Tax Planning Frequently Asked Questions
General Tax Questions
Is there any way to reduce taxes after the year is over?
Unfortunately, there are only a few post-December 31st planning opportunities available to individual taxpayers. The one significant deduction available through April 15th of the following calendar year is a contribution to a traditional IRA account. Even if you are covered by an employer plan, you may still make this contribution as long as your income level is below certain limits. Another viable option is to make sure you maximize your eligible deductions. Look through your receipts and take every deduction possible for the year. In particular, make full use of all home office and business expenses.
A self-employed person may generate a deduction by adopting a retirement plan. There are many types of plans that allow you to put more money away than an IRA. Once established, you have the opportunity to make contributions after the end of the tax year.
For the future, it is important to keep in mind that most deductible expenses are an economic loss to you in that the average taxpayer has to spend around $3 to save $1 in taxes. In this example, it is easy to see that it is s not a good idea to incur expenses just to save taxes.
For current contribution limits, click here
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How is the income shown on Form 1099 B representing cash received in lieu of fractional shares reported on Form 1040?
This is dividend income that is reported on Schedule B with any other interest and dividend income received during the year. Any confusion on the treatment of this dividend is understandable.
The origination of this income comes from owning stock of a company that has declared a stock dividend, verses a cash dividend. In some cases, companies do not want to bother with all of the calculations and allocations of fractional shares, so they give cash instead. This cash is a taxable dividend even if the fractional shares received escaped tax.
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What options are available, if any, for the redemption of IRA funds received from a former spouse through incidence of divorce?
When an IRA is transferred from one spouse to another due to a divorce, the IRA funds are transferred into a new or existing IRA account for that individual. This account is then treated like any other IRA account in that there are no special provisions available to withdraw funds without penalty prior to age 59 and 1/2.
There are some limited exceptions that apply whether there was a divorce or not. They include first-time home purchases, medical expenses, education expenses, and substantially equal payment over a person's life expectancy. This latter exception allows a person to start receiving annual payments from the IRA.
Note: IRA's are different from employer-sponsored retirement plans on the divorce issue. If all or part of a 401(k) plan, for example, is awarded to another spouse, they can get the money out without penalty. This is not true of an IRA.
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How can the early withdrawal penalty relating to 401(k) plan withdrawals be avoided?
First a direct trustee-to-trustee transfer may be made. This is where the trustee of the 401(k) plan sends the money directly to the trustee of the same recipients IRA account.
The other method is where some taxpayers get in trouble if not all of the rules are followed. A taxpayer has 60 days, after the date of a distribution from a retirement plan, to roll 100% of the withdrawal into an IRA account. This includes any amounts that were withheld for taxes. Note that employers are required to withhold tax on retirement plan distributions paid directly to the account holder. In other words, to avoid a penalty you will need to deposit not only the amount of the check that was received, but also the amount of taxes that were withheld.
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To avoid gift taxes, is there a way to gift a percentage of a home to another in increments of $11,000 until the full value is gifted (i.e. parents gifting home to children)?
History: Tax-free gifts are available up to $11,000 per year. For example, a married couple can each use their own gift tax exclusions and gift a total of $22,000 per year per to each of their children. The concept of doing this annually to reduce the size of a future estate is called an annual gifting program.
There are two problems with the idea of gifting a percentage of a home. The first problem has to do with figuring out what percentage of the home is worth $11,000. To do this accurately, an appraisal should be completed every year. The second problem has to do with the fact that the donor(s) may choose to continue living in the home. This represents a gift of a future interest and does not qualify for the gift tax exclusion.
A way around this would entail gifting the full ownership immediately, subject to the donors right to live in the house until they die. This is attractive from an estate tax planning standpoint because the value of the interest can be discounted due to the donors right to live in the house for the rest of their lives. The discount has real impact in reducing the combination of gift and estate tax. Since this is a highly complicated area, the involvement of a CPA and attorney is important to analyze the situation and draft up the trust or trusts that will be required.
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How is the sale of real estate treated for tax purposes when the land has been subdivided and only a portion of the subdivided property is sold in a subsequent sale?
Assuming that the seller is not in the business of selling property, there is capital gain treatment equal to the difference between the selling price and the tax basis in the land that was sold. The tax basis is calculated by dividing up the total basis of the property between the subdivided portions of the property. This is usually based on each parcels proportionate share of the fair market value.
Note that taxpayers will not be treated as in the business of selling property "solely" because they have sold a parcel of land. However, they will be if three requirements are met:
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they have never held the land primarily for sale to customers,
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they have not made substantial improvements to the land, and
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(3) they have held the land for five years.
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What is the marriage penalty?
The term marriage penalty refers to the fact is that some married couples pay more in income taxes than they would if they were single. The couples who pay more feel like they are penalized, but in reality it is more of a statistical fluke than a penalty. Congress never had the intention to enact a marriage penalty. In fact, history shows that Congress has acted consistently to provide extra benefits for married taxpayers. This "fluke" is just one place where the complexity of the tax law has overwhelmed congress' intent.
Two-income couples are usually the ones who are penalized. The more equal a couple's income, the greater the "penalty." If incomes are unequal, the opposite is true. At the time Congress created special rates for married couples, most wives were staying at home and the rates were created to help this kind of marriage. Since this enactment our society has changed, but this aspect of our taxes has until recently remained the same.
Congress has, recently changed this law by creating a new rates for married filing separately and married filing jointly (and surviving spouse). The married filing separately brackets are NOT the same as single or head of household and the married filing jointly (and surviving spouse) brackets are exactly 2x the income per bracket as the married filing separately. Please click here for current tax tables
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How can I take an expense for the business use of my vehicle?
A taxpayer who uses their car or truck in their work or business has a choice on how these vehicle expenses may be deducted. First the standard mileage rate may be used. Alternatively, the actual expenses for running the vehicle may be used. Depreciation expense is part of this actual expense total.
If you want to use the standard mileage rate, you have to use it from the time you started using your car in business. This is because depreciation starts off high and then tapers off. The IRS doesn't want you to take depreciation in the high years and then switch to the standard mileage rate when depreciation gets low.
If you use the actual expenses and depreciate your car, you should know that the depreciation schedule is set when the car is "placed in service." Unless you bought a relatively inexpensive car, you may exceed the "luxury car" limits that were in effect for that year. In this case, you don't look at depreciation tables, but the luxury auto limits table. This table limits the amount of depreciation available for the year. You should also look at tax breaks that allow you to write off the cost of certain types of vehicles used in business (primarily SUV's)
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How are distributions from my Employee Stock Ownership Plans (ESOP) treated?
A distribution from an ESOP is taxed similarly to a distribution from any other retirement plan. They are subject to regular income taxes plus a 10 percent penalty if you
are under the age 59-1/2. A difference of ESOP plans is that the value of the stock that you use for tax reporting purposes may be different than the current market value of the stock. If you receive a distribution and don't want to be hit by any taxes and penalties, you may roll 100% of the gross distribution into an IRA within 60 days of the date of distribution.
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Is all Home Mortgage Interest deductible?
There are two types of deductible home mortgage interest. One type is called "acquisition indebtedness" which is a mortgage to either purchase the home or substantially improve the home. The mortgage interest on this type of loan is deductible on the first $1,000,000 of indebtedness.
The other type of loan on which a taxpayer may deduct mortgage interest is the "home equity loan". Home equity loans may be used for any purpose, but must be secured by the equity in the home. The deduction is limited to the interest expense on the first $100,000 of indebtedness. Note that these dollar limits are cut in half if you are married and file a separate return.
For either of these loan types to qualify for the home mortgage interest deduction, the loan must be secured by a mortgage. It is not enough to say that the loan is secured; all the formalities of creating a mortgage must be followed. This includes filing of the mortgage with the recorder of deeds.
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What is the best way to plan for payment of the current years income taxes?
>If your income and deductions are fairly predicable or consistent, you (or your advisor) can complete tax planning for the year in question to figure out the estimated amount of total tax due. You may pay this tax as you go either through withholding or estimated tax payments. Withholding is usually done if you earn your money as an employee, estimated tax if you don't.
The IRS will allow a $1,000 underpayment of tax go without interest and penalties if you pay the tax by April 15th. This is also the case if you at least match last year's tax liability or pay 90 percent of the current year's liability. This creates some slack in the system. You can take advantage of this slack by arranging your withholding or estimated tax payments to hit the minimum. This way you will be paying on the day due rather than getting a refund. This is the IRS's interest-free loan to you.
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What is the Alternative Minimum Tax (AMT)?
The Alternative Minimum Tax is a peculiar concept. The AMT exists because some higher income tax payers were not paying enough, many times nothing at all in taxes. Prior to the AMT system it was possible to invest money in such a way that deductions exceeded income.
To alleviate this situation, a new top-to-bottom method of computing taxes was set up, the AMT system. A number of deductions, called "preferences", were either disallowed or reduced and different tax rates were established. In theory, you compute your taxes under both the regular method and the AMT method and pay the higher amount.
In practice, for most of these people, the regular tax is significantly higher than the AMT. One little irony about the AMT is that it comes close to being the flat tax that politicians have been talking about for years. If you look at the AMT alone, there are few deductions and two basic tax rates, 26 and 28 percent.
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In what year are income and deductions reported?
Individuals are pretty much limited to reporting income in the year it is actually received. This is also true of deductions. This is technically called the "cash method of accounting." The rule is fairly simple: a transaction is deemed to occur in the year the payment(s) are made.
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What is the maximum amount that can be contributed to a 401(k) plan?
