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Tax Extenders to Use in Your Tax Planning

Temporary tax provisions that have been passed by Congress on an annual basis for several years are more commonly referred to as “tax extenders.”  Most of the approximately 50 tax provisions that comprise the usual list of tax extenders were originally enacted as economic incentives; they were meant to encourage taxpayers to spend money in areas that would spur economic growth in exchange for a tax deduction or other beneficial tax position.  Unfortunately, Congress’ habit of passing the tax extender legislation so late in the year tends to eliminate or greatly reduce taxpayer’s spending.  The timing effectively changes tax extenders from tax planning tools to spending rewards.

So as taxpayers evaluate their current year tax positions and look to ways of reducing their current year tax bill, they need to ask themselves which tax extenders will likely be passed by Congress in the final days of this year that will be retroactive for the entire year.  Just as investors speculate when they invest in the stock market, taxpayers will need to speculate which tax extenders will be available to them.

The House has passed several individual bills which would pass some of the tax extenders either temporarily or permanently, but the Senate continues to pursue a single bill that would pass certain tax extenders temporarily.  If a taxpayer intends to speculate on the tax extenders that will ultimately be approved by both houses of Congress, they first need to know which tax extenders have the most broad based support.  The tax extenders that appear to have the most support include:

  1. Increased Section 179 expense limit for deducting qualifying qualifying property (i.e., $500,000 with a phase-out beginning at $2,000,000);
  2. Bonus depreciation write-off of 50 percent for property acquired and placed in service;
  3. Shorter five year recognition period for determining built-in gains of a S-corporation;
  4. Research credit of 20% for qualified research expenses;
  5. Deduction to adjusted gross income for college tuition and fees for higher education;
  6. Deduction to adjusted gross income for educator expenses;
  7. Itemized deduction for mortgage insurance premiums;
  8. itemized deduction for state and local general sales taxes;
  9. Exclusion from income of the discharge of qualified principal residence indebtedness; and
  10. Tax-free charitable donation from an IRA of up to $100,000.

So as taxpayers review their current year tax situation and look for ways to reduce their anticipated tax bill, they should consider the preceding tax extenders when tax planning and evaluate the risk of their speculation that these tax extenders will ultimately be passed by Congress.

Contact Flexible Accounting Services of the Triangle today and discuss with our professionals your unique tax planning needs and which tax extenders could benefit you most.


Health Care Penalty

If a taxpayer, their spouse (if married and filing jointly) or any of their dependents did not have minimum essential health care coverage or a health coverage exemption for each month during 2014, they will be required to compute and report a health care penalty (a.k.a. shared responsibility payment) on their 2014 income tax return.

The health care penalty will be the greater of the following:

  • 1% of household income that exceeds the tax return filing threshold for the taxpayer’s filing status, or
  • The family’s flat dollar amount, which is $95 per adult and $47.50 per child, up to a family maximum of $285.

The total health care penalty is capped at the cost of the national average premium for a bronze level health plan available through the insurance marketplace. For 2014, this amount is $204 per individual per month.

Household income is the taxpayer’s modified adjusted gross income (MAGI) plus the MAGI of every other individual in the family for whom the taxpayer can claim a personal exemption and who is required to file a federal income tax return. Individuals, who file only to claim a refund of federal income tax withholding or estimated tax payments but would not be required to file otherwise, are not included.

MAGI is computed by determining an individual’s adjusted gross income and adding the following:

  • Foreign income,
  • Nontaxable Social Security benefits (not Supplemental Security Income),
  • Nontaxable tier 1 railroad retirement benefits, and
  • Tax-exempt interest.

If you did not carry minimum essential coverage (e.g., qualified health insurance through your workplace or an insurance marketplace, Medicare, Medicaid, etc.) during 2014, contact Flexible Accounting Services of the Triangle and allow us to assist you in determining whether you qualify for a health coverage exemption or if you are required to pay the health care penalty created by the Affordable Care Act.

Health Coverage Exemptions

As required by the Affordable Care Act (a.k.a. “Obamacare”) individuals were required beginning in 2014 to purchase qualified health care coverage for themselves, their spouse (if filing jointly) and their dependents. If the taxpayer failed to obtain coverage or allowed the coverage to lapse during the year, they must qualify for a health coverage exemption or pay a penalty (a.k.a. “share responsibility payment”).

Health coverage exemptions can either be granted directly by the Marketplace (i.e. a state insurance exchange) or be claimed on the taxpayer’s annual income tax return. In either case, the exemption is reported on the taxpayer’s income tax return.

The Marketplace will grant a health care exemption for the following circumstances:

  • The individual is a member of a health care sharing ministry;
  • The individual is a member of a federally-recognized Indian tribe;
  • The individual is in a jail, prison or similar penal institution or correctional facility;
  • The individual is a member of certain recognized religious sects; or
  • The individual qualifies for a hardship.

The hardships the Marketplace recognized included the following:

  • The individual is an American Indian, Alaska native, or the spouse or descendent of either who is eligible for services through an Indian health care provider;
  • The individual is experiencing circumstances that prevents them from obtaining coverage under a qualified health plan;
  • The individual does not have access to affordable coverage based on their projected household income;
  • The individual is ineligible for Medicaid solely because they live in a state which did not participate in the Medicaid expansion under the Affordable Care Act; or
  • The individual has been notified that the health insurance policy they currently have will not be renewed and other plans available are unaffordable.

If the taxpayer did not receive an exemption during 2014 from the Marketplace, they can still claim a health coverage exemption on their tax return for the following circumstances:

  • The individual cannot afford coverage because the minimum amount for premiums is more than 8% of household income;
  • The individual went without coverage for less than 3 consecutive months during the year;
  • The individual is a U.S. citizen living abroad or certain non U.S. citizens;
  • The individual’s household income is below the minimum threshold for filing a tax return;
  • The individual is a member of a health care sharing ministry, a member of federally-recognized Indian tribe, or incarcerated; or
  • The individual qualifies for a hardship.

The hardships the taxpayer can recognize include the following:

  • Two or more family members’ aggregate cost of self-only employer-sponsored coverage is more than 8% of household income, as is the cost of any available employer-sponsored coverage for the entire family;
  • The individual purchased insurance through the Marketplace during the initial enrollment period but had a coverage gap at the beginning of 2014;
  • The individual applied for CHIP coverage during the initial open enrollment period and was found eligible for CHIP based on that application but had a coverage gap at the beginning of 2014;
  • The individual is an American Indian, Alaska native, or the spouse or descendent of either who is eligible for services through an Indian health care provider; or
  • The individual’s gross income is below the filing threshold.

Obamacare and the resulting regulations rolled out by the Internal Revenue Service can be complex. Do not pay the penalty on the tax return if it is not required. Contact Flexible Accounting Services of the Triangle today and let us assist you in determining if you qualify for one of the health coverage exemptions.

Qualified Tuition Programs

Qualified Tuition Programs (“QTP”), a.k.a. Section 529 College Savings Plans, are education tax incentive programs that enable a person to either prepay a beneficiary’s tuition (i.e., prepaid plans) or contribute to a savings account established for paying a beneficiary’s qualified education expenses (i.e., savings plans). The two types can be summarized as follows:

  1. Prepaid Plans establish prepaid tuition accounts that provide certain agreed-upon educational services (e.g., certain number of credit hours) to the beneficiary in return for the contributions received. The beneficiary receives the educational services regardless of the cost when actually provided, thus shielding them from inflation in college costs. These plans generally have a more conservative investment philosophy and are restricted to specific private or state-run schools.
  2. Savings Plans establish college savings accounts that have the opportunity to earn investment income in excess of the rate of inflation of college costs. The account holder bears the risk of what the account will be worth and thus how much of the educational expenses it can pay when the beneficiary attends college. These state plans are professionally managed by investment or mutual fund companies and can generally be used at any U.S. college or university.

Both types of plan have the following requirements:

  • They can only accept cash contributions (i.e., cash, checks, money orders or credit card payments);
  • They cannot give contributors direct or indirect control over the investment of the accounts (Note that they do allow the contributor to select investment options or strategies for the account at the date of contribution, annually, and when the beneficiary is changed); and
  • They cannot accept contributions once the plan is funded with enough to pay for tuition, fees, and room and board for five years of undergraduate enrollment (this amount is determined using actuarial estimates) at the highest cost institution allowed by the plan.

There is no federal income tax consequences to the contributor or beneficiary when funds are contributed to QTP or while the funds remain invested in the account plans. Distributions are tax-free if used for any of the following qualified education expenses:

  • Tuition, fees, books, supplies and equipment required for enrollment or attendance at a college, university or certain vocational schools;
  • Room and board if the student carries at least half of a full-time course load; and
  • Expenses of a special needs student which are necessary for his or her enrollment or attendance at an eligible educational institution.

Qualified educational expenses are reduced by the tax-free part of scholarships, veteran’s educational assistance, Pell grants, employer-provided educational assistance, and any other tax-free payments received as educational assistance when computing the tax-free amount. In addition, the same qualified educational expenses cannot be claimed for both an education tax credit and tax-free distribution.

The earnings portion of a distribution not used for qualified education expenses is subject to income tax and a 10% non-qualified withdrawal penalty. The penalty has exceptions if the beneficiary dies or becomes disabled, receives a scholarship or attends a U.S. Armed Forces Academy, or the qualified expenses were used to claim an education tax credit.

Contact Flexible Accounting Services of the Triangle to discuss the tax consequences of QTP and other education tax incentives available to you.

Selecting the Right Education Tax Incentive

The taxpayer has several tax credits and deductions they can claim to reduce their income tax if they have incurred education costs during the year. The difficulty is claiming the one which creates the greatest benefit.

The first step in selecting the credit or deduction that is most beneficial to your circumstances is to compare and contrast the requirements of each tax incentive. The most common education tax incentives to consider include the following:

  1. American Opportunity Credit
  2. Lifetime Learning Credit
  3. IRA Withdrawals for education expenses
  4. Savings Bond interest exclusion
  5. Student Loan Interest Deduction
  6. Tuition and Fees Deduction
  7. Qualified Tuition Programs
  8. Educational Savings Accounts

Each education tax incentive has different requirements, but all can be compared and contrasted using the following questions:

  • What is the tax benefit provided;
  • What is the annual limit of the tax benefit;
  • Which education costs are considered to be qualified education expenses;
  • Who incurred the qualified education expenses;
  • What education program is the student enrolled;
  • What other requirements or limitations exist; and
  • When is the tax benefit phased-out because of the taxpayer’s income?

Once the taxpayer knows which tax incentives they are eligible to claim, they can then begin the next step of evaluating which one creates the greatest tax benefit (i.e., the one that will generate the lowest tax liability or greatest refund when claimed).

Contact Flexible Accounting Services of the Triangle today and let us assist you in evaluating which tax credit or deductions you can claim to maximize your tax refund or lower your tax liability.

Stock Donations

Donating appreciated stock is an excellent tax-efficient method of funding charitable gifts because the taxpayer making the donation avoids paying capital gains tax on the appreciation while still being able to deduct the fair market value of the stock as a charitable contribution.

The taxpayer’s process for valuing, substantiating and reporting the stock donation depends on the type of stock donated as follows:

  1. Publicly Traded Stock – is stock for which market quotations are readily available on established securities markets (e.g., stock exchanges, over-the-counter markets, or mutual fund listings that have daily published quotations). The donation is valued as the average of the highest and lowest selling prices on the contribution date (not the closing price) except for shares of a mutual fund which are valued at the public redemption price on the contributions date. The donation is reported on Form 8283, Part A of the taxpayer’s income tax return.
  2. Non-publicly Traded Stock – is stock evidenced by a stock certificate that does not qualify as publicly traded stock. The donation’s value is estimated by considering the corporation’s net worth, prospective earning power, dividend-paying capacity, and other relevant factors including the business’s nature, history and goodwill; the industry’s economic outlook; the company’s position within its industry; and the value of stock of corporations in the same or similar business. A qualified appraisal is required if the donation is valued over $10,000. The donation is reported on Form 8283, Part A of the taxpayer’s income tax return if the donation is $5,000 or less and on Form 8283, Part B is greater than $5,000.

Closely-held or S Corporation stock may not be the best choice for a stock donation because:

  • The fair market value of the shares may be difficult or costly to determine;
  • If the donation to be deducted exceeds $10,000, the donor must obtain a qualified appraisal;
  • If the stock is donated to a private non-operating foundation, the deduction is limited to the lesser of the donor’s basis or the fair market value;
  • If the recipient cannot sell the closely-held stock (due to its lack of market), the gift may have limited value unless enough stock is donated to provide the recipient with control or influence over business matters; and
  • If the recipient receives S Corporation stock, pass-through income reported on Schedule K-1 will be subject to unrelated business taxable income.

Stock donations can be an excellent financial and tax planning tool, particularly before the end of the calendar year. Contact Flexible Accounting Services of the Triangle today and let us assist you with valuing, substantiating and reporting your donations of stock.

Maximizing Charitable Deductions

Taxpayers can lower their taxable income by incurring travel, paying for out-of-pocket expenses as a volunteer, or directly giving money or property to any of the following:

  • Churches, synagogues, temples, mosques or other religious organizations;
  • Federal, state and local governments (if the contribution is solely for a public purpose);
  • Nonprofit schools and hospitals;
  • Public parks and recreational facilities;
  • Service organizations (e.g., Salvation Army, Red Cross, CARE, United Way, Boy/Girl Scouts, etc.);
  • War veterans’ groups; and
  • Other organizations listed in IRS Publication 78.

The deduction for charitable contributions to the preceding groups cannot exceed 50% of a taxpayer’s adjusted gross income (“AGI”); moreover, certain contributions have a reduced limit of 30% or 20%. Contributions that exceed the AGI limit in the current year can be carried over to each of the five succeeding years.

Transferring cash is the simplest way to make a tax-deductible contribution because cash does not have to be valued, costs associated with title transfers are avoided, and the AGI limits on cash contributions are generally higher than the limits on non-cash contributions. Transferring property is more difficult because of associated transfer costs and special rules governing specific types of property (e.g., tangible personal property, intangible personal property and real property).

Taxpayers should consider the following strategies before making contributions to ensure that they are maximizing the charitable contribution deduction:

  1. Cash – ensure cash contributions are made in a year when the taxpayer can itemize deductions;
  2. Appreciated short-term capital gain property, inventory, or donor-created property – limit donations to property for which fair market value approximates cost or delay donations until the property has been held for more than one year so that fair market value can be deducted instead of adjusted basis;
  3. Appreciated long-term capital gain property or tangible personal property donated for use unrelated to a charitable group’s exempt function – donate the property instead of cash to avoid the tax on the unrealized gain;
  4. Appreciated tangible personal property for charitable group’s unrelated use – donate property when fair market value approximates cost (if long-term capital gain property, sell at fair market value and donate proceeds so gain is taxed at lower capital gain rate and deduction is taken against higher ordinary income tax rate);
  5. Appreciated gifts to private non-operating foundations – donate property with fair market value that approximates cost or donate qualified appreciated stock eligible for fair market value deduction (if long-term capital gain property, it may be more beneficial to sell the property and donate proceeds because of the tax rate differences);
  6. Depreciated property used in a trade or business or for the production of income – sell the property (thereby recognizing the tax loss) and donate the proceeds to obtain a combined deduction equal to the entire tax basis; and
  7. Depreciated personal use property – since the loss on sale cannot be recognized for tax, donate the property or sell the property and donate the proceeds as both options yield the same tax deduction.

Before making charitable contributions, particularly property contributions, contact Flexible Accounting Services of the Triangle so we can assist you in maximizing your charitable contribution deduction.

Special Loss Allowance for Passive Losses

Passive activities are defined as any trade or business activity in which the taxpayer does not materially participate. The deductibility of losses from passive activities is limited to income generated from other passive activities. Any passive losses not allowed are carried forward to subsequent tax years.

Although rental real estate is generally a passive activity, a special loss allowance can be claimed by certain taxpayers which allows for up to $25,000 of passive losses from rental real estate losses to be deducted against non-passive income (e.g., wages or portfolio income). To claim the special allowance:

  • The taxpayer must actively participate in the rental activity (this standard is met if the taxpayer owns 10% of the rental property and has substantial involvement in managing it);
  • The taxpayer cannot own the activity as a limited partner; and
  • The amount of the eligible loss is determined by netting income and losses from all of the taxpayer’s rental real estate activities in which the taxpayer actively participates.

The active participation standard that applies to this special loss allowance is a lower standard of involvement than material participation under the passive activity rules. Active participation requires taxpayers to arrange for others to provide rental services (such as repairs) or to participate in management decisions such as:

  • Approving new tenants;
  • Deciding on rental terms; and
  • Approving capital or repair expenditures.

The $25,000 special loss allowance starts to phase out once a taxpayer’s modified adjusted gross income (“MAGI”) exceeds $100,000 until it is reduced to zero when MAGI reaches $150,000. MAGI is a taxpayer’s regular adjusted gross income without:

  • Any net passive activity loss;
  • Taxable Social Security or tier 1 railroad retirement benefits;
  • Deductions for IRA contributions;
  • Series EE U.S. bond interest;
  • Income excluded under employer’s adoption assistance program;
  • Rental losses allowed from activities involving a real estate professional;
  • Losses from publicly traded partnerships; and
  • Deductions for self-employment tax, student loan interest, domestic production activities, and qualified tuition and fees.

The deductibility of passive loss activities is a complicated area. Contact Flexible Accounting Services of the Triangle today to see if your rental activities qualify for the special loss allowance, and how much you can claim on your return.

Maximizing Real Property Depreciation

Cost segregation is the practice of identifying depreciable assets and their costs, and classifying those assets into the appropriate depreciable life in order to obtain the maximum allowable depreciation under federal tax law. The following three-step process for allocating costs helps taxpayers assign as much cost as possible to the most advantageous depreciable life:

  1. Make an initial cost allocation between land and building based on their relative fair market values (note that if a cost allocation is agreed to between a buyer and seller and included in the sales contract, the IRS will generally use the agree-upon allocation instead of another cost segregation plan);
  2. Identify land costs that can be classified as land improvement costs and thus be depreciated over a 15 year recovery period (e.g., sidewalks, roads, paved parking lots, drainage facilities, bridges, fences and landscaping adjacent to buildings); and
  3. Analyze building costs to identify tangible personal property that can be segregated and depreciated over 5 or 7 year recovery periods.

When trying to determine how to allocate land and building in step 1, absent a qualified appraisal, taxpayers can use any reasonable method provided it is realistic and supportable. The IRS has previously accepted the following methods as reasonable:

  • Estimated replacement cost;
  • A taxpayer’s own expertise and knowledge; and
  • The appraisals of local tax assessors in the absence of better evidence to determine fair market value.

Typically, most of the time and effort in the aforementioned three-step process occurs in step 3 where the building costs are allocated between structural components and tangible personal property. Structural components (e.g., walls, floors, ceilings, central heating and air systems, plumbing, electrical wiring, lighting fixtures, etc.) are depreciated using recovery periods of 39 or 27.5 years whereas movable building costs (e.g., carpeting, partitions, removable floor tiles, seating booths, signs, ornamental structures, etc.) although contained in or attached to a building qualify as tangible personal property that can be depreciated using recovery periods of 5 or 7 years.

Cost segregation studies used to substantiate accelerated depreciation recovery periods normally require the individuals or firms creating them to have expertise and experience in such projects (such as engineers) because the IRS challenges those that are not well-prepared and documented or prepared by unqualified persons. Due to the cost of hiring a cost segregation expert, a cost-benefit situation exists whenever a taxpayer considers if they need a cost segregation study. Typically, cost segregation studies benefit acquisitions and constructions that exceed $1 million (excluding land) and that are held for more than three years; however, other factors also come into play.

Cost segregation can be one of the most valuable tax strategies available to commercial real estate owners by accelerating the depreciation of individual components included in the original cost. Contact Flexible Accounting Services of the Triangle today to see if this strategy could reduce your tax bill by increasing or accelerating your allowable depreciation.

Small Business Stock Losses

Section 1244 of the tax code encourages new investment in small businesses by permitting investors to claim an ordinary loss on disposition (including worthlessness) of eligible small business stock. The maximum deductible ordinary loss under Section 1244 is limited to $50,000 per year ($100,000 for married filing joint). If the loss exceeds the annual deductible limit, the excess is classified as a capital loss subject to the capital loss rules and limitations.

To qualify under Section 1244, the small business stock must comply with certain requirements when issued and in the year the stock is disposed at a loss. The requirements at issuance include:

  • The corporation must be a domestic corporation;
  • The cumulative amount of money and property received by the corporation for the stock must be $1 million or less;
  • The stock must be issued in exchange for cash or other property (not for stock, securities, or in exchange for services provided);
  • The stock must be issued directly to the original owner (i.e., a taxpayer who purchases an existing company via a stock purchase is not eligible for Section 1244 because they would not be the original owner of the stock);
  • The original owner must be an individual or partnership; and
  • The stock can be either common or preferred stock issued after July 18, 1984.

The requirements in the year the stock is disposed at a loss include:

  • During the five most recent tax years before the loss, the corporation must have derived more than 50% of its gross receipts from sources other than royalties, rents, dividends, interest, annuities, and gains from sales and trades of stocks and securities;
  • If the corporation was in existence for at least a year, but less than five year, the 50% gross receipts test applies to all the tax years ending before the loss;
  • If the corporation was in existence less than a year, the 50% gross receipts test applies to the entire period of the corporation’s existence; and
  • The corporation must be largely an operating company during the gross receipts testing period, not merely a holding or investment company.

To take advantage of the Section 1244 stock loss, it is important that both the shareholder and the corporation keep adequate records. The shareholders need to track Section 1244 stock and non-Section 1244 stock in the same corporation separately. Corporations should maintain the following records:

  • The names of the person to whom Section 1244 stock was issued;
  • The date that Section 1244 stock was issued;
  • A description of the amount and type of consideration received by the corporation from each shareholder (if property was received, the corporation should document the shareholder’s adjusted basis and the fair market value of the property when received by corporation);
  • A breakdown of money and basis in the hands of the corporation of property received in exchange for stock, as a contribution to capital or as paid-in surplus;
  • Information regarding any tax-free stock dividends or tax-free reorganizations; and
  • Tax returns for the five most recent years preceding the year in which a shareholder claims a Section 1244 loss in order to substantiate the gross receipt test requirement.

Taxpayers who invest in small business stock that qualifies for Section 1244 have a significant advantage if the stock is sold at a loss. Contact Flexible Accounting Services of the Triangle today to see if you can benefit from Section 1244.