January 31 Deadline for Charitable IRA Rollovers

Eligible taxpayers still have a few more days to make tax-free contributions to charities from an IRA.  This provision had expired on December 31, 2009, but was renewed for 2010 in the tax bill passed by Congress last month.  The National Association of Enrolled Agents has more coverage, from one of their weekly news updates for members:

The tax deal reached by Congress and the President in December included a provision which retroactively extends the ability of taxpayers to contribute tax-free to authorized charities from their IRA (up to $100,000). The issue that is unique with the charitable IRA rollover is that because the bill wasn't passed until mid-December, but is retroactive to January 1, 2010, Congress gave taxpayers the ability to elect to treat a charitable rollover made in January 2011 as if it were made on December 31, 2010. There is only a short window of opportunity to take advantage of the incentive.

Cell Phones Are Not Listed Property - Part 2

I wanted to follow-up on this blog post where I wrote about cell phones no longer being "listed property."  Listed property is property covered under Section 274 of the Internal Revenue Code and includes "entertainment" property such as computers and cameras.  Vehicles are also considered to be listed property.  Section 274 requires strict documentation of the business vs. non-business usage of listed property.

Legislation in 2010 removed cell phones from the "listed property" category.  As I talked about in my original blog post, this is big news for employees who are provided cell phones by their employers.  The employee will no longer have to track business vs. non-business usage, and the non-business portion will no longer be included in the employee's income.  But what does it mean for people who are self-employed?

The answer is, it really doesn't change anything.  The self-employed will still have to track business vs. non-business usage, and will still only be able to deduct the business portion of cell phone expenses.

Business Credit Card Transactions Now Reported on a 1099

Starting in 2011, credit card companies will begin issuing a new type of Form 1099 (Form 1099-K) to some businesses and individuals.  The 1099-K will detail, month-by-month, the amount of income the business received from credit card transactions.  It will also apply to debit card transactions, and to payments processed by third-party providers such as Pay Pal.

Form 1099-K will only be issued to business or individuals who have at least 200 transactions and who receive at least $20,000 from those transactions.  The goal with these thresholds is to avoid having a 1099-K issued to someone who, for example, sells things casually on e-Bay.

View a draft of Form 1099-K at the IRS website.

New 1099 Provisions Start This Year for Rental Owners

With the new year comes a new law that applies to owners of rental properties.  For the first time, rental owners will have to issue 1099s to service providers (accountants, lawyers, unincorporated plumbers and electricians).  This applies to payments made after January 1, 2011. 

And starting on January 1, 2012, rental owners will face even stricter 1099 requirements, as will all businesses.  Starting in 2012, businesses and rental owners will have to issue 1099s to anyone and any company that they purchase more than $600 of ANYTHING from -- including purchases of goods, supplies, inventory, etc. 

Thus, if you own a rental house and you pay the utilities, you'll have to issue a 1099 to the utility company, starting in 2012.

I think Congress will provide relief to the stricter provisions that take effect in 2012.  But I think the stricter 2011 requirements on rental owners are here to stay.

Read prior coverage of the 1099 issue here, here and here.

Earned Income Credit Remains "Expanded" in 2011

The expanded Earned Income Tax Credit (EITC) that has been in place for 2009 and 2010 has been extended through 2011 and 2012.  The expanded credit allows a higher EITC for families with three or more qualifying children (the "normal," non-expanded EITC rules are based on a maximum of 2 qualifying children). 

For 2010, the EITC could be available to taxpayers with 3 children and income of up to $48,362 if married, and $43,352 for other filing statuses.  This is a slight increase over the 2009 amounts.

Federal Tax Due Date is April 18

Tax season will last a little longer this year thanks to a holiday being celebrated in Washington, DC.  The deadline for filing your 2010 tax return will be Monday, April 18, 2011.  The due date is normally April 15, but this year, the 15th falls on a holiday called "Emancipation Day" that is celebrated by Washington, DC.  Even though the holiday is only celebrated in Washington, DC, we all benefit from it by getting 3 extra days to file our tax returns.

Tax Implications of the Unlicensed Daycare Provider

One of my areas of specialty is in-home daycare operations, and it's something I haven't blogged about much.  One of the questions about in-home daycare operations is what the tax consequences are to an unlicensed daycare provider.

Different states have different licensing requirements for daycare providers.  In Iowa, an in-home provider can care for up to 5 children without being registered or licensed.  A provider caring for 6 children must be registered, and a provider caring for 7 or more children must be licensed.  (Read more at the DHS website.)

For tax purposes, your in-home daycare is considered a business whether you or not you are registered or licensed.  Income should be reported as business income; legitimate business expenses can be claimed as a deduction against business income.

The tricky part for the unlicensed/unregistered is figuring out whether they can take the deduction for "business use of the home."  This deduction allows a taxpayer to partially deduct expenses associated with the house, such as utilities and mortgage interest.  Only daycare operators who are licensed or registered with the state -- or who are not required to be licensed or registered -- can take the deduction for business use of the home.

So in Iowa, a provider caring for less than 6 children CAN take the deduction for business use of their home, because they aren't required to be registered or licensed.  But if a provider cares for 6 or more children and is not registered or licensed, then no deduction is allowed for business use of their home.  Of course, aside from the tax deduction issue, there could also be problems with the DHS!

When is Income Taxable, When are Expenses Deductible?

As we head into the last few days of 2010, it is important to consider when income and expenses are recognized for tax purposes.

Most individual taxpayers are on the cash method of accounting, so any income that you have in your hands before the end of the year will be taxable in 2010.  This is true even if the income is in the form of a check and you don't deposit the check until the first part of January.  The same logic applies to expenses.  If you write the check and send it before the end of the year, you can deduct it this year, even if the recipient doesn't cash the check until January.

It gets a little trickier for accrual basis taxpayers.  Many businesses use the accrual method.  Under the accrual method, income is recognized and expenses are deducted when the "all-events" tests have been met.  For income, this means (from IRS Publication 334):

Under an accrual method, you generally include an amount in your gross income for the tax year in which all events that fix your right to receive the income have occurred and you can determine the amount with reasonable accuracy.

For expenses, the all-events test is met in much the same way, except that "economic performance" must have occurred as well, which means the goods or services must have been received or performed, as well.  (NOTE:  this is a very, very general overview of economic performance.)

Special rules apply when related taxpayers are involved and they use different methods of accounting.

Federal Tax Provisions and the State of Iowa

One of the considerations of tax planning is the impact of state taxes.  Many states follow along with most federal provisions for calculating income, but almost every state varies from federal law on at least a few items.  This is often referred to as "de-coupling" from federal law. 

For example, Iowa in 2009 "de-coupled" from federal law on Section 179 expensing and bonus depreciation.  Section 179 expensing was limited to $133,000 (as opposed to $250,000 on federal returns), and bonus depreciation was not allowed at all on Iowa returns.  (Read more about this tax issue in this article.)

Iowa often "de-couples" from other "extender" items such as the front-side deduction for college expenses and the front-side deduction allowed to K-12 teachers for out-of-pocket classroom expenses.  These were a part of the federal tax bill signed into law last week.  The Iowa legislature will decide next month on whether to de-couple from these items and not allow them to be deductible on Iowa tax returns.  It is a safe bet that the legislature will vote to de-couple on these items, and also on the increase in Section 179 and bonus depreciation.

One federal provision that Iowa is coupling with is the provision in the "health care bill" passed earlier this year that allows people to keep children on their health insurance through age 26.  The value of this insurance coverage will be tax-free for federal purposes, and Iowa has announced that it will go along with federal law in this case.  Read more in this informational post from the Iowa Department of Revenue.

IRS Says Itemizers Will Have to Wait a Bit to File

The IRS on Thursday announced that its computer systems won't be ready to handle certain types of tax returns until mid-to-late February.  This is because of certain tax law changes enacted in last week's tax bill passed by Congress.

The IRS says people who itemize deductions, people who claim a "front-side" deduction for college expenses, and K-12 teachers who take the "front-side" deduction for purchases of classroom supplies will have to wait to file until sometime in February. 

The IRS says it will soon give a more-solid date for when these types of returns can be filed.

Standard Deductions Increase Slightly for 2011 Tax Returns

On Thursday the IRS released the standard deduction amounts for 2011.  This will affect your 2011 tax return that you'll file in 2012.

• The personal exemption amount will increase to $3,700 (up from $3,650 for 2010 returns).
• The standard deduction for married couples will be 11,600 (up $200 from 2010); $5,800 for single and married filing separately (up $100); and $8,500 for head of household (up $100).
• The tax bracket thresholds will increase slightly.  For example, the 25% tax bracket for a married couple will begin at $69,000 (up $1,000 from 2010).

Read more in this IRS news release.

Residential Energy Credit Extended, But It's Not As Generous

The tax bill signed into law last week extended the "residential energy credit" that provides a tax credit for purchases of certain energy efficient doors, windows, insulation, furnaces, air conditioning systems, certain types of water heaters, and even certain types of roofs. 

The credit had been set to expire on December 31, 2010, but has been extended through 2011.  There's a catch though -- the amount of available credit has decreased, and people who have taken the credit in the past may not be able to take it at all in 2011.

2010 Rules vs. 2011 Rules

• 2010:  The credit is 30% of the purchase price.  The maximum amount of residential energy credit that you can take in total from 2005-2010 is limited to $1,500 (the credit has existed in several forms since 2005).
• 2011:  The credit is 10% of the purchase price, and the maximum amount of residential energy credit that you can take in total from 2005-2011 is limited to $500.

This means if you have claimed $500 or more in residential energy credits since 2005, the credit is not available to you in 2011.

The Importance of Documenting Charitable Contributions

The Dinesen Tax Times has been providing a series of articles about charitable contributions this month (in between the updates on the Congressional debate over taxes ... and of course, Wesley Snipes!).  A recent Tax Court case fits in nicely with that series of articles, in particular this article about documenting charitable contributions.

The Tax Court case involved a couple (a Mr. and Mrs.  Murphy) from California who had more than $27,000 of charitable contributions disallowed by the IRS on their 2006 tax return.  The Court ruled against the couple, costing them nearly $11,000 in taxes and penalties.

The case centered around a lack of documentation for the contributions.  According to the Court report, the Murphys had no receipts for any of the contributions they made.  In one instance, the couple donated items to the Salvation Army and could have gotten a receipt, but chose not to because they "didn't want to wait in line to get one."

Mr. Murphy told the Court that he kept a journal that detailed all of the contributions, but the journal was stolen when his car was broken into in 2007.  When things like that happen, a taxpayer can reconstruct their deductions using credible evidence.  In this case, though, the only evidence offered was the testimony of Mr. Murphy.  The couple also tried to invoke the "Cohan Rule," which allows for the use of reasonable estimates (the Cohan Rule is another blog post for another day), but again, the taxpayer has to have credible evidence on which to base the estimates.

In the end, the Murphys lost $27,000 in deductions for charitable contributions, amounting to additional tax owed of $9,011.  The Tax Court also found the couple to be subject to the 20% "negligence penalty," which tacks on another $1,802 in penalties.  In ruling that the couple was negligent, the Court said:

Even if Mr. Murphy's journal was in fact stolen, there is no evidence that he made a reasonable attempt to reconstruct his contributions.  We therefore hold that the petitioners failed to meet their burden of showing that the reasonable cause and good faith exception applies.  Accordingly, the Court concludes that the petitioners are liable for the ... accuracy-related penalty....

The moral?  Keep good records, and if your records are lost, destroyed or stolen, do all you can to reconstruct them!  The IRS will not rely on your "word" alone.  That goes for all your tax-related records, not just records of charitable contributions.

Additional Standard Deduction for Real Estate Taxes is No More

Many tax breaks that had expired or were set to expire got extended in the tax bill passed by Congress last week.  But one break that did not get extended and thus has gone away is the additional standard deduction for property taxes paid.

This tax break allowed people who don't itemize deductions to add up to $500 ($1,000 for married taxpayers) to the standard deduction for property taxes paid.  This was a handy extra deduction for anyone who didn't have enough itemized deductions and had to take the standard deduction.  Unfortunately, this tax break expired on December 31, 2009, and was not renewed in any legislation in 2010, meaning that this extra deduction for non-itemizers has ridden off into the sunset.

People who itemize deductions will still get to claim an itemized deduction for property taxes, same as always.  The expiration of this tax break only affects those who take the standard deduction.

No 1099 Relief in Tax Deal

A website visitor asks if the tax deal contained any relief from 1099 reporting for small businesses.  The answer is NO, it didn't.  But there is still hope that Congress will provide relief before the stricter reporting requirements take affect in 2012.  Both Republicans and Democrats seem to agree that the stricter requirements will be a burden on small businesses, but for some reason, they can't reach an agreement to actually provide relief.

Oh, and rental property owners:  you are subject to stricter 1099 rules starting January 1, 2011.  Rental owners have not had to issue 1099s in the past, but now they will, if they pay $600 or more to service providers (accountants, lawyers, plumbers, electricians, etc.).

Read prior Dinesen Tax Times coverage here and here.

Analyzing the Tax Cut Deal

President Obama signed a tax bill into law yesterday (Friday) that gives us some clarity on what the tax situation will be for 2011 and 2012.  Here are the highlights of the bill:

• Tax brackets to remain the same, with a 10% bottom rate and a 35% top rate.  Without this legislation, the bottom rate would have increased to 15% and the top rate to 39.6%.
• A "payroll tax holiday" that reduces the amount of FICA withholding by 2% (self-employed taxpayers will see their self-employment tax decrease by 2%).  For a person making $40,000/year, this would equal an $800 savings.  (But the Making Work Pay Credit is expiring, which negates some of the savings.)
• Another "patch" to the Alternative Minimum Tax that will help millions of taxpayers avoid this tax.
• The capital gains and qualified dividends rates remain at 0% for taxpayers in the 10% and 15% tax brackets, and at 15% for taxpayers in the higher tax brackets. 
• The Child Tax Credit will remain at $1,000 (it had been set to decrease to $500 in 2011).
• You can claim dependent care expenses of $3,000 for one child or $6,000 for two or more children.  These amounts had been set to decrease to $2,400 and $4,800.
• The expanded Earned Income Credit remains in place through 2012.
• The credit available for energy efficient upgrades to your home remains in place through 2012 (it had been set to expire at the end of this year).
• Extension of the American Opportunity Credit for college expenses, and an extension of the "above-the-line" deduction for college expenses.
• Special 100% "bonus depreciation" for purchases of brand-new assets from September 9, 2010, through the end of 2011.
• The estate tax returns with a $5 million exemption per person, and a 35% top rate, retroactive to January 1, 2010.  Estates arising in 2010 will have the option of of using these rules, or using the "old rules" of no estate tax and a reduction in the amount of increase in carryover basis.

Section 179 and Bonus Depreciation for Iowans

Following up on my last post about Section 179 expensing and bonus depreciation:  one other aspect of tax planning for asset purchases is to examine what your state's rules are.  Some states, such as Iowa, do not follow federal guidelines for either Section 179 or bonus depreciation.

For example, in Iowa, Section 179 expensing is capped at $134,000, and bonus depreciation is not honored at all.  If your federal Section 179 expense exceeds $134,000, you'll only be able to deduct $134,000 as Section 179 expensing on your Iowa return; the rest will have to be depreciated.  This means an Iowan  could easily have to track two sets of basis and two sets of depreciation schedules - one for the IRS and one for Iowa.

Iowa isn't the only state that does this.  For example, I prepared an Ohio tax return last year, and they have a strange "5/6" rule on bonus depreciation and Section 179 expensing.  The rule gets its name because you have to add back 5/6 of the bonus depreciation amount as income on your Ohio tax return.  And for Section 179 expensing, you have to compare the amount of Section 179 expensing in the current year with the amount that would have been allowable if it was still 2002 (when the 179 limit was $25,000).  Basically, you add back to income 5/6 of the dollar amount of Section 179 expensing in excess of $25,000.

Preparing this Ohio return opened my eyes to the fact that Iowa, while it rightfully ranks very poorly in tax friendliness, is not the only state with mystifying tax rules.

More on Section 179 and Bonus Depreciation

I have had a number of visitors to this blog with questions about Section 179 expensing, which is something I posted about briefly last week (December 10).  I'll go into a little more detail in this post.

When a business purchases an asset that has a useful life of more than 1 year, the tax code gives the business 3 options for deducting the cost of that asset:  depreciation, Section 179 expensing, and bonus depreciation.

Depreciation means the business can deduct a certain amount of the purchase price each year over a number of years set by the tax code for that type of asset.  For example, computers are depreciated over 5 years.  The number of years is set by the code and has nothing to do with how long you actually intend to use the asset in your business. 

Section 179 expensing allows you to write off 100% of the cost of the purchase of an asset in the year of purchase.  For 2010 and 2011, a business can write off up to $500,000 of asset purchases.  If you purchase more than $2 million of assets during the year, your Section 179 deduction will be phased out.  Your total Section 179 deduction is limited to your taxable income for the year; unused Section 179 expenses in one year can be carried forward to the next year.  Please note that most - but not all - property qualifies for Section 179 expensing.  Examples of property that does NOT qualify is leased property and air-conditioning or heating units.

Note for rental property owners:  Section 179 does not apply to rental properties; if you own rental property, you can't use Section 179 expensing.

Bonus depreciation is a sort of hybrid between regular depreciation and Section 179 expensing, where you can claim 50% of the cost of an asset as a deduction, and then depreciate the remainder of the cost.  Bonus depreciation is available to rental property owners.  One caveat on bonus depreciation:  it can only be claimed on assets that are brand new.  (Section 179 can be claimed on used assets, as long as the asset is "new" to your business.)  One other note on bonus depreciation:  the tax bill being debated right now by Congress proposes to allow 100% bonus depreciation on assets purchased between September 9, 2010, and December 31, 2011.  (UPDATE:  this proposed legislation became official in the tax bill passed by Congress.)

Most of the time, a business will just take the Section 179 expense and be done with it.  It provides an immediate deduction and eliminates the need for cumbersome depreciation schedules.  However, Section 179 expenses are limited to the amount of taxable income (as calculated before the Section 179 deduction).  In other words, Section 179 cannot create a business loss.  But regular depreciation and bonus depreciation can create business losses.  Plus, if you expect that your business income will grow in future years but you won't be purchasing assets in those years, it might be nice to have a depreciation deduction available to offset the increase in income. 
As you can see, your depreciation/Section 179/bonus depreciation strategy is part of tax planning and is a good conversation to have with your tax advisor.

Roth IRAs Must Be Converted by Year-End to Defer Taxes

A deadline is approaching for Roth conversions.  The deadline is December 31st for anyone who wants to defer taxation on the conversion into 2011 and 2012. 

I talk about Roth conversions in much more detail in this article, but in general:  the amount of the conversion must be claimed as income on your tax return.  For conversions happening in 2010 only, you have the option of claiming all the income in 2010, or deferring recognition to 2011 and 2012.

For conversions happening after the first of the year, the income will have to be recognized in full in the year the conversion takes place.

Deal Reached on Taxes (Maybe)

President Obama and Republicans in Congress have reached an agreement on taxes.  The agreement calls for the following:

• Extension of the Bush Tax Cuts through the end of 2012.  For more on what this means, see this article posted a few days ago on the Dinesen Tax Times.
• A two-year "AMT patch."  This will prevent an estimated 22 million taxpayers from falling victim to this tax.  For more on what would happen without this patch, see this Dinesen Tax Times article.
• Extension of the expanded Earned Income Tax Credit, extension of the expanded child tax credit, and extension of the American Opportunity Credit for college expenses.
• Extension of miscellaneous tax provisions such as the additional standard deduction for real estate taxes paid by non-itemizers.  The $250 "above-the-line" deduction for classroom expenses of K-12 teachers is also extended.
• Unlimited expensing of new assets in 2011.
• A reduction in the employee portion of FICA withholding, from the current 6.2% to 4.2%.  For a person making 40,000 per year, this would equate to a savings of $800 over one year.  This provision may have been put in the agreement to make up for the expiration of the Making Work Pay Credit.
• The estate tax will return with a $5 million exemption and a top rate of 35%

Democrats are not happy with this proposal, so it remains to be seen if it will actually be passed into law.