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Posts Tagged ‘tax preparation’

Tax Tip: Deducting Sales Taxes

Sales taxes are generally not deductible, unless paid in connection with a qualified business expense.  Even in a business context, sales taxes paid for the purchase of a capital asset must be added to the cost of the asset and are recaptured through depreciation.

In the 2010 Tax Relief Act, Congress extended a provision that allows individual taxpayers to claim a sales tax deduction in lieu of deducting state income taxes.  This provision is allowable for tax years 2010 and 2011.  Frequently, it is only beneficial to taxpayers who reside in those states that do not have a state income tax. 

The deduction amount is determined by either (1) accumulating actual receipts showing general sales tax paid or (2) using IRS tables.  The tables are published in the instructions to Schedule A (Itemized Deductions).  You can also click here and go to an IRS link that will calculate the deduction for you.  The deduction tables are based upon your state, the number of exemptions claimed on your tax return, and your income.  Carefully review the instructions for calculating your income.  Income for this purpose is your adjusted gross income, plus certain nontaxable income such as tax-exempt interest, nontaxable Social Security benefits, worker’s compensation, etc.

Taxpayers who use the IRS tables can also add the sales taxes paid for certain large purchases, such as vehicles, boats, motorcycles, RV’s, etc.   If you made a substantial purchase of one of these items in 2010, you may receive a larger benefit from claiming the sales tax deduction in lieu of state income taxes, especially if your state income tax liability is not that large. 

You must personally pay the expenses in order for the tax to be deductible. This provision may eliminate a potentially large benefit to taxpayers who engaged in a substantial construction project.  The sales taxes on construction materials are often paid by the contractor, which would prevent you from claiming the deduction.

Some of what Congress gives, they also take away.  Keep in mind that no taxes are deductible for the alternative minimum tax.  Thus, your benefit may be reduced or eliminated as a result of the alternative minimum tax.

Sales taxes paid on personal purchases have generally not been deductible since 1986.  Congress added a benefit in 2005, which was primarily targeted towards those individuals living in states without a state income tax.  Although set to expire in 2009, the provision was extended through 2011. 

No matter where you live, if you made large purchases in 2010 and can document the sales taxes paid, you may benefit from the sales tax deduction.

Tax Tip: Mortgage Interest Deduction

If you have a mortgage on your personal residence, you’re probably well aware of the mortgage interest deduction, but like many tax provisions, a simple rule can be complex.  There are many factors involving the deductibility of mortgage interest. 

Generally, you are able to deduct the interest associated with $1 million of acquisition indebtedness and $100,000 of home equity debt.  The interest can relate to your principal residence (as defined) and one other residence you select. 

Some of the requirements for deducting the interest associated with acquisition indebtedness are as follows.

  • Acquisition debt is associated with acquiring, constructing or substantially improving a qualified residence.
  • The debt must be secured by the residence.  Not a problem if you borrowed money from a financial institution, since they will definitely secure their mortgage.  However, if you borrowed money from a family member, your loan document may not state that the loan is secured by the property.
  • You must own the property on the debt you are paying and must personally make the payments. For example, if parents pay the mortgage for their children, the interest isn’t deductible by either of them.

The following are some of the rules related to deducting interest on a home equity loan.

  • The home equity loan can’t exceed the equity in your house.  You generally can’t borrow more than the value of your home, but this could be problematic given the recent decline in real estate prices.
  • The proceeds from a home equity can be used for any purpose, except to purchase tax-exempt securities. 
  • Interest associated with proceeds used for purposes other than for a residence may be subject to the alternative minimum tax.

Mortgage points are generally deductible when paid for an initial loan to purchase a property.  Points paid upon the refinance of a mortgage must be amortized over the life of the new loan.

The IRS is very strict in apply the $1 million acquisition and $100,000 home equity debt limits.  However, the Service issued a ruling in 2009 in which they stated that acquisition indebtedness in excess of $1 million to acquire, construct or substantially improve a residence could be considered home equity interest.  Thus, taxpayers could deduct interest on $1.1 million of acquisition indebtedness without having to take out a separate home equity loan.

As you can see, a simple deduction has rather complex requirements.  If you have an unusual situation or are unclear about the tax rules, you should consult a tax professional.  A mortgage interest deduction can drastically reduce your tax bill, but it can also be quite costly if your deduction is disallowed.

Tax Tip: Self-Employed Health Insurance

While the debate over health care and health insurance continues in the U.S., there is one thing we call agree on… health insurance is expensive.  If you are paying for health insurance, any tax benefits you receive will help reduce the effective cost of your coverage.

A majority of people in the U.S. receive their health insurance coverage as a tax-free employee fringe benefit.  You may contribute to the expense, but the portion your employer pays is typically tax-free to you.  In order to attain parity between an employer and someone who is self-employed, self-employed taxpayers are allowed to deduct 100% of their premiums in calculating their adjusted gross income.  While it may seem logical and fair, it was not always this way.

In order to take the deduction, you must have self-employment income equal to or greater than your health insurance premiums.  Your salary, wages, interest, dividends, pension and other income are not considered self-employment income.  Thus, the portion of insurance you are contributing to your employee benefits and premiums you are paying while unemployed do not count.  The premiums may be deductible as an itemized deduction, but they do not qualify for the self-employed health insurance deduction.

There are a couple of changes that can affect your 2010 tax liability.

  • Your health insurance premiums are treated as a deduction for calculating your net self-employment income, which will reduce the self-employment taxes you pay.  This benefit is only applicable for 2010, unless otherwise extended by Congress.
  • The IRS has determined that Medicare Part B premiums can be treated as self-employed health insurance premiums.  Thus, if you are over 65 and are having Medicare Part B premiums deducted from your Social Security check, you can deduct the premiums if you have net self-employment income greater than or equal to your Medicare Part B premiums.
  • After March 30, 2010, any premiums paid for a child who is under age 27 will qualify for the deduction.
  • After March 30, 2010, the deduction is not allowed for anyone who is eligible to participate in any subsidized health insurance plan for themselves, their spouse or dependent (i.e., you can’t deduct your portion of the premiums paid as part of a subsidized employer health plan).

If you are self-employed or have self-employed income, the self-employed health insurance deduction may help reduce the cost of maintaining health insurance coverage.  The tax savings may not make get you over the affordability hump, but if you are paying, you might as well take advantage of whatever tax breaks you can.

Tax Tip: Self-Employment Taxes

Self-Employment taxes are Social Security and Medicare taxes.  If you are an employee, half of the taxes are withheld from your paychecks and the other half is paid by your employer.  If you are self-employed, you get to pay all of the taxes yourself.   Lucky you.

Self-employment taxes are assessed upon your net self-employment income over $400.  Without delving into all of the various types of self-employment income, it basically means being paid for your hard work and efforts.  It does not include interest income, dividends, capital gains, pensions or other investment income.  Some of the common forms of self-employed income include:

  • Net earnings from a trade or business
  • Consulting and director fees
  • Tips
  • Payments for any services you provide to another person (e.g., maintenance, repairs, cleaning)
  • Pass through income from a partnership or limited liability company

A portion of your self-employed income may be reported to you on a 1099-MISC or a partnership Schedule K-1, but it’s highly likely that some self-employed income won’t be reported to you.  The income is taxable to you even if you don’t receive a 1099, Schedule K-1 or other tax reporting statement, and getting paid in cash doesn’t mean you don’t have to report the income.

Just like an employee, the tax is divided between Social Security and Medicare.  The Social Security tax portion is assessed at 12.4% on the first $106,800 of income for 2010 and 2011.  Since there is no cap on Medicare earnings, you’ll pay 2.9% on all of your self-employed income, no matter how high it goes.  The good news is that you get to deduct half of the self-employment tax in computing your adjusted gross income.  The bad news is that if you’re married, you and your spouse are subject to the tax separately.

There is one taxpayer favorable provision that you want to take advantage of in 2010.  For this year only, you can deduct your self-employed health insurance premiums in determining your net self-employed income.  It’s a one-year benefit, unless Congress decides to extend it.

Special rules can apply to farmers, real estate professionals, ministers, and investors.  It can get complex rather quickly, and the myriad of potential issues are beyond the scope of this article.  If you have questions or wonder if certain income is subject to self-employment taxes or exempt, you should consult a tax professional. 

With an effective tax rate that can be over 15%, self-employment taxes add up quickly.  Better to get it right, than be surprised with an unexpected tax bill later.