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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When two married people are jointly involved in the operation of an unincorporated business, it is very common, yet incorrect, for all of that business’s income to be reported as just one spouse’s income, even when/if they both work in the business.
In such cases, the spouse not taking credit for his or her portion of the earned income loses out on the chance to accumulate his or her own eligibility for Social Security benefits. In addition, to claim a child care credit, both spouses on a joint return must have earned income (or imputed income if one of the spouses is a full-time student or is disabled), so unless the spouse not including a portion of the income from the joint business has another source of earned income, the couple will not be allowed a child care credit.
There are ways to remedy this situation, however. One option is to file a partnership return for the activity, in which case each spouse will receive a K-1 that reports his or her share of the net profit. An approach that avoids the necessity of filing a partnership return, and that is probably less complicated, is a qualified joint-venture election, in which each spouse elects to file a separate Schedule C for his or her respective share of the business. This gives them both self-employed income for the purposes of the self-employment tax and for claiming the child care credit.
A qualified joint venture refers to any joint venture involving the conduct of a trade or business if:
(1) The only members of the joint venture are husband and wife,
(2) Both spouses materially participate in the trade or business, and
(3) Both spouses elect to apply this rule.
Generally, to meet the material participation requirement, each spouse will have to participate in the activity for 500 hours or more during the tax year.
If the net income from the business exceeds the annual cap on income subject to the Social Security tax, the combined self-employment tax for the spouses with split Schedule Cs will exceed what a single spouse would have paid if he or she had filed a single Schedule C.
An additional benefit when filing split Schedule Cs is the opportunity for both spouses to participate in IRAs and self-employed retirement plans.
If you have questions about how splitting the business income between spouses might apply to your specific situation, please contact Dagley & Co. today.
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Divorced or separated parent with a child/children? Commonly encountered but an often-misunderstood issue is who claims the child or children for tax purposes. This is sometimes a hotly disputed issue between parents; however, tax law includes some very specific but complicated rules about who profits from the child-related tax benefits. At issue are a number of benefits, including the children’s dependency tax exemption, child tax credit, child care credit, higher-education tuition credit, earned income tax credit, and in some cases even filing status.
This is actually one of the most complicated areas of tax law, and serious mistakes can be made by taxpayers preparing their own returns or inexperienced tax preparers, especially if the parents are not communicating well. Where parents will cooperate with each other, they often can work out the best tax result overall, even though it may not be the best for them individually, and compensate for it in other ways.
Where a family court awards physical custody of a child to one of the parents, tax law is very specific in awarding that child’s dependency to the parent with physical custody, regardless of the amount of child support provided by the other parent. However, the custodial parent may release the dependency (exemption) to the non-custodial parent by completing the appropriate IRS form.
On the other hand, if the family court awards joint physical custody, only one of the parents may claim the child as a dependent for tax purposes. If the parents cannot agree between themselves as to who will claim the child and the child is actually claimed by both, the IRS tiebreaker rules will apply. Per the tiebreaker rules, the child is treated as a dependent of the parent with whom the child resided for the greater number of nights during the tax year, or if the child resides with both parents for the same amount of time during the tax year, the parent with the higher adjusted gross income claims the child as a dependent.
Child’s Exemption – The parent who claims the child as a dependent is entitled to the child’s tax exemption – which is actually a deduction from income of $4,050 in 2016. However, the exemption begins to phase out for higher-income taxpayers with an AGI of $259,400 for single taxpayers, $285,350 for those qualifying for head of household filing status and $311,300 for married taxpayers filing jointly.
Head of Household Filing Status – An unmarried parent can claim the more favorable head of household, rather than single, filing status if the parent is the custodial parent and pays more than one-half of the cost of maintaining as his or her home a household which is the principal place of abode for more than one-half the year for that child. This is true even when the child’s dependency (and therefore the $4,050 exemption deduction) is released to the non-custodial parent.
Tuition Credit – If the child qualifies for either the American Opportunity or the Lifetime Learning higher-education tax credit, the credit goes to whoever claims the child’s exemption. Credits are significant tax benefits because they reduce the amount of tax dollar-for-dollar, while deductions reduce income to arrive at taxable income that is then taxed according to the individual’s tax bracket. For instance, the American Opportunity Tax Credit (AOTC) provides a tax credit of up to $2,500, 40% of which is refundable. However, both education credits phase out for higher-income taxpayers. For instance, the AOTC phases out between $65,000 and $80,000 for unmarried taxpayers and $130,000 and $160,000 for married taxpayers.
Child Care Credit – A nonrefundable tax credit is available to the custodial parent for the care of the child while the parent is gainfully employed or seeking employment. To qualify for this credit, the child must be under the age of 13 and be a dependent of the parent. However, a special rule for divorced or separated parents provides that where the custodial parent releases the child’s exemption to the non-custodial parent, the custodial parent would still qualify to claim the childcare credit, and it cannot be claimed by the noncustodial parent.
Child Tax Credit – A credit of $1,000 is allowed for a child under the age of 17. That credit goes to the parent claiming the child as a dependent. However, this credit phases out for higher-income parents, beginning at $75,000 for unmarried parents and $110,000 for married parents filing jointly.
Affordable Care Act – Parents must keep in mind that where the child does not have medical insurance during periods of the year, the parent claiming the child as a dependent (claims the $4,050 exemption) is the one responsible for any applicable penalties when the child does not have health insurance coverage.
Earned Income Tax Credit (EITC) – Lower-income parents with earned income (wages or self-employment income) may qualify for the EITC. This credit is based on the number of children (under age 19 or a full-time student under age 24) the custodial parent has, up to a maximum of three children. Releasing the dependency exemption to the noncustodial parent will not disqualify the custodial parent from using the children to qualify for the EITC. In fact, the noncustodial parent is prohibited from claiming the EITC based on the child or children whose exemption has been released by the custodial parent.
As you can see, there are some complex rules that apply to the tax benefits provided by children of divorced parents. It is highly recommended that you consult with Dagley & Co. for the preparation of your return. If you are the custodial parent you should also consult with this office before making the decision to release a child’s exemption.
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Are you caring for a disabled family member? Caring for ill or disabled family members in homes can be expensive, time-consuming, and exhausting, but many taxpayers prefer to care for them this way, rather than placing them in nursing homes. The government also recognizes home care as a means of reducing the government’s costs in terms of caring for individuals who otherwise would be institutionalized (because they require the type of care that is normally provided in a hospital, nursing facility, or intermediate care facility).
To promote home care and reduce the government’s institutional care expenses, Medicaid (through state agencies) pays home caregivers a small wage (usually reported on Form W-2 but sometimes on Form 1099-MISC) referred to as a Medicaid waiver payment to care for an individual in the care provider’s home.
The IRS historically has taken the position that these payments were taxable income to the caregiver. However, in a notice issued in 2014, the IRS announced that, if the care met certain requirements, it would no longer challenge the excludability of these wages and instead would treat them in the same manner as excludable difficulty-of-care payments under the foster care payments rule. This is the case even when the caregiver and the individual being cared for are related.
Therefore, the exclusion can be applied to all future years and to all prior open years if the following requirements are met:
The compensation must be required due to a physical, mental, or emotional handicap with respect to which the State has determined that there is a need for additional compensation.
The care must be provided in the care provider’s home. The “provider’s home” may be the care recipient’s home if the care provider resides there and regularly performs the routines of the provider’s private life, such as sharing meals and holidays with family. In contrast a care provider who sleeps at the care recipient’s home several nights a week but on weekends and holidays resides with his or her own family in a separate home would not be providing the care in the care provider’s home and would not qualify to exclude the Medicaid waiver payments received.
The payments must be designated as compensation for qualified foster care or difficulty of care.
To be excludable, the care payments are limited to a maximum of five individuals age 19 and older or ten individuals age 18 and younger.
Since these payments are now treated the same as qualified foster care difficulty-of-care payments, and since compensation for qualified foster care payments is mandatorily excluded, Medicaid waiver payments are also mandatorily excluded. That is, the care provider receiving these payments may not choose to include them in income.
This change is a double-edged sword, as some lower-income caregivers were previously able to qualify for the earned income tax credit (EITC) based upon this income.
The EITC is a refundable federal tax credit for lower-income taxpayers with earned income. The amount of credit is based on income and increases based on the number of children that the taxpayer has (qualified children include those under age 19 and full-time students under the age of 24; there is no age limit when the child is permanently and totally disabled).
Now, since these Medicaid payments are mandatorily excludable, the compensation no longer counts as earned income for the EITC.
On the other hand, those with substantial other income will welcome the IRS policy change, as it reduces their income and thus their income tax.
Still other care providers—those with earned income from other sources—may benefit from both the reduction of income and the EITC. The EITC phases out for higher-income individuals, so with the Medicaid waiver payment excluded, these individuals’ modified adjusted gross incomes may be reduced enough to qualify for the EITC based on their other earned income. These individuals also may benefit from a lower income tax based upon the exclusion.
As you can see, the impact of the exclusion can be quite different depending upon your particular circumstances. If you are receiving Medicaid waiver payments and have not yet dealt with the exclusion, please call Dagley & Co. to see how excluding these payments might affect you.
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Some Americans end up owing and cannot pay their tax liabilities. Are you one of these unfortunate people?
The IRS encourages you to pay the full amount of your tax liability on time by imposing significant penalties and interest on late payments if you don’t. So if you are unable to pay the tax you owe, it is generally in your best interest to make other arrangements to obtain the funds for paying your taxes rather than be subjected to the government’s penalties and interest. Here are a few options to consider.
Family Loan – Obtaining a loan from a relative or friend may be the best bet because this type of loan is generally the least costly in terms of interest.
Credit Card – Another option is to pay by credit card with one of the service providers that work with the IRS. However, since the IRS will not pay the credit card discount fee, you will have to pay it and pay the higher credit card interest rates.
Installment Agreement – If you owe the IRS $50,000 or less, you may qualify for a streamlined installment agreement where you can make monthly payments for up to six years. You will still be subject to the late payment penalty, but it will be reduced by half. Interest will also be charged at the current rate, and there is a user fee to set up the payment plan. In making the agreement, a taxpayer agrees to keep all future years’ tax obligations current. If the taxpayer does not make payments on time or has an outstanding past due amount in a future year, they will be in default of their agreement and the IRS has the option of taking enforcement actions to collect the entire amount owed. Taxpayers seeking installment agreements exceeding $50,000 will need to validate their financial condition and need for an installment agreement by providing the IRS with a Collection Information Statement (financial statements). Taxpayers may also pay down their balance due to $50,000 or less to take advantage of the streamlined option.
Tap a Retirement Account – This is possibly the worst option for obtaining funds to pay your taxes because you are jeopardizing your retirement and the distributions are generally taxable at your highest bracket, which adds more taxes to your existing problem. In addition, if you are under age
59½, the withdrawal is also subject to a 10% early withdrawal penalty that compounds the problem even further.
Whatever you decide, don’t just ignore your tax liability because that is the worst thing you can do. Please call Dagley & Co. for assistance.
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