Before you start tapping into your retirement savings, you may want to read this first:
If you are under age 59½ and plan to withdraw money from a qualified retirement account, you will likely pay both income tax and a 10% early-distribution tax on any previously un-taxed money that you take out. Withdrawals you make from a SIMPLE IRA before age 59½ and those you make during the 2-year rollover restriction period after establishing the SIMPLE IRA may be subject to a 25% additional early-distribution tax instead of the normal 10%. The 2-year period is measured from the first day that contributions are deposited. These penalties are just what you’d pay on your federal return; your state may also charge an early-withdrawal penalty in addition to the regular state income tax.
The following exceptions may help you avoid the penalty:
- Withdrawals from any retirement plan to pay medical expenses—Amounts withdrawn to pay unreimbursed medical expenses are exempt from penalty if they would be deductible on Schedule A during the year and if they exceed 10% of your adjusted gross income. This is true even if you do not
- IRA withdrawals annuitized over your lifetime—To qualify, the withdrawals must continue unchanged for a minimum of 5 years, including after you reach age 59½.
- Employer retirement plan withdrawals—To qualify, you must be separated from service and be age 55 or older in that year (the lower limit is age 50 for qualified public-service employees such as police officers and firefighters) or elect to receive the money in substantially equal periodic payments after your separation from service.
- Withdrawals from any retirement plan as a result of a disability—You are considered disabled if you can furnish proof that you cannot perform any substantial gainful activities because of a physical or mental condition. A physician must certify your condition.
- IRA withdrawals by unemployed individuals to pay medical insurance premiums—The amount that is exempt from penalty cannot be more than the amount you paid during the year for medical insurance for yourself, your spouse, and your dependents. You also must have received unemployment compensation for at least 12 weeks during the year.
- IRA withdrawals to pay higher education expenses—Withdrawals made during the year for qualified higher education expenses for yourself, your spouse, or your children or grandchildren are exempt from the early-withdrawal penalty.
- IRA withdrawals to buy, build, or rebuild a first home—Generally, you are considered a first-time homebuyer for this exception if you had no present interest in a main home during the 2-year period leading up to the date the home was acquired, and the distribution must be used to buy, build, or rebuild that home. If you are married, your spouse must also meet this no-ownership requirement. This exception applies only to the first $10,000 of withdrawals used for this purpose. If married, you and your spouse can each withdraw up to $10,000 penalty-free from your respective IRA accounts.
You should be aware that the information provided above is an overview of the penalty exceptions and that conditions other than those listed above may need to be met before qualifying for a particular exception. You are encouraged to contact this office before tapping your retirement funds for uses other than retirement. Distributions are most often subject to both normal taxes and other penalties, which can take a significant bite out of the distribution. However, with carefully planned distributions, both the taxes and the penalties can be minimized. Please call Dagley & Co. for assistance.
Planning to adopt a child or children? Or, are you already an adoptive parent? If so, we have good news for you! You may be able to qualify for an income-tax credit. This credit will be based on the amount of expenses you have incurred during the adoption period, which are directly related to the adoption of the following: 1. A child under the age of 18, or 2. a person who is physically or mentally incapable of self-care.
This is a 1:1 credit for each dollar of qualified expenses up to a maximum for the year, which is $13,570 for 2017 (up from $13,460 in 2016). The credit is nonrefundable, which means it can only reduce tax liability to zero (as opposed to potentially resulting in a cash refund). But the good news is that any unused credit can be used for up to five years to reduce future tax liability.
Qualified expenses generally include adoption fees, court costs, attorney fees and travel expenses that are reasonable, necessary and directly related to the adoption of the child, and may be for both domestic and foreign adoptions; however, expenses related to adopting a spouse’s child are not eligible for this credit. When adopting a child with special needs, the full credit is allowed whether or not any qualified expenses were incurred. A child with special needs is, among other requirements, a child who the state has determined (a) cannot or should not be returned to his or her parents’ home and (b) that the child won’t be adopted unless assistance is provided to the adoptive parents.
The credit is phased out for higher-income taxpayers. For 2017, the AGI (computed without foreign-income exclusions) phase-out threshold is $203,540, and at the AGI of $243,540, the credit is completely phased out. Unlike most phase-outs, this one is the same regardless of filing status. However, the credit cannot be claimed by taxpayers using the filing status married filing separately.
If your employer has an adoption-assistance program, up to $13,570 of reimbursements by the employer are excludable from income. Both the tax credit and the exclusion may be claimed, though not for the same expenses.
If you think you qualify for this credit or are planning an adoption in the future, please contact Dagley & Co. for further credit details and to find out how this credit can apply to your particular circumstances.
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Are you a single parent? If so, we all know that working and raising a family can become extremley difficult on your own. For your benefit, Dagley & Co. has found a number of tax benefits/issues that you should be aware of. Please carefully read and understand the following:
Filing Status – Just because you are single or widowed does not mean you have to file your tax returns using the single filing status. Tax law provides two far more beneficial filing statuses that you might qualify for. These statuses provide higher standard deductions and more beneficial tax rates:
Head of Household – If you are unmarried and pay more than half the cost of maintaining a household that is the principal place of abode for your qualified child or children for more than one-half of the year, then you qualify for the head of household status. Qualified children generally include your children, grandchildren, foster children or stepchildren under the age of 19 or a full-time student under the age of 24 who is not self-supporting. This is true even if you allow the other parent to deduct the dependency exemption for the child.
Qualified Widow – If you are widowed, you may qualify for the head of household status discussed just above. However, if your spouse passed away in one of the two prior years, you have a child or stepchild (not including a foster child or grandchild) whom you can claim as a dependent and who lived with you the whole year, and you paid more than half the cost of keeping up the home, you can use the higher standard deduction for married individuals filing jointly. In comparison, in 2016, the standard deduction for marrieds filing jointly is $12,600, which is twice the amount for a single individual.
Child Support – Any child support you receive from the non-custodial parent is tax-free to you. Child support is also not included in household income for the purposes of determining the premium tax credit if you are otherwise qualified and obtain your health insurance through a government marketplace.
Alimony – In most cases alimony payments received from your former spouse must be included in your income and are subject to tax. However, you can treat the alimony as earned income for purposes of making an IRA contribution of as much as $5,500 ($6,500 for those age 50 and over).
Exemptions – You are entitled to an exemption allowance of $4,050 for yourself and each of your children and others whom you claim as dependents on your tax return. Generally, the custodial parent will be the one eligible to claim a child’s exemption allowance. The value of the exemptions you claim is subtracted from your gross income when you are figuring out the amount of your taxable income. For example, if you are in the 25% tax bracket, each exemption allowance you deduct saves you $1,013 of tax. However, if you allow the non-custodial parent to claim the exemption of a qualified child, then you forego the $4,050 exemption allowance for that child.
Releasing the exemption of a child to the noncustodial parent must be done in writing and to IRS’s specifications as to required information. The noncustodial parent must then attach the written form to his or her return. The release can be for one year, for specified years or for all future years. If the exemption for the child is released, then the noncustodial parent will be able to claim the child tax credit (discussed below). Note: If a child is older and attending college, keep in mind when relinquishing the child’s exemption that the partially refundable tuition credit goes to the one who claims the child.
Child Care Credit – If your child or children are under age 13, and you are working or attending school, you may qualify for the non-refundable child and dependent care credit, which is based upon the amount of your earnings from working (or imputed income if attending school) and the amount of child care expenses, up to $3,000 for one child and $6,000 for two or more children. The credit can be as much as $1,050 for one child and $2,100 for two.
Child Tax Credit – You are also entitled to a non-refundable tax credit of $1,000 for each child under the age of 17 that you claim as a dependent. However, this credit begins to phase out for those filing as head of household with incomes in excess of $75,000. Some taxpayers with lower income may qualify for some portion of this credit to be refundable.
Earned Income Tax Credit (EITC) – If you are working, you may also qualify for the EITC. This refundable credit is available to lower-income taxpayers and is based on your income and the number of children you have, up to three. The maximum credits for 2016 are $506 with no children, $3,373 with one, $5,572 with two, and $6,269 with three or more. The credit is totally phased out at incomes of $14,880 with no children, $39,296 with one, $44,648 with two, and $47,955 with three or more.
As you can see, there are a number of tax benefits that apply to single parents. As always, please contact Dagley & Co. with any questions or issues. If you are a custodial parent, before releasing your child’s exemption to the noncustodial parent, you may wish to contact Dagley & Co. so the tax impact on your return(s) can be determined.
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…And just like that it’s the first week of December! Year-end is quickly approaching, and so is the busy holiday season. Dagley & Co. has complied and easy-to-understand list of business due dates for you and your company. We reccomend adding them to you calendars ASAP. Contat us with any questions!
December 1 – Employers
During December, ask employees whose withholding allowances will be different in 2017 to fill out a new Form W4 or Form W4(SP).
December 15 – Social Security, Medicare and Withheld Income Tax
If the monthly deposit rule applies, deposit the tax for payments in November.
December 15 – Non-Payroll Withholding
If the monthly deposit rule applies, deposit the tax for payments in November.
December 15 – Corporations
The fourth installment of estimated tax for 2016 calendar year corporations is due.
December 31 – Last Day to Set Up a Keogh Account for 2016
If you are self-employed, December 31 is the last day to set up a Keogh Retirement Account if you plan to make a 2016 Contribution. If the institution where you plan to set up the account will not be open for business on the 31st, you will need to establish the plan before the 31st. Note: there are other options such as SEP plans that can be set up after the close of the year. Please call the office to discuss your options.
December 31 – Caution! Last Day of the Year
If the actions you wish to take cannot be completed on the 31st or a single day, you should consider taking action earlier than December 31st.Image via public domain
Hobbies and Income Tax
Millions of U.S. taxpayers engage in hobbies such as collecting coins or stamps, refurbishing old cars, crafting, painting or breeding horses.
Some hobbies will actually generate income, or even evolve into businesses. The tax treatment of hobbies with income is quite different than that of a trade or business, and making the distinction can be rather complicated. The main issue here is that the IRS does not want taxpayers to write off hobby expenses under the guise of trade or businesses expenses.
The first question to ask yourself is whether the activity is a hobby, trade or business. The tax law doesn’t really provide a bright-line definition of the term “trade or business,” probably because no single definition will apply in all cases. But certainly, to be considered a trade or business, an activity must be motivated by the taxpayer’s profit motive, even if that motivation is unrealistic. Along with a profit motive, the taxpayer must carry on some kind of economic activity.
Factors to determine profit motive – The IRS uses a series of factors to determine whether an activity is for profit. No one factor is decisive, but all of them must be considered together in making the determination.
- Is the activity carried out in a businesslike manner?
- How much time and effort does the taxpayer spend on the activity?
- Does the taxpayer depend on the activity as a source of income?
- Are losses from the activity the result of sources beyond the taxpayer’s control?
- Has the taxpayer changed business methods in attempts to improve profitability?
- What is the taxpayer’s expertise in the field?
- What success has the taxpayer had in similar operations?
- What is the possibility of profit?
- Will there be a possibility of profit from asset appreciation?
Presumption of profit motive – There is a presumption that a taxpayer has a profit motive if an activity shows a profit for any three or more years during a period of five consecutive years. However, if the activity involves breeding, training, showing or racing horses, the period is two out of seven consecutive years. An activity that is reported on a tax return as a business but has had year after year of losses and no gains is likely to eventually come under scrutiny by the IRS.
Tax Treatment of Hobbies – While trades or businesses can have losses without restriction, if the activity is deemed to be a hobby, then special rules – frequently referred to as “hobby loss” rules – apply. Under these rules, any income from the hobby is reported on the face of the tax return, and the expenses are only deductible if a taxpayer itemizes their deductions on Schedule A. In addition, hobby expenses are limited by category as follows:
Category 1: This category includes deductions for home mortgage interest, taxes, and casualty losses. They are reported on the appropriate lines of Schedule A as they would be if no hobby activity existed.
Category 2: Deductions that don’t result in an adjustment to the basis of property are allowed next, but only to the extent that gross income from the activity is greater than the deductions under Category 1. Most expenses that a business would incur, such as those for advertising, insurance premiums, interest, utilities, wages, etc., belong in this category.
Category 3: Business deductions that decrease the basis of property are allowed last, but only to the extent that the gross income from the activity is more than the deductions under the first two categories. The deductions for depreciation and amortization belong in this category.
Additional limit – Individuals must claim the amounts in categories (2) and (3) as miscellaneous deductions on Schedule A, which are subject to the 2% AGI reduction; as a result, they are not deductible for alternative minimum tax purposes.
Hobby loss rules can be complicated. Need assistance determining whether your activity qualifies as trade or business, or whether it is subject to the hobby loss rules? Give Dagley & Co. a call at (202) 417-6640 or email at firstname.lastname@example.org.
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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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