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Frequently Asked Questions
General Questions
Tax related Questions
Questions on starting a business
IRA Questions
The Roth IRA - An alternative to the traditional IRA
The Education IRA - A headstart on college expenses
Questions about home offices
Questions about automobiles
Questions about the sale of a residence
How can I help prevent Identity Theft?
Be ready before your wallet gets stolen or lost. Photocopy both sides of each
license, credit card, id card, health insurance card and any other cards in your
wallet. Keep this paper in a safe place.
Everyone advises to cancel your credit cards immediately if your wallet
is stolen. The key is having the toll free numbers and card numbers handy,
so you know whom to call and the necessary information.
File a police report immediatly in the jurisdiction where your wallet was
stolen. This proves to credit providers you were diligent and this is
the first step to an investigation.
Call the three national credit reporting organizations immediately to place
a fraud alert on your name and social security number. The alert means any
company that checks your credit will know your information was stolen. They will
have to contact you by phone to authorize new credit. Thieves will try to
to apply for credit cards in your name over the internet!
Important numbers:
Equifax: 1-800-5-5-6285
Experian (form-erly TRW): 1-888-397-3742
Trans Union: 1-800-680-7289
Social Security Administration's Fraud Line: 1-800-269-0271
What Should I Do If I'm Contacted By the IRS?
The IRS normally communicates with taxpayers by letter, but occasionally by telephone. Telephone
calls are usually made just to clear up very minor questions. Letters come in a variety of styles, each
with their own purpose. Common letters include:
"Here's is your refund", "An adjustment has been made to your return",
"We have received your change of address request", and the memorable
"Please come visit us at the above scheduled time".
First, remain calm. The return address showing "Internal Revenue Service" is enough to
scare anyone, but the letter may be totally harmless. Even if it states you are being audited or you
owe thousands of dollars, STAY CALM. Going into a panic does not make it disappear.
Second, read the letter carefully. DO NOT IGNORE IT. Most of the trouble taxpayers get into
occurs when they receive IRS communications and ignore them. The top right hand corner will indicate
which year's return the letter is addressing. It may be something simple like "Here is your tax
refund check", in which case you will immediately know what to do. It could be asking you to
verify Social Security numbers for yourself or your dependants. Many simple things like this can be h
andled on your own, but make a copy of your records and for your tax preparer, who will also want to
know everything that happens to your return.
If the letter is confusing to read or the idea of reading it causes you to panic, then make
an appointment to see your tax preparer.
Third, respond to the letter.
Here are the most common types of letters.
'Don't have to file' letter
This is simply a letter stating that the IRS doesn't want you to file if you don't have to.
This letter is harmless, since there are no penalties for continuing to file, even if it's unnecessary.
If circumstances change you may have to file, so it is still important to check the filing requirement each year.
'Audit' letter
This is a request to meet with the IRS to discuss your tax return. To prepare, total your receipts
for the expenses in question, attach the calculator tape to the receipts , and label it with the type of
expense. Obtain documents to verify other request such as church offerings, leases, loans obtained or
paid back, bank statement, contracts, Social Security cards, etc.
You may want to visit your tax preparer for help in preparing or reviewing your records and the
audit process prior to the actual audit. The tax preparer may accompany you to the audit or he/she may
want to represent you with "Power of Attorney" , thereby saving you time and aggravation of having to
attend personally. Some tax preparers charge for this service.
If your tax preparer is going to the audit without you, he/she will need to be able to answer
questions about your tax and financial matters. Provide him/her with the full and accurate information.
For example, if the IRS letter asks about property you own and you don't tell your tax preparer you own in
another state, the IRS may doubt anything your tax preparer says.
IRS auditors are trained to thoroughly cover the items shown on your tax return and also items which
may have been missed. They will occasionally discuss nonbusiness items which can help them discover some
income which they may have been missed. For example, they may ask if you've had any good vacations lately.
Since these are not normally deductible for tax purposes, they seem harmless. But, if you've been to
Europe twice this year as well as other exotic places with your family, you must have had assets to pay
for these trips. If the income on your return is not large enough to pay for the trips, the auditor may
start to question where you got the money and whether it was taxed. Be careful how you answer questions.
Auditors are people just like you, but they also have a job to do.
'Adjustment' letter
This letter usually claims that some income (such as interest or dividends) does not appear to have been
included on your return. It also includes a "balance due" amount to pay if you agree. The letter
lists the income amounts which appear to be missing along with who paid the amounts. Cross check the figures
shown on the W-2s and 1099s received that year with the return and IRS letter. Pay special attention to the
income item(s) which the IRS says have not been reported under another name.
If you did receive the amount of income shown and it was not reported on your return, you may indeed
owe the amount the IRS is requesting. If you did not receive the amount of income shown or it was reported
on your return, a letter of explanation needs to be sent back to the IRS. Your tax preparer may have more
experience in writing these letters and may be able to resolve the issue quickly, thus avoiding seemingly
endless correspondence between you and the IRS.
Summary
The IRS does occasionally call or send letters for items. Each of these should be handled on a case
by case basis.
Regardless of the type of communications received, stay calm. Do not ignore any IRS communications.
Unless you are very comfortable with what the IRS wants, discuss the matter with your tax preparer before responding.
What Tax Records Should I Save?
Why Save Records?
Once the tax return has been filed, everything is finished and there is no need to use
these records again, right? Unfortunately, that perception is very dangerous. There are many
reasons for saving records. The main reason to save tax records is to substantiate the information
reported on the tax return.
The statute of limitations for most federal tax returns is three years. It is helpful, and
even required in some cases, to save certain records even longer.
How Long Should Different Kinds of Tax Records be Kept?
Prior Year's Income Tax Returns
Prior year's income tax return should be kept for a minimum of 3 years, unless your state
requires a longer period. Keeping a tax return is advisable when the reported transactions may affect future years.
Tax Receipts
Most audits occur within 3 years of the filing of the tax return. The receipts used to
document expenses should be kept through the statute of limitations for that return. After that
period has expired, the receipts should be examined to see if they fall into one of the areas that
need to be saved for a longer period. The receipts that do not need to be kept longer, such as
canceled checks, bank statements, and receipts which will not affect future transactions, can be discarded.
Business Records
If you own a business, you may have records for the sale or purchase of inventory and assets
used in the business as well as other operating expenses. After the statute of limitations, you can
discard most receipts that deal with operating expenses. Retain the receipts that relate to property
you still own to verify the cost for future sales. Payroll records must be retained for a minimum of 4 years.
When your business produces an overall loss on the tax return, this loss is either carried
backward or forward depending on the situation. The tax return and the records of the calculation
creating the carryover, and the tax return for any year in which part of the carryover loss is
absorbed, should be retained for 3 years following the last year the loss is up.
Employee business Expenses
The most common employee business expenses are transportation and travel expenses. The mileage
logs, should be saved for the 3 year limitation period. If you are a trucker who claims the standard
meal allowance, the logbooks should be retained for 3 years.
Closing Papers from the Sale or purchase of your home
The closing papers from the sale or purchase of your home should be retained for a minimum of
3 years after the sale of the home. If you have previously deferred the gain from the sale of a
residence, the closing papers and the tax return from the sale should be retained through the
limitation period of your next home sold.
Building or Improving Your Home
If you build your own home, careful records should be kept of all the monies paid to the
outside contractors. This is also true of improvements made to your home. Theses should be
kept for at least 3 years after the sale of the home.
Investment Records
Year-end brokerage statements from the purchase of stocks, bonds, and mutual funds should
be retained until 3 years after the investment is sold. Theses statements will show the reinvestment
of dividends, the purchase of shares, and the purchase of shares, and the redemption of shares.
IRA Contribution and Distribution Records
IRA contribution and distribution records need to be kept indefinitely. Particularly important
are records of nondeductible contributions.
Gifts
If you have received gifts of property other than cash, it is important to find out what the
cost to the donor was and obtain receipts to verify the costs. This becomes your cost in the
property for future sales consequences.
Inheritance
If you inherit property, you need to keep records that establish the value on the date of
death. These records usually come from the fiduciary's records and should be retained for 3
years after the property is sold.
Summary
While the most common statute of limitations is 3 years from the filing of the return,
a return that was never filed has no statute of limitations. The statute of limitations for
returns where income has been understated by 25% or more is ten years.
Saving tax records for a minimum of 3 years is essential. Saving the tax returns for an indefinite period may provide good historical information in addition to providing substantiation.
Starting a Business
Do you have the desire to be your own boss? Do you think you have some good ideas about
a business venture? Many people have that desire but they either lack the courage to take the
next step or they don't know where to step. Here is some information that may help guide you.
Once you have gotten past the preliminary stages of deciding what kind of business you want
to start, you need to examine the financial side. One of the first items necessary to start a
business is to have working capital. This capital can come from assets you may have or it can
come from loans you have secured. This capital will be necessary to acquire the items to
start your business. If you don't have the cash or assets you need to seek financing. This
financing could come from financial institutions, the Small Business Administration (SBA),
friends, relatives, or other investors.
After a financial plan has been established you need to look at other issues.
Registration of Business
From a tax standpoint, you need to decide whether your going to embark on this endeavor
by yourself as a sole proprietor or with others as a partnership. You may also want to consider
whether you need to incorporate. Depending on which of these you may choose you may have to deal
with legal ramification. In some states you can hang out a shingle so to speak and you're in
business. Other state require you to register the type of business and follow certain
guidelines before you are able to open the doors.
Location of Business
The location of your business could be crucial depending on what type of business you have.
Certain business may be easily run out of your home. Other business need to have a fixed location
that is easily accessible to your clients. Parking, space, and cost are all important considerations.
Tax Considerations
Most businesses need to have an employer identification number (EIN). This number is
equivalent of the Social Security number for a business. If you have employees you will need to
have this number for the payroll reports regardless of what type of business entity you are. If you
are an entity other than a sole proprietorship, you will need an EIN to file your income tax
return even if you have no employees. In addition, your state will require a state identification
number for the same reasons.
A federal EIN is obtained by filling Form SS-4, Application for Employer Identification Number.
This form is available from your tax preparer, the IRS, or the Social Security Administration. You
can mail it to the IRS service center for your area, fax it to the IRS, or use the tele-TIN phone
number listed in the instructions.
Employees
If you plan to have employees, you are responsible for payroll taxes. As an employer you generally
are responsible to pay Social Security taxes, Medicare taxes and unemployment taxes. In addition you need to
collect federal and state (where applicable) withholding and the employee's share of Social Security and
Medicare taxes. You are responsible for making deposits of these taxes at the appropriate times throughout the year. On a quarterly basis you need to file a Form 941 to inform the government of the collections. A Form 940 for unemployment tax information is required on an annual basis.
Some employers decide to avoid the payroll cycle by treating individuals as independent contractors.
Before you make this determination, talk it over with your tax advisor. The IRS has a set of criteria it
uses to determine whether an individual is an employee as an independent contractor, you may be subject to
penalties.
Deposits of employment taxes will need to be made throughout the year. Those deposits may need to
include estimated tax payments for business entity. The sole proprietor would be responsible for income
tax and self-employment tax on the business profits.
Recordkeeping
It is important to establish a good record keeping system early in your business. In addition to keeping
payroll records, an accurate account of all of the income of the business as well as the expenses is necessary.
You will need to determine what accounting method is appropriate for you. Most businesses have the option of
choosing the cash method, the accrual method, or a hybrid method. If the IRS were to audit your return you may
have to prove expenses by producing receipts. Accurate records of travel expenses are very important.
Start up Costs
Some expenses may need to be separated. The two categories are: 1) expenses incurred in exploring
and setting up the business, and 2) expenses incurred from the time the business officially begins. The
first group may be amortized over a 60 month period beginning with the start of the business, while the
other group is currently deductible. Start up expenses may include training wages, pre-opening utilities,
rent, advertising, and any exploration costs.
Capital Expenditures
Not all of the expenses paid for a business are currently deductible. Items which have a life of
more than one year are depreciated rather than currently deductible. Equipment and real estate are common
examples of depreciable assets.
If you're in a business that requires you to maintain an inventory of the items you sell or use to
make a product, these costs are deductible as you sell the product. It is necessary to keep accurate
records of the beginning and ending inventory each year.
Other Considerations:
- Liability and asset protection.
- Fringe benefits desired (if any).
- State and local requirements such as permits and registration of the business.
IRAs
Savings for the Future
What is an IRA?
An individual retirement account (IRA) is a trust created in the United States for your
exclusive benefit or the benefit of your beneficiary that allows up to $2,000 of income per tax
year to be deferred from current taxation (a married couple can defer a total of $4,000).
Who Can Make Contributions?
If you have earned income in a tax year and have not reached age 70 1/2 by the end of the
tax year, you can make a contribution to an IRA. Earned income includes wages, salaries, bonuses,
tips, commissions, alimony, and other amounts received for performing personal services, including
those performed by a self-employed individual.
How Much Can Be Contributed to an IRA?
You can contribute the lesser of your earned income or $2,000 for any tax year. Married
taxpayers filing a joint return can contribute up to $2,000 each to an IRA if : )1 each spouse
has at least that amount of earned income; or 2) together, they have at least $4,000 if earned
income. Maximum deductible contributions are based on the combined modified AGI of the spouses.
Contributions that exceed the maximum amount allowed are subject to an access contribution penalty of 6%.
Excess contributions withdrawn from the IRA before the due date (plus extensions) of the tax
return are not taxed provided that no deduction is taken for the amount withdrawn. Income earned on
the amount withdrawn, however, is taxable and the 10% penalty for early withdrawal applies to this
amount unless an exception applies.
What Contributions Are Deductible?
Contributions to an IRA are fully deductible (regardless of level income level) if neither you nor
your spouse (if any) is an active participant in an employer-maintained retirement plan. If one of you
is an active participant in an employer-maintained plan, no amount of the contribution is deductible
if your AGI exceeds: 1) $60,000 if married filing a joint return; 2) $40,000 if single; or 3) $10,000
if married filing a separate return. A partial deduction is allowed for any category above that is
lower by $10,00 or less. These limits increase in 1999. An individual not covered by an employer
plan but whose spouse is covered can take a full IRA deduction if their joint AGI is less than
$150,000. Joint AGI between $150,000 and $160,000 qualifies for a partial deduction.
Nondeductible contributions are reported on Form 8606. While the contributions are made
with after-tax dollars, the earnings accumulate tax free until distributed. If a Form 8606 is
not filed, the contributions are considered to be deductible contributions.
Time Deadline for Establishing Plan and Making Contributions
An IRA must be established and funded by the tax return filing deadline (not including extensions)
for the year in which the plan is to become effective.
When Can IRA Distributions be Taken?
IRA distributions can be taken any time but there is a 10% penalty on the amount distributed in
addition to the regular tax if the distribution is made before you reach age 59 1/2. You must start to
take distributions by April 1st of the year following the year you reach age 70 1/2 or there is a 50%
penalty on the amount not distributed as required.
In taking distributions, there are exceptions to paying the 10% penalty discussed earlier if:
- The distribution is a series of substantially equal payments based on your life expectancy (or your life and the life of your beneficiary ). These must continue for at least five years or until you reach age 591/2, whichever is later.
- Death or disability occurs.
- The distribution is a return of non-deductible contributions.
- The distribution is rolled into another IRA within 60 days.
- The distribution is used for medical expenses in excess of 7.5% of your AGI, regardless of whether you itemize.
- Beginning in 1998, you are a first time homebuyer or pay higher education expenses.
- The distribution is used to pay excess medical expenses or to pay health insurance premiums when you are unemployed for 12 weeks or more.
How Are IRA Proceeds Taxed?
Deductible amounts contributed to an IRA will be fully taxable. For contributions of nondeductible amounts, only the earnings portion will be taxed. There are special rules for determining the taxable amount when both deductible and nondeductible amounts have been contributed to an IRA.
What About Self-Employed Individuals?
Self-employed individuals can contribute to an IRA. Earned income for the self-employed is the
net amount obtained form the business. Wages also count as earned income. This amount does not include
amounts contributed to retirement plans or one-half of the self-employment tax. For business income
amounts to count as income, personal services must have been provided to the business. If a business
has a loss but there are other earnings, the loss form the business does not reduce the other earnings
for the IRA contribution purposes.
Roth IRA
An Alternative to the Traditional IRA
What is a Roth IRA?
A Roth IRA is an individual retirement account that allows you to exclude earnings from income tax forever. While contributions are not tax deductible, the earnings will never have to be included in income if the rules are followed. Since there are no minimum distribution requirements for this kind of account, savings can be distributed as needed after the account has been held for five years and age 591/2 is reached, or passed on to beneficiaries tax free at death.
Who Can Make Contributions?
If you have earned income and your modified adjusted gross income (MAGI) is less than certain limits,
you are eligible to make contributions to a Roth IRA. [For the most taxpayers, MAGI is the same as adjusted
gross income (AGI).] The contributions limits relative to MAGI are as follows:
| MAGI | Filing Status |
Contribution |
| $95,000 or less | S, HH, QW | Full |
| $95,000-$110,000 | S, HH, QW | Partial |
| More than $110,000 | S, HH, QW | None |
| $150,000 or less | MFJ | Full |
| $150,000-$160,000 | MFJ | Partial |
| More than $160,000 | MFJ | None |
| Zero- $10,000 | MFS | Partial |
| More than $10,000 | MFS | None |
There are no restrictions on making contributions to a Roth IRA after age 70 1/2 proving the
taxpayer has earned income. Also, there are no restrictions on making contributions if a taxpayer
is a participant in a retirement plan. The rules for spousal contributions are the same as for the
traditional IRA.
How Much Can Be Contributed to a Roth IRA?
The rules are the same as for a traditional IRA except that contributions to a Roth and/or a
traditional IRA in total cannot exceed $2,000 for the year per taxpayer.
What Contributions Are Deductible?
All contributions are nondeductible contributions but earnings accumulate tax free in the
account until distributed.
Time Deadline For Establishing Plan and Making Contributions
Like the traditional IRA, the Roth must be established and funded by the tax return filing (not
including extensions) for the year in which the plan is to become effective.
When Can Distributions Be Taken?
Distributions can be taken at any time but are taxed differently depending on when taken. Unlike a traditional IRA, minimum distributions are not required from a Roth IRA at age 701/2 or any other age. Amounts in the account may remain or be distributed as desired.
How Are Proceeds Taxed?
If distributions are to be tax free, earnings must be left in the account for five years
beginning with the year the first deposit is made. After this five year period, distributions of
earnings made after reaching age 501/2, upon death, after becoming
Education IRA
A Head-Start on College Expenses
What is an Educational IRA?
The education IRA is a nondeductible individual account that allows $500 per year plus
earnings to be accumulated for educational expenses. Distributions are both tax free and
penalty free if the rules are followed.
Who Can Make Contributions?
Contributions can be made by anyone for the benefit of a child under the age of 18 if the
child has not had any funds paid for his/her benefit to a state prepaid tuition program in that
year. In addition, the contributor's modified adjusted gross income (MAGI) must be within accepted
limits shown below. (MAGI is the same as adjusted gross income for most taxpayers.)
| MAGI |
Filing Status | Contribution |
| $95,000 or less | S, HH, QW, MFS | Full |
| $95,000-$110,000 | S, HH, QW, MFS | Partial |
| More than $110,000 | S, HH, QW, MFS | None |
| $150,000 or less | MFJ | Full |
| $150,000-$160,000 | MFJ | Partial |
| More than $160,000 | MFJ | None |
Contributions to an education IRA can be made by the child as well as other taxpayers.
These contributions are allowed in addition to any traditional or Roth IRA contributions for this
individual. This IRA is allowed for each of your qualified children. An individual need not have
earned income to contribute to an education IRA.
How Much Can Be Contributed?
Up to $500 per year may be contributed for any one child. This is the total maximum amount
no matter how many people share in the contribution. All contributions must be in cash,
What Contributions Are Deductible?
The contributions to an education IRA are not deductible. Furthermore, contributions made
to an education IRA during the same year a contribution is made to a state tuition program for the
beneficiary results in a 6% excise tax on the education IRA amount contributed unless the contribution
came from the education IRA. This same penalty applies when more than $500 is contributed during the
year unless the excess is withdrawn by the due date of the contributor's tax return including extensions.
Time Deadline for Making Contributions
Contributions must be made by December 31st of the tax year.
When Can Distributions Be Taken?
Distributions may be taken at any time to pay qualified education expenses at an institution
of higher education for the qualified child. An eligible institution is a college, university,
vocational school or other qualified post secondary educational institution. Eligible expenses
include tuition, books, fees, supplies, and equipment regardless of time enrolled, plus room and
board for a student who attends an eligible institution at least half time. Room and board
expenses are limited to $2,500 if the student lives off campus and not at home. Distributions
must be made during the year in which the expenses occurred. Amounts withdrawn that exceed
the amount for qualified education expenses are nonqualified distributions.
How Are Distributions Taxed?
Qualified distributions (those used to pay qualified education expenses ) are free of
tax for both the principal and earnings distributed. Nonqualified distributions are subject to
tax on the earnings plus a 10% penalty unless they are made on account of death, disability, or
funding of a scholarship (payment to a state tuition program) for the beneficiary.
At the death of a beneficiary, a transfer of an account to the surviving spouse is tax free.
A transfer to any other person creates a taxable event. Distributions must occur within 30 days
after the death of the account beneficiary.
Funds still remaining in the account when the beneficiary finishes school or reached age
30 may be withdrawn subject to tax and penalty or rolled over to an education IRA for a member of
the beneficiary's family. Family members may include a son, daughter, stepson, stepdaughter,
brother, sister, father, mother, stepfather, stepmother, nephew, niece, uncle, aunt, mother-in-law,
father-in-law, or sister-in-law.
Even a qualified distribution will not be tax free to the extent of earnings withdrawn if a
Hope credit or Lifetime Learning credit is claimed for the beneficiary in the same year.
Home Office
With the increasing use of computers, modems, and job sharing, more and more people work from their homes. Whether you are self-employed or work for someone else, the home office can give extra deductions on your tax return, but can create extra headaches when you sell your home.
Requirements
The Internal Revenue Code allows taxpayers to claim a deduction for expenses incurred in operating
a business from their home if they meet certain requirements.
This home office must be used regularly and exclusively 1) as the principle place of business for a
trade or business; 2) as a place to meet with patients, clients, or customers in the course of the trade or
business; or 3) in connection with the taxpayer's trade or business if the location is in a separate
structure not attached to the dwelling unit. The "regular and exclusive" requirement does not
have to be met if you are operating a day care business in your home.
In addition, if you are an employee, the business use of your home must be required by your employer
for his/her convenience.
Prior to 1999, the courts had interpreted the "principal place of business" very narrowly and
disallowed a deduction if the office was only used for administrative and management activities rather than
for the actual generation of income. However, the Taxpayer Relief Act of 1997 changed this, effective
1/1/99. Now a deduction for an office used only for those activities is allowed if there is no other
location available to perform them.
In addition, a deduction may be allowed for inventory storage if the product is regularly sold
to others and there is no other fixed location for the business.
Calculations
The expenses that are considered when making the home office calculations include both direct
and indirect expenses. Direct expenses are things that pertain exclusively to the home or office,
such as painting the walls or putting in new carpeting. Indirect expenses are those that pertain to
the entire residence, such as rent, mortgage interest , taxes, insurance, repairs, utilities, casualty
losses, and depreciation. Indirect expenses must be allocated between the business and nonbusiness
portions of the home.
The most accurate method of allocation is to divide the square footage of the office by the
total amount of usable space in the home. If rooms are of approximately equal size, you can divide
the number of rooms used for business by the total number of rooms.
In the case of a day care business, you multiply this percentage by the fraction obtained by
dividing number of hours the home is used for business by the total number of hours in the year (8760
hours except in leap years).
Once these figures are known, the indirect expenses are multiplied by the business percentage
in order to apply the limitations.
Limitations
The amount of expenses that can be deducted are subject to specific limitations and ordering
provisions. The overall limitation is based on the taxpayer's net income from his trade or business.
For an employee, this is wages less other business expenses on Form 2106. For a self-employed person,
this is the net income on Schedule C without the home office deduction. If there is a loss, no
deduction is allowed and the expenses are carried forward to future years when there is net income.
However, three deductions are allowed in full regardless of the net income limitation.
Mortgage interest, real estate taxes, and casualty or theft losses are allowed under other code
sections and may create a Schedule C loss. They must be claimed in full before using any other expenses.
Once net income has been reduced by the otherwise deductible expenses, the other business expenses
are deducted. If there is still net income at that point, depreciation is deducted. Any time the net
income reaches a balance of zero, the balance of the expenses is carried forward. If the taxpayer goes
out of business before using these amount, they are lost.
Sale of Property and Excludible Gain
When you sell the home that had been the location of your home office, new problems can arise.
First of all, if you have used part of residence for business purposed, that part is no longer a
principal residence. This means you cannot exclude the gain on that part unless it had not been business
property for more than two years in the five years prior to the sale.
Secondly, the depreciation allowed to be claimed on your home office is subject to taxation even if
you meet the personal use rules. This depreciation is considered "unrecaptured Section 1250 gain" and will
be taxed at a maximum rate of 25%.
These potential tax situations are avoided if you are renting your principal residence.
Planning Considerations
The home office expenses can represent a significant amount in computing your tax liability. If you think your situation meets the requirements, talk to your tax advisor for more specific details on how to qualify for this deduction.
Autos
Your car may provide you with several tax deductions that may lower your income tax. As with
all deductions, it is important to maintain accurate records of your expenses.
You cannot deduct commuting mileage that is, mileage from your home to your regular job.
Business
If you use your car for business purposes, you may use either the standard mileage rate or actual car
expenses. If you are self-employed and maintain an eligible office in your home, you can deduct the mileage
to and from your client's/customer's place of business as well as between jobs. As an employee, you can
deduct mileage to your second job or to a temporary assignment. A temporary work assignment is defined
as lasting a few days or weeks, but less than a year. If you do not have a regular place of business, you
can only deduct your transportation expenses to a temporary location outside your general area of employment.
If you are an armed forces reservist, you can generally deduct your transportation expenses to attend
meetings. The meetings must take place on a day that you normally work. You cannot deduct expenses for
transportation on a day you normally do not work. If you travel overnight to attend a guard or reserve
meeting, you can deduct your travel expense.
Expenses
There are two ways to calculate your auto deduction-the standard mileage rate or actual expenses.
These methods are available whether you own or lease your vehicle.
For most taxpayers, the standard mileage rate is easier to use. From January 1 to March 31,1999,
the rate is 32 cents per mile. For business miles on or after April 1, 1999, the rate is 31 cents per mile.
You multiply the rate by your business miles to come up with your deduction. In addition to the standard
mileage rate, you can also deduct the cost of business related parking fees and tolls.
The actual expense method is a little more complicated and requires a lot more detail record keeping
and receipts. Actual expenses include such cost as gas, oil, insurance, repairs, maintenance, tires,
washing, licenses, and depreciation or lease payments. In addition, you can deduct the cost of business
related parking fees and tolls.
If you use your car for personal and business purposes, you will have to divide the expenses between
the personal and business portion.
Example: if you use your car 50% for business use and 50% for personal use, you will only be able to
deduct half of the cost of your eligible expenses.
Record Keeping
You will need to maintain an accurate record of miles you use your car for business purposes,
date of business use, destination and business purpose. You also need odometer readings at the beginning
and end of the year to determine the total miles for the year for all uses. The business percent of
interest is allowed if you are self employed. This can be figured by keeping a record of this
information in a notebook in the glove box of your vehicle or by purchasing a logbook from your
local office supply store or department store. The important thing is to make sure you maintain
accurate records. The IRS may disallow a deduction for mileage if you are unable to substantiate
your deduction. If you use the standard mileage rate, you cannot use your actual expenses.
Medical Mileage
You can deduct 10 cents a mile if you use your car to obtain medical care. This can be to the
doctor's office, dentist's office or to the hospital to get medical treatment. You can also deduct the
cost of parking fees and tolls. If you choose to use actual car expenses, you can only deduct the cost
of gas and oil, not depreciation, repairs, etc. These expenses are added to your other medical expenses
and deducted on Schedule A subject to the normal limitations (7.5% of AGI)
Charitable Mileage
You can deduct 14 cents per mile if you use your car for charitable purposes. You can also
deduct parking fees and tolls. If you choose to use actual expenses, you are again limited to
unreimbursed expenses for gas and oil. You cannot deduct mileage or expenses for charitable purposes
if a significant part of the travel is for personal pleasure.
Moving Mileage
If you move and qualify for the moving expense deduction, you are allowed either the actual
expenses for the move itself or 10 cents a mile for the actual relocation.
Sale of Residence
Buying a Home
For most people, buying a home is the single most expensive purchase they will ever make. It is
important to make the most of dollars spent. Negotiating the sale can involve the payments of points.
If you can get the seller to pay the points, you will save money. Points, whether paid by you or the
seller, are deductible by as long as you pay at least that amount of money at closing.
Many people who buy a home expect the purchase to lower their taxes. Some are disappointed in the
first year when they cannot itemize their deductions. This may happen because the interest and property
taxes are for only a portion of the year. Keep in mind that mortgage interest is deductible only if the
loan is secured by the residence. If you borrow the money from a relative as a nonsecured creditor, the
interest would not be deductible.
Property taxes paid on the homes are a deductible expense. In the year of purchase those taxes are
split between you and the seller. In many states, you will have to put in escrow the prorata share of the
taxes. If you agree to pay delinquent property taxes of the seller, those taxes are not deductible since
you were not liable for the taxes. The taxes increase your cost of the home.
Making Improvements
The more years you live in a house or the older the home is when you buy it, the more work you
will normally do. Sometimes this work is ordinary maintenance and sometimes it is improvement. It is
important to keep track of the amount spent on improvements along with the receipts for the future
reference. These expenses increase the total cost invested in your home.
To determine if an expense is an improvement or a repair, consider whether the work done on the
home increases its value. If so, the expense is an improvement. If it merely retains the value, it
is probably a repair. Normal painting and wallpapering are repairs. If these are done in connection
with a renovation project, the total cost of the project would be an improvement. Replacing the
carpeting, the furnace, or storm windows is an improvement. Adding shrubbery, fencing, or a storage
shed is an improvement. Fixing the roof may be a repair but replacing the roof is an improvement.
Selling a Home
The cost invested in the home should be one factor taken into account to help you establish
selling price. This cost will also be needed to correctly calculate your gain or loss on the sale.
The closing statement of the original purchase contains important information that you will need.
In addition to the purchase price, closing costs such as appraisal fees, commissions, and the title
insurance, which were not deductible when you purchased the home, are part of the cost of the home.
Improvements made to the home after the purchase are added to determine the total cost in the home.
Painting and repair costs associated with the sale do not add to the cost but may reduce the amount
of gain under certain circumstances.
If the sales results in a loss, you will report the sale as a nondeductible personal loss. If
the sales results in a gain, you may be able to gain up to $250,000. You must have owned and used the
property for two years out of the previous five years. You cannot have used the exclusion for any house
sold in the previous 24 months. The excludable gain increases to $500,000 if you are married and both
of you lived in the house for two years out of the previous five years. If any portion of your house
has been used for business or rental at any time since May 7,1997, some of the gain will be taxable.
Tax planning may be an important part of the sale. If you have high income and a large taxable
gain on the sale, you may want to receive payments under the installment sale method. Using this method,
only the gain from the payments made in the current year would be taxable. If the proceeds of the sale
are needed immediately, that option would not be available. Receiving the entire proceeds, paying the
tax, and investing the money may be a better option. Your tax advisor or investment counselor should
be consulted to determine you're alternatives.
The Effect of Divorce
When divorce occurs, the ownership of home may change as well. The home can be sold to a third party
or it can become the sole property of one the spouses.
If one of the spouses receives the house due to divorce, either by purchase or property settlement,
no sale occurs for tax purposes. The cost of the house for the future sale purposes is the same as it was
to the couple prior to divorce. Money paid to the departing spouse does not increase that cost.
If the home is sold as a result of the divorce, the sale must be reported by the owners. If both
individuals share the title to the home after divorce, both will report their portion of the sale on their
individual returns. If one spouse gave up the home before the sale, the sale is solely the responsibility
of the other spouse even though the decree may assign a portion of the proceeds to the ex-spouse.
In the event that joint ownership is retained by the couple after divorce, both spouses may be able
to take advantage of the $250,000 exclusion.
Before you sell your home see your tax advisor to help determine your best course of action.
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All information herein is believed to be accurate, but is not warranted
and is subject to error, change and withdrawal without notice.
Brennan & Associates are not certified
public accountants.
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