A Choice for Taxpayers: The State and Local Tax Deduction

Posted on July 2 2015 by admin

Now that you finally have the time, you decide to review the tax return you recently filed. In doing so, you know that you supplied the preparer with the amount of sales tax that you paid on the new car sitting in your driveway, but to your dismay it looks like there has been an error. There is nothing on your return that that is designated as sales tax at all! Before you pick up the phone or write the e-mail, you should take a look at line 5 in your itemized deductions. Chances are, if you live in a state where there is a state income tax, your deduction was based on these rather than the state sales tax.

State and local taxes have been allowed as a deduction since the inception of the federal income tax system in 1913. For tax years 2014 and prior, taxpayers were allowed to take an itemized deduction for either the state and local income taxes or the state and local general sales taxes they paid. It is an either or situation. The deduction for state and local general sales taxes has faced numerous provisions that would eliminate the deduction; however, it has been saved in the last minute congressional dealings numerous times. Under current law, the deduction for state and local sales tax expired at the end of 2014. While nothing is ever a given, it would seem likely that there would again be an extension of this deduction given heavily populated states such as Texas do not have a state income tax.

So, how will you know if you would get a bigger deduction if you elected to use the sales tax deduction? You can base your sales tax deduction on the actual amount of sales tax paid during the tax year. This requires that you retain receipts that show the amount of general sales taxes paid. If you are like me, that could be a lot of paper by the end of the year. There must be an easier way, and there is. The IRS has created tables that can be used to determine the amount of state and local sales tax deduction available to you. The tables are built on the average consumption of taxpayers on a state-by-state basis, taking into account your filing status, adjusted gross income, number of dependents and state and local sales tax rates. There is a great tool on the IRS website that can be used to compute the state and local general sales tax deduction. The “Sales Tax Deduction Calculator” can be accessed on the IRS website-IRS.gov by entering sales tax deduction calculator in the search box. In addition to the amount calculated from the tables, taxpayers are allowed to add the sales tax paid on motor vehicle purchases and boats. Additionally, the IRS allows the tax paid on aircraft and homes, home building materials and substantial additions to or major renovations to the home. There are additional requirements related to the sales tax on expenditures related to homes, so be sure to check with your tax professional to verify the sales tax you paid qualifies. Foreign sales tax you pay is not deductible.

Your decision as to which type of tax to deduct is not binding on you. One year you may choose to deduct the state and local income tax and in the next year the state and local sales tax. The deduction for state and local taxes is a preference item in the calculation of the alternative minimum tax. If you are subject to this tax, you will find that the benefit of your deduction is reduced or, in some cases, eliminated in its entirety.

As the deduction for the state and local sales taxes has expired, this may be a moot point. The fate of the state and local sales tax deduction for tax years after 2014 will likely not be known until the end of 2015. If the deduction rises like the phoenix from the ashes, this however, may well be an area for you to look at when preparing your individual income tax return next year and is most certainly a choice you have for your 2014 return. Who doesn’t like choices?

By Cheryl Dickerson, CPA

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Kiddie Tax

Posted on July 1 2015 by admin

The “Kiddie Tax” was enacted in 1986 and was intended to close a tax loophole that allowed a small number of wealthy parents to reduce their tax bill by shifting income-producing assets to their young children in lower a tax bracket. Originally the law provided that, for any child who was under the age of 14 at the end of the tax year, any unearned income (such as dividends and interest) of the child over $2,000 would be taxed at the higher of the child’s marginal tax rate or the parent’s. In May of 2006, Congress passed the Tax Increase Prevention and Reconciliation Act, raising the application of the kiddie tax from under age 14 to under age 18. Just a year later, the Small Business Work Opportunity and Tax Act of 2007 increased the age to under 19, or 24 for full-time students. The rising age application may have served its purpose of raising tax revenues, but it also lost the original intent of the legislation and more often hurts middle class families paying for college.

The age of 14 in the original legislation was chosen first because it was the age at which children may work in certain employment under the Fair Labor Standards Act and second, to minimize complexity. It was thought that children above the age of 14 were more likely to have earned income, and thus had substantially more complicated financial situations. The later increases in the age from 14 to 23 vastly increased the number of taxpayers required to deal with the complexity. According to a 2010 report by the President’s Economic Recovery Advisory Board, about half of kiddie tax filers at that time were college students, and about 40% were between the ages of 14 and 18, meaning that only 10% of the filers were the intended targets of the original legislation.

The law provides a method for parents to “simplify” reporting of their children’s unearned income by including the child’s income on the parent’s own return instead of filing a separate return for the child. This “simplified” method comes with its own set of complexities: the child’s investment income can consist only of interest, dividends, and certain capital gain distributions. Sales of securities will make the child’s income ineligible for reporting on the parents return. Also, no estimated tax payments can have been made in the child’s name. Even if eligible for the simplified method, reporting the child’s income on the parent’s return can have negative tax consequences. If the child received qualified dividends or capital gain distributions, the election may result in a higher tax than if a separate return for the child was filed. Also, choosing to include the child’s income on the parent’s return may increase the parent’s adjusted gross income (AGI) to the extent that it may trigger the phase-out of deductions, personal exemptions, and credits on the parent’s return that are based on AGI. It can also reduce IRA contributions and increase the taxable portion of Social Security benefits.

Filing a separate return for the child presents its own set of challenges. Parents with more than one child subject to the Kiddie Tax must determine the tax attributable to each child and a child with an otherwise simple return cannot file until the parent’s return is filed.

Often, a child’s income is not a result of income shifting from a parent, but comes from an inheritance, insurance settlement, or gifts from a grandparent or other family member. Early drafts of the original legislation attempted to address these circumstances by making a distinction between parental and non-parental-source incomes, but such a segregation of assets was (correctly) determined to be an “administrative and compliance nightmare” and the distinction was dropped.

There are still a few methods available to reduce or eliminate a hit from the Kiddie Tax. First, if possible, keep the dependent child’s unearned income under $1,900 per year by choosing investments for your children that don’t generate current taxable income, such as growth stocks and mutual funds geared toward capital appreciation. Second, defer gifts of cash and investments to the dependent child until they are age 24, or 19 if not a full-time student. Finally, for college savings, take advantage of 529 accounts instead of UTMA custodial accounts, as the investments in 529 accounts can grow and be withdrawn tax free as long as the funds are used for qualified education expenses.

By Janet Berry-Johnson, CPA

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Revised Arizona Form 5005

Posted on June 30 2015 by admin

There have been a lot of sales tax updates for Arizona businesses in the construction/contracting industries. The modified Contractor’s Certificate (Form 5005) is yet another item you need to consider.

Arizona Form 5005 is a certificate that provides subcontractors with the validation required for tax exemption of a particular project, for a period of time, or until revoked. The certificate establishes responsible party for the transaction privilege tax. The form must be completed by the prime contractor assuming the contracting transaction privilege tax liability for any given contracting project. The Arizona Department of Revenue has revised Arizona Form 5005 as of June 10, 2015. The new Form 5005 may be issued by either a prime contractor, a general contractor working on an MRRA project or the person assuming the responsibility of remitting the tax due on the prime contracting project.

Some of the new exemption certificate rules require contractors to prove: (1) they do not work directly for the owner of the real property, but work on a job that is in control of a taxable prime contractor; (2) they may only use the exemption certificate for materials that will be incorporated into a taxable construction project; (3) may not have a delinquent tax balance; and (4) they must submit documentation to the Department showing that it meets these conditions. If a prime contractor does not issue Form 5005 to a subcontractor, the subcontractor should assume the project is not a modification and the retail tax will be due on materials purchased.

You can find the new form 5005 at Arizona Department of Revenue’s website http://www.azdor.gov/.

By Shant Andonian

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Supreme Court Says No to Double Taxation!

Posted on June 25 2015 by admin

If you have ever earned income in another state, you may have been unpleasantly surprised when your tax adviser informed you that you owed taxes to two states – to the state where the income was earned and to your state of residency. What?! How can this double taxation be?

The concept of double taxation seems unfair to taxpayers and in most cases, the situation is resolved by State #1 giving you a tax credit for the taxes paid to State #2. My state of residency, Arizona, gives you a tax credit for taxes paid to 40 other states and taxes paid to foreign countries.

However, some states also have “county” and “city” income taxes and have not allowed its residents to claim a credit on their resident tax return for taxes paid to another state.

In May, the United States Supreme Court ruled that Maryland cannot impose double taxation on residents by denying them a full credit for certain taxes paid on income earned in other states.

In a 5-4 ruling, the justices sided with taxpayers Brian and Karen Wynne in finding that Maryland’s taxation policy violated the U.S. Constitution by discriminating against interstate commerce, upholding lower-court decisions favoring the couple.

Maryland offers a tax credit for income taxes paid by residents to other states. But it said the credits available to the Wynnes for their out-of-state income did not apply to the couple’s county income tax.

The Wynnes were denied the full $84,550 tax credit they sought based on their healthcare business that paid taxes in 39 states in 2006. Maryland said they owed around $25,000.

The Supreme Court ruling could reduce tax revenues collected by local jurisdictions in Maryland by up to $50 million a year, according to a brief filed by the U.S. Conference of Mayors and other groups that backed the state.

New York City, Detroit and Philadelphia are among the other cities that impose income taxes and do not provide a full credit for taxes paid out of state.

It remains to be seen how these governments will respond to the new Supreme Court ruling and the many applications for tax refunds that are sure to come!

By Melinda Nelson, CPA

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New AZ Law Establishes Tax Recovery Program in 2015

Posted on June 24 2015 by admin

Do you owe money to the State of Arizona? If you do, you can minimize that amount by taking advantage of a new tax recovery program!

On March 12, 2015 the State of Arizona passed Senate Bill 1471 to establish a tax recovery program for the Arizona Department of Revenue. The program will begin September 1, 2015 and continue through October 31, 2015. During this period, all taxpayers who meet the application requirements will be eligible to have their civil penalties and tax interest associated with their tax liabilities for any period before January 1, 2014 for annual filers and February 1, 2015 for all other filers reduced or waived. Taxpayers who apply for the tax amnesty will not, however, be eligible for any refunds or credits that would reduce their tax liability for the taxable years to which they are applying.

How to apply:

1. Fill out an application from the Arizona Department of Revenue and include any returns and reports for the taxable periods for which you are applying. If you have insufficient information to complete a full income tax return, you may qualify by completing a gross income tax return.

2. If you already have an established tax liability, include the most recent notices or other related documentation you have received.

3. File during the amnesty period and include a payment for the tax due.

For more information: http://www.azleg.gov/legtext/52leg/1r/bills/sb1471s.pdf

By Amber White

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No Longer Tax Free – Nevada Enacts Commerce Tax

Posted on June 23 2015 by admin

Nevada has been a favored place to transact business as an income tax-free state. That all ended on June 10, 2015, when Governor Sandoval signed a bill enacting a new “Commerce Tax” applicable to each “business entity” with Nevada gross revenue exceeding $4,000,000 in a taxable year.

The Nevada Commerce Tax is a gross revenue tax subject to specific statutory exceptions including income from intangibles. The tax is applied to revenue over $4,000,000. Nevada gross revenue is generally measured by market-based sourcing.

The applicable tax rate varies depending upon the industry category in which the business entity is “primarily engaged.” Tax rates range from .051% for mining to .331% for railroads, so classification of industry type will be important.

The tax applies on an entity-by-entity basis on “each business entity whose ‘Nevada gross revenue’ in a taxable year exceeds $4,000,000.” For this purpose, the term “business entity” is defined to include a “corporation, partnership, proprietorship, limited liability company, business association, joint venture, limited liability partnership, business trust, professional association, joint stock company, holding company and any other person engaged in business.” This includes individuals who file Form 1040 Schedule C, E or F as well as single member LLCs.

Unlike your typical tax period, Nevada Commerce Tax is based on a fiscal year of July 1 to June 30th with tax report due on August 14th, so businesses will need to track revenue on that basis.

By Melinda Nelson, CPA

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The Benefits of Cost Segregation Studies

Posted on June 18 2015 by admin

Have you recently purchased a building? Have you done any build-out work on an existing building? Have you recently remodeled? Are your leasehold improvements properly classified for tax purposes? Are you looking to enhance your cash flow? If you answered yes to any of these questions, then you may benefit from having a cost segregation study performed.

A cost segregation study captures all of the costs associated with a building or building improvement and breaks them out into their appropriate personal or real property classification. As a result of the cost segregation study, a business owner can depreciate the personal property over a shorter period of time (5, 7, or 15 years) and benefit from the deductions up front rather than allowing the total construction cost to be depreciated over the life of a building, which is 39 years. The tax savings generated by depreciating more assets as personal property usually more than make up the extra cost incurred in conducting the study.

Completing a cost segregation study generally involves professional engineers reviewing blueprints and AIA payment application forms. The engineers review all the costs associated with the building or building improvement. Costs are broken out into various categories: indirect costs, direct costs related to personal property and direct costs related to real property. Indirect costs include architect fees, interior design fees, engineering costs and other miscellaneous construction costs. Direct costs related to personal property include machinery and equipment and furniture and fixtures. Direct costs related to real property include the building, fire protection and alarm systems, flooring, doors, and the HVAC system.

The goal for the cost segregation study is to identify costs related to real property that can be reallocated to short-life personal property. An example of this could be identifying electrical or plumbing costs that may be related to the operation of machinery and equipment, which is generally depreciated over 5 years.

Once the real property costs are reallocated, the final step is to allocate the indirect costs to the personal and real property buckets. Again, the end result is an allocation that provides a significant portion to personal property that can be depreciated over 5, 7, or 15 years. This reallocation of costs ultimately provides greater cash flow to the business owner by reducing the overall tax burden.

By Kelly Lynch, CPA

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The Importance of Adequate Tax Records

Posted on June 17 2015 by admin

Failure to generate and keep adequate tax records to support a certain position can have costly results as detailed recently in Tax Court Memo 2015-95.

In this case, a husband and wife purchased an oceanfront condo as a seasonal home never intending it to be their primary residence. A few years later, an unfortunate family tragedy prompted them to no longer stay at the property. Rather than sell it, the family decided to rent it out because they were confident in the future appreciation of the property while generating some cash in the short term.

While the condo was listed for rent with the development’s real estate company (the area was still being developed), efforts to rent it were limited to showing the property as a model home and letting prospective clients know that it was available to rent. After failing to rent it, the condo was listed for sale with another broker until it sold. In the interim, the couple claimed various deductions related to the condo on Schedule E and took a loss for its sale. Not only were all these losses disallowed, but accuracy-related penalties applied as well.

The tax court held there was insufficient evidence to support the condo had been converted to a rental property. While the property was featured in a portfolio of rental properties in the realty company’s office, no evidence was provided to show efforts the realtor took to market the property outside of the development. Nor was the taxpayer even able to provide a copy of the agreement with the realty company that attempted to rent it out. And no evidence was presented that the second realty company attempted to rent it out. In the end, failure to provide such rudimentary evidence resulted in a costly result to the taxpayers.

By Dale F. Jensen, CPA

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Is your small business impacted by the Affordable Care Act?

Posted on June 16 2015 by admin

Most employers have fewer than 50 full-time employees or full-time equivalent employees and are therefore not subject to the employer shared responsibility provision of the Affordable Care Act.

If an employer has fewer than 50 full-time employees, including full-time equivalent employees, on average during the prior year, the employer is not an applicable large employer (ALE) for the current calendar year. Therefore, the employer is not subject to the employer shared responsibility provisions or the employer information reporting provisions for the current year. Employers with 50 or fewer employees can purchase health insurance coverage for employees through the Small Business Health Options Program – better known as the SHOP Marketplace.

Calculating the number of employees is especially important for employers that have close to 50 employees or whose workforce fluctuates throughout the year. To determine workforce size for a year, an employer adds its total number of full-time employees for each month of the prior calendar year to the total number of full-time equivalent employees for each calendar month of the prior calendar year, and divides that total number by 12.

Employers that have fewer than 25 full-time equivalent employees with average annual wages of less than $50,000 may be eligible for the small business health care tax credit if they cover at least 50 percent of their full-time employees’ premium costs and generally, after 2013, if they purchase coverage through the SHOP.

All employers, regardless of size, that provide self-insured health coverage for themselves or their employees must file an annual information return reporting certain information for individuals they cover. The first returns are due to be filed in 2016 for coverage provided during 2015.

To answer your questions about the ACA and to find out more about what your obligations are pertaining to the reporting requirements or the shared responsibility requirements of the ACA, please contact your Henry & Horne, LLP business adviser.

By Gary W. Fleming, CPA

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Pushing Tax Reform – TPR De Minimis Safe Harbor Threshold

Posted on June 11 2015 by admin

The American Institute of Certified Public Accountants (AICPA) has recently been participating in U.S. House of Representatives, Committee on Small Business hearings on tax reform with the goal of ensuring that main street isn’t left behind. One area of focus in this regard has to do with rules relative to the de minimis safe harbor threshold for tangible property regulations.

The safe harbor allows taxpayers to set a minimum capitalization amount under which amounts are not capitalized, with the objective being relief from compliance burdens placed on small businesses. Currently, the de minimis safe harbor threshold amount for taxpayers without an “applicable financial statement” (one example being a financial statement required to be filed with the SEC) is $500. The AICPA has recommended this amount be increased to $2,500 and additionally, that it be adjusted on an annual basis for inflation.

The AICPA has pointed out that many small business owners have stated that repairs are consistently over $500 (parts are at least $250 and labor is at least $250). That a cell phone or printer can easily cost over $500 and are replaced quickly, making it administratively impractical and costly to track. The $500 threshold being too low to effectively achieve any reduction in the administrative burden of small businesses. A recent informal survey showed that many small businesses have a minimum capitalization threshold in excess of $500 anyway since few items costing $500 or less have a useful life greater than one year.

By Dale F. Jensen, CPA

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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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