Index to Questions
15. What is an IRA?
16. What is e-file?
Answers to the Questions
Over the past several years, numerous changes have been
made to the tax treatment of dependents, alimony, child support, property settlements,
and other divorce related issues which can produce unintended results for divorced individuals.
Failure to understand these rules can be very costly.
Child Dependency Exemption
The custodial spouse is entitled to the outright exemption for the dependent child for any divorce
or separation agreement granted on or after January 1, 1985.
There are certain exceptions which allow the non-custodial spouse to claim the exemption for the child:
1. The custodial parent releases the exemption of the child(ren) to the non-custodial spouse
through the use of IRS Form 8332. In lieu of Form 8332, the IRS will accept a copy of the
cover page of the agreement (with the custodial parent's social security number added),
the specific clause unconditionally stipulating the exemption to the non-custodial parent,
and the signature page showing the date of the agreement.
2. There is a pre-1985 divorce agreement, whereby a completely different set of rules and
regulations are in effect.
Eligible taxpayers may claim a basic credit of $500 or more for each qualifying child in
1999 and later years. The basic credit reduces your taxes dollar for dollar but is non-refundable.
There is an additional child credit for low-income taxpayers that is refundable if they have 3
or more qualifying children. A qualifying child must be under 17 at the close of the tax year
on December 31.
Child Care Tax Credit
If, under the terms of the divorce or separation agreement, you may not claim your child as
a dependent, you are nevertheless be entitled to the child care tax credit. To be able to claim
this credit these criteria must be met: (1) You must file a separate return; (2) Provide your
home as the home of the qualifying child for more than half the year; (3) Pay more than
half the cost of keeping up your home for the year; (4) Your spouse may not live in your house
for the last six-months of the year.
Payments of alimony made under a decree of divorce or separation are deductible by the
payor spouse and taxable to the payee spouse. In order to qualify as alimony, the payment
must be in cash and cannot be a transfer of property or assets. There must also be a
requirement that these payments will cease upon the death of the payee. This need
not be stipulated in the agreement if state law requires that payments cease after the
death of the payee spouse. If the individuals are either divorced or separated, they must
not be living together when the cash payments are made. Single payments of cash may
qualify as alimony if the amount is $15,000 or less. Payments exceeding $15,000 per
year are subject to a recapture rule if they do not continue for 3 years or more unless
ended because of the death of either spouse or the remarriage of the payee.
Any cash payments made to a third party, if required by the agreement on behalf of
the payee spouse, will still qualify as alimony payments. Thus, payments made for
rent, mortgage, tuition, or living expenses of the payee spouse under the terms of the
divorce or separation instrument can qualify as alimony payments.
The agreement may also call for property settlement payments to be made from
pension or retirement funds under a Qualified Domestic Relations Order (QDRO).
Transfers made under a QDRO are exempt from the 10% penalty on premature
distributions from qualified retirement plans.
Disposition of Principal Residence
What happens to a jointly-owned principal residence is usually a key item in a divorce
agreement. The three most frequent provisions chosen are (1) sell the house and divide
the proceeds with each spouse reporting his or her share of the sale on separate returns; (2)
transfer the house to one spouse or the other; (3) retain joint ownership allowing the custodial
parent to reside therein but delay the sale of the house until the occurrence of a specific event
(remarriage of the custodial parent, children reaching specific ages, etc.).
Child support is neither taxable to the recipient nor deductible by the payor. Under current law,
if part of an alimony payment is based on a child's situation (such as coming of age,
marriage, college), that portion of the payment is presumed to be child support and is
not deductible or taxable.
Alimony payments received by a payee are considered to be "earned income" for the
purpose of allowing alimony recipients to contribute to an Individual Retirement
Account. This is true even if the alimony recipient is not employed.
Deductibility of Legal Fees
Legal fees paid in connection with obtaining a divorce are not deductible. Fees paid
for obtaining and/or maintaining alimony or income producing property and for
tax advice are deductible. In order to qualify as deductible legal fees, the attorney
must stipulate, on the bill, the amount or percentage of the fee which is attributable
to tax matters. Legal fees are miscellaneous itemized deductions subject
to the 2% of AGI limitation.
Innocent Spouse Provisions
The IRS Restructuring and Reform Act of 1998 made the benefits of Innocent Spouse
status easier to obtain. The Act expands the benefits to all understatements of tax
attributable to erroneous items of the other spouse, regardless of the dollar amount.
The Act offers three types of potential relief based on factors such as how much the
innocent spouse was aware of the understatement, for taxpayers no longer married
to or legally separated from the person with whom they originally filed a joint
return, and for taxpayers for whom the IRS may grant equitable relief. Consult
your Enrolled Agent for details.
Community Property States If you live in a Community Property State
(AZ, CA, ID, LA, NV, NM, TX, WA, or WI), the tax rules for filing the tax return
for the year of the divorce or legal separation are different from the instructions
in the tax booklet you receive from the IRS. These special rules may also apply
to any returns filed Married Filing Separate prior to the divorce or legal separation.
A: To claim a home office deduction, your home office must be used regularly and exclusively:
1. as the principal place of your trade or business;
2. to meet or deal with patients, clients or customers in the normal course of your trade or business; or
3. in connection with your trade or business if it is a separate structure that is not attached to your home.
Employees must meet an additional requirement. Their use of the home for any of the above conditions must be for the convenience of the employer. In addition, home-related deductions are available for space regularly used for inventory storage by a wholesaler or retailer, or for use as a day care facility. Regular and Exclusive Use For expenses associated with a home office to be deductible, it must be used on a regular basis. It isn't enough to use the office occasionally. Use must be continuous, ongoing or recurring. If you did not operate a business for the entire year, you can only deduct the expenses paid or incurred for the portion of the year you used your home for business. The exclusive use test is not met if an area is used exclusively for business purposes during business hours, but for personal purposes at other times. If you use the room to watch TV, house overnight guests or even play games on the computer in that room, it does not qualify for the deduction. Your office space must
be a designated area set apart from the rest of the house for only business use. A spare bedroom in the house can be converted to a legitimate home office by removing the bed. The Tax Court has held that a portion of a room can qualify for the home-office deduction even though the room is not divided by a partition or physically separated in some manner. However, this determination is based on facts and circumstances. Principal Place of Business If your home is the sole
location of your business, and you supply services or sell goods from that location, then you automatically meet the principal place of business test. Beginning in 1999 , a home office qualified as a principal place of business if it was used to conduct
administrative or management activities of a business or practice, as long as there was no other fixed location used to conduct substantial administrative or management activities. Deductible Expenses Certain costs of operating and maintaining the part of the home used for business are deductible. Indirect expenses are the expenses that cover the entire home. These include rent (if your home is rented), or if owned, real estate taxes, mortgage interest and depreciation of the home. Include only mortgage interest that qualifies as an indirect expense. You cannot include interest on a mortgage loan that did not directly benefit your home (e.g., a home equity loan used to pay off credit card bills, buy a car or pay tuition costs). Other indirect expenses are utilities such as lights and heating, home insurance and repairs. The deductible portion is based on the percentage of your home used for business. Direct expenses are those that cover only the area used for business, for example, painting, decorating or repairs of your home office. Direct expenses are deductible in full. Limit on Deductions Your home office deductions
cannot exceed the net income derived from the business. This means you cannot use home office expenses to create or increase a tax loss from your business. However, unallowed home office expenses can be carried over to later years when there is more
income from the business. Effect of Business Auto Deductions If your home office is your principal place of business, the costs of traveling between the home office and other work locations in the same trade or business, regardless of whether the other work location is regular or temporary, and regardless of its distance, are deductible transportation expenses. Effect on Sale of Home Depreciation - recapture rules apply to the profit on the portion of the residence used as a home office.
Consult your Enrolled Agent for details.
Recordkeeping: Good recordkeeping is vital to ensure that you will be able to substantiate all your deductions in the event of an audit. Save bills, receipts and cancelled checks. Keep a work diary of all hours spent working in and out of the office. Take a picture of your home office so you can show that it indeed existed in the event you move or change offices.
A: Has it been a while since you filed a tax return? Feeling guilty? Scared? · Don't know what to do? · or where to turn? · Do you even need to file?
Your first step to solving these problems is calling an Enrolled Agent. If you come forward and voluntarily file your missing tax returns, the system works more in your favor. Since nearly three out of four tax returns filed are due a refund, there is a good chance that the IRS might owe money to you. The only catch is that if you don't ask for your refund within three years, the IRS isn't going to give you what was yours in the first place. Members of the National Association of Enrolled Agents (NAEA) are available to help you file your returns and, if necessary, act as your representative before the IRS. Enrolled Agents work for you, not the IRS. Sometimes things just happen. If there is a good reason for not filing a tax return, some of the penalties can be reduced. Generally, if the IRS owes you a refund there are no penalties at all.
Scared of volunteering? If the IRS decides to come looking for you, life can become very difficult and frequently embarrassing.
There is a chance that your employer might be requested to send part of your paycheck to the IRS instead of handing your paycheck to you. Your bank account could be frozen or even seized. A lien could be placed on your house. In the worst case, you could face criminal prosecution.
What if you owe money?
Installment agreements - If you owe less than $30,000 and can pay the full amount within five years,
you may be able to set up a monthly payment plan and make regular installment payments.
Check with your Enrolled Agent for details.
What if you owe a lot of money?
If you owe so much money that you will never be able to pay your tax liability, your Enrolled Agent may
be able to work out a compromise where the IRS will accept less than you actually owe. If the
IRS accepts your Offer-In-Compromise (OIC), your total tax liability including interest and
penalty is considered paid in full. An OIC is a mathematical formula, NOT an amnesty program.
Professional assistance is strongly recommended when compromising a tax liability. Don't be afraid to ask for help. By law, you have the right to professional representation. Only an Enrolled Agent, CPA or attorney can represent your case before an IRS Collections Officer.
Remember, your representative is working for you.
A: I moved to a bigger house on the other side of town. Can I claim a moving expense deduction?
No. A deduction for the reasonable expenses of moving from one location to another may be taken
only if you are an employee or self-employed person whose move is made in conjunction with the
start of work in your new location and that location is your principal place of work.
You must also meet distance and time requirements.
How far must I move to qualify?/span>
The distance from your new place of work must be at least 50 miles more from your former
residence than the distance from your old place of work to that residence.
First time job seekers qualify if their new work location is more than 50 miles
from their former residence.
How long must my new employment last?
You must be a full-time employee in the general location of your new residence for at least
39 weeks in the 12-month period immediately following your arrival at the new location.
The 39 weeks do not have to be at the same job. Exceptions: Death, disability, involuntary
separation from the service of your employer or a transfer for the benefit of your employer.
Are there any special rules for self-employed persons?
You must perform services on a full-time basis in the general location of your new residence
for at least 78 weeks in the 24-month period immediately following your arrival at the new
location. At least 39 of the 78 weeks must be worked in the first 12-month period.
What types of moving expenses are deductible? Deductible moving expenses include:
1. The cost of travel (including lodging, but not meals) from your former residence to your new residence.
2. The cost of transporting your household goods and personal effects.
3. Storage charges are deductible while moving and for foreign moves.
If my employer reimburses me for my moving expenses will they be included on my W-2?
Reimbursements to an employee under an accountable plan are treated as excludable
fringe benefits and not reported on the W-2. Employer payments under a non-accountable plan
or payments for expenses that do not qualify for a deduction would be included as taxable
compensation in Box 1 of the W-2.
If my employer pays the moving expense directly to a third party,
will this be included as income on my W-2?
Generally, qualifying moving expenses paid directly to a third party are treated as an
excludable fringe benefit and are not reported as income on the W-2.
If I am not reimbursed for all my moving expenses and cannot itemize my
deductions, can I still deduct my moving expenses?
Yes. The unreimbursed expenses you incurred and/or paid are deductible even if you do not itemize.
Moving expenses are an "above the line" deduction on the Form 1040.
If I move one year and pay my expenses in the next year, when can I deduct my qualifying expenses?
The deduction may be taken in either the year incurred or the year paid.
Do I have to meet the employment time test before I deduct my expenses?
If the due date of your return falls before you can satisfy the time test, you may still
claim the deduction.
If you do take the deduction and then do not satisfy the required time test,
you must either file an amended return for that year or report the amount originally
deducted as income in the year you failed the time test.
My employer is transferring me out of the United States. Can I still deduct moving expenses?
Yes. The rules on the deductibility of moving expenses incurred in connection with a move by
a U.S. citizen or resident alien to a new job location outside the United States are similar
in many respects to the moving expense deduction rules for moves within the United States.
You may also qualify for additional tax benefits.
Consult with an Enrolled Agent (EA) to determine how these rules apply to your specific situation.
What form do I use to report my deductible moving expenses?
Form 3903 (Moving Expenses) is used to report moving expenses for moves within the United States.
Form 3903F (Foreign Moving Expenses) is used to report moving expenses for moves outside the United States.
If I sell my principal residence to move, can I deduct my selling expenses as a moving expense?
No. These expenses are not considered moving expenses.
A: Hiring a Caregiver. When you hire someone to care for your child in your home, you become
an employer and must treat the caregiver as an employee. (We use the term in-home caregiver,
although they are sometimes called nannies, babysitters or Au Pairs.) Because the caregiver
works under your direction and control, the caregiver is not an independent contractor who is
responsible for paying his or her own taxes. Some parents choose not to withhold the proper
taxes because the caregiver is not reporting the income to the government. This is illegal.
Parents should realize that if they are audited, the IRS will hold them liable for unpaid Social
Security and Medicare taxes. There are several exceptions to the rule that an in-home caregiver
is your employee. Ask your Enrolled Agent about these exceptions.
Summary of Federal Rules. /span> When you hire an in-home caregiver, you must follow some specific
federal laws. Check with your state for its rules. The federal law requires the following:
Every employer must verify that the employee is a U.S. citizen or is eligible
to work legally in the U.S. To do this, the employee must have documents and both the employer
and the employee must sign Form I-9 Employment Eligibility Verification. The employer should keep
this form for three years after the date of hiring or one year after the employment is terminated,
whichever is later. This form must be filled out even if the caregiver is hired through a nanny agency.
Obtain Employer Identification Number.
All employers need to fill out Form SS-4 and send it in to the IRS to receive a personal Employer
Identification Number (EIN). Use this number on all IRS employer forms that you file each year.
Note: You may need a state identification number and you may have to report a new hire to your
state to help them track down those who are behind on child support payments. Check your state
for its rules.
Pay Minimum Wage.
You must pay the employee at least the federal minimum wage. You do not have
to pay minimum wage if the caregiver works less than 20 hours per week. Above 40 hours per week,
you must pay time-and-a-half wages. A live-in caregiver does not have to be paid overtime if you
establish the regular hours that the caregiver's service is needed. You may exclude sleeping,
meal time and free time in the calculation of hours worked. Employers are not required to pay any
benefits such as vacation days, holidays, sick leave, medical insurance or any other benefits.
Offering specific benefits is up to each employer and can be negotiated with individual caregivers.
Federal Income Tax Withholding.
You do not need to withhold federal income tax from your employee's
paycheck unless the employee requests this. The employee must fill out Form W-4 at the time the
employee is hired. If they do not want you to withhold, you should keep on file a signed W-4 with
the notation "no withholding requested." If the employee wants you to withhold, you must look at
the tables in IRS Publication Circular E to determine how much to withhold. You would report and
pay income tax withholding on Schedule H Household Employment Taxes when you file your individual
Form 1040. At the end of the year you must issue a W-2 to the employee and the Social Security
office. If you do not withhold federal income tax for your employee, you must notify the person
that they may be eligible to receive advance payment of the earned income credit. To do so, give
them Notice 797, Possible Federal Tax Refund Due to the Earned Income Credit or a Form W-2, which
has the notice printed on the back of Copy C. Social Security & Medicare Withholding. Employers
are responsible for withholding and paying Social Security and Medicare taxes for their employees,
although there are several exceptions to this general rule. Check with your Enrolled Agent.
Federal Unemployment Taxes.
If you pay one or more in-home caregivers a total of $1,000 or more
in any calendar quarter, you must pay Federal Unemployment Taxes (FUTA).
Advanced Earned Income Credit.
You must ask the caregiver if he or she wishes to participate in the Advanced Earned Income Credit.
Summary. Finding the right person to provide reliable and loving care for your child can be difficult.
BBy understanding your tax responsibilities in hiring an in-home caregiver, you will avoid additional problems.
Q: What about more recent tax law changes?
A: Tax laws change almost daily. Be sure to consult with your Enrolled Agent.
A: Is stock a capital asset? Generally, property owned and used by an individual for personal or investment purposes is a capital asset. Some examples are houses, furniture, cars, stocks and bonds. Sales of most capital assets must be reported to the Internal Revenue Service (IRS) on your tax return. Losses on the sale of an item owned for personal use, such as a car, furniture or personal residence, are not deductible.
What is a "holding period"? Gains and losses on sales of stock are categorized as having either long-term or short-term holding periods depending upon the length of time you owned the stock. The date of disposition, called the trade date, is the date of the actual sale. For tax purposes, gain or loss is recognized on the trade date. To determine how many months you have held the stock, begin counting on the day after the purchase date. The same day of each succeeding month begins a new month. The date of disposition is considered the last day of the holding period.
Short-term or long-term? Capital gains are characterized as either short-term (held one year or less) or long-term (held more than one year). Short-term gains are taxed as ordinary income (the rates could be as high as 39.6%) while long-term gains are taxed at a maximum of 20%. There are some exceptions such as collectible art or coins, which do not qualify for the special treatment. Beginning 2001, there is now special treatment available if your holding period is 5 or more years.What is the basis of my stock? The cost of your stock is usually the basis. Certain costs of purchase, such as commissions and recording or transfer fees should also be included. The basis of inherited stock is its fair market value (FMV) at the date of the decedent's death (unless a federal estate tax return was filed and an alternate valuation date chosen). To determine the basis of stock you receive as a gift, you must know its adjusted basis to the donor just before it was given to you, its FMV at the time it was given to you and the amount of gift tax, if any, paid on it. Is it important to save the purchase confirmations when I buy stock? Yes! Without confirmations showing the purchase date, price and expenses, it will be next to impossible to determine your basis and possibly your holding period. Due to changes in capital gains law, taxpayers with capital gains on mutual funds must file Schedule D, even if they have no other investments. It is important to keep the last statement of the year for each fund. The year-end statement shows the transactions for the entire year.
What amount do I report as my sales price? If you sold your stock through a broker, you should receive Form 1099-B, Statement for Recipients of Proceeds From Broker and Barter Exchange Transactions, by February 1 of the year following the year the transaction occurred. Unless special circumstances apply, the sales price you list on your tax return will be the amount reported to you on Form 1099-B as Gross Proceeds. Gross Proceeds usually consists of the total proceeds of the sale less any commissions or fees incurred on the sale. If the amount reported as Gross Proceeds does not take into account any commissions or fees paid, you should add these selling expenses to the basis of the stock sold.
How important is Form 1099-B? Because the amount reported on Form 1099-B is entered into the IRS computer and "matched"
against the amount reported on your tax return, Form 1099-B is very important. If for some reason the amount you list on your tax return as Sales Price does not equal the amount reported on Form 1099-B, you should attach an explanation to your return explaining the difference. Otherwise, the IRS computer will detect that a different amount was reported on your return and you will receive a letter proposing an adjustment to your return.
Where do I report my gain or loss? Stock sales and other capital transactions are reported on Schedule D (Form 1040), Capital Gains and Losses. It is important to separate your transactions by holding periods: short-term or long-term.
What is a wash sale? A wash sale occurs when you sell a particular stock and, within 30 days before or after the sale, you purchase substantially identical stock. Losses from wash sales are not deductible, but are used to figure the basis of the new stock. Any gain, however, is taxable.
Is there a limit on the amount of capital loss I can deduct? Yes. If after combining all your capital gains and losses for the year you end up with a net capital loss, the maximum loss you may deduct is limited to $3,000 per year ($1,500 if you are married and file a separate return). Net losses in excess of $3,000 can be carried forward to the following years until they are used up.
I frequently switch from one mutual fund to another. Do I have to report these transactions on my tax return? Yes! If you sell or exchange shares of a mutual fund with a fluctuating share price, the IRS considers the transaction a taxable event. You must
calculate a capital gain or loss for each sale or exchange - whether made by telephone, wire, mail or check. You should receive a Form 1099-B for each transaction. Calculating gain or loss on the sale of mutual fund shares can be quite complex and is beyond the scope of this publication. Capital Gains laws become more complex every year.
If you need assistance in this area, consult your Enrolled Agent for help.
A: The Taxpayers Relief Act of 1997 drastically changed the rules for reporting gain on the sale of a personal residence. Current law provides for a universal exclusion of $250,000 ($500,000 on a Married Filing Joint return) for gain realized on sales of personal residences on or after May 7, 1997. The new rules have generally made recordkeeping less onerous for taxpayers and allow most homeowners to pay no income tax on these sales. An obvious advantage of not being required to pay
tax on the sale allows taxpayers to make decisions based on their needs and wants rather than on the tax consequences. This is especially beneficial to taxpayers who relocate from an area of high home values to an area of more moderate values. Prior tax planning ideas are now obsolete.
1. There is no provision allowing the reinvestment of proceeds in order to avoid taxes on a gain.
2. The $125,000 exclusion for taxpayers over 55 was repealed. This was replaced by the larger exclusion for all taxpayers.
3. Fixing up expenses prior to a sale are no longer considered. However, improvements are still added to basis on a highly appreciated home.
4. Renting a home while attempting to sell will usually not be significant.
What are the requirements to be eligible for the exclusion?
1. The home must be the principal residence of the taxpayer. It must have been owned and used as the principal residence for two or more years during the five year period ending on the date of sale.
2. The exclusion is available regardless of age and will be available for more than one principal residence as long as the taxpayer does not use it more than once every two years.
3. For married taxpayers, the $500,000 exclusion is available if either spouse meets the ownership test and both spouses meet the use test. In addition, neither spouse can have used the exclusion in the past two years.
What happens if I need to move before the 2-year period is up? Taxpayers may be eligible for a partial exclusion if they fail to meet the ownership and use requirements due to:
1. A change in place of employment;
2. Health; or
3. Unforeseen circumstance.
Possible circumstances could be death of a spouse or divorce or some other major problem. There was concern over how the exclusion would be calculated. Congress provided an answer favorable to taxpayers in 1998. The taxpayer will use a proration of the $250,000/$500,000 exclusion rather than the proration of the gain. For example, if the taxpayer was forced to sell after one year due to health problems, the taxpayer would be entitled to an exclusion of 50% of the full amount. This is much more favorable than an exclusion of 50% of the gain.
What if I rent my home for a period of time prior to the sale? Renting a home will not disqualify a taxpayer from using the exclusion. As long as the two year ownership and use tests are met, the home will retain its personal residence character. Be
aware that any depreciation claimed on the rental use of the house after May 6, 1997 must be recaptured and is subject to tax.
What happens if I have a two-family house and I sell? If the entire property is not used as a principal residence then the sale will be considered as two sales. The first sale will be the personal residence portion and will be eligible for the exclusion. The second sale will be the business use portion and will not be eligible for the exclusion. The gain on this "second" sale will be taxable. The same type of calculation will be applicable for taxpayers who have an office in the home in the year of sale. The personal residence portion qualifies for the exclusion but the "business" portion (i.e., the home office) will not and tax will be due on the gain.
What if I sell my vacation home? Only personal residences qualify for the exclusion. However, it is possible to sell a principal residence, claim the exclusion on that sale and move into the vacation home making it your new principal residence. After two years this home could in turn be sold and a new exclusion would be applicable on this sale. What happens if I sell my home at a loss? A loss on the sale of a personal residence is not deductible on a tax return.
What happens if an elderly taxpayer must reside in a nursing home? Current law provides special relief for taxpayers who become physically or mentally unable to care for themselves and reside in a licensed care facility. The time spent in the nursing
home is considered time spent in the principal residence for purposes of the two out of five year residence rule. This applies as long as the taxpayer used the residence as a principal residence for at least one year during the 5 year period prior to the sale and continues to own the property during the period spent in the nursing home or licensed care facility.
A: An IRA (Individual Retirement Account) is a tax-advantaged personal savings plan used to set aside money for retirement. There are two types of retirement IRAs, a regular IRA and a Roth IRA. There is also an IRA for education.
Can Everyone Contribute? Every gainfully employed individual, whether an employee or self-employed, is eligible to contribute
to an IRA. Alimony may also be counted as wages for the purpose of computing an IRA. The contribution may or may not be tax deductible depending on your circumstances.
How Much Can I Contribute? The maximum contribution is limited to $2,000 per person per year. If the person's earned income
is less than $2,000, the amount of earned income is the limit. Nonworking spouses can contribute up to $5,000 to their own IRA. A married couple, therefore, with combined earned income of at least $10,000.
Is there a limit to the deductibility of my contribution to a regular IRA? There is a limit to the deductibility of your contribution to an IRA based on your Adjusted Gross Income (AGI). For a married couple, the current AGI phase out is between $80,000 to $100,000. These rules are changing constantly, so please consult your tax professional.
When Must Withdrawals from Regular IRAs Begin? Taxpayers may begin to make withdrawals without being subject to an early withdrawal penalty when they reach age 59 1/2. Taxpayers must begin to take distribution no later than April 1 of the
year following the year in which the taxpayer reaches age 70 1/2. Penalty Free Withdrawals from IRAs There are three exceptions to the 10 percent penalty for early withdrawal from regular IRA's. Qualifying higher education expenses for the taxpayer, spouse, or taxpayers child or grandchild are not subject to the early withdrawal penalty. First time home purchases qualify for the exception. First time home buyers include the taxpayer, spouse, children, grandchildren, and ancestors who
have not owned a home for the prior two-year period. These distributions are limited to a lifetime $10,000 per individual IRA owner. The third exception allows qualifying unemployed individuals to withdraw IRA funds without penalty in order to pay for medical insurance for the individual and his or her spouse and dependents. The individual must have received federal or state unemployment compensation for 12 consecutive weeks. This includes a self-employed individuals who would be eligible for unemployment if he or she were an employee. IRA funds may be withdrawn to pay for medical insurance until the individual is reemployed for 60 days (not necessarily consecutive). If you plan to withdraw IRA funds for any of the three exceptions,
remember that the exceptions are only on the penalties, and not on the tax. You must report the distribution and pay tax at your normal rate on all distributions.
The Roth IRA: Taxpayers may also contribute to a nondeductible IRA called the Roth IRA. Earnings grow tax-free and can be withdrawn tax-free, provided the Roth IRA has been open and funded for at least 5 years and one of the following events has occurred: you have reached 59 1/2; you die or become disabled; or you are using the money for a first-time home purchase ($10,000 lifetime maximum). Combined contributions to traditional and Roth IRAs cannot exceed $2,000 per person per year, subject to phase out rules. The current phase outs are between $95,000 - $110,000 for singles and $150,000 - $160,000 for married couples. Taxpayers are not required to begin taking distributions after reaching age 70 1/2. In fact, the taxpayer may continue to contribute to the Roth IRA as long as he or she has earned income, and never has to take any distributions from the account. Taxpayers with AGIs less than $100,000 can rollover regular IRAs into Roth IRAs with no penalty. Proceeds from qualified retirement plans such as a 401(k) plan or a 403(b) cannot be rolled over directly into a Roth IRA. The income level applies to all taxpayers, single or married. Married taxpayers must file a joint return. While there is no penalty associated with this rollover, income tax must be paid on the taxable income in the rollover.
Education IRAs (Renamed the Coverdell Education Savings Account with new limits in 2002 and later). An Education IRA may be established for a child under age 18. The maximum amount which may be contributed in a single year is $500 and the contributions are nondeductible. Earnings accumulate tax-free. Money taken from an Education IRA is not taxable to the individual provided it is used for qualifying higher education expenses and does not exceed the actual expenses for the year.
Qualifying expenses include tuition, fees, room and board, books, supplies and equipment at a post-secondary educational institution. If the individual who is the beneficiary of the Education IRA decides not to pursue higher education, the Education IRA can be transferred to another member of the family. All funds must be used before reaching age 30. Any unused funds will then become taxable income. The phase out rule for funding this IRA is the same as the rule for the Roth IRA.
A: How will tax changes affect my rental? The rules for rental property change continuously through new legislation, IRS regulations, and court cases. It is always a good idea to consult an Enrolled Agent before buying, selling, trading, or making changes to a rental property.
Are there any limitations on my rental losses? Maybe. Rental losses are considered "passive" losses for taxpayers. This means that owning rental property is not the usual "trade or business" of the taxpayer. Most taxpayers may take at least the first $25,000 of the losses from rental property. Phase out rules may prohibit higher income taxpayers from using losses to offset other income. What happens if I have losses from my rental property that I cannot use because of these limitations? Losses which cannot be utilized in the year incurred are suspended and carried over indefinitely until they can be used. What if I die before I use up these suspended losses? The value of your property to your heirs will be "stepped up" to fair market value. To the extent
the fair market value exceeds your basis in the property, your suspended losses will be extinguished. Any remaining suspended loss can be used on your final Form 1040 to offset any type of income. The suspended losses cannot be transferred to the estate or heirs.
My tenants pay me first and last month's rent and a security deposit. How much of that must I declare as income? Advance rent is always included as income in the year you receive it regardless of the period the rent covers or the method of accounting you use. The security deposit is not counted as income until you keep all or part of it because your tenant did not live up to the terms of the lease.
I own a rental house. This year I painted it and added a deck. Can I deduct these expenses? Repairs, which keep your property in good condition, are fully deductible. Painting is usually considered a repair. Improvements, which add value to your property, prolong its useful life or adapt it to new uses, are capital expenditures and must be depreciated. This would apply to the new deck. In either case, you cannot take any deduction for the value of your own labor.
I heard that I can rent my home and not pay tax on the income. Is this true? If you rent your residence or vacation home for less than 15 days during the year, you do not report the rent as income. You may not deduct any expenses incurred in operating the home while it was rented. You may deduct property taxes and interest on your mortgage as usual, if you itemize deductions.
I am planning to buy a new washer, dryer, and refrigerator for my rental house.
I know I must depreciate these items, but over how long a period of time? Consult the Modified Accelerated Cost Recovery System (MACRS), to determine the number of years. Can I turn my personal residence into rental property? Yes, but you may create a large tax increase. Under new capital gains rules and new rules for the sale of personal residence, you may not owe any tax on the sale of your home. You are allowed to exclude $500,000 for a joint return and $250,000 for a single filer on the sale of a residence. There is no such exclusion for the sale of a rental property.
I bought a rental property for $50,000 and have taken depreciation deductions of $20,000. If I sell the property for $75,000, on how much gain will I have to pay tax? You should pay gain on $45,000. Your basis in the property is $30,000; $50,000 cost, less $20,000 of depreciation. Your gain is the difference between the selling price and your basis. You can reduce this gain by any expenses of sale you incur.
Will my gain be taxed at capital gains rates? For assets held more than one year, the part of the gain attributable to depreciation is taxed at a maximum rate of 25%. The remaining part of the gain is taxed at a maximum rate of 20%. Note these rates are maximums - the rate can be lower. As an example, for taxpayers in a 15% tax bracket, the depreciation gain would also be taxed at a 15% rate to the extent of any remaining 15% tax bracket amount. This is a complicated area. Consulting your Enrolled Agent may be advisable.
Can I postpone tax when selling my rental property? Yes, if you exchange your property for another like property. This is known as a Section 1031 tax deferred exchange. You may also sell your property on the installment method and spread the gain
over the life of the loan (except for depreciation). Special rules apply to both types of sales.
A: Education Tax Benefits or Planning for a Lifetime of Learning. Education IRAs (Now the Coverdell Education Savings Account) Education Incentives A key aspect of the Taxpayer Relief Act of '97 focuses on encouraging education beyond high school. New credits, deductions, and savings incentives form the core of these education related changes. Because there are numerous exceptions, elections, phaseouts, etc. associated with these tax benefits, you may wish to obtain professional advice from an Enrolled Agent. Credits.
Since 1998, two credits have been available for taxpayers who pay qualified tuition and related expenses:
1. Hope Scholarship Credit. The Hope Scholarship Credit is allowed for tuition and related expenses for the first two years of post secondary education. A maximum credit of $1,500 is allowed, determined by taking 100 percent of the qualified expenses paid during the tax year up to $1,000 plus 50 percent of the next $1000. Students must be at least a half-time student pursuing a degree or recognized credential at a qualified educational institution. The credit may be claimed for more than one family member.
2. The Lifetime Learning Credit (LLC). A credit is allowed for up 20 percent of the amount of the qualified tuition and related expenses not to exceed $5,000. The maximum credit is $1,000. The LLC is allowed for undergraduate and graduate level courses as well as any course of instruction at an eligible institution to acquire or improve job skills. There is no requirement to be a half-time student. The LLC is calculated on a per family basis rather than a per student basis.
Special Rules Applicable to Both Credits Eligible Expenses:
1. Tuition and fees for the taxpayer, taxpayer's spouse, or a dependent of the taxpayer.
2. Payments for room, board, student activities, and books are not eligible for the credits.
3. Qualified expenses are reduced by any amounts that are excluded from income by any other provision of the law.
4. Expenses for which a taxpayer elects the Hope credit would not be eligible for the LLC.
5. Expenses must generally be paid during the year for an academic period that begins in that tax year, but there is a prepayment rule that allows a credit for expenses paid in one tax year for academic period that begins in first 3 months of the following year.
6. Tuition expenses paid with loan proceeds are eligible for the credit in the year the tuition is paid, not when the loan is repaid.
Phaseout. Both credits have an AGI phaseout for taxpayers with modified AGI between $40,000 and $50,000 ($80,000 to $100,000 for joint returns).
Who's Eligible? Credits may be taken for the taxpayer, spouse, or a dependent. A dependent isn't allowed the credit even if he or she pays the expense. The taxpayer claiming the dependency exemption may claim the credits for expenses paid by the dependent. Neither of the credits are allowed if a taxpayer files married filing separately. Taxpayers who are nonresident aliens for any portion of the tax year aren't allowed the credits. Deductions Interest payments on educational loans may be deductible as an adjustment to income for certain qualified taxpayers. The new law phased in the deduction over several years. The maximum allowable amount for each year is: 1999 - $1,500 2000 - $2,000 2001 and beyond - $2,500 An educational loan means any loan incurred to pay qualified higher educational expenses which were incurred by the taxpayer, spouse, or dependent.
1. Deduction allowed for interest paid during the first 60 months in which interest payments are required.
2. Deduction is phased out for taxpayers with modified AGI between $40,000 and $55,000 ($60,000 and $75,000 for joint filers).
3. Married couples must file a joint return to claim the deduction.
4. Dependents are not allowed the deduction. The deduction does not depend on whether or not the loan was federally guaranteed or subsidized. Refinancing won't cause the loan to lose its qualifications. Former students whose loans are already in repayment may be eligible for this deduction as long as the payments are for the first 60 months that interest payments are
required on the loan.
Savings Incentives. Now there's a new way for taxpayers to save for the future costs of higher education. Education IRA. (now the Coverdell Education Savings Account.) The Education IRA was created exclusively for the purpose of paying higher education costs for a designated beneficiary. A nondeductible cash contribution of up to $500 per year can be made for the beneficiary until age 18. Anyone (including the child) may contribute to a child's Education IRA. Beginning in 2002, this has
been renamed the Coverdell Education Savings Account (ESA) and the restrictions and dollar limitations have been changed. The $500 contribution is phased out if the contributor's AGI is between $95,000 and $110,000 ($150,000 and $160,000 MFJ). There is no limit as to the number of Education IRAs that may be established for a particular child. However, in any given taxable year the total contributions to all accounts for a particular child may not exceed $500. Beginning in 2002, this has been renamed the Coverdell Education Savings Account (ESA) and the restrictions and dollar limitations have been changed.
Distributions. Distributions from the Education IRA are not taxable if used to pay qualified educational expenses. If distributions are not used to pay educational expenses, a portion may be taxable and subject to a 10 percent additional tax. Beneficiaries must withdraw the amounts in the Education IRA before reaching age 30.
Rollovers. Amounts remaining in an account when the beneficiary finishes his or her education or before reaching age 30 can be rolled over to another member of the original beneficiary's family. It is also possible just to change the designated beneficiary of an account.
A: The Internal Revenue Service is becoming more aggressive in it's enforcement of tax law. Part of the process they follow be initiated with a telephone call to you. If you receive a telephone call, letter or any other form of contact from the Internal Revenue Service or any other taxing agency, be sure to contact a tax professional for assistance as soon as possible. We provide audit representation, as well as assisting you in negotiating outstanding returns or debt with taxing agencies.
A: Your first job is to decide what form of business entity you will be. Sole proprietor, Partnership, Limited Partnership, Corporation, Subchapter S Corporation, LLC, Association, or some other variant of these. This is a complicated choice and you should seek outside help in making the decision. IRS provides helpful information at http://www.irs.gov/smallbiz/index.htm. and you can order their Small Business Resource Guide at http://www.irs.gov/businesses/small/ Once you have decided what form of business entity you will be, the following items are necessary to start up:
(1) Fictitious Business Name Filing - File application with the county and then publish with a newspaper. More info and the forms at http://www.co.alameda.ca.us/auditor/reclerk.shtml
(2) Business checking - We suggest "One-Write" checks available at your bank, but probably cheaper through Mc Bee, (510) 733-9349 or http://www.mcbeesystems.com/ or through most office supply stores. You will need payroll disbursement checks if you think you ever will have employees.
(3) Business Insurance - At least a liability insurance policy is highly recommended. You may be able to get Errors & Omissions and/or liability through a trade association.
(4) City Business License - contact the city hall for the city you operate in. For Fremont, CA see http://www.ci.fremont.ca.us/business/businessinformation.html
ONLY IF YOU ARE SELLING PRODUCTS
(5) Resale number - go to the State Board of Equalization at 1515 Clay St #303, Oakland, CA 94612 (800)432-2829, or you may call the main office at (800) 400-7115 to receive information by fax or mail.
ONLY IF YOU WILL HIRE EMPLOYEES
(6) Payroll-Before putting anyone to work they must have completed forms I-9 and W-4 and returned to you. You must also file a form DE 34 with state to report new employees.
(7)Federal Employer ID Number-Complete & return form SS-4.
(8) State Employer ID Number-Compete & return form DE 1.
(9) Workman's Compensation Insurance. You will find competitive rates at STATE COMPENSATION INSURANCE FUND - 2955 Peralta Oaks Ct, Oakland, CA 94605 (510)577-3000 or 120 W Mission St, San Jose, CA 95110 (408) 297-1714.
You may have additional requirements and filings to meet because of the type of business entity you have selected (Sole Proprietorship, Corporation or Partnership) or because of the industry (such as a contractor's license). We are more than happy to help you with any and all of these items. We offer complete bookkeeping, payroll, and tax filing services; as well as
assistance with setup and maintenance of your own in-house systems.
A: An Enrolled Agent (EA) is an individual who has demonstrated technical competence in the field of taxation. Enrolled Agents, or EAs, can represent taxpayers before all administrative levels of the Internal Revenue Service.
What does the term "Enrolled Agent" mean? "Enrolled" means EAs are licensed by the federal government. "Agent" means EAs are authorized to appear in place of the taxpayer at the Internal Revenue Service. Only EAs, attorneys and CPAs may represent taxpayers before the IRS. The Enrolled Agent profession dates back to 1884 when, after questionable claims had been presented
for Civil War losses, Congress acted to regulate persons who represented citizens in their dealings with the Treasury Department.
How can an Enrolled Agent help me? EAs advise, represent and prepare tax returns for individuals, partnerships, corporations, estates, trusts and any entities with tax-reporting requirements. EAs prepare millions of tax returns each year. Enrolled Agents' expertise in the continually changing field of tax law enables them to effectively represent taxpayers audited by the IRS.
What are the differences between EAs and other tax professionals? Only Enrolled Agents are required to demonstrate to the Internal Revenue Service their competence in matters of taxation before they may represent a taxpayer before the IRS. Unlike attorneys and CPAs, who may or may not choose to specialize in taxes, all EAs specialize in taxation. EAs are the only taxpayer representatives who receive their right to practice from the United States government. (CPAs and attorneys are licensed by the states.)
How does one become an Enrolled Agent? The EA designation is earned in one of two ways:
(1) an individual must pass a difficult two-day examination administered by the IRS which covers taxation of individuals, corporations, partnerships, estates and trusts, procedures and ethics. Next, successful candidates are subjected to a rigorous background check conducted by the Internal Revenue Service; or
(2) an individual may become an EA based on employment at the Internal Revenue Service for a minimum of five years in a job where he/she regularly applied and interpreted the provisions of the Internal Revenue Code and regulations.
Are EAs required to take continuing professional education? In addition to the stringent testing and application process, EAs are required to complete 72 hours of continuing professional education, reported every three years, to maintain their status.
Because of the difficulty in becoming an Enrolled Agent and keeping up the required credentials, there are fewer than 35,000 active EAs in the United States.
Are Enrolled Agents bound by any ethical standards? EAs are required to abide by the provisions of U.S. Treasury Department Circular 230. EAs found to be in violation of the provisions contained in Circular 230 may be suspended or disbarred.
Why should I choose an EA who is a member of the National Association of Enrolled Agents (NAEA)? NAEA is the organization of and for Enrolled Agents. The principal concern of the association and its members is honest, intelligent and ethical representation of the financial position of taxpayers before governmental agencies. Members of NAEA are required to complete a minimum of 30 hours of continuing professional education each year in the interpretation, application and
administration of federal and state tax laws in order to maintain membership in the organization. This requirement surpasses the IRS required minimum of 24 hours per year.
How can I find an EA? Obviously you have found more than one just by being at this website. If you live near Fremont, CA
call us at (510) 657-0574. The ability to locate an EA in your local area is as close as your computer, your telephone or your mailbox. You can search our website at http://www.naea.org/ and then search first by state and then by zip code. This is an instant referral service available at any time. You can also call the NEA 24-hour referral service at 800-424-4339 (7 days a week) or write the National Association of Enrolled Agents. You will be sent a list of names and addresses of members located in your area. Many EAS are listed in the yellow pages under "Tax Preparation." Look for the words Enrolled Agent, Enrolled to Represent Taxpayers Before the IRS and the EA designation. Privilege and the Enrolled Agent The IRS Restructuring and Reform Act of 1998 allows federally authorized practitioners (those bound by the previously mentioned Circular 230) a limited client privilege. This privilege allows confidentiality between the taxpayer and the Enrolled Agent under certain conditions. The privilege applies to situations where the taxpayer is being represented in cases involving audits and collection matters. It is not applicable to the preparation and filing of a tax return. The new privilege does not apply to state tax matters, although a number of states have an accountant-client privilege.
A: Top Ten Reasons You Need An EA
10.Unlike CPAs and attorneys, who may or may not choose to specialize in taxes, All Enrolled Agents specialize in taxation.
9. Enrolled Agents are subjected to a rigorous background check conducted by the IRS r>8.8. Enrolled Agents are bound by Circular 230,which gives them limited client privilege in situations where the taxpayer is being represented in cases involving audits and collections matters.
7. Enrolled Agents are required to complete 72 hours of continuing education every three years to keep them abreast of any and all tax law changes.
6. Enrolled Agents take a difficult two-day examination administered by the IRS, which covers taxation of individuals, corporations, partnerships, estates and trusts, procedures and ethics.
5. Only Enrolled Agents are required to demonstrate to the IRS their competence in matters of taxation before they represent a taxpayer.
4. Enrolled Agents are authorized to appear in place of the taxpayer at the Internal Revenue Service r>3.3. Enrolled Agents are the only tax professionals who receive their right to practice from the United States Government.
2. Enrolled Agents are licensed by the federal government And the number one reason you should choose an EA
1. The profession has been regulated by Congress since 1884!
A: e-file is how the Internal Revenue Service refers to the electronic filing of tax returns. It started out as a pilot project in 1986 with 25,000 tax returns being filed electronically. Today, four out of every five taxpayers files electronically, and the IRS goal is for all taxpayers to file electronically in the near future. The greatest benefit of electronic filing is the speed at which you can receive a refund compared to paper returns. When coupled with direct deposit, you can receive your refund in as few as 10 days. Even if you owe taxes, e-file allows you to file now and pay later. If you owe a balance, you can e-file in January, but delay payment until April 15th. More importantly, e-file provides a confirmation of your filing.
The e-file Advantage:
1. With e-file, the transmission process is as quick as a phone call.
2. The IRS computers receive your data from your tax professional.
3.3. An electronic validity check is performed to verify, among other things, the Direct Deposit and Social Security numbers.
4. Accepted returns are input electronically to the same tape system as paper returns. r>5. The process is completed within the same day.
6. The transmitter receives an acknowledgment from the IRS within 24 hours of the initial transmission.
Who Can Use e-file? Practically anyone who files forms 1040EZ, 1040A or 1040 may file electronically. A completed Form 8453, U.S. Individual Income Tax Declaration for Electronic Filing is needed to authorize electronic transmission of your return. Your Enrolled Agent will have the necessary forms. If you are filing a joint return, both you and your spouse must sign the form. You may now also be able to file using only an electronic signature. Talk with your Enrolled Agent. Direct Deposit Direct deposit is a free government service that enables you to have your tax refund deposited directly into your checking or savings account - the fastest and safest way to receive your refund. Payments are sent by electronic funds transfer, thereby eliminating the need to print and mail checks. Most states also now offer e-file.