Are you planning on going into business for yourself, as a sole proprietor? There are several important rules that you should be aware of:
(1) For income tax purposes, you’ll report your income and expenses on Schedule C of your Form 1040. The net income will be taxable to you regardless of whether you withdraw cash from the business. Your business expenses will be deductible against gross income (i.e., “above the line”) and not as itemized deductions. If you have any losses, the losses will generally be deductible against your other income, subject to special rules relating to hobby losses, passive activity losses, and losses in activities in which you weren’t “at risk.”
(2) You may be eligible for the pass-through deduction. To the extent your business generates qualified business income, you will be eligible to take the 20% pass-through deduction, subject to various limitations. The deduction is taken “below the line,” so that it reduces taxable income, rather than being taken “above the line” against your gross income. However, you can take the deduction even if you don’t itemize deductions and instead take the standard deduction.
(3) You may be able to deduct office-at-home expenses. If you’ll be working from an office in your home, performing management or administrative tasks from an office-at-home, or storing product samples or inventory at home, you may be entitled to deduct an allocable portion of certain costs of maintaining your home. And if your office is in your home, you may be able to deduct expenses of traveling from there to another work location.
(4) You’ll have to pay self-employment taxes. For 2023, you’ll pay self-employment tax (social security and Medicare) at a 15.3% rate on your net earnings from self-employment of up to $160,200 ($147,000 for 2022), and Medicare tax only at a 2.9% rate on the excess. An additional 0.9% Medicare tax (for a total of 3.8%) will be imposed on self-employment income in excess of $250,000 for joint returns; $125,000 for married taxpayers filing separate returns; and $200,000 in all other cases. Self-employment tax is imposed in addition to income tax, but you can deduct half of your self-employment tax as an adjustment to income.
(5) You’ll be allowed to deduct 100% of your health insurance costs as a trade or business expense. This means your deduction for medical care insurance won’t be subject to the rule that limits your medical expense deduction to amounts in excess of 7.5% of your adjusted gross income.
(6) You’ll have to make quarterly estimated tax payments. We can work with you to minimize the amount of your estimated tax payments while avoiding any underpayment penalty.
(7) You’ll have to keep complete records of your income and expenses. In particular, you should carefully record your expenses in order to claim the full amount of the deductions to which you are entitled. Certain types of expenses, such as automobile, travel, entertainment, meals, and office-at-home expenses, require special attention because they’re subject to special recordkeeping requirements or limitations on deductibility.
(8) If you hire any employees, you’ll have to get a taxpayer identification number and will have to withhold and pay over various payroll taxes.
(9) You should consider establishing a qualified retirement plan. The advantage of a qualified retirement plan is that amounts contributed to the plan are deductible at the time of the contribution, and aren’t taken into income until the amounts are withdrawn. Because of the complexities of ordinary qualified retirement plans, you might consider a simplified employee pension (SEP) plan, which requires less paperwork. Another type of plan available to sole proprietors that offers tax advantages with fewer restrictions and administrative requirements than a qualified plan is a “savings incentive match plan for employees,” i.e., a SIMPLE plan. If you don’t establish a retirement plan, you may still be able to contribute to an IRA. If you’d like any additional information regarding the tax aspects of your new business, or if you need assistance in satisfying any of the reporting or recordkeeping requirements, please give us a call.
You might be able to dispose of appreciated real property without being taxed on the gain by exchanging it rather than selling it. You can defer tax on your gain through the “like-kind” exchange rules.
A like-kind exchange is any exchange (1) of real property held for investment or for productive use in your trade or business (relinquished property) for (2) like-kind investment real property or trade or business real property (replacement property). For these purposes, “like-kind” is very broadly defined and most real property is considered to be like-kind with other real property. However, neither the relinquished property nor the replacement property can be real property held primarily for sale. If you are unsure whether the property involved in your exchange is eligible for a tax -free like-kind exchange, please call and we can discuss the matter.
Assuming the exchange qualifies, here’s how the tax rules work:
If it’s a straight asset-for-asset exchange, you will not have to recognize any gain from the exchange. You will take the same “basis” (your cost for tax purposes) in the replacement property that you had in the relinquished property. Even if you do not have to recognize any gain on the exchange, you still have to report the exchange on Form 8824.
Frequently, however, the properties are not equal in value, so some cash or other (non-like-kind) property is tossed into the deal. This cash or other property is known as “boot.” If boot is involved, you will have to recognize your gain, but only up to the amount of boot you receive in the exchange. In these situations, the basis you get in the like-kind replacement property you receive is equal to the basis you had in the relinquished property you gave up reduced by the amount of boot you received but increased by the amount of any gain recognized.
Example. Ted exchanges land (investment property) with a basis of $100,000 for a building (investment property) valued at $120,000 plus $15,000 in cash. Ted’s realized gain on the exchange is $35,000: he received $135,000 in value for an asset with a basis of $100,000. However, since it’s a like-kind exchange, he only has to recognize $15,000 of his gain: the amount of cash (boot) he received. Ted’s basis in his new building (the replacement property) will be $100,000: his original basis in the relinquished property he gave up ($100,000) plus the $15,000 gain recognized, minus the $15,000 boot received.
Note that no matter how much boot is received, you will never recognize more than your actual (“realized”) gain on the exchange.
If the property you are exchanging is subject to debt from which you are being relieved, the amount of the debt is treated as boot. The theory is that if someone takes over your debt, it’s equivalent to his giving you cash. Of course, if the replacement property is also subject to debt, then you are only treated as receiving boot to the extent of your “net debt relief” (the amount by which the debt you become free of exceeds the debt you pick up). Like-kind exchanges are an excellent tax -deferred way to dispose of investment or trade or business assets. If you have additional questions or would like to discuss the topic further, please call.
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!
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.