbursements as other income.
Special rules apply if both you and your employer paid the premiums for medical insurance and your receive reimbursements in excess of your expenses.
If you are reimbursed in a later year for medical expenses your deducted in an earlier year, report as income the amount you received from insurance or other sources that is equal to, or less than, the amount you previously deducted as medical expenses.
Tax Tip--On the other hand, if you did not deduct a medical expense in the year you paid it either because you did not itemize or the total medical expenses didn't exceed the 7.5% of your AGI threshold, you don't have to include the reimbursement in income.
Damages for personal injury. If you receive an amount in settlement of a personal injury suit, the part that is for medical expenses deducted in an earlier year is included in income in the later year if your medical deduction in the earlier year reduced your income tax in that year.
Taxes
General rules. In order to deduct a tax it must be imposed on you and the tax must be paid during your tax year. Thus, if you pay the real estate taxes on your son's house, you can't claim a deduction because the taxes aren't imposed on you and he can't deduct the taxes because he didn't pay them. The best approach is to give the money to your son and let him pay the taxes.
The taxes are considered paid during the year if you mail the check by December 31.
Income taxes. You can deduct state and local taxes withheld from your pay during the year (the amount shown on your W-2) and any estimated payments, or payments for a prior year made during the year.
Example--Fred Flood made his last estimated payment for his 1997 state taxes in January 1998. That amount is deductible on his 1998 return. He paid $1,000 with his state return and made quarterly estimated payments of $2,000 in April, June and September, 1998. He can deduct all those amounts on his 1998 return. He made his final estimated payment in January, 1999. That amount is deductible on his 1999 return.
Real estate taxes. This one isn't as clear. Not all the amounts you pay for real estate taxes may be deductible. Deductible taxes include only taxes on real property levied for the general public welfare. The taxes must be based on the assessed value of the property and charged uniformly against all property under the jurisdiction of the taxing authority. Deductible taxes don't include charges for local benefits and improvements that increase the value of your property. For example, the following don't qualify as deductible taxes:
If you incur any of these charges, check your tax bill and reduce the total by the amount of the nondeductible charges.
Taxes for local benefits. Charges such as assessments for streets, sidewalks, water mains, sewer lines, public parking facilities, and similar improvements that increase the value of your property aren't deductible. However, they do increase the basis in your property. That will decrease your gain or increase your loss when you sell.
On the other hand, local benefit taxes for maintenance, repair, or interest charges related to those benefits are deductible.
Example--Your house is on a dead-end, unpaved road. The town assesses all the houses on your road a fee for paving the road. The fee is not deductible. On the other hand, future maintenance charges on the road are deductible.
Tax Tip--While the portion of your taxes that represent garbage collection may not be deductible as taxes, the amount should be included on Form 8829 as a home office expense.
Purchase and sale of real estate. If you bought or sold real estate during the year, the real estate taxes must be divided between the buyer and the seller. The amount is divided according to the number of days in the real property tax year that each party owned the property.
If you pay any delinquent taxes on the property, the amount is not deductible. Instead, add the amount to your basis in the property.
State and local personal property taxes. These are deductible if they are:
Sales taxes. These have not been deductible for some time, either for individuals or businesses. In the case of a business, the amount of the tax is added to your cost in the property and deducted as the cost of the property would be deducted.
Example--You purchase $100 worth of supplies for your business. In addition to the purchase price you pay $5 in sales tax. The tax is not separately deductible. However, when you deduct the supplies your deduction is $105. Similarly, if you purchase a computer for $2,000 and pay $100 in sales tax, you would take depreciation on $2,100.
Interest Expense
In general. Only certain types of interest are deductible, and even those are subject to restrictions. Interest on a first mortgage on your first and second (e.g., a vacation home) home is fully deductible. (There's a limit. No more than the first $1 million of debt counts. Mortgages taken out before October 14, 1987 don't have these restrictions.) Here are some of the other rules. You must be legally liable for the loan and both you and the lender must intend that the loan be repaid. In addition, the mortgage must be a secured debt on a qualified home. (Generally, that means that you put up the home as collateral.)
Other home mortgages. Home mortgages taken out to improve a first or second home generally qualify in full. However, you must be able to show you used the money for improvements.
Interest on home equity loans qualify for a tax deduction, but only on the first $100,000 of principal.
A boat can qualify as a second home if it has living accommodations such as a bath, kitchen, bedroom.
Intrafamily loans. You can deduct the interest on a loan from a family member, but it must be a bona fide loan. That is, there should be a promissory note, interest must be paid, etc. In the case of a home mortgage, the loan must be secured by the home. Record the mortgage with the county clerk or similar office. If you find later that you can't make the payments, check with your tax advisor.
Late charges and prepayment penalties. You can deduct as home mortgage interest a late payment charge if it was not for a specific service performed by the lender.
If you pay off the mortgage early, you may have to pay a penalty. You can deduct that penalty as home mortgage interest.
Sale of your home. You can deduct your home mortgage interest paid up to, but not including, the date of the sale.
Prepaid interest. If you pay interest in advance for a period that goes beyond the end of the tax year, you must spread this interest over the tax years to which it applies.
Graduated payment mortgage. In this type of loan, some of the interest in the early years is not paid, but added to the principal of the loan. Future interest is figured on the increased unpaid mortgage loan balance. You can only deduct the interest you actually paid during the year.
Reverse mortgage loan. A reverse mortgage loan is a loan that is based on the value of your home and is secured by a mortgage. The lending institution pays you the proceeds of the loan, either upfront or in monthly installments. The loan usually provides that the interest is added to the outstanding principal. You can deduct the interest on a reverse mortgage when you actually pay it, not when it is added to the outstanding loan balance. Any interest deduction is limited to the amount of the interest on the first $100,000 of principal amount, just like a home equity loan.
Points. If you pay points to get the mortgage, they may be deductible in the year you pay them. There are a number of rules, but, generally, the points have to be computed as a percentage of the principal amount of the mortgage, can't be for services rendered, must be for the acquisition or improvement of your principal home, and the payment of the amount of points paid must be an established practice in your area.
If you pay points on a second home or a refinancing, the points may be amortized over the life of the mortgage. If you refinance an existing loan and take down additional funds to improve the residence at the same time, you can allocate the points paid to the different portions of the loan. That is, a portion of the points paid would be deductible immediately and a portion amortizable over the life of the loan.
Seller pays points. If you are the seller and pay the points, you cannot deduct them. However, you can add them to the selling expenses of the home. If you're the buyer and the seller paid the points, you must reduce your basis in the house by the amount of the points.
Deducting unamortized points. If the mortgage ends early (e.g., you sell the house), you can deduct any unamortized points in full at that time.
More than one borrower. If you and at least one other person (other than your spouse) were liable for and paid interest on a mortgage that was for your home, and the other person received a Form 1098 showing the interest that was paid during the year, attach a statement to your return explaining this. Show how much of the interest each of you paid, and give the name and address of the person who received the 1098. Deduct your share of the interest on line 11 of Schedule A, and write 'see attached' next to the line.
Reporting the interest on Schedule A. If you received a 1098 for the interest, report the amount on line 10. If you paid more than the amount shown on the 1098, show the full deductible amount on line 10, but attach a statement. Write 'see attached' next to line 10. If you did not receive a 1098, report the amount on line 11. If you paid interest to the seller, show the seller's name, address, and taxpayer identification number on the dotted lines next to line 11. If you take a deduction for points that were not reported on a 1098, deduct the amount on line 12.
Mortgage proceeds invested in tax-exempt securities. You can't deduct home mortgage interest on grandfathered debt or home equity debt if you used the proceeds to buy securities or certificates that produce tax-free income.
Student loan interest. It's new for 1998. You can deduct up to $1,000 of interest paid on student loans. This isn't an itemized deduction. See line 24 of the front page of Form 1040.
Auto loan. Interest on an auto loan is generally not deductible. There's one exception. If you're self-employed and use the car in your business you can deduct the portion applicable to business use.
Investment interest. This interest is deductible up to the amount of your investment income. For example, you borrow $50,000 to invest in the stock market. You paid $5,000 in interest in 1998. All your stocks, bonds, savings accounts, etc. produce $4,500 in investment income. You can deduct $4,500 of investment interest on your tax return. The remaining $500 can be carried forward and deducted in subsequent years, subject to the same restrictions. Use Form 4952.
If you don't have sufficient income from interest, dividends and short-term gains, you can include long-term capital gains, but you must make a special election and forgo long-term capital gain treatment.
If you borrowed money to purchase an interest in a regular (C) corporation, even if it's your business, the interest is deductible only under the investment interest rules discussed above. If you borrowed funds and loaned the funds to your C corporation, the same rules apply.
However, if you borrowed money to purchase an ownership interest in an S corporation or partnership, the interest is fully deductible. Don't enter it here. Put the amount on Schedule E on the second page.
Allocating business interest. If you do business as a sole proprietorship and took out a loan where some of the proceeds were used for business purposes and some for personal purposes, you must allocate the proceeds and the associated interest payments.
Contributions
Qualifying organizations. Not all tax-exempt organizations qualify for a deduction. Legitimate churches always do. If you're unsure about the other organizations, get IRS Publication 78 (available at many libraries).
Contributions to fraternal societies, orders, and associations operating under the lodge system may or may not qualify. Your contribution is deductible only if it is to be used solely for charitable, religious, scientific, literary, or educational purposes, or for the prevention of cruelty to animals.
Foreign charities. Most foreign charities do not qualify for a tax deduction. Canadian and Mexican charities are a special exception. However, to deduct your contribution, you must have income from those countries.
Benefits you receive. If you receive a benefit as a result of making a contribution to a qualified organization, you can deduct only the amount of your contribution that is more than the value of the benefit you receive. There's an exception to this rule. If the benefit is nominal or the organization determines that the value of the item or benefit you received is not substantial and informs you of that, you can deduct the payment in full. If the value of the benefit you receive is more than $75, the organization must inform you of the value.
If you pay more than the fair market value to a qualified organization for the merchandise, goods, or services, the amount you pay that is more than the value of the item can be a charitable contribution. For the excess amount to qualify, you must pay it with the intent to make a charitable contribution.
Example--You go to an auction run by a charitable organization. The value of a doll is no more than $20, but you win it with a bid of $200. The excess amount, $180, is a charitable contribution.
Out-of-pocket expenses. If you do volunteer work for a charitable organization you can deduct your out-of-pocket expenses. In order to qualify the amounts must be unreimbursed, directly connected with the services, expenses you had only because of the services you gave, and not personal, living, or family expenses. Meal expenses associated with the performance of services are not deductible unless it is necessary for you to be away from home overnight.
For example, you purchase a uniform for use in your volunteer work. The cost of the uniform and laundering would be deductible, but only if the uniform is not suitable for everyday wear.
Car expenses are deductible. You can deduct out-of-pocket expenses such as the cost of gas and oil, but not general repairs, maintenance, depreciation, etc. Alternatively, you can take the standard mileage allowance of 14 cents per mile. Generally, you'll come out better using the standard mileage.
Conventions and travel. If you are a chosen representative attending a convention of a qualified organization, you can deduct actual unreimbursed expenses for travel and transportation, including a reasonable amount for meals and lodging. You cannot deduct personal expenses for sightseeing, theater tickets, etc. And you can't deduct your spouse's expenses.
You can claim a charitable contribution deduction for travel expenses incurred while you are away from home performing services for a charitable organization, only if there is no significant element of personal pleasure, recreation, or vacation in the travel. This applies whether you pay the expenses directly or indirectly. You are paying the expenses indirectly if you make a payment to the charitable organization and the organization pays for your travel expenses. You must have genuine and substantial duties throughout the trip.
Contributions to individuals. You cannot deduct contributions to specific individuals. For example, you make a contribution directly to a needy family whose home was destroyed in a flood. You can't take a deduction. On the other hand, if you contribute to a qualified organization that donates the money to the same family, you can take a deduction. You can't take a deduction if you can specify the needy family.
Payments to a member of the clergy that can be spent as he or she wishes are not deductible.
Payments to a hospital that are for services for a specific patient or for a specific patient's care are not deductible.
Other nondeductible contributions. You can't deduct contributions to chambers of commerce, or civic leagues and associations. However, these may be deductible as a business expense.
Tuition, or amounts you pay instead of tuition, even if you pay them for children to attend parochial schools or qualifying nonprofit day care centers aren't deductible. You can't deduct any fixed amount you may be required to pay in addition to the tuition fee to enroll in a private school, even if it is designated as a donation.
Property contributions. We discussed this topic in detail in an earlier issue, Charitable Contributions of Property. Go to there for more detail.
Here are some of the rules in a nutshell. If you made noncash contributions of less than $250, you must get a receipt from the organization showing:
You don't need a receipt if it's impractical to get one. For example, you deposit clothes in a drop-off bin.
If the contribution is at least $250 but not more than $500, you must get and keep an acknowledgment of your contribution from the qualified organization.
If the total of your noncash contributions is over $500, you've got to complete Form 8283. Read the instructions. If each individual contribution is under $500 you don't have to provide the date acquired, how acquired or the adjusted basis of the item.
If you contribute a group of similar items (books, stamps, etc.) during the year, even if to different charities at different times, and the claimed contribution exceeds $5,000 you'll need an appraisal.
When to deduct. If you mail a check, it's considered a contribution on the day mailed.
If you pay by credit card, take a deduction in the year you make the charge.
If you issue and deliver a promissory note or make a pledge, you can't take a deduction until the year you actually make payments on the note or pledge.
Recordkeeping. For each cash contribution that is less than $250 you need a canceled check or a diary or account statement notation that shows the check number, amount, date posted and to whom paid. If made by credit card, the amount, transaction date, and to whom paid.
If the contribution is $250 or more, you must get a written acknowledgment from the charity. The charity will know what information to include on the receipt. You must have the receipt on the earlier of, the date you file your return for the year your make the contribution or the due date, including extensions, for filing the return.
Casualty Losses
In general. Because a casualty loss must exceed 10% of your adjusted gross income (plus $100 per loss) in order to claim any deduction, you'll have to have a substantial loss before even considering a casualty loss. We won't go into detail here, just mention some high points. You must use Form 4684 to report a casualty or theft loss.
Amount of loss. The amount of your loss is the decrease in the fair market value of the property before and after the loss. It's not the cost of repairs, although they can be a good indication of the amount of the loss.
Example--You incur $10,000 in auto repairs as a result of an accident. You weren't covered by collision. The value of the car before the accident was $20,000. The cost of repairs would be a good indication of the loss.
Example--The facts are the same as in the example above, but the value of the car before the accident was only $8,000. Your loss would be limited to $8,000.
Of course, in the case of a theft loss, there is no value after the loss.
Appraisal. There's a high probability the IRS will question a casualty loss. Getting an appraisal generally makes sense. The cost of the appraisal is deductible, but only as a miscellaneous itemized deduction subject to the 2% of AGI rule. In the case of auto, you can often rely on a recognized blue book. Be sure to take photos, get a police report, etc. You can't have too much documentation.
Cleanup costs. Like repairs, they're technically not part of the casualty loss, but they are an indication of the decrease in fair market value as a result of the casualty.
Nondeductible loss. Some losses are not casualty losses. They include accidental breakage, progressive deterioration, a car accident or other casualty if your willful negligence or willful act caused it, misplacing property, etc.
Employee Business Expenses
In general. If you're an employee (that includes an employee/owner in an S or regular corporation) you can only deduct unreimbursed business expenses if the employer has a policy of not reimbursing for some or all expenses. You won't have any deductible employee business expenses if all of the following are true:
Car expenses. You probably know the rules by now. You can take the standard mileage allowance of 32.5 cents per mile or your actual expenses. You can't take the standard mileage allowance if you ever used the actual expense method and depreciated the car using an accelerated method.
Not all travel is deductible. Generally, travel from your home to the office is commuting and not deductible. If you have two jobs, there's a good chance you'll be able to deduct at least some of your expenses. Here's a quick review:
Educational Expenses
There have been a number of changes to the rules for educational expenses in recent years. We've covered some of the changes in back issues. Here's a quick summary.
Work related courses. These may or may not be deductible. If your employer requires you to take courses, but won't pay for them, you should be able to deduct them. Generally, the courses must be necessary to keep your present salary, status, or job. The education must not be part of a program that will qualify you for a new trade or business. You must have already met the minimum education requirements for the job. CAUTION. The definition of a new trade or business is broad. An accountant taking courses to qualify to become a CPA is taking courses for a new trade or business.
If your education is not required by your employer or a law (such as continuing professional education requirements to keep a license), it must maintain or improve skills need in your work.
If you meet the above criteria, you can deduct tuition, books, supplies, lab fees, certain transportation and travel costs, related costs such as the cost of research and typing when writing a paper. Meals and lodging may be deductible if you travel overnight to obtain the education and the main purpose is to attend a work-related course or seminar.
If you could have been reimbursed from your employer, but did not seek reimbursement, you can't deduct the expenses.
If you're an employee, you should generally start by putting the expenses on Form 2106. If none of your expenses were reimbursed, and you're not claiming travel expenses, you can put the amount directly on Schedule A as a miscellaneous itemized deduction.
If you're self employed, deduct the amount on Schedule C.
Employer education assistance program. If your employer has such a program, payments up to $5,250 per year for most educational expenses are excludable from your income.
Hope credit. For expenses paid after December 31, 1997, for academic periods beginning after that date, you may be able to claim a Hope credit of up to $1,500 for the qualified tuition and related expenses paid for each eligible student. You can claim the maximum credit if you have at least $2,000 of qualifying expenses. The credit may be claimed for only two taxable years for each eligible student. The credit is phased out for taxpayers with incomes above $80,000 for a married couple filing jointly or $40,000 for a single individual. Use Form 8863.
Lifetime learning credit. The maximum credit per year, per family is limited to $1,000, but there's no requirement that the student take a certain work load (one course will produce a benefit), no restriction on the first two years, graduate-level courses qualify, etc. The credit is phased out above certain income levels. See the Hope credit. Use Form 8863.
Child tax credit. You're eligible for a $400 credit for each qualifying child you have. A qualifying child is:
The credit is phased out if your AGI is above $110,000 (married filing joint) or $75,000 for a taxpayer filing single or head of household.
If you have 3 or more qualifying children, you may be able to claim an additional credit.
Miscellaneous Deductions
In general. Miscellaneous deductions are generally subject to a 2% of AGI floor. That means only the amount that exceeds 2% of your AGI is deductible. There are some exceptions.
Here's a list of items that may be deductible, subject to the 2% floor:
Certain expenses are not subject to the 2% floor. They included:
If you're claiming gambling losses against your winnings, you must keep a diary with the following information:
More
There's plenty of extra help available. If you're going it alone, the first place to look is in the IRS publications. You can download them from the IRS website. Our Fast Facts page has a listing of the most important IRS publications and forms along with a host of other information.
Previously Reported In Daily Update
Year 2000 . . . Less people are laughing about the problem. They're finding problems in software they thought was bullet proof. And, if you think your insurance company will bail you out, think again. The renewal policy you just signed may have a clause specifically excluding claims associated with a year 2000 problem. For example, your business interruption insurance may exclude such claims. That could have far reaching effects. For example, you don't have a problem, but the supplier of a critical part does. You don't get the part and your line shuts down. If your insurance doesn't cover you, your only recourse may be to sue your supplier. If a security system fails, losses from theft may not be covered. Read your policy, ask your agent, and plan ahead.
Responsibility and control . . . If you have the responsibility for certain actions, you should have the ability to control the outcome. That's especially important if you're in business with another. (That's why a partnership can be dangerous. You can be held liable for any actions of the other partners.) Whether it's a joint venture, corporation, etc. if you aren't in control, be sure your liability is limited to your investment, and be sure you're kept up to date on the business and can bail out if necessary.
Buying a business? . . . If you're buying stock in a corporation, life is easy. You simply have the seller sign over the certificates. However, if you're buying assets, the tax laws see it as a sale and purchase of the individual assets. For sales tax purposes inventory items will probably be exempt; so may equipment used in the production process. (Check with your tax advisor to be sure.) But desks, computers, trucks, etc. are probably all subject to sales tax. That's another good reason to assign a value to individual items in the sales contract. Without it you may need an appraisal to determine the values.
Collision damage waivers . . . You know what this is. It's the extra coverage on a rental car that covers collision and theft, usually at a hefty price. Do you need it? Probably not. More than likely your regular auto insurance policy will pay for the damage. Even if you don't have regular auto insurance, you may still be covered if you rented the car using a major credit card. Check with your insurance company or credit card issuer to see if you're covered. And be sure to ask about any limitations. You may not be covered for the rental of a luxury auto or a sport utility vehicle. Another point. Even if you purchase coverage from the rental car company, read the small print. You may not be covered if the damage occurs while you were under the influence of alcohol or in violation of a traffic law.
Package deals may not be the most economical . . . You know the pitch. Give us your business and personal checking and savings accounts and we'll give you a special deal. Or use our long distance, cellular, internet, and paging, etc. package and get one low monthly bill. Maybe. But unless your major objective is convenience (e.g., one stop banking or one bill), check out your other options. You may be able to get better service or a lower rate by using one carrier for long distance, another for cellular. And, as always, review your choice at least once a year, especially if the market is competitive and/or changing.
What's in a name? . . . Plenty of trouble if you're not careful. Make sure the check is correctly made out to your business before accepting it. You don't want to get into a hassle with your bank. If you're changing your name or merging with another business, or do business as a division using a d/b/a, make sure you have the required paperwork to prove the name change, etc. Change all letterheads, business cards, etc. as soon as possible. You don't want to mislead suppliers, customers, etc. That could result in legal problems, particularly if you're changing from a sole proprietorship or partnership to a corporation or LLC.
Free gift good direct marketing tool . . . Will the offer of a free gift, whether or not the prospect buys, pay off? According to some experts, yes. In a test, the cost of the gift was low, but the perceived value was significant. The giveaway pulled so many paying customers that the return more than outweighed the extra cost of the gift compared to a direct mailer with no gift. We're certainly not suggesting it'll work in every case, but it's worth a test.
Estate taxes . . . The executor or administrator of an estate is the one responsible for filing the estate return and paying the taxes. But what if there is no executor or administrator? In that case, every person who is in actual or constructive possession of any property of the decedent is considered to be an executor. If you're an heir and find yourself in such a situation, you should seek a competent attorney. You may want to get together with the other parties and pool your resources to file the return.