Those torturous tax questions that keep you up at night, answered once and for all
It’s that time of year again — for procrastination, free-floating anxiety and pencil-chewing late nights at the kitchen table as you tackle the family taxes. It doesn’t have to be that way. Here are some of the more common tax questions that may be nagging you, answered by local experts.
I’m retired. I’m wondering how my investment income is going to be affected by Obamacare and what I can do to alleviate any tax increases.
Bad news first: Tax on investment income has gone up anywhere from 20 percent to 60 percent, depending on your level of total income and what kind of investment income you earn. For example, if you earn more than $250,000 if you’re married, and more than $200,000 if you’re single, every dollar of investment income above that threshold is subject to an additional 3.8 percent tax. Ouch. That’s significant for people earning capital gain income, qualified dividend income and interest and rental income. So, there’s a significant tax burden on seniors with those types of incomes, in those tax brackets. Add to that the fact that the deductions for offsetting that income have been limited as well. Currently, itemized deductions can be phased out up to 80 percent, depending on the current level of earnings. So another hidden tax cost is incurred by limiting the investment expenses that are incurred to actually earn that investment income.
The good news: Fortunately, there are many ways to alleviate this extra tax cost. The most obvious is to have income that’s not subject to the Obamacare tax — like income from tax-exempt securities and tax-exempt municipal bonds. Have losses to offset any passive investment income, like deductions from certain master-limited partnership investments. Typically, oil and gas investments can generate these types of tax losses, for example. Invest in vehicles that are tax-deferred, such as annuities or maxing out on life insurance premiums in a cash balance plan. Minimize how much you take in distributions from a pension plan to keep you under the $200,000 or $250,000 thresholds. Maybe change your retirement plan distribution amount per year by making it over a longer life expectancy. — Jason Thomas, tax partner, Fair, Anderson and Langerman
I’m going to use QuickBooks to do my accounting. Any advice before I dive in?
Make sure that you get all the different accounts that you’re going to be using properly input. It sounds obvious, but it’s crucial. For instance, you’re going to have your bank account, your accounts receivable, your accounts payable, the loans, your credit cards and then all of your income and expense items, as well. Once you have the basic format of your financial statements entered, then you start coding all the transactions. QuickBooks memorizes the coding for your transactions, so if it memorizes something that you’ve done wrong, it will post every single additional transaction wrong, as well — which will require a lot of work to go back and correct everything.
Nobody likes to hear this next tip, because they think balancing their checkbooks is a long, tedious process already. However, another of the most important things is to use the software’s bank reconciliation feature, because it’s very easy to miss an entry or to double-post an entry, and the only way to know for sure if your reports are right is to use the built-in bank reconciliation. Also, QuickBooks has got a lot of great built-in features, features that a lot of people don’t even know are in there. A lot of those things can really save you a lot of time and make your life easier, so it’s worth taking a look at some of those extra things besides just your basic accounting. — Adam Hodson, president, Adam Hodson CPA
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My business is finally making money again. What’s a tax-smart way for me to invest my profits?
When we talk about tax-smart opportunities for investments, there are three different approaches we can take. Tax avoidance is the legal way of not paying tax. (Tax evasion, as you know, is the illegal way. Bad, bad, bad!) Tax avoidance opportunities are very specific within the tax law, particular to the individual, and quite rare, but they do exist. For instance, for a homebuilder, the tax law allows for someone to live in a home for two years and, when they sell it, not to pay any tax on it, as long as the profit is less than half a million dollars.
Tax reduction, meanwhile, is having the profit but paying the tax at a lesser rate. Can you covert what normally might be ordinary income, taxed at ordinary rates, into a capital event and pay it at capital gains tax rates? There’s about a 15 to 20 point difference on the amount of tax you pay for ordinary income versus capital gains income. Here’s an example: Let’s say we have a business that’s making good profits, and dad is the entrepreneur and his children are young adults or high-schoolers. In that case, we could establish an opportunity for dad to sell a portion of the business to his children, in trust — so dad still controls the cash flow. We structure the sale so that the gain is set up as an installment method, so we can pay this note out of the profits of the business, which generates long-term capital gain for dad, and the business gets a step up in basis, something like good will, which can be an ordinary deduction. That one’s a little technical and a little complicated, but it does work and it’s a great little tool.
Tax deferral is a situation where we can currently deduct an investment, but later, when we try to have access to that investment, it would be taxable. The best example of this is a pension plan, or a 401K, or an IRA. The benefit of those devices are two-fold. One is the time value of money: Saving a dollar today is better than saving a dollar tomorrow. The other is that, often in retirement, our tax bracket is lower than it is during our productive careers. — Leland Pace, senior partner, Stewart, Archibald and Barney, LLP
I own my own business, so I can deduct all of my car expenses, right?
That’s a common misconception. Actually, you really should track your miles. How many are for business and how many are not? The not-for-business miles (which include your commute in the morning and your commute at night) are not deductible because this is considered personal mileage. There are two ways to calculate business expenses for your auto. One is the standard business mileage rate, which is 56.5 cents per mile for 2013. For the business miles, which would be all that time that you run around to different clients or banks or whatever, that would be deductible at the standard business mileage rate. If you don’t want to use the standard business mileage rate, you can use actual expenses. For that you’ll need to keep track of your gas, oil, car washes and all your various car expenses and you will want to depreciate the cost of the vehicle. Then you use a ratio. So, if 10 percent of your miles are personal and 90 percent are business, then you can deduct 90 percent of these auto expenses. Either way, you can deduct the portion of interest that would be related to the business portion of your car payments. So, if you determined that 90 percent of your car expenses are for business purposes, then you can deduct 90 percent of the interest portion of your car payment. You also get a depreciation deduction based on the business portion use of your car. — Marianne Reeves, partner, De Joya Griffith
If I want to make more charitable contributions, how can I know which charities are legitimate and worthy?
I would start by going to irs.gov and searching public charities. The IRS has a place where you can go to make sure that a charity has registered with the IRS, and that it is a legitimate 501(c)(3) organization. From there, you can go to guidestar.org. GuideStar gives financial information, including the annual Form 990 that all nonprofits need to file. You want to make sure that, first, the charity exists, and that it’s spending its money on the program, not on a bunch of fundraising and administrative costs. On the Form 990, you can see where the organization spends its money.
Also, if you’re going to give to a 501(c)(3), make sure you get a receipt from that organization stating how much you gave, that there were no goods or services provided, and that you get that receipt prior to filing your tax return.
— Dianna Russo, managing principal, Houldsworth, Russo & Company