Brian Borawski CPA, PC

Archive for the ‘Personal Taxes’ Category

Selling an asset can be taxing and sometime you run into problems when you sell an asset and you don’t collect all of the money at once.  Let’s look at an extreme example.  You have a building that’s worth $1 million but you’ve owned it for so long that it’s fully depreciated so if you sell if for $1 million, you’re going to have quite the gain.  Since it’s a long term capital asset and you sell it by the end of this year, your gain would be 15%, or $150,000.  You had a hard time finding a buyer and the one you finally found is cash strapped and they put 10% down and you seller-finance the rest.  The problem here is, your tax ($150,000) is actually more then the cash you received ($100,000) so you’re left with a shortfall.

That’s where the installment sale rules come in.  You can elect to report your gain on an installment basis if you expect payments in a tax year after the year of sale.  This is done on Form 6252 and the first thing you need to do is compute the gross profit percentage. In our example, since there’s no longer any depreciable basis, the gross profit percentage is easy because it’s 100%.  That means whenever you collect principal payments, you pay tax on 100% of the amount received.  In our example, the down payment would result in a $100,000 or $15,000 in tax (assuming this year).  If you collected $50,000 in principal next year, that would be your gain in that year and so on until the note is paid off.

One interesting quirk this year is capital gains are expected to go up in 2013 so you might want to actually pay the tax on the entire amount rather than wait and potentially pay a higher tax rate in the future.  The good news is, you elect the installment method when you file your return so you could potentially put off the decision until you have a better handle on what tax rates will be.

Cancellation of indebtedness (COD) income has become a bigger issue in the past few years then I ever remember it being.  At its core, if you take on debt and that debt is subsequently forgiven, you should be taking the amount of debt into your tax return as income.  It seems harsh because usually debt is cancelled because of a hardship but the good news is, there a couple of different exclusions that mean when you get a 1099-A (Acquisition or Abandonment of Secured Property) or a 1099-C (Cancellation of Debt) you should be talking to a tax professional.  If you ignore it, the IRS will come back at you (I know because I’ve helped people fix this when they’ve gotten a notice) but you also don’t want to just take the full amount reported as income and pay the tax either.

The first major exclusion addresses the foreclosure crisis and was part of the Mortgage Debt Relief Act of 2007.  The provision basically says that if debt was forgiven on your purchase of a principal residence, you can exclude up to $2 million of COD income if the debt was forgiven between 2007 and 2016 (expiring soon).  In order to qualify as your personal residence you have to had lived there for two or more years out of the last five.  Also be careful because this usually includes just the amount on the original note.  If you refinanced at some point and pulled cash out, then that debt might not qualify (again, be sure to talk to a tax professional) so it’s not as easy as just ignoring anything related to your home.

The next major exclusion is a four parter detailed in Code Section 108.  The four exclusions are for

1)  a debt discharge in a bankruptcy action under Title 11 of the U.S. Code in which the taxpayer is under the jurisdiction of the court and the discharge is either granted by or is under a plan approved by the court.
2)  a discharge when the taxpayer is insolvent outside of bankruptcy
3)  a discharge of qualified farm indebtedness
4)  a discharge of qualified real property business indebtedness

Okay, take a breath.  The exclusion most people will fall under is number two.  The short explanation is, if you have a debt that’s cancelled and you’re insolvent (liabilities are less then assets and you get to take into account the debt that was forgiven), you can exclude the debt. It get’s tricky when you have multiple COD events (i.e., you have three credit cards and their forgiven at certain times) and in that event, as your liabilities come down, you might find yourself paying tax on some of the COD income.  And I’ll say it for a third time, but when you’re working in this arena, be sure to talk to a tax professional.

This question came up recently.  I had a financial adviser ask me if a client could gift some appreciated stock to their child and receive a step up in basis.  Unfortunately, you only get a step up in basis when it’s an estate situation.  When you gift appreciated stock, both the holding period and the basis carry over. So if your parents bought stock back in 1980 for $1,000 and now it’s worth $100,000 your basis would be $1,000 but you’d get the 1980 holding period so it would be long term capital gain if you sold it.  For gift tax purposes, the value of the gift would still be the fair market value, which in this case, would be $100,000.

Note that this is different than if you gift your shares to a charity.  In that situation, there is no gain triggered but your charitable deduction is the full fair market value of the shares.

This is part two in a series of article explaining the changes that happened when the American Taxpayer Relief Act of 2012 was enacted.  Like Individual Income Tax rates. the changes to the capital gains rate only changed for those who exceed a certain income threshold.  The news 20% rate applies to individuals making more than $400,000, couples who make more than $450,000 and head’s of household who make more than $425,000.  Anyone under those amounts will pay a capital gains rate based on their income that ranges from zero to 15%.  For a look at the new capitals gains rates, please click through to this article which provides the specific brackets.

This is the first in a series on the recent changes enacted as part of the American Taxpayer Relief Act of 2012.  The first thing we will look at is how income tax rates have changed.  The good news is, for most people, there are no changes other then the usual increases due to inflation.  Where things change is when your taxable income is $400,000 or more if you’re single, $450,000 if you’re married filing jointly and $425,000 if you’re a head of household.  For taxpayers that exceed that threshold, the tax rate goes from 35% to 39.6%. If you want to see exactly where you fall, please click through to this Forbes article which breaks down each of the tax brackets.

The other change the Act made was to extend the marriage penalty relief for another year.  Prior to 2001, there was the marriage penalty where two people who filed single would pay less tax than when those two filed married jointly.  For more than the last ten years, this penalty was alleviated by adjusting the marginal tax rates and the standard deduction to where two single filers would pay the same tax as a married couple under similar circumstances.  The Act made the marriage penalty relief permanent.

We have a new tax bill.  I’m going to cover each of these items in detail but I wanted to make sure everyone had a quick summary version they could refer too

Individual Income Tax Rates – If your single and make less than $400,000, married and make less than $450,000 or a head of household and you make less than $425,000, your marginal tax rates won’t change. If you make more than this, your new marginal tax rate will go up from 35% to 39.6%.

Capital Gains and Dividends Rate – The top rate on dividends and capital gains will go up from 15% to 20%.  This new rate will apply to those who saw their individual income tax rate increase.

AMT Relief – There’s a new and permanent AMT exemption amount.  If you’re single, it’s $50,600, if you’re married filing jointly it’s $78,750 and if you’re married filing seperately it’s $39,375.

Itemized Deduction Limitation – Called PEACE, the phaseout on itemized deductions is back.  At certain income levels, your itemized deductions begin to phase out.  This level is $300,000 for married couples and surviving spouses, $275,000 for head of households, $250,000 for unmarried tax payers and $150,000 for those married but filing seperately.

Personal Exemption Phaseout – Exemption phaseouts are back and the income limits are the same as the itemized deduction limit.

Federal Estate, Gift and GST Tax – The new maxmimum estate and gift tax is now 40% and the exclusion amount has been fixed at $5 million.

State and Local Sales Tax Deduction – The state and local sales tax deduction has been extended for 2013.

Child Tax Credit – The $1,000 child tax credit has been extended permanently.

Earned Income Tax Credit – Some of the more recent changes to the EIC have either been made permanent or extended through 2017.

Those are the bigger things but there were also quite a few other items that were either enacted or extended.  I’ll be touching on all of these things either by themselves or grouped up over the next few days.

November and December is when I normally start sitting down with my clients to talk about what they can do at the end of the year to minimize or defer their taxes.  Everyone’s tax situation is going to be different so the meetings are tailored to the clients but here are some general themes that will come up and that you can use in a discussion with you tax professional.  Keep in mind that a lot of this could change depending on which way the elections go.

1)  Do you pay less now or potentially more later?  Right now, the long term capital gains rate is 15% for those in the top tax brackets.  If Congress does nothing, that rate is going to go up to 20%.  If you’re looking to sell a long term asset, you have a decision to make.  You can sell now and pay the 15% rate, or you can hold off, pay later but pay at the higher 20% rate.

2)  What should I do with my dividend paying stocks?  Right now, dividends are taxed at the long term capital gains rate which maxes out at 15%.  If nothing is done, that rate could go up to as high as 39.6% depending on your marginal rate.  While this could affect what corporations do, if you have large holdings in dividend paying stocks, you’re going to see your tax bill go up if you don’t make any adjustments.  Also keep in mind that you’re going to have to pay medicare tax on unearned income if you’re over a certain threshold ($200,000 if you’re single, $250,000 if you’re married) so you also have to take that into account.

3)  What if I have my own C-Corporation?  If you have your own C-Corporation and you have some excess cash you might want to consider flushing out as a distribution.  You’re probably not going to see rates any lower then 15% and you might even combine this with an S-Corporation election in 2013.  This would also apply if you have an S-Corporation and you have some C-Corporation earnings and profits that you want to get out before rates go up.

4)  Expect your payroll taxes to go up.  A big deal last year, it looks like the payroll tax cut isn’t going to be extended.  If you have your own business where you pay yourself a salary, it might be worth looking into whether you can justify a lower one.

As always, this is general information and you should be discussing these matters with a professional.

Let’s start with a case study to set this up.  You live in the Detroit area so let’s assume a major sporting event is coming back to town like the U.S. Open and they’re holding it at Oakland Hills.  You’re lucky enough to own a home less than a mile away from the golf course and an international financier agrees to rent your house for an obscene amount of money to live in your house for the week.  You move into a local hotel and a week later, you move back into your house.  Tax time rolls around and now you’re worrying about how to report this on your taxes.

Fortunately, the answer is, you don’t have to do anything.  If you rent your home (or your vacation home) for less then 15 days, you don’t have to report it all.  There is no income limit so if someone was stupid enough to pay your$100,000 to rent your house for a week, you wouldn’t have to show it anywhere on your tax return.  The safe harbor period is two weeks. As long as you rent your home less than 15 days, then no reporting is required.

Things get a trickier if you rent your house for a longer period of time.  Then it’s a big proration exercise.  So if you spend $2,400 on property taxes that’s $200 a month and if you rent your house for the four winter months, then $800 would be reported as a rental expense and the rest would show up on Schedule A if you itemize.  This also creates some extra reporting when you sell your house because if you qualify for the principal residence exclusion, you’ll have to recapture and pay tax on any depreciation you took while renting out the house.

In their summertime tax tip series, the Internal Revenue Service recently issued guidance to those people who adopted a child recently yet also extended their 2011 tax return.  According to the report, there’s eight things you need to know.

1. The adoption credit for tax year 2011 can be as much as $13,360 for each effort to adopt an eligible child. You may qualify for the credit if you adopted or attempted to adopt a child in 2010 or 2011 and paid qualified expenses relating to the adoption.

2. You may be able to claim the credit even if the adoption does not become final. If you adopt a special needs child, you may qualify for the full amount of the adoption credit even if you paid few or no adoption-related expenses.

3. The credit for qualified adoption expenses is subject to income limitations, and may be reduced or eliminated depending on your income.

4. Qualified adoption expenses are reasonable and necessary expenses directly related to the legal adoption of the child who is under 18 years old, or physically or mentally incapable of caring for himself or herself. These expenses may include adoption fees, court costs, attorney fees and travel expenses.

5. To claim the credit, you must file a paper tax return and Form 8839, Qualified Adoption Expenses, and attach all supporting documents to your return. Documents may include a final adoption decree, placement agreement from an authorized agency, court documents and the state’s determination for special needs children. You can use IRS Free File to prepare your return, but it must be printed and mailed to the IRS. Failure to include required documents will delay your refund.

6. If you filed your tax returns for 2010 or 2011 and did not claim an allowable adoption credit, you can file an amended return to get a refund. Use Form 1040X, Amended U.S. Individual Income Tax Return, along with Form 8839 and the required documents to claim the credit. You generally must file Form 1040X to claim a refund within three years from the date you filed your original return or within two years from the date you paid the tax, whichever is later.

7. The IRS is committed to processing adoption credit claims quickly, but must also safeguard against improper claims by ensuring the standards for receiving the credit are met. If your return is selected for review, please keep in mind that it is necessary for the IRS to verify that the legal criteria are met before the credit can be paid. If you are owed a refund beyond the adoption credit, you will still receive that part of your refund while the review is being conducted.

8. The expanded adoption credit provisions available in 2010 and 2011 do not apply in later years. In 2012 the maximum credit decreases to $12,650 per child and the credit is no longer refundable. A nonrefundable credit can reduce your tax, but any excess is not refunded to you.

If you know someone serving in the armed forces and is helping protect our country, like everyone, they have to file a tax return.  While most of the regular rules apply to those serving in the military there are a couple of things that those in the Armed Forces have to look out for.  Most of those special situations are discussed in Publication 3, the Armed Forces’ Tax Guide.  Rather then letting you read the 30 page publication, here are some of the highlights.

1)  People in the armed forces have several income types that are excluded from gross income.  Combat zone pay, your Basic Allowance for Housing (BAH) and your Basic Allowance for Subsistence (BAS) are all excluded from your taxable income as are moving allowances and travel allowances.

2)  There’s a combat zone exclusion.  If you’re serving in a combat zone, you can exclude certain pay from your income.  If you qualify for the earned income credit, you can choose to include your combat pay in your income and include it for purposes of the earned income credit.

3)  While grim to talk about it, a decedent can have their tax liability forgiven if they served and passed while in active service in a combat zone.  This can go back multiple years and you’ll need to amend prior years’ tax returns to take advantage of it.

4)  The normal deadlines don’t necessarily apply.  If you serve in a combat zone or you’re away from your permanent duty station you may qualify for an extension of the normal tax deadline.  Your extension of the deadline is 180 days after the later of either the last day you are in a combat zone or the last day of any continuous qualified hospitalization.  You can also add the number of days to the 180 that you would have had when you entered the combat zone as well.

5)  Similarly, you can defer any payment tax under many of the same rules in number four.  In this case you have to notify the IRS that your ability to pay the income tax has been materially affected by your military service.

6)  If you’re overseas, there are additional rules that might let you exclude some or all of your income from tax.  This isn’t covered in Publication 3.

For more information, the IRS has a resources page on their website.  There’s a couple of videos and several links (including one to Pub 3) to help you out.