Trying to figure out whether you and your spouse should file a joint tax return or separate returns? As is often the case with tax questions, the answer depends on your particular tax picture.
In general, your decision will depend upon which filing status results in the lowest tax. But bear in mind that, if you and your spouse file a joint return, each of you is jointly and severally liable for the tax on your combined income, including any additional tax that IRS assesses, plus interest and most penalties. This means that IRS can come after either of you to collect the full amount. Although there are provisions in the law that offer relief from joint and several liability, each of those provisions has its limitations. Thus, even if a joint return results in less tax, you may choose to file a separate return if you want to be certain of being responsible only for your own tax.
In most cases, filing jointly offers the most tax savings, particularly where the spouses have different income levels. The “averaging” effect of combining the two incomes can bring some of it out of a higher tax bracket. For example, if one spouse has $75,000 of taxable income and the other has just $25,000, filing jointly instead of separately for 2023 can save $1,972.50 in taxes.
Note that filing separately doesn’t mean you go back to using the “single” rates that applied before you were married. Instead, each spouse must use the “married filing separately” rates. These rates are based on brackets that are exactly half of the married filing joint brackets but are still less favorable than the “single” rates. This means the “marriage penalty” (which requires some marrieds to pay at a higher tax rate on the same total income than they would pay if each filed as a single) isn’t eliminated by filing separate returns. Although Congress has provided relief from the marriage penalty in the tax rates, those changes don’t provide a complete solution.
There is a potential for tax savings from filing separately, however, where one spouse has significant amounts of medical expenses. Medical expenses are deductible only to the extent they exceed 7.5% of adjusted gross income (AGI).
If a medical expense deduction is isolated on the separate return of a spouse, that spouse’s lower (separate) AGI, as compared to the higher joint AGI, can result in larger total deductions. For example, if one spouse has $19,500 in medical expenses and the spouses’ joint income is $260,000, then the jointly filing spouses can’t deduct any of the medical expenses, because 7.5% of $260,000 is $19,500 (and $19,500 − $19,500 = $0). But if the separate income of the spouse with the medical expenses is $140,000, the deduction increases to $9,000 on a separate return, because 7.5% of $140,000 is only $10,500, and $19,500 − $10,500 equals $9,000.
Other tax factors may point to the advisability of filing a joint return. For example, the child and dependent care credit, adoption expense credit, American Opportunity tax credit, and Lifetime learning credit are available to a married couple only on a joint return. And you can’t take the credit for the elderly or the disabled if you file separate returns unless you and your spouse lived apart for the entire year. Nor can you deduct qualified education loan interest unless a joint return is filed. You may also not be able to deduct contributions to your IRA if either you or your spouse was covered by an employer retirement plan and you file separate returns. Nor can you exclude adoption assistance payments or any interest income from series EE or Series I savings bonds that you used for higher education expenses if you file separate returns.
In addition, social security benefits may be more heavily taxed to a couple that files separately. The benefits are tax-free if your “provisional income” (your AGI with certain modifications plus half of your social security benefits) doesn’t exceed a “base amount.” The base amount is $32,000 on a joint return, but zero on separate return (or $25,000 if the spouses didn’t live together for the entire year).
The decision you make for federal income tax purposes may have an impact on your state or local income tax bill, so the total tax impact has to be compared. For example, an overall federal tax saving by filing separately might be offset by an overall state tax increase, or a state tax saving might offset a federal tax increase.
Unfortunately, we can’t give you any hard and fast rules of thumb for when it pays to file separately. The tax laws have grown so complex over the years that there are often a number of different factors at play for any given situation. However, there is one approach guaranteed to come up with the correct decision. We can simply calculate your tax bill both ways: jointly and separately. Then the approach that leads to overall tax savings could be used. We are happy to run the numbers for you to make sure you pay the minimum amount of taxes possible. Call us to arrange for a consultation or if you have any additional questions.
The recently passed Inflation Reduction Act of 2022 includes changes to the credit available for electric vehicles. The changes are complex, and phase in over time. If you are in the market for an electric vehicle, we should review the new rules to help you maximize the credit you are allowed.
North American assembly requirement. One of the new rules is in effect right now. To qualify for the electric vehicle credit, final assembly of the vehicle must take place in North America. You can check whether a particular vehicle meets this requirement by entering its vehicle identification number (VIN) into the VIN decoder at https://afdc.energy.gov/laws/inflation-reduction-act or https://www.nhtsa.gov/vin-decoder. There is also a list of makes and models that generally should meet the requirement at https://afdc.energy.gov/laws/inflation-reduction-act, but you should double-check for any particular vehicle by using the VIN decoder.
Manufacturer limitation. The good news is that, effective as of January 1, 2023, the manufacturer limitation is going away. Under the manufacturer limitation, once a manufacturer had sold 200,000 electric vehicles, a taxpayer’s ability to take a tax credit for vehicles produced by that manufacturer began to phase out. Taxpayers are currently prevented from taking the electric vehicle credit for automobiles manufactured by General Motors and Tesla. Starting at the beginning of 2023, taxpayers will be able to take the credit for GM vehicles and Teslas once again, but see the manufacturer’s suggested retail price (MSRP) limits below.
Calculation of the credit. The way the credit is calculated is changing later this year. We do not know when the rules are changing yet, but it will be as soon as the IRS issues regulations implementing the new rules. Under the previous rules, the base amount of the electric vehicle credit is $2,500 per vehicle. The allowable credit increases to $7,500 per vehicle based on a formula which increases the credit by $417 for every kilowatt hour of battery capacity in excess of five.
Under the new rules, the amount of the credit will be based on two separate requirements, each one based on where the vehicle’s battery is sourced:
Taxpayers also can get a $3,750 credit for satisfying the battery component requirement (which requires that a minimum percentage of the value of the components of the battery be manufactured or assembled in North America.
Taxpayers can satisfy either or both requirements, for either a $3,750 credit (if only one requirement is satisfied) or a $7,500 credit (if both requirements are satisfied).
The new rules are designed to encourage electric vehicle manufacturers to move their battery supply chains from China to North America or countries with which the United States has better relations than China.
New qualified fuel cell motor vehicle. Effective January 1, 2023, the credit will also be available for new qualified fuel cell motor vehicles. New qualified fuel cell motor vehicles are vehicles propelled by power derived from one or more cells that convert chemical energy directly into electricity by combining oxygen with hydrogen fuel, and that meets certain additional requirements. New qualified fuel cell motor vehicles have to meet the North American final assembly requirement. They can qualify for either a $3,750 or $7,500 credit based on whether they satisfy one or both of the critical minerals requirement and battery components requirements.
Modified adjusted gross income limitation. Starting on January 1, 2023, your ability to take the electric vehicle credit will be limited based on your modified adjusted gross income (MAGI). MAGI is adjusted gross income (AGI) with adjustments for income received from U.S. territories. For most taxpayers, MAGI will be equal to AGI. You may not take the credit if your MAGI exceeds the threshold amount. The threshold amount is:
These amounts are not adjusted for inflation. If your MAGI exceeds this amount, you should buy the electric car before the first of the year.
MSRP limitation. Also starting on January 1, 2023, vehicles will not be eligible for the credit if they exceed an MSRP limit: $80,000 for vans, pickup trucks, and sport utility vehicles; $55,000 for other vehicles. This means that if you are looking at a higher-end electric vehicle, you need to act by the end of December.
Unfortunately, the manufacturer limitation (see above) will not go away until January 1, so you will not be able to claim the credit for higher-end GM and Tesla vehicles that exceed the MSRP limits.
Transition rule. Finally, if you had a binding contract to purchase an electric vehicle as of August 15, 2022, or earlier, you can choose to apply the old rules.
Call us today with any questions you might have about your electric vehicle purchase.
Are you planning to refinance the mortgage on your home and wondering about the tax rules regarding the refinancing? This article will discuss whether you can deduct the interest you will pay on your new mortgage, the points that you pay, and other fees that you may pay in connection with the refinancing.
Interest deduction on refinanced mortgage. Interest on a refinanced mortgage will be deductible, within the limits discussed, if it falls into one of the following categories:
Your old mortgage was taken out after Dec. 15, 2017. Debt that results from the refinancing of debt that was incurred after Dec. 15, 2017 to buy, build, or substantially improve your main or second home, and that is secured by that home. But interest on this debt is deductible only to the extent that the amount of the debt from refinancing doesn’t exceed: (a) the amount of the original debt that has been refinanced, and (b) $750,000 ($375,000 for married taxpayers filing separately).
Your old mortgage was taken out after Oct. 13, 1987, but before Dec. 16, 2017. Debt that results from the refinancing of debt that was incurred after Oct. 13, 1987, but before Dec. 16, 2017, to buy, build, or substantially improve your main or second home, and that is secured by that home. But interest on this debt is deductible only to the extent that the amount of the debt from refinancing doesn’t exceed: (a) the amount of the original debt that has been refinanced, and (b) $1 million ($500,000 for married taxpayers filing separately). Note that for the $1 million ($500,000) limit to apply, the refinancing debt has to be incurred before the expiration of the term of the old debt.
Your old mortgage was taken out before Oct. 14, 1987. Debt that results from the refinancing of debt that was incurred before Oct. 14, 1987-no matter how the proceeds of the mortgage were used-and that is secured by your first or second home. All of the interest you pay on this debt is fully deductible, as long as the term of the old mortgage hasn’t expired, and the amount of the debt resulting from the refinance doesn’t exceed the amount of principal remaining on the old debt immediately before the refinancing.
Interest on refinanced “home equity loans” isn’t deductible, 2018 – 2025. “Home equity debt,” as specially defined for purposes of the mortgage interest deduction, means debt that: (1) is secured by the taxpayer’s home, and (2) wasn’t incurred to acquire, construct, or substantially improve the home). From 2018 through 2025, there’s no deduction for the interest on home equity debt, no matter when the home equity debt was incurred. And interest on debt resulting from the refinancing of such home equity debt isn’t deductible.
Beginning with 2026, home equity debt will be deductible, as will the debt resulting from a refinancing of home equity debt. However, the interest that can be deducted will be limited to loan amounts of the lesser of $100,000 ($50,000 if your filing status is married filing separately) or your equity in the home.
Points. In general, points that you pay to refinance your home aren’t fully deductible in the year that you paid them. Instead, you can deduct a portion of the points each year over the life of the loan.
To figure your deduction for points, divide the total points by the number of payments to be made over the life of the loan. Then, multiply this result by the number of payments you made in the tax year.
For example, if you paid $3,000 in points and you will make 360 payments on a 30-year mortgage, you can deduct $8.33 per monthly payment. For a year in which you make 12 payments, you can deduct a total of $99.96 ($8.33 × 12).
However, you may be entitled to a larger first-year deduction for points if you used part of the proceeds of the refinancing to improve your home and you meet certain other requirements. In that case, the points associated with the home improvements may be fully deductible in the year they were paid.
For example, say that you refinance a high-rate mortgage that has an outstanding balance of $80,000 with a new lower-rate loan for $100,000. You use the proceeds of the new mortgage loan to pay off the old loan and to pay for $20,000 of improvements to your home. Since 20% of the new loan was incurred to pay for improvements, 20% of the points you paid can be deducted in the year of the refinancing.
If you’re refinancing your mortgage for the second time, the portion of the points on the first refinanced mortgage that you haven’t yet deducted may be deductible at the time of the second refinancing.
Penalties and fees. A prepayment penalty that you pay to terminate your old mortgage is deductible as interest in the year of payment.
However, fees paid to obtain the new mortgage aren’t deductible, nor can you add them to your basis in your home to reduce the gain when you sell it. Examples of such nondeductible fees are credit report fees, loan origination fees, and appraisal fees.
Give us a call today to go over these rules with you in greater detail!
Income that you generate conducting your business as a sole proprietorship (or through a wholly-owned limited liability company (LLC)) is subject to both income tax and self-employment tax. The self-employment tax is imposed on 92.35% of self-employment income at a 12.4% rate for social security up to the social security maximum ($142,800 for 2021; $147,000 for 2022) and at a 2.9% rate for Medicare. An additional 0.9% Medicare tax is imposed on income exceeding $250,000 for married couples ($125,000 for married persons filing separately) and $200,000 in all other cases. No maximum tax limit applies to the Medicare tax. Similarly, if you conduct your business as a partnership in which you are a general partner, in addition to income tax you would be subject to the self-employment tax on your distributive share of the partnership’s income. On the other hand, if you conduct your business as an S corporation you will be subject to income tax, but not self-employment tax, on your share of the S corporation’s income.
An S corporation is not subject to tax at the corporate level. Instead, the corporation’s items of income, gain, loss, and deduction are passed through to the shareholders. However, the income passed through to the shareholder is not treated as self-employment income. Thus, by using an S corporation, you can avoid self-employment income tax.
There is a problem, however, in that IRS requires that the S corporation pay you reasonable compensation for your services to the S corporation. The compensation is treated as wages subject to employment tax (split evenly between the corporation and the employee), which is equivalent to the self-employment tax. If the S corporation does not pay you reasonable compensation for your services, IRS may treat a portion of the S corporation’s distributions to you as wages and impose social security taxes on the deemed wages. There is no simple formula regarding what is reasonable compensation. Presumably, reasonable compensation would be the amount that unrelated employers would pay for comparable services under like circumstances. There are many factors that would be taken into account in making this determination.
Give us a call today to discuss the practical aspects of conducting your business through an S corporation and how much the S corporation would have to pay you as compensation.
Speaking broadly, you may be able to benefit by carrying what is called a “net operating loss” (NOL) into a different year-a year in which you have taxable income-and taking a deduction (the “NOL deduction”) for the loss against that year’s income.
The NOL deduction equals the total of your NOL carryovers and NOL carrybacks to the particular tax year. But, for tax years after 2020, the deduction will be subject to an 80%-of-taxable income limitation.
Your NOLs for tax years 2018, 2019 and 2020 are carried back for five years. But, NOLs for 2021 and later tax years generally can’t be carried back (although farm losses can be carried back two years). And, NOLs for tax years after 2017 are generally carried forward indefinitely.
You must carry the NOL first to the earliest year allowed, and, then, successively, to the next earliest year, etc. until the loss is used up. But, if it would benefit you more to just carry a NOL forward, you can waive carryback of that loss.
To determine the amount of your NOL for a particular tax year, you don’t just use the negative taxable income reported on your tax return for that year. Instead, several modifications must be made to compute the amount of your NOL. These include the following:
Example. N has a loss of $20,000 from business operations for the year. N also has (i) nonbusiness capital gains of $9,000 and nonbusiness capital losses of $4,000, and (ii) nonbusiness income of $13,000 and nonbusiness deductions of $14,000 (not including personal or dependency exemptions). N has no business capital gains or losses.
N’s “starting point” for calculating N’s NOL is N’s $20,000 business loss. N’s capital losses reduce N’s capital gains to $5,000 ($9,000 − $4,000). N’s nonbusiness deductions wipe out N’s nonbusiness income ($13,000 − $14,000), leaving N with $1,000 “excess” nonbusiness deductions. N can use the $1,000 excess nonbusiness deductions to further reduce N’s capital gains to $4,000. But, the $4,000 of capital gains do reduce N’s NOL from $20,000 to $16,000. The final result: N incurs a $16,000 NOL for the tax year.
Note that N’s taxable income will show a loss that’s greater than N’s $16,000 NOL, because N’s taxable income includes items such as personal exemption that aren’t allowed in figuring N’s NOL. Only the $16,000 NOL, however, can be carried forward to other years for use as a deduction.
The above computations can grow quite complex, depending upon your circumstances.
In addition to the rules above, special rules allow farmers to retain a pre-2018, two-year NOL carryback election and then applicable 80%-of-taxable-income limitation, for farming losses arising in 2018, 2019 or 2020 tax years, and to revoke a previously made waiver of the two-year carryback for 2018 or 2019 farming losses, and apply the five-year carryback instead. Obviously, there’s a lot to consider in determining the amount of your NOL, and whether to claim an NOL deduction. Please contact us today and we will be happy to discuss further.
Individuals must pay 25% of a “required annual payment ” by Apr. 15, June 15, Sept. 15, and Jan. 15, to avoid an underpayment penalty. When that date falls on a weekend or holiday, the payment is due on the next business day.
The required annual payment for most individuals is the lower of 90% of the tax shown on the current year’s return or 100% of the tax shown on the return for the previous year. However, if the adjusted gross income on your previous year’s return was over $150,000 (over $75,000 if you are married filing separately), you must pay the lower of 90% of the tax shown on the current year’s return or 110% of the tax shown on the return for the previous year.
Most people who receive the bulk of their income in the form of wages satisfy these payment requirements through the tax withheld by their employer from their paycheck. Those who make estimated tax payments generally do so in four installments. After determining the required annual payment, they divide that number by four and make four equal payments by the due dates.
But you may be able to use the annualized income method to make smaller payments. This method is useful to people whose income flow is not uniform over the year, perhaps because of a seasonal business. For example, if your income comes exclusively from a business that you operate in a resort area during June, July, and August, no estimated payment is required before Sept. 15. You may also want to use the annualized income method if a significant portion of your income comes from sales of securities that are made at various times during the year.
If you fail to make the required payments, you may be subject to an underpayment penalty. The penalty equals the product of the interest rate charged by IRS on deficiencies, times the amount of the underpayment for the period of the underpayment.
However, the underpayment penalty doesn’t apply to you:
In addition, IRS may waive the penalty if the failure was due to casualty, disaster, or other unusual circumstances and it would be inequitable or against good conscience to impose the penalty. The penalty can also be waived for reasonable cause during the first two years after you retire (after reaching age 62) or become disabled. Third quarter estimated taxes for 2022 are coming due on September 15th. If you think you may be eligible to determine your estimated tax payments under the annualized income method, or you have any other specific questions about how the estimated tax rules apply to you, please contact our office today!
Are you thinking about setting up a retirement plan for yourself and your employees, but are concerned about the financial commitment and administrative burdens involved in providing a traditional pension or profit-sharing plan? An alternative program you may want to consider is a “simplified employee pension,” or SEP.
SEPs are intended as an alternative to “qualified” retirement plans, particularly for small businesses like yours. The relative ease of administration and the complete discretion you, as the employer, are permitted in deciding whether or not to make annual contributions, are features that are especially attractive. Here’s how these plans work.
If you don’t already have a qualified retirement plan, you can set up a SEP simply by using the IRS model SEP, Form 5305-SEP. By adopting and implementing this model SEP, which doesn’t have to be filed with the IRS, you will have satisfied the SEP requirements. This means that you, as the employer, will get a current income tax deduction for contributions you make on behalf of your employees. Your employees will be taxed not when the contributions are made, but at a later date when distributions are made, usually at retirement. Depending on your specific needs, an individually-designed SEP-instead of the model SEP-may be appropriate for you.
When you set up a SEP for yourself and your employees, you will make these deductible contributions to each employee’s IRA, called a SEP-IRA, which must be IRS-approved. The maximum amount of deductible contributions that you can make to an employee’s SEP-IRA, and that he or she can exclude from income, is the lesser of: (i) 25 percent of compensation, and (ii) $61,000 (for 2022). The deduction for your contributions to employees’ SEP-IRAs isn’t limited by the deduction ceiling applicable to an individual’s own contribution to a regular IRA. Your employees control their individual IRAs and IRA investments, the earnings on which are tax-free.
There are other requirements which you have to meet to be eligible to set up a SEP. Essentially, all regular employees must elect to participate in the program, and contributions can’t discriminate in favor of the highly compensated employees. But these requirements are minor compared to the bookkeeping and other administrative burdens connected with traditional qualified pension and profit-sharing plans. The detailed records that traditional plans must maintain to comply with the complex nondiscrimination regulations aren’t required for SEPs. And employers aren’t required to file annual reports with IRS-Forms 5500-which, for a pension plan, could require the services of an actuary. What record-keeping is required can be done by a trustee of the SEP-IRAs-usually a bank or mutual fund.
We are happy to meet with you to explain your SEP options in greater detail as well as answer any questions you may have. Give us a call today!
If you are planning to make a relatively substantial contribution to a charity, college, etc., you should consider donating appreciated stock from your investment portfolio instead of cash. Your tax benefits from the donation can be increased and the organization will be just as happy to receive the stock.
This tax planning tool is derived from the general rule that the deduction for a donation of property to charity is equal to the fair market value of the donated property. Where the donated property is “gain” property, the donor does not have to recognize the gain on the donated property. These rules allow for the “doubling up,” so to speak, of tax benefits: a charitable deduction, plus avoiding tax on the appreciation in value of the donated property.
Example: Tim and Tina are twins, each of whom attended Yalvard University. Each plans to donate $10,000 to the school. Each also owns $10,000 worth of stock in ABC, Inc. which he or she bought for just $2,000 several years ago.
Tim sells his stock and donates the $10,000 cash. He gets a $10,000 charitable deduction, but must report his $8,000 capital gain on the stock.
Tina donates the stock directly to the school. She gets the same $10,000 charitable deduction and avoids any tax on the capital gain. The school is just as happy to receive the stock, which it can immediately sell for its $10,000 value in any case.
Caution: While this plan works for Tina in the above example, it will not work if the stock has not been held for more than a year. It would be treated as “ordinary income property” for these purposes and the charitable deduction would be limited to the stock’s $2,000 cost.
If the property is other ordinary income property, e.g., inventory, similar limitations apply. Limitations may also apply to donations of long-term capital gain property that is tangible (not stock), and personal (not realty).
Finally, depending on the amounts involved and the rest of your tax picture for the year, taking advantage of these tax benefits may trigger alternative minimum tax concerns.
If you’d like to discuss this method of charitable giving more fully, including the limitations and potential problem areas, please give us a call.
Under these rules, up to $250,000 of the gain from the sale of single person’s principal residence is tax-free. For certain married couples filing a joint return, the maximum amount of tax-free gain doubles to $500,000.
Like most tax breaks, however, the exclusion has a detailed set of rules for qualification. Besides the $250,000/$500,000 dollar limitation, the seller must have owned and used the home as his or her principal residence for at least two years out of the five years before the sale or exchange. In most cases, sellers can only take advantage of the provision once during a two-year period.
However, a reduced exclusion is available if the sale occurred because of a change in place of employment, health, or other unforeseen circumstances where the taxpayer fails to meet the two-year ownership and use requirements or has already used the exclusion for a sale of a principal residence in the past two years. A sale or exchange is by reason of unforeseen circumstances if the primary reason for the sale or exchange is the occurrence of an event that the taxpayer does not anticipate before purchasing and occupying the residence. Unforeseen circumstances that are eligible for the reduced exclusion include involuntary conversions, certain disasters or acts of war or terrorist attacks, death, cessation of employment, change of employment resulting in the taxpayer’s inability to pay certain costs, divorce or legal separation, multiple births from the same pregnancy, and events identified by IRS as unforeseen circumstances (for example, the September 11 terrorist attacks). The amount of the reduced exclusion equals a fraction of the $250,000/$500,000 dollar limitation. The fraction is based on the portion of the two-year period in which the seller satisfies the ownership and use requirements.
These rules can get quite complicated if you marry someone who has recently used the exclusion provision, if the residence was part of a divorce settlement, if you inherited the residence from your spouse, if you sell a remainder interest in your home, if there are periods after 2008 in which the residence isn’t used as your (or your spouse’s) principal residence, or if you have taken depreciation deductions on the residence. Also, the exclusion does not apply if you acquired the residence within the previous five years in a “like-kind” exchange in which gain was not recognized.
Let us know if you have any questions about the exclusion or would like additional information. We are happy to go over the specifics of your situation with you to determine whether a sale of your residence would qualify for this valuable tax break.
A corporation can deduct the compensation that it pays, but not its dividend payments. Thus, if funds are withdrawn as dividends, they’re taxed twice, once to the corporation and once to the recipient. Money paid out as compensation is taxed only once, to the employee who receives it.
However, there’s a limit on how much money you can take out of the corporation in this way. The law says that compensation can be deducted only to the extent that it’s reasonable. Any unreasonable portion is nondeductible and, if paid to a shareholder, may be taxed as if it were a dividend. As a practical matter, IRS rarely raises the issue of unreasonable compensation unless the payments are made to someone “related” to the corporation, such as a shareholder or a member of a shareholder’s family.
How much compensation is “reasonable”? There’s no simple formula. IRS tries to determine the amount that similar companies would pay for comparable services under like circumstances. Factors that are taken into account include:
There are a number of concrete steps you can take to make it more likely that the compensation you earn will be considered “reasonable,” and therefore deductible by your corporation. For example, you can:
As in most tax situations, planning ahead avoids problems later. Contact our office today to discuss this or any other aspect of your current or deferred compensation strategies.