10.20.10
Posted in Complaints and Rants at 7:16 pm by Robert Waldeck
Some common occupations that receive a 1099-Misc form, as opposed to the standard W2 at the end of the year, are sub contractors, real estate brokers and insurance agents. Those who have their income reported on a 1099-Misc are considered independent contractors or self-employed by the IRS, and are responsible for paying their own taxes—to put it simply, none of their taxes are withheld during the year.
This can be a double edged sword for many independent contractors in this country—for those with adequate tax knowledge, or access to a qualified tax professional, receiving a 1099 can actually be a good thing. For those who are new to an occupation that reports income via the 1099, or believe they are pseudo tax expert by being able to enter their W2’s in to Turbo Tax—receiving a 1099-Misc can be a disaster at tax time.
In most circumstances, an employee’s (someone who gets a W2 by January 31) net wages, have already had taxes withheld for federal, FICA, and state. They are not totally responsible for their own taxes, but an independent contractor is. The first thing you have to do as one is make sure that you pay your taxes quarterly. The total amount you have to pay is the smaller of these two numbers—either 100 percent of last year’s tax liability, or 90% of the current year’s tax liability. Failure to pay in enough throughout the tax year will result in an estimated tax penalty on your tax return.
The second and most crucial part of being an independent contractor is tracking your business expenses during the year. Taxpayers who receive 1099’s are allowed to deduct their expenses from business activities just like a business owner can, in fact, most small business owners and independent contractors use the same form to report their income, a Schedule C.
The most important expense for independent contractors to keep track of is their auto expenses—namely business miles driven if using the standard mileage calculation. The IRS allows taxpayers to deduct 50 cents for every business mile driven during 2010, the standard mileage rate cannot be taken in addition to actual vehicle expenses like gas, repairs, depreciation, and insurance. Independent contractors must decide whether or not they want to use actual expenses, or the standard mileage rate.
Something else that an independent contractor must take in to consideration in regards to mileage is the definition of business miles—not all miles driven are considered business miles. Miles driven from home to your office are considered commuting miles, not business miles. Miles driven from the office to your worksite or appointment are considered business miles—and obviously miles that your drive while not at work are considered personal miles and cannot be deducted. For those who decide to use the actual expenses method, your deduction can be figured by totaling up your auto expenses and multiplying that number by the ratio of business miles driven. For example, if you drove 30,000 miles for the year, and half of them were business miles, then you could take half of your auto expense for the year as a deduction.
Other expenses in addition to auto expenses that need to be recorded and can be deducted include:
- Advertising expenses
- Office supplies,
- Cost of uniforms/Equipment
- Utilities
- Insurance,
- Interest paid
- Legal/professional services
- Meals and Entertainment Expenses
- Lodging expenses
One last topic that independent contractors need to consider is the home office deduction. If you use a portion of your home exclusively for business purposes, you can take the deduction. This will enable you to not only deduct a portion of your living expenses, including rent/interest, insurance, taxes and utilities, but the home office deduction will allow you to turn some of your commuting miles in to business miles.
You can include commuting miles as business miles if you are a small business owner or self-employed person, and you have two offices or work locations: one outside the home and one inside the home. You will need to fill out form 8832 in addition to a schedule C to correctly file the home office deduction.
The best way for small business owners and independent contractors to save money at tax time is to understand what they are allowed to deduct, and also have an expense tracking system during the year that does not include stuffing receipts in to a shoe box—using an excel spreadsheet or QuickBooks is a better option.
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Posted in ezine articles at 12:56 pm by Robert Waldeck
The two most common places where people keep their savings are in their IRA and 401k accounts. While most people realize that it is in their long term financial interest to not tap in to these accounts until retirement, sometimes they do not have a choice. So what happens if a short term financial struggle suddenly outweighs your long term financial goals? The answer is that the short term struggle will usually win out at the expense of your nest egg.
But what happens to you from a tax perspective? The answer is–if you withdraw out of your retirement account early, the IRS imposes a 10% penalty on that distribution. They do this to discourage the use of retirement funds for purposes other than normal retirement, and because the fact that taxpayers invested pretax dollars in to a retirement account.
In most cases, the contributions either came out of your paycheck before taxes were taken out, or you were given a deduction on your tax return for contributing to an IRA. The early distribution that you receive will also be considered income for the tax year, and subsequently taxed at your personal income tax rate. The IRS considers a distribution early when you withdraw it from a qualified retirement plan like a 401k or IRA before reaching the age of 59 ½, but just like every other area of tax, there are exceptions to this rule, and to complicate matters even further, the IRS has a different set of exceptions for both IRA and a 401k early withdraws.
Taxpayers can avoid the ten percent penalty on withdraws from either plan under these circumstances; the distribution was made because the participant was disabled at the time of withdraw, or was made to you as a beneficiary because the participant passed away. The penalty can be removed if the distribution was to cover a debt due to an IRS levy, dispersed as part of a qualified annuity, or was dispersed to qualified reservists after age 55. These exceptions listed above will only remove the additional ten percent penalty, taxpayers will still have to include the total distribution as income for the tax year.
There are a few exceptions to the early withdraw penalty for participants of IRA plans that do not apply to participants of 401k plans. These include distributions used to build or buy a first home, distributions used on qualified higher education expenses, and also the cost of medical insurance for those who are unemployed. Any amounts of the early distribution that are in excess of the exceptions mentioned above, will be subject to the ten percent penalty. For example, if a taxpayer withdrew 20,000 dollars from their IRA, but only had 15,000 dollars of college expenses, then the difference (5,000) will be subject to the ten percent tax.
There are a few common exception issues that usually arise with participants of 401k accounts, as opposed to IRA participants, most notably loans against 401k’s, and distributions to reduce excess contributions. Generally, if a loan is permitted by the 401k plan, a participant may borrow up to 50% of the account balance, with a maximum of 50,000 dollars. The loan must be repaid within 5 years, unless the loan is used to buy the participant’s home.
401k loans do not have to be picked up as income, and are not subject to the ten percent penalty as long as they are paid back in the appropriate time frame. Also, 401k distributions taken to reduce excess contributions from you, or your employer, are not subject to the ten percent penalty, the maximum contribution for 2010 is 16,500 dollars.
Avoiding the ten percent penalty can have a massive financial impact on you, and your family, going forward. If you believe that you have incorrectly paid a penalty on a distribution, you can amend a prior year return up to three years from the due date. You will need to file form 5329 for the appropriate tax year to recoup the additional tax for the IRS.
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08.18.10
Posted in ezine articles at 10:07 am by Robert Waldeck
A college diploma has almost become a prerequisite for a successful career in this day and age, so understanding the tax breaks that are associated with college tuition costs is essential. While many of the traditional tax breaks remain in place, some new changes have been implemented that assist taxpayers in paying for a higher education.
Tax credits were expanded for students and parents by way of the American Recovery and Reinvestment Act of 2009, a few highlights of this act were modifying the Hope Tax Credit with the American Opportunity Credit, increasing income limits to qualify for tax credits, and expanding the scope of qualified expenses to include required course materials.
The American Opportunity Credit is made available to a broader range of taxpayers than the existing educational credits. The maximum credit is 2,500 per student, and 40% of that credit is now refundable for students and parents with little or no taxable income. The credit is offered for those who are completing their first four years of college, the Lifetime Learning and Hope Tax Credits are still available for graduate students, but are not refundable, and only help those with tax liability during the year.
A student with qualified expenses over 4,000 dollars will be able to receive the full credit, and for those with fees that are below that level will be credited 100% percent for the first 2,000 dollars of expenses, and 25% for the next 2,000 dollars in expenses. Qualified expenses have also been modified to now include not only tuition and course fees, but textbooks and other required materials for each class.
Parents who claim a student as their dependent, and have a modified gross income below 160,000 dollars a year, (80,000 if filing single, head of household) will be eligible for the full credit; incomes above that amount will begin to be phased out. The existing Hope and Lifetime learning credits have higher income ceilings, allowing those with higher incomes to still receive benefits.
Student loan interest is still deductible for those with modified adjusted gross incomes below 75,000 dollars (150,000 filing jointly). The student loan interest deduction is an above the line deduction, which means you do not have to itemize to be able to take it. Parents can take the deduction if your dependent incurred the loans and the maximum amount of deductible interest per year is 2,500.
Another tax break that is still available is the qualified tuition and fees deduction for college expenses paid during the year for your dependents or yourself. This deduction is also above the line, just like student loan interest and can be taken without itemizing. The maximum benefit allowable is 4,000 dollars a year, to find out your tax benefit, multiply the total deduction by your marginal tax rate. Similar income ceilings are in place for this deduction as well, if your modified AGI is above 80,000 a year, (160,000 if filing jointly) then you will not be eligible.
The best place to start when figuring out how to pay for school is by filling out your FAFSA, this will determine you what types of grants and cheap loans that you will qualify for, for example Pell grants and Stafford loans. The best time to do this is when you file your taxes in the spring, because you will need your tax return to complete the FAFSA.
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08.17.10
Posted in ezine articles at 10:54 am by Robert Waldeck
Choosing the correct entity structure is a concept that many LLC’s and small business owners often overlook in their attempt to reduce their tax bill, as opposed to more commonly known strategies like deducting business expenses and depreciating assets, but there are a few situations where filing as a different entity can reduce your tax liability significantly.
A popular trend for small businesses is to incorporate as a Limited Liability Corporation within their state of operation. A LLC shelters your personal assets from possible litigation against your company in most cases, but from a tax perspective, a limited liability corporation does very little, in fact, the IRS does not recognize an LLC as an entity for tax purposes.
Businesses that incorporate as an LLC will usually file their taxes as one of the following—a Partnership, S Corp, or Sole Proprietor. (Companies can also choose to file as a C corporation as well, but you will be subjected taxation at the corporate and personal levels.) There are some advantages and disadvantages associated with each of these different filing entities, and being informed about each of them can be a major asset for your business going forward.
Sole Proprietors are unincorporated businesses or LLC’s with one owner, they usually file their business taxes using a schedule C, or schedule E on their 1040. Filing your business taxes using a schedule C is by far the easiest and cheapest way, mainly because of the simplicity of the forms in comparison to corporate returns, but if you have more than one owner, filing this way is not possible, you are considered a partnership. Profits from a sole proprietor business are added in to your adjusted gross income and are also subject to the self employment tax of 15.3%.
The IRS deems your business a general partnership if two or more persons join to carry on a trade or business, and each share in the profit and losses. (Incorporating as an LLC will not affect your partnership status; the LLC will make it less complicated to declare a different entity though, like an S Corp.) If this is the case for your business, you will need to file a federal 1065 form at tax time and a corresponding state partnership form.
A partnership itself does not actually owe income tax, but the profits from it flow through to each partner’s personal income tax return via a K-1 form. Income from a partnership is also subject to self employment tax of 15.3%, that fact in many cases is what makes an S Corp a better option for some small businesses.
As mentioned above, changing your entity structure from a partnership to an S Corp can actually lower your tax bill each year. This is possible because S corp profits are broken down in to two different buckets of income, owner’s salary and distributive share; only an owner’s salary is subject to the self employment tax. A word of caution though, you cannot set your salary at a ridiculously low level to avoid this tax, owner’s salary needs to conform to the fair market wage for that job in your specific area.
Let say for example that you set your salary around 50,000 dollars for the year, any profit above and beyond that total that your company makes will be considered a distributive share, and consequently not subject to the self employment tax. If your entity structure was still a partnership, or schedule C sole proprietor, all of the profits would be subject to a 15.3% tax.
An S corp files a 1120-S form at tax time along with their corresponding state’s subchapter S corporation tax form. Profits from the business will flow through to your personal 1040, just as a partnership would, and will be taxed at your personal marginal tax rate. Small business owners will need to first form a corporation, like an LLC, and then file form 2553 with the IRS to declare subchapter S. You will also need to call your state’s government to find out if they will require you to pay any additional fees.
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07.18.10
Posted in ezine articles at 12:43 pm by Robert Waldeck
One thing is for certain, there is no shortage of tax forms in this country, and having an understanding for each one is a daunting task, even for most accountants. The most practical approach for taxpayers is to have a general understanding of the forms that might affect them the most. Here are a few to consider, listed in no particular order of importance:
W-4: Employee Withholding Allowance Form
This form determines the amount of federal taxes that are withheld from your paycheck each pay period. It is important because the number of allowances that you claim will affect your paycheck cash flow and the size and scope of a refund or balance due at tax time. It is not in your financial interest to have either a large refund or a balance due, so adjust your withholding allowances accordingly to avoid sizeable discrepancies.
1040-X: Amended U.S Tax Return
The 1040X form is used to amend and adjust returns that have already been submitted to the IRS. The most common use of this form stems from late arriving w2’s and interest statements that were omitted from the original tax calculation. You can also use this form to correct mistakes made by yourself, or by a tax preparer on your tax return and receive a refund; taxpayers can amend back up to three years. The 1040-X is also used in to claim various tax credits, like the homebuyer tax credit, and the credit for energy efficient improvements.
8829: Expenses for Business Use of Your Home
This is more commonly known as the home office deduction, and what this form allows you to do is to deduct home expenses like utilities, taxes, interest, depreciation and insurance from your business income. The office must be used exclusively for business on a regular basis to enable you to take the deduction. To figure the allowed expense, take your total home expenses and multiply that number by this ratio, office square feet/ total home square feet.
4868: Application for Automatic Extension to File Tax Return
This form allows taxpayers to extend their filing deadline six months, but it is not an extension to pay, only an extension to file. You will still incur penalties and interest for not paying on time, even if you file the extension. The failure to pay penalty is only 0.5% per month of the balance due, while the failure to file penalty is 5% per month of your balance due, with a maximum penalty of 25%.
One other caveat is that if you have no tax liability, or are receiving a refund, there is no penalty to file late. So if you expect a refund, do not worry about filing an extension.
5695—Residential Energy Credits
This form is used to claim a tax credit resulting from the purchase and installation of energy efficient materials and appliances in your main home. Examples of allowable improvements include upgrades to insulation, windows, doors, central air units, heat pumps, and furnaces that meet energy efficiency requirements.
The credit is non refundable and amounts to either thirty percent of the improvement cost, or 1500 dollars whichever is less. Taxpayers would need to file this form in conjunction with form 1040-X to amend your 2009 taxes if the improvements were made in 2009, improvements made this year can be filed on your 2010 tax return.
Robert Waldeck is a Tax Accountant, and owner of Waldeck Tax. You can find printable tax forms at waldecktax.com/taxforms, and find an affordable tax service at waldecktax.com
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07.15.10
Posted in ezine articles at 11:21 pm by Robert Waldeck
Contrary to what you what might hear on the nightly news, getting approved for a home loan is actually still possible. Banks are not lending to borrowers without jobs like they were three years ago, but if you have consistent income, and a decent FICO score, you will get approved for a mortgage.
To ensure that you get the best rate, you need to prepare your personal balance sheet in advance of the loan process. The first thing you should do is run your credit, and take care of any errors and outstanding collections. Remedying these can take a few months, so do not procrastinate.
Next, pay down your credit card balances as much as possible. Credit score agencies use a ratio of outstanding debt over total available credit; you want to keep these ratios on your credit cards as low as possible, shoot for 25-30 percent. Doing these few things will send your credit score skyward, improve the interest rate you will qualify for, and lower the amount of money you will need to bring to the closing table.
Another thing to consider, make sure your down payment capital and or cash reserves, are seasoned for a few months in a bank account. Lenders are going to request at least two months of bank statements during the loan process, and what they are looking for is a consistent account balance. So if the source of your down payment is a family gift, or is simply hidden underneath your mattress, make sure you deposit the funds in to a bank account months in advance.
The most common reason for a qualified buyer to be rejected for a home loan is their debt to income ratio. Banks use this ratio to determine if you can afford the new loan payment, when added to your existing debt payments. To figure your DTI ratio, take the monthly payments you have on your debt (including the proposed mortgage payment) and divide it by your current gross income (debt/income). The highest debt to income ratio lenders will usually allow is around fifty percent, so eliminating a portion of your monthly reoccurring debt before the loan process will drastically improve the likelihood of a loan approval, and a better rate.
Getting an early start is the key to qualifying for the best financing, the rate you will ultimately end up with is determined by the financial snapshot you provide lender. So clean up your respective balance sheet before you invite the bank over for cocktails.
Keep in mind, the interest rate on your home loan will normally carry more weight financially over time, than the variance in purchase price of homes you search for. Here is a good tip, put equal focus in to your financial house cleaning, as you do your home search.
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07.09.10
Posted in tax questions at 1:55 pm by Robert Waldeck
To submit a tax question, or view a past question, click on the comment link below.
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Posted in ezine articles at 1:53 pm by Robert Waldeck
Net positive cash flow from a rental property is the equivalent to the Holy Grail for landlords; it may seem mythical or even impossible to some would be investors, but what makes positive cash flow attainable are the tax breaks given to rental property investors.
The concept of owning a rental property is pretty simple in theory, you buy a property, and over the course of a few years the asset increases in value, while your tenant essentially pays the mortgage and lowers the loan amount. This creates a scenario where the gap between the home price and the note amount, or your equity, is continually increasing.
The one major hurdle with this premise is that is difficult to find a property where the area rent for the home will cover the mortgage, insurance, taxes, and repairs up front. This is what keeps most people out of the real estate investment game, negative monthly cash flow.
The best way to negotiate negative cash flow is through knowledge of tax planning and tax deductions. Real estate investors are allowed to deduct mortgage interest, insurance, taxes, home repairs, depreciation expense and any utilities bills that are paid out of pocket. These expenses are netted against rental income, and the subsequent gain or loss is reported on Schedule E of your 1040.
By far, the most important tax deduction for real estate investors is depreciation of the building. You do not spend any capital to take this deduction, like you would for taxes or insurance, depreciation is only a loss on paper, but is fully deductible. For example, a home purchased for 200,000 dollars will generate a yearly depreciation expense between six and seven thousand dollars depending on the price of the land in that area.
Add the depreciation expense to the loss generated by rental property, (assuming you have negative monthly cash flow) and you arrive with your total tax deduction for the year. This deduction will reduce your taxable income, and your total tax bill, giving you the opportunity to greatly improve your net cash flow from the rental. The easiest way to determine your total tax relief is to multiply the tax deduction by your marginal tax rate, or the tax rate you pay on the last dollar you make.
Have your tax professional crunch the numbers for you in regards to a rental investment, and you will see it is very possible to turn a three or four hundred dollar a month loss, in to positive monthly cash flow.
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Posted in ezine articles at 1:31 pm by Robert Waldeck
Real estate prices have famously fallen over the past few years, but what has not decreased in value are the breaks that the US tax code bestows upon home owners. The largest expense that most of us incur each month is the cost of our respective place of residence, so that expense is easily the most valuable to be able to deduct each year. The concept is pretty simple; home owners can deduct the majority of their house payment, while renters cannot deduct any of their rent. You have to pay for somewhere to live, so why not have that payment effectively reduce your tax bill?
Mortgage interest and real estate taxes compose the majority of a monthly house payment, especially in the first few years of a loan, due to how mortgages are amortized. A 150,000 dollar home loan at six percent interest can easily generate a 10,000-15,000 dollar tax deduction each year, depending on how expensive real estate taxes are in your area. This is important on another level as well, this large deduction that home owners can take, will also allow them to itemize their deductions instead of using the standard deduction-enabling the use of medical, dental, charitable, and unreimbursed job related expenses to be deducted as well.
The most effective tax deductions result from expenditures that are necessary in your everyday life, and can concurrently improve your financial situation in the short term and long term. (Real estate expenses and IRA contribution are great examples). When you take in to consideration where home prices and interest rates are right now with the tax incentives that go with purchasing real estate, why try to perfectly time the market? If any of you are on the preverbal home buying fence, my advice is to jump in, with both feet. A decision to buy real estate will not only help you next tax season, but also for years to come.
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Posted in ezine articles at 1:28 pm by Robert Waldeck
Most of you probably have heard about the home buyer tax credit by now, (guessing by the fact that the credit has been going on in some form or the other for nearly three years) and maybe even some of you remember the Cash for Clunkers program that was all the rage a few months ago, but did you know that the federal government is offering a tax credit for up to 30 percent off the purchase price for a new central air conditioner?
The tax credit was included in the American Recovery and Reinvestment Act of 2009, and is set to expire at the end of the 2010. As long as the new unit is at least 16 SEER, (a measure of efficiency) taxpayers can file Form 5695, and receive up to a 1,500 credit, or 30 percent of the purchase price, whichever is less. This tax credit is also retroactive to the beginning of 2009, so if you purchased a unit in 2009, you are still eligible to claim it.
The only catch is that the credit is nonrefundable, meaning it will only reduce your tax liability to zero. So if you have little or no tax liability for the year, your credit will be reduced. Line 44 of your 1040(line 28 on 1040A) is where you want to look to determine your tax liability for the year.
That being said, all homeowners know how expensive it is to replace a new unit, and also how much your air conditioning unit moves the meter on your electric bill. So if your existing unit is starting to get old, or is not as efficient as it used to be, think about making the purchase now at 70 cents on the dollar, instead of paying full price a few years from now.
One more thing that needs to be stressed is the monthly savings that these new systems produce. It is not out of the question to save hundreds of dollars each year on your electric bill, because these energy efficient units do not have to work as long to cool your home to the desired temperature. Think of your monthly savings as dividends, paid by a wise investment, financially and environmentally.
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