Important Tax FYI for taxpayers claiming either the Earned Income Tax Credit, Child Tax Credit or Education Credit beginning for tax year 2016: The IRS is requiring tax preparers to perform additional due diligence for all 3 of those items by asking more questions and requesting additional documentation, or be faced with substantial penalties. In addition, refunds from those returns won’t be released until after February 15, and won’t be direct-deposited until the week of February 27.
Why the additional work and hassle? Refundable Credits (a tax credit where you get a refund above and beyond what you paid) are a hotbed for fraud and errors: In 2015 alone, $15.6 BILLION in refundable credits were INCORRECTLY paid out, of which 24% was for the Earned Income Tax Credit alone. That being said, the IRS wants to make sure that those credits are awarded to those who are legitimately entitled to them.
Another reason I love real estate: If you rent your vacation home LESS than 15 days in a year, you do not have to claim the rental income. Of course, you cannot claim the rental expenses either.
So what does this mean to a vacation homeowner whose business is incorporated? If your corporation utilizes your second home for board meetings, employee conferences, etc., you can charge your corporation rent for the use. Make sure it’s a REASONABLE amount by getting quotes from local hotels for their boardroom use. Also make sure it’s truly a business use and that you provide documentation as such.
As long as you rent the home LESS than 15 days in the tax year, you do not have to claim the rental income that you collected from your corporation. However, your corporation will be expensing the rent that it paid you for the business use of the property.
Did I ever tell you how much I love real estate?
My friends and clients who know me well know I love real estate. Not the selling part (I leave that to my realtor friends), but the concept of the buying, the fixing, the investing part. In addition to being a great wealth-building medium, it can provide a steady income stream and tax deductions. Plus, you can leverage your money to purchase real estate (who ever heard of a bank willing to lend you money to purchase stocks?). While I certainly have no issue with investing in the stock market, I encourage you to also include real estate in your financial portfolio. Entire books and courses have been put together on this subject, but here are a few of my thoughts:
- What kind of real estate investing attracts you? Do you want to buy and hold; do you want to buy rental properties; or do you want to buy, fix up and sell? The direction will determine the team you want to assemble. Either way, you want a real estate expert who has your back, as well as a good tax professional!
- The “Fix and Flip” trend has seen a lot of press lately, thanks to several TV shows, and definitely has its merits. Like any investment, you really need to know the market, the financing, and have a good rehab team. If that’s the direction you want to take, the IRS will consider it a business and tax it as such, where you report the activity on a Schedule C and be subject to self-employment taxes (15.3%).
- You can purchase a piece of property and hold onto it, hoping to re-sell it at a gain, like you would a stock. You obviously will need to know the market and be comfortable with the risks associated. The IRS will treat this transaction as a capital investment where you will report the gain or loss on your Schedule D form. The disadvantage here is that if you incurred a capital loss, your loss is only limited to other gains, and then the maximum loss you’re allowed is $3,000 per year.
- You can purchase a property in the hopes of renting it out for monthly rental income. That will require substantial research on the market, lots of spreadsheets and cash flow analysis, as well as a good, reliable team (realtor, property manager, loan officer and of course, tax professional). If that’s the route you’re going to take, the IRS will treat you as a landlord, and you’ll file a Schedule E form with your tax return. In addition to the regular expenses ordinary and necessary in operating a rental property (property management fees, travel expenses, supplies, taxes, interest), you can also deduct depreciation expense on the building portion of the real estate– what we call “phantom expense.” If you sell the property later on, you will have to pay capital gains tax on the gain, plus “recapture” the depreciation that was taken. Or, you can choose to do a 1031 tax-free exchange, where you sell the property and purchase another “like-kind” property. Again, always consult with the tax professional in your team!
- No matter which direction you take, please make sure you run the numbers and consult with your tax professional before making any financial decisions.
If you’ve made cash and/or non cash charitable contributions over the year, now is the time to review your documentation by going through your check register, credit card statements, receipts and mileage logs. A few tips along the way:
- Obviously, the recipient must be a tax-exempt, 501(c)(3) charity. Giving money or goods to your neighbor in need does NOT qualify for a deduction. If you want to help a needy neighbor, donate these items to your church and have the church assist them.
- If you donated $250 or more to a single charity, make sure you get an acknowledgement letter from the organization. Also, make sure the phrase “No goods or services were provided in exchange for this donation” appears on the acknowledgment receipt. This is very important, as deductions have been disallowed in the past if this phrase was missing!
- If you donated a vehicle or boat valued at $500 or more to a charity make sure the charity issues you a Form 1098-C so that you can deduct the donation.
- If you volunteer for a charity, don’t forget to track your miles driven in the line of your charitable work. Also, if you incur out-of-pocket expenses (printer ink, office supplies, etc) that were not reimbursed, you can deduct them as cash donations.
- Purchasing raffle tickets is not deductible as charity. Neither is buying Girl Scout cookies. 🙂
- If you wish to claim more than $500 in non cash charitable contributions, be prepared to give your tax preparer additional information, such as name of the charity, date donated, items donated, approximate purchase dates and prices, etc.
- If you received something for your donation, say a gift or a dinner, your donation must be reduced by the value of that gift. For example, if you purchased a $100 dinner to a fundraising event, you’re allowed to donate the $100, LESS the value of the dinner. To avoid any issued, now most charities will now list the value on the ticket.
It’s almost that time already. 2016 is behind us, and now the document-gathering begins. By the end of this month, you should start receiving your various year-end tax documents (1099s, W-2s, 1098s, etc.). If the envelope says “Important Tax Documents,” do NOT throw it out (you’d be surprised that people still do…)! A few things to note about this filing season:
- The IRS doesn’t start accepting returns until at least January 23. Just because they’re delayed doesn’t mean that you should delay in getting your documents in order. Use this time to continue looking for possible deductions, receipts, etc.
- If your refund includes tax credits via the Earned Income Tax Credit or Additional Child Tax Credit, the IRS won’t even begin issuing those refunds until at least the middle of February. That is to allow time for additional due diligence and ID verification, as those items are both hotbeds for fraud. If you’re counting on those refunds, make sure you budget accordingly. Some tax preparation services will issue “Refund Anticipation Loans” or RALs, but there are fees involved.
- If you deduct your vehicle expenses, make sure you have a mileage log to back up your deduction. The IRS can and will disallow your deduction without a log.
- If you paid labor or rents of $600 or more in 2016 and plan to deduct them as expenses, make sure you issue the recipient a From 1099 no later than January 31, 2017. Failure to do so will result in penalties and disallowance of your deduction.
- If you’re deducting Travel and Entertainment expenses, make sure you have documentation of the business nature of the trip.
If you use your vehicle for your business, make sure you deduct the expenses ordinary and necessary for your business, as well as ensure that they are properly documented. For example, now that 2016 is almost behind us, here are some tips to make this job a little easier:
1. Don’t forget to document your vehicle’s year-end odometer reading! Better yet, schedule a vehicle service so that you have an official odometer reading from the mechanic. Tip: the IRS loves checking repair bills to verify odometer readings and mileage.
2. Review your business mileage log, checking it against your calendar or day planner, to make sure you didn’t miss anything. If you don’t like keeping mileage logs and your business driving is pretty steady year-round, the IRS will allow you to just keep a mileage log for 90 days (come on, you can do THAT), and then multiply it by 4 to get an annual business mile reading.
3. Try to keep just one credit card EXCLUSIVELY for your business, so that, at year-end, you can download a year-end summary to help with your tax document preparation. All of your vehicle expenses should be on that card (or, if you use public transportation, all of those expenses should be on the card). This will also help with your other business expenses, such as meals and supplies, etc.
4. Even if you’re a cash-basis business taxpayer, expenditures paid with your credit card will count for that year, even if you don’t pay the bill until the following tax year. Just make sure you don’t double-dip. 🙂
5. If you have any questions, always check with your tax professional!
If you have some upcoming unreimbursed, out-of-pocket medical expenses (dental work, braces, vision expenses, etc.), make sure you pay them with your Flexible Spending Account (FSA) or Health Savings Account (HSA). You can only deduct medical expenses if you Itemize Deductions, and then, only that amount which exceeds 10% of your Adjusted Gross Income (7.5% if you’re 65 or older, although that exception ends Dec. 31, 2016). Since contributions to your FSA or HSA are tax-deductible, paying your medical expenses using these pre-tax dollars will reduce your taxes.