Going to School? Get a Break with the American Opportunity Tax Credit

Posted on October 23 2014 by admin

Sending a child to school is expensive. Really expensive. I have 2 sons in college and the costs of tuition, books, and extracurricular activities add up quickly. Fortunately, there are tax credits you can take advantage of to help offset the rising cost of education.

If you, your spouse, or dependents are currently attending or planning to attend college, you may be able to claim the American Opportunity Tax Credit.

The American Opportunity Tax Credit for “qualified tuition and related expenses” is available through 2017 for the first four years of undergraduate education.

Eligible institutions. Accredited schools offering credit towards a bachelor’s or associate’s degree and certain vocational schools are eligible.

Eligible students. The student must be enrolled in a degree or certification program on at least a half-time basis. The student also must never have been convicted of a federal or state felony drug offense.

Qualified tuition and related expenses. This includes tuition, books, and academic fees required for enrollment or attendance. Student activity fees, athletic fees, insurance, room and board, transportation costs or other personal living expenses do not qualify. The cost of a course or education involving sports, games or hobbies doesn’t qualify unless it’s part of the student’s degree program.

Maximum credit. You can claim up to $2,500 per student. Since the limit is per student and not per taxpayer, qualifying expenses for you and two children, for example, may be as high as $7,500.

Who can claim the credit? If the student is claimed as a dependent, only the parent may claim the credit. It would be based on qualified expenses paid by both the parent and child. If the parent is eligible to, but does not claim the student as a dependent, only the student can claim the credit. If the student is not claimed as a dependent, then qualifying expenses paid by a parent can be claimed by the child. The child may also claim payments made directly to the school by a third party, such as grandparents.

Phase-out ranges for modified adjusted gross income (AGI). In tax year 2014, for married couples filing jointly: $160,000 and $180,000, and it’s unavailable if AGI is $180,000 or more. For individual taxpayers or heads of household: $80,000 to $90,000. No credit is available for married couples filing separately.

Payments with borrowed funds. The credit can be claimed for qualified tuition and related expenses paid by a loan.

The credit is 40% refundable. Not only can it reduce your regular tax bill to zero, you may also receive a refund. For example, someone who has at least $4,000 in qualified expenses, but no tax liability to offset the credit against, would qualify for a $1,000 (40% of maximum credit of $2,500) refund. One caution: Credits that are claimed by dependents are often NOT refundable and can only be used to offset tax.

By Melinda Nelson, CPA

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Student Loan Interest: Can Tax Law Keep Up?

Posted on October 22 2014 by admin

Student loans have been a hot topic in the media and on Capitol Hill. A recent analysis of student loan trends from the credit bureau Experian found that student loan debt increased by 84% from 2008 to 2014, surpassing the debt related to home equity loan and lines of credit, credit cards and automobiles. Currently, the average student graduates with around $29,400 in loans and 58% of all student loan debt is held by families in the bottom 25% of household incomes.

Not surprisingly, the tax law related to the student loan interest deduction has not kept up with such growth.

The interest paid on student loans has been specifically included as a deductible expense under our tax laws since the Taxpayer Relief Act of 1997. Prior to that, it had been considered non-deductible personal interest, just like interest paid on a credit card, since 1986. Under TRA 1997, taxpayers with student loans could deduct interest paid on student loans as an “above the line” deduction, lowering their adjusted gross income (AGI). The above the line deduction can be taken regardless of whether you itemize.

In 1998, the maximum amount of student loan interest that could be deducted was $1,000; the amount increased to $1,500 in 1999, $2,000 in 2000, and $2,500 for 2001 and the years following. Additionally, under TRA 1997, the deduction was only available for interest payments made during the first five years in which interest payments were required on the loan. In 2001, under the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA), the five year rule was lifted. At the time, the elimination of the five year rule was only temporary, but has since been permanently extended.

As with any tax law, there are a laundry list of rules and limitations to the deduction:

  • If you are married and file Married Filing Separately, you cannot take the deduction.
  • Regardless of your filing status, you cannot take the deduction if you can be claimed as an exemption on anyone else’s tax return, even if you made the student loan interest payments.
  • You must have taken out the loan solely to pay for educational expenses. This means you can’t tack on education costs to a personal loan and expect to deduct the interest.
  • The loan cannot be from a related person or made under a qualified employer plan.
  • The student must be you, your spouse, or a dependent and must have been enrolled at least half time in a degree program at an eligible educational institution.
  • The deduction is phased out for taxpayers with Modified Adjusted Gross Income (MAGI) between $60,000 and $75,000 if single or head-of-household, and $125,000 to $155,000 if married filing jointly.

Recently, a bill was introduced that would double the student loan interest deduction limit for low-income married couples. The Student Loan Interest Deduction Fairness Act, introduced by Rep. Mark Pocan, D-Wisconsin, would allow married couples to deduct $5,000 in student loan interest, the total amount that would have been available to the individuals prior to marriage.

Another bill related to student loan interest, the Bank on Students Emergency Loan Refinancing Act, was recently blocked by the Senate. The bill would have allowed federal and private student loan borrowers to refinance to rates set for first-time borrowers: 3.89% for Undergraduate Direct Loans, 5.41% for Graduate Loans, and 6.41% for PLUS Loans taken out by a student’s parents. The majority of outstanding student loans have interest rates fixed from the time they were taken out. While interest rates are historically low right now, at the time most were issued, federal loan rates were at 6.8% or higher.

With total U.S. student loan debts totaling $1.2 million and one-in-three student loans considered delinquent, this topic will continue to generate a lot of interest from consumer advocates and legislators.

By Janet Berry-Johnson, CPA

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You’re the Lucky Winner! Well, Sort of. Taxation of Prizes and Awards

Posted on October 21 2014 by admin

The question sometimes arises “do I have to pay tax if I win a prize or award from my employer?” Unfortunately, the answer usually makes Uncle Sam the winner as well. So before you take those big winnings with you on a cruise to the Bahamas, it’s good to know what some of the rules are.

Monetary prizes, awards, bonuses and gift certificates, including achievement awards, are generally considered taxable compensation and subject to the full array of employment taxes including federal and state withholding, unemployment tax, and FICA taxes. This includes wellness incentives (i.e. weight loss contests) that are becoming a popular offering by employers. Prizes, bonuses, awards that involve goods or services, such as a vacation trip for meeting a certain goal, also generally result in taxable income.

Now for the part that helps make taxes so complicated. And that is, all the exceptions to the rules. Probably the most widely used exception would be awards and gifts of minimal value. The IRS says that items such as a holiday turkey generally fall under the IRS’s “de minimis” rule. Where if an employer provides an employee with a product or service that costs so little that it would be unreasonable for the employee to account for it, the value is not taxable income. You should note that cash awards and gift cards redeemable for cash, are not included in this exception.

There are other exceptions out there such as awards for safety achievement, so check with your tax adviser. But if you lose some weight and win a prize, not only will your body thank you, so will Uncle Sam for getting a share of your winnings.

By Dale F. Jensen, CPA

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London Embassy Makes Applying for an ITIN a Little Easier

Posted on October 16 2014 by admin

Many foreign taxpayers who need to apply for an Individual Taxpayer Identification Number (ITIN) have struggled to comply with strict new requirements set forth by the IRS. The new requirements insist applicants send in original documents, such as passports or other support, or have these documents certified by the issuing agency. You can review the new requirements in my other blogs by clicking here and here.

Many ITIN Applicants find it difficult or even impossible to send in original documents or to return to the issuing agency to have their documents certified. The U.S. Embassy in London has made the process a little easier for those traveling or living near London. This Embassy will take your completed W-7 and supporting forms and documents, have your passport (or other document) certified, and complete the filing process for you. There is no need for you to leave your passport as they will certify it and return it to you while you are in the Embassy. You also won’t need to send anything to the IRS, since they will take care of all the necessary filing. The London Embassy contact information is as follows:

Internal Revenue Service
American Embassy
24 Grosvenor Square
London W1K 6AH
Phone: [44] (0)20 7894-0477
Fax: [44] (0)20 7495-4224

Please note, these services are specific to London. Not all U.S. Embassies offer this service.

By Jill A. Helm, CPA

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Taxes and International Boycott Operations

Posted on October 15 2014 by admin

U.S. taxpayers who have operations in, with, or related to certain countries participating in boycotts not sanctioned by the U.S. government may be required to report such operations to the IRS. Willful failure to file may result in large penalties, including $25,000 and/or imprisonment.

As of August 20, 2014, the current list of countries that participate in an international boycott is as follows:

  • Iraq
  • Kuwait
  • Lebanon
  • Libya
  • Qatar
  • Saudi Arabia
  • Syria
  • United Arab Emirates
  • Yemen

A report must be filed with the IRS on Form 5713 if you or any of the following persons have operations in or related to a boycotting country or with the government, a company, or a national of a boycotting country.

  • A foreign corporation in which you own 10% or more of the voting power of all voting stock, but only if you own the stock of the foreign corporation directly or through foreign entities.
  • A partnership in which you are a partner.
  • A trust you are treated as owning.

In addition to the reporting requirement, taxpayers participating in boycotts with the above mentioned countries may forfeit certain tax benefits. For example, you must reduce either the total taxes available for the foreign tax credit or the credit otherwise allowable by your foreign taxes resulting from boycott activities. Other tax benefits that may be lost or reduced include: deferral of income from a controlled foreign corporation; deferral of tax of IC-DISC income; exemption of foreign trade income of a foreign sales corporation; and exclusion of extraterritorial income from gross income.

By Jill A. Helm, CPA

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Record Retention: When to Hold ‘Em and When to Fold ‘Em

Posted on October 9 2014 by admin

As the world continuously moves toward digital bill paying, statement delivery, and record retention, why do we still have so much paper? No matter how much of your financial life you move online, there are still some documents you’ll need to maintain, whether in paper form or in a backed-up digital file. But, for how long? Here are some guidelines:

Tax Returns: You should retain tax returns and the supporting documentation for at least seven years. The IRS can audit you for three years from the date you filed your return, six years if they believe you underreported income by at least 25%, or seven years if you claim a loss for bad debt or worthless securities. If you don’t file, or file a fraudulent return, then there is no statute of limitations. If you file a state return, the statute of limitations depends on the state. In Arizona, that is generally four years after the return is filed or required to be filed, whichever is later. Like the IRS, Arizona extends the statute of limitations for six years if you understated your gross income by 25% or more and there is no statute of limitations for a fraudulent return.

Year-end Account Statements: Because these statements show the cost basis of your investment, you’ll want to hold on to them for as long as you own the investment, plus a bit longer to support the sale reported on your tax return. While brokerage houses are now required to report cost basis for securities sold on your year-end 1099-B, shares of corporate stock purchased prior to January 1, 2011 and shares of stock in mutual funds and stock acquired in connection with a dividend reinvestment plan purchased prior to January 1, 2012 are exempt.

Home-related Documents: Keep your purchase and refinance documents as long as you own the property, then an additional seven years as support for your tax return. You should also maintain records for home improvements, additions, and remodels, which can be used to calculate your cost basis if you sell the home or convert it to a rental property.

Insurance Policies: Hold on to your homeowners or renters insurance policies, car, umbrella, and health insurance policies for the policy year. They can be shredded once you receive the renewal. Keep life, disability, and long-term care policies as long as they are in force.

Monthly utility bills: Once you know the bill is correct, you can shred it. However, if you deduct some of these expenses on your tax return (such as for a home office deduction or in the case of a rental property), you’ll want to maintain these with your tax return.

Credit card statements: Again, these can be shredded if the charges are correct, but if there are deductible purchases on the statement (perhaps for medical expenses or business-related expenses), hold on to it for your tax return.

Bank statements and/or cancelled checks: These should be maintained for three years. While you can often obtain statements online from your bank, they may be limited as to how far you can go back or may charge for copies.

Pay stubs: If your employer still gives out paper pay-stubs, these can be shredded after you’ve reconciled them to your W-2 at year end. However, if you’re planning on applying for a mortgage, your lender may ask to see a few months’ worth.

Loan paperwork: As long as you are still paying on a loan, maintain the loan documents and/or contract. Once the loan is paid in full, the lender should give you a pay-off statement. This should be kept indefinitely in case of errors on your credit report.

The following documents should be kept forever. While they can be replaced, it is often a major headache to do so. Maintain them in a firebox or a safety-deposit box:

  • Birth and death certificates
  • Adoption records
  • Pension and retirement plan documents
  • Marriage and divorce papers
  • Military records
  • Wills, powers of attorney and health care proxies
  • Social security cards
  • ID cards and Passports
  • Appraisals for jewelry and other valuables (unless you sell the item)
  • Vehicle titles (for as long as you own the vehicle)
  • Inventories along with videos or photographs of your home’s contents to help with insurance claims in the event of a home fire. This should also be updated once a year.

In general, you should shred any document that contains identifying information such as your name, address, social security number or account numbers. Shred anything with your signature, which could be used to forge documents. Even mailings from your financial institution that don’t contain account numbers should be shredded, since they give fraudsters a little more information that could be used to commit identity theft.

If you prefer to maintain records digitally, make sure they are backed up beyond your computer’s hard drive. In the event of the “blue screen of death”, you’ll need to make sure you still have access to those documents.

By Janet Berry-Johnson, CPA

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Received a Notice from the IRS or a State…Now What?

Posted on October 8 2014 by admin

It appears that more and more notices are being sent out than ever from the IRS and state agencies. Most letters from these agencies don’t make anyone jump for joy when spotted while sifting through the week’s mail. Unless, of course, you are expecting a check back for overpaid taxes, in which case, lucky you.

The first recommendation is to open the notice to see what it entails. Ignoring a notice could lead to heavy penalties and interest on any monies owed that accumulate by the day; so the sooner the reason for the notice is resolved, the less likely you will be paying extra.

Carefully read the notice and follow any instructions given. If you agree with the notice and no money is due, you are not required to respond. If you owe money and agree with the amount, simply write a check and mail it as soon as possible. We recommend you send any check or correspondence by certified mail.

If you disagree with the amount or reason for the notice, call the number given in the upper right hand corner. Make sure to have copies of checks written and the form or tax return the notice pertains to before calling. Always retain a copy of any notice received and notes regarding conversations for your records.

Your accountant can be helpful in resolving any matters related to notices received. Be sure to get them involved as soon as possible. They will ask that you sign a power of attorney in order to speak on your behalf, so be prepared to sign a form.

Don’t fall prey to any scams. The IRS will always contact you first by mail, not by phone or email. Click here for more details on scams.

By Julie Duley

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Proceed with Caution When Helping Children Purchase a Home

Posted on October 7 2014 by admin

According to The Project on Student Debt, in 2013 more than 7 in 10 college graduates carried an average student debt of $29,400. Add to that the sluggish job market that promises low starting wages and little job security, and it is very difficult for first-time homeowners to jump into the market.

But there are some tough questions you should ask – and answer – before jumping in with home loan help. How much will your help cost you both now and in the future? Is this the right time for your child to purchase a home? Are you giving up more than you can afford? Can you continue to meet your own needs now and still maintain a comfortable retirement in the future? Are you prepared for the possibility of never seeing the money again? Do you intend your help to be a gift or a loan?

If you are planning to gift the funds, you are allowed to give $14,000 (in 2014) to your child per year without it counting against your lifetime gift-tax exemption. If your child is married you could give up to $56,000 in a year ($14,000 from you to your child and $14,000 from you to their spouse, plus $14,000 from your spouse to your child and $14,000 from your spouse to your child’s spouse). The advantage of a gift is that it does not add to the child’s debt burden and therefore should not hurt the child’s chances of qualifying for a loan. However, you probably need to make sure the gift is given long before your child tries to buy a home as some banks want to make sure the money is not a loan, which will affect their debt-to-asset ratio.

If the funds are a loan, be sure to fully document the note. You should have your attorney review the note to be sure it is legal and that it includes all of the necessary information including the repayment terms, the interest rate, and the consequences if the note is not repaid timely. The note must include a reasonable interest rate or risk being reclassified as a gift by the IRS.

There are a few more options to consider including co-signing a loan, having a shared-equity arrangement, and setting up a rent-to-own plan. Keep in mind that co-signing a loan should only be done if you are confident your child has stable employment and can meet their mortgage payments. You may be on the hook for the mortgage payments if your child fails to make them which could affect your standard of living and potentially impact your retirement plans. Be sure to consult your attorney if you decide to go the route of rent-to-own or shared equity to be sure all legal contingencies are covered and help mitigate your risk in the event anything goes wrong.

By Pamela Wheeler, EA

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Tax Aspects of Employee Terminations

Posted on October 2 2014 by admin

Although taxes probably are the last thing on your mind after losing or quitting a job, tax aspects of your changed personal and professional circumstances can be significant. Depending on your situation, the tax aspects can be complex, and require you to make decisions that can affect your tax picture this year and for years to come. Here are just a few of the factors to think about.

Although severance pay is taxable and is subject to federal income tax withholding, some elements of a severance package may be specially treated. For example:

  • If you sell stock acquired by way of an incentive stock option (ISO), part or all of your gain may be lightly taxed long-term capital gain, depending on whether you meet a special dual holding period.
  • If you received or will receive what is commonly referred to as a golden parachute payment, you may be subject to an excise tax equal to 20% of the portion of the payment that’s treated as an “excess parachute payment” under extremely complex rules.
  • The value of job placement assistance you receive from your former employer usually is tax-free. However, the assistance is taxable if you had a choice between receiving cash or outplacement help.

You should also be aware that under the so-called COBRA rules, most employers that offer group health coverage must provide continuation coverage to most terminated employees and their families. The cost of any premium you pay for insurance that covers medical care is a medical expense and as a general rule, results in a tax benefit to you if you claim itemized deductions and your total medical expenses exceed 10% (7.5% for those 65 and older) of your adjusted gross income. If your ex-employer pays for some of your medical coverage for a period of time following termination, you will not be taxed on the value of this benefit.

Employees who terminate employment also need tax planning help to determine the best course of action for amounts they’ve accumulated in retirement plans sponsored by their former employer. For most, a tax-free rollover to an IRA is the best move, if the terms of the plan allow a pre-retirement payout. If you are under age 59 1/2, and must make withdrawals from your company plan or IRA to supplement your current income, there may be an additional 10% penalty tax to pay unless you’re positioned to qualify under one of several escape hatches.

Further, any loans you’ve taken out from your employer’s retirement plan, such as a loan from a 401(k) plan, may be required to be repaid immediately, or within a specified period of your termination of employment, or be treated as if it were in default. If the balance of the loan is not repaid within the required period, it will typically be treated as a taxable deemed distribution.

Finally, the expenses, including travel expenses, of hunting for a new job in the same trade or business are deductible as miscellaneous itemized deductions if certain requirements are met.

By Scott Clouse, CPA

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Whose Property Is It?

Posted on October 1 2014 by admin

The IRS filed liens against Christopher Deinlein who owed taxes to the IRS. Chris was a 1/3 beneficiary in his mother’s estate. Presumably to prevent the IRS from receiving his share of the estate’s assets, Chris disclaimed his interest in the estate under Kentucky law. The IRS sought to seize his 1/3 interest. The District Court held that the assets due to an estate beneficiary can still be reached by the IRS in payment of the beneficiary’s delinquent federal taxes, even if the beneficiary disclaims the estate interest.

What’s interesting in this case is that typically, state disclaimer law creates the legal fiction that the disclaimant predeceased the decedent. On its face, this would appear to prevent a creditor of the disclaimant from reaching the disclaimed assets since the disclaimant is never treated as owning the disclaimed assets.

However, when the creditor is a nonfederal creditor, whether this holds up is a question under state law. But when the creditor is the IRS, this brings in a blend of state and federal law and a determination of property rights.

The District Court walked through several steps to reach its final conclusion, including looking to state law to determine what rights the taxpayer has in the property the IRS seeks to reach. It then applied federal law to determine whether such state rights qualify as “property or rights to property” under federal law. It determined since a potential disclaimant inevitably exercises dominion over the property simply by determining whether the subject property will remain with him or pass to a known other, the disclaimer statute gives the taxpayer the power to channel the estate’s assets. Therefore, the taxpayer retained some rights in the property under state law, despite the disclaimer, and the property can be reached by the IRS in payment of the beneficiary’s delinquent federal taxes.

By Pamela Wheeler, EA

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There is nothing more complex than the world of taxes. We know this and yet we chose careers where we face these issues everyday. We get questions day in and day out about new tax laws, forms and news items and how they affect everyday people and businesses. Well, here at Henry & Horne, LLP we have set out to do what we do best; help everyday people understand what is going on in the world of state, local, federal, estate and international taxation. We will provide these weekly posts and we encourage you to give us feedback on those posts as well as letting us know what else you would like to know more about. Welcome to "Tax Insights." We hope you find this blog informative and worthy of your time.

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