In accounting, there is a saying: “Those who keep records win.” If you are an investor, you may have a variety of securities, including stocks, bonds, mutual funds and more. When you sell those securities, you want to minimize your gains or maximize your losses for tax purposes. Gain or loss is measured from your tax basis in the investment (asset), which makes it important to keep track of the basis in all your investments.
What is Basis? Generally, your basis in an investment begins with the price that was paid to purchase the investment. However, that will not be the case if the investment was acquired by gift or inheritance. For inherited assets, the basis generally begins with the FMV of the asset on the decedent’s date of death or an alternative valuation date, if chosen by the executor of the estate. Assets acquired by gift actually have a basis for gain – the donor’s basis – and a basis for loss – the fair market value of the asset on the date of the gift. When an asset is acquired through a division of property in a divorce, the asset retains the basis it had when it was owned jointly by the couple.
Basis is not a fixed value; it can change during the time the asset is owned and is adjusted by certain events. For an investment asset, these events include:
• Reinvested cash dividends,
• Stock splits and reverse splits,
• Stock dividends,
• Return of capital,
• Additional investments,
• Broker’s commissions,
• Interest previously taken into income under an election under the accrued market discount rules,
• Interest taken into income under the original issue discount rules,
• Attorney fees,
• Acquisition costs,
• Casualty losses, etc.
These events can increase or decrease the tax basis in the investment, which makes adequate recordkeeping so important.
Another issue associated with basis is when a portion of the investment is sold. Let’s say 100 shares of a particular stock were purchased in 2011 at $10 a share and another 100 shares in 2013 at $20 a share. The investor plans on selling 100 shares of the stock at $30 a share. Using the general rule of “first in – first out,” there would be a $20 per share gain. However, if the investor can identify each specific block of stock sold, such as the 100 share block bought in 2013, there would only be a $10 per share profit. This is known as the “specific identification” method.
The following is a discussion of the more commonly encountered basis adjustments where recordkeeping is essential:
• Reinvested cash dividends – Investors are frequently given the opportunity to reinvest their dividends instead of taking them in cash. By participating in these plans, they are actually purchasing additional sales with their taxable dividends. Unless records are kept, the investor can’t prove how much he or she paid for the shares or establish the amount of gain that is subject to tax (or the amount of loss that can be deducted) when it is sold.
• Stock dividends – It is possible to receive both taxable and nontaxable stock dividends. Stock dividends that are taxable provide the investor with additional stock with a basis equal to the taxable stock dividend. If the dividends are nontaxable, the number of shares that are owned increases, but the basis remains unchanged. If the investor can associate the dividends with a specific block of stock, then the basis of that block can be adjusted accordingly. If not, the adjustment will apply to the entire holdings in that particular stock.
• Return of capital – A return of capital is a nontaxable return of a portion of the investment. Thus, a return of capital will reduce the investor’s basis in security. Suppose an investor has 100 shares of XYZ Corporation that cost $1,000 ($10 per share), and the corporation distributes to him a $100 nontaxable return capital. His basis in the stock is reduced to $900 ($1,000 – $100) or $9.00 per share. If, over a period of time, the return of capital exceeds his basis in the investment, then the excess becomes taxable because he cannot have a negative basis.
• Stock splits – Stock splits can be confusing if they are not tracked as they occur. Let’s assume that an investor owns 100 shares of XYZ Corporation for which he paid $2,000 ($20 a share). Later on, the corporation splits the stock 2 for 1. The result is that he now owns 200 shares, but his basis in each has been reduced to $10 per share (200 shares times $10 equals $2,000 – what was paid for the original shares). This generally occurs when the “per share value of stocks” becomes too high for small investors to purchase 100 share blocks. Also watch for reverse splits, which have the opposite effect.
• Stock spin-off – Occasionally, corporations will spin-off additional companies. The most classic example is the break up of AT&T some years ago into regional phone companies, who themselves later split into additional companies or merged with others. Each time one of these transactions takes place, the corporation will provide documentation on how to split the prior basis between the resulting companies. Tracking these events as they happen is very important, as it may be difficult to reconstruct the information several years down the road.
• Broker fees – Although broker fees are a deductible expense, they are generally already accounted for in most stock and bond transactions. The purchase price of a block of stock generally includes the broker fees, and the sales price reported to the IRS (gross proceeds of sale) is the net of the sales costs.
Depending upon the investment vehicle, tracking the basis in an investment can be quite complicated. If you have questions, please get in touch with us at Dagley & Co. You’ll find our contact information at the bottom of this screen.
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Alright small business owner. Let’s talk about balance sheets.
The best way for small business owners to stay aware of their company’s financial status is to have an accurate, up-to-date balance sheet. By keeping this information up to date every quarter, you can help yourself avoid a lot of problems and surprises down the road.
A balance sheet provides you with an at-a-glance summary of your company’s financial health as of a specific day. It is broken down into what the business’s assets are, what the business’s liabilities are, and the amount of owner or shareholder equity. The balance sheet gets its name from the fact that the assets must be balanced by and equal to the liabilities plus the equity. Some business owners have found current balance sheets so helpful that they update them every month.
Understanding the Asset Portion of the Balance Sheet
When entering assets onto the balance sheet, the business owner needs to include everything that is owned by the business, whether current or liquid assets, fixed assets (http://www.investopedia.com/terms/f/fixedasset.asp), or some other type of asset. Current or liquid assets include:
- Cash that is immediately available
- Money that is owed to you (Accounts Receivable)
- Products currently in stock (Inventory)
- Expenses paid in advance, such as insurance premiums
- Money-market accounts, investments and other securities
- Additional monies owed to you
Fixed assets are items that can’t be easily sold or moved, including equipment and furnishings, buildings, land and vehicles. In most cases these assets depreciate, or decrease in value. Beyond current and fixed assets, items that are intangible, such as goodwill, copyrights and patents, are also considered assets on a balance sheet. It is important to note that money that is owed to you that you expect will not be paid is classified as a Reserve for Bad Debts, which decreases the amount of the Accounts Receivable on the balance sheet.
Understanding the Liability Portion of the Balance Sheet
When entering liabilities onto the balance sheet, the business owner needs to include all of the business’s debts, both current and long term. Current liabilities include accounts payable, sales and payroll taxes, payments on short-term business loans such as a line of credit, and income taxes. Long-term liabilities are those that are paid over a longer period of time, generally over more than a year. These include mortgages and leases, future employee benefits, deferred taxes and long-term loans.
Understanding the Equity Portion of the Balance Sheet
When entering information onto the equity portion of the balance sheet, you should include the value of any capital stock that has been issued, any additional payments or capital from investors beyond the par value of the stock, and the net income that has been kept by the business rather than distributed to owners and shareholders.
In order to be sure that all of the information on the balance sheet is correct, you can double-check your numbers by subtracting assets from liabilities – the result should equal the equity amount. For more information on how to structure a balance sheet, check out this website: “http://www.accountingcoach.com/balance-sheet/explanation/4″>sample balance sheet</a>.
The Value of a Balance Sheet
At first glance a balance sheet may look like an incomprehensible collection of numbers, but once you understand all of the various components and how they relate to one another, they will provide you with the opportunity to detect trends and spot issues before they become problems. Your balance sheet can alert you to:
- Times when inventory is outpacing revenue, thus alerting you to a need for better management of your inventory and production process
- Cash flow problems and a shortage of cash reserves
- Inadequacies in your cash reserves that are making it difficult to invest in continued growth
- Problems with collecting accounts receivables
The most essential tools that are available to you as a small business owner for gauging your operation’s financial health are the balance sheet, the income statement and the cash flow statement. If you are unsure of how to prepare these documents for yourself or don’t have the time, then let a qualified professional at Dagley & Co. take over and provide the information that you need.
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Surprise, surprise: The IRS doesn’t like it when you underpay your quarterly taxes. Congress considers our tax system as a “pay-as-you-go” system. To facilitate that concept, the government has provided several means of assisting taxpayers in meeting the “pay-as-you-go” requirement. These include:
- Payroll withholding for employers;
- Pension withholding for retirees; and
- Estimated tax payments for self-employed individuals and those with other sources of income not covered by withholding.
When a taxpayer fails to prepay a safe harbor (minimum) amount, he or she can be subject to the underpayment penalty. This nondeductible interest penalty is higher than what might be earned from a bank and is computed on a quarter-by-quarter basis.
Federal law and most states have safe harbor rules. There are two Federal safe harbor amounts that apply when the payments are made evenly throughout the year.
- The first safe harbor is based on the tax owed in the current year. If your payments equal or exceed 90% of your current year’s tax liability, you can escape a penalty.
- The second safe harbor – and the one taxpayers rely on most often – is based on your tax in the immediately preceding tax year. If your current year’s payments equal or exceed 100% of the amount of your prior year’s tax, you can escape a penalty. If your prior year’s adjusted gross income was more than $150,000 ($75,000 if you file married separate status), then your payments for the current year must be 110% of the prior year’s tax to meet the safe harbor amount.
Where taxpayers get into trouble is when their income goes up or their withholding goes down for the current year versus the prior year. Examples are having a substantial increase in income, such as when investments are cashed in, thereby increasing income but without any corresponding withholding or estimated payments. Another frequently encountered situation is when a taxpayer retires and his payroll income is replaced with pension and Social Security income without adequate withholding. Taxpayers who don’t recognize these types of situations often find themselves substantially underpaid and subject to the underpayment penalty when tax time comes around.
Bottom line, 100% (or 110% for upper-income taxpayers) of your prior year’s total tax is the only true safe harbor because it is based on the prior year’s tax (a known amount), whereas the 90% of the current year’s tax amount is a variable based on the income for the current year, and often that amount isn’t determined until it is too late to adjust the prepayment amounts.
Please contact us at Dagley & Co. if you anticipate a substantial increase in income, so that withholding or estimated tax payments can be adjusted to avoid a penalty.
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Taxpayers with disabilities, and parents of children with disabilities, may qualify for a number of tax credits and benefits. Listed below are several tax credits and other benefits we have put together that are available if you or someone else listed on your federal tax return is disabled.
- Increased Standard Deduction – If a tax return filer and/or spouse are legally blind, they are entitled to a higher standard deduction on their tax return.
- Exclusions from Gross Income – Certain disability-related payments, Veterans Administration disability benefits, and Supplemental Security Income are excluded from gross income.
- Impairment-Related Work Expenses - Employees, who have a physical or mental disability limiting their employment, may be able to claim business expenses in connection with their workplace. The expenses must be necessary for the taxpayer to work.
- Credit for the Elderly or Disabled – This credit is generally available to certain taxpayers who are 65 and older, as well as to certain disabled taxpayers who are younger than 65 and are retired on permanent and total disability.
- Earned Income Tax Credit – EITC is available to disabled taxpayers as well as to the parents of a child with a disability. If you retired on disability, taxable benefits that were received under your employer’s disability retirement plan are considered earned income until a minimum retirement age is reached. The EITC is a tax credit that not only reduces a taxpayer’s tax liability but may also result in a refund. Many working individuals with a disability who have no qualifying children, but are older than 25 and younger than 65, may qualify for EITC. Additionally, if the taxpayer’s child is disabled, the age limitation for the EITC is waived. The EITC has no effect on certain public benefits. Any refund that is received because of the EITC will not be considered income when determining whether a taxpayer is eligible for benefit programs, such as Supplemental Security Income and Medicaid.
- Child or Dependent Care Credit – Taxpayers who pay someone to come to their home and care for their dependent or disabled spouse may be entitled to claim this credit. For children this credit is usually limited to the care expenses paid only until age 13, but there is no age limit if the child is unable to care for him- or herself.
- Special Medical Deductions – In addition to conventional medical deductions, the tax code provides special medical deductions related to disabled taxpayers and dependents. They include:
- Learning Disability – Tuition fees paid to a special school for a child who has severe learning disabilities caused by mental or physical impairments, including nervous system disorders can be included in medical expenses. A doctor must recommend that the child attend the school. Tutoring fees recommended by a doctor for the child’s tutoring by a teacher who is specially trained and qualified to work with children who have severe learning disabilities might also be included.
- Impairment-Related Expenses – Amounts paid for special equipment installed in the home, or for improvements, may be included in medical expenses, if their main purpose is medical care for the taxpayer, the spouse, or a dependent. The cost of permanent improvements that increase the value of the property may only be partly included as a medical expense.
- Drug Addiction – Amounts paid by a taxpayer to maintain a dependent in a therapeutic center for drug addicts, including the cost of the dependent’s meals and lodging, are included in medical expenses.
- Exclusion Of Qualified Medicaid Waiver Payments –Payments made to care providers caring for related individuals in the provider’s home are excluded from the care provider’s income. Qualified foster care payments are amounts paid under the foster care program of a state (or political subdivision of a state or a qualified foster care placement agency). For more information please call our office – you can find our contact information at the bottom of this page.
- ABLE Accounts – Qualified ABLE programs provide the means for individuals and families to contribute and save for the purpose of supporting individuals with disabilities in maintaining their health, independence, and quality of life.
Federal law enacted in 2014 authorizes the States to establish and operate an ABLE program. Under the ABLE program, an ABLE account may be set up for any eligible state resident, which would generally be the only person who could take distributions from the account. ABLE accounts are very similar in function to Sec 529 plans. However, they should not be considered as estate planning devices, as is sometimes the case with 529 plans; the main purpose of ABLE accounts is to shelter assets from means testing required by government benefit programs. Individuals can contribute to ABLE accounts subject to Gift Tax limitations. Distributions to the disabled individual are tax free if the funds are used for qualified expenses of the disabled individual. These accounts are new and must be established at the state level before taxpayers can start making contributions to them. Call the office for more information.
For more information on tax credits and benefits available to disabled taxpayers, please consult us at Dagley & Co.
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We’ve discussed this subject once before — and yes, we are harping on it because of the profound tax consequences — this is a reminder that, beginning this year, individuals are only allowed one IRA rollover in any 12-month period (this includes SEP and Simple accounts, traditional and Roth IRAs). Twelve months must have elapsed from the date a rollover is completed before another rollover can be made. Failure to abide by this rule can be expensive, and the rule applies no matter how many IRAs an individual owns.
Example – Joe makes an IRA rollover on March 1, 2015. He cannot roll over another IRA distribution, without penalties, until March 2, 2016.
If Joe, in the example, were to make another IRA rollover before March 2, 2016, that entire distribution would be treated as a taxable distribution and would also be subject to the 10% early distribution penalty if Joe is under the age of 59.5 at the time of the distribution. Additionally, if Joe deposited the distributed amount into another IRA, or redeposited the funds into the same IRA, those funds are treated as an excess contribution and are subject to a 6% penalty per year for as long as they remain in the IRA.
That doesn’t mean you can’t transfer funds between IRA trustees multiple times during the year. In a rollover, a taxpayer takes possession of the funds and then must redeposit them within 60 days to avoid being taxed on the distribution. In contrast, a transfer moves the funds directly from one trustee to another with the taxpayer never taking possession of the funds. Unlimited direct transfers are allowed, including moving traditional IRA funds to a Roth IRA (called a conversion).
If, through no fault of yours, a trustee does not follow your instructions to make a transfer and instead distributes the funds to you, procedures are available to obtain relief.
If you are planning an IRA rollover, before taking the distribution, please check with your IRA trustee or get in touch with us at Dagley & Co. to ensure you are not violating the 12-month rule.
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Have you heard of the “bunching” strategy for tax deductions? If your tax deductions normally fall short of itemizing your deductions, or even if you are able to itemize, but only marginally, you may benefit from using the “bunching” strategy.
The tax code allows most taxpayers to utilize the standard deduction or itemize their deductions if that provides a greater benefit. As a rule, most taxpayers just wait until tax time to add everything up and then use the higher of the standard deduction or their itemized deductions.
If you want to be more proactive, you can time the payments of tax-deductible items to maximize your itemized deductions in one year and take the standard deduction in the next.
For the most part, itemized deductions include medical expenses, property taxes, state and local income (or sales) taxes, home mortgage and investment interest, charitable deductions, unreimbursed job-related expenses, and casualty losses. The “bunching strategy” is more commonly associated with medical expenses, tax payments and charitable deductions, although there are circumstances in which the other deductions might come into play. There are many opportunities to bunch deductions, and the following are examples of the bunching strategies most commonly used:
- Medical Expenses – You contract with a dentist for your child’s braces. The dentist may offer you an up-front, lump sum payment or a payment plan. By making the lump sum payment, the entire cost is credited in the year paid, thereby dramatically increasing your medical expenses for that year. If you do not have the cash available for the up-front payment, then you can pay by credit card, which is treated as a lump-sum payment for tax purposes. If you use a credit card, you must realize that the credit card interest is not deductible, and you need to determine if incurring the interest is worth the increased tax deduction. Another important issue with medical deductions is that only the amount of the total medical expenses that exceeds 10% of your adjusted gross income (AGI) is actually deductible. If you are 65 or over the medical deduction floor is 7.5% through 2016, unless you are caught by the Alternative Minimum Tax (AMT). Then only the amount that exceeds 10% of your AGI is actually deductible. So, there is no tax benefit in bunching medical deductions unless the expenses exceed these limitations.
If the current year is an abnormally high-income year, you may, where possible, wish to put off making medical expense payments until the subsequent year when the 10% (7.5% threshold is less.
- Taxes – Property taxes on real estate are generally billed annually at mid-year, and most locales allow the tax bill to be paid in semi-annual or quarterly installments. Thus, you have the option of paying it all at once or paying in installments. This provides the opportunity to bunch the tax payments by paying one semi-annual installment or two quarterly installments and a full year’s tax liability in one year and only paying one semi-annual installment or two quarterly installments in the other year. In doing so, you are able to deduct 1-½ year’s taxes in one year and 50% of a year’s taxes in the other. If you are thinking of making the property tax payments late as a way to accomplish bunching, you should be cautious. The late payment penalty will probably wipe out any potential tax savings.
If you reside in a state that has state income tax, the state income tax paid or withheld during the year is deductible as a federal itemized deduction. So, for instance, if you are paying state estimated tax in quarterly installments, the fourth-quarter estimate is generally due in January of the subsequent year. This gives you the opportunity to either make that payment before December 31st, and be able to deduct the payment on the current year’s return, or pay it in January before the January due date and use it as a deduction in the subsequent year.
A word of caution about the itemized deduction for taxes! Taxes are only deductible for regular tax purposes. So, to the extent you are taxed by the AMT, you derive no benefits from the itemized deduction for taxes.
• Charitable Contributions – Charitable contributions are a nice fit for “bunching” because they are entirely payable at the taxpayer’s discretion. For example, if you normally tithe at your church, you could make your normal contributions during the year and then prepay the entire subsequent year’s tithing in a lump sum in December of the current year, thereby doubling up on the church contribution one year and having no charity deduction for church in the other year. Normally, charities are very active with their solicitations during the holiday season, giving you the opportunity to make the contributions at the end of the current year or simply wait a short time and make them after the end of the year. Be sure you get a receipt or acknowledgment letter from the organization that clearly shows in which year the contribution was made.
If you think a “bunching” strategy might benefit you, please call this office to discuss the issue and set up an appointment for some in-depth strategizing with Dagley & Co. You’ll find our information at the bottom of this webpage.
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People are living longer, which means many find themselves becoming the care provider for elderly parents, spouses and others who can no longer live independently. When this happens, questions always come up regarding the tax ramifications associated with the cost of nursing homes or in-home care.
Generally, the entire cost of nursing homes, homes for the aged, and assisted living facilities are deductible as a medical expense, if the primary reason for the individual being there is for medical care or the individual is incapable of self-care. This would include the entire cost of meals and lodging at the facility. On the other hand, if the individual is in the facility primarily for personal reasons, then only the expenses directly related to medical care would be deductible and the meals and lodging would not be a deductible medical expense.
As an alternative to nursing homes, many elderly individuals or their care providers are hiring day help or live-in employees to provide the needed care at home. When this is the case, the services provided by the employees must be allocated between household chores and deductible nursing services. To be deductible, the nursing services need not be provided by a nurse so long as the services are the same services that would normally be provided by a nurse, such as administering medication, bathing, feeding, dressing, etc. If the employee also provides general housekeeping services, then the portion of the employee’s pay attributable to household chores would not be a deductible medical expense.
Household employees, like other employees, are subject to Social Security and Medicare taxes, and it is the responsibility of the employer to withhold the employee’s share of these taxes and to pay the employer’s payroll taxes. Special rules for household employees greatly simplify these payroll withholding and reporting requirements and allow the federal payroll taxes to be paid annually in conjunction with the employer’s individual 1040 tax return. Federal income tax withholding is not required unless both the employer and the household employee agree to withhold income tax. However, the employer is still required to issue a W-2 to the employee and file the form with the federal government. A federal employer ID number (FEIN) and a state ID number must be obtained for reporting purposes. Most states have special provisions for reporting and paying state payroll taxes on an annual basis that are similar to the federal reporting requirements.
The employer’s portion of the employment taxes (Social Security, Medicare, and federal and state unemployment taxes) that relate to the employer’s deductible medical expenses are also allowed as a medical expense.
If you need assistance in setting up a household payroll, please contact Dagley & Co. for additional details and filing requirements.
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