• Big Tax Break for Adoptive Parents

    18 May 2017
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    dag fam

    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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  • Using Home Equity for Business Needs

    8 May 2017
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    Often times, small business owners find difficulties in obtaining financing for their businesses without putting their personal assets up as collateral. With this, tapping into your home equity is a tempting alternative but should be carefully considered.

    In general, interest on debt used to acquire and operate your business is deductible against that business. However, debt secured by your home may be nondeductible, only partially deductible or fully deductible against your business.

    Home mortgage interest is limited to the interest on $1 million of acquisition debt and $100,000 of equity debt secured by a taxpayer’s primary residence and designated second home. The interest on the debts within these limits can only be treated as home mortgage interest and must be deducted as part of your itemized deductions. Only the excess can be deducted for your business, provided that the use of the funds can be traced to your business use. This creates a number of problems:

    • Using the Standard Deduction – If you do not itemize your deductions, you will be unable to deduct the interest on the first $100,000 of the equity debt, which cannot be allocated to your business.
    • Subject to the AMT – Even if you do itemize your deductions, if you happen to be subject to the alternative minimum tax (AMT), you still would not be able to deduct the first $100,000 of equity debt interest, since it is not allowed as a deduction for AMT purposes.
    • Subject to Self-Employment (SE) Tax – Your self-employment tax (Social Security and Medicare) is based on the net profits from your business. If the net profit is higher, because not all of the interest is deductible by the business, your SE tax may also be higher.

    Example: Suppose the mortgage you incurred to purchase your home (acquisition debt) has a current balance of $165,000 and your home is worth $400,000. You need $150,000 to acquire a new business. To obtain the needed cash at the best interest rates, you decide to refinance your home mortgage for $315,000. The interest on this new loan will be allocated as follows:

    New Loan:                                                  $ 315,000

    Part Representing Acquisition Debt                 <165,000>  52.38%

    Balance                                                      $ 150,000     

    First $100,000 Treated as Home Equity Debt    <100,000>  31.75%

    Balance Traced to Business Use                     $ 50,000      15.87%

    If the interest for the year on the refinanced debt was $10,000, then that interest would be deducted as follows:

    Itemized Deduction Regular Tax                     $ 8,413         84.13%

    Itemized Deduction Alternative Minimum Tax   $ 5,238         52.38%

    Business Expense                                        $ 1,587         15.87%        

    There is a special tax election that allows you to treat any specified home loan as not secured by the home. If you file this election, then interest on the loan can no longer be deducted as home mortgage interest, since tax law requires that qualified home mortgage debt be secured by the home. However, this election would allow the normal interest tracing rules to apply to that unsecured debt. This might be a smart move if the entire proceeds were used for business and all of the interest expense could be treated as a business expense. However, if the loan were a mixed-use loan and part of it actually represented home debt (such as a refinanced home loan), then the part that represented the home debt could not be allocated back to the home, and the interest on that portion of the debt would become nondeductible and would provide no tax benefit.

    As you can see, using equity from your home can create some complex tax situations. Please contact Dagley & Co. for assistance in determining the best solution for your particular tax situation.

     

     

     

     

     

     

     

     

     

     

     

     

     

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  • May 2017 Business Due Dates

    1 May 2017
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    Happy May 1st! We’ve compiled your business due dates for this new month. Add these to your calendar NOW to stay on track!

    May 1 –  Federal Unemployment Tax 
    Deposit the tax owed through March if it is more than $500.

    May 1 – Social Security, Medicare and Withheld Income Tax
    File Form 941 for the first quarter of 2017. Deposit or pay any un-deposited tax under the accuracy of deposit rules. If your tax liability is less than $2,500, you can pay it in full with a timely filed return. If you deposited the tax for the quarter in full and on time, you have until May 10 to file the return.

    May 10 – Social Security, Medicare and Withheld Income Tax
    File Form 941 for the first quarter of 2017. This due date applies only if you deposited the tax for the quarter in full and on time.

    May 15 – Employer’s Monthly Deposit Due
    If you are an employer and the monthly deposit rules apply, May 15 is the due date for you to make your deposit of Social Security, Medicare and withheld income tax for April 2017. This is also the due date for the non-payroll withholding deposit for April 2017 if the monthly deposit rule applies.
    Contact Dagley & Co. with any questions regarding May’s due dates.

     

     

     

     

     

     

     

     

     

     

     

     

     

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  • Tax Implications of Crowdfunding

    17 April 2017
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    When raising money through Internet crowdfunding sites such as GoFundMe, Kickstarter or Indiegogo, it is important to understand the “taxability” of the money raised. Whether the money raised is taxable depends upon the purpose of the fundraising campaign. For example, fees can range from 5 to 9% depending on the site.

    Gifts – When an entity raises funds for its own benefit and the contributions are made out of detached generosity (and not because of any moral or legal duty or the incentive of anticipated economic benefit), the contributions are considered tax-free gifts to the recipient.

    On the other hand, the contributor is subject to the gift tax rules if he or she contributes more than $14,000 to a particular fundraising effort that benefits one individual; the contributor is then liable to file a gift tax return. Unfortunately, regardless of the need, gifts to individuals are never tax deductible.

    The “gift tax trap” occurs when an individual establishes a crowdfunding account to help someone else in need (whom we’ll call the beneficiary) and takes possession of the funds before passing the money on to the beneficiary. Because the fundraiser takes possession of the funds, the contributions are treated as a tax-free gift to the fundraiser. However, when the fundraiser passes the money on to the beneficiary, the money then is treated as a gift from the fundraiser to the beneficiary; if the amount is over $14,000, the fundraiser is required to file a gift tax return and to reduce his or her lifetime gift and estate tax exemption. Some crowdfunding sites allow the fundraiser to designate a beneficiary so that the beneficiary has direct access to the funds.

    Charitable Gifts – Even if the funds are being raised for a qualified charity, the contributors cannot deduct the donations as charitable contributions without proper documentation. Taxpayers cannot deduct cash contributions, regardless of the amount, unless they can document the contributions in one of the following ways:

    • Contribution Less Than $250: To claim a deduction for a contribution of less than $250, the taxpayer must have a cancelled check, a bank or credit card statement, or a letter from the qualified organization; this proof must show the name of the organization, the date of the contribution, and the amount of the contribution.
    • Cash contributions of $250 or More – To claim a deduction for a contribution of $250 or more, the taxpayer must have a written acknowledgment of the contribution from the qualified organization; this acknowledgment must include the following details:
      • The amount of cash contributed;
      • Whether the qualified organization gave the taxpayer goods or services (other than certain token items and membership benefits) as a result of the contribution, along with a description and good-faith estimate of the value of those goods or services (other than intangible religious benefits); and
      • A statement that the only benefit received was an intangible religious benefit, if that was the case.

    Thus, if the contributor is to claim a charitable deduction for the cash donation, some means of providing the contributor with a receipt must be established.

    Business Ventures – When raising money for business projects, two issues must be contended with: the taxability of the money raised and the Security and Exchange Commission (SEC) regulations that come into play if the contributor is given an ownership interest in the venture.

    • No Business Interest Given – This applies when the fundraiser only provides nominal gifts, such as products from the business, coffee cups, or T-shirts; the money raised is taxable to the fundraiser.
    • Business Interest Provided – This applies when the fundraiser provides the contributor with partial business ownership in the form of stock or a partnership interest; the money raised is treated as a capital contribution and is not taxable to the fundraiser. (The amount contributed becomes the contributor’s tax basis in the investment.) When the fundraiser is selling business ownership, the resulting sales must comply with SEC regulations, which generally require any such offering to be registered with the SEC. However, the SEC regulations were modified in 2012 to carve out a special exemption for crowdfunding:
      • Fundraising Maximum – The maximum amount a business can raise without registering its offering with the SEC in a 12-month period is $1 million. Non-U.S. companies, businesses without a business plan, firms that report under the Exchange Act, certain investment companies, and companies that have failed to meet their reporting responsibilities may not participate.
    • Contributor Maximum – The amount an individual can invest through crowdfunding in any 12-month period is limited:
      • If the individual’s annual income or net worth is less than $100,000, his or her equity investment through crowdfunding is limited to the greater of $2,000 or 5% of the investor’s annual net worth.
      • If the individual’s annual income or net worth is at least $100,000, his or her investment via crowdfunding is limited to 10% of the investor’s net worth or annual income, whichever is less, up to an aggregate limit of $100,000.

    If you have questions about crowdfunding-related tax issues, please give Dagley & Co. a call.

     

     

     

     

     

     

     

     

     

     

     

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  • 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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  • April 2017 Business Due Dates

    3 April 2017
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    april da

    April is a busy month for business owners, accountants, accounting departments, CFOs and more. As Tax Day is quickly approaching, plan out your month in advance with these business due dates:

    April 18 – Household Employer Return Due

    If you paid cash wages of $2,000 or more in 2016 to a household employee, you must file Schedule H. If you are required to file a federal income tax return (Form 1040), file Schedule H with the return and report any household employment taxes. Report any federal unemployment (FUTA) tax on Schedule H if you paid total cash wages of $1,000 or more in any calendar quarter of 2015 or 2016 to household employees. Also, report any income tax that was withheld for your household employees. For more information, please call this office.

    April 18 – Corporations

    File a 2016 calendar year income tax return (Form 1120 or 1120-A) and pay any tax due. If you need an automatic 5-month extension of time to file the return, file Form 7004, Application for Automatic Extension of Time To File Certain Business Income Tax, Information and Other Returns, and deposit what you estimate you owe. Filing this extension protects you from late filing penalties but not late payment penalties, so it is important that you estimate your liability and deposit it using the instructions on Form 7004.

    April 18 – Social Security, Medicare and Withheld Income Tax

    If the monthly deposit rule applies, deposit the tax for payments in March.

    April 18 – Corporations

    The first installment of 2017 estimated tax of a calendar year corporation is due.

    April 18 – Partnerships

    Last day file 2016 calendar year fiduciary return or file an extension.
    Contact Dagley & Co. with any questions, or if you’d like to schedule your last-minute tax refund meeting.

     

     

     

     

     

     

     

     

     

     

     

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  • April 2017 Individual Due Dates

    31 March 2017
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    April is an important month for many as tax season comes to a close. If you have not filed your tax returns, please reach out to Dagley & Co. and we can set up a one-on-one appointment before Tax Day on April 18th. Here are all your important individual due dates for the month of April:

    April 1 – Last Day to Withdraw Required Minimum Distribution

    Last day to withdraw 2016’s required minimum distribution from Traditional or SEP IRAs for taxpayers who turned 70½ in 2016. Failing to make a timely withdrawal may result in a penalty equal to 50% of the amount that should have been withdrawn. Taxpayers who became 70½ before 2016 were required to make their 2016 IRA withdrawal by December 31, 2016.

    April 10 –  Report Tips to Employer

    If you are an employee who works for tips and received more than $20 in tips during March, you are required to report them to your employer on IRS Form 4070 no later than April 10. Your employer is required to withhold FICA taxes and income tax withholding for these tips from your regular wages. If your regular wages are insufficient to cover the FICA and tax withholding, the employer will report the amount of the uncollected withholding in box 12 of your W-2 for the year. You will be required to pay the uncollected withholding when your return for the year is filed.

    April 15 – Taxpayers with Foreign Financial Interests

    A U.S. citizen or resident, or a person doing business in the United States, who has a financial interest in or signature or other authority over any foreign financial accounts (bank, securities or other types of financial accounts), in a foreign country, is required to file Form FinCEN 114. The form must be filed electronically; paper forms are not allowed. The form must be filed with the Treasury Department (not the IRS) no later than April 15, 2017 for 2016. An extension of time to file of up to 6 months may be requested This filing requirement applies only if the aggregate value of these financial accounts exceeds $10,000 at any time during 2016. Contact our office for additional information and assistance filing the form or requesting an extension.

    April 18 –  Individual Tax Returns Due

    File a 2016 income tax return (Form 1040, 1040A, or 1040EZ) and pay any tax due. If you want an automatic six-month extension of time to file the return, please call this office.

    Caution: The extension gives you until October 16, 2017 to file your 2016 1040 return without being liable for the late filing penalty. However, it does not avoid the late payment penalty; thus, if you owe money, the late payment penalty can be severe, so you are encouraged to file as soon as possible to minimize that penalty. Also, you will owe interest, figured from the original due date until the tax is paid. If you have a refund, there is no penalty; however, you are giving the government a free loan, since they will only pay interest starting 45 days after the return is filed. Please call this office to discuss your individual situation if you are unable to file by the April 18 due date.

    Note: the normal April 15 due date is a Saturday, and the following Monday is a federal holiday in the District of Columbia, so for almost all individuals their 2016 Form 1040 returns aren’t due until the next business day, which is Tuesday, April 18.

    April 18 – Household Employer Return Due

    If you paid cash wages of $2,000 or more in 2016 to a household employee, you must file Schedule H. If you are required to file a federal income tax return (Form 1040), file Schedule H with the return and report any household employment taxes. Report any federal unemployment (FUTA) tax on Schedule H if you paid total cash wages of $1,000 or more in any calendar quarter of 2015 or 2016 to household employees. Also, report any income tax that was withheld for your household employees. For more information, please call this office.

    April 18 – Estimated Tax Payment Due (Individuals)

    It’s time to make your first quarter estimated tax installment payment for the 2017 tax year. Our tax system is 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 employees;
    • 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, they can be subject to the underpayment penalty. This penalty is equal to the federal short-term rate plus 3 percentage points, and the penalty is computed on a quarter-by-quarter basis.

    Federal tax law does provide ways to avoid the underpayment penalty. If the underpayment is less than $1,000 (the “de minimis amount”), no penalty is assessed. In addition, the law provides “safe harbor” prepayments. There are two safe harbors:

    • The first safe harbor is based on the tax owed in the current year. If your payments equal or exceed 90% of what is owed in the current year, you can escape a penalty.
    • The second safe harbor is based on the tax owed in the immediately preceding tax year. This safe harbor is generally 100% of the prior year’s tax liability. However, for taxpayers whose AGI exceeds $150,000 ($75,000 for married taxpayers filing separately), the prior year’s safe harbor is 110%.

    Example: Suppose your tax for the year is $10,000 and your prepayments total $5,600. The result is that you owe an additional $4,400 on your tax return. To find out if you owe a penalty, see if you meet the first safe harbor exception. Since 90% of $10,000 is $9,000, your prepayments fell short of the mark. You can’t avoid the penalty under this exception.

    However, in the above example, the safe harbor may still apply. Assume your prior year’s tax was $5,000. Since you prepaid $5,600, which is greater than 110% of the prior year’s tax (110% = $5,500), you qualify for this safe harbor and can escape the penalty.

    This example underscores the importance of making sure your prepayments are adequate, especially if you have a large increase in income. This is common when there is a large gain from the sale of stocks, sale of property, when large bonuses are paid, when a taxpayer retires, etc. Timely payment of each required estimated tax installment is also a requirement to meet the safe harbor exception to the penalty. If you have questions regarding your safe harbor estimates, please call this office as soon as possible.

    CAUTION: Some state de minimis amounts and safe harbor estimate rules are different than those for the Federal estimates. Please call this office for particular state safe harbor rules.

    April 18 – Last Day to Make Contributions

    Last day to make contributions to Traditional and Roth IRAs for tax year 2016.

     

     

     

     

     

     

     

     

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  • Tax Filing Deadline Is Around the Corner

    29 March 2017
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    REMINDER: April 18, 2017 is the due date to file your return(s), pay any taxes owed, or file for a six-month extension. It is important to know that with this extension you will end up paying the tax you estimate to be due.

    In addition, this deadline also applies to the following:

    • Tax year 2016 balance-due payments – Taxpayers that are filing extensions are cautioned that the filing extension is an extension to file, NOT an extension to pay a balance due.  Late payment penalties and interest will be assessed on any balance due, even for returns on extension.  Taxpayers anticipating a balance due will need to estimate this amount and include their payment with the extension request.
    • Tax year 2016 contributions to a Roth or traditional IRA – April 18 is the last day contributions for 2016 can be made to either a Roth or traditional IRA, even if an extension is filed.
    • Individual estimated tax payments for the first quarter of 2017 – Taxpayers, especially those who have filed for an extension to file their 2016 return, are cautioned that the first installment of the 2017 estimated taxes are due on April 18.  If you are on extension and anticipate a refund, all or a portion of the refund can be allocated to this quarter’s payment on the final return when it is filed at a later date. If the refund won’t be enough to fully cover the April 18 installment, you may need to make a payment with the April 18 voucher. Please call this office for any questions.
    • Individual refund claims for tax year 2013 – The regular three-year statute of limitations expires on April 18 for the 2013 tax return.  Thus, no refund will be granted for a 2013 original or amended return that is filed after April 18. Caution: The statute does not apply to balances due for unfiled 2013 returns.

    If Dagley  & Co. is holding up the completion of your returns because of missing information, please forward that information as quickly as possible in order to meet the April 18 deadline.  Keep in mind that the last week of tax season is very hectic, and your returns may not be completed if you wait until the last minute.  If it is apparent that the information will not be available in time for the April 18 deadline, then let the office know right away so that an extension request, and 2017 estimated tax vouchers if needed, may be prepared.

    If your returns have not yet been completed, please call Dagley & Co. right away so that we can schedule an appointment and/or file an extension if necessary.

     

     

     

     

     

     

     

     

     

     

     

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  • Consequences of Filing Married Separate

    27 March 2017
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    Married? Thinking about NOT filing a joint return with your spouse? Most likely, you will utilize the ‘married filing separate’, or MFS, filing status. With this, you must be aware that there are special tax codes involved that married individuals CANNOT benefit by filing as MFS. Dagley & Co. describes some of the most frequent issues we’ve encountered  when making the choice of the MFS filing status. (Please note, all dollar amounts are those for 2017)

    Joint & Several Liability – When married taxpayers file joint returns, both spouses are responsible for the tax on that return. What this means is that one spouse may be held liable for all the tax due on a return, even if the other spouse earned all the income on that return. In some marriages, this becomes an issue and causes the spouses to decide to file separately. In other cases, especially second marriages, the couple may want to keep their finances separate. Unless all the income, exemptions, credits and deductions are divided equally, which usually happens in community property states, this generally causes the incomes to be distorted and could easily push one of the spouses into a higher tax bracket and create a greater combined tax than filing jointly. Being in a separate property state, where each spouse claims their own earnings, can also create an uneven allocation of income and a higher tax bracket for one of the spouses.

    Exemptions – Taxpayers are allowed a $4,050 tax exemption for each of their dependents. However, the $4,050 allowance cannot be divided between the MFS filers, so only one of the filers can claim a dependent’s exemption, and where there are multiple dependents, the spouses would need to allocate the exemptions between them.

    Itemizing Deductions – To prevent taxpayers from filing MFS and one spouse taking advantage of itemized deductions and the other utilizing the standard deduction, the tax regulations require both to itemize if one of them does.

    Social Security Income – When filing a joint return, Social Security (SS) income is not taxable until the modified AGI (MAGI) – which is regular AGI (without Social Security income) plus 50% of the couple’s Social Security income plus tax-exempt interest income and plus certain other infrequently encountered additions – exceeds a taxable threshold of $32,000. However, for married taxpayers who have lived together at any time during the year and are filing married separate, the threshold is zero, generally making more of the Social Security income taxable.

    Section 179 Deduction – Businesses can elect to expense, instead of depreciate, up to $510,000 of business purchases, generally including equipment, certain qualified leasehold property and off-the-shelf computer software. The $510,000 cap is reduced by $1 for every $1 that the qualifying purchases exceed $2,030,000 for the year. Married taxpayers are treated as one taxpayer for purposes of the Section 179 expense limit. Thus, they generally must split the limit equally unless they can agree upon and elect an unequal split.

    Special Passive Loss Allowance – Passive losses are generally losses from business and rental activities in which a taxpayer does not materially participate. Those losses are not allowed except to offset income from other passive activities. Rental property is an example of a passive activity, and for lower-income taxpayers, a special allowance permits taxpayers who are actively involved in the rental activity to currently deduct a loss of up to $25,000 if their AGI does not exceed $100,000. That $25,000 special loss allowance phases out by 50 cents for each $1 of AGI over $100,000 and is completely eliminated when the AGI reaches $150,000. When filing separately, this special allowance is not allowed unless the spouses live apart the entire year, and then the allowance is reduced to $12,500 each.

    Traditional IRA Deduction Phase-Out – If a married taxpayer filing jointly is participating in a qualified employer pension plan, the deductibility of a traditional IRA contribution is phased out ratably for an AGI between $99,000 and $119,000. If the taxpayers file married separate, the phase-out begins at $0 if the taxpayer participates in their employer’s plan, and when the AGI reaches $10,000, no traditional IRA deduction is allowed. So little, if any, IRA deduction will be available to such an MFS filer.

    Roth IRA Contribution Phase-Out – Taxpayers may choose to contribute to a non-deductible Roth IRA. However, Roth IRA contributions are ratably phased out for higher-income married filing jointly taxpayers with an AGI between $186,000 and $196,000. For a married taxpayer filing MFS status, that AGI phase-out range drops to $0 through $9,999, virtually eliminating the possibility of a Roth contribution.

    Coverdell Education Accounts – Taxpayers are allowed to contribute up to $2,000 per beneficiary to a Coverdell education savings account annually. However for joint filers, the amount that can be contributed ratably phases out for AGIs between $190,000 and $220,000. For married filing separate taxpayers, the phase-out is half that amount, from $95,000 to $110,000.

    Education Tax Credits – Taxpayers are allowed a tax credit, called the American Opportunity Tax Credit, of up to $2,500 per family member enrolled at least half-time in college for the cost of tuition and qualified expenses. This credit phases out ratably for higher-income married taxpayers filing jointly with an AGI between $160,000 and $180,000.

    There is a second higher-education credit called the Lifetime Learning Credit, which provides a credit of up to $2,000 per family. This credit also phases out ratably for higher-income married taxpayers filing jointly with an AGI between $112,000 and $132,000.

    However, neither credit is allowed for married filing separate taxpayers.

    Higher Education Interest – Taxpayers can take a deduction of up to $2,500 for student loan interest paid on higher-education loans. Like other benefits, it is phased out for higher-income married taxpayers filing jointly, in this instance when the AGI is between $135,000 and $165,000. It is not allowed at all for taxpayers filing as married separate.

    Education Exclusion For U.S. Savings Bond Interest – Although not frequently encountered, interest from certain U.S. Savings Bonds can be excluded if used to pay higher-education expenses for the taxpayers and their dependents. The exclusion phases out for married taxpayers with an AGI between $117,250 and $147,250. This deduction is not allowed at all when filing married separate.

    Premium Tax Credit – For married taxpayers who qualify for the PTC (health insurance subsidy) under Obamacare, if they file married separate, they may be required to repay the subsidy.

    Earned Income Tax Credit – This is a refundable tax credit that rewards lower-income taxpayers for working and can be as much $6,318 for families with three or more qualifying children. Taxpayers filing as married separate are not qualified for this credit.

    Child Care Credit – If both spouses work and incur child care expenses, they qualify for the child care credit. However, for those married filing separate, the credit is not allowed.

    Halved Deductions & Credits – Many of the deductions and credits allowed to a married couple filing jointly are cut in half for the married filing separate filing status. They include:

    • Standard Deduction
    • Standard Deduction Phase-Out
    • Alternative Minimum Tax Exemptions
    • Alternative Minimum Tax Exemptions Phase-Outs
    • Child Tax Credit Phase-Out

    Head of Household Filing StatusWhere a married couple is not filing jointly, one or both spouses may qualify for the more beneficial Head of Household (HH) filing status rather than having to file using the MFS status. A married individual may use the HH status if they lived apart from their spouse for at least the last six months of the year and paid more than one-half of the cost of maintaining his or her home as a principal place of abode for more than one-half the year of a child, stepchild or eligible foster child for whom the taxpayer may claim a dependency exemption. (A non-dependent child only qualifies if the custodial parent gave written consent to allow the dependency to the non-custodial parent or if the non-custodial parent has the right to claim the dependency under a pre-’85 divorce agreement.)

    As you can see, there are a significant number of issues that need to be considered when making the decision to use the married filing separate status. And these are not all of them, but only the more significant ones. The filing status decision should not be made nonchalantly, as it can have significant impact on your taxes. Please contact Dagley & Co. for assistance in making that crucial decision.

     

     

     

     

     

     

     

     

     

     

     

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