Tax Tips Blog

Debbie writes:I can pay my property taxes in 2007 and claim them in 2007, or pay them in January and claim them for 2008. In 2007 we are in a higher tax bracket than we will be in for 2008. So, it makes sense to use the property tax (and state income tax) deduction this year, but only up until the point when it would trigger AMT, right? In other words, the most efficient way to work it would be to pay as much of the property tax bill in 2007 as would bring our AMT amount close to the regular tax amount, right? Or, do I go ahead and pay the whole property tax bill and state tax in 2007 because I’m in a higher bracket? Thanks!

My reply: Hello Debbie! Assuming they do not change the law, and they are working on it, so they might, then you have the right idea.

Ideally, you’ll time matters so that you reduce the amount of your 2008 regular tax liability precisely down to your 2007 AMT liability. Anything higher wastes some of the available deduction, because payment of state taxes does not reduce your AMT liability. Anything less causes you to pay more than necessary in 2007, because you have failed to reduce your regular tax liability to the AMT amount.

By the way, to the extent you overshoot, and end up “wasting” some of your state income tax deduction, keep track of that. If you get a state income tax refund, some of it will be attributable to the “wasted” deduction, and therefore won’t be taxable.

Again, all the above is assuming they do not change the law.

Best wishes,

Gina

Olivia asks: What are some sample miscellaneous deductions? I have an investment newsletter scheduled to renew on the 31st and I might let it renew or cancel it…but I don’t know if it’s even deductible to me. My AGI should be around $75,000 for 2007, so I’d need Misc. deductions of at least 2% before I can get a benefit, correct? Are charitable contributions counted as misc. deductions? What types of things are? Thank you, Olivia

My response: Miscellaneous deductions as they pertain to Form 1040, are part of your itemized deductions an are generally deductions for expenses incurred for the production of income - but not in a trade or business, or rental property. Those go on schedules C,E, or F, as the case may be.

Miscellaneous deductions on Form 1040 include employee business expenses, which also involve Form 2106, and investment expenses. The newsletter you mentioned would be an example. Also union and professional dues, job-hunting and related expenses, and tax return preparation and planning expenses.

Charitable deductions are not included as part of miscellaneous deductions, but are deductible as a separate category of itemized deductions.

With the figure of $75,000 AGI you mentioned, you need $1,500 (2%) of miscellaneous deductions to get any tax benefit against your regular taxes assuming you itemize your deductions. If you do not itemize your deductions you will get no benefit regardless of the amount of your miscellaneous deductions.

In addition, miscellaneous deductions subject to the 2% limit are added back for AMT purposes. So if you know you’re not going to itemize your deductions or that you’re subject to AMT, you probably don’t need to dig through your check registers and receipts too hard, looking for miscellaneous deductions.

There are a few specified items of miscellaneous deductions which are not subject to the 2% floor. These include gambling losses (to the extent of winnings); estate tax on items of IRD (income double taxed for income and estate tax); a “loss” on an annuity policy; repaid items of income; and a few other odd things. The IRS Pub 17, Your Federal Income Tax, and the instructions for Schedule A, cover this topic.

Best wishes,

Gina

Abby asks: I’ve been baby sitting for favors with friends for the last several years. I babysit for an afternoon, they help with yard work, that sort of thing. This year I started babysitting for someone in exchange for her professional services, and I expect to receive around $1500 of services from her by year end. Am I considered to be earning income equal to the cost of the services she’s providing? How do I report this on my tax return? Do I owe self-employment taxes on this money I never received? Does this count as earned income for the purposes of funding an IRA and the like? Thanks! - Abby

My response:Hello Abby! You are correct that the IRS requires that you report the value of your services as income, even if you received other services (or products) in exchange for your services and did not receive any cash.

Babysitting is a trade or business and you would report this business on Schedule C of your 1040. You are allowed to deduct any costs you may have incurred in your business as well (did you advertise for your services, purchase items used specifically for this business, etc?).

If your net earnings from this business is greater than $400 then you will owe self-employment taxes on your net earnings. Your net earnings from self-employment is considered earned income for the purposes of funding an IRA.

Best wishes,

Gina

Rob asks:Hello Gina. I’ve been trying to figure out what my income and taxes will be in retirement and was hoping to get some help. If a married couple does not work after the age of 65, and we receive money from pensions/social security/401k/Traditional IRA/Roth IRA annually and/or monthly, do we have to pay Social Security & Medicare (7.65%) taxes on any of the income we receive from these payments? I’m aware that we will have to pay federal income tax on the 401k and traditional ira distributions, and i don’t believe we have to pay any federal income tax on the pensions/social security/roth ira distributions, but i have no knowledge of whether or not they have to pay the 7.65% on any of this. Thanks for the help. Rob

My reply:Hello Rob! I think it’s great that you’re thinking about this before your retire, as it may not be as straight forward as you imagined.

First, you paid Social Security & Medicare taxes on the income that was used to make your contributions into your pension / 401(k) / IRA, so they’re not owed again when money comes out. Assuming that you do not have any after-tax contributions in your 401(k)’s and traditional IRAs, then you are correct that you will have to pay Federal tax on those distributions.

If you have any after-tax contributions in these accounts then you already paid Federal tax on the amount of those contributions and do not owe it again.

As for your Roth, you are correct that you will not owe Federal tax (because Roth Contributions are made with money you already paid Federal tax on) as long as you make a “qualified” distribution.

Your pension distributions will be at least partially taxable, perhaps completely taxable.

Whether or not your Social Security benefits are taxed, and how much of them is taxed, depends on what other income you have at that time. In the scenario you describe, at least after your mandatory distributions from your 401(k) and traditional IRA begin at age 70 1/2, at least a portion of your Social Security will probably be taxed.

A qualified tax professionally will gladly help you with this calculation. Short of that, you may wish to spend some time on the IRS website and read up on Publication 590 (Individual Retirement Arrangements), Publication 575 (Pension and Annuity Income) and Publication 17, (Your Federal Income Tax).

Best wishes,

Gina

Amy asks:If a special needs irrevocable trust is set up and a distribution is made to beneficiary with the special need, are the earnings of the trust up to the amount of the distribution passed onto the beneficiary and therefore not taxed to the trust? Thank you, Amy

My reply: You are correct, Amy.

The trust has a “distribution deduction” for amounts paid or required to be paid to a beneficiary. Usually, you follow the money for who pays taxes with trust income.

Revocable trusts are different, because their income is usually taxed to the original grantor under the grantor trust rules, and the trust is essentially a disregarded entity, but this is not the case for irrevocable trusts.

Best wishes,

Gina

Bob writes: I was under the impression that disability premiums were tax deductible. But looking at irs.gov, looks like I’m wrong. Personal DI premiums are clearly listed in the can not deduct category. What if you are self-employed? Deductible then or no? What if the premiums are being paid with after-tax dollars?

My reply: Generally, disability insurance premiums are not deductible.

If you pay disability premiums personally they are not deductible, but the income is not taxable. If your employer pays the disability premiums for you, the income is taxable. If your employer pays the premiums for you with your after tax dollars then the income is not taxable.

Having said the above, payments to certain mandatory state disability programs, such as California, New Jersey and New York, are deductible on schedule A as state and local taxes.

Best wishes,

Gina

Karen writes:I know this is an easy stupid question and I need an answer really fast. I’m trying to do my 2006 taxes. I’m filing joint. I have maxed out my 401K and will not be making any additional IRA contributions. I’m not yet 50. I had a business for a part of the year this year. My income from my job for part of the year barely makes it above the $76,000 mark for Social Security, so I shouldn’t have to pay any self-employment SS taxes. However, I know that Medicare is not capped. Can you please tell me what the tax rate is for Medicare (I can’t seem to locate it,) so I can figure my SEP-IRA contribution correctly? Thanks.

My reply: I hate to be the bearer of bad news, but the social security tax limit goes up every year and in 2006 that limit was $94,600, not the $76,000 you thought it was (that was correct in 2000). You can find these limits and the rates on the Social Security Adminstration’s website. This means you will probably have to pay self-employment taxes. The rates for 2006 are as follows:

• SS (OASDI) employee 6.20% (capped at $94,600)
• SS (OASDI) employer 6.20% (capped at $94,600)
• Medicare employee 1.45% (no limit)
• Medicare employer 1.45% (no limit)

So if you made exactly $76,000 from your part time job, you’ll be paying 7.65% in Social Security and Medicare taxes on those wages. Then you’ll be paying 15.3% on $up to 18,400 from your self-employment income and paying 2.9% on your self employment earnings above $18,400, if any. You are entitled to an adjustment for one-half of the self-employment taxes that you will be paying.

401(k) and IRA deductions do not affect Social Security or Medicare taxes - only income taxes, so if your part year job was $76,000 after your $15,000 401(k) deduction, you won’t have to pay social security taxes on quite so much of your self-employment income, but you would still be a little under the limit at $91,000.

You’ll need to compute your self-employment tax, which is not affected by the SEP deduction, before you can figure your maximum SEP contribution. You may want to read IRS Publication 560 and then find a qualified tax professional to help you finish your return.

Best wishes,

Gina

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