Surprised By the Kiddie Tax??

To prevent parents from placing investments in their children’s names to take advantage of the child’s lower tax rate, Congress created, several years back, what is referred to as the “Kiddie Tax”. Under the Kiddie Tax, a child’s investment income in excess of $1,900 is taxed at the parent’s tax rate rather than the child’s. These rules do not apply to married children who file a joint return with their spouse or self-supporting children.

Depending upon your circumstances, this can be either a tax return preparation nuisance or a penalty tax – or maybe both. Many insightful parents seek tax-advantaged ways to put money aside for their children’s education, first home, etc. They should not be deterred by the Kiddie tax, as there are legal ways to minimize or eliminate it. This is generally accomplished by making investments that produce tax-free income or that defer income until a year the child is no longer subject to the Kiddie Tax. If, at that time, the child is in school or just starting in the work force with little or no other income, the deferred income could then be realized with little or no income tax.

The following are examples of investments that either defer income or generate tax-free income. However, you must also consider that some of these might have a lower rate of return than a taxable investment and may not always be appropriate in the current economic climate:

• U.S. savings bonds – Interest can be deferred until the bonds are cashed.
• Municipal bonds – Generally produce tax-free interest income for Federal taxes. Most states with a state income tax also permit tax-free treatment of interest from bonds of that state or local governments within that state.
• Growth stocks – Stocks that focus more on capital appreciation than current income. The child could wait to sell them until he or she is no longer subject to the Kiddie tax.
• Mutual funds – Mutual funds that focus on growth stocks or municipal bonds. Although they might throw off some taxable income, their primary goal is capital appreciation or tax-free income.
• Unimproved real estate – That provides appreciation without current income.

If the family has a business, that family business could employ the child. The child’s earned income is not subject to the Kiddie tax rules and will generate a deduction for the family business (assuming the wages are reasonable for work actually performed). The child’s earned income can be offset by the standard deduction for a dependent, and the excess income will be taxed at the child’s rate (not the parent’s). In addition, the child would also qualify for a Traditional or Roth IRA, which provides additional income shelter.

If you have questions regarding the Kiddie Tax, please give our office a call.

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Can You Write Off a Bad Debt?

Most small businesses have receivables that cannot be collected. These receivables can be from the sale of products, providing services to customers, or a combination of the two.

Whether or not a bad debt deduction will apply generally depends upon which accounting method is used (either the cash or accrual method). Why does this make a difference? Let’s look at what happens under both methods of accounting.

• Accrual – If the accrual method is used, all of your billings must be treated as income whether or not they have been collected. This means that the taxable income already includes the income from your deadbeat customers. Therefore, these items are considered a bad debt when those receivables become uncollectible and can be deducted. If the accrual method of accounting is used, bad debts are deductible. 
• Cash – On the other hand, if the cash method of accounting is used, income is not reported until it is received (unlike the accrual method). Since the income was never reported in the first place, a deduction cannot be taken if payment was never made for the goods or services that were provided. However, if you made a loan to a customer or supplier and there is a business reason for the loan, you may have a business bad debt.

Proof of Worthlessness – Proving a debt (or receivable) is worthless requires the taxpayer or business to show that the debt has become worthless and that reasonable steps were taken to collect the debt. 

Non-Business Bad Debts – Some bad debts may actually be personal debts, such as personal loans to individuals. In those cases, the bad debt is not deducted as a business expense but is treated as a short-term capital loss on Schedule D subject to the $3,000 annual loss limit.

If you still have questions, please give our office a call for additional information. 

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100 Percent Write-Off for Qualified Leasehold Improvements

In an effort to get the economy back on the rails again, the 2010 Tax Relief Act permits businesses to claim a 100% depreciation deduction (100% bonus depreciation allowance) in the year that qualifying assets are placed in service. Qualified leasehold improvements clearly are eligible for this special 100% write-off.

Bonus depreciation basics - In general, a leasehold improvement qualifies for the 100% bonus depreciation allowance if it is acquired and placed in service after Sept. 8, 2010 and before Jan. 1, 2012, and the original use of the improvement commences with the taxpayer.

Qualified leasehold improvement property - Generally, qualified leasehold improvement property includes interior improvements to a building which is nonresidential real property if:

(1) The improvement is real property;

(2) The improvement is made to leased property. A lease for this purpose is defined as any grant of a right to use property, either by the lessee, sublessee or lessor of the building portion;

(3) The leased portion of the building is occupied exclusively by the lessee (or sublessee); and

(4) The improvement is placed in service more than 3 years after the date the building was first placed in service.

The following expenditures, however, do not qualify: amounts paid for the enlargement of a building, a structural component that benefits a common area, an elevator or escalator, or the internal structural framework of the building.

Whether you have already made leasehold improvements or are contemplating in doing so, and have questions on how this special write-off can fit into your business planning for 2011, please give this office a call.

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Read This Before Tossing Old Tax Records

Now that your taxes have been completed for 2010, you are probably wondering what old records can be discarded. If you are like most taxpayers, you have records from years ago that you are afraid to throw away. It would be helpful to understand why the records needed to be kept in the first place.

Generally, we keep “tax” records for two basic reasons: (1) in case the IRS or a state agency decides to question the information reported on our tax returns, and (2) to keep track of the tax basis of our capital assets so that the tax liability can be minimized when we actually dispose of them.

With certain exceptions, the statute for assessing additional tax is three years from the return due date or the date the return was filed, whichever is later. However, the statute of limitations for many states is one year longer than the federal. In addition to lengthened state statutes clouding the recordkeeping issue, the federal three-year assessment period is extended to six years if a taxpayer omits from gross income an amount that is more than 25 percent of the income reported on a tax return. And, of course, the statutes don’t begin running until a return has been filed. There is no limit where a taxpayer files a false or fraudulent return in order to evade tax.

If an exception does not apply to you, for federal purposes, most of your tax records that are more than three years old can probably be discarded; add a year or so to that if you live in a state with a longer statute.

Examples - Sue filed her 2010 tax return before the due date of April 18, 2011. She will be able to dispose of most of her records safely after April 15, 2014. On the other hand, Don files his 2010 return on June 2, 2011. He needs to keep his records at least until June 2, 2014. In both cases, the taxpayers may opt to keep their records a year or two longer if their states have a statute of limitations longer than three years. Note: If a due date falls on a Saturday, Sunday or holiday, the due date becomes the next business day.

The big problem! The problem with the carte blanche discarding of records for a particular year because the statute of limitations has expired is that many taxpayers combine their normal tax records and the records needed to substantiate the basis of capital assets. They need to be separated and the basis records should not be discarded before the statute expires for the year in which the asset is disposed. Thus, it makes more sense to keep those records separated by asset. The following are examples of records that fall into that category:

• Stock acquisition data – If you own stock in a corporation, keep the purchase records for at least four years after the year the stock is sold. This data will be needed in order to prove the amount of profit (or loss) you had on the sale.
• Stock and mutual fund statements – Where you reinvest dividends. Many taxpayers use the dividends that they receive from a stock or mutual fund to buy more shares of the same stock or fund. The reinvested amounts add to the basis in the property and reduce gain when it is finally sold. Keep statements at least four years after the final sale.
• Tangible property purchase and improvement records – Keep records of home, investment, rental property, or business property acquisitions AND related capital improvements for at least four years after the underlying property is sold.

For example, when the large $250,000 and $500,000 home exclusion was passed into law several years back, homeowners became lax in maintaining home improvement records thinking that the large exclusions would cover any potential appreciation in the home’s value. Now that the exclusion may not always be enough, records of home improvements are vital. Records can be important, so please use caution when discarding them.

Have questions about whether or not to retain certain records? Give this office a call first; it is better to make sure before discarding something that might be needed down the road.

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Is Your Credit Rating Correct?

Why do you care? Well for starters, people with a better credit rating enjoy significantly lower interest rates that can add up to thousands of dollars less in interest payments over the term of the loan. For example, a fixed 30-year mortgage payment varies with respect to credit score and the interest rates corresponding to the credit score. Having a score that is two hundred points higher can offer a savings of $448 a month for the same $200,000 house loan. Good credit ratings also provide for quicker loan approvals, fairer loan terms, and more credit.

Although there are various credit ratings or scores, the FICO® score is probably the most widely used of credit bureau scores. The FICO® ranges from 300 to 850. If you have a credit score lower than 650, your options for financing, ability to get a job, rent a home, and eligibility for a lease could be significantly affected.

Your credit rating can be affected by fraud and identity theft. So it is important to not only maintain a good credit rating but to periodically check on it for fraudulent activity and errors that can adversely affect your financial security. If someone has accessed your Social Security number, very little additional information is required to commit identity fraud in your name. Identity theft typically entails establishing false bank accounts, credit cards, utilities, and loans. Early detection is the best way to mitigate lasting damage to your credit record.

If you discover an error on a credit report, you should immediately take steps to have the error corrected. The law allows you to ask for an investigation of information in your file that you dispute as inaccurate or incomplete. There is no charge for this. Some people hire a company to investigate on their behalf, but anything a credit repair clinic can do legally, you can do for yourself at little or no cost.

According to the Fair Credit Reporting Act (FCRA):

You are entitled to a free report if a company takes “adverse action” against you, like denying your application for credit, insurance, or employment. You have to ask for your report within 60 days of receiving notice of the action. The notice will give you the name, address, and phone number of the consumer reporting company. You are also entitled to one free report a year if you are unemployed and plan to look for a job within 60 days; if you are on welfare; or if your report is inaccurate because of fraud, including identity theft.

Each of the nationwide consumer reporting companies — Equifax, Experian, and TransUnion — is required to provide you with a free copy of your credit report once every 12 months, if you ask for it. The three companies have a central website, a toll-free telephone number, and a mailing address for consumers to order the free annual credit reports that the government entitles them to. To order, click on annualcreditreport.com, call 1-877-322-8228, or complete the Annual Credit Report Request.

You may order reports from each of the three consumer reporting companies at the same time, or you can stagger your requests, ordering one from each company throughout the year from the central address. Don’t contact the three nationwide consumer reporting companies individually or at another address because you may end up paying for a report that you are entitled to get for free. In fact, each consumer reporting company may charge you up to $10.50 to purchase an additional copy of your report within a 12-month period.

It doesn’t cost anything to dispute mistakes or outdated items on your credit report. Under the FCRA, both the consumer reporting company and the information provider (that is, the person, company, or organization that provides information about you to a consumer reporting company) are responsible for correcting inaccurate or incomplete information in your report. To take advantage of all your rights under the FCRA, contact the consumer reporting company and the information provider.

How to challenge an error – Although you can hire firms to do credit repair, there is nothing they can do that you cannot do yourself. Here is the simple 2-step process to challenge an error on your credit report:

STEP 1:

Tell the consumer reporting company, in writing, what information you think is inaccurate. Include copies (NOT originals) of any documents that support your position. In addition to providing your complete name and address, your letter should identify each item in your report that is being disputed; state the facts and the reasons you are disputing the information and ask that it be removed or corrected. You may want to enclose a copy of your report and circle the items in question. Send your letter by certified mail with a “return receipt requested” so you can document that the consumer reporting company received it. Keep copies of your dispute letter and enclosures.

Your letter may look something like the one below suggested by the Federal Trade Commission.

Consumer reporting companies must investigate the items you question within 30 days — unless they consider your dispute frivolous. They also must forward all the relevant data that was provided about the inaccuracy to the organization that provided the information. After the information provider receives notice of a dispute from the consumer reporting company, it is required to investigate, review the relevant information, and report the results back to the consumer reporting company. If this investigation reveals that the disputed information is inaccurate, the information provider has to notify the nationwide consumer reporting companies so they can correct it in your file.

When the investigation is complete, the consumer reporting company must give you the results in writing, too, and a free copy of your report if the dispute results in a change. If an item is changed or deleted, the consumer reporting company is not permitted to put the disputed information back in your file unless the information provider verifies that it is accurate and complete. The consumer reporting company also must send you written notice that includes the name, address, and phone number of the information provider. If you ask, the consumer reporting company must send notices of any correction to anyone who received your report in the past six months. You also can ask that a corrected copy of your report be sent to anyone who received a copy during the past two years for employment purposes.

If an investigation doesn’t resolve your dispute with the consumer reporting company, you can ask that a statement of the dispute be included in your file and in future reports. You also can ask the consumer reporting company to provide your statement to anyone who received a copy of your report in the recent past. You can expect to pay for this service.

STEP 2:

Tell the creditor or other information provider, in writing, that you dispute an item. Be sure to include copies (NOT originals) of documents that support your position. Many providers specify an address for disputes. If the provider reports the item to a consumer reporting company, it must include a notice of your dispute. And if you are correct — that is, if the information is found to be inaccurate — the information provider may not report it again.

For more detailed information, visit the FTC website Consumer Protection page. Please call this office for assistance.

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Two Tax Credits to Help Pay Higher Education Costs

There are two federal tax credits available to help individuals offset the costs of higher education for themselves or their dependents. They are the American Opportunity Credit and the Lifetime Learning Credit.

To qualify for either credit, a taxpayer must pay post-secondary tuition and fees for themselves, their spouse or their dependent. The credit is claimed by the individual who claims the student as a dependent, even if someone else pays the tuition including the student. However, if the student is not claimed as a dependent of another, then the student will claim the credit.

For each student, only one of the credits can be claimed in a single tax year. For example, the American Opportunity Credit cannot be claimed to pay for part of a student’s tuition charges and then the Lifetime Learning Credit claimed for $2,000 more of the school costs.

However, if college expenses are paid for two or more students in the same year, a taxpayer can choose to take credits on a per-student, per-year basis. Thus, for example, the American Opportunity Credit can be claimed for one child and the Lifetime Learning Credit for the other.

Here are some key facts you should know about these valuable education credits:

American Opportunity Credit 

• The credit can be up to $2,500 per eligible student.
• It is available for the first four years of post-secondary education.
• Forty percent of the credit is refundable, which means that a claimant may be able to receive up to $1,000, even if they owe no taxes.
• The student must be pursuing an undergraduate degree or other recognized educational credential.
• The student must be enrolled at least half-time for at least one academic period.
• Qualified expenses include tuition and fees, course-related books, supplies and equipment.
• The full credit is generally available to eligible taxpayers who make less than $80,000 or $160,000 for married couples filing a joint return. Above those amounts, the credit quickly begins to phase out.

Lifetime Learning Credit

• The credit can be up to $2,000 per eligible student.
• It is available for all years of post-secondary education and for courses to acquire or improve job skills.
• The credit is non-refundable; thus, the maximum amount credited is limited to the amount of tax that must be paid on your return.
• The student does not need to be pursuing a degree or other recognized education credential.
• Qualified expenses include tuition and fees, course-related books, supplies and equipment.
• The full credit is generally available to eligible taxpayers who make less than $60,000 or $120,000 for married couples filing a joint return. Above those amounts, the credit quickly begins to phase out.

There is also an above-the-line tuition and fees tax deduction available, but you cannot claim the tuition and fees tax deduction in the same year the American Opportunity Tax Credit or the Lifetime Learning Credit is claimed. Choose to take either the credit or the deduction and consider which is more beneficial for you. Generally, the credits provide the greater benefit.

Please call this office if you have any questions related to education credits.

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