Tax and Accounting Unique Content

Changes to Make Now to Optimize Your 2018 Tax Return

With the 2017 tax season in full swing, thinking about what to do for 2018’s taxes may seem too far away right now. But with the last-minute sweeping overhaul made to the tax code late last year, it’s definitely not too early to start making some changes to your ordinary recordkeeping habits for your taxes sooner and change some decisions you had planned. Most of the provisions will expire in eight years without further action from Congress but for now, here’s what you need to do to get off on the right foot for 2018 taxes.

Change your tax withholding if necessary.

When you have taxes taken out of your paychecks, they go by a table the IRS updates every year. When starting a new job, people file a Form W-4 to claim allowances where the more you claim, the less taxes you’ll have withheld. You can always update your withholding by giving your employer a new W-4. Now that the withholding tables have significantly changed, you might not be having enough taxes taken out and could end up with a smaller refund than expected or owing taxes. Your employer must implement the new withholding tables by February 15, 2018.1

Once your 2017 tax return is completed, if you expect 2018 to be similar in terms of income and deductions you should definitely compare your withholding and make sure enough is being taken out. Since the IRS is also updating Form W-4 for these tables, you will want to submit one once the 2018 version is available.

Don’t neglect state and local income taxes.

You also don’t want to forget about withholding at the state and local level. Washington DC, Maryland, and Virginia residents are subject to state income taxes while Philadelphia and New York City residents also pay them at the city level. If you’re starting a new job you will also need to file the state and local equivalents of Form W-4 to have taxes properly withheld.

However, major changes were made to itemized deductions where state and local income taxes now have to be combined with real estate taxes for a maximum deduction of $10,000. The state and local income tax deduction has been the largest expenditure in itemized deductions, particularly for taxpayers earning $200,000 per year or higher.2 While you need to ensure that your state income taxes are also sufficiently withheld, there is now less incentive to over-withhold at the state and local level to get a larger itemized deduction.

If you’re thinking of taking out a home equity loan, only do so if you’re going to use it for major home improvements.

There is a lot of confusion surrounding the deductibility of home equity loan and HELOC interest since it was outlined in the tax bill as a deduction being eliminated. Provided that the proceeds of the loan are being used to make a substantial improvement (like an addition) to your home, you can still deduct the interest. But you can no longer deduct home equity interest used for personal purposes.

With the state income and real estate tax deductions severely hampered for the next eight years, you’ll want to take advantage of the bigger mortgage and home equity loan interest deduction that comes in the early years of their lives when your payments are predominantly interest. However, the mortgage interest deduction is now limited to $750,000 in principal on new mortgages.4 Older mortgages have been grandfathered in under the old limit of $1,000,000 ($1,100,000 after accounting for home equity debt) but there is no grandfathering for home equity loans. Be mindful of how much you are borrowing relative to your home’s principal so your total outstanding debt is less than $750,000.

Pay extra attention to medical expenses for the year.

The tax overhaul limited the largest itemized deductions in favor of a higher standard deduction. However, the medical expense deduction rolled back to 7.5% of adjusted gross income regardless of age.5 While this provision is also retroactive for the 2017 tax year, it will revert to 10% of adjusted gross income (7.5% for taxpayers age 65 and older) in 2019.

Given that the new standard deduction is $24,000 for married couples filing jointly, $18,000 for heads of household, and $12,000 for all other taxpayers, this benefit would only apply to those who are extremely burdened by healthcare costs. Deductible medical expenses include premiums for health and dental insurance, payments to doctors and hospitals, transportation to and from healthcare facilities, and prescription drugs. If you have any doctor visits or medical bills you were putting off and you’re under 65, 2018 would be a good time to claim them since they will be harder to deduct in 2019 onward.

Make efficient use of 529 plans.

If you send your children to private school, you can now make tax-free withdrawals from 529 education savings plans. You can withdraw up to $10,000 per student (not per account) for tuition paid to an elementary or secondary school.6 In spite of this limitation, you may want to consider opening a second 529 plan separate from your children’s college savings given the shorter timeframes for the investments.

Consider making a career change to freelance or contract if you frequently have unreimbursed job-related expenses.

The tax reform eliminated the employee business expense deduction.7 Self-employed taxpayers can still deduct business expenses as usual and there is also a new 20% deduction of profits for the owners of pass-through business entities like sole proprietorships and S corporations. While transitioning from employee to self-employed entails new recordkeeping requirements and having to pay self-employment taxes (Social Security and Medicare that you now must pay both the employee and employer share of), the loss of several tax benefits for employees and the new deduction for small business owners has made switching to contract status more preferable for some taxpayers in 2018 and onward. If you have to pay for conferences, travel, continuing education and licenses, and similar expenses out of pocket that take a significant bite out of your pay then it’s definitely worth considering.

The IRS may issue further interpretations of the 2018 tax reform and Congress could also make additional updates before 2019. With the reforms that are currently in effect, making or considering these changes while it’s still early in the year can result in a lower tax bill when it’s time to file your 2018 tax return.

2018 Tax Reform – Effect on Businesses

With the sweeping changes brought to individual taxation from the Tax Cuts and Jobs Act, business taxpayers also face a significant overhaul that will affect 2018 tax planning. The corporate tax cuts will be permanent unlike the personal tax provisions, but items that affect small businesses are subject to more frequent changes although some will expire by 2025 just like the personal tax changes. For professionals operating as sole proprietors, there are many incentives to grow your business and switch to a corporate form but also new benefits for pass-through business entities. Here are the provisions most likely to affect small business taxpayers.

Computers Are No Longer Listed Property

Listed property refers to types of business assets that often have highly personal elements like cars and computers. They were in this category for a long time since they’ve become necessary for daily life but this restriction has been lifted. You no longer have to keep records proving that the computer was used solely for business (such as having no games or personal files on it.)

Changes to Business-Related Meals and Entertainment

In the regular course of business and traveling for work, meals are still 50% deductible if you’re self-employed. If you have employees and provided meals for them because it was for your convenience, this was fully deductible but is now also subject to the 50% limit. This provision is set to expire in 2025 meaning that there will no longer be a deduction for on-site meals.

Business entertainment however, such as taking a client out to a concert, was also subject to the 50% limit and is now no longer deductible. The only entertainment expense that survived the 2018 tax reform is office parties on the premises when you have employees. You can’t deduct off-site recreation anymore or facility rental regardless of whether you have employees or not.

20% Deduction on Pass-Through Profits

95% of all American businesses are pass-through entities, even some very large businesses such as Georgia-Pacific. For many professionals like doctors and attorneys, choosing whether to operate as a pass-through or corporation depends on both legalities in the states where you operate in addition to taxes. There are new benefits to operating as a pass-through like an S corporation, partnership, or sole proprietorship for tax purposes to go hand in hand with the major cuts to corporate tax rates.

This deduction has both an income limit and phaseout range. To be able to take the deduction, your total taxable income needs to be under $315,000 if married filing jointly and less than $157,500 for all other filing statuses. If your income falls below these amounts, you can take a 20% deduction of your business profits. The phaseout range employs the next $50,000 in total taxable income so if your income is above $365,000 for married filing jointly and $207,500 for every other filing status, then you don’t qualify for the deduction. But if your income falls between those two amounts, then you can deduct a percentage of your profit but not the full 20% and there are also two limitations to contend with. The first is your chief product followed by a "required investment" formula.

If your income is higher $315,000 (or $157,500), you cannot be in a line of work where the chief product is your skills or reputation so this excludes most professional-class small business owners with one exception for engineers. You are then limited by the required investment formula. The formula limits your deduction to 25% of employee wages reported on W-2s plus 2.5% of the unadjusted basis of eligible business property (which must be in the 10-year class or greater such as office furniture and fixtures and real estate.) It doesn’t matter when the property was put into service, so long it’s in a 10-year class or longer.

Regardless of whether you qualify for the pass-through deduction or not though, your self-employment tax obligations do not change. This deduction only reduces income tax while only business expenses will reduce your self-employment tax.

Corporate Tax Rates Permanently Reduced

If you plan on reorganizing your business as a C corporation, now may be a good time to do so. The maximum corporate tax rate has been reduced to 21% and this is permanent. For professionals operating as personal service corporations, the House initially proposed a 25% rate but since the new maximum is 21% this is the new rate for personal service corporations.

The bill has sought to make it easier to convert pass-through businesses to C corporations within the next two years in the event that you don’t benefit from the pass-through deduction and/or face a tax increase from other personal and business provisions of the bill.

Net Operating Losses Now Generate Interest

If your pass-through business generated a loss in the past, you could usually always offset both future and past income by carrying net operating losses up to 20 years forward and two years back.

2018 tax reform vastly changed net operating losses in a few ways. First, there is no election to carry back. You can only carry forward now but the 20-year limit is gone so you can carry forward indefinitely. However, your perpetual carryover has another limit: only 80% of business net income can be offset now. If your revenue was low and you had a lot of expenses as is common with starting a new business, you’ll benefit less compared to past calculations which only looked at the big picture and also let you offset other types of income with it. For instance, if you still work at a job or your spouse does, your loss could offset both of your wages and result in significant tax savings. You can’t do this anymore.

While limiting the loss to business income only puts a damper on the massive deductions net operating losses used to bring, there are two new benefits as well. You can carry a net operating loss forward infinitely, so if you decide to save it for a year when you greatly exceed your business goals then you can do so. Additionally, net operating losses are now also treated as if they generated interest over time to preserve the value of what you invested in your business so you’ll get to deduct the "interest".

Given that the provisions of the 2018 tax bill disproportionately benefits business over wage earners, contract workers and self-employed professionals are included with the former. It could be a good time to think about making a career change given that employees can’t deduct business expenses anymore but the self-employed have new benefits.

2018 Tax Reform – Effects On Individuals

Tax laws change every year, but the 2018 Tax Cuts and Jobs Act is one of the largest overhauls to the tax code that has taken place in over 30 years. It will vastly change the way that personal income taxes are prepared for the next decade: while the corporate tax cuts in the final bill are permanent, the individual provisions described below are set to expire in 2025.

Your 2017 tax return will not be affected by the new law, but this major change goes into effect for the 2018 tax season and beyond. Here are the chief individual tax provisions that have drastically changed the most with the frenzied passage of this bill.

Dependents, Exemptions, and Expanding the Child Tax Credit

One of the foremost changes the 2018 overhaul is bringing is in the way that taxpayers claim dependents. Personal and dependent exemptions have been eliminated in favor of virtually doubling the standard deduction for all filing statuses.

While it seems simplified and possibly more beneficial for a single filer with no dependents, families and caregivers can no longer claim multiple exemptions. However, this is expected to be offset with the Child Tax Credit has been vastly expanded. It is now available for taxpayers earning up to $200,000 ($400,000 if married filing jointly) and doubled from $1,000 to $2,000 per qualifying child. If you claimed dependents as qualifying relatives, such as parents or grandparents, you can get a nonrefundable credit of up to $500.

Above-the-Line Deductions Eliminated

Normally, you’d be able to deduct Job-related moving expenses if you moved more than 50 miles from your current residence to your new job. This deduction has been eliminated with the only exception for members of the armed forces who are changing stations or under orders to move.

Transit benefits you receive from your employer are also no longer tax-free.

Filing Statuses and Tax Rates

The marriage penalty has largely been eliminated since the income thresholds for all but the top two tax brackets have doubled for married people who file jointly. In previous years, it was possible for two people to pay a lower tax rate as single taxpayers or filing separately if their income would’ve put them in a higher tax bracket as a result of filing jointly. With the exception of couples with taxable income exceeding $400,000, the marriage penalty is no longer a concern.

Additionally, the proposal to put personal income taxes in just three brackets did not go through in the final bill. There are still seven brackets but at lower rates, with the lowest bracket still at 10% but the highest is now 37%. The middle brackets are now 12%, 22%, 24%, 32%, and 35%.

Changes were also made to the capital gains tax. Short-term capital gains are still taxed at ordinary rate but ordinary rates are much lower for seasoned investors than they were previously. The three different capital gains tax brackets now don’t completely sync with the seven income tax brackets in that while there’s 0% up to $38,600 in income ($77,200 for married filing jointly), the 15% bracket applies from $38,601 to $425,800 ($479,000 for married filing jointly) and the 20% bracket applies over those last two amounts.

The net investment income tax (NIIT) is also still in effect for high-income taxpayers. If Congress repeals the Affordable Care Act, this tax may be eliminated in the coming years.

Itemized Deductions Materially Changed or Eliminated

Given the massive increase to the standard deduction for each filing status, along with the following limitations that have been imposed, it’s expected that far fewer people will itemize than they had in the past.  The chief deductions that push most people to itemize– mortgage interest, real estate taxes, and SALT (state and local income taxes)– have been subject to major changes.

Mortgage interest can only be deducted if the principal is $750,000 or less and you went under contract prior to December, 15, 2017 with a closing date preceding January 1, 2018. Mortgages that already exist are not affected by this change and you can keep deducting mortgage interest on principal up to $1 million. The interest on home equity debt is also no longer deductible regardless of the purpose or amount, when it used to be up to $100,000 providing that it was to maintain or improve your home. Any existing or new home equity loans will no longer result in deductible interest.

Real estate, personal property, general sales tax, and SALT taxes are still deductible but the limit is $10,000 for all of those taxes combined. If your real estate taxes alone exceed $10,000, you’re still limited to $10,000 total which wasn’t the case in the past. This move is expected to disproportionately impact taxpayers in high-tax states where income or real estate taxes can easily exceed $10,000 on their own.

Various itemized deductions were also eliminated such as employee business expenses as well as the other miscellaneous deductions subject to the 2% threshold. Tax preparation fees are no longer deductible. Casualty and theft losses were also cut with the only exception being losses that occurred in federally-declared disasters. Expenses not subject to the 2% threshold, such as gambling losses and legal fees for reclaiming taxable income, are still deductible. The definition for gambling losses was also expanded to include expenses incurred as part of gambling activities.

Charitable contributions and medical expenses were the only provisions that became more beneficial with the tax bill. You can now deduct donations equaling up to 60% of your income, and the standards for gifts to charity are largely unchanged although gifts to colleges in for the right to buy tickets for athletic events can’t be deducted anymore. Medical expenses still have a threshold based on adjusted gross income which rolled back from 10% to 7.5% regardless of your age. Unlike the other material changes made to the tax code, this provision also applies for qualified medical expenses in 2017.

Shared Responsibility Payment to be Eliminated in 2019

Congress did not repeal the Affordable Care Act but they did cut the individual mandate. The shared responsibility payment ("Obamacare penalty") you are charged if you don’t have health coverage and aren’t exempt is going to be eliminated. However, this penalty still applies for the 2018 tax year.

529 Plans Now Cover Private School and Tutoring

The tax benefits for higher education have been unchanged in that the tuition waiver for grad students is still in place, student loan interest is still deductible, and the Lifetime Learning Credit is still in place. But if you started a 529 plan for your child’s college education, you can now make tax-free withdrawals from these plans to pay for private school at any education level in addition to tutoring for your K-12 student.

With the exception of medical expenses which currently applies, and the penalty for lacking health insurance which isn’t until 2019, none of these provisions will affect your 2017 return but will need to be kept in mind for your 2018 tax return.

How to Save Taxes with Your Family Business: Tax-Free Payments to Your Kids

The federal income tax was first enacted in 1913. The tax code was relatively concise, and in these simpler times family businesses were once the backbone of the US economy. The tax code is now several million words long and requires a vast majority of people to use a tax professional in order to navigate it. But despite its complexity, there are various parts of the tax code that cling to the ideals from the its early days: family businesses are one of them.

It’s less common for business owners to pass their companies directly onto their children and keep it running in perpetuity since we live in a more mobile world today where adult children are more encouraged to pursue their own dreams. But whether the business will be passed onto your children, sold at retirement, or passed onto an unrelated successor, favorable treatment has remained in the tax code for hiring your own children to work at your company. It used to be a given that "keeping it in the family" was just what you did in the early 20th century before things like valuing children’s education and child labor laws also came about. But the tax code still allows you to reap some massive benefits for hiring your children.

How Your Family Benefits From Hiring Your Own Children

Just like you would with an unrelated employee, you can deduct the wages or salaries paid to your own children as a normal business expense. However, a major difference between hiring your child opposed to an unrelated person is that if your child is under 18 then you don’t have to pay FICA and FUTA (Social Security, Medicare, and federal unemployment insurance) payroll taxes in a majority of cases. This benefit only applies if your business is a partnership or sole proprietorship, however, there workarounds if you operate as an S or C corporation such as a family management company.

Unless your profit level is extremely low, this effectively shifts your business income to your child’s tax bracket which is likely to be practically nonexistent. This represents significant tax savings both in terms of income tax and payroll taxes and related administrative burden. Your children also receive what is essentially tax-free income providing that their wages fall below the standard deduction amount for the year.

As an added bonus, your children learn the value of having their own money and can start paying their own way for things they want as well as starting to save for college and other major expenditures such as retirement savings. Your child can reap enormous tax savings in the future by putting their paychecks into a Roth IRA and letting the funds grow tax-free while they’re very young.

Your Children Must Still Be Bona Fide Employees

This means that you need to comply with all of the same regulations that you would with hiring an unrelated employee, such as having your child fill out an I-9 that certifies their eligibility to work in the US. Your child needs to fill out a W-4 (and state equivalent) for tax withholding and a W-2 must be issued to your child just as they would receive from any other job. Even though they would be exempt from Social Security and Medicare taxes in most circumstances, your child may still need to file a tax return in order to get any withheld income taxes back.

After paperwork formalities are taken care of, the job must be a legitimate need for labor that your business has. Since this dated, but still effectively employed, method results in major tax savings the IRS is often watchful as to what constitutes a "real employee" of the business when that employee happens to be your child. The wages paid must be ordinary and necessary for your business for services actually performed, opposed to nondeductible personal services your child is performing such as childcare or maintaining the home. Even if your child is helping with menial tasks like stuffing envelopes, answering phones, keeping business social media pages up to date, and keeping the office clean, all of those services count for this tax benefit.

You also must comply with child labor laws. The IRS hasn’t issued definitive guidance on what age is considered too young to perform helpful or necessary services for your business, but it’s safe to assume that most children under 10 wouldn’t pass muster. Regardless of age, your child must be under 18 to avoid payroll taxes.

Reasonable Compensation

The amount paid to your child must be below the standard deduction amount for the year in order for them to pay no tax. However, there’s no limit for the parent to shift business profits to their child in the form of wages, wages with no payroll taxes if that child is under 18. Even if your payments go past the standard deduction amount, your child is far more likely to be in a lower tax bracket than you.

Since this statute could be easily abused, the IRS enforces a reasonable compensation rule on paying your own children to help with your business. A basic rule of thumb is think about what you would pay a total stranger for the same kind of work. Your child’s total compensation should be in line with that going rate you’d pay a stranger, along with any fringe benefits that your spouse receives if they participate in your business such as health insurance premiums and medical expense reimbursements. Paying your child $75 per hour to stuff envelopes would not hold up in Tax Court. But if you need help with administrative work for example, research how much an entry-level administrative assistant earns in your area by the hour. You can start with statistics from the Department of Labor and workplace sites like Glassdoor, as well as contacting local employment agencies and asking what the going rate is for the type of work you want your child to do.

While you still have the same administrative burden of having your child work for you as you would a total stranger, there are more tax benefits and overall financial benefits to your entire family to have your child work for you instead. In addition, you’ll be bringing your family closer together and instilling work ethic in your child. They will also have the opportunity to utilize the same savings tools as you such as Roth IRAs and 529 plans to let their wages grow tax-free to pay for college and retirement in the future, as well as having their own money for personal purchases to learn the value of a dollar.

What You Need to Know About Deducting Your Car Expenses

Buying, leasing, fueling, and maintaining a car can take a big bite out of your budget. Fortunately, these car expenses can also take a big bite out of your taxes if you keep excellent records. Whether you’re a rideshare driver or you use your car frequently in a trade or business, you might be overlooking some valuable auto deductions. However, because a lot of people also essentially try to write off the entire cost of their personal cars, auto deductions can be a common audit target. Here’s what you need to know about deducting business use of your car and keeping excellent records to back up your deductions.

You Have to Pick Standard Mileage or Actual Costs

There are two methods of deducting your car expenses: standard mileage and actual cost. The IRS sets a business mileage rate (will be $0.535/mile for 2017) which applies for all domestic business travel done by car. Thanks to the numerous mileage tracking apps currently out there, you no longer have to keep onerous pen-and-paper logbooks full of guesswork. Many apps will measure your mileage in real time and if you do ridesharing, some even track miles right in the rideshare apps themselves.

A common misconception about using the standard mileage method is that you don’t need to keep further records beyond how much you traveled. You still need to be able to prove how much you use your car for business, and whether each trip was also considered a bona fide part of your trade or business. This part is relatively cut and dry for rideshare side hustles, but less so for other types of work.

Parking and Tolls Are Always Deductible in Full

Standard mileage tends to be more beneficial than the actual cost method if you drive a lot for business purposes and also live in an area where car maintenance costs are relatively low. If you’re not making lease or car note payments as well, standard mileage is more likely to benefit you.

Regardless of which method you choose though, parking and tolls are always going to be fully deductible. If you use an automated toll-paying device like EZ-Pass, your business-related tolls are still fully deductible but the device itself needs to be allocated between personal and business usage.

You Need to Determine a Reasonable Business Percentage

When determining which auto deduction method is more beneficial, you need to figure out your business percentage. This is typically based on how many miles a year that you drive for business purposes versus personal. For example, if you drove 30,000 miles last year but only 10,000 of them were for business, then your business percentage is 1/3 (33%) so you’re limited to 33% of your actual costs with the exception of parking and tolls for strictly business-related travel. Mileage apps that keep track of your total time spent on the road can definitely help substantiate your business percentage.

Once you’ve determined your business percentage, you can then deduct the following costs subject to that percentage:

  • Car insurance
  • License renewal and registration
  • Maintenance (inspections, washing, interior cleaning, tires)
  • Actual cost of gas and oil
  • Personal property taxes based on the value, not weight, of the car
  • Lease payments
  • Interest on car notes
  • Depreciation of the car (the actual purchase price, based on a 5-year depreciation period)
  • Garage rent, if applicable

Switching Methods Isn’t That Seamless

By keeping tabs on how many miles you drive for the whole year and tallying up how many of those miles had a bona fide business purpose, you can easily approach your business percentage. You’ll also have the number of miles handy to see whether you’d benefit more from the actual cost method or standard mileage. With that said, you can switch methods every year to see which one benefits you more but with some caveats.

If you were using the standard mileage rate and switch to actual expenses, you need to reduce the depreciable basis of your car by a portion of the standard mileage previously deducted. It creates additional work and results in a smaller depreciation deduction. This doesn’t apply for cars that were already fully depreciated from being in use several years.

Auto Expenses Are 100% Deductible if the Vehicle is Solely for Business Use

A vast majority of people don’t have a separate car just for business usage, hence the rules for allocating your vehicle between personal and business use on your tax return. But if your trade or business relies on having a separate vehicle, such as general contracting or food delivery, these vehicles can have 100% of their costs deducted but still require strong substantiation for mileage and their actual purpose.

Contrary to popular belief, you can’t simply have your personal car painted to advertise your business and have it suddenly meet the 100% business usage test. You still need to maintain concise records of your car-related expenses and mileage logs to prove how much you use your vehicle for business. The paint job would deductible as an advertising expense but it otherwise wouldn’t affect your business percentage if the car’s primary use is personal.

Using Your Car as an Employee

When you’re an employee and using your personal car for work, you don’t have as much leeway tax-wise as someone who’s using their car for rideshare or other forms of self-employment. If you have any unreimbursed car expenses for business trips, then you also need to keep strong records of how much you use your car for your job and deduct the same expenses. If you work more than one job, you can also deduct the mileage or actual costs of commuting between both jobs but this deduction is nullified if you’re going home first. However, parking passes and similar fees associated with parking near your workplace are nondeductible commuting expenses.

However, unlike taxpayers who have some form of self-employment income, most employees need to itemize deductions in order to see any tax benefits from car-related and other employee business expenses. The expenses also must pass a certain threshold based on your adjusted gross income. The only exception to this rule are reservists in the armed forces, certain performance artists (such as symphony members treated as employees for tax purposes), and fee-basis officials who can deduct these expenses regardless of whether they itemize or not.

Deducting your car expenses can seem like a cumbersome headache but it’s not as difficult once you determine which method is more likely to benefit you, and you can take advantage of the many apps out there which will make your mileage-related recordkeeping much easier to handle.

Year-End Investment Decisions: Capital Gains and Losses

With 2017 quickly coming to a close, you definitely want to think about last-minute maneuvers that can help you save a significant amount of taxes. If you have an investment portfolio, now is definitely the time to think about whether you want to sell or hold your assets if doing so will have tax impacts. There are certain rules for netting capital gains and losses if you engage in a lot of investment activity. Here’s what you need to know about the intricacies of tax planning when it comes to capital gains and losses.

Long-Term vs. Short-Term Capital Gains and Losses, Ordinary and Capital Gains Rates

You may have heard the terms "realized gain" and "recognized gain" and there’s a major difference between the two. You realize a capital gain when the asset appreciates in value. However, you don’t need to worry about reporting it on your tax return until the gain is actually recognized. Capital gains are only recognized when you sell the asset.

In addition to paying attention to assets that appreciated in value and those that declined in value or became worthless, the length of time in which you held the assets is also important. Short-term capital gains and losses apply to assets held for less than one year, while long-term are for assets held longer than a year.

Long-term capital gains and losses are more favorable than short-term. When you have a net short-term capital gain, it is taxed at what’s known as the ordinary rate and without regard to the tax bracket that you are in. The ordinary rate refers to the graduated tax rates that apply to most of your income (such as wages and business profits.) Net long-term capital gains are taxed at a preferential rate which is 15% for most taxpayers or 20% for higher-income taxpayers in the 39.6% ordinary income bracket. If your income is in the bottom two tax brackets– 10% and 15%– you have a 0% long-term capital gains tax.

So, if you are in a higher income bracket for 2017 than you expect to be in 2018 due to career or lifestyle changes like starting a business, retiring, or taking a pay cut, then it’s wise to postpone your capital gains until 2018 if you can reasonably expect to be in one of the bottom two tax brackets.

The Limit on Capital Loss Deductions

If you have more capital losses than gains, you are limited to deducting $3,000 of your loss every year until you use it up. This is referred to as a carry-forward (or carry-over) and you can use it until your final tax return. There’s no time limit. For instance, if you have a $20,000 capital loss you can deduct $3,000 for 2017 then assuming you have no more capital gains, $3,000 for the next five years, then $2,000 in the final year.

However, if you have long-term capital gains in the future then this loss being carried over would be considered first when calculating your net capital gain for the year.

How Are Net Capital Gains Calculated?

First, you need to know your basis in that asset which is the purchase price plus whatever broker fees were paid. You deduct the basis from the sale price, along with any broker fees that were charged for the sale. In recent years, the IRS mandated that brokers started issuing tax statements differentiating covered transactions from non-covered. A covered transaction is one where your basis was reported to the IRS and non-covered means that it wasn’t. For non-covered transactions (such as stocks purchased prior to this mandate) you need to have adequate records of your basis.

However, the calculation for your net long-term and short-term capital gains isn’t as simple as aggregating the gains and losses for the year. The IRS utilizes the following formula: short-term gains are netted against short-term losses while long-term gains are netted against long-term losses. If both of these holding periods have the same results– both result in gains or both result in losses– then they are reported separately on Schedule D. Gains are  then taxed at the appropriate rate, ordinary for short-term and preferential for long-term, and your total capital loss can be deducted up to $3,000 against all your other ordinary income for the year with any excess amount to be carried over.

But if one holding period has a gain and the other one has a loss, then they need to be netted against each other after the above steps have been taken. For example, you have several covered transactions on your brokerage statement. You have $2,000 in short-term losses, $500 in short-term gains, no long-term losses, and $1,000 in long-term gains. The correct way to calculate your gain for the year is to net the short-term amounts together first so there’s a $1,500 short-term loss. With no long-term losses, this results in a $500 deductible capital loss after netting it against the $1,000 long-term gain.

Going back to the $3,000 per year limit and the $20,000 loss example, then this capital loss carry-forward would come first and the extra $500 would be accounted for. But if you have better luck in the market and have a huge capital gain? That carry-forward can help absorb it until it’s used up. So if you were only able to deduct $3,000 of your net capital loss in 2017 with a $17,000 carry-forward balance for 2018 and you suddenly have a $10,000 capital gain, then that loss absorbs it. Your deduction is still limited to $3,000 per year, but now you have a capital loss carry-forward of just $4,000 ($17,000 – $10,000 gain – $3,000 deduction) and no capital gains tax.

Ultimately though, there is no carry-forward for capital gains. Capital gains must be recognized in the year that the sale occurred and with the appropriate holding period. Only losses can be carried foward until they are absorbed.

In the event that you are facing a massive capital gain or loss, it’s definitely prudent to determine probable transactions in the future and what course of action is best to take. Large capital loss carry-forwards are more beneficial if you’re expecting equally large capital gains in the future. If you are expecting your income bracket to substantially change, this is also important for effectively planning how to make the most of a capital loss carry-forward as well as the timing of selling your assets. And if you’re in the lower two brackets and quickly need some cash for holiday spending, you can enjoy tax-free capital gains.

What You Need to Know About Year-End Charitable Giving

As the holidays loom closer, you might be thinking about opening your heart and pocketbook and giving to the causes and people that you care about. The holidays indeed evoke generosity in most people to give all that they can. But there’s also good reason that the holiday season is when nonprofits get major boosts to their funding: year-end appeals are effective if you’re hoping to get some last-minute tax savings.

If you’re thinking about ways to get a tax break before 2018 rings in, seasonal giving can definitely be both a great and generous way to do so. However, there are many misconceptions about charitable donations and volunteering and your taxes. Here’s what you need to know about making year-end plans.

Your Donation Must Be Made to an Eligible Organization

In order to get a tax deduction, this means that you must donate to an IRS-approved charity. This encompasses most 501(c)(3) organizations that have a scientific, artistic, or community purpose. It also includes schools, fraternal lodges, and houses of worship.

It doesn’t include contributions to social clubs, political candidates or organizations, or civic organizations. The same is also true for community fundraisers that aren’t going to an eligible organization or gifts to individuals, such as donating to crowdfunding campaigns or other forms of direct giving.

If you have doubts that your donation will have an effect on your taxes, consult the IRS Select Check database to confirm that the organization you’re giving to is an eligible nonprofit. There is often a lot of confusion surrounding causes people support and whether or not those donations are tax-deductbile, but there are also many charity scams that abound during the holiday season. If you’re unfamiliar with the name of an organization, always run it through Select Check first.

While you may still feel compelled to give to people directly as well as raise funds in your community for other important purposes, bear in mind that unless your money is going to a qualified charity then you won’t see a difference on your tax return.

You Can Get a Deduction for Certain Expenses Associated with Volunteer Work

The holidays are a popular time for doing volunteer work and serving your community in addition to donating. And contrary to popular belief, you can get some tax benefits for volunteer work although there are a few caveats.

You cannot deduct the value of your time based on market rates for what you did, or a flat rate estimate, such as if you’re an attorney charging $400 an hour and you decide to help out a cause that you care about by handling their legal issues. However, you can deduct certain personal expenses incurred for doing volunteer work for a qualified organization. Travel costs are deductible such as airfare and public transit and if you’re driving in the course of volunteer work, you can also deduct $0.14/mile plus parking and tolls. Other related expenses such as supplies, uniforms and safety gear, and postage are also deductible.

Non-Cash Donations Require Additional Documentation

That is, documentation on both your part and the organization’s depending on the amount and nature of the donation.

Non-cash deductions are supposed to be deducted at their fair market value or appraised value and the organization is supposed to provide you with a letter or other acknowledgement for non-cash donations exceeding $250 in value. (A receipt alone isn’t enough.) When donating old clothing and household items to thrift stores, this deduction is commonly overvalued since the items aren’t catalogued and no acknowledgement is given unless it’s an unusually large amount donated. Goodwill posted a handy valuation guide on their site which can help you determine the value for thrift store donations of used clothing and household items which are definitely lower than the fair market value of buying them new.

If you are buying a new item specifically to donate, such as a boxed toy for a toy drive, proof of the actual amount that you paid should be sufficient but remember to request a letter from the organization you donated to if you donated enough new toys to reach that $250 threshold.

Then when it comes to items with higher average values than clothing and household goods that typically go to thrift stores, checking online marketplaces like eBay for average sale price relative to condition and saving the proof can help substantiate your deduction in addition to acknowledgement from the organization. When it comes to extremely high-value donations such as furniture, artwork, or collectibles, a professional appraisal is prudent. It is also required for non-cash donations worth $5,000 or greater. In either case, you can also get a deduction for the appraisal fee.

Donating Stock Can Help Avoid Capital Gains Tax

While donating household items and collectibles can result in a decent deduction, an efficient way to donate to causes that you care about which also nets you substantial tax savings is to donate appreciated stock or other financial assets.

Your donation is based on the fair market value on the day that the stock was donated, not what your basis is in that stock. If your stock significantly increased in value on the day that you donate it, you not only get a much larger deduction without having to sell the stock first but because there was no sale, you also avoid having to report the capital gain and pay tax on it.

Donations Made By Credit Card Still Count for 2017

Donations by cash, check, or credit card are all deductible for 2017, even if you don’t pay your credit card bill until January or later. Even if you make that donation on New Year’s Eve, so long as records show that it was made in 2017 then it will count for the 2017 tax year.

If you made any donations to qualified charities using digital currency, take note of what the cash value equivalent was at the date and time of your donation.

Giving to the people and causes you care about may not always result in a tax benefit although you should still do it if it makes you happy. But when it does, take note of the timing relative to your income and other itemized deductions for the year so far. By determining if you need tax savings now or next year, this can help map out your holiday giving plans. It can also help you decide if now is a good time to clear out your unwanted items or if you should hold off until the new year begins.

Identity Theft and Filing Your Tax Return: Risks and Prevention

Identity theft has became a major problem in recent years. Cybercriminals are only becoming more effective at what they do whether they are acting alone or with major crime syndicates: in many cases, they only need a name to get started on stealing your assets and opening fraudulent accounts in your name. Additionally, too many organizations rely on Social Security numbers opposed to other personally-identifiable information (PII) to verify users’ identities. This is unfortunately what facilitates large-scale theft like the recent Equifax breach.

When it comes to filing your taxes, identity theft creates a whole other set of inconveniences. You may find that your tax refund has been denied or a hold placed on your return if someone already filed a tax return under your name and/or Social Security number. By getting to know the various types of identity theft scams and tactics related to tax filing, you can safeguard yourself ahead of time. Here are some things you should know about identity theft and your taxes.

1. Keep email communications with your tax professional as secure as possible.

Do you communicate with your tax professional via email? Refund theft is a major motivator for identity thieves and you may be at risk without even knowing it. Hackers have gotten very sophisticated when it comes to this: no longer content with just stealing your Social Security number, they can actually impersonate you by hacking into your email account and telling your tax professional that they now want your tax refund to go to another address or bank account. Or, they can impersonate your tax professional and ask you to verify information via email that they already have.

First, tell your tax professional to always notify you by phone in the event they receive such an email (or that you receive one that looks suspicious.) Any tax documents, like copies of your returns, need to have a strong password or other safeguard if you send or receive them via email. Encrypted documents should be as tough to crack as possible so don’t include the password in that email. You should also check in with your tax professional’s PII practices since tax offices are popular targets of identity thieves, even if they take care to shred documents.

Use a secure email account with actual end-to-end encryption such as ProtonMail. Enable two-factor authentification so that it gives hackers less of a chance of getting in, and don’t use a "pet password" for your email.

2. Report your identity theft to the IRS and take proper precautions if you think your information was compromised.

If you can confirm that your information was stolen in a breach, or suspect that it was, the IRS has a set of protocols for this. Breaches don’t always result in having your identity stolen, but if your account was indeed compromised or you received a notice from the IRS that your tax return was rejected due to a duplicate filing under the same Social Security number, you must file an identity theft affidavit. You can also apply for an IP PIN, an identity theft PIN number that will let you file your tax return without using your Social Security number.

In the meantime, you should also report the identity theft to the appropriate channels like the FTC, requesting a credit freeze from the credit bureaus to prevent new accounts from being opened in your name, and financial institutions to halt having your bank accounts and credit cards used fraudulently. 

3. Become familiar with the "dirty dozen" tax scams, including the fact that the IRS will never contact you by phone or email regarding taxes due.

Few things strike fear into peoples’ hearts more than hearing from the IRS and finding out that they owe a lot of money in taxes and need to take immediate action. However, if this is the case for your tax situation, you’re being scammed. These are referred to as the "dirty dozen" scams in tax professional circles.

Ignore any phone calls and voicemails that you receive from callers claiming to be the IRS and that you owe all this money in taxes. You should always do a reverse look-up on those numbers then report them to the FTC since they are scams. Less tech-savvy people tend to be hit harder by these scams a result.

In the event that you DO owe taxes, you will always get a written notice from the IRS that details a proper assessment made against your account and how much your bill is. This notice and/or bill will be sent to the last-known address they have on your file. In the event of actual collection issues for past-due accounts, you are also contacted via mail and given at least 30 days’ notice before your wages are garnished or assets seized. The IRS will never call or email you about it.

Because of this, you should also never open any attachments from emails that come from unfamiliar addresses claiming to be with the IRS or your state tax agency. They are direct phishing attempts to get your identity information.

4. Become aware of signs of tax-related identity theft.

If you haven’t had any of the telltale signs of identity theft such as noticing new accounts opened in your name or suspicious transactions on your credit cards, it doesn’t mean it hasn’t happened necessarily. If an identity thief fraudulently filed a tax return on your behalf, you may actually receive a refund check at your home address without filing your real tax return. You may also receive notices from the IRS that a tax return was already filed, or notices for adjustments to be made to your tax return based on the fraudulent one that was already submitted.

Keep an eye out on the mail for these signs of tax-related identity theft, then take proper actions with the IRS by requesting an IP PIN and certificate of identity theft.

The IRS, and some state tax agencies, are taking identity theft very seriously. However, it’s not enough to stop cybercriminals who are getting better and better at what they do while lawmakers can be slow to act on penalizing them while protecting taxpayers. By taking proper precautions with your PII and records containing it, as well as the means of contact you use like your email accounts and devices, you can help deter identity thieves from accessing your information. Always be wary of communications from parties you are unfamiliar with that claim the content and/or attachments are concerning your tax returns.

Casual Rental Income and Your Tax Return: Tax Treatment of Being an Airbnb Host

The gig economy isn’t going anywhere anytime soon: whether you’ve got an extra seat in your car for the night or a powerdrill you’d like to put to use, the whole world of app-driven side hustles has helped people pay their bills or even serve as stopgaps for career changes. And the tax authorities have certainly noticed as the IRS even launched a sharing economy tax center in recent years given how prevalent the gig (or sharing) economy has become.

Casual rental income such as being an Airbnb host or listing your home on VRBO is a hot-button issue that the IRS has been paying close attention to. Casual rental income stands out from the other well-known forms of gig work like driving for Uber or delivering food for Grubhub. Why? Driving, doing deliveries, and other forms of gig work are considered self-employment, whereas rental income entails a whole other set of rules. The rental income rules are then dissected into renting out your principal residence where you live, renting out a second or vacation home, or investment properties purchased specifically to earn rental income. Most Airbnb, VRBO, and Craigslist casual, short-term rentals fall under the "living in principal residence" guidelines most of the time.

Do I Need to Report Casual Rental Income Even if I’m a Renter?

Yes. If you are subletting your apartment regularly to travelers or other people who are giving you money for that extra room (or even your couch) then you need to report the income.

Good News if You Rented Out Your Primary Residence and Didn’t Like Being a Host for Long

Did you decide that being an Airbnb host just wasn’t for you after trying it out for a few days? There’s some good news: you don’t actually have to pay the tax on the rental income if you rented your primary residence out for 15 days or less. It doesn’t matter what platform you used or if you informally listed a room for rent for a few days on Craigslist or the newspaper: if you rent out your primary residence for 15 days or less during the tax year, this is tax-free income.

You may receive a 1099 form if you used a platform like Airbnb and received $600 or more. You would then report the income on your federal tax return, but then also claim an adjustment on your return which means it wasn’t actually taxed. If you receive a 1099 and don’t report the income, you may get a notice from the IRS so you should produce records that prove you meet the exception for renting less than 15 days. It doesn’t matter if you own or rent the property, so long as it is used as your primary residence you will qualify.

However, if you have a vacation home or rental property, then you would need to report all of the income regardless of how many days it’s rented out. The rest of this post assumes that you are using your primary residence given the large amount of Airbnb and VRBO users who have found themselves reliant on the income from casually renting out the homes they actually live in.

How to Report Your Casual Rental Income

For more good news, you can deduct some of the expenses associated with your income from being an Airbnb host or doing other short-term, casual rentals of your primary residence. The bad news is that you need to prorate these expenses according to how many days your home was used for this activity, and you also can’t deduct a loss resulting from these expenses. Your loss is limited to the casual rental income you received, so the income just gets canceled out to zero at best if your living and hosting expenses are high.

Additionally, you also must allocate the expenses based on the square footage or percentage of your home used for rental purposes. This is referred to as indirect expenses that affect the entire property, such as utilities, the mortgage, and real estate taxes. Direct expenses, like painting or cleaning a room that you specifically set aside from rental would be 100% deductible. Anything related to the collection or generation of rental income like advertising and property management is also 100% deductible, along with any amenities you purchase specifically for guests.

The following types of expenses are deductible:

  • Mortgage interest
  • Depreciation (the actual purchase price of your home)
  • Rent, if you’re a renter
  • Real estate taxes
  • Insurance
  • Utilities (heat, water, electric, gas, cable and Internet)
  • Cleaning and maintenance services
  • Management fees (if a friend or professional property manager is being paid to let people in and out if you are not home for your guests)
  • Advertising or featuring listings
  • Amenities (e.g. towels and linens for guests)
  • Fees the platform charges

If you are renting out a single room or area of your home that can be measured in square footage, you need to prorate by this area first. Using the IRS’ example of an 1,800 square foot home that uses a spare bedroom that is 12 x 15 feet (180 square feet, 10% of the home) that is the first number you will need. If your homeowners’ insurance is $500 per year, you start with a $50 deduction based on 10% of your home being rented out.

Next, since this is your primary residence being rented out, you need to prorate by the number of days that the room is for rent. Going back to the example the IRS provided, you use an app like Airbnb and have a paying guest for 73 days which is 20% of the year. 20% of your $50 prorated insurance deduction comes to $10. You unfortunately can’t deduct the $490 left over.

If you are renting out your entire home on a sublet basis or just to get some extra cash while you’re not at home, you would need to then just prorate the expenses by the number of days you are renting it out.

Pitfalls if You Own Your Home

Even if you meet the exception for renting out your home for less than 15 days, you need to apportion your mortgage interest and real estate taxes to those days that they were rented out if you deduct the interest and taxes on Schedule A.

Depreciation of your home, which is the actual principal, can also be extremely tricky to calculate without a tax professional’s help. If you sell the property before the depreciable life is over (which is 39 years for commercial property, which is what rental property is classed as- even if you live in it!) you may need to pay what is called a recapture tax at the time of sale. The recapture may or may not be worth the benefit of taking that deduction now.

Are You in the Vacation Rental Business?

Be careful with how much additional work you do for your guests beyond providing them a place to sleep. If you’re cooking meals for them, doing more than a cursory cleaning, or providing additional services then the IRS could classify this as being in the trade or business of vacation rentals or bed-and-breakfast. This would mean that you have to pay self-employment tax- Social Security and Medicare taxes that are 15.3% of your net income- and possibly apply for additional licenses and occupancy tax certificates where you live or rent out the property.

As home sharing becomes more ubiquitous over time, Congress may update the tax code for simplified treatment of sharing economy income and the IRS subsequently release more detailed guidelines. Nevertheless, be mindful of your expenses as well as how many days your home is used for casual rental, in order to avoid headaches at tax time.

Tax Treatment of Cryptocurrency Sales and Exchanges

Cryptocurrency, such as Bitcoin, Ethereum, Monero, and Litecoin among others, has picked up major traction in recent years to the point that it has become a major concern for tax and accounting professionals, the authorities, and cryptocurrency users themselves.

People started using cryptocurrency to save money on cash remittances outside the country (for example, a $200 cash transfer to the Philippines would cost about $12 through a money service business but "pennies" via Bitcoin) and small transactions like spotting a friend for coffee. Now, you can see cryptocurrency being accepted for a sandwich at the local deli and Overstock.com is reporting an average of $50,000 per week in sales from Bitcoin users alone thanks to their partnership with ShapeShift.

Cryptocurrency has gone beyond a novelty enjoyed by the tech-savvy to a full-blown alternative to using credit cards, bank accounts, and even actual cash to pay for purchases, remit money to friends and family, and make investments. With more sales transactions being completed with cryptocurrency instead of cash, this poses a major accounting challenge to both large and small retailers as well as tax consequences that are harder to spell out than typical cash and credit transactions.

In order to understand the tax impacts of cryptocurrency sales and exchanges, it’s best to become familiar with how cryptocurrency itself works.

How Does Cryptocurrency Work?

Cryptocurrency is an asset with value just like stocks, bonds, commodities, and precious metals. However, it is not actual cash that would go in a bank or perhaps a digital cash service like PayPal. Unlike the cash that would sit in one’s PayPal account from sales, services, or remittances from friends and family however, there is no central authority or server that rules over cryptocurrency transactions. There is no mint that constantly creates new cryptocoins, or authority you go to like a bank’s fraud prevention department. It is also not a trust-based system: i.e. you trust that the bank will not spend your money and that the cash in your PayPal account is also secure from the retailer taking more of that cash than they were authorized to.

Transactions are publicly available through a peer-to-peer means called a blockchain. The blockchain exists to prevent double-spending among the peers in the network. Each peer in the network knows what each transaction is in the blockchain, and checks it for validity and that it was not an attempt to double-spend. The consensus for transactions is among those peers: not a central authority. This is in contrast to a bank card, credit card, or centralized digital cash like PayPal where if you must dispute a transaction, you get one of the aforementioned parties involved. Whereas with cryptocurrency, if the peers do not reach consensus on the transactions, the entire system could collapse: this hasn’t happened yet despite the lack of central authority.

Cryptocurrency also earned the moniker from the "crypto" part coming from math securing the location and personally-identifiable information (PII) of each peer, although your real-world identity is known to the other peers. Monero and Dash offer additional privacy features that Bitcoin and the like do not, but in general, it is easier for a hacker to steal your PII from your bank account or credit card than the location of most cryptocurrency. In light of recent large-scale breaches like what went down with Equifax, more people are looking to cryptocurrency as a result.

The Current Consensus on Tax Treatment of Cryptocurrency

The IRS issued Notice 2014-21 when Bitcoins began to pick up steam. Since cryptocurrency is not actual currency, the regulations that apply to foreign currency do not apply to cryptocurrency sales and exchanges such as the way one would recognize a gain or loss on the sale from receiving foreign currency for goods or services. However, taxpayers must include these sales (and applicable exchanges) in their income.  IRS Publication 525 provides more in-depth guidance on what constitutes a taxable sale or exchange but in general, if you are accepting cryptocurrency on your website as payment for goods or services then you must include these sales in your income just as you would for physical and digital cash sales.

Because cryptocurrencies are traded on exchanges just like stocks and other financial assets, but are not actually stocks, the current guidelines from the IRS state that you must utilize the fair market value of the cryptocurrency on the date of the sale. The fair market value would need to be converted into US dollars using a reasonable method, such as the closing value on that date or the average trade price. For example, if you are selling your music on your website for $15 per album and you accept Bitcoin, you’d need to convert the Bitcoin sale to US dollars first. If the closing value of one Bitcoin is $3,901.95 on the day of the sale (as it is at the time of writing), your album would sell for 0.003844 Bitcoins. If you receive more or fewer Bitcoins given its dynamic nature, you’d recognize whatever the conversion totals out to be in US dollars.

Depending on which digital wallet that you use, the conversion may be automatically calculated for you at the time of each sale which would provide a reasonable calculation for tax and recordkeeping purposes.

If you "mine" digital currency of any type, you also must recognize it as taxable income using the same method for the date and time you mined each digital coin.

Making Purchases with Cryptocurrency

The same rules would apply for making purchases with cryptocurrency, such as if you are a freelancer making business purchases using Bitcoin or other cryptocurrencies. You can still take a deduction assuming all the other rules are met, but you need to convert that purchase into US dollars first with a reasonable method for determining the rate.

Crypto-Exchanges

While cryptocurrencies aren’t stocks or bonds, they are considered capital assets just like them. However, the more generous capital loss and gains provisions and tax rates do not apply to these exchanges. They are instead considered ordinary exchanges, which means that they are taxed at the same rate as the rest of your income.

Since cryptocurrencies aren’t considered securities however, this also means that more burden falls on the taxpayer to record basis and sale price, unlike the "covered transactions" shown on a 1099-B or combination statement from a securities broker.

As more of society embraces cryptocurrency, the IRS and other authorities will issue more definitive guidance on how to treat these transactions. Digital wallets and other means of recording crypto-transactions and exchanges will also become more sophisticated and make recordkeeping simpler, but until then, cryptocurrency users need to keep excellent records to make tax time go smoother.