Category: Tax Services

Posted on Sep 13, 2016

Fall is a good time to pause and review your financial planning strategy. A lot can happen in a year. If your personal life, market conditions or tax laws have changed, you may need to revise your long-term financial plans. Here are some retirement and estate planning considerations that may be worthwhile.

IRS Proposal Threatens Discounts on Transfers of Family-Owned Business

For years, proactive taxpayers have used family limited partnerships (FLPs) and other family-owned business entities in estate planning. If properly structured and administered, these estate-planning tools allow high net worth individuals to transfer their wealth to family members and charities at a substantial discount from the value of entities’ underlying assets. Examples of assets that may be contributed to an FLP include marketable securities, real estate and private business interests.

Important Note. The FLP must be set up for a legitimate purpose (such as protecting assets from creditors and professional-grade asset management) to preserve valuation discounts.

Valuation discounts on FLPs relate to the lack of control and marketability associated with owning a limited partner interest. These interests are typically subject to various restrictions under the partnership agreement and state law.

The IRS has targeted FLPs and other family-owned businesses in various Tax Court cases. To strengthen its position in court, the IRS issued a proposal in August that could significantly reduce (or possibly eliminate) valuation discounts for certain family-owned business entities. Among other changes, the proposal would add a new category of restrictions that would be disregarded in valuing transfers of family-owned business interests.

If finalized, the proposed changes won’t go into effect until 2017 (at the earliest). So there still may be time to use these estate-planning tools and be grandfathered in under the existing tax rules. If you’ve been considering setting up an FLP or transferring additional interests in an existing one, it may be prudent to act before year end.

Contact your estate planning advisor for more details on this proposal — or to utilize this strategy before any new restrictions go into effect.

Roth IRAs

Do you understand the key differences between traditional and Roth IRAs? Roth IRAs can be an effective retirement-saving tool for people who expect to be in a higher income tax bracket when they retire. Here’s how it typically works.

You open up a Roth IRA and make after-tax contributions. The tax savings come during retirement: You don’t owe income taxes on qualified Roth withdrawals.

As an added bonus, unlike with traditional IRAs, there’s no requirement to start taking annual required minimum distributions (RMDs) from a Roth account after reaching age 70 1/2. So you’re free to leave as much money in your Roth account as you wish for as long as you wish. This important privilege allows you to maximize tax-free Roth IRA earnings, and it makes the Roth IRA a great asset to leave to your heirs (to the extent you don’t need the Roth IRA money to help finance your own retirement).

The maximum amount you can contribute for any tax year to any IRA, including a Roth account, is the lesser of:

  1. Your earned income for that year, or
  2. The annual IRA contribution limit for that year. For 2016, the annual IRA contribution limit is $5,500, or $6,500 if you’ll be age 50 or older as of year end.

If you’re married, both you and your spouse can make annual contributions to separate IRAs as long as you have sufficient earned income. For this purpose, you can add your earned income and your spouse’s earned income together, assuming you file jointly. As long as your combined earned income equals or exceeds your combined IRA contributions, you’re both good to go.

Unfortunately, your ability to make annual Roth contributions may be reduced or eliminated by a phaseout rule that affects high-income individuals. But you may be able to circumvent this rule by making an annual nondeductible contribution to a traditional IRA and then converting the account into a Roth IRA. In this indirect fashion, high net worth individuals can make Roth contributions of up to $5,500 if they’re under age 50 or up to $6,500 if they’re at least 50 and younger than 70 1/2 as of the end of the year. (Once you hit 70 1/2, you become ineligible to make traditional IRA contributions, and that shuts down this strategy.)

If you’re married, you can double the fun by together contributing up to $11,000 or up to $13,000 if you’re both at least 50 (but under age 70 1/2). There are various rules and restrictions to using this strategy, and it may be less advantageous if you have one or more existing traditional IRAs. So, consult with your tax advisor before attempting it.

Self-Directed IRAs

Self-directed IRAs expand the menu of investment options available in a typical IRA. For instance, with a self-directed IRA you may be able to include such alternatives as hedge funds, real estate and even equity interests in private companies. These types of investments often offer higher returns than traditional IRA investment options.

But self-directed IRAs aren’t a free-for-all. The tax law prohibits self-dealing between an IRA and “disqualified” individuals. For example, you can’t lend money to your IRA or invest in a business that you, your family or an IRA beneficiary controls. The consequences for self-dealing can be severe, so consult with your financial advisor before making the switch.

Deductible Losses on Underperforming Stocks

Do you own stocks and other marketable securities (outside of your retirement accounts) that have lost money? If so, consider selling losing investments held in taxable brokerage firm accounts to lower your 2016 tax bill. This strategy allows you to deduct the resulting capital losses against this year’s capital gains. If your losses exceed your gains, you will have a net capital loss.

You can deduct up to $3,000 of net capital loss (or $1,500 if you are married and file separately) against ordinary income, including your salary, self-employment income, alimony and interest income. Any excess net capital loss is carried forward to future years and puts you in position for tax savings in 2017 and beyond.

Gifts of Appreciated Assets

Suppose you are lucky enough to have the reverse situation: You own stocks and other marketable securities (outside of your retirement accounts) that have skyrocketed in value since they were acquired. Taxpayers in the 10% or 15% income tax brackets can sell the appreciated shares and take advantage of the 0% federal income tax bracket available on long-term capital gains. Keep in mind, however, that depending on how much gain you have, you might use up the 0% bracket and be subject to tax at a higher rate of up to 20%, or 23.8% when considering the Medicare surcharge that may apply.

While your tax bracket may be too high to take advantage of the 0% rate, you probably have loved ones who are in the lower tax brackets. If so, consider gifting them assets to sell.

Important Note. Gains will be considered long-term if your ownership period plus the gift recipient’s ownership period equals at least a year and a day.

Giving qualified-dividend-paying stocks to family members eligible for the 0% rate is another tax-smart idea. But before making a gift, consider the gift tax consequences.

The annual gift tax exclusion is $14,000 in 2016 (the same as 2015). If you give assets valued at more than $14,000 (or $28,000 for married couples) to an individual during 2016, it will reduce your $5.45 million gift and estate tax exemption — or be subject to gift tax if you’ve already used up your lifetime exemption. Also keep in mind that if your gift recipient is under age 24, the “kiddie tax” rules could potentially cause some of his or her capital gains and dividends to be taxed at the parents’ higher rates.

Charitable Donations

Charitable donations can be one of the most powerful tax-savings tools because you’re in complete control of when and how much you give. No floor applies, and annual deduction limits are high (20%, 30% or 50% of your adjusted gross income, depending on what you’re giving and whether a public charity or a private foundation is the recipient).

If you have appreciated stock or mutual fund shares that you’ve owned for more than a year, consider donating them instead of cash. You can generally claim a charitable deduction for the full market value at the time of the donation and avoid any capital gains tax hit.

If you own stocks that are worth less than you paid for them, don’t donate them to a charity. Instead, sell the stock and give the cash proceeds to a charity. That way, you can generally deduct the full amount of the cash donation while keeping the tax-saving capital loss for yourself.

Life Changes

Have there been any major changes in your personal life, such as a recent marriage or divorce, the birth or adoption of a new child, or a death in the family? If so, you may need to revise the beneficiaries on your retirement accounts and life insurance policies. You also may need to update your will and power of attorney documents.

Life changes can be stressful, and it’s very common for these administrative chores to be overlooked. But failure to update financial plans and legal documents can lead to unintended consequences later on, either when you die or if you become legally incapacitated and need someone else to make certain decisions on your behalf.

Got Questions?

These are just a handful of financial issues to consider at year end. Your financial and legal advisors can run through a more comprehensive checklist of planning options based on your personal circumstances. Call Cornwell Jackson to schedule a meeting as soon as possible, before the hustle and bustle of the holiday season starts.

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Posted on Aug 23, 2016

tax planning

Say an IRA is inherited by multiple individual beneficiaries or by one or more individuals and one or more charities or other beneficiaries that aren’t “natural persons.” How do these scenarios affect the rules for required minimum distributions (RMDs) that apply after the IRA owner dies? And how can you optimize the tax results for individual beneficiaries?

Here, we answer these questions and explain the importance of the fast-approaching deadline on September 30, 2016, that must be met to change beneficiaries for IRAs that were owned by individuals who died in 2015.

Required Distribution Rules and Penalties for Noncompliance

After an IRA owner’s death, the account beneficiary or beneficiaries must take RMDs each year. RMDs from traditional accounts are generally subject to tax (unless the beneficiary is tax-exempt, such as a charity, or the distribution is attributable to nondeductible contributions), and each withdrawal also reduces the amount left in the account that can continue to grow tax-deferred (or tax-free, in the case of a Roth IRA).

If the RMD rules aren’t followed for a tax year in question, the IRS can assess a penalty equal to 50% of the shortfall (the difference between the required amount and the amount that was actually withdrawn during the year, if anything). That’s one of the most expensive tax penalties on the books. So, complying with the RMD rules isn’t something that can be ignored with impunity.

Inherited IRAs with Multiple Individual Beneficiaries

An inherited IRA is said to have multiple individual beneficiaries when more than one individual is designated as a primary co-beneficiary. For RMD purposes, however, the beneficiaries of a deceased IRA owner’s account aren’t finalized until September 30 of the year following the account owner’s death. This rule allows for creative planning options to achieve better tax results for the beneficiaries. Here are some examples.

When the account owner died before the RBD. The latest date for an original traditional account owner’s initial RMD is April 1 of the year after he or she turns age 70½. That April 1 deadline is referred to as the “required beginning date” (RBD). When the original account owner dies before the RBD (say, at age 70 or younger), beneficiaries can usually follow the life expectancy rule to calculate their annual RMDs.

How do you calculate RMDs using the life expectancy rule? When all the IRA beneficiaries are individuals, the general rule is that RMDs for each year are calculated using the single life expectancy figures for the oldest beneficiary. The RMD for each year is calculated by dividing the IRA balance as of December 31 of the previous year by the oldest beneficiary’s remaining life expectancy as set forth in IRS tables. The RMD is then split up between the beneficiaries based on their account ownership percentages.

This rule isn’t optimal for a younger beneficiary who wants to stretch out the inherited IRA’s tax advantages by taking smaller RMDs over his or her longer life expectancy. Thankfully, IRS regulations allow a postmortem planning solution: After the IRA owner dies, the IRA can be divided into separate IRAs for each beneficiary.

This strategy is implemented using tax-free direct transfers from the original IRA into new IRAs set up for each beneficiary. That way, a younger beneficiary can take smaller RMDs based on his or her longer life expectancy figures. In turn, this setup allows the younger beneficiary to keep his or her tax-saving IRA going longer.

However, any direct transfers to split up the account must be completed by September 30 of the year after the year of the IRA owner’s death. So if the owner died in 2015, the deadline to divide up the account for tax-saving results is September 30, 2016.

When the account owner died on or after the RBD. A different set of rules applies if the owner of a traditional IRA dies on or after the RBD (for example, at age 72 or older). The first order of business is calculating and withdrawing the RMD for the year of the account owner’s death. (If the account owner died in 2015, the RMD should have been taken last year.)

For subsequent years, RMDs are usually calculated using the beneficiary’s life expectancy figures as set forth in IRS tables. However, if there are multiple individual beneficiaries, RMDs for subsequent years are calculated using the oldest beneficiary’s life expectancy figures.

Once again, this rule isn’t optimal for a younger beneficiary who wants to stretch out the inherited IRA’s tax advantages by taking smaller RMDs over his or her longer life expectancy. Fortunately, again relief can be found in the IRS regulations allowing a deadline of September 30 of the year after the year of the IRA owner’s death to split the IRA into multiple accounts.

Here’s an example of the postmortem RMD planning permitted under this rule.

Example 1: Inherited IRA with Multiple Individual Beneficiaries

Uncle Henry was 73 years old when he died in 2015. His traditional IRA has two equal beneficiaries: son Iggy (age 53) and niece Jenny (age 38). Under the RMD rules that apply for 2016 and beyond, Jenny can achieve better tax results for her share of the inherited IRA if the account is split up into two accounts: one for her and one for Iggy. That way, Jenny can calculate her annual RMDs using her longer life expectancy figures, which will result in smaller RMD amounts and a longer tax-saving life for the inherited IRA. However, the IRA must be divided into separate accounts by no later than the upcoming deadline of September 30, 2016.

When the account is a Roth IRA. To calculate RMDs from an inherited Roth IRA, follow the rules for account owners who die before the RBD. Those rules apply regardless of how old the Roth IRA owner was when he or she died. Again, if there’s a younger beneficiary who’d like to take advantage of his or her longer life expectancy, the Roth IRA can be split up by the September 30 deadline.

Inherited IRAs with a Nonhuman Beneficiary

If an IRA has one or more nonhuman beneficiaries (other than certain types of trusts), it’s the same as having no beneficiaries for RMD-calculation purposes — even when one or more human individuals are also named as beneficiaries.

In this scenario, when the IRA owner dies before the RBD, the account must be completely liquidated by December 31 of the fifth year following the year of the account owner’s death. Obviously, the five-year rule curtails the tax-saving life of the inherited account for any human beneficiaries.

When the account owner dies on or after the RBD — for example, at age 72 or older — the first order of business is calculating the RMD for the year the account owner died. (Again, if the account owner died in 2015, the RMD should have been taken out last year.) RMDs for subsequent years are calculated using the deceased account owner’s remaining life expectancy as if he or she were still alive.

Unfortunately, this rule also results in less-than-optimal tax results for any human beneficiaries who are younger than the now-deceased account owner. They’ll have to take larger RMDs each year, which will deplete the tax-saving IRA more quickly.

The problem can be resolved by paying out the non-natural beneficiary in a lump sum and then removing that beneficiary by September 30 of the year after the year of the account owner’s death. If the account owner died last year, you’ll have until September 30, 2016, to finalize IRA beneficiaries for purposes of calculating RMDs for 2016 and beyond. If the removal strategy is employed, subsequent RMDs are calculated as if the removed beneficiary had never been in the picture.

Here’s an example of the postmortem RMD planning permitted under this rule.

Example 2: Removal of Charitable Beneficiary of Inherited IRA

Ken, age 32, is a 50% beneficiary of his mother Jan’s traditional IRA. Jan died last year at age 66 (before the RBD). The other 50% beneficiary is a charity. Therefore, Jan’s account is considered to have no beneficiary for RMD calculation purposes. Because Jan died before the RBD, the dreaded five-year rule will apply, which means curtailed tax deferral advantages for Ken. The charity doesn’t care about tax deferral because it’s tax-exempt.

The tax-savvy strategy in this situation is to distribute 50% of the IRA balance by September 30, 2016, to cash out the charity. That way, Ken can calculate RMDs for 2016 and beyond using his relatively long single life expectancy figures. He’s only 32 years old, so the tax deferral advantages of the inherited IRA will last much longer than if the RMDs had been calculated using his deceased mother’s life expectancy figures.

Act Now

The September 30 deadline for finalizing beneficiaries can be an important consideration when trying to maximize the tax advantages of an inherited IRA for individual beneficiaries. That deadline is fast approaching for account owners who died in 2015. Contact your tax advisor to fully understand the impact of making beneficiary changes and make any tax-saving moves before it’s too late.

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Posted on Aug 17, 2016

 

1-rustic-cabin-in-the-woodsVacation properties are subject to different federal income tax rules depending on how much personal and rental use they have during the year. Now is a good time to plan how to use your vacation property for the rest of this year with tax savings in mind.

Guidelines on Personal Use

For federal income tax purposes, personal use of a vacation property includes use by:

  • You,
  • Other family members, whether or not they pay fair market rent, and
  • Anyone else who pays less than market rent.

For the purpose of these rules, family members include your spouse, siblings, half-siblings, ancestors (such as parents and grandparents) and lineal descendants (such as children and grandchildren).

Personal use also includes time spent at your property by another party under a reciprocal sharing arrangement, whether or not the other party pays market rent. Under such an arrangement, the parties agree to “swap” properties.

Tax Rules for Vacation Home Rentals

Your vacation home will be treated as a rental property for federal tax purposes if you rent it out for more than 14 days and your personal use does not exceed the greater of:

  • 14 days, or
  • 10% of the rental days.

For example, if you rent your property for 210 days and vacation there for 21 days, your property will be treated as a rental. But if you vacation there for 22 days, the property is considered a personal residence.

If your property qualifies as a rental, follow this six-step procedure to report the income and expenses for federal income tax purposes.

  1. Report 100% of the rental income on your tax return.
  2. Deduct 100% of any direct rental expenses, such as rental agency fees and advertising.
  3. Allocate mortgage interest, property taxes and indirect property expenses between rental and personal use based on actual days of rental and personal use. Indirect expenses include such items as maintenance, utilities, association fees, insurance and depreciation.

Continuing with the previous example, you would allocate 210/231 of the mortgage interest, property taxes and indirect expenses to rental use. Then you would allocate 21/231 of these expenses to personal use.

  1. Deduct as rental expenses the allocable expenses from Step 3.
  2. Stop here if you show a profit. Sorry, you owe taxes. But if you show a loss, you’ll need to figure out whether the potential write-off is limited by the passive activity loss (PAL) rules.

In general, you can only deduct passive activity losses to the extent you have passive income from other sources, such as rental properties that produce positive taxable income. Fortunately, an exception allows you to write off up to $25,000 of passive rental real estate losses even if you have no passive income.

To qualify, you must actively participate in renting the property and have adjusted gross income (AGI) under $100,000. The exception is phased out between AGI of $100,000 and $150,000. Also, the IRS says the exception is unavailable if the average rental period for your property is seven days or less, which is often the case in resort areas. So, many owners of rental properties find their tax losses postponed by the PAL rules.

You’re allowed to carry forward any unused passive losses to future tax years when they can be deducted if you, 1) report enough passive income from other sources, or 2) sell the property.

  1. Deal with mortgage interest, property taxes and indirect operating expenses allocable to periods of personal use. Unfortunately, you can’t deduct the personal-use portion of mortgage interest from a rental property, because it doesn’t qualify as a personal residence for mortgage interest deduction purposes.

In the previous example, the ratio of personal use to total use was 21/231. So, you’d lose out on 21/231 of your mortgage interest and indirect expense deductions. But you can deduct 21/231 of the property taxes as an itemized deduction on Schedule A of your return, but it’s subject to the phase-out rule for high-income folks that normally applies to these deductions.

Mid-Year Tax Strategies

From a federal tax perspective, you may benefit from taking some extra vacation days during the rest of the year. That could move your home from being classified as a rental property for tax purposes to being classified as a personal residence. With a personal residence, you can usually deduct all the mortgage interest and property taxes (part as rental expenses and part as itemized deductions). And you can usually shelter any remaining rental income with allocable indirect operating expenses (such as utilities, maintenance and depreciation).

On the other hand, you may have plenty of passive income or AGI below $100,000 and no problem with the seven-day rule. In these scenarios, you can currently deduct your whole rental loss. If the nondeductible mortgage interest allocable to personal use would be a relatively small amount, consider minimizing your personal use for the rest of the year in order to increase your fully deductible rental loss. You might also be able to rent the place out for more days, which would boost your cash flow.

The rules explained here apply only to vacation home rentals that have limited use by you (or your family and friends). For properties that are classified as personal residences, different tax rules apply. Contact your tax professional for more information on vacation home rentals.

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Posted on Aug 15, 2016

With both major political party conventions finally behind us, it’s time to focus on the upcoming national election. Among their many differences, the Republicans and Democrats have widely divergent tax platforms. While platforms are always relatively nonspecific and not necessarily synced with what the presidential candidates have in mind, it’s still good to know what tax positions the two parties and their presidential candidates have staked out. Here’s a quick summary.

Democratic Party Tax Platform

Republican Party Tax Platform
The 2016 Democratic national platform was adopted on July 25. It includes generalized goals that you might expect from the Democrats, such as closing tax loopholes that benefit wealthy individuals and supporting small businesses by providing tax relief and simplifying the tax code.

More specific proposals include:

    • Helping fund Social Security by taxing certain individuals with annual earnings above $250,000,
    • Creating a surtax on multimillionaires and restoring fair taxation on multimillion-dollar estates to ensure that wealthy individuals pay their fair share of federal taxes,
    • Expanding the earned income tax credit program for low-wage workers who aren’t raising children,
    • Expanding the child credit by making more of it refundable and/or indexing it to inflation,
    • Reducing the tax penalties and simplifying the reporting requirements for Americans living abroad,
    • Clawing back tax breaks for companies that ship jobs overseas, cracking down on inversions and other methods that companies use to “dodge their tax responsibilities,” and ending tax deferral on foreign business profits,
    • Implementing a tax on financial transactions to curb excessive speculation and high-frequency trading,
    • Providing tax incentives for clean energy and other green business practices, while eliminating special tax breaks and subsidies for fossil fuel companies, and
  • Repealing the Affordable Care Act’s (ACA’s) 40% excise tax on high-cost health insurance, which is scheduled to take effect in 2020.
 The 2016 Republican national platform was adopted on July 18. In general, the Republicans want to promote economic growth and eliminate unspecified special-interest loopholes, while being mindful of the tax burdens that are imposed on the elderly and families with children.

More specific proposals include:

    • Making the Internal Revenue Code so simple and easy to understand that the IRS becomes obsolete and can be abolished,
    • Removing all marriage penalties from the tax code,
    • Repealing the Affordable Care Act (ACA) and any ACA-related tax increases,
    • Replacing the ACA with an approach to improving healthcare that’s based on competition, patient choice and timely access to treatment,
    • Considering options to preserve Social Security benefits without tax increases,
    • Reducing the corporate tax rate to be on a par with (or below) the rates of other industrialized nations,
    • Simplifying the tax rules for U.S. citizens who live overseas, including repealing the Foreign Account Tax Compliance Act (FATCA) and the Foreign Bank and Asset Reporting (FBAR) requirements,
    • Adopting a balanced-budget amendment that would impose a government spending cap and require a supermajority approval for any tax increases (except in the case of war or legitimate emergencies),
    • Tying any new value added tax or national sales tax to the simultaneous repeal of the Sixteenth Amendment, which authorizes the federal income tax, and
  • Opposing any legislation that would impose a carbon tax on businesses or individuals.

Clinton on Taxes

Trump on Taxes
So far, Democratic presidential nominee Hillary Clinton has provided more specific details on her tax proposals than her opponent. Some of these ideas elaborate on (or contrast with) her party’s platform.

Individuals. Clinton’s plans include higher income tax rates for wealthy individuals. She advocates a 4% fair-share surcharge on individuals who earn more than $5 million per year. And she’d ask the wealthiest to contribute more to Social Security. In addition, she proposes limiting certain itemized deductions for high-income individuals and disallowing IRA contributions for individuals who have large IRA balances.

Capital gains. Clinton proposes a graduated tax rate regime where the capital gains tax rate decreases from 39.6% to 20% over a six-year period. (The 3.8% net investment income tax would still apply, however.) The idea is to encourage long-term investing. The biggest impact would be on assets held for more than one year but not more than two years: Tax rates on gains from those assets would nearly double.

Businesses. Clinton would like to impose new restrictions and tax increases on U.S. companies with foreign operations. Her plans also include a risk fee on large banks and financial institutions, as well as curbing tax subsidies for oil and gas companies.

She’d also offer a 15% tax credit for employers that share profits with workers and a $1,500 tax credit to businesses for each new apprentice that they hire and train.

Estate tax. She proposes reducing the federal estate tax exemption to $3.5 million (from $5.45 million) and the lifetime federal gift tax exemption to $1 million (from $5.45 million). Her plans also would raise the federal estate and gift tax rate to 45%.

Healthcare. Clinton proposes a 20% credit to help taxpayers offset caregiving costs for elderly family members (up to a maximum credit of $1,200).

In addition to liberalizing the existing premium tax credit to make healthcare coverage more affordable, she’d establish a tax credit of up to $5,000 per family for buying health coverage on ACA exchanges.

 Republican presidential nominee Donald Trump has several ideas to simplify our tax system, which don’t always sync with the Republican platform.

Here’s what’s been discussed on his website or on the campaign trail to date.

Individuals. Trump proposes fewer tax brackets and lower tax rates for individuals. His plan now calls for three federal income tax brackets: 12%, 25% and 33%.

Currently, individuals can fall into seven federal income tax brackets: 10%, 15%, 25%, 28%, 33%, 35% and 39.6%. He’d also like to abolish the alternative minimum tax.

His plans would curtail some existing individual write-offs, but he’d retain the deductions for home mortgage interest and charitable donations that the tax code currently allows. He also recently proposed making U.S. families’ child-care costs tax-deductible.

Capital gains. His proposed tax rates on long-term capital gains and dividends would be 0%, 15% and 20%.

Businesses. Trump proposes cutting the corporate tax rate to 15% (from the current 35%). His proposed 15% tax rate would also apply to business income from sole proprietorships and business income passed through to individuals from S corporations, limited liability companies and partnerships.

He’d impose a cap on business interest deductions. Trump would eliminate the tax deferral on overseas profits and allow a one-time 10% rate for repatriation of corporate cash that’s held overseas.

His plan also ends the current tax treatment of carried interest for speculative partnerships that don’t grow businesses or create jobs and are not risking their own capital.

Estate tax. Trump would like to eliminate the federal estate tax.

Healthcare. Trump would like to repeal the ACA and any ACA-related tax increases, including the 3.8% net investment income tax on wealthy individuals. But he would let individuals fully deduct health insurance premium payments.

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Posted on Aug 15, 2016

Charitable giving is on the rise. And the momentum is expected to continue, given the natural disasters and human tragedies that have happened in recent months.

Highlights of the Giving USA Report

A recent report, Giving USA 2016: The Annual Report on Philanthropy for the Year 2015, shows charitable-giving trends based on contributions made by individuals, foundations, estates and corporations. Here’s the breakdown of where donations came from and how much they increased in 2015:

Source Amount donated Increase from 2014 to 2015
Living individuals $264.58 billion 3.8%
Foundations $58.46 billion 6.5%
Charitable bequests $31.76 billion 2.1%
Corporate giving $18.45 billion 3.9%
Total $373.25 billion 4.1%

Contributions from living people accounted for about 71% of the total donations, underscoring the importance of individual donations. For a free copy of this report, visit The Giving Institute’s website.

Last year, charitable donations reached an all-time high of approximately $373.25 billion, according to Giving USA 2016: The Annual Report on Philanthropy for the Year 2015. This report is published jointly by the Giving USA Foundation, a public-service initiative of The Giving Institute and the Indiana University Lilly Family School of Philanthropy.

Besides fulfilling their philanthropic needs, donors may also benefit from charitable deductions on their personal tax returns. If you’re considering donating to a new cause or a long-standing favorite one, remember that gift-giving may come in many different forms. Here are seven ways you can offer support:

  1. Monetary Contributions

If you donate cash to a qualified charity, your gift is generally tax deductible. The same holds true for cash-equivalent contributions, such as an online payment to the charity using a credit or debit card.

Important note. To determine if an organization qualifies as a charitable organization, go to the IRS Exempt Organizations Select Check. Giving money to an individual or a foreign organization is generally not deductible, except for donations made to certain qualifying Canadian not-for-profits. Political donations also don’t qualify for a deduction.

The deduction limit for your total annual donations, including cash gifts, is 50% of your adjusted gross income (AGI) (or 30% to the extent donations are made to a private foundation). Any excess may be carried forward up to five years. In addition, the tax code imposes strict recordkeeping requirements for charitable contributions. For example, if you make a cash donation of $250 or more, you must obtain a contemporaneous written acknowledgment from the charity that states the amount of the donation and whether any goods or services were received in exchange for it.

  1. Gifts of Property

You may also donate property — such as marketable securities, artwork or clothing — to a qualified charitable organization. In some situations, this can result in an extra tax break: For property that would have qualified for long-term capital gains treatment had you sold it — such as marketable securities you’ve owned longer than a year — you may deduct the full fair market value of the property. Thus, the appreciation in value while you owned the property will never be taxed.

For you to deduct the fair market value of gifts of appreciated tangible personal property, the property must be used to further the charity’s tax-exempt mission. For instance, if you give a work of art to a museum, it has to be included in its collection, rather than auctioned off at a fundraiser. Gifts of appreciated property are limited to 30% of your AGI, subject to the same five-year carryforward rule as cash gifts.

For you to deduct gifts of clothing or household goods, the items generally must be in good used condition or better. Your deduction equals the current fair market value of the item, which likely is substantially less than what you paid for it.

For a donation of property worth $250 or more, you must obtain a contemporaneous written acknowledgment from the charity describing the property, including a statement of whether any goods or services were received in exchange for the donation and a good-faith estimate of the gift’s value. Note that an independent appraisal generally is required for a charitable gift of property valued above $5,000 other than publicly traded securities.

  1. Quid Pro Quo Contributions

In some cases, a charitable donor may receive a benefit in return for the contribution. These are referred to as “quid pro quo contributions.” If you make a donation at least partially in exchange for goods or services exceeding $75, the charity should provide you with a good faith estimate of the goods and services received and the amount of payment exceeding the value of the benefit. Your deduction is limited to the difference between these amounts.

For example, suppose you attend a charitable fundraising dinner. You pay $200, but the charity values the meal at $50. In this case, your deduction is limited to $150. Low-cost trinkets and nominal gifts, such as a mouse pad featuring the charity’s logo, won’t reduce your deduction.

  1. Volunteer Services

Unfortunately, you can’t deduct the value of the time you spend helping out a qualified charity. But you may be eligible to write off out-of-pocket expenses you pay on behalf of the organization. This includes such items as travel, mailing costs and lodging at a convention where you’re an official delegate. But travel expenses aren’t deductible if the trip is merely a disguised vacation.

If you have to buy special clothing for your charitable activities — such as a Boy Scout or Girl Scout uniform for a troop leader — the cost is deductible. And any uniform cleaning costs also may be deductible as a miscellaneous expense, subject to the usual 2%-of-AGI floor.

  1. Donor-Advised Funds

A donor-advised fund may appeal to someone who wants to retain some control over how the charity will spend his or her contributions. Typically, these funds are established with a reputable institution that vets charities for you and doles out money based on your recommendations. A minimum deposit of at least $5,000 may be required.

As with other donations to qualified charities, contributions to a donor-advised fund are fully deductible within the usual rules and limits. Donor-advised funds are usually easy to set up and maintain because the institution does all the administrative work for you. If you want to stay out of the limelight, you can even arrange to make your gifts anonymous. The increase in the popularity of donor-advised funds has been documented in the Giving USA reports in recent years.

  1. Booster Clubs

Do you support your alma mater or a local college by contributing to its athletic booster club? Typically, these clubs enable you to purchase preferred seating at the school’s sporting events. For example, booster club members might receive priority ticket ordering privileges for home football and basketball games.

Under the current rules, you can deduct 80% of the cost of a donation made to a booster club. Any part of the payment that goes toward the purchase of actual tickets is nondeductible. But you might want to grab this tax break while it’s still available: The Obama administration has advocated its repeal and support for repeal is also growing in Congress.

  1. Conservation Easements

Usually, you must give something away in order to claim a charitable donation deduction. However, under the rules for conservation easements, you can donate an interest in real estate to a qualified organization, such as a government unit or publicly supported charity, without relinquishing ownership and still qualify for a deduction. The donation generally preserves or protects the land or building in its current state so it can be viewed or studied.

The amount of the deduction is based on the difference between the fair market value of the land with and without the easement. Under special rules, the annual deduction is limited to 50% of AGI (or 100% for farmers and ranchers), as opposed to the usual 30%-of-AGI limit. Any excess may be carried forward for up to 15 years instead of five years. This tax break was recently made permanent by the Protecting Americans from Tax Hikes Act of 2015.

The catch is that the gift must be made in perpetuity. In other words, you or your heirs can’t alter the property or rescind the organization’s rights to the property at a later date.

Considering a Charitable Donation?

There are many creative gifting options available to philanthropic individuals — and many types of donations also qualify for a tax break on your federal return. But special tax rules may apply, so consult with a tax adviser to help ensure that your donation is deductible and your recordkeeping is sufficient.

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Posted on Aug 3, 2016

Income Tax Monopoly Blog

Few people enjoy giving money to the IRS, but some types of taxes are viewed more unfavorably than others. Here are three worthy candidates vying for the title of most-hated tax.

Penalty Tax on Individuals without Health Insurance

As you probably know, the Affordable Care Act (ACA) imposes a penalty on individuals who fail to have so-called minimum essential health insurance coverage for any month of the year. This requirement is commonly called the “individual mandate,” and individuals must pay a penalty for noncompliance with the mandate.

You may be exempt from paying the penalty, however, if you fit into one of these categories for 2016:

  • Your household income is below the federal income tax return filing threshold, which is generally $10,350 for singles, $20,700 for married joint-filing couples and $13,350 for heads of households.
  • You lack access to affordable minimum essential coverage.
  • You suffered a hardship in obtaining coverage.
  • You have only a short-term coverage gap.
  • You qualify for an exception on religious grounds or have coverage through a health care sharing ministry.
  • You’re not a U.S. citizen or national.
  • You’re incarcerated.
  • You’re a member of a Native American tribe.

How much can the penalty cost? That’s a tricky question. If you owe the penalty, the tentative amount equals the greater of the following two prongs:

  1. The applicable percentage of your household income above the applicable federal income tax return filing threshold, or
  2. The applicable dollar amount times the number of uninsured individuals in your household, limited to 300% of the applicable dollar amount.

In terms of the percentage-of-income prong of the penalty, the applicable percentage of income is 2.5% for 2016 and beyond.

In terms of the dollar-amount prong of the penalty, the applicable dollar amount for each uninsured household member is $695 for 2016. This amount will be adjusted for inflation for 2017 and beyond. For a household member who’s under age 18, the applicable dollar amounts are cut by 50%.

The final penalty amount can’t exceed the national average cost of “bronze coverage” (the cheapest category of ACA-compliant coverage) for your household. For 2015, the national average cost for bronze coverage was $207 per person, per month or $1,035 per month for a family of five or more. Numbers currently aren’t available for 2016, but they’ll probably be somewhat higher. Meanwhile, the important thing to know is that a high-income person or household could owe more than 300% of the applicable dollar amount but not more than the cost of bronze coverage.

Important note: If you have minimum essential coverage for only part of the year, the final penalty is calculated on a monthly basis using pro-rated annual figures.

Example: You’re unmarried and live alone. During all of 2016, you have no health coverage. Your income for the year is $100,000. Your tax return filing threshold for the year is $10,350. Assume the monthly national average premium for bronze coverage for one person is $215 for 2016, which amounts to $2,580 for the entire year (12 × $215).

In this example, the percentage-of-income prong for 2016 is $2,241. That’s 2.5% of the difference between $100,000 and $10,350.

The dollar-amount prong is $695.

The tentative penalty amount is $2,241 (the greater of $2,241 or $695).

In this example, the annual national average cost of bronze coverage is assumed to be $2,580 for one person who’s uncovered for all of 2016. Therefore, the final penalty amount for failing to comply with the individual mandate is $2,241 (the lesser of $2,241 or $2,580).

Penalty Tax on Employers that Pay Employee Health Insurance Premiums

The ACA also established a number of so-called “market reform restrictions” on employer-provided group health plans. These restrictions generally apply to all employer-provided group health plans, including those furnished by small employers with fewer than 50 workers.

The penalty for running afoul of the market reform restrictions is $100 per employee, per day. This penalty can amount to $36,500 per employee over the course of a full year. Even worse, the penalty can be assessed on employers who offer an employer payment arrangement in which the company’s health plan simply reimburses employees for premiums paid for individual health insurance policies or pays premiums directly on behalf of employees.

This penalty doesn’t apply to employer payment arrangements that have only one participating employee. Therefore, a business can still use such an arrangement to reimburse or pay for individual health policy premiums for one employee (such as the owner’s spouse) without triggering this expensive penalty.

Many S corporations have set up employer payment arrangements to cover individual health policy premiums for employees who also own more than 2% of the company stock. Under long-standing IRS rules, amounts paid under such plans are treated as additional wages that are subject to federal income tax but exempt from Social Security and Medicare taxes. Qualifying shareholder-employees can deduct the premiums on their individual federal income tax returns under the provision for self-employed health premiums. These plans are also exempt from the $100 per-employee-per-day penalty. But S corporation employer payment arrangements that benefit other employees are still exposed to the penalty.

Medicare Surtax on Net Investment Income

The 3.8% Medicare surtax on net investment income was also enacted as part of the ACA. Taxpayers who are hit with the net investment income tax (NIIT) can have a marginal federal tax rate as high as 43.4% (39.6% top federal income tax rate plus 3.8% NIIT). The NIIT can potentially affect anyone with consistently high income or anyone with a major one-time shot of income or gain, say, from selling some highly appreciated company stock or a highly appreciated personal residence. For purposes of the NIIT, net investment income includes the following after subtracting related expenses:

  • Capital gains, including the taxable portion of gain from selling a personal residence and capital gains distributions from mutual funds,
  • Dividends,
  • Interest, excluding tax-free interest (such as municipal bond interest),
  • Most royalties,
  • The taxable portion of annuity payments,
  • Income and gains from passive business activities (in other words, activities in which you don’t spend a significant amount of time),
  • Rental income,
  • Gain from selling a passive ownership interest in a partnership, limited liability company, or S corporation, and
  • Income and gains from the business of trading in financial instruments or commodities.

You’re exposed to the NIIT only if your modified adjusted gross income (MAGI) exceeds the applicable threshold of:

  • $200,000 if you are unmarried,
  • $250,000 if you are a married joint-filer, or
  • $125,000 if you use married filing separate status.

The amount hit by the NIIT is the lesser of: 1) your net investment income, or 2) the amount by which MAGI exceeds the applicable threshold. MAGI is defined as regular adjusted gross income plus certain excluded foreign-source income net of certain deductions and exclusions. (Most individuals are unaffected by this addback, however.)

Focus on the Positive

There’s some good news about these three most-hated taxes: With thoughtful advance planning, they can often be avoided or significantly reduced. For more information about these taxes, consult your tax adviser.

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Posted on Aug 2, 2016

Tax Planning Tips

For some reason, tax time always seems to be lurking around the corner, worrying business owners and individuals alike. While it is true that you shouldn’t take your tax obligation lightly, planning in advance will help ease the stress of tax time from your life.

Don’t Wait to Start Tax Planning

Procrastination is the downfall of any personal project. If you wait until the last minute, the stress will hurt your personal health and business. Everyone knows that April 15th is Tax Day. By getting on top of your return early, you will have more time to check over your work and in turn will make fewer mistakes. Unlike others who will be rushing to figure out all the required paperwork, you’ll be spending Tax Day worry free.

Look Back

Review your previous year’s return. It is helpful to see how you filed last year so that any necessary changes or improvements can be made the upcoming year. Reviewing your previously filed documents will also help offer a lot of insight into what you accomplished last year and where you are heading in terms of income.

Fund a Qualified Retirement Plan

The ultimate goal for anyone is to retire, with no sense of worry. If you’re going to have enough saved, then a plan is a necessity. There are many ways to go about accomplishing that but a main one is to make sure you invest in your 401(K). Try to maximize the amount allowed to contribute to your companies 401(K). Talk to an expert to fund a continual plan. The earlier you start the easier it is later in the year.

Plan Charitable Contribution

Americans are actually giving more money in recent years to charity. Giving to charities is a good way to help your community and simultaneously find tax breaks. However, make sure you give to a qualified charity, and remember that donations to individuals don’t count as deductions. When donating, make sure you receive a receipt to include in your tax organizer. Lastly, there are limits to charitable giving deductions ratio so double check your deduction limit before writing the check.

Defer your income

Deferring income makes sense only if you’re going to be in the same or lower tax bracket as the previous tax year. Don’t get hit with a higher tax bill next year by receiving additional income. This option might also help if your employer gives out bonuses at year-end.

Record keep

It’s tedious, but the IRS won’t doesn’t allow estimates, so it is vital to make sure and keep track of your expenses. Keeping a record of appointments, emails and summaries will only help in dealing with the IRS and also keep organized on activities throughout the year. Most small businesses struggle with record keeping and it leads to substantial losses. Don’t let you or your company fall behind. Always stay on course with record keeping.

“Green” Tax Breaks

The new popular lifestyle is to go “green”. To make it seem more enticing, the government has put in place a system to reward individuals and businesses for putting cleaner and more environmentally friendly devices in your workplace and home. The government will provide tax incentives for putting up solar panels and renewable energy systems. This will help save the planet as well as putting some more green in your pocket.

Keep up with Tax Law changes (In Congress)

Every year, congress makes changes that affect the daily lives of Americans. Be sure to stay attuned to all decisions that could potentially affect your finances. Watch local and national news to see if there have been any changes to when and how to file taxes or major reforms that may potentially affect the tax bill year to year.

Remember your State and Local Tax duties

The national timeline is often parallel with the local timeline in terms of taxes. However, local governments have different filing and payment responsibilities with various income, property, and sales taxes. Make sure you are keeping up with out of state expenses and that your business is in tune with what your local responsibilities as well.

Avoid the “kid” tax

There are many tax breaks that parents receive. To learn more – check out our blog article: Ten Tax Breaks Available for Parents.

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Posted on Aug 1, 2016
Tax forms 1065
Tax forms 1065

Unless you’ve extended the due date for filing last year’s individual federal income tax return to October 17, the filing deadline passed you by in April. What if you didn’t extend and you haven’t yet filed your Form 1040? And what if you can’t pay your tax bill? This article explains how to handle these situations.

“I Didn’t File but I Don’t Owe”

Let’s say you’re certain that you don’t owe any federal income tax for last year. Maybe you had negative taxable income or paid your fair share via withholding or estimated tax payments. But you didn’t file or extend the deadline because you were missing some records, were too busy, or had some other convincing reason (to you) for not meeting the deadline.

No problem, since you don’t owe — right? Wrong.

While it’s true there won’t be IRS interest or penalties (these are based on your unpaid liability, which you don’t have), blowing off filing is still a bad idea. For example:

You may be due a refund. Filing a return gets your money back. Without a return, there is no refund.
Until a return is filed, the three-year statute-of-limitations period for the commencement of an IRS audit never gets started. The IRS could then decide to audit your 2015 tax situation five years (or more) from now and hit you with a tax bill plus interest and penalties. By then, you may not be able to prove that you actually owed nothing. In contrast, when you do the smart thing and file a 2015 return showing zero tax due, the government must generally begin any audit within three years. Once the three-year window closes, your 2015 tax year is generally safe from audit, even if the return had problems.
If you had a tax loss in 2015, you may be able to carry it back as far as your 2013 tax year and claim refunds for taxes paid in 2013 and/or 2014. However, until you file a 2015 return, your tax loss doesn’t officially exist, and no loss carryback refund claims are possible.
There are other more esoteric reasons that apply to taxpayers in specific situations.

The bottom line is, you should file a 2015 return, even though you’ve missed the deadline and believe you don’t owe.

“I Owe but Don’t Have the Dough”

In this situation, there’s no excuse for not filing your 2015 return, especially if you obtained a filing extension to October 17.

If you did extend, filing your return by October 17 will avoid the 5%-per-month “failure-to-file” penalty. The only cost for failing to pay what you owe is an interest charge. The current rate is a relatively reasonable 0.83% per month, which amounts to a 10% annual rate. This rate can change quarterly, and you’ll continue to incur it until you pay up. If you still can’t pay when you file by the extended October 17 due date, relax. You can arrange for an installment arrangement (see below).

If you didn’t extend, you’ll continue to incur the 5%-per-month failure-to-file penalty until it cuts off:

Five months after the April 19 due date for filing your 2015 return or
When you file, whichever occurs sooner.
While the penalty can’t be assessed for more than five months, it can amount to up to 25% of your unpaid tax bill (5 times 5% per month equals 25%). So you can still save some money by filing your 2015 return as soon as possible to cut off the 5%-per-month penalty. Then you’ll continue to be charged only the IRS interest rate — currently 0.83% per month — until you pay.

If you still don’t file your 2015 return, the IRS will collect the resulting penalty and interest. You’ll be charged the failure-to-file penalty until it hits 25% of what you owe. For example, if your unpaid balance is $10,000, you’ll rack up monthly failure-to-file penalties of $500 until you max out at $2,500. After that, you’ll be charged interest until you settle your account (at the current monthly rate of 0.83%).

Save Money with an Installment Agreement

By now you understand why filing your 2015 return is crucial even if you don’t have the money to pay what you owe. But you may ask: When do I have to come up with the balance due? The answer: As soon as possible, if you want to halt the IRS interest charge. If you can borrow at a reasonable rate, you may want to do so and pay off the government, hopefully at the same time you file your return or even sooner if possible.

Alternatively, you can usually request permission from the IRS to pay off your bill in installments. This is done by filing a form with your 2015 return. On the form, you suggest your own terms. For example, if you owe $5,000, you might offer to pay $250 on the first of each month. You’re supposed to get an answer to your installment payment application within 31 days of filing the form, but it sometimes takes a bit longer. Upon approval, you’ll be charged a $120 setup fee or $52 if you agree to automatic withdrawals from your bank account.

As long as you have an unpaid balance, you’ll be charged interest (currently at 0.583% a month, which equates to a 7% annual rate), but this may be much lower than you could arrange with a commercial lender. Other details:

Approval of your installment payment request is automatic if you owe $10,000 or less (not counting interest or penalties), propose a repayment period of 36 months or less, haven’t entered into an earlier installment agreement within the preceding five years, and have filed returns and paid taxes for the preceding five tax years.
A streamlined installment payment approval process is available if you owe between $10,001 and $25,000 (including any assessed interest and penalties) and propose a repayment period of 72 months or less.
Another streamlined process is available if you owe between $25,001 and $50,000 and propose a repayment period of 72 months or less. However, you must agree to automatic bank withdrawals, and you may have to supply financial information.
If you owe $50,000 or less, you can apply for an installment payment arrangement online instead of filing an IRS form.
Finally, if you can pay what you owe within 120 days, you can arrange for an agreement with the IRS and avoid any setup fee.
Warning: When you enter into an installment agreement, you must pledge to stay current on your future taxes. The government is willing to help with your 2015 unpaid liability, but it won’t agree to defer payments for later years while you’re still paying the 2015 tab.

Pay With a Credit Card

You can also pay your federal tax bill with Visa, MasterCard, Discover or American Express. But before pursuing this option, ask about the one-time fee your credit card company will charge and the interest rate. You may find the IRS installment payment program is a better deal.

Act Soon

Filing a 2015 federal income return is important even if you believe you don’t owe anything or can’t pay right now. If you need assistance or want more information, contact your tax adviser.

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Posted on Jul 30, 2016

When I work with small business owners, particularly family-owned businesses in manufacturing and distribution, succession planning is stalled because of a lack of communication. Owners don’t want to face the sometimes tough conversations around who will take over the business and what that will mean for family members, employees or customer relationships. Before beginning the final phase of building your succession plan, consider the following questions:

  • How will you communicate the plan to leaders, clients, employees, family?
  • What can reinforce buy-in and cooperation?
  • What contracts and documents must be in place?
  • What is the exact timetable and launch?

Usually, I try an objective process of elimination. If there are family members in the business, I ask if any are interested — and able — to operate the company. Based on the owner’s responses, we take a look at other scenarios such as a leveraged buy-out or ESOP arrangement. And finally, we look at the potential for selling to an outside buyer (e.g. private equity, competitor, affiliated vendor).

Based on the owner’s selection of a Plan A and Plan B succession scenario, we have to plan communication with family and management. The depth and detail of communication is directly related to how significant each family member’s or management leader’s role will be in Plan A or Plan B. The smaller the role, the less detailed you will be in communication. Key topics of discussion may or may not include:

  • How your buyout or retirement will be handled and impact on the business operationally and financially going forward
  • How the plan will affect each stakeholder in particular – who will be offered stock or ownership
  • How you are dealing with family members not involved in the business — helping them understand that the business is like any other stock in their portfolio
  • Your planned date of exit
  • Getting feedback on their concerns

There may be some hard conversations. This is where you can seek help from your advisory team to guide the conversation. For example, I’ve seen situations in which a child thinks the parent will bring him into the business, but the child doesn’t have any experience or education. You may also have one child already working in the business and another who isn’t. The parents want to be fair to both children, but it’s not necessarily the best decision to hand the reins of the company to both.

The same conversations must be discussed with management. Depending on the details of Plan A and Plan B, you want to avoid a mass exodus of skilled management. Therefore, discussions of transition should also include compensation of key employees to support retention and timely — rather than sudden — exits.

Set up the Timetable and Deliverables

The final timetable is of utmost importance so that you can address issues and gaps in your plan, properly structure your exit and leave the company in good hands.

Let’s say, for example, you have seven years to exit. In year three, you may arrange to step out of the CEO role and take on a support role of transitioning relationships and training management. Making such transitions over time is usually best to preserve customer relationships and value of the business.

Owners must also set up a timetable for addressing and solving issues and gaps in the plan. Perhaps you need to restructure entities for a better tax position upon sale. You may have outstanding debt and collections that need cleaning up. You will need to schedule a valuation to determine the true value (or estimation of value) of all company assets. You will also need to revisit your organizational chart to determine hiring of key management and/or transition of management.

The last 30 days of your succession planning involve reviewing your written Plan A and Plan B, establishing a timetable to address gaps and issues, and ensuring that many documents are updated and in place. Some of the key documents in a succession plan can include the following:

  • A one page executive summary succession Plan A and Plan B in writing
  • A management emergency plan
  • Shareholder agreements – buy /sell
  • Review of wills and estate plan documents
  • Purchase price formula or method with discounts and terms
  • Final proforma balance sheet, income statement and cash flow

Remember, you are not alone in this planning. Rely on your designated succession planning quarterback, such as your CPA, to keep everyone on your advisory team informed and involved. You will be amazed at the sense of relief after handling a critical piece in business ownership — that is, how to leave your business in good hands.

For more information on guiding your small business through succession planning, download the whitepaper: Do You Need a Succession Planning Starter Kit?

Gary Jackson, CPA, is the lead tax partner in Cornwell Jackson’s business succession practice as has led or assisted in hundreds of succession and sales transactions. Gary has built businesses, managed them, developed leadership teams and sold divisions of his business, and he utilizes this real world practical experience in both managing Cornwell Jackson and in providing consulting services such as succession planning to management teams and business leaders across North Texas. 

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Posted on Jul 25, 2016
Photo Credit: Claire L. Evans, Flickr
Photo Credit: Claire L. Evans, Flickr

With real estate prices recovering in many markets, it might make sense to buy a condo where your child can live during college. He or she can live there while attending school, and you can avoid “throwing away” money on dorm costs or rent for an apartment. If you buy a place that has extra space, you also can rent it to your child’s friend(s) to offset some of the ownership costs.

Additionally, you may be able to sell the condo for a gain after the four or five (or maybe even six) years that it takes for your son or daughter to graduate. A gain may be even more likely if you have more than one child — and you can persuade a younger child to attend the same college as an older sibling. Here are some tax issues to consider before you buy a condo near campus.

Rules about Deducting College Condo Ownership Costs

The federal income tax rules generally prevent you from deducting losses from owning and renting out a residence to a family member. But an exception applies when you rent at market rates to the family member who uses the property as his or her principal home. This loophole is open to you if you buy a condo and rent it out to your college kid (and any roommates) at market rates.

As long as you charge market rent, you can — subject to the passive activity loss (PAL) rules explained later — deduct the mortgage interest and write off all the other operating expenses, including utilities, insurance, association fees, security monitoring, cleaning, maintenance and repairs. As a bonus, you can depreciate the cost of the structure (but not the land) over 27.5 years, even if its market value is increasing.

Where will your cash-strapped college student get the money to pay you market rent for the condo? The same place he or she would get the cash to pay for a dorm room or apartment rent. You can gift your child up to $14,000 annually without any adverse federal tax consequences. If you’re married, you and your spouse, combined, can give up to $28,000. Your child can then use that money to write monthly rent checks back to you.

For recordkeeping purposes, your child should send checks that say “rent” on the memo line. It’s also helpful for you to open a separate checking account to handle rental income and expenses. Taking these steps will minimize problems with the IRS if you get audited.

Key point: Even if you don’t charge your child market rent for the condo, you can still deduct the property taxes. Designate the condo as your second home, and then you can also deduct the interest on up to $1.1 million of combined mortgage debt on your main home and the condo as an itemized deduction on your personal tax return (subject to the phaseout rule for high-income folks that normally applies to these deductions).

Watch Out for PAL Rules

The condo is likely to generate tax losses after you consider depreciation deductions. If so, the PAL rules generally apply. The fundamental concept is simple: You can deduct PALs only to the extent you have passive income from other sources, such as positive taxable income from other rental properties or gains from selling them.

A special exception allows you to deduct up to $25,000 of annual PALs from rental real estate provided:

  1. Your adjusted gross income before the real estate loss is less than $100,000, and
  2. You “actively participate” in the rental activity.

Active participation means you’re making management decisions, such as approving tenants, signing leases and authorizing repairs.

If you qualify for this exception, you won’t need any passive income to claim a deductible rental loss of up to $25,000 annually. However, if your adjusted gross income (AGI) is between $100,000 and $150,000, the special exception gets proportionately phased out. If your AGI exceeds $150,000 and you have no passive income, you can’t currently deduct any passive rental real estate losses. Fortunately, any unused losses will be carried forward to future tax years, and you can deduct them when you sell the condo.

Expect More Tax Benefits When You Sell

When you sell a rental property that you’ve owned for more than a year, the profit — the difference between sales proceeds and the tax basis of the property after subtracting depreciation — is a long-term capital gain.

For most folks, the maximum federal tax rate on long-term gains is 15%. But if you are in the top federal bracket, the maximum rate is 20%. Higher-income taxpayers may also owe the 3.8% net investment income tax on rental property gains. Also be aware that, if you’re in the 25% regular income tax bracket or above, part of the gain — the amount equal to your cumulative depreciation write-offs — is taxed at a maximum federal rate of 25%.

Finally, remember those carryover passive losses that we talked about earlier? You get to use them to shelter all or part of the gain from selling the place.

Act Quickly but Not Hastily

While the idea of buying a college condo can be attractive purely from a tax perspective, it makes sense only if you expect to make money on the investment. If you can buy relatively low now and sell high later, you’ll come out ahead. But if you don’t expect to be able to make a profit on a future sale, you may be better off simply paying for your child to live in a dorm or apartment.

The start of school is just around the corner, so act fast if you think this investment opportunity will work for you. Before you meet with a realtor, contact your tax professional for more information.

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