TaxMamas TaxQuips: Tax Quips

LLC and Business Structure

Eva Rosenberg — Wed, 11 Nov 2009 06:17:00 -0800

Today TaxMama hears from Norm in California with a common question. “What is the best tax set up for in home consulting business. Is it LLC or? I have seen and heard so many different comments.”

Dear Norm,

There’s a reason you’ve heard so many different comments. There is no BEST structure.

The structure of your business depends on your short-term needs, your long-term goals and your exit strategy. That’s why, even though I outline the pros and cons of each business structure in Chapter 3 of Small Business Taxes Made Easy, I also advise you to consult with your tax professional.
http://www.taxmama.com/AskTaxMama/book/

I could spend about two hours outlining all the considerations you need to take into account in order to make the right decision. But there’s just not enough room here. Read Chapter 3.

One thing I will tell you, though. As long as you live and work in California, the last thing you want is an LLC.

In addition to the annual minimum tax of $800, there is a gross receipts fee of $900 and up. That means, even if your net profit is $2, or even if it’s a loss,...if your gross revenue started out at $250,000 or above, you pay an extra tax of at least $900. http://www.ftb.ca.gov/forms/02_forms/02_3556.pdf

So forget the LLC in California. They may be the perfect choice in some other state.

And remember, you can find answers to all kinds of questions about business structures and other tax issues, free. Where? Where else? At TaxMama.com.

[Note: If you were subscribed to the e-mailed TaxQuips, you’d be getting other exciting news and tips by e-mail, that never appear on the site. Please click on the subscribe link and join us.]

Ask TaxMama :: Where taxes are fun and answers are free
www.TaxQuips.com :: The number ONE free tax podcast online
TaxMama's Book :: Small Business Taxes Made Easy
FTB FAQs :: All about California LLCs, including the Gross Receipts Fee chart

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Divorce Settlement

Eva Rosenberg — Tue, 10 Nov 2009 06:02:00 -0800

Today TaxMama hears from Misty in Missouri who wants validation. “I received a settlement in my divorce for half the equity in our home. It was $15,000. I think in reading this is not going to be taxable. Is that correct? I’m keeping my fingers crossed that it isn’t!”

Dear Misty,

Great news!

You’re right. Getting cashed out for half the equity in your home is not a taxable event. In this case, it would not be taxable even you and your ex husband sold the house first and then split the money. Why? Because the profits are under $250,000 each.

Beware, though. If you and your ex have been refinancing and drawing out cash – and your real profits are over $500,000…there could be a taxable event. You sound too smart for that.

Just so you know, most property splits in a divorce are not taxable. About the only things that might be taxable are splits of IRAs and other retirement accounts. Even then, if you roll the funds over to your own IRA, they would not be taxable until you actually were to draw the money.

You can read more about tax issues relevant to divorced or separated folks in IRS Publication 504.
http://www.irs.gov/publications/p504/

Congratulations on your new life!

And remember, you can find answers to all kinds of questions about divorces and other tax issues, free. Where? Where else? At TaxMama.com.

[Note: If you were subscribed to the e-mailed TaxQuips, you’d be getting other exciting news and tips by e-mail, that never appear on the site. Please click on the subscribe link and join us.]

Ask TaxMama :: Where taxes are fun and answers are free
www.TaxQuips.com :: The number ONE free tax podcast online
IRS Publication 504 :: Divorced or Separated Individuals

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Child Care Benefits

Eva Rosenberg — Mon, 09 Nov 2009 06:15:00 -0800

Today TaxMama hears from Melissa in Texas with this question. “ I would like to sign up for my employer’s cafeteria plan for the preschool child care expenses. It will allow me to pay for about $5,000 of the child care tax free. But my son’s daycare is over $11,000 a year. Can I claim the child care credit for the remaining $6,000+ on my itemized 1040? If I can only do one or the other, with which one I would come out ahead?”

Dear Melissa,

I was just looking at the Form 2441, page 2, to see what would happen if you used the $5,000 flexible spending allowance. http://www.irs.gov/pub/irs-pdf/f2441.pdf

Yup, it would wipe out your child and dependent care credit.

That’s OK. The credit is only worth $600 to you, for one child ($1200 for two children).

But not paying any taxes at all is worth much more!

...$375 – You save your share of Social Security 7.5%
$1,250 – Your share of your IRS taxes 25%
...-0- – State taxes in Texas – 0% ————$1,625.00 – Total –

So, personally, I’d opt for the cafeteria plan.

But, when you file your tax return next year, try to enter the data into Form 2441 anyway. Who knows what laws will have changed by then, possibly allowing you to use some additional expenses.

And remember, you can find answers to all kinds of questions about cafeteria plans and other tax issues, free. Where? Where else? At TaxMama.com.

[Note: If you were subscribed to the e-mailed TaxQuips, you’d be getting other exciting news and tips by e-mail, that never appear on the site. Please click on the subscribe link and join us.]

Ask TaxMama :: Where taxes are fun and answers are free
www.TaxQuips.com :: The number ONE free tax podcast online
IRS Form 2441 :: Child and Dependent Care Credit

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Sale of Inherited Home

Eva Rosenberg — Thu, 05 Nov 2009 06:06:00 -0800

Today TaxMama hears from Dottie in Massachusetts with this question. “Does the maximum personal residence exclusion apply to someone who inherited a home, had it for 370 days, sold it for a long-term capital gain and received a K-1? He and his dad had lived in the home for 10 yrs previously.”

Dear Dottie,

First of all, you don’t receive a K-1 when you sell a home. Possibly, the escrow company sends you a 1099.

If you are receiving a K-1, that means there’s an estate. The estate sold the home, not the heir. If that’s the case, the tax professional handling the estate should have provided enough information for the heir to be able to file a tax return. If they didn’t, ask them for the details.

Secondly, when someone dies, there is a step-up in the basis of the home. What does that mean? The tax cost of the home becomes the current fair market value. (See Alannah Kern’s comments to yesterday’s TaxQuip – http://www.taxquips.com/index.php?id=1394 )

When you sell the house within a year or so of the death, especially in the current real estate market, odds are that there will be no gain. Even when the value has risen a bit since the death, you will find that commissions and selling costs will eat up that profit.

Take this year’s tax return and information to a tax professional. I suspect there will be no tax due at all. Once they see the information the tax pros will know what else to ask you to clarify the whole transaction.

And remember, you can find answers to all kinds of questions about death-related tax matters and other tax issues, free. Where? Where else? At TaxMama.com.

[Note: If you were subscribed to the e-mailed TaxQuips, you’d be getting other exciting news and tips by e-mail, that never appear on the site. Please click on the subscribe link and join us.]

Ask TaxMama :: Where taxes are fun and answers are free
www.TaxQuips.com :: The number ONE free tax podcast online
TaxQuip #1394 :: See Alannah Kern’s comments

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Personal Residence Exclusion

Eva Rosenberg — Wed, 04 Nov 2009 06:20:00 -0800

Today TaxMama hears from Nony in California who wants to know. “My parents recently moved to a retirement community and were preparing their house for sale. Mom just died – the house was not yet on the market. Does Dad still get the $500K capital gains exemption or only $250K since Mom died before the house sold. Her name is still on the deed since her death was just a few days ago.”

Dear Nony,

Oh, that’s so sad. That same thing happened to my friends several years ago. Just when they were able to retire and have fun!

Oh well. If there’s any way that you can sell the house this year, Dad will get the full $500,000 personal residence exclusion on their final joint tax return.

However, no need to rush. California is a community property state. Odds are that the whole house got a stepped-up basis on the day your mother died. That means, that for tax purposes, the cost basis of the house is the fair market value on that day. So, even if Dad sells it next year, there probably won’t be any gain.

If there is, his own $250,000 personal residence exclusion will absorb it.

And remember, you can find answers to all kinds of questions about death-related tax matters and other tax issues, free. Where? Where else? At TaxMama.com.

[Note: If you were subscribed to the e-mailed TaxQuips, you’d be getting other exciting news and tips by e-mail, that never appear on the site. Please click on the subscribe link and join us.]

Ask TaxMama :: Where taxes are fun and answers are free
www.TaxQuips.com :: The number ONE free tax podcast online
IRS Publication 523 :: Sale of home after death of spouse

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Living in the UK

Eva Rosenberg — Tue, 03 Nov 2009 06:31:00 -0800

Today TaxMama hears from Catherine in the United Kingdom. “I am a US citizen, employed by a UK employer and living and working in the UK where I pay taxes. I own an apartment in NY which I rent out. I report the rental income on my US tax return. Must I report my UK income as well?”

Dear Catherine,

Well that sounds like a delightful place to live.

Yes, you should be reporting the UK income. Americans must report all their worldwide income.

You have two ways of reporting the income:

1) Report the full income and deduct the UK taxes you pay as a credit to offset all or part of the US taxes.
Remember, if you are still a NYS resident, you have to report all the income for New York State, too. And I don’t know if NYS allows for foreign tax credits or deductions. So, if you’re not planning to return to live in NY, be sure to establish yourself as a non-NYS resident. Look up their rules for residency.
http://www.tax.state.ny.us/

2) You can use the foreign earned income exclusion of $91,400 (2009) That is reported on Form 2555
http://www.irs.gov/pub/irs-pdf/f2555.pdf

Of course, NYS does not offer the same benefit.

For more information about federal tax breaks, click here.

And remember, you can find answers to all kinds of questions about living overseas and other tax issues, free. Where? Where else? At TaxMama.com.

[Note: If you were subscribed to the e-mailed TaxQuips, you’d be getting other exciting news and tips by e-mail, that never appear on the site. Please click on the subscribe link and join us.]

Ask TaxMama :: Where taxes are fun and answers are free
www.TaxQuips.com :: The number ONE free tax podcast online
New York State Tax website ::
IRS Form 2555 :: Foreign Earned Income Exclusion
IRS FAQs :: Americans Living Overseas
Roger B. Adams, EA :: TaxMama's International Expert

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Equitable Owner

Eva Rosenberg — Mon, 02 Nov 2009 06:03:00 -0800

Today TaxMama hears from Sean in North Carolina. “As I understand it you must be an owner and be liable to claim the home mortgage interest and property tax as deductions on schedule A. Now I hear you can be an equitable owner whose name is not on the mortgage and also whose name is not on the deed. Can you explain?”

Hi Sean,

Good question. And one that affects many people.

In essence, an equitable owner is the real owner of the house, despite the fact that tile and the loan may be in someone else’s name. This is usually the case when someone doesn’t have enough credit to qualify for their own loan. A close relative or friend qualifies on their behalf.

But the person or couple who have inadequate credit are the ones who live in the home and make all the payments and take care of all the upkeep. For all intents and purposes, they are the real owners of the home. They just don’t have the title to prove it.

Case after case in Tax Court supports the taxpayer in this situation. Here is an article in the Journal of Accountancy that explains the concept more fully. They are discussing a Tax Court case where the taxpayer won.

But there’s no need to drag this to Tax Court. Just get the proper paperwork done to prove your claim. You need to have title documents drawn up in the real owners’ names. And you need to have a loan document drawn up between the buyer on title and on the loan, and the real borrowers.

If you didn’t do that in the beginning, you can have your attorney draw up memorialized contracts. That means you don’t back date documents illegally. You produce contracts that explain that this was the intention at the date of the purchase, and use the current dates for the signatures.

And remember, you can find answers to all kinds of questions about equitable ownership and other tax issues, free. Where? Where else? At TaxMama.com.

[Note: If you were subscribed to the e-mailed TaxQuips, you’d be getting other exciting news and tips by e-mail, that never appear on the site. Please click on the subscribe link and join us.]

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www.TaxQuips.com :: The number ONE free tax podcast online
Journal of Accountancy Article :: Equitable Owner Equals Deduction

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Qualifying Person for HOH

Eva Rosenberg — Thu, 29 Oct 2009 06:25:00 -0700

Today TaxMama hears from Orla in Colorado. “I have a friend who has provided full support for his girl friend who is unemployed, and her daughter who is 18 and in high school. They both have lived with him for the full year. He should be able to file head of household but can he claim them as dependents?”

Dear Orla,

Actually, you have it a bit backwards.

He can claim them as dependents. But he cannot use head of household status.

They don’t qualify as either family or qualified relatives for HOH. Sorry.

BUT, since they are dependents, he can use medical deductions, education expenses, etc.

[See working links in the Resource Box below]

HOH rules
http://www.irs.gov/publications/p17/ch02.html

Qualifying Person
http://www.irs.gov/publications/p17/ch02.html

And remember, you can find answers to all kinds of questions about being head of household and other tax issues, free. Where? Where else? At TaxMama.com.

[Note: If you were subscribed to the e-mailed TaxQuips, you’d be getting other exciting news and tips by e-mail, that never appear on the site. Please click on the subscribe link and join us.]

Ask TaxMama :: Where taxes are fun and answers are free
www.TaxQuips.com :: The number ONE free tax podcast online
IRS Publication 17 :: Head of Household rules
IRS Publication 17 :: Who Qualifies for Head of Household

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529 Contributions

Eva Rosenberg — Wed, 28 Oct 2009 06:20:00 -0700

Today TaxMama hears from Rick in New Jersey with this stroke of genius. “I am a salaried employee for ABC company and will be doing a separate consulting engagement for another company in my spare time. I’d like to take the entire $55,000 I will earn and put it directly into a 529 college plan for my son, who is a senior and will be attending college in the fall of 2010. Do I need to report the $55K income to the IRS?”

Dear Rick,

That’s a brilliant strategy!

Now, if only the tax code would support it.

Of course you’re going to have to pay income taxes on the consulting fees. Heck, you’re even going to have to pay self-employment taxes on that money. That’s going to cost you an extra 15.3% on top of your 32% – 35% federal and state tax bracket.

If you’re going to be earning that kind of money freelancing, you really need to invest in a good tax professional who can help you structure your business so that you can take the best advantage of deductions available to you. With a bit of good planning, you can really minimize your taxable profits and maximize the money you can set aside for your son’s college.

Incidentally, contributions to IRC Sec. 529 plans are not deductible.
http://www.irs.gov/newsroom/article/0,,id=213034,00.html
They are simply exempt from gift tax. If your son is starting college so soon, there’s no need for the complexities and restrictions of the 529 plan. You’re better off paying his tuition and taking advantage of some of the higher education deductions or credits in the ARRA.
http://www.irs.gov/newsroom/article/0,,id=213044,00.html

And remember, you can find answers to all kinds of questions about being self-employed, 529 plans and other tax issues, free. Where? Where else? At TaxMama.com.

[Note: If you were subscribed to the e-mailed TaxQuips, you’d be getting other exciting news and tips by e-mail, that never appear on the site. Please click on the subscribe link and join us.]

Ask TaxMama :: Where taxes are fun and answers are free
www.TaxQuips.com :: The number ONE free tax podcast online
IRS Information :: abou 529 Plans - video and audio available
IRS Information :: Tax Benefits for Education: Information Center -- video and audio available

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Cashing Out Retirement

Eva Rosenberg — Tue, 27 Oct 2009 05:25:00 -0700

Today TaxMama hears from Jessie in California, who’s broke. “ I am 22 years old and unemployed. I recently hit a financial snag and am really considering cashing out my 401(k) plans. In total it would amount to $4,995.85. Because of state and federal taxes as well as the fee for cashing out early, how much of that money would I actually see once its deposited into my account?”

Dear Jessie,

Surely, you can find some work, however beneath you, to cover your fixed living expenses? I cannot imagine being 22, healthy, and smart and not finding anything at all – even if it’s as onerous as phone soliciting or washing dishes. I know the market’s rough out there. But if you want to work, there is always something to find. Just knock on doors at local businesses. You’d be surprised. Sometimes, you’ve knocked at exactly the right moment!

Of course, if you’re collecting unemployment, there’s no incentive to look for menial work. Unemployment pays better.

So, how much will drawing the 401(k) prematurely cost you? I don’t know. That will depend on your tax bracket this year. However, this I know for sure. Your early withdrawal penalties will be 12.5% (IRS 10% – CA 2.5%) – that’s about $625.00 (rounded) .

Your income taxes on the funds will be higher than you think for IRS. You see, the unemployment you collect is taxable on your federal tax return. It’s not taxable for California.

But let’s say you are only in a 10% bracket for IRS. You probably won’t owe any state taxes at that level. So your income tax would be an additional $500.00. Expect to lose about $1125.00 + whatever fees your investment company charges. If you’re in higher tax bracket, the taxes could run as high as 30% – so you would lose over 42% of your money – nearly half of it! Is it still worth it?

If not, consider using a 0% credit card – if your credit is still good. They will charge you about 3% as a cash advance fee. But that’s still far less than 25% – 42%, don’t you think? Check with your own credit card company to see if they can offer you a cash advance or balance transfer at 0%. If not, visit TaxMama’s Credit Card Center. http://www.cardoffers.com/partners/links/cpa/all.asp?tempid=339850
Use the search tool at the bottom of the page to search for cards with 0% interest.

Besides losing 25% of your savings, if you can somehow manage to leave your retirement savings alone, they will continue to grow, in the long run. If you start making a habit of tapping into retirement funds every time life hits a snag, you’ll never have anything left when you retire. You’re young. Find work. Good luck!

And remember, you can find answers to all kinds of questions about drawing on retirement funds and other tax issues, free. Where? Where else? At TaxMama.com.

[Note: If you were subscribed to the e-mailed TaxQuips, you’d be getting other exciting news and tips by e-mail, that never appear on the site. Please click on the subscribe link and join us.]

Ask TaxMama :: Where taxes are fun and answers are free
www.TaxQuips.com :: The number ONE free tax podcast online
TaxMama's Credit Card Center :: Use the search tool at the bottom of the page to search for cards with 0% interest.

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