Planning a new business start-up? Incurring some expenses? You probably anticipate deducting those expenses in the first year of the business’s operation. Unfortunately it is a little more complicated than that. At the beginning of a new business, expenses can include equipment purchases, vehicle purchases and use, leasehold improvements, organizational costs and start-up expenses, and each receives a different tax treatment.
- Equipment – The equipment you buy can’t be deducted until it is placed in service. For that reason, you can’t make any equipment deductions until the business is actually functioning. However, deductions for most equipment purchases are very liberal. For most small businesses, this means the entire cost of equipment and office furnishings can generally be written off in the year of purchase, if that is also the year when the equipment is put into service, using the Sec 179 expensing election. However, the deductible amount is limited to taxable income from all the taxpayer’s active trades or businesses (including a spouse’s active trades or businesses if married and filing jointly). Income from trades also includes W-2 income.
Sometimes it may not be appropriate to write off the entire cost in the first year, in which case the equipment can be depreciated over its useful life (according to recovery periods established by the IRS). Most office furniture, fixtures and equipment are assigned a 7 year recovery period, but the depreciable period for computers is 5 years. The recovery period of equipment may vary depending on the type of business activity. There is also a 50% bonus depreciation election for the first year the equipment is placed in service.
- Vehicles – Automobiles and small trucks that are purchased for use by the business are treated like equipment, as above, except their recovery period is 5 years and they are subject to the so-called luxury auto rules. These rules limit the depreciation to a maximum of $3,160 ($3,560 for light trucks and vans) for the first year. If bonus depreciation is elected, add $8,000 to the first-year maximum.
- Leasehold Improvements – Generally, leasehold improvements are depreciated over 15 years. But through 2019, bonus depreciation may be elected, allowing between 30% and 50% of the cost of interior qualified improvements to non-residential property after the building is placed in service to be deducted in the first year. In addition, the Sec 179 expense deduction is allowed for qualified leasehold property, qualified restaurant property and qualified retail improvements.
- Start-Up Costs – Taxpayers can elect to deduct up to $5,000 of start-up costs in the first year of a business. However, the $5,000 amount is reduced by the amount of the start-up costs in excess of $50,000. If the election is made, the start-up costs over and above the first-year deductible amount are amortized over 15 years. If the election is not made, the start-up costs must be capitalized, meaning the expenses can only be recovered upon the termination or disposition of the business. Start-up costs include:
- Surveys/analyses of potential markets, labor supply, products, transportation, facilities, ;
- Wages paid to employees, and their instructors, while they are being trained;
- Advertisements related to opening the business;
- Fees and salaries paid to consultants or others for professional services; and
- Travel and related costs to secure prospective customers, distributors and suppliers.
- Organizational Expenses – If the new business involves a partnership or corporation, the business can elect to deduct up to $5,000 of organization expenses in the first year of a business. This is in addition to the election for start-up expenses. Like start-up expenses, the $5,000 amount is reduced by the amount of the start-up costs in excess of $50,000. If the election is made, the start-up costs over and above the first-year deductible amount are amortized over 15 years. If the election is not made, the start-up costs must be capitalized. Organizational expenses include outlays for legal services, incorporation fees, temporary directors’ fees and organizational meeting costs, etc.
Major decisions need to be made that can have a lasting impact on the new business. We encourage you to consult with our office for additional details and assistance in preparing a tax plan for your new business. Give us a call a 202-417-6640.
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Summer is unfortunately coming to an end, and with that means back to school for many young adults. What this also means is time for their parents or family members to dig into their pockets to help pay for that schooling.
Paying for education can be financially challenging for many families. However, tuition and related expenses paid for higher education can qualify for one of two tax credits, which will lower the income tax burden for the individual who claims the exemption for the student. For example, if the student were claimed as a dependent on the parents’ return, the parents would claim the credit, but if the student filed independently, he or she would get the credit. This is true regardless of who actually pays the tuition and related expenses.
American Opportunity Tax Credit (AOTC) – The AOTC provides a credit of up to $2,500 per year per eligible student. Generally, tax credits are non-refundable, meaning they can only be used to offset any tax liability the taxpayer may have for the year. However, up to 40% of the AOTC is refundable, even when the taxpayer has no tax liability. Thus, it can result in a refund of as much as $1,000 (40% of $2,500).
The credit is for 100% of the first $2,000 of tuition and related expenses and 25% of the next $2,000 of qualifying expenses. However, the AOTC is only allowed for four years of post-secondary education. It is also determined on a per student basis and phases out for higher-income taxpayers. The student must be enrolled at least half-time in a program leading to a degree, certificate, or other recognized educational credential for at least one academic period beginning in the tax year of the credit.
Lifetime Learning Credit (LLC) ‒ The LLC is a non-refundable credit worth up to $2,000 per year, and there is no limit on the number of years that the LLC can be claimed. Unlike the AOTC, there is no “half-time student” requirement, and single courses can qualify. The credit is 20% of the cost of tuition and related expenses. However, while the AOTC is determined on a per student basis, the LLC is based upon the tax family’s qualified education expenses for the year. Where a student qualifies for the more beneficial AOTC, that student’s expenses cannot be used for the LLC.
There are additional requirements that apply to both credits:
- Qualified expenses ‒ Qualified expenses include the costs you pay for tuition, fees, and other related expenses for an eligible student to enroll at or attend an eligible educational institution.
- Eligible educational institutions ‒ Eligible institutions generally include any accredited public, nonprofit, or proprietary post-secondary institution eligible to participate in the student aid programs administered by the Department of Education. This includes most colleges and universities. Vocational schools or other post-secondary schools may also qualify. If you aren’t sure if the student’s school is eligible, ask the school if it is an eligible educational institution.
- Form 1098-T ‒ In most cases, you (or the student) should receive Form 1098-T, Tuition Statement, from the school reporting the qualifying expenses to the IRS and to you. The amount shown on the form may be either (1) the amount you paid to the school for qualifying tuition and related expenses, or (2) the amount billed by the school for qualifying tuition and related expenses. Therefore, the amount shown on the form may be different from the amount eligible for the credit. Don’t forget that you can only claim an education credit for the qualifying tuition and related expenses that you paid in the tax year and not just the amount the school billed. There is a provision that allows the tuition for the first three months of the next year to be prepaid and deducted on the tax return for the year of payment. However, prepaid tuition cannot be deducted in the subsequent year.
There are other education tax benefits available as well, such as the education loan interest deduction and savings bond interest exclusion. If you are reading this article so you can plan for the future, there are also tax-advantage education savings plans available – the Coverdell and Sec 529 plans.
Interested in how the education credits or other tax benefits might apply to you? Give Dagley & Co., CPA a call at (202) 417-6640.
In addition to winning an Olympic medal, winners are compensated by the U.S. Olympic Committee with prize money: $25,000 for a gold medal, $15,000 for a silver medal and $10,000 for a bronze medal.
Also, did you know, the gold medals are not solid gold? In fact, they have not been solid gold since the Stockholm Olympic Games in 1912. This year’s gold medals are 92.5% silver with 24k gold plating. The 2016 Summer Olympics medals are worth roughly $587 in precious metals; however, they can bring many times that in an auction.
According to Sen. Charles Schumer, D-NY, both the prize money and the value of the medals are taxable income to our athletes. Schumer and Sen. John Thune, R-SD, have sponsored legislation exempting the value of medals and prizes awarded to Olympic and Paralympic athletes. The Senate has already passed the bill, but it has not been taken up by the House yet.
Gone (for 30 years now) are the days of Olympic participants being amateurs only. Some oppose exempting U.S. Olympians from being taxed on their awards for a couple of reasons: (1) recipients of other prizes, such as the Oscar swag bags, are required to pay tax on the value of their prizes, so why should Olympic athletes be treated differently? and (2) professional athletes who participate in sports as a business (NBA players, PGA golfers, etc.) can deduct their training and travel expenses as business expenses, and those who participate as a hobby may also be allowed some limited deductions. So is it necessary to exempt the Olympians’ winnings?
Congress is currently in summer recess. We will have to wait for the results post-games, considering they will not reconvene until after the games are completed. Exempt or not, we are eager to learn more.
Dagley & Co. is a firm based in Washington, D.C., specializing in the unique accounting needs of small and medium-sized companies all over the globe. We assist business owners with accounting, reporting, payroll, tax services, financial consulting and more. Give us a call at (202) 417-6640 or send us an email at email@example.com if you are interested in learning more about what we can offer you.
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Is your partnership treating you and other partners as employees in order to participate in employee benefit plans? If so, you better read this. Temporary tax regulations(1), which was recently issued by the IRS, take aim at this practice and were written to put a stop to it.
Background: A disregarded entity is treated as a corporation(2) for the purposes of employment taxes. Therefore, the disregarded entity, rather than the owner, is considered to be the employer of the entity’s employees for the purposes of employment taxes. However, the owner is not treated as an employee and instead pays self-employment tax on the net earnings from self-employment resulting from the disregarded entity’s activities.
The current regulations do not include an example where the disregarded entity is owned by a partnership, and because of that some taxpayers have interpreted the regulations in a way unintended by the IRS. Under this incorrect interpretation of the regulations, some partnerships have permitted partners to participate in certain tax-favored employee benefit plans, which is contrary to the IRS’s intention.
The IRS and the Treasury have noted that regulations did not create a distinction between a disregarded entity owned by an individual (a sole proprietorship) and a disregarded entity owned by a partnership in the application of the self-employment tax rule. In addition, the IRS does not believe that the regulations alter the long- standing holding(3) that:
- A bona fide member of a partnership is not an employee of the partnership, and
- A partner who devotes time and energy to conducting the partnership’s trade or business, or who provides services to the partnership as an independent contractor, is considered self-employed and is not an employee.
To resolve this issue, the IRS has issued temporary regulations modifying the original regulations to clarify the rule that an entity disregarded for self-employment tax purposes applies to partners in the same way that it applies to a sole proprietor owner. Accordingly, the partners are subject to the same self-employment tax rules as partners in a partnership that does not own a disregarded entity.
The IRS is allowing any plan sponsored by an entity that is disregarded as an entity separate from its owner to apply the revisions on Aug. 1, 2016, or the first day of the latest-starting plan year following May 4, 2016, whichever is later.
If you are finding issues like this in your office, please give Dagley & Co. a call at (202) 417-6640.
(1) Reg. Sec. 301.7701-2T
(2) Reg. Sec. 301.7701-2(c)(2)(iv)(B)
(3) Rev. Rul. 69-184
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Many people are using rental agents or online rental services, such as Airbnb, VRBO and HomeAway, that match property owners with prospective renters. If you are one of these people who rents, then some special tax rules may apply to you.
These special (and sometimes complex) taxation rules can make the rents that you charge tax-free. However, other situations may force your rental income and expenses to be treated as a business reported on a Schedule C, as opposed to a rental activity reported on Schedule E.
The following is a synopsis of the rules governing short-term rentals.
Rented for Fewer than 15 Days During the Year – When a property is rented for fewer than 15 days during the tax year, the rental income is not reportable, and the expenses associated with that rental are not deductible. Interest and property taxes are not prorated, and the full amounts of the qualified mortgage interest and property taxes are reported as itemized deductions (as usual) on the taxpayer’s Schedule A.
The 7-Day and 30-Day Rules – Rentals are generally passive activities. However, an activity is not treated as a rental if either of these statements applies:
A. The average customer use of the property is for 7 days or fewer – or for 30 days or fewer if the owner (or someone on the owner’s behalf) provides significant personal services.
B. The owner (or someone on the owner’s behalf) provides extraordinary personal services without regard to the property’s average period of customer use.
If the activity is not treated as a rental, then it will be treated as a trade or business, and the income and expenses, including prorated interest and taxes, will be reported on Schedule C. IRS Publication 527 states: “If you provide substantial services that are primarily for your tenant’s convenience, such as regular cleaning, changing linen, or maid service, you report your rental income and expenses on Schedule C.” Substantial services do not include the furnishing of heat and light, the cleaning of public areas, the collecting of trash, and such.
Exception to the 30-Day Rule – If the personal services provided are similar to those that generally are provided in connection with long-term rentals of high-grade commercial or residential real property (such as public area cleaning and trash collection), and if the rental also includes maid and linen services that cost less than 10% of the rental fee, then the personal services are neither significant nor extraordinary for the purposes of the 30-day rule.
Profits & Losses on Schedule C – Profit from a rental activity is not subject to self-employment tax, but a profitable rental activity that is reported as a business on Schedule C is subject to this tax. A loss from this type of activity is still treated as a passive-activity loss unless the taxpayer meets the material participation test – generally, providing 500 or more hours of personal services during the year or qualifying as a real estate professional. Losses from passive activities are deductible only up to the passive income amount, but unused losses can be carried forward to future years. A special allowance for real estate rental activities with active participation permits a loss against non passive income of up to $25,000 – phasing out when modified adjusted gross income is between $100K and $150K. However, this allowance does NOT apply when the activity is reported on Schedule C.
These rules can be complicated; please call or email Dagley & Co., CPA at (202) 417-6640 or firstname.lastname@example.org. We can determine how they apply to your circumstances and what you can do to minimize tax liability and maximize tax benefits from your rentals.
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Ever noticed an amount on line 45 of your tax return? If so, it this is because you are subject to the alternative minimum tax, also known as AMT. The AMT is a generally punitive method of computing income tax that does not allow some of the tax preferences and deductions that regular tax computation allows. When an AMT computation results in a higher tax, the higher tax applies, and the additional tax from the AMT is added on line 45 of your return.
The AMT was originally designed (nearly 50 years ago) to impose a minimum tax on higher-income taxpayers who were avoiding taxes by claiming certain (legal) deductions or other tax benefits (also termed “preferences”). However, years of inflation have caused an increasing number of taxpayers to be subject to the AMT.
It is complicated to determine when an individual will be subject to the AMT, for many tax preferences can trigger the AMT, alone or in combination. The following are some of the items that frequently trigger the AMT for the average taxpayer:
- Medical Deductions – Deductions for medical expenses are allowed for the AMT computation – but only to the extent that they exceed 10% of the taxpayer’s income. Although the limit is also 10% for regular tax purposes, through 2016, taxpayers age 65 and over enjoy a lower limit of 7.5%, which leads to an AMT adjustment. Sometimes, it is possible to defer or accelerate medical expenses from one year to another (for example, by paying an orthodontist in installments or all at once). If your employer offers a flexible spending plan, consider participating, as such plans allow you to pay medical expenses with pretax dollars while avoiding both regular and AMT deduction limitations.
- Deduction for Taxes Paid – When itemizing deductions, a taxpayer is allowed to deduct a variety of other taxes, such as real or personal property taxes and state income or sales taxes. However, for AMT purposes, none of these itemized taxes is deductible. For most taxpayers, this represents one of the largest tax deductions, and it frequently triggers the AMT. If you are affected by the AMT, conventional wisdom dictates deferring tax payments to a subsequent year when the AMT may not apply. When deferring, care should be exercised regarding late-payment penalties and interest on underpayments. In addition, taxpayers can annually elect to capitalize their taxes on unimproved and unproductive real estate. This means foregoing the deduction and adding the tax paid to the cost basis of the real property.
- Home Mortgage Interest – For both regular tax and AMT computations, interest paid on a debt to acquire or substantially improve a first or second home is deductible as long as it does not exceed the debt limit (generally $1 million). This is also true of refinanced debt, except that any increase in debt is treated as equity debt. For regular tax purposes, the interest on up to $100,000 of equity debt on the first two homes can also be deducted. However, equity debt is not deductible when computing the AMT; neither is acquisition or equity debt on a motor home or boat that may qualify as a second home. Therefore, taxpayers should exercise caution when incurring home equity debt. Generally, loan brokers are not aware of these limitations, and there are numerous pitfalls.
- Miscellaneous Itemized Deductions – Among miscellaneous deductions, the category that includes employee business and investment expenses is not deductible for AMT purposes. For certain taxpayers with deductible employee business expenses, this will often trigger the AMT. Employees with significant employee business expenses should attempt to negotiate an “accountable” reimbursement plan with their employers. Under this type of plan, reimbursement for qualified expenses is tax-free. An employee who has been reimbursed no longer claims a deduction for those expenses, thus eliminating the miscellaneous deduction. Another strategy would be to defer the expenses to a year that is not affected by the AMT.
- Personal Exemptions – The AMT computation does not allow a deduction for personal exemptions, which in 2016 is $4,050 each for the taxpayer, his or her spouse (if any) and any dependents. Divorced or separated parents should carefully consider which party should claim the exemption for their children if one of the parents is subject to the AMT.
- Standard Deduction – For regular tax purposes, taxpayers have the option of itemizing their deductions or taking the standard deduction. However, for AMT purposes, there is no standard deduction. Thus, a taxpayer who ends up with an AMT when taking the standard deduction should try to force itemized deductions, even if the result is less than the standard deduction. The result will be an increased regular tax but a reduced AMT, which could result in overall tax savings. Even the smallest of deductions will benefit those who are taxed at a minimum of 26% (the lowest bracket for the AMT).
- Incentive Stock Options – Although not frequently encountered, incentive stock options (ISOs) can have a profound impact on a taxpayer’s AMT. Generally, to achieve the beneficial long-term capital gains rates on stock acquired through an ISO, a taxpayer must hold the stock for more than one year after exercising the stock option and two years after the option is granted. However, the difference between the fair market value and the option price must be added to the taxpayer’s AMT income in the year the option is exercised. To avoid this substantial AMT preference income, the taxpayer can sell the stock in the year that the option is exercised and forego long-term capital gains rates. Alternatively, when doing so is beneficial, the taxpayer can exercise the option in small blocks over a period of years.
- Business Incentives – Taxpayers’ investments in businesses and partnerships sometimes provide tax incentives that the AMT does not allow. There is a long list of these incentives, but the most common are depletion allowances and intangible drill costs. Generally, these items appear on a Schedule K-1 (which the business activity issues to the investor) and are then included in the taxpayer’s AMT calculation.
AMT is a very complicated area of the tax law. You must be very careful while planning to minimize the effects of AMT as much as possible.
Dagley & Co., CPA is here to assist you with this planning. Please contact our office at (202) 417-6640 or send us an email at email@example.com.
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Employment legal actions in monetary settlements and damage awards have complex and sometimes discriminatory tax laws. The actual taxation of the award is primarily based on the following factors: the nature of the legal action, whether a settlement occurred before trial, and how the legal costs were handled.
Nature of the Legal Action – Generally, all monetary awards as the result of an employment-related legal action are fully taxable, with one exception. Under the exception, the tax code allows an exclusion from gross income for damages received due to a personal physical injury or a physical sickness. Consequently, when a lawsuit is based on a physical injury or sickness, all damages (other than punitive damages, which are always taxable) flowing from that suit are treated as payments received due to a physical injury or sickness, and are therefore excluded from income. This is true whether or not the recipient of the damages is the injured party.
Here are some commonly encountered situations and their taxability: Wrongful Death – Wrongful death is considered physical injury or physical sickness for purposes of the income exclusion. In addition, punitive damages are excludable where state law provides that only punitive damages can be awarded in wrongful death suits. Emotional Distress – Emotional distress isn’t considered physical injury or physical sickness for purposes of the income exclusion. However, the exclusion from gross income does apply to the amount of damages received for emotional distress that is attributable to a physical injury, but not in excess of the amount paid for medical care related to emotional distress. Previously Deducted Medical Expenses – Even though awards for physical injury or physical sickness are excludable, if any part of the award received is compensation for medical expenses deducted in a prior year, that portion of the award must be included as income, up to the amount of the deduction taken. Employment Discrimination – No exclusion is allowed for damages received in a suit involving employment discrimination or an injury to reputation that is accompanied by a claim of emotional distress. However, the exclusion would apply to a claim of emotional distress related to a physical injury or physical sickness. Age Discrimination - The law doesn’t consider back pay or liquidated damages received under the Age Discrimination in Employment Act (ADEA) to be compensation for personal injuries; therefore, these payments are includable in income. But see the special treatment of attorney fees below. Punitive Damages – Punitive damages are made as a punishment for unlawful conduct and are always taxable; they cannot be excluded from income as damages received due to personal physical injury or physical sickness, except as noted above for wrongful death. Unpaid or Disputed Employment Earnings – Back pay, severance pay, overtime pay, etc., are all treated as W-2 type income and are both taxable and subject to payroll FICA withholding. Interest – Interest that may be included in an award, even one for personal injury or sickness, is not excludable and must be included in gross income.
Settlements – In legal actions, the plaintiff may frequently sue for both excludable and non-excludable damages. For example, an employee is injured on the job and sues for back vacation pay of $10,000 and damages for personal injury in the amount of $90,000 (a total of $100,000). If the suit is settled for $50,000 without a stipulation of how the settlement is applied, the settlement will need to be allocated in the same manner as the original suit. In this example, the settlement would be allocated $5,000 for back vacation pay (taxable) and $45,000 for personal injury (excludable).
Legal Costs – Generally, legal costs associated with employment-related legal actions can only be deducted as a miscellaneous itemized deduction on the employee’s Schedule A itemized deductions. When all or some of the monetary award is excludable, the fees are prorated between the taxable and excludable award, and only the portion allocated to the taxable portion is deductible.
This is where significant tax problems are encountered because miscellaneous itemized deductions must be reduced by 2% of the employee-taxpayer’s adjusted gross income (AGI), and the gross monetary award received is included in the employee’s AGI, making it abnormally high. On top of that, miscellaneous itemized deductions are not even allowed for purposes of the alternative minimum tax (AMT), which is very frequently triggered in situations of this nature. This would result in the taxpayer having to include the entire monetary award in income and not being able to deduct much, if any, of the legal costs. The taxpayer, in effect, is paying taxes on just about the entire, or in some cases the total, amount, including what the attorney got.
There is a very limited exception that allows attorney fees to be deducted above-the-line (without itemizing), thus eliminating the 2% reduction and the AMT issues. However, it only applies in connection with a claim of unlawful discrimination, certain claims against the federal government, or a private cause of action under the Medicare Secondary Payer statute.
So, before you rush out and spend any of the award money you received, you had better drop by the office and see what the government’s share is, because it could be substantial. In addition, with some careful analysis, it may be possible to take actions that will reduce the tax.
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Considering a new car? If you are considering purchasing a new car or light truck (less than 14,000 pounds), maybe you should consider one of the many electric vehicles currently being offered for sale and take advantage of a federal income tax credit worth as much as $7,500.
The tax credit is actually made up of two parts: the basic amount of $2,500, which requires the electric vehicle to have a battery with at least 5 kilowatt-hours of capacity, and an additional $417 of credit for each kilowatt-hour of battery capacity in excess of 5 kilowatt-hours. The total amount of the credit allowed for any qualified vehicle is limited to $7,500.
However, the credit begins to be phased out for a particular manufacturer’s vehicles when at least 200,000 qualifying vehicles have been sold for use in the United States.
If you are not an electrical engineer, it may seem a little complicated to figure out which vehicles qualify for the credit and for how much. You can usually rely on the information provided by the dealer. However, to be on the safe side, you can verify which vehicles are qualified and the credit amount available, based on the vehicle’s kilowatt-hours and the reduction in credit due to the credit phase-out, by visiting the IRS website From the list on the linked page, click on the manufacturer of the vehicle you are interested in to find out if the model and year of that vehicle qualify for the credit and the amount of the credit.
To be eligible for the credit, you must acquire the vehicle for use or lease and not for resale. Additionally, the original use of the vehicle must commence with you, and you must use the vehicle predominantly in the United States. The vehicle is not considered acquired prior to the time when its title passes to you under your state’s law. The credit is available whether you use the vehicle for business, personally or a combination of both. The prorated portion of the credit that applies to business use becomes part of the general business credit, and any amount not used on your return for the year when you purchase the vehicle can be carried back to the previous year and then carried forward until used up, but for no more than 20 years.
What a Dealer May Not Tell You – The portion of the credit that is not treated as a general business credit (i.e., the personal use portion of the credit) is non-refundable. That means it can only be used to offset your tax liability for the year when you purchase the vehicle, and any excess credit is lost. Assuming you purchase the vehicle in 2016 and your 2016 tax return will be similar to your 2015 return, you can get an idea of how the credit will apply to you by comparing the amount on line 47 of your 2015 Form 1040 to the credit the vehicle provides. If line 47 is greater than the credit, then you will probably benefit from the entire amount of the credit on your 2016 return. If it is less, then you will only benefit from the amount on line 47 as it will be figured for your 2016 return.
If your 2016 tax return will be significantly different from your 2015 return, or you simply want to verify your benefit from the credit, please give Dagley & Co. a call.
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