Tax Tips Blog

Dales writes:Hello, Have a question about deducting property tax. I purchased property from my sister. I have been paying her property taxes for some time now, and I understand that I was not able to deduct this from my federal taxes (even though she could deduct what I paid since she owns the property). Since I purchased her property this year, I want to know if I can now deduct all payments made in 2006, or only payments made after the sale. Thanks very much!

My reply:Hello Dale! Thanks for visiting. I hope you sister did not deduct the property taxes that you paid on her behalf, because the only taxpayers who can deduct real estate taxes are those who are both legally obligated to pay the tax and actually pay the tax. Therefore, you are only able to deduct the taxes you paid after you owned the property. Best wishes, Gina

Rosemarie from Saugus, MA inquires: Re: your article on Hiring your children…Can you pay them by depositing money directly into a 529 plan for their education each month - as opposed to a pay check?

I reply:Hello Rosemarie! Thank you for visiting my blog. If you hire your children to work for you, in your business, and pay them a reasonable wage for their age and the service they perform, you can deposit their net payroll check into their Section 529 plan (or a bank account in their child’s name, or their own Roth IRA). You will still have to issue them a W-2 at the end of the tax year, but if your business is taxed as a sole proprietorship (Schedule C on Form 1040) or partnership (Form 1065), then you don’t owe any Social Security or Medicare taxes on your child’s wages until they reach age 18 years and 6 months. You don’t owe Federal unemployment tax until they reach age 21 and 7 months. Hiring your children may also help you establish a medical expense reimbursement plan, education assistance plan or retirement plan. Before you hire your children it is best to speak to your tax professional to make sure you are paying them a reasonable wage and have properly documented them as a true employee.

Best wishes, Gina

Karen from Ohio asks:I have a question about how much depreciation I should use on a rental property that I sold. I placed the property in service on Nov. 1, 2000, using MACRS (GDS), straight line depreciation, mid-month convention. If this were a normal year, as the past few have been, I could depreciate 3.636% of the basis. The date of the sale was 4-23-06. So, I figure that I can use 1.212%, since I owned the property for 1/3 of the year and 1.212% is 1/3 of 3.636%. But I just did this math on my own, and I couldn’t find any official IRS info about this–but this kind of occurrence should happen all the time, as very few people will depreciate their RE over the full 27.5 years. I must be close to the right answer on this, but what should I really do? Do I have to count days. (Including April 23th in the count?) Karen

My response: Depreciation is a complex area of tax and accounting. I do not recommend that anyone try to compute their own depreciation. I will assume that you are referring to “regular” Federal depreciation schedules, but taxpayers should be aware that property may be depreciated differently for State, AMT (another Federal method) and ACE (yet a 3rd Federal method).

So, even if I help you figure out your regular Federal depreciation amount, you still have depreciation work to do, which is usually best left for your tax professional. Now to answer your question….you would also use mid-month for the year of disposal.

In YOUR case the “factor” or percentage that you would multiply your basis by would be 1.061%. This is 3.5 twelfths of the full year factor that you were using (3.636%). And why 3.5 twelfths? Because of the mid-month convention. Your property was sold (as far as the IRS is concerned) on April 15, which is 3.5 months into the year.

It should also be noted that when computing the gain or loss on disposal of property the depreciation allowed is used whether the depreciation expense was taken or not. Deciding not to mess with depreciation or taking a lessor amount than you are allowed will save you nothing.

And one final note…with proper advanced tax planning, taxpayers can use a 1031 exchange to postpone the gain. Best wishes, Gina

Tax credits cut your actual tax - dollar for dollar. There are way more tax credits available then most taxpayers are aware exist. The following is a general overview of some of the tax credits that are available to you. Tax credits generally come with complex guidelines, so if you do think you may qualify for one or more, please consult your tax professional to make sure you claim it properly.

• Adoption Tax Credit - You may be entitled to take a credit for some (or all) of your “reasonable and necessary” expenses related to adopting an eligible child. This credit is subject to a dollar limit and an income limit.
• Child Tax Credit - You may be able to claim up to $1,000 for each qualifying child. This credit is limited based on your filing status, modified adjusted gross income, the amount of regular and alternative minimum tax you owe.

• Dependent Care Tax Credit -If you paid someone to care for your child or dependent so you could work or look for work, you may be able to claim up to $3,000 for one child (or dependent) or $6,000 for more than one child (or dependent). This credit is a percentage of the dependent care expenses that you incurred. The percentage varies depending on your income.

• Disabled Access Tax Credit - Eligible small businesses who incurred expenses in order to comply with the American Disabilities Act may be able to claim a tax credit of up to $5,000.

• Earned Income Tax Credit - If you have “earned income” (income from working), and you meet certain other requirements you may be able to claim a credit. This credit is limited based on the amount of your investment income, earned income and modified adjusted gross income.

• Elderly and Disabled Tax Credit - If you are age 65 or older at the end of the year or you are retired on permanent and total disability, you may be eligible for this credit. This credit is limited by your adjusted gross income and your nontaxable income.

• Employer Provided Child Care - Eligible companies may be entitled to a credit for certain of the costs involved in acquiring, constructing, rehabilitating or expanding their property to meet guidelines for a qualified child care facility for their employees.

• Foreign Tax Credit - This credit is available to eligible taxpayers who invest in foreign taxable income, but do not get the benefit of itemizing their deductions. This credit is generally limited to the amount of income tax you paid or was accrued to a foreign country or a U.S. possession that qualified for this credit.

• Hope Scholarship Credit - This credit is available for eligible taxpayers who have an eligible student, in their first year or two of undergraduate education, who was enrolled at least half-time for at least once academic period at an eligible school leading to a degree or certificate. This credit is limited by the taxpayers adjusted gross income and the net amount of qualified educational expenses paid.

• Lifetime Learning Tax Credit - If there are any students in your family, you may be eligible to claim this credit. This credit is based on qualified tuition and related expenses from eligible institutions.

• Low-Income Housing Tax Credit - If you have invested in low-income housing and have met other Federal guidelines you may be eligible for a tax credit of up to 9 cents for every dollar you spent on the housing for up to 10 years.

• Rehabilitation Credit -If you have renovated, restored or reconstructed a historical building or a building placed in service before 1939, you may be eligible to take a credit for part of the costs that you incurred.

• Retirement Savings Contribution Credit - If you are over the age of 18, not a student and have, what the IRS refers to as “low or moderate” adjusted gross income, and contribute to a retirement plan you may be eligible for as much as $1,000 of the amount you contributed to your retirement as a credit against the taxes you pay.

• Telephone Excise Tax Refund. Although not really a credit, I thought I’d add it to this list. For 2006, individual and business taxpayers will be able to request a refund if they paid the federal excise tax on long-distance or bundled service. You can read more about it here.

Randy inquires: I realize with the passage of the Pension Act of 2006 a taxpayer can make a contribution directly to charity, have it excluded from their taxable income, included in their required minimum distributions, and not deductible on Schedule A. Is there an exception to the deductibility on Schedule for taxpayers with an IRA which has been completely funded with non-deductible contributions?

I respond:Are you over 70-1/2 years old? Is the charity you wish to contribute to a 501(c)(3)? Do you wish to contribute $100,000 or less? Do you have any other fully deductible IRAs that you can use for this contribution? How much of your IRA is taxable earnings? As you can see this seemingly simple question, has a lot of follow-up questions which should be answered in order to make the best decision possible. You may be better off cashing out your IRA, pay the tax on the earnings and then make a charitable contribution and get the full benefit of the deduction. Then again, the distribution will be counted toward the amount you have to withdrawal and the withdrawal is not taxable to you. This will lower your AGI, which may help with your 2007 Medicare payments, which are scheduled to increase. According to IR 2006-192, which was released December 14, 2006, the situation that you are referring to (non-deductible IRA) states that the distribution/contribution is first taken out of your earnings (taxable funds) and the remainder from your non-deductible contributions. This ruling is silent as to whether or not the non-taxable distribution/contribution can then be deducted on Schedule A. No matter what your situation, if you plan on utilizing this tax benefit please consult your tax professional for appropriate guidance.

You have already been bombarded with “tips” and ideas of how to get those last minute tax deductions in order to reduce your taxes or even get yourself a nice refund. These tips usually include:

• Paying property taxes in December instead of January to increase your itemized deductions
• Making an extra mortgage payment to increase your interest expense deduction.
• Now that sales tax has been extended, there are ads telling you to buy a new vehicle before the end of the year and deduct your sales tax
• Pay your investment fees in December instead of January as another way to increase your itemized deductions
• Paying your medical expenses in December instead of January

While all of the above are good suggestions to decrease you regular tax you may inadvertently subject your self to AMT by doing so. Since more and more taxpayers are being caught in the AMT trap, you shouldn’t increase your deductions at year end without first doing a little tax planning to figure out if you will be subject to AMT. If you find that you will be subject to AMT then instead of trying to increase your deductions you should be trying to decrease your “non-AMT” deductions and increase your income. Some ways to achieve this include:

• Pay your property taxes in January instead of December (assuming you won’t be hit with a penalty)
• Do not make any extra mortgage payments in December
• Wait until next year to pay any medical expenses if the total of your medical expenses do not exceed 10% of your adjusted gross income
• Pay your employee business expenses, union dues, investment expenses, etc. in 2007
• Spread the exercise of your stock options over multiple years
• Redeem savings bonds or CDs before year end
• Sell short-term securities for a gain before year end

Every time they try to simplify the tax code it gets more complex, which means that every year is more important than the last to do tax planning in order to avoid or minimize any unexpected tax situations such as AMT.

Hank from Plano, Texas asks: Hi, If I’m reading Publication 17 correctly, I can pay in all the taxes that I owe and then there is no late filing penalty if the tax return is submitted late (after the extension date). Right? If so, then this seems to be saying that if there is no tax due there will NEVER be a late filing penalty. So why submit the return at all? Hank

My response:Whoa! First, I would never say that there would “never be a penalty”. If additional tax is assessed by the IRS, a late filing penalty will be assessed.Second, there are many reasons why you should file a return, including:

1. You are legally required to file a return (assuming you meet the minimum guidelines). § 7203 “Willful failure to file return, supply information, or pay tax” states that there are civil and criminal penalties for failing to file a tax return.

2. The statue of limitations starts when the tax return is filed or the filing date which ever is later. If you never file the IRS has forever to catch up with you.

3. If you are using any of the available techniques to minimize your tax liability (itemized deductions, credits, etc.). The IRS does not know which ones you may want to use nor which ones you qualify for.

4. If the return is not timely filed then any elections that must be made by that date will not be “timely” and therefore may be denied.

5. If you are due a refund.

6. You have investment sales that were reported to the IRS on Form 1099-B. The IRS does not know your cost basis or your expenses.

7. If you paid in taxes through withholding the IRS will receive a copy of your W-2 income and may compute your tax due based on income alone.

Best of luck, Gina

Bill from San Antonio, Texas asks: Hi! Do you know if there is any way for me to average my taxes between two years, like if I had a really good year last year and a really bad year this year, can I average the two years? This may be a silly question, but I thought I would ask to make sure because I heard it’s possible. Thanks, Bill My reply: Hello Bill! Thanks for stopping by. I have no way of knowing, from your email, if you would be able to average your taxes between two years. For most taxpayers, this is no longer possible (this was possible about 20 years ago). However, it is still possible for farmers.

Since it is common for farmers to have large fluctuations in their income from year to year, they may elect to average their income over the previous three years. Since we are dealing with the tax code, it is not a simple “averaging” of income. Thus, if you believe this may apply to your situation you should seek the help of a qualified tax professional.

Best wishes, Gina

As far as income taxes are concerned, we have a “pay as you go” system. We called it this because income taxes are required to be paid as you generate taxable income either through withholding or estimated tax payments. Withholding is the amount of taxes that are taken out of your paycheck as you earn your money. This allows the government to track how much money you are making and how much taxes they are collecting throughout the year. It also makes it harder for you to realize how much taxes you are paying. If you are self-employed then you will not have wages so the IRS requires that you make estimated tax payments on a quarterly basis. You are required to estimate your total taxes for the year, and then pay the appropriate quarterly amount due. For 2006, you should have paid 22.5% by April 17, 2006, 45% by June 15, 2006, 67.5% by September 15, 2006 and should pay 90% by January 16, 2007. If you do not pay in enough federal income taxes by the end of the year you will owe the IRS interest on the taxes you should have paid, when you should have paid them. In order to avoid paying interest in 2006, the amount that you would need to withhold (or pay in estimated tax payments) depends on your 2005 Adjusted Gross Income (AGI). If your 2005 AGI was $150,000 or less, you’ll need to withhold 100% of the amount of your 2005 tax liability or 90% of your 2006 tax liability. If your 2005 Adjusted Gross Income was more than $150,000, you’ll need to withhold 110% of your 2005 tax liability or 90% of your 2006 tax liability. However, if you pay in more federal taxes than you are required to, the IRS keeps your money interest free. Since your taxable income is rarely computed based on your wages alone, and often times your tax situation changes throughout the year is it advisable to review and adjust your withholding (or estimated tax payments) throughout the year.

Most people are aware that getting married changes their tax situation. If you get married before January 1, then you can file a joint return for the entire prior year. This is beneficial for most taxpayers. Most married couples end up paying less in taxes filing jointly because a lot of the “marriage penalty” was removed from the tax laws. Couples with combined incomes of less than $123,700 shouldn’t see any marriage penalty. Still others are now able to take advantage of the low-income housing tax credits, Hope Scholarship and Lifetime Learning credits, the income exclusion for U.S. Savings Bonds used for college costs, Roth IRA conversions, and the rental real estate loss allowance. As soon as you have set the date for your marriage you should begin seeking the advice of a tax professional, such that they can help you file new W-4 with your employer, calculate new estimated quarterly withholding amounts, advice you on new potential tax breaks mentioned above as well as the new phase-out amount for deductible IRAs and ROTH IRAs, child and dependent care credits, college credits, and other deductions and credits that change after marriage.