90th Anniversary - The 1928 Individual Income Tax Return

LWH CPAs is a public accounting firm with four locations, including Paris, Casey, and Tuscola, Illinois and Terre Haute, Indiana.  We seek to be our clients’ most trusted advisor and provide innovative solutions, while focusing on client needs, quality, and timeliness. We provide a wide range of services, from tax planning and compliance to auditing, accounting, payroll, and business valuation services.  Clients range from individuals with small businesses to multi-state corporations.  

This year, LWH is celebrating its 90th anniversary.  To celebrate our anniversary, we are hosting events in each city related to common QuickBooks mistakes and the effects of the Tax Cuts and Jobs Act.  Please contact us for details if you are interested in attending any of our presentations.

LWH was founded in 1928 and many things have changed over the decades.  One drastic change is the length of the individual income tax packet.  In 1928, the individual income tax return packet was only three pages!  The main form, schedules, and instructions were each one page in length.  See below for a look at the 1928 tax return packet. 

Today, the process is significantly more involved.  The 2017 1040 is only two pages.  However, this does not include countless schedules and forms that are required to be attached to the main form.  The instructions alone for the form are 107 pages.

Nothing is as simple as it used to be, but the IRS has been working on significant changes to the 2018 form to help shorten it. Although the 2018 Form 1040 has been condensed based on the drafts released, it will still include countless additional schedules that may need to be attached.  We are unlikely to have a tax form as simple as the one below again.

LWH looks forward to another 90 years of providing quality services to the communities we serve.

 

 

 

Alimony Tax Treatment Changes from the Tax Cuts and Jobs Act

The Tax Cuts and Jobs Act (TCJA) has made changes to the tax treatment of alimony that you may be interested in. These changes take effect for divorces and legal separations after 2018.

Under the current rules, an individual who pays alimony may deduct an amount equal to the alimony or separate maintenance payments paid during the year as an "above-the-line" deduction. (An "above-the-line" deduction, i.e., a deduction that a taxpayer need not itemize deductions to claim, is more valuable for the taxpayer than an itemized deduction.)

Also under current rules, alimony and separate maintenance payments are taxable to the recipient spouse (includible in that spouse's gross income).

Please note that the tax rules for child support – i.e., that payers of child support don't get a deduction, and recipients of child support don't have to pay tax on those amounts – is unchanged.

Under the new TCJA rules, there is no deduction for alimony for the payer. Furthermore, alimony is not gross income to the recipient. So for divorces and legal separations that are executed (i.e., that come into legal existence due to a court order) after 2018, the alimony-paying spouse won't be able to deduct the payments, and the alimony-receiving spouse doesn't include them in gross income or pay federal income tax on them.

The current rules continue to apply to already-existing divorces and separations, as well as divorces and separations that are executed before 2019.

Under a special rule, if taxpayers have an existing (pre-2019) divorce or separation decree, and they have that agreement legally modified, then the new rules don't apply to that modified decree, unless the modification expressly provides that the TCJA rules are to apply. There may be situations where applying the TCJA rules voluntarily is beneficial for the taxpayers, such as a change in the income levels of the alimony payer or the alimony recipient.

If you wish to discuss the impact of these rules on your particular situation, please contact us.

Tax Benefits of Putting Junior Family Members on the Payroll

As a business owner, you should be aware that you can save family income and payroll taxes by putting junior family members on the payroll. You may be able to turn high-taxed income into tax-free or low-taxed income, achieve social security tax savings (depending on how your business is organized), and even make retirement plan contributions for your child.

In addition, employing a child age 18 (or if a full-time student, age 19-23) may be a way to save taxes on the child's unearned income, as explained below.

You can turn some of your high-taxed income into tax-free or low-taxed income by shifting some of your business earnings to a child as wages for services performed by him or her. In order for your business to deduct the wages as a business expense, the work done by the child must be legitimate and the child's salary must be reasonable.

For example, suppose a business owner operating as a sole proprietor is in the 37% tax bracket. He hires his 17-year-old daughter to help with office work full-time during the summer and part-time into the fall. She earns $11,100 during the year (and has no other earnings).

The business owner saves $4,107 (37% of $11,100) in income taxes at no tax cost to his daughter, who can use her $12,000 standard deduction for 2018 to completely shelter her earnings. The business owner could save an additional $2,035 in taxes if he could keep his daughter on the payroll longer and pay her an additional $5,500. She could shelter the additional income from tax by making a tax-deductible contribution to her own IRA.

Family taxes are cut even if the child's earnings exceed his or her standard deduction and IRA deduction. That's because the unsheltered earnings will be taxed to the child beginning at a rate of 10%, instead of being taxed at the parent's higher rate.

Keep in mind that bracket-shifting works even for a child who is subject to the kiddie tax, which causes the child's investment income in excess of $2,100 for 2018 to be taxed at the trust rates. The kiddie tax has no impact on the child's wages and other earned income.

The kiddie tax doesn't apply to a child who is age 18 or a full-time student age 19 through 23, if the child's earned income for the year exceeds one-half of his or her support. Thus, employing a child age 18 or a full-time student age 19-23 could also help to avoid the kiddie tax on his or her unearned income.

For children under age 18, there's no earned income escape hatch from the kiddie tax. But in all cases, earned income can be sheltered by the child's standard and other deductions, as noted above, and earnings in excess of allowable deductions will be taxed at the child's low rates.

Your business probably will have to withhold federal income taxes on your child's wages. Usually, an employee can claim exempt status if he or she had no federal income tax liability for last year, and expects to have none for this year. However, exemption from withholding can't be claimed if (1) the employee's income exceeds $1,050 for 2018 and (2) the employee can be claimed as a dependent on someone else's return. Keep in mind that your child probably will get a refund for part or all of the withheld tax when he or she files a return for the year.

If your business isn't incorporated, you can also save some self-employment (i.e., social security) tax dollars by shifting some of your earnings to a child. That's because services performed by a child under the age of 18 while employed by a parent isn't considered employment for FICA tax purposes.

A similar but more liberal exemption applies for FUTA (unemployment) tax, which exempts earnings paid to a child under age 21 while employed by his or her parent. The FICA and FUTA exemptions also apply if a child is employed by a partnership consisting solely of his parents.

Note that there’s no FICA or FUTA exemption for employing a child if your business is incorporated or a partnership that includes non-parent partners. However, there’s no extra cost to your business if you’re paying a child for work you’d pay someone else to do, anyway.

Your business also may be able to provide your child with retirement benefits, depending on the type of plan it has and how it defines qualifying employees. For example, if it has a simplified employee pension (SEP), a contribution can be made for the child up to 25% of his or her earnings but the contribution can't exceed $55,000 for 2018. The child's participation in the SEP won't prevent the child from making tax-deductible IRA contributions as long as adjusted gross income (computed in a special way) is below the level ($63,000 in 2018) at which deductions for IRA contributions begin to be disallowed.

If you have any questions about how these rules apply to your particular situation, please don't hesitate to contact us.

Dependent Care – Tax Credit and Flexible Spending Account

If you pay for care for a dependent and have earned income, you should consider the benefits of the dependent care credit and dependent care flexible spending account.

For an expense to qualify for the dependent care credit, it must be an "employment-related" expense, i.e., it must enable you and your spouse to work, and it must be for the care an eligible dependent, who's under 13, lives in your home for over half the year, and doesn't provide over half of his or her own support for the year. It could also be for the care of your spouse or dependent who's handicapped and lives with you for over half the year.

The typical expenses that qualify for the credit are payments to a day-care center, nanny, or nursery school. Sleep-away camp doesn't qualify. The cost of first grade or above doesn't qualify. The rules on kindergartens aren't clearly defined.

To claim the credit, you and your spouse must file a joint return. You must provide the care-giver's name, address, and social security number (or tax ID number if it's a day-care center or nursery school).

You also must include on the return the social security number of the children who receive the care. Omission of the social security numbers while still claiming the credit will result in a summary assessment of tax liability against you.

Several limits apply. First, qualifying expenses are limited to the income you or your spouse earns from work, using the amount for whoever of the two earns less. If one of you has no earned income, you won't be entitled to any credit. However, under certain conditions, when one spouse has no actual earned income and is a full-time student or disabled, that spouse is considered to have monthly income of $250 (if the couple has one qualifying child) or $500 (two or more qualifying children).

Next, qualifying expenses can't exceed $3,000 per year if you have one qualifying child, or $6,000 per year for two or more. In most cases, this dollar limit will set the ceiling for you. Note that if your employer has a dependent care assistance program under which you receive benefits excluded from gross income, the dollar limits ($3,000 or $6,000) are reduced by the excludable amounts you receive.

Finally, the credit will be computed as a percentage of your qualifying expenses-in most cases, 20%. (If your joint adjusted gross income is $43,000 or less, the percentage will be higher, but not above 35%.)

Example: Lyle and Ellen both work, and place their son in a day-care center. Lyle earns $114,000 but Ellen earns only $6,000. They spend $8,500 on day care. The earned income limitation discussed above limits the qualifying expenses to $6,000, Ellen's earned income. The dollar limitation limits them further to $3,000. Twenty percent of this amount is $600 and that's their dependent care credit. (If the expenses were for two or more children, their credit would be $1,200, 20% of the $6,000 dollar limit.)

Note that a credit reduces your tax bill dollar for dollar. Thus, in the above example, Lyle and Ellen pay $600 less in taxes by virtue of the credit.

If your employer offers a dependent care flexible spending account (FSA), you may wish to consider participating in the FSA instead of taking the dependent care credit. Under a dependent care FSA, you may contribute up to $5,000 on a pre-tax basis. The money is withheld by your employer from your paycheck and placed with a plan administrator in a non-interest bearing account. As you incur dependent care costs, you submit a statement with the plan administrator substantiating the cost, and receive reimbursement.

If your marginal tax rate is more than 15%, participating in the FSA is more advantageous than taking the dependent care credit. This is because the exclusion from income under the FSA gives a tax benefit at your highest tax rate, while the credit rate for taxpayers with AGI over $43,000 is limited to 20%.

In addition to a federal income tax savings, participating in a dependent care FSA will result in savings on FICA (social security) taxes, because the amount contributed to the FSA isn't included in wages for FICA purposes. Consequently, you may save up to 7.65% of the amount contributed to the dependent care FSA, depending upon your income and the FICA tax wage base for the year in which the contribution is made.

If your marginal rate is 15% or less, taking the credit may be more advantageous than participating in the FSA. In making the choice, you must consider the effect of the earned income credit, the refundable child tax credit, and Social Security tax.

It should also be noted that residents of some states can save on their state income tax by taking advantage of the dependent care credit or an employer's dependent care FSA.

There are three drawbacks to dependent care FSAs. First, money is deposited in an FSA on a "use it or lose it" basis. If you don't incur dependent care expenses that equal or exceed the amount you deposit in the FSA, you forfeit the surplus. In addition, once you elect to participate in an FSA, and elect the amount withheld, with limited exceptions, you may not change your election. Finally, it often takes several weeks to receive reimbursement for the expenses submitted.

We hope the above clarifies the essential elements of the dependent care credit and dependent care FSAs. If your employer offers a dependent care FSA, we would be more than happy to prepare a comparison of the savings the FSA would afford you with the tax savings afforded by the dependent care credit.

If you have any questions or would like to discuss the subject further, please contact us.

Household Employees

Are you aware of the federal tax obligations for household employees? This tax is also commonly referred to as the “nanny tax.” It applies to nannies, housekeepers, maids, babysitters, gardeners, or other household employees who aren't independent contractors. The tax doesn't apply to a household employee who's also a farm worker.

If you employ someone as a household employee, you aren't required to withhold federal income taxes from the employee's pay. You have to withhold only if your household employee asks you to and you agree to withhold. (In that case, have the household employee fill out a Form W-4 and give it to you, so you can withhold the correct amount.) However, you may be required to withhold social security and Medicare tax (FICA). And may also be required to pay (but not withhold) federal unemployment (FUTA) tax.

FICA: You have to withhold and pay FICA taxes if your household employee earns cash wages of $2,100 (annual threshold) or more (excluding the value of food and lodging) during calendar year 2018. If you reach the threshold, the entire wages (not just the excess) will be subject to FICA.

However, if your household employee is under age 18 and child care isn't the household employee's principal occupation, you don't have to withhold FICA taxes. So, if your household employee is really a student who is a part-time baby-sitter, there's no FICA tax liability for services the household employee provides. On the other hand, if your household employee is under age 18 and the job is the household employee's principal occupation, you must withhold and pay FICA taxes.

You should withhold from the start if you expect to meet the annual threshold; your household employee won't appreciate a large, unexpected withholding from pay later on. If you aren't sure whether the annual threshold will be met, you can still withhold from the start. If it turns out the annual threshold isn't reached, just repay the withheld amount. If you make an error by not withholding enough, withhold additional taxes from later payments.

Both an employer and a household employee have an obligation to pay FICA taxes. As an employer, you're responsible for withholding your household employee's share of FICA. In addition, you must pay a matching amount for your share of the taxes. The FICA tax is divided between social security and Medicare. The social security tax rate is 6.2% for the employer and 6.2% for the household employee, for a total rate of 12.4%. The Medicare tax is 1.45% each for both the employer and the household employee, for a total rate of 2.9%.

Example: In 2018, you pay your household employee $300 a week, and no income tax withholding is required. You must withhold a total of $22.95, consisting of $18.60 for your household employee's share of social security tax ($300 × 6.2%) and $4.35 ($300 × 1.45%) for your household employee's share of Medicare tax. You would pay the household employee a net of $277.05 ($300 − $22.95). For your (employer's) portion, you must also pay $22.95 ($300 × 7.65%), for total taxes of $45.90.

If you prefer, you may pay your household employee's share of social security and Medicare taxes from your own funds, instead of withholding it from pay. Using the figures from the above example, for each $300 of wages, you would pay your household employee the full $300 and also pay all of the total $45.90 in taxes.

If you do pay your household employee's share of these taxes, your payments aren't counted as additional cash wages for social security and Medicare tax purposes. In other words, you don't have to compute social security and Medicare tax on the payments. However, your payments of the household employee's taxes are treated as additional income to the household employee for federal income tax purposes, so you would have to include them as wages on the Form W-2 that you must provide, as explained below.

FUTA: You also have an obligation to pay FUTA tax if you pay a total of $1,000 or more in cash wages (excluding the value of food and lodging) to your household employee in any calendar quarter of the current year or last year. The FUTA tax applies to the first $7,000 of wages paid. The maximum FUTA tax rate is 6.0%, but credits reduce this rate to 0.6% in most cases. FUTA tax is paid only by the employer, not by the employee, so don't withhold FUTA from the household employee's wages.

Reporting and paying: You must satisfy your "household employee tax" obligations by increasing your quarterly estimated tax payments or increasing your withholding from your wages, rather than making an annual lump-sum payment.

As an employer of a household employee, you don't have to file any of the normal employment tax returns, even if you're required to withhold or pay tax (unless you own your own business, see below). Instead, you just report the employment taxes on your tax return, Form 1040, Schedule H.

On your income tax return, you must include your employer identification number (EIN) when you report the employment taxes for your household employee. The EIN isn't the same number as your social security number. If you already have an EIN from a previous household employee, you may use that number. If you need an EIN, you must file Form SS-4 to get one.

However, if you own a business as a sole proprietor, you must include the taxes for your household employee on the FICA and FUTA forms (940 and 941) that you file for your business. And you use the EIN from your sole proprietorship to report the taxes for your household employee.

You're also required to provide your household employee with a Form W-2. If the household employee's 2018 wages are subject to FICA or income tax withholding, the W-2 is due by Jan. 31, 2019. Additionally, you must file a Form W-2 for 2018 with the Social Security Administration by Jan. 31, 2019. Your EIN must be included on the Form W-2.

Recordkeeping: Be sure to keep careful employment records for each household employee. Keep the tax records for at least four years from the later of the due date of the return or the date when the tax was paid. Records should include: employee name, address, social security number; dates of employment; dates and amount of wages paid; dates and amounts of withheld FICA or income taxes; amount of FICA taxes paid by you on behalf of your household employee; dates and amounts of any deposits of FICA, FUTA or income taxes; and copies of all forms filed.

We realize this is a lot of information to absorb. We’d be happy to go over any questions you still have about how to comply with these employment tax requirements. If you think you might have any problems for earlier years, we can also help.  Please contact us for additional information or to get answers to questions you have.

Life Insurance Trusts

Few people realize that, even though they may have a modest estate, their families may owe hundreds of thousands of dollars in estate taxes because they own a life insurance policy with a substantial death benefit. This is so because life insurance proceeds, while not subject to federal income tax, are considered part of your taxable estate and are subject to federal estate tax.

The solution to this problem is to create an irrevocable life insurance trust (sometimes referred to as an "ILIT") that will own the policy and receive the policy proceeds on your death. A properly drafted life insurance trust keeps the insurance proceeds from being taxed in your estate as well as in the estate of your surviving spouse. It also protects the trust beneficiaries from their own "excesses," against their creditors, and in the event of divorce. Moreover, the trust also provides reliable management for the trust assets. Here's how the irrevocable life insurance trust works.

You create an irrevocable life insurance trust to be the owner and beneficiary of one or more life insurance policies on your life. You contribute cash to the trust to be used by the trustee to make premium payments on the life insurance policies. If the trust is properly drafted, the contributions you make to the trust for premium payments will qualify for the annual gift tax exclusion, so you won't have to pay gift tax on the contributions.

The life insurance trust typically provides that, during your lifetime, principal and income, in the trustee's discretion, may be paid or applied to or for the benefit of your spouse and descendants. This allows indirect access to the cash surrender value of the life insurance policies owned by the trust, and permits the trust to be terminated if desired despite its being irrevocable. On your death, the trust continues for the benefit of your spouse during his or her lifetime. Your spouse is given certain beneficial interests in the trust, such as the right to income, limited invasion rights, and eligibility to receive principal. On the death of your spouse, the trust assets are paid outright to, or held in further trust for the benefit of, your descendants.

If you own a life insurance policy with a significant death benefit, an irrevocable life insurance trust may be of substantial benefit to you and your loved ones. Please contact us if you would like to discuss this further.

The Gift Tax Annual Exclusion

Taxpayers can transfer substantial amounts free of gift taxes to their children or other donees each year through the proper use of this annual exclusion, which is $15,000 for 2018.

The exclusion covers gifts an individual makes to each donee each year. Thus, a taxpayer with three children can transfer a total of $45,000 to his or her children every year free of federal gift taxes. If the only gifts made during a year are excluded in this fashion, there is no need to file a federal gift tax return. If annual gifts exceed $15,000, the exclusion covers the first $15,000 and only the excess is taxable. Further, even taxable gifts may result in no gift tax liability thanks to the unified credit (discussed below). (Note, this discussion is not relevant to gifts made by a donor to his or her spouse because these gifts are gift tax-free under separate marital deduction rules.)

Gift-splitting by married taxpayers: If the donor of the gift is married, gifts to donees made during a year can be treated as split between the spouses, even if the cash or gift property is actually given to a donee by only one of them. By gift-splitting, therefore, up to $30,000 a year can be transferred to each donee by a married couple because their two annual exclusions are available. Thus, for example, a married couple with three married children can transfer a total of $180,000 each year to their children and the children's spouses ($30,000 for each of six donees).

Where gift-splitting is involved, both spouses must consent to it. Consent should be indicated on the gift tax return (or returns) the spouses file. IRS prefers that both spouses indicate their consent on each return filed. (Because more than $15,000 is being transferred by a spouse, a gift tax return (or returns) will have to be filed, even if the $30,000 exclusion covers total gifts.)

The "present interest" requirement: For a gift to qualify for the annual exclusion, it must be a gift of a "present interest." That is, the donee's enjoyment of the gift can't be postponed into the future. For example, if you put cash into a trust and provide that donee A is to receive the income from it while A is alive and donee B is to receive the principal at A's death, B's interest is a "future interest." Special valuation tables are consulted to determine the value of the separate interests you set up for each donee. The gift of the income interest qualifies for the annual exclusion because enjoyment of it is not deferred, so the first $15,000 of its total value will not be taxed. However, the gift of the other interest (called a "remainder" interest) is a taxable gift in its entirety.

Exception to present interest rule: If the donee of a gift is a minor and the terms of the trust provide that the income and property may be spent by or for the minor before he or she reaches age 21, and that any amount left is to go to the minor at age 21, then the annual exclusion is available (that is, the present interest rule will not apply). These arrangements allow parents to set assets aside for future distribution to their children while taking advantage of the annual exclusion in the year the trust is set up.

"Unified" credit for taxable gifts: Even gifts that are not covered by the exclusion, and that are thus taxable, may not result in a tax liability. This is so because a tax credit wipes out the federal gift tax liability on the first taxable gifts that you make in your lifetime, up to $11,180,000 (for 2018). However, to the extent you use this credit against a gift tax liability, it reduces (or eliminates) the credit available for use against the federal estate tax at your death.

Please contact us if you wish to discuss this area further or have questions about related topics.