Are you having a low taxable income year? Are you unemployed, had an accident that’s kept you from earning income, incurring a net operating loss (NOL) from a business, or suffering a casualty loss? These incidents will result in abnormally low taxable income for the year. But, these can actually give rise to some interesting tax planning strategies. See below for some key elements that govern tax rates and taxable income, and some actual strategies by Dagley & Co.
Taxable Income – First, of all, to be simplistic, taxable income is your adjusted gross income (AGI) less the sum of your personal exemptions and the greater of the standard deduction for your filing status or your itemized deductions:
Taxable Income XXXX
If the exemptions and deductions exceed the AGI, you can end up with a negative taxable income, which means to the extent it is negative you can actually add income or reduce deductions without incurring any tax.
Graduated Individual Tax Rates – Ordinary individual tax rates are graduated. So as the taxable income increases, so do the tax rates. Thus, the lower your taxable income, the lower your tax rate will be. Individual ordinary tax rates range from 10% to as high 39.6%. The taxable income amounts for 10% to 25% tax rates are:
Single Married Filing Jointly Head of Household Married Filing Separate 10% 9,275 18,550 13,250 9,275 15% 37,650 75,300 50,400 37,650 25% 91,150 151,900 130,150 75,950
For instance, if you are single, your first $9,275 of taxable income is taxed at 10%. The next $28,375 ($37,650 – $9,275) is taxed at 15% and the next $53,500 ($91,150 – $37,650) is taxed at 25%.
Here are some strategies you can employ for your tax benefit. However, these strategies may be interdependent on one another and your particular tax circumstances.
Take IRA Distributions – Depending upon your projected taxable income, you might consider taking an IRA distribution to add income for the year. For instance, if the projected taxable income is negative, you can actually take a withdrawal of up to the negative amount without incurring any tax. Even if projected taxable income is not negative and your normal taxable income would put you in the 25% or higher bracket, you might want to take out just enough to be taxed at the 10% or even the 15% tax rates. Of course, those are retirement dollars; consider moving them into a regular financial account set aside for your retirement. Also be aware that distributions before age 59½ are subject to a 10% early withdrawal penalty.
Defer Deductions – When you itemize your deductions, you may claim only the deductions you actually pay during the tax year (the calendar year for most folks). If your projected taxable income is going to be negative and you are planning on itemizing your deductions, you might consider putting off some of those year-end deductible payments until after the first of the year and preserving the deductions for next year. Such payments might include house of worship tithing, year-end charitable giving, tax payments (but not those incurring late payment penalties), estimated state income tax payments, medical expenses, etc.
Convert Traditional IRA Funds into a Roth IRA – To the extent of the negative taxable income or even just the lower tax rates, you may wish to consider converting some or all of your traditional IRA into a Roth IRA. The lower income results in a lower tax rate, which provides you with an opportunity to convert to a Roth IRA at a lower tax amount.
Zero Capital Gains Rate – There is a zero long-term capital gains rate for those taxpayers whose regular tax brackets are 15% or less (see table above). This may allow you to sell some appreciated securities that you have owned for more than a year and pay no or very little tax on the gain.
Business Expenses – The tax code has some very liberal provisions that allow a business to currently expense, rather than capitalize and slowly depreciate, the purchase cost of certain property. In a low-income year it may be appropriate to capitalize rather than expense these current year purchases and preserve the deprecation deduction for higher income years. This is especially true where there is a negative taxable income in the current year.
If you have obtained your medical insurance through a government marketplace, employing any of the strategies mentioned could impact the amount of your allowable premium tax credit.
Interested in discussing how these strategies might provide you tax benefit based upon your particular tax circumstances? Or, would like to schedule a tax planning appointment? Give Dagley & Co. a call today at (202) 417-6640.
Image via public domain
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
Image via. public domain
Household goods and used clothing are some of the most common tax-deductible charitable contributions that are encountered. Establishing the dollar value is the major complication of this type of contribution. According to the tax code, this is the fair market value (FMV), which is defined as the value that a willing buyer would pay a willing seller for the item. FMV is not always easily determined and varies significantly based upon the condition of the item donated. For example, compare the condition of an article of clothing you purchased and only wore once to that of one that has been worn many times. The almost-new one certainly will be worth more, but if the hardly worn item had been purchased a few years ago and become grossly out of style, the more extensively used piece of clothing could actually be worth more. In either case, the clothing article is still a used item, so its value cannot be anywhere near as high as the original cost. Determining this value is not an exact science. The IRS recognizes this issue and in some cases requires the value to be established by a qualified appraiser.
Remember that when establishing FMV, any value you claim can be challenged in an audit and that the burden of proof is with you (the taxpayer), not with the IRS. For substantial non-cash donations, it might be appropriate for you to visit your charity’s local thrift shop or even a consignment store to get an idea of the FMV of used items.
The next big issue is documenting your contribution. Many taxpayers believe that the doorknob hanger left by the charity’s pickup driver is sufficient proof of a donation. Unfortunately, that is not the case, as a recent United States Tax Court case (Kunkel T.C. Memo 2015-71) pointed out. In that case, the court denied the taxpayer’s charitable contributions, which were based solely upon doorknob hangers left by the drivers who picked up the donated items for the charities. The court stated that “these doorknob hangers are undated; they are not specific to petitioners; they do not describe the property contributed; and they contain none of the other required information.”
The IRS requires documentation for noncash contributions based on the total value of the donation. First, they require deductions of less than $250 – A taxpayer claiming a noncash contribution with a value under $250 must keep a receipt from the charitable organization that shows: the name of the charitable organization, the date and location of the charitable contribution, and a reasonably detailed description of the property. Please note that the taxpayer is not required to have a receipt if it is impractical to get one (for example, if the property was left at a charity’s unattended drop site).
Second, the IRS requires documentation for deductions of at least $250 but not more than $500 – If a taxpayer claims a deduction of at least $250 but not more than $500 for a noncash charitable contribution, he or she must keep an acknowledgment of the contribution from the qualified organization. If the deduction includes more than one contribution of $250 or more, the taxpayer must have either a separate acknowledgment for each donation or a single acknowledgment that shows the total contribution. The acknowledgment(s) must be written and must include: the name of the charitable organization, the date and location of the charitable contribution, a reasonably detailed description of any property contributed (but not necessarily its value), and whether or not the qualified organization gave the taxpayer any goods or services as a result of the contribution (other than certain token items and membership benefits). If the charitable organization provided goods and/or services to the taxpayer, the acknowledgement must include a description and a good-faith estimate of the value of those goods or services. If the only benefit received was an intangible religious benefit (such as admission to a religious ceremony) that generally is not sold in a commercial transaction outside the donative context, the acknowledgment must say so, and in this case, the acknowledgment does not need to describe or estimate the value of the benefit.
Third, the IRS requires documentation if deductions are over $500 but not over $5,000 – If a taxpayer claims a deduction over $500 but not over $5,000 for a noncash charitable contribution, he or she must attach a completed Form 8283 to the income tax return and must provide the same acknowledgement and written records that are required for contributions of at least $250 but not more than $500 (as described above). In addition, the records must also include: how the property was obtained. (for example, purchase, gift, bequest, inheritance, or exchange), the approximate date the property was obtained or—if created, produced, or manufactured by the taxpayer—the approximate date when the property was substantially completed, and the cost or other basis, and any adjustments to this basis, for property held for less than 12 months and (if available) the cost or other basis for property held for 12 months or more (this requirement, however, does not apply to publicly traded securities). If the taxpayer has a reasonable case for not being able to provide information on either the date the property was obtained or the cost basis of the property, he or she can attach a statement of explanation to the return.
Last, the IRS requires documentation if deductions are over $5,000 – These donations require time-sensitive appraisals by a “qualified appraiser” in addition to other documentation. When contemplating such a donation, please call this office for further guidance about the documentation and forms that will be needed.
Caution: The value of similar items of property that are donated in the same year must be combined when determining what level of documentation is needed. Similar items of property are items of the same generic category or type, such as coin collections, paintings, books, clothing, jewelry, privately traded stock, land, and buildings. For example, say you donated $5,300 of used furniture to 3 different charitable organizations during the year (a bedroom set valued at $800, a dining set worth $1,000, and living room furniture worth $3,500). Because the value of the donations of similar property (furniture) exceeds $5,000, you would need to obtain an appraisal of the furniture to satisfy the substantiation requirements—even if you donated the furniture to different organizations and at different times during the year. The IRS has strict rules as to who is considered a qualified appraiser.
To help you document some of these noncash contributions, you can download a fillable Noncash Charitable Contribution statement (http://images.client-sites.com/NonCash_Contribution2010.pdf). The statement includes an area for the charity’s agent to verify the contribution and a check box denoting whether the qualified organization provided any goods or services as a result of the contribution. Although not specifically blessed by the IRS, this statement includes everything needed for noncash contributions of up to $500—provided, of course, that you and the charitable organization’s representative accurately complete the form.
Do not include items of de minimis value, such as undergarments and socks, in the deductible amount of your contribution, as they specifically are not allowed.
Please call Dagley & Co. with any questions about documenting or valuing your non-cash contributions.
Image via. public domain