Grossbach Zaino & Associates, CPA's, PC


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To Itemize or Not To Itemize?

That is a question many taxpayers have during income-tax filing season. Claiming the standard deduction can be easier since it’s a set amount and you don’t need to have expense records to claim it. But itemizing could save you taxes. It depends on your personal situation.

When you itemize, you deduct the actual dollar amount of certain types of expenses, subject to various tax law limitations. Common expenses that can be itemized include:

 

  • Charitable contributions

 

  • Qualified mortgage interest

 

  • Property taxes

 

  • State and local income taxes

 

  • Unreimbursed medical expenses for yourself, your spouse, and your dependents

 

  • Certain miscellaneous expenses

 

Unlike most other itemized expenses, no deduction is allowed for expenses in the medical and miscellaneous categories until your total expenses in that category exceed a “floor” (a specified percentage of your adjusted gross income). Only the amount in excess of the floor is deductible.


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The Home Office Deduction for Telecommuting Employees

If you are one of a growing number of employees who telecommute, you may be eligible to deduct some of your home office expenses. But strict rules apply.

 

Which Home Offices Qualify?

 

For the expenses to be deductible, your home office must satisfy three tests.

 

Test #1. The office must serve the convenience of your employer. You may be able to satisfy this test if your employer requires you to have a home office and to work there, if the home office is necessary for the operation of your employer’s business, or if the home office allows you to perform your work duties properly. You will not be able to satisfy this test if the home office is for your own convenience.

 

Test #2. The second test relates to how you use the space and its type. You can satisfy the second test in one of three ways.

 

Principal Place of Business — The home office is the principal place of business for your work as an employee. You may be able to meet the principal place of business requirement if the most important part of your work is done in the home office and you spend most of your work time there.

 

Separate Structure — The office is an unattached structure on the same property as your home.

 

Place To Meet Clients — You use the office space as a place to meet with patients, clients, or customers of your employer. Physical presence is required, so making telephone calls to patients, clients, or customers does not qualify. And the face-to-face meetings must be on a regular, not an occasional, basis.

 

Test #3. Additionally, the home office must be used exclusively and regularly as your home office. This can be a difficult hurdle. For example, the rule requires that your home office be used as only your home office. If your children also use the area to play in, or if overnight guests occasionally sleep there, your home office will not satisfy the test. However, the area doesn’t need to be a separate room — it may be a portion of a room, provided it otherwise meets the relevant tests.

 

Calculating the Deduction

 

The amount of your home office expenses may be calculated using either the “actual expense” or the “simplified” method. The actual expense method involves dividing various expenses of operating your entire home between personal and business use and adding in expenses that pertain only to your home office. (An income limitation applies.) The simplified method — which the IRS began allowing in 2013 — entails taking the square footage of the home office (up to 300 square feet) and multiplying it by $5. Which method is better for you depends on your particular situation.

 

An employee’s unreimbursed home office expenses are taken as an itemized “miscellaneous expense” deduction. As a result, they are deductible only to the extent that they, when combined with other unreimbursed employee expenses and miscellaneous expenses, exceed 2% of your adjusted gross income. You must itemize to claim the deduction.

 

Questions?

 

Contact us if we can help with questions about deducting your home office expenses. We’d be happy to review the rules with you in more detail and help you determine whether the deduction is available to you.


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Time for a Home Equity Loan?

Unlike the interest on consumer loans, home equity loan interest is tax deductible if certain requirements are met. Thinking of capitalizing on the equity in your home? Here are a few factors to weigh.

 

TAX CONSIDERATIONS

The interest you pay on a home equity loan of up to $100,000 ($50,000 if you are married filing separately) which is secured by your home generally qualifies as an itemized deduction. But there are other considerations.

 

To find out whether a home equity loan is your best financing option, compare the effective after-tax interest rate on the home equity loan with the interest rate available on consumer loans. To calculate a home equity loan’s effective after-tax interest rate, subtract your marginal income-tax rate (your tax bracket) from 100% and multiply the result by the home equity loan’s interest rate.

 

Example. If your marginal income-tax rate is 25% and you can secure an 8% home equity loan rate, the effective after-tax interest rate of the loan will be 6% (100% – 25% = 75%; 8% ´ 75% = 6%). Thus, if the lowest consumer loan interest rate available to you is higher than 6%, the home equity loan may be the better choice.

 

OTHER CONSIDERATIONS

Remember that you will need to pay off the home equity loan when you sell your home. So before you go through the trouble and expense of getting a loan, consider how long you plan to live in your current home. And while home equity loans can be a tax-smart financing option, you should also consider the risks associated with pledging your home as collateral if you become unable to make the loan payments. There may also be some costs associated with obtaining a home equity loan.


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Think Taxes if You Rent Your Vacation Home

If you own a vacation home that you’re thinking about renting out this year, do some tax planning first.

Your home will be considered investment property if you limit your personal use of the home to no more than 14 days a year or, if greater, 10% of the total number of days it is rented out. The tax result: Expenses associated with renting the property, such as utilities and maintenance, generally will be tax deductible in full (but see notation below* regarding the tax law’s passive activity rules). Exceed the 14 days/10%-of-rental-days threshold and your tax deductions for rental expenses generally will be limited to the amount of rental income you collect.

What counts as a day of personal use? Generally, you must count any day you occupy the home. But you may exclude days you spend fixing up the home in preparation for renting it, if that is your primary purpose for being there. Also note that you must count days you allow family members to use the home as personal use days.

Your days of personal use won’t be important if you rent your vacation home for less than 15 days a year. Why? The tax law gives you a special break in this situation: You don’t have to report any of your rental income (nor can you deduct rental expenses, other than property taxes and qualifying mortgage interest). Thus, the income you collect will be tax free.

This special tax break isn’t limited to vacation homes. It is also possible to lease your primary residence for two weeks or less and enjoy the rental income free of tax.

 

* In general, losses from renting real estate may be used only to offset income from other “passive activities,” not ordinary income like wages and interest. However, if you actively participate in managing your property, you are allowed to deduct up to $25,000 of rental losses against ordinary income (subject to an income-based phaseout).


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The “New” Rules of IRA Rollovers

For many years, owners of individual retirement accounts (IRAs) have had the ability to roll over funds from one IRA to another IRA without tax consequences, as long as the rollover is completed within 60 days of receiving the funds. The benefit of a rollover is that the individual has unrestricted use of the funds during those 60 days. The tax law allows one IRA rollover per year.

 

A Different Interpretation

 

Previously, the IRS con­sidered the one-per-year rollover rule to apply to each of a taxpayer’s IRAs individually and not to all of the taxpayer’s IRAs collectively. Recently, however, the U.S. Tax Court determined that the rule should be applied to a taxpayer’s combined IRAs. According to the new interpretation, a taxpayer can’t make a nontaxable rollover from one IRA to another if the taxpayer already made a rollover from any IRA in the preceding one-year period.

 

The IRS has announced that it will follow the Tax Court’s decision.

 

If the one-per-year rule is violated, the extra rollover amount is generally taxable and may be subject to the 10% early distribution penalty.

 

No Limits on Direct Transfers

 

If you own multiple IRAs, keep in mind that the once-per-year rule does not apply to direct, trustee-to-trustee transfers between IRAs. Since transfers aren’t considered distributions or rollover contributions, there are no limits on the number of direct IRA-to-IRA transfers you can make during the year.


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Taxes on Mutual Fund Transactions

Mutual fund ownership has grown steadily over the years. A recent study* found that more than 43.3% of households in the United States own mutual fund investments. It’s easy to understand why: Mutual funds are professionally managed, and fund shares can be bought or sold every trading day. Because a fund holds many securities, it provides greater diversification than an investment in a single stock or bond.

 

How mutual fund transactions must be handled for tax purposes depends on whether shares are held in a tax-deferred or taxable account. Here’s a brief overview.

 

Tax-deferred Retirement Accounts

If you invest in mutual funds through a 401(k) or other tax-deferred retirement plan sponsored by your employer, or if you hold fund shares in an individual retirement account (IRA), you can buy and sell funds within your account without having to report the transactions to the IRS or pay taxes on capital gains or fund distributions. Income taxes generally become payable — at ordinary rates — when you take a distribution from your plan or traditional IRA. Distributions of Roth IRA investment earnings are tax free after five years if you are age 59½ or older (or in certain other circumstances).

 

Taxable Accounts

A mutual fund is required to distribute nearly all its income, including realized net capital gains, dividends, and interest, to its shareholders each year. As a fund shareholder, you typically can choose to receive distributions in cash or opt to have the distributions automatically reinvested in additional shares. Either way, you’ll generally be taxed on the distributions. Distributed capital gains may be long term or short term in nature.

 

You must report capital gains or losses on sales of your fund shares in the year you sell them. Your cost basis includes any automatically reinvested income dividends and capital gains distributions. For 2015, the maximum tax rate on long-term (held for more than one year) capital gains is 20% for investors in the top 39.6% regular tax bracket. It’s 15% for most other investors. Short-term capital gains are taxed at ordinary income-tax rates.

 

 

* Characteristics of Mutual Fund Investors, 2014, Investment Company Institute, November 2014


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Taxable vs. Tax-free Bond Investing

When it comes to bond returns, appearances can sometimes be deceiving. For example, a corporate bond that pays interest at a 6.5% rate is not necessarily a better investment than a municipal bond that pays interest at 4.5%. Why? Municipal bond interest is generally exempt from federal income taxes. Moreover, if you live in the state where the municipal bond was issued, the interest also might be exempt from state income tax (and perhaps city tax where applicable).

 

Because of the tax benefits, a lower yielding municipal bond may turn out to be a better investment than a taxable bond depending on your tax bracket.

 

Municipals and the Alternative Minimum Tax

There’s an additional tax-related twist that you should consider. Interest on private activity bonds that is tax exempt for regular tax purposes may be taxable under the alternative minimum tax (AMT) system. However, tax-exempt interest on private activity municipal bonds issued (or, in certain cases, reissued) in 2009 and 2010 is not considered an AMT preference item.

 

Will you come out ahead with a municipal? Review the attached table and find the taxable rate in your tax bracket that is equivalent to the municipal’s tax-exempt rate.

 

Comparing Yields — Tax-exempt vs. Taxable Bonds

Tax-exempt Yield Equivalent Taxable Yields Federal Tax Bracket
  25% 28% 33% 35% 39.6%
2% 2.67% 2.78% 2.99% 3.08% 3.31%
3% 4% 4.17% 4.48% 4.62% 4.97%
4% 5.33% 5.56% 5.97% 6.15% 6.62%
5% 6.67% 6.94% 7.46% 7.69% 8.28%
6% 8% 8.33% 8.96% 9.23% 9.93%
           

State income taxes are not considered in the table.                                                        Source: DST