• Can’t Pay Your Tax Liability?

    13 April 2017
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    on time

    Can’t pay your tax liability for 2016? We have the information you need to know:

    First, do not let your inability to pay your tax liability in full keep you from filing your tax return on time. If your return is not on time, you must still pay the “failure to file” penalty, which accrues at a rate of 5% per month on the amount of tax that you owe based on your return.

    If in doubt, you can delay the “failure to file” penalty for six months by filing an extension, but this still won’t keep you penalty free.

    Although an extension provides you with more time to file your actual return, it is not an extension of your payment date. If you do not pay the balance of your 2016 tax liability, you will be subject to the “failure to pay” penalty. This penalty accrues at the rate of 0.5% per month or partial month (up to a maximum of 25%) on the amount that you owe based on your return.

    If both penalties apply, the “failure to file” penalty drops to 4.5% per month or part thereof, so the total combined penalty remains 5%. The maximum combined penalty for the first five months is thus 25%. Thereafter, the “failure to pay” penalty will continue to increase at 1/2% per month for 45 more months (up to an additional 22.5%). Thus, the combined penalties can reach a total of 47.5% over time. Both of these penalties are in addition to the interest charges on the late payments.

    The bottom line is that, if you owe money, it is best to file your return on time even if you can’t pay the entire liability. That will minimize your penalties. Paying as much as you can with your return will further minimizing your penalties. By the way, neither the penalties nor the interest are tax-deductible.

    Possible Solutions – The following are possible ways to pay your tax liability when you don’t have the funds readily available:

    • Relatives and Friends – Borrowing money from family members or close friends is often the simplest method to pay a tax bill. One advantage of such loans is that the interest rate will probably be low; however, you must also consider that loans of more than $10,000 at below-market interest rates may trigger tax consequences. Any interest paid on this type of loan would be nondeductible.
    • Home-Equity Loans – A home-equity loan is another potential source of funds; such a loan has the advantage that the interest is deductible as long as the total equity loans on the home don’t exceed $100,000. However, in today’s financial environment, qualifying for these loans may be too time-consuming.
    • Credit or Debit Cards – Using your credit card to pay your taxes is another option. The IRS has approved three firms to provide this service. The disadvantages are that the interest rates are relatively high and that you must pay the merchant fee (because the IRS does not). For information about this fee and about making payments by credit card, visit the IRS website.
    • Installment Agreements – You can request an installment arrangement with the IRS. You must be up-to-date when filing your returns. There are also fees associated with setting up an installment agreement, and if you do not follow some strict payment rules, the agreement can be terminated. If your liability is under $50,000 and you can pay off the full liability within 6 years, you will not be required to submit financial statements, and you can apply online. When applying online, you’ll get an immediate acceptance or rejection of your payment plan.

    The fee for establishing such an agreement can be as high as $225, but it can be as low as $31 if you set up an online payment agreement and pay using direct debit from your bank account. You will also be charged interest, but the late-payment penalty will be half of the usual rate (1/4% instead of 1/2%) if you file your return by the due date (including extensions).

    If any of the following occur, the installment agreement may terminate, causing all of your taxes to become due immediately: the information you provided to the IRS in applying for the agreement proves inaccurate or incomplete; you miss an installment; you fail to pay another tax liability when it is due; the IRS believes that its collection of the tax involved is in jeopardy; or you fail to provide an update regarding your financial condition when the IRS makes a reasonable request for you to do so.

    • Pension Plans – Tapping into one’s pension plan or IRA should be a very last resort, not only because it degrades your future retirement but also because of the potential tax implications. Generally, except for Roth IRAs, the funds in retirement accounts are pretax; as a result, when withdrawn, they become taxable. If you are under 59½, any such distribution will also be subject to the 10% early-withdrawal penalty. Federal tax, state tax (if applicable), and this penalty can chew up a hefty amount of the distribution, which may be too high a price to pay.

    A Final Word of Caution – Ignoring your filing obligation only makes matters worse, and doing so can become very expensive. It can lead to the IRS collection process, which can include attachments, liens or even the seizure and sale of your property. In many cases, these tax nightmares can be avoided by taking advantage of the solutions discussed above. If you cannot pay your taxes, please call Dagley & Co. to discuss your options.

     

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  • Hobbies and Income Tax

    12 September 2016
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    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 info@dagleyco.com.

     

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  • Short-Term Rental, Special Treatment

    11 August 2016
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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 info@dagleyco.com.  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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  • Short-Term Rental, Special Treatment

    23 June 2016
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    Do you rent out a first or second home? If you are one of the many taxpayers who do so using rental agents or online rental services (such as Airbnb, VRBO and HomeAway) that match property owners with prospective renters, 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: First, 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. Second, 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 nonpassive 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 Dagley & Co. to determine how they apply to your particular circumstances and what actions you can take to minimize tax liability and maximize tax benefits from your rental activities.

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