Tuesday, February 13, 2018

Substantiating Charitable Contributions by Individuals

If you make charitable contributions and deduct them on your tax return, there are requirements to substantiate such charitable contributions. If the contribution is $250 or more, you'll need a written receipt from the charity. If you donate property valued at more than $500, additional requirements apply. Here are the details.

General rules. For each check that is written for less than $250, a copy of your cancelled check will be considered adequate substantiation of your contribution.  For a contribution of cash or other monetary gift, regardless of amount, you must obtain a written communication from the donee organization showing its name, plus the date and amount of the contribution. Any other type of written record, such as a log of contributions, is insufficient.

For a contribution of property other than money, you generally must maintain a receipt from the donee organization that shows the organization's name, the date and location of the contribution, and a detailed description (but not the value) of the property. If circumstances make obtaining a receipt impracticable, you must maintain a reliable written record of the contribution. The information required in such a record depends on factors such as the type and value of property contributed.

If the contribution is worth $250 or more, stricter substantiation requirements apply. No charitable deduction is allowed for any contribution of $250 or more unless you substantiate the contribution with a written receipt from the donee organization. You must have the receipt in hand when you file your return (or by the due date, if earlier) or you won't be able to claim the deduction. If you make separate contributions of less than $250, you won't be subject to the written receipt requirement, even if your contributions to the same charity total $250 or more in a year.

The receipt must set forth the amount of cash and a description (but not the value) of any property other than cash contributed. It must also state whether the donee provided any goods or services in return for the contribution, and if so, must give a good-faith estimate of the value of the goods or services.

If you received only "intangible religious benefits," such as attending religious services, in return for your contribution, the receipt must say so. This type of benefit is considered to have no commercial value and so doesn't reduce the charitable deduction available.

In general, if the total charitable deduction you claim for non-cash property is more than $500, you must attach a completed Form 8283 (Noncash Charitable Contributions) to your return or the deduction isn't allowed.

For donated property with a value of more than $5,000, you're generally required to obtain a qualified appraisal and to attach an appraisal summary to the tax return. However, a qualified appraisal isn't required for publicly traded securities for which market quotations are readily available.

For gifts of art valued at $20,000 or more, you must attach a complete copy of the signed appraisal (rather than an appraisal summary) to your return. IRS may also request that you provide a photograph.

If an item of art has been appraised at $50,000 or more, you can ask IRS to issue a "Statement of Value" which can be used to substantiate the value.

Recordkeeping for contributions for which you receive goods or services. If you receive goods or services, such as a dinner or theater tickets, in return for your contribution, your deduction is limited to the excess of what you gave over the value of what you received. For example, if you gave $100 and in return received a dinner worth $30, you can deduct $70.

If you made a contribution of more than $75 for which you received goods or services, the charity must give you a written statement, either when it asks for the donation or when it receives it, that tells you the value of those goods or services. Be sure to keep these statements.

Cash contribution made through payroll deductions. You can substantiate a contribution that you make by withholding from your wages with a pay stub, Form W-2, or other document from your employer that shows the amount withheld for payment to a charity. You can substantiate a single contribution of $250 or more with a pledge card or other document prepared by the charity that includes a statement that it doesn't provide goods or services in return for contributions made by payroll deduction.

The deduction from each wage payment is treated as a separate contribution for purposes of the $250 threshold.

Substantiating out-of-pocket costs. Although you can't deduct the value of services you perform for a charitable organization, some deductions are permitted for out-of-pocket costs you incur while performing the services. You should keep track of your expenses, the services you performed and when you performed them, and the organization for which you performed the services. Keep receipts, canceled checks, and other reliable written records relating to the services and expenses.

As discussed above, a written receipt is required for contributions of $250 or more. This presents a problem for out-of-pocket expenses incurred in the course of providing charitable services, since the charity doesn't know how much those expenses were. However, you can satisfy the written receipt requirement if you have adequate records to substantiate the amount of your expenditures, and get a statement from the charity that contains a description of the services you provided, the date the services were provided, a statement of whether the organization provided any goods or services in return, and a description and good-faith estimate of the value of those goods or services.

Please contact us if you have any questions about these rules that you would like to discuss to help ensure you get all of the deductions to which you are entitled.

Saturday, January 13, 2018

Net Investment Income Tax

High-income taxpayers face a special tax-a 3.8% net investment income tax. Here's an overview of this tax and what it means to you.

This tax applies, in addition to income tax, on your net investment income. The tax only affects taxpayers whose adjusted gross income (AGI) exceeds $250,000 for joint filers and surviving spouses, $200,000 for single taxpayers and heads of household, and $125,000 for married individuals filing separately. These threshold amounts aren't indexed for inflation. Thus, as time goes by, inflation will cause more taxpayers to become subject to the 3.8% tax.

Your AGI is the bottom line on Page 1 of your Form 1040. It consists of your gross income minus your adjustments to income, such as the IRA deduction.

If your AGI is above the threshold that applies to you, the 3.8% tax applies to the lesser of (1) your net investment income for the tax year or (2) the excess of your AGI for the tax year over your threshold amount. This tax is in addition to the income tax that applies to that same income.

Take, for example, a married couple that has AGI of $270,000, of which $100,000 is net investment income. They would pay a net investment income tax on only the $20,000 amount by which their AGI exceeds their threshold amount of $250,000. That is because the $20,000 excess is less than their net investment income of $100,000. Thus, the couple's net investment income tax would be $760 ($20,000 × 3.8%).

Now assume that the couple's AGI was $350,000. Because their AGI exceeds their threshold amount by $100,000, they would pay a net investment income tax on their full $100,000 of net investment income. Their tax would then be $3,800 ($100,000 × 3.8%).

What is net investment income? The "net investment income" that is subject to the 3.8% tax consists of interest, dividends, annuities, royalties, rents, and net gains from property sales. Income from an active trade or business isn't included in net investment income, nor is wage income.

However, passive business income is subject to the net investment income tax. Thus, rents from an active trade or business aren't subject to the tax, but rents from a passive activity are subject to it.

Income that is exempt from income tax, such as tax-exempt bond interest, is likewise exempt from the 3.8% net investment income tax. Thus, switching some of your taxable investments into tax-exempt bonds can reduce your exposure to the 3.8% tax. Of course, this should be done with due regard to your income needs and investment considerations.

Home sales. Many people have asked how the 3.8% tax applies to home sales. If you sell your main home, you may be able to exclude up to $250,000 of gain, or up to $500,000 for joint filers, when figuring your income tax. This excluded gain isn't subject to the 3.8% net investment income tax.

However, gain that exceeds the limit on the exclusion is subject to the tax. Gain from the sale of a vacation home or other second residence, which doesn't qualify for the income tax exclusion, is also subject to the net investment income tax.

For example, say that a married couple has AGI of $200,000 and in addition sold their main home for a $540,000 gain. The couple qualified for the full $500,000 exclusion of gain on the sale, leaving only $40,000 of taxable gain. As a result, the couple isn't subject to the 3.8% tax, because their total AGI ($200,000 + $40,000) falls below the $250,000 threshold.

But if the gain on the home sale was $680,000, of which $180,000 was taxable, the couple would be subject to the 3.8% tax on $130,000 of the gain. That is the amount by which their total AGI of $380,000 ($200,000 + $180,000) exceeds their $250,000 threshold.

Retirement plan distributions. Distributions from qualified retirement plans, such as pension plans and IRAs, aren't subject to the net investment income tax. However, those distributions may push your AGI over the threshold that would cause other types of investment income to be subject to the tax.

This makes Roth IRAs more attractive for higher-income individuals, because qualified Roth IRA distributions are neither subject to the net investment income tax nor included in AGI. Distributions from traditional IRAs are included in AGI, except to the extent of after-tax contributions, although they aren't subject to the net investment income tax.

How the tax is reported and paid. The net investment income tax is computed on Form 8960, attached to and filed with your Form 1040. The tax must be paid at that time.

The net investment income tax must be taken into account in calculating your quarterly estimated tax. Thus, if you expect to be subject to the tax, you may have to make or increase your estimated tax payments to avoid an underpayment penalty.

As you can see, this tax has a significant effect on your tax picture. If you would like to discuss this tax and how its impact can be reduced, please contact us.

Thursday, December 21, 2017

Tax Changes Coming in 2018

Congress appears poised to enact a major tax reform law that could potentially make fundamental changes in the way you and your family calculate your federal income tax bill and the amount of federal tax you will pay. Keep in mind, however, that while most experts expect a major tax law to be enacted this year, it is by no means a sure bet. So keep a close eye on the news and don't swing into action until the ink is dry on the President's signature of the tax reform bill.
Beginning next year, the bill would repeal or reduce many popular tax deductions in exchange for a larger standard deduction. Here's what you can consider doing before year end to maximize your tax benefits:

For taxpayers that itemize:

  • Pay the last installment of estimated state and local taxes for 2017 by December 31 rather than on the 2018 due date and prepay real estate taxes on your home.  They are proposing limiting the taxes that can be included in itemized deductions to $10,000.

  • Because most other itemized deductions would be eliminated in exchange for a larger standard deduction (e.g., $24,000 for joint filers), charitable contributions after 2017 may not yield a tax benefit for many. If you think you will fall in this category, consider accelerating some charitable giving into 2017.

Timing of business income and deductions:

Due to a general reduction in tax rates and new reduced tax rates on business income in the tax reform bill, it will often be advisable (more often than most years) to defer income and accelerate expenses. So if you have purchases you need to make in the near future, accelerating those expenses into 2017 will likely result in greater tax savings than incurring the same expense in 2018. Similarly, income may be deferred by delaying billings (cash-basis taxpayers) or delaying deliveries (accrual-basis taxpayers).

We have included the proposed tax rates for single and married taxpayers below.  If you would like more details about any aspect of how the proposed legislation may affect you, please do not hesitate to contact us. 


If taxable income is:          The tax is:
--------------------           -----------

Not over $19,050               10% of taxable income

Over $19,050 but not           $1,905 plus 12% of the
  over $77,400                   excess over $19,050

Over $77,400 but not           $8,907 plus 22% of the
  over $165,000                  excess over $77,400

Over $165,000 but not          $28,179 plus 24% of the
  over $315,000                  excess over $165,000

Over $315,000 but not          $64,179 plus 32% of the
  over $400,000                  excess over $315,000

Over $400,000 but not          $91,379 plus 35% of the
  over $600,000                  excess over $400,000

Over $600,000                 $161,379 plus 37% of the
                                 excess over $600,000



If taxable income is:          The tax is:
--------------------           ----------

Not over $9,525                10% of taxable income

Over $9,525 but not            $952.50 plus 12% of the
  over $38,700                    excess over $9,525

Over $38,700 but not           $4,453.50 plus 22% of the
  over $82,500                    excess over $38,700

Over $82,500 but not           $14,089.50 plus 24% of the
  over $157,500                   excess over $82,500

Over $157,500 but not          $32,089.50 plus 32% of the
  over $200,000                   excess over $157,000

Over $200,000 but not          $45,689.50 plus 35% of the
  over $500,000                   excess over $200,000

Over $500,000                  $150,689.50 plus 37% of  
                                  the excess over $500,000


Tuesday, December 12, 2017

Health Savings Accounts

For eligible individuals, health savings accounts (HSAs) offer a tax-favorable way to set aside funds (or have their employer do so) to meet future medical needs. Here are the key tax-related elements:

       contributions you make to an HSA are deductible, within limits,

       contributions your employer makes aren't taxed to you,

       earnings on the funds within the HSA are not taxed, and

       distributions from the HSA to cover qualified medical expenses are not taxed.
Who is eligible? To be eligible for an HSA, you must be covered by a "high deductible health plan" (discussed below). You must also not be covered by a plan which (1) is not a high deductible health plan, and (2) provides coverage for any benefit covered by your high deductible plan. (It's okay, however, to be covered by a high deductible plan along with separate coverage, through insurance or otherwise, for accidents, disability, or dental, vision, or long-term care.)

For 2017, a "high deductible health plan" is a plan with an annual deductible of at least $1,300 for self-only coverage, or at least $2,600 for family coverage. For self-only coverage, the 2017 limit on deductible contributions is $3,400. For family coverage, the 2017 limit on deductible contributions is $6,750. Additionally, annual out-of-pocket expenses required to be paid (other than for premiums) for covered benefits cannot exceed $6,550 for self-only coverage or $13,100 for family coverage.

An individual (and the individual's covered spouse as well) who has reached age 55 before the close of the tax year (and is an eligible HSA contributor) may make additional "catch-up" contributions for 2017 of up to $1,000.

A high deductible health plan does not include a plan if substantially all of the plan's coverage is for accidents, disability, or dental, vision, or long-term care, insurance for a specified disease or illness, or insurance paying a fixed amount per day (or other period) of hospitalization.

HSAs may be established by, or on behalf of, any eligible individual.

Deduction limits: You can deduct contributions to an HSA for the year up to the total of your monthly limitations (1/12 of the annual maximum contribution) for the months you were eligible. Also, taxpayers who are eligible individuals during the last month of the tax year are treated as having been eligible individuals for the entire year for purposes of computing the annual HSA contribution.

However, if an individual is enrolled in Medicare, he is no longer an eligible individual under the HSA rules, and so contributions to his HSA can no longer be made.

Employer contributions: If you are an eligible individual, and your employer contributes to your HSA, the employer's contribution is treated as employer-provided coverage for medical expenses under an accident or health plan and is excludable from your gross income up to the deduction limitation, as described above. Further, the employer contributions are not subject to withholding from wages for income tax or subject to FICA or FUTA. The eligible individual cannot deduct employer contributions on his federal income tax return as HSA contributions or as medical expense deductions.

An employer that decides to make contributions on its employees' behalf must make comparable contributions to the HSAs of all comparable participating employees for that calendar year. If the employer does not make comparable contributions, the employer is subject to a 35% tax on the aggregate amount contributed by the employer to HSAs for that period.

An exception to the comparable contribution requirements applies for contributions made on behalf of non-highly compensated employees. Under this exception, an employer may make larger HSA contributions for non-highly compensated employees than for highly compensated employees.

Earnings: If the HSA is set up properly, it is generally exempt from taxation, and there is no tax on earnings. However, taxes may apply if contribution limitations are exceeded, required reports are not provided, or prohibited transactions occur.

Distributions: Distributions from the HSA to cover an eligible individual's qualified medical expenses, or those of his spouse or dependents, are not taxed. Qualified medical expenses for these purposes generally mean those that would qualify for the medical expense itemized deduction. If funds are withdrawn from the HSA for other reasons, the withdrawal is taxable. Additionally, an extra 20% tax will apply to the withdrawal, unless it is made after reaching age 65, or in the event of death or disability.

As you can see, HSAs offer a very flexible option for providing health care coverage, but the rules are somewhat involved. Please contact us if you would like to discuss this topic further.

Friday, November 10, 2017

Year-End Tax Tips for Employees

As year-end approaches, taxpayers generally are faced with a number of choices that can save taxes this year, next year or both years. Employees have some special considerations to take into account that retirees and other nonworking individuals don't face. To help our clients who are employees take advantage of these special tax saving opportunities, we have put together a list of items to consider.

Health flexible spending accounts. Many employees take advantage of the annual opportunity to save taxes by placing funds in their employer's health flexible spending arrangement (health FSA). A pre-tax contribution of $2,600 to a health FSA is the current limit. You save taxes because you use pre-tax dollars in the health FSA to pay for medical expenses that might not otherwise be deductible (due to not itemizing, or due to a portion being nondeductible because of the 10% adjusted gross income floor). Additionally, the amounts that you contribute to a health FSA are not subject to FICA taxes. This would allow you to save $199 in FICA taxes alone, on a health FSA contribution of $2,600. You would save an additional $520 in income taxes based on an effective income tax rate of 20%. Total annual tax savings would equal $719 ($199 + $520).

Your plan should have a listing of qualifying items and any documentation from a medical provider that may be needed to get a reimbursement for these items.

To avoid any forfeiture of your health FSA funds because of application of the use-it-or-lose-it rule, you must incur qualifying medical expenditures by the last day of the plan year, unless the plan allows an optional grace period. Any grace period cannot extend beyond the 15th day of the third month following the close of the plan year (e.g., March 15 for a calendar year plan), so, if the plan allows a grace period, qualifying medical expenses that you incur through that date can be reimbursed using your prior-year health FSA account. An additional exception to the use-it-or lose-it rule permits health FSAs to allow a carryover of a participant's unused health FSA moneys, up to a $500 (or lower plan) maximum.

As a cautionary note, if you or your spouse intend to participate in a high deductible health plan (HDHP) in 2018, your participation in a health FSA may hamper your ability to contribute to a health savings account (HSA).

Examining your year-to-date expenditures now will also help you to determine how much to set aside for next year. Don't forget to reflect any changed circumstances in making your calculation.

Dependent care FSAs. Some employers also allow employees to set aside funds in dependent care FSAs. A $5,000 maximum annual contribution is permitted ($2,500 for a married couple filing separately). A dependent care FSA allows employees to use pre-tax dollars to pay for dependent care. In particular cases, participating in a dependent care FSA can yield greater tax savings than foregoing participation and claiming a dependent care credit. Taxpayers who are eligible to participate in a dependent care FSA and are (a) in a high tax bracket and/or (b) have only one dependent and more than $3,000 of dependent care-related expenses, should use the FSA to pay for child care expenses. For these taxpayers, the FSA almost always provides greater federal tax savings than does the dependent care credit. State income tax savings also may apply. Additionally, participating in a dependent care FSA also saves you FICA taxes on the amount of the contribution.

However, like health FSAs, dependent care FSAs are subject to the use-it-or lose it rule, but neither the grace period nor the up-to-$500 forfeiture exception applies. Thus, now is a good time to review expenditures to date and to project amounts to be set aside for next year.

Adjustments to federal and state withholding. You can ask your employer to increase withholding of federal and/or state and local taxes by amending your federal and/or state withholding forms before year-end if a) you expect to owe federal and/or state and local income taxes when you file your return next year (this will pull the deduction of those taxes into this year) or b) if you face a penalty for underpayment of estimated tax and you want to eliminate or reduce it. If you become married or single in 2017, or have added or lost a dependent, you should be sure to provide your employer with an updated federal and state tax withholding form that reflects the new filing status or changed exemptions. Be sure to review your withholding if you hold multiple jobs, you and your spouse both work, or you can be claimed as a dependent by another person.

Increase 401(k) contributions. The pre-tax and Roth 401(k) contribution limit for 2017 is $18,000. Employees age 50 or older by year-end are also permitted to make an additional contribution of $6,000, for a total limit of $24,000 in 2017. If your employer makes a matching contribution to your contribution, your total retirement savings will increase even faster. Review and make appropriate adjustments to the contributions you make to your employer's 401(k) retirement plan for the remainder of this year, and next year. It's also a good idea to review your investment elections, and their periodic performance. Keep in mind the amount you need to save for the age at which you plan to retire and consider seeing a financial planner to set, and keep to, your savings goals.

Make Roth IRA contributions. The ability to make a Roth IRA contribution (which is a special after-tax contribution) continues even if you're participating in an employer savings plan (like a 401(k)), so it is not subject to the "active participant" rules that may prevent employees who participate in an employer plan from making a deductible contribution to a traditional IRA. The benefit of the Roth IRA is that the earnings on the IRA will not be taxable to you on distribution (provided, generally, that distributions of income are made to you after you attain age 59 1/2). You are allowed to withdraw contributions you have previously made at any time without penalty.  The 2017 Roth contribution limit is $5,500, rising to $6,500 if you're age 50 or older by the end of 2017. Your ability to make a Roth IRA contribution in 2017 will be reduced if your adjusted gross income (AGI) in 2017 exceeds a certain amount, which is dependent upon your filing status.

Be on the watch for 2018 plan election forms to be coming from your employer.  If you would like to discuss any of these matters in greater detail, please contact us.

Monday, October 16, 2017

Tax Implications of Divorce

Unfortunately, in addition to the difficult personal issues the process entails, several tax concerns need to be addressed when facing a divorce or legal separation to ensure that tax costs are kept to a minimum and that important tax-related decisions are properly made.

Support Provisions: Support payments required to be made from one spouse to another upon divorce or separation are deductible by the payor and taxable to the recipient if they qualify under the tax rules for "alimony." There are several factors that are used to determine if support payments qualify as alimony.

Support payments for children ("child support") aren't deductible by the paying spouse (or taxable to the recipient). These include payments specifically designated as child support as well as payments which otherwise might look like alimony but are linked to an event or date related to a child.

Tax planning for support payments generally seeks to make them deductible if the paying spouse is in a higher tax bracket than the recipient, as is often the case. The tax savings for the paying spouse can be shared with the recipient through higher payment amounts or other benefit provisions.

Dependency exemptions: To some extent, the parties can determine who's entitled to claim the dependency exemption for their dependent children. The exemption for the child goes to the spouse who has legal custody of the child. However, that spouse can waive his or her right to the exemption, thus allowing the noncustodial spouse to claim it.

The dependency exemption entitles the spouse who claims it to more than just the exemption. For example, the child tax and the higher education credits are only available to the spouse who claims the child as a dependent.

Property settlements: When property is split up in connection with a divorce, there are usually no immediate tax consequences. Thus, property transferred between the spouses won't result in taxable gain or loss to the transferring spouse. Instead, the receiving spouse takes the same basis (cost) in the property that the transferring spouse had. (The receiving spouse may have to pay tax later, however, when the recipient spouse sells the property).

Personal residence: In general, if a married couple sells their home in connection with divorce or legal separation they should be able to avoid tax on up to $500,000 of gain (as long as they owned and used the residence as their principal residence for two of the previous five years). If one spouse continues to live in the home and the other moves out (but they remain owners of the home), they may still be able to avoid gain on the future sale of the home (up to $250,000 each), but special language may have to be included in the divorce decree or separation agreement to protect the exclusion for the spouse who moves out.

Pension benefits: A spouse's pension benefits are often part of a property settlement. When this is the case, the commonly preferred method to handle the benefits is to get a "qualified domestic relations order (QDRO)." A QDRO gives one spouse the right to share in the pension benefits of the other and taxes the spouse who receives the benefits. Without a QDRO the spouse who earned the benefits will still be taxed on them even though they are paid out to the other spouse.

A QDRO isn't needed to split up an IRA, but special care must be taken to avoid unfavorable tax consequences. If a specific IRS-approved method for transferring the IRA from one spouse to the other is not used, the transaction could be treated as a taxable distribution (possibly also triggering penalties).

Business interests: When certain types of business interests are transferred in connection with divorce or separation, care must be taken to make sure "tax attributes" aren't forfeited. In particular, interests in S corporations may result in "suspended" losses; where these interests change hands in connection with a divorce, the suspended losses may be forfeited. If a partnership interest is transferred a variety of complex issues may arise involving partners' shares of partnership debt, capital accounts, built-in gains on contributed property, and other complex issues. The parties involved should be aware of the tax consequences that their transfer may generate.

Estate planning considerations: The upheaval a divorce causes in family relations and property holdings makes it imperative for the parties to reassess their wills and estate plans in connection with the divorce. First, the typical will in which all property is left to a surviving spouse is no longer likely to reflect the testator's wishes. Second, the property to be left by the spouses may have changed hands via a property settlement. Finally, guardianship and trustee issues for surviving minor children must be addressed. That is, who will manage the assets of, and serve as guardian for, minor children in the event of the death of the parents.

Tax records: Make sure you get copies of, or access to, any records or documents that can have an impact on your tax situation. You need copies of joint returns filed with your spouse along with supporting documentation. Also, records relating to the cost of jointly owned property or property transferred to you in connection with the divorce are essential. You'll need to establish cost when these assets are eventually sold.

Filing status: If a "final" decree or divorce or, in the case of separation, decree of separate maintenance, is issued by the end of the year, then you can't file your tax return for the year as a married person. Your filing status will be "single." However, if you cover more than half the costs of a household in which a child of yours lives, you may qualify for more favorable "head of household" rates.

If an above-described decree hasn't been issued by year-end, you're treated as still married even if you're separated from your spouse under a separation agreement or "nonfinal" decree. In this case, you may still file jointly with your spouse, which may result in lower overall tax for you and your ex-spouse, but may put you at risk for an unpaid tax obligation of your spouse's. It also requires contact between the parties to prepare the joint return, which may not be desirable in some circumstances. The other available filing status is "married filing separately," which is the least favorable status.

Adjusting income tax withholding: The calculation of your withholding on the Form W-4, Employee's Holding Allowance Certificate, that you gave to your employer is based on your married status and on the earnings of both spouses. When you get divorced, you should submit a new Form W-4 with the revised information. The fact that deductible alimony payments will be made (or taxable alimony received) should also be taken into account. This will ensure that the correct amount of tax is withheld.

Notifying IRS of a new address or name change: If you'll be moving, or if you're changing your name because of divorce, file Form 8822 with IRS so you'll receive any notices or correspondence from IRS promptly.

We hope this overview of a complex area has been helpful to you. Please contact us if we can be of assistance regarding any of these matters.

Monday, September 11, 2017

Tax Aspects of Self-Employment

As a sole proprietor, there are several important rules that you should be aware of:

(1) For income tax purposes, you'll report your income and expenses on Schedule C of your Form 1040. The net income will be taxable to you regardless of whether you withdraw cash from the business. Your business expenses will be deductible against gross income (i.e., "above the line") and not as itemized deductions. If you have any losses, the losses will generally be deductible against your other income, subject to special rules relating to hobby losses, passive activity losses, and losses in activities in which you weren't "at risk."

(2) You may be able to deduct office-at-home expenses. If you'll be working from an office in your home, performing management or administrative tasks from an office-at-home, or storing product samples or inventory at home, you may be entitled to deduct an allocable portion of certain of the costs of maintaining your home. And if you have an office-at-home, you may be able to deduct commuting expenses of going from your home to another work location.

(3) You'll be required to pay self-employment taxes. For 2017, you'll pay self-employment tax (social security and Medicare) at a 15.3% rate on your net earnings from self-employment of up to $127,200, and Medicare tax only at a 2.9% rate on the excess. An additional 0.9% Medicare tax (for a total of 3.8%) will be imposed on self-employment income in excess of $250,000 for joint returns; $125,000 for married taxpayers filing separate returns; and $200,000 in all other cases. Self-employment tax is imposed in addition to income tax, but you can deduct half of your self-employment tax as an adjustment to income.

(4) You'll be allowed to deduct 100% of your health insurance costs as a trade or business expense. This means your deduction for medical care insurance won't be subject to the limitation on your medical expense deduction that is based on a percentage of your adjusted gross income.

(5) You'll be required to make quarterly estimated tax payments. Self-employed individuals are required to pay their income taxes in quarterly using the estimated tax payment guidelines, in order to avoid an underpayment penalty.

(6) You'll have to keep complete records of your income and expenses. In particular, you should carefully record your expenses in order to claim the full amount of the deductions to which you are entitled. Certain types of expenses, such as automobile, travel, entertainment, meals, and office-at-home expenses, require special attention because they're subject to special recordkeeping requirements or limitations on deductibility.

(7) If you hire any employees, you'll have to get a taxpayer identification number and will have to withhold and pay over various payroll taxes.

(8) You should consider establishing a qualified retirement plan. The advantage of a qualified retirement plan is that amounts contributed to the plan are deductible at the time of the contribution, and aren't taken into income until the amounts are withdrawn. Because of the complexities of ordinary qualified retirement plans, you might consider a simplified employee pension (SEP) plan, which requires less paperwork. Another type of plan available to sole proprietors that offers tax advantages with fewer restrictions and administrative requirements than a qualified plan is a "savings incentive match plan for employees," i.e., a SIMPLE plan. If you don't establish a retirement plan, you may still be able to make a contribution to an IRA.

If you’d like any additional information regarding the tax aspects of your business, or if you need assistance in satisfying any of the reporting or recordkeeping requirements, please contact us.