Grossbach Zaino & Associates, CPA's, PC


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Understanding the Kiddie Tax

Transferring investments to your children to take advantage of their lower tax rates may seem like a good idea. However, before you execute this income shifting strategy, consider how the “kiddie tax” might apply.

Basic Rules

The kiddie tax applies when a child has taxable unearned income (as opposed to earned income from a job) above a certain limit ($2,100 in 2015). The rules affect children under age 18 and children who have earned income that is no more than half of their support and are either age 18 or full-time students under age 24.

Once the tax is triggered, the following rules generally apply:

  • The child has a standard deduction equal to $1,050*
  • The next $1,050 of unearned income is subject to the child’s rate
  • Additional unearned income above $2,100 is taxed at the parent’s rate

Example. Bob is in the 25% bracket and his 16-year-old son, Todd, has no income other than $2,500 in investment income. Todd’s standard deduction shields the first $1,050, the 10% rate applies to the next $1,050, and Bob’s marginal rate applies to the remaining $400, for a total tax of $205. Alternatively, if Bob had kept the investments and paid the tax himself, he would have paid 25% of $2,500, or $625.

Is It Worth It?

Though tax savings are possible, consider also the added administrative expense of maintaining a second investment account. And, if your child is going to attend

college, assets held in his or her name may reduce future financial aid awards. You may want to consider a Section 529 college savings account, which produces investment earnings that are tax free if used for qualified education expenses.

* For 2015, the standard deduction will equal the lesser of $1,050 or the child’s earned income plus $350.


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Can You Deduct a Good Time?

Wouldn’t it be great to be able to take a tax deduction for your vacation? Combine vacation with a business trip and maybe you can. But, for expenses to be tax deductible, they must meet certain requirements. It’s a good idea to know what those requirements are before you plan your travel.

Add It on

If the primary purpose of your trip is business, you can deduct the cost of your transportation to and from your destination, even when you’ve tacked on a few vacation days. However, with certain exceptions, you’ll be able to deduct food and lodging costs only for days you actually spend on business.

Bring the Crew

While you can’t deduct food, lodging, or airfare for your family, you’re still entitled to your own write-offs for a trip that combines business and pleasure. That includes the single-occupancy rate for lodging on days when you’re conducting business. And, if you travel by car, you can deduct the full cost of transportation, just as you would if you were traveling alone.


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The Early Bird Gets the Tax Savings

At this time of the year, you may be thinking more about raking leaves than reviewing your taxes. After all, your 2015 income-tax return isn’t due to the IRS for several months yet. But waiting too long can rob you of the opportunity to use planning strategies that may help reduce your tax bite. Here are a few you may be able to use.

Paying Less by Saving More

You may be able to lower your tax bill by increasing your pretax contributions to an employer-sponsored retirement plan. Since you don’t pay current taxes on the money you contribute, deferring a greater amount of your pay means less money is withheld for taxes. If you’re age 50 or older and are already contributing the maximum annual amount through salary deferrals, your plan may allow you to make catch-up contributions.

Another strategy is to contribute to a traditional individual retirement account. Contributions made by the April tax-filing deadline may be deductible on your 2015 return. The 2015 contribution limit is $5,500 ($6,500 if you’re age 50 or older). Talk to your tax advisor about the deduction requirements.

Being Charitable

Making donations to your favorite charitable organizations by the end of the year positions you to claim an itemized deduction for charitable contributions. Donating with a credit card or with a check mailed by December 31 allows you to take the deduction on your 2015 return even though you won’t pay your credit card bill or have your check processed until 2016. Verify that the organization qualifies to receive deductible contributions, and keep your receipts and bank/credit card records as proof of your donations. Deduction limits apply.

Losses You Can Use

Until you actually sell an underperforming investment, your “losses” are only on paper. Reviewing your taxable portfolio for investments that haven’t performed the way you expected them to may turn up potential “sell” candidates. A short period of lower values doesn’t necessarily make an investment a poor choice. But an investment that has lost value since you acquired it and consistently underperformed a benchmark may need another look. Selling the investment would give you a capital loss you can claim for tax purposes. Capital losses are fully deductible to offset capital gains and up to $3,000 of ordinary income each year ($1,500 if married, filing separately). Any losses you can’t deduct can be carried over for deduction in future years, subject to the same limitations.

Favorable Rates, More Profit

If you’ve been thinking of taking profits on appreciated stock you’ve held longer than one year, favorable capital gain tax rates may make this a good time to sell. Long-term capital gains from the sale of stocks and other securities are currently taxed at 15% for most taxpayers. The exceptions: Gains are taxed at 0% for taxpayers in brackets below 25% and at 20% for taxpayers in the top regular tax bracket (39.6%).

Now remember those losses you incurred by selling your underperforming investments? You can use them to offset your gains from the sale. Never make taxes your only reason for selling an investment. Before you decide, consider how the sale will affect your overall portfolio.

Bunching Expenses

You may be able to exceed the floor amount for medical deductions by scheduling and paying out-of-pocket medical costs before year-end. For 2015, medical expenses are deductible only in the amount that exceeds 10% of adjusted gross income (AGI) or 7.5% of AGI for taxpayers age 65 or older.


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Why Business Structure Matters

When you start a business, there are endless decisions to make. One of the most important is how to structure your business. Why is it so significant? Because the structure you choose will affect how your business is taxed and the degree to which you (and other owners) can be held personally liable. Here’s an overview of the various structures.

 

Sole Proprietorship

This is a popular structure for single-owner businesses. No separate business entity is formed, although the business may have a name (often referred to as a DBA, short for “doing business as”). A sole proprietorship does not limit liability, but insurance may be purchased.

You report your business income and expenses on Schedule C, an attachment to your personal income-tax return (Form 1040). Net earnings the business generates are subject to both self-employment taxes and income taxes. Sole proprietors may have employees but don’t take paychecks themselves.

LLC

If you want protection for your personal assets in the event your business is sued, you might prefer a limited liability company (LLC). An LLC is a separate legal entity that can have one or more owners (called “members”). Usually, income is taxed to the owners individually, and earnings are subject to self-employment taxes.

Note: It’s not unusual for lenders to require a small LLC’s owners to personally guarantee any business loans.

Corporation

A corporation is a separate legal entity that can transact business in its own name and files corporate income-tax returns. Like an LLC, a corporation can have one or more owners (shareholders). Shareholders generally are protected from personal liability but can be held responsible for repaying any business debts they’ve personally guaranteed.

If you make a “Subchapter S” election, shareholders will be taxed individually on their share of corporate income. This structure generally avoids federal income taxes at the corporate level.

Partnership

In certain respects, a partnership is similar to an LLC or an S corp. However, partnerships must have at least one general partner who is personally liable for the partnership’s debts and obligations. Profits and losses are divided among the partners and taxed to them individually.


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Are You Serious?

Turning a hobby into a business can be an exciting proposition. But don’t get tripped up by the IRS’s “hobby loss” tax rules.

What’s the Difference?

Basically, a trade or business is an activity you engage in to make a profit (whether or not a profit actually results). A hobby, on the other hand, doesn’t have a profit motive. If the IRS views your activity as a hobby rather than a business, your tax deductions for business expenses generally will be limited to the extent of income from the activity.

What Does It Take?

The IRS will presume your activity is a trade or business if you’ve shown a profit in three of the past five years (two out of seven years if the activity involves breeding, showing, training, or racing horses). If your profit “picture” isn’t conclusive, there are nine subjective factors the IRS then uses to determine whether a profit motive exists.

A Tale of Two Court Rulings

A law firm partner who produced a documentary film in her spare time was found by the U.S. Tax Court to have a profit motive because she conducted the activity in a businesslike manner. Specific points in her favor included that she created a production company with separate bank accounts, obtained proper liability insurance, and spent numerous hours a week working on the project.

An individual who was a photographer, however, did not pass the profit motive test, said the court, because the activity was not conducted in a businesslike manner. Key factors included the photographer’s failure to keep a separate bank account and to make significant efforts to improve profitability.


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Hobby or Business?

Who knew you had a green thumb? You started gardening as a way to de-stress. Now, you’re growing exotic orchids in your family room. It was a pricey hobby until you learned how to propagate orchids and started selling them to other hobbyists. And now you’re thinking you might be able to turn growing orchids into an income source — and your hobby into a business.

Once people start making money from their hobbies, they frequently start to deduct all of their hobby-related expenses. At this point, the IRS can become very interested in the nature of the taxpayer’s hobby/business. There are certain tax guidelines to keep in mind.

Deducting Expenses

If you earn income from your hobby, you generally can deduct bona fide hobby-related expenses up to the amount of the annual income your hobby generates. You must itemize to claim the deduction. Hobby expenses fall into the “miscellaneous” category, so they are grouped with any other miscellaneous expenses you have, and only the amount exceeding 2% of your adjusted gross income is deductible.

These restrictions don’t apply to business expenses. If you operate an active business, your business-related expenses generally will be deductible, even if they exceed your business income (limitations apply).

Passing the Test

The IRS won’t just take your word for it. It has a set of guidelines to determine whether a hobby qualifies as a business. First and foremost, you must be pursuing the activity with the goal of making a profit. If you’ve made a profit in three of the last five years (two of the last seven if your activity is horse breeding, showing, or racing), the IRS assumes you had a profit motive.

If you don’t meet the profit criteria, here are a few of the other questions the IRS may ask:

l Do you keep accurate books and separate your venture’s finances from your personal finances?

l Do you spend significant time and effort carrying out the venture?

l Does the activity involve a significant element of personal pleasure or recreation?


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Are Social Security Benefits Taxable?

It depends. If your income exceeds certain tax law thresholds, a portion of your Social Security retirement benefits will be subject to federal income taxes.

The Thresholds

The IRS uses your “provisional income” to determine the percentage of benefits subject to tax. Generally, provisional income includes your modified adjusted gross income plus tax-exempt interest and half of the Social Security benefits you received during the year.

Individuals with provisional income between $25,000 and $34,000 and married couples (filing jointly) with provisional income between $32,000 and $44,000 are taxed on up to 50% of their benefits. And up to 85% of benefits are taxable for individuals with provisional income over $34,000 and married couples with provisional income over $44,000.

Because these thresholds are not adjusted for inflation, more taxpayers tend to be affected as overall income levels increase. For example, according to the IRS, the number of taxpayers with taxable benefits in 2012 was about one million more than in 2011.

Minimizing the Tax Bite

If you are collecting Social Security, be aware that certain actions, such as taking a large retirement account distribution or recognizing capital gain from the sale of a second home, could push your provisional income past a threshold and/or increase your overall tax rate.

To help lessen the impact of taxes on your benefits, you might consider:

  • Structuring a vacation home sale or traditional individual retirement account (IRA) distribution so that income is received over more than one year
  • Liquidating assets in a taxable investment account rather than a retirement account if it will mean recognizing only a small capital gain or you have capital losses on other transactions that would offset the gain