Facing college expenses? What you should know

The U.S. tax code provides multiple tax-saving opportunities
related to higher education costs for yourself and your dependents. To take advantage of these breaks, you must first know what is available and which may apply to you.

While the tax code has a marvelous way of complicating even the simplest concepts, making every situation unique, you and your school-aged child may find a crash course in the basics helpful.

American Opportunity Credit

The American Opportunity Credit would have expired at the end of 2012, but the passage of the American Taxpayer Relief Act extended the credit until 2017. An improved version of the Hope Credit, the American Opportunity Credit is calculated as 100 percent of the first $2,000 of qualified expenses plus 25 percent of the next $2,000, for a maximum benefit of $2,500.

The credit is allowed for the first four years of postsecondary education and is phased out between a modified adjusted gross income (MAGI) of $80,000 and $90,000, for single taxpayers, and $160,000 and $180,000, for married taxpayers filing jointly in 2013 and 2014.

The biggest advantage of the American Opportunity Credit is that 40 percent of the unused amount is refundable. This means that a taxpayer who qualifies for the full $2,500 of credit but has no tax liability can request a cash refund of up to $1,000 (40 percent of $2,500).

Tuition and fees are qualified expenses, and required supplies and books are now included as qualified expenses. This is an improvement over the credit’s predecessor, the Hope Credit. To be eligible, a student must be considered enrolled at least half the time. Room and board are never considered qualified.

Lifetime Learning Credit

The Lifetime Learning Credit has a maximum value of $2,000 per year, calculated as 20 percent of the first $10,000 of qualified expenses. Unlike the American Opportunity Credit, which can be taken only for the first four years of postsecondary education, the Lifetime Learning Credit can be used during any year.

And the student does not have to be enrolled half time or be in the process of earning a degree or educational credential. This makes the credit particularly valuable to graduate students.

The Lifetime Learning Credit is not refundable, meaning it can be used only to offset a tax liability. Any amount not used in the current year is lost. The costs of books and supplies are considered qualified expenses only if they are purchased directly from the eligible institution. This requirement differs from the American Opportunity Credit, which allows them to be purchased anywhere.

For 2013 tax returns, the credit phases out between MAGI of $53,000 and $63,000, for single taxpayers, and $107,000 and $127,000, for married taxpayers filing jointly. For 2014 returns, the credit phases out between MAGI of $54,000 and $64,000 for single taxpayers and $108,000 and $128,000 for married taxpayers filing jointly.

One important item to note is that the Lifetime Learning Credit is available up to a maximum of $2,000 per return. Even if there are three students included on one tax return and all have education expenses, the maximum credit remains $2,000. It is a per-return limitation, not a per-student limitation.

In contrast, the American Opportunity Credit, including the refundable portion, is available on a per-student basis.

Tuition and Fees Deduction

For 2013 returns, the deduction for tuition and fees can be taken dollar for dollar up to a maximum of $4,000 of qualified expenses. The good news: This deduction is considered an “above-the-line deduction,” which means it is available whether you itemize or take the standard deduction.

There are MAGI phaseout issues to consider. The 2013 limits are:

  • $65,000-$80,000 for singles
  • $130,000-$160,000 for married couples filing jointly

The deduction is not allowed for married taxpayers filing separately.

Like the Lifetime Learning Credit, the costs of books and fees paid directly to the college or university are considered qualified, but personal expenses such as room and board are not.

The tuition and fees deduction was set to expire after 2011 but was extended through 2013 by the American Taxpayer Relief Act. The deduction expired at the end of 2013.

The tuition and fees deduction cannot work in conjunction with education credits. You must choose one or the other for each student.

If you paid qualified expenses for more than one student, you can claim a credit for one and the deduction for the other – but never both for the same student. However, you can choose between the credit and the deduction based on which produces the largest benefit to you.

You can’t claim both the American Opportunity Credit and the Lifetime Learning Credit for the same student. You must choose one or the other.

Remember: A credit is more valuable than an equivalent amount of deduction. If you’re eligible for both, the American Opportunity Credit has a larger benefit than the Lifetime Learning Credit.

Student Loan Interest Deduction

If you have a loan to pay for qualified higher education expenses for yourself or a dependent, you may be able to deduct the interest paid on the loan. A deduction is available for the lesser of $2,500 or the amount of interest paid.

Like the tuition and fees deduction, the student loan interest deduction is considered an above-the-line deduction, making it available to taxpayers who do not itemize their deductions.

For 2013 returns, the benefit is available only at certain income levels. It phases out between MAGI of $125,000 and $155,000 for married couples filing jointly and $60,000 and $75,000 for single filers. For 2014, the phaseout ranges are $130,000-$160,000 for married couples filing jointly and $65,000-$80,000 for single filers. No benefit is available for a married person filing separately.

Savings Plans

The IRS has allowed for certain savings plans that can provide tax benefits if the proceeds are used for qualified education expenses upon distribution. But the same qualifying expenses can’t be used for both an education credit and an education savings plan.

Contributions to a 529 plan, also known as a QTP (qualified tuition plan), are not deductible. However, the principal and earnings are allowed to grow tax free. The distributions aren’t taxable if they’re used for qualified education expenses. This offers a tremendous tax-planning opportunity since there are no income limits for either the contributor or the beneficiary.

Qualified education expenses include postsecondary tuition, books and supplies. Room and board is also qualified if the student is enrolled at least half time in postsecondary education. There are no limitations on the amount that can be contributed, but any amounts not used for education will be taxable upon distribution.

It’s important to note that contributions to a 529 plan for someone other than yourself or your spouse are considered gifts. Therefore, the contributions may have gift tax implications if the amount is more than $14,000, which is the annual per-person gift tax exclusion for both 2013 and 2014.

Another savings plan available is the Coverdell Education Savings Account. Like the 529 plan, contributions to a Coverdell are not deductible, and the distributions, including growth in the account, are tax free if used for qualified education expenses.

This plan differs from a 529 plan in that the proceeds can be used to pay expenses for K-12th grade education as well as graduate level education. In return for this amazing benefit, the Coverdell plan is substantially more restricted. Contributions are limited to $2,000 per beneficiary and generally can’t be made once the beneficiary reaches age 18.

There are also income limitations to be considered. The ability to contribute is phased out when the contributor’s MAGI reaches amounts between $95,000 and $110,000 for singles and $190,000 and $220,000 for married taxpayers filing jointly.

IRA Distribution

Typically, distributions made from an IRA account before the account owner reaches age 59 1/2 are subject to income tax and a 10 percent early withdrawal penalty. However, an exception to the early withdrawal penalty exists if the proceeds are used for qualified education expenses. Since this option subjects the distributions to income taxation, it would likely be the least favorable method of funding education from an income tax perspective.

These tax savings opportunities have been summarized for simplicity. These options can be subject to further restrictions based on every taxpayer’s unique situation.

Understand the issues involved with business use of vehicles

The business use of vehicles seems to be an inexhaustible topic with a new twist or wrinkle every year.

A review of the basics, specifically for automobiles, SUVs and pickup trucks, can serve as a foundation for a proper understanding of how vehicle expenses relate to tax deductions. Ownership, risk management and business-use percentages are good areas to review, in addition to the usual “How much can I write off on my taxes?” items.


Ownership is an area that is often taken for granted.

First, let’s look at purchased vehicles. Whose name appears on the title to the vehicle? Is it the corporation or LLC, or is it the name of the officer or owner of the business?

More often than not, vehicles intended for business use are purchased in an individual’s name. But then they find their way onto the books of a corporation or LLC, along with the loan if there is one.

This decision may have several reasons. Perhaps the transaction at the dealership is easier for an individual, or a manufacturer’s incentive isn’t offered to a business purchaser. Perhaps the purchase in the name of the business would make the insurance more expensive than if it were in the individual’s name.

Something as simple as this could expose the person or business to unfore­seen risks. It’s a good idea to discuss with your insurance agent how you will take title to the vehicle and what insurance coverage is appropriate.

Consider a contractor who does business as a corporation – primarily for liability protection – but purchases a pickup truck in his individual name. He obtains insurance under an individual policy. The contractor may or may not tell his agent that there will be business use of the truck.

The truck is recorded on the books of the corporation as an asset and is depreciated. All ownership costs are borne by the corporation.

Perhaps an employee takes the truck to run an errand and is involved in an accident that inflicts serious injury to another party. The truck is owned and insured by an individual.

How does that sound to the injured party’s legal counsel? Is this clear-cut and worry-free for the truck owner? Does it seem as if the corporate liability protection is firmly in place with no threat to the truck owner’s personally owned assets?

Most rational folks conclude that the more expensive but correct way to own and insure business vehicles is in the business name. By the way, the same general theme applies to leased vehicles.

Business-Use Percentages

Many business owners purchase or lease a vehicle and automatically assume that 100 percent of the costs are business related. In reality, the business use is often well below 100 percent. Mixed-use – that is, business and personal – vehicles are more the norm.

Beyond the initial purchase invoice or lease agreement, other records must be kept to support business deductions. Do you maintain a mileage log for your business vehicles?

This is an often mentioned and more often ignored area. The requirement to maintain contemporaneous mileage records shouldn’t be ignored. The log should contain enough information to tell someone reviewing it what happened.

It isn’t enough to have beginning and ending odometer readings of the vehicle. You need dates and business-purpose notations regarding the mileage. Any personal use of the vehicle also should be reflected.

The service records for the vehicle should tie into and corroborate entries in your logbook. Are you rolling your eyes? The thought of reconstructing such records when called for under IRS audit should be enough to motivate you to start doing it currently.


To make a discussion of depreciation easier, assume 100 percent business use of the automobile (however unlikely that is!). If your percentage is less than that, reduce the amounts accordingly. Beware if your business use drops below 50 percent because you will be subject to further reductions.

Any passenger car that costs more than $15,800 is considered a luxury auto and is subject to depreciation restrictions. When was the last time you noticed prices like that when automobile shopping?

SUVs and pickup trucks with a gross vehicle weight rating (GVWR) of over 6,000 pounds are exempt from the luxury auto depreciation limits. For federal tax purposes, large expensing deductions under Code Section 179 are currently available for these types of vehicles. Be sure to check whether your state goes along with the federal expensing rules.

The luxury automobile depreciation limits are as follows:

  • First tax year maximum – $3,160
  • Second tax year maximum – $5,100
  • Third tax year maximum – $3,050
  • Maximum for subsequent tax years – $1,875

Trucks and vans subject to these rules (GVWR 6,000 or less) are allowed only slightly higher amounts than these. Search online for Revenue Procedure 2013-21 for tables that spell this out.

Leased Vehicles

Assuming 100 percent business use, lease payments are deductible. However, lessees must add back a certain amount to income each year to partially offset the difference between the fully deducted lease payments and the luxury auto depreciation limits that would apply if they owned the vehicle.

How to handle 2 percent shareholders’ health insurance

As the 2013 year-end closes in, it’s a good time to revisit the proper treatment of health insurance premiums and S corporation “2 percent shareholders.”

If you own more than 2 percent of the outstanding stock of an S corporation (or stock giving you more than 2 percent of the total voting power), a good chance may exist that your health insurance premiums are not being handled properly at the corporate level. As a result, you could be at risk from a personal tax standpoint.

Health insurance premiums paid by an S corporation on behalf of its 2 percent shareholders should be reported as wages on shareholder W-2 forms. Too often, these payments are not included in wages because the premiums are paid along with those for rank-and-file employees.

From the corporation’s perspective, premiums are different than payroll. Unfortunately, in the eyes of the IRS, they belong on the W-2.

Excluding these amounts from wages jeopardizes the 2 percent shareholders’ ability to deduct these premiums on their personal tax return as self-employed health insurance in arriving at adjusted gross income (AGI). Based on the cost of health insurance, the value of this tax deduction is not something to take lightly.

If there are family members employed by the corporation and covered under the health plan, premium payments made on their behalf may also be required to be included in their wages. Generally, this applies to a spouse, sons, daughters, parents and other direct relatives of 2 percent shareholders.

As wages, these amounts are subject to withholding. But what about Social Security and Medicare tax?

If the 2 percent shareholders are participating in a corporate plan established for the benefit of employees and their dependents, these amounts are not subject to Social Security and Medicare. But they are subject if there is no such plan for the employees.

As far as premium payments and the personal deduction for AGI, it’s important that the corporation make the premium payment or reimburse the 2 percent shareholder making the payment. The 2 percent shareholder cannot make the payment personally and claim the deduction unless the corporation provides reimbursement.

If you are an employee/2 percent shareholder in an S corporation, and you think your company-paid health insurance hasn’t been handled appropriately, you may want to make a correction for 2013 year-end payroll reporting and get on track for the future.

Tax issues involved with repeal of marriage defense act

The recent Supreme Court decision to invalidate a section of the Defense of Marriage Act has far-reaching tax implications.

Section 3 of the Defense of Marriage Act (DOMA) defines marriage for federal law purposes as the “legal union between one man and one woman as husband and wife.” The Supreme Court case reviewed a surviving same-sex spouse’s claim seeking an estate tax refund based on the disallowance of the marital deduction. The Internal Revenue Service’s position was that a marital deduction was not available because the federal government does not recognize the couple’s marriage under DOMA.

The Supreme Court ruled that DOMA violates the right to equal protection under the Fifth Amendment of the U.S. Constitution. While this case was based on estate tax matters, the ripple effect is significant for other federal tax laws relating to income taxes, compensation and benefits afforded to married couples.

Registered domestic partners are not married for federal purposes. Civil unions are also not recognized. The only way to qualify for these federal tax benefits is to enter into a lawful marriage.

For federal purposes, same-sex married couples will now be treated the same as a heterosexual married couple. Their filing options will be married filing jointly or married filing separately. They will not be able to file two single returns.

Federal rules currently stipulate that an income tax return that was originally filed under the status of married filing separately may be amended to married filing jointly. However, the filing status of an original return filed under the status of married filing jointly cannot be changed to married filing separately by amending the return. As decisions are made on how to file both amended returns and future returns, this will need to be considered.

Another important item to remember: When using the married filing separately status, if one spouse itemizes deductions, both must itemize. The standard deduction would be zero to a non-itemizing spouse. Same-sex spouses will now be able to deduct alimony and pursue innocent spouse protection if they meet all the legal requirements of deductibility.

Both Congress and the IRS will need to clarify a number of items:

  • Are married same-sex couples who filed federal tax returns as single individuals prior to the ruling required to amend those returns? Will this be optional?
  • Will the IRS accept married filing jointly returns on a going-forward basis? Will it be retroactive to Jan. 1, 2013, or will the couple have to amend prior years’ returns?
  • If they are required to amend returns, will they have to amend only those within the three-year statute of limitations?

Those who don’t have the luxury of waiting until the issues are clarified should file protective refund claims for open tax years as soon as possible.

Ultimately, some couples will benefit from a joint return while others will be subject to additional taxation. Married same-sex couples could now be impacted by the marriage penalty as well as the phaseout of deductions and exemptions.

The exclusion of gain from the sale of a principal residence at the $500,000 level is now available for same-sex spouses. And now that joint filing is allowable, couples should consider amending a return if one spouse previously had capital gains that could have been offset by the other spouse’s capital losses.

How will same-sex married couples file their taxes if the state they reside in does not recognize their marriage? If the state doesn’t recognize same-sex marriages, the couple may need to file a joint federal return and potentially two single state returns.

How will the federal government treat a same-sex couple who married in a state that allows same-sex marriage but moved to a state that doesn’t recognize the out-of-state marriage?

The IRS provided additional guidance in late August. Click here for the IRS News Release, Revenue Ruling 2013-17, FAQs for Domestic Partners and FAQs for Same-Sex Spouses.

In states that do not recognize same-sex marriage, couples may not enjoy all of the benefits available to residents of states that do recognize these marriages. This could change a couple’s decision-making process when considering which state they want to live in. Although same-sex couples have won a major victory, until the states they reside in recognize their marriage, they will have additional hurdles to navigate.

Estate tax benefits will include the unlimited marital deduction and portability of the deceased spouse’s unused exclusion deduction. For gift tax purposes, they will benefit from the spousal exemption and the ability to split gifts made to non-spouses. We will have to wait and see the effect on property transactions in community property law states.

Wills, trusts and any other planning that has been done in the past will have to be reviewed to make sure it is still valid. Planning related to state issues, depending on where the couple resides, will need to be considered.

Same-sex married couples should review their beneficiary designation forms to make sure they are including the spouse on their retirement accounts. If they aren’t, they will need to obtain the correct signatures. Spousal rollovers of retirement accounts will be available.

From a benefits perspective, same-sex couples will be eligible to collect Social Security based on their spouse’s earning record and receive survivorship benefits on retirement plans. If a spouse served in the military, spousal benefits will now apply.

Same-sex couples will be eligible to receive health benefits tax free. In the past, the premium that was deducted from an employee’s paycheck for same-sex spouse coverage was not considered a pretax deduction and was therefore subject to tax. The same coverage for a heterosexual spouse has always been treated as a tax-free benefit.

Other results of the Supreme Court’s DOMA decision include the following:

  • Same-sex couples will benefit from the Family and Medical Leave Act if necessary to care for their spouse.
  • The couples will have the same immigration benefits available to heterosexual couples.
  • If a state-maintained plan for qualified long-term care coverage provides for coverage of a spouse, same-sex spouses will also be eligible to receive this benefit.

When you consider these issues, take into account the current state of our economy and the current status of our Social Security system. The question of retroactive treatment and its impact will be huge. This law change will have implications that probably haven’t even been considered yet.

Affordable Care Act – What to expect in 2013 and 2014

In June 2012, the U.S. Supreme Court ruled in favor of the constitutionality of the Patient Protection and Affordable Care Act, often called Obamacare, clearing the way for the law’s implementation.

The Affordable Care Act, along with the Healthcare and Education Reconciliation Act, represents the most significant regulatory overhaul of the U.S. healthcare system since the passage of Medicare and Medicaid in 1965. Aimed at reducing the number of uninsured Americans and reducing the overall cost of health care, the act provides a combination of mandates, subsidies, taxes and credits to both employers and individuals to increase the insurance coverage rate.

Although the major non-tax-related changes of the act are yet to come, a few significant tax provisions will take place in 2013 and 2014.

Many people are aware of the Medicare payroll tax and the surtax on net investment income, but there are additional provisions that may affect taxpayers. These taxes are meant to alleviate the Medicare system’s financial difficulties as well as offset the cost of healthcare legislation. 

Effective Jan. 1, 2013 

Medical device tax

This excise tax of 2.3 percent is levied on medical device manufacturers or importers on the sale of any taxable medical device. Generally, it doesn’t apply to over-the-counter medical devices, such as eyeglasses, contact lenses, hearing aids and some prosthetics.

The tax mostly applies to medical devices used and implanted by medical professionals. The manufacturer or importer of the device is responsible for paying the tax using Form 720, Quarterly Federal Excise Tax Return, which is due at the end of the month following the last month of the calendar quarter. The first quarter 2013 return is due April 30, 2013. Semimonthly tax deposits may be due if the tax exceeds $2,500 for the quarter.

Medicare payroll tax increase and surtax

The Medicare Part A (hospital insurance) tax rate on wages will be increased by 0.9 percent (from 1.45 percent to 2.35 percent) on earnings over $200,000 for individual taxpayers and $250,000 for married couples filing jointly. The increased tax will be withheld by employers, similar to the existing Medicare tax.

In addition, a 3.8 percent surtax will be imposed on net investment income if the taxpayer’s modified adjusted gross income exceeds $200,000 for individual taxpayers and $250,000 for married couples filing jointly. Net investment income includes interest, dividends, annuities, royalties, rents and capital gain income.

Capital gain includes the gain from sale of a principal residence but only for that portion of the gain above the existing exclusion. Capital gains associated with an asset used in a business are not included in the definition of investment income.

Net investment income also includes trade or business income from a “passive activity” as defined in Internal Revenue Code Section 469 (and related regulations). Although some rental activities engaged in by a real estate professional are not passive activities, they may still be subject to the surtax. More guidance is needed in this area.

Net investment income is defined as gross investment income less deductions allocable to that income. Typically, investment-related deductions are certain itemized deductions subject to a number of thresholds and limits for regular income tax purposes, including the investment interest deduction, which has its own separate limitations. It appears these thresholds and limitations will apply in calculating net investment income.

The 3.8 percent surtax also applies to trusts and estates on income in excess of approximately $12,000.

Limit on flexible spending contribution

A new cap of $2,500 will apply to contributions by employees to a flexible spending account. The annual $2,500 cap will be indexed for cost-of-living adjustments for plan years beginning after Dec. 31, 2013. Under previous law, no limit applied to an employee’s contribution amount unless the employer imposed one.

Loss of employer retiree drug subsidy deduction

The federal tax deduction for employers who receive the Medicare Part D retiree drug subsidy coverage is eliminated. The retiree drug subsidy was established by the Medicare Prescription Drug, Improvement, and Modernization Act of 2003 to encourage employers to continue offering prescription drug benefits to their retirees.

Employers who received the subsidy also were allowed to deduct the entire cost of the benefits. The healthcare act retains the drug subsidy but eliminates the employer�s ability to deduct the amount of the subsidy.

Medical itemized deduction threshold increased

The adjusted gross income (AGI) threshold for claiming medical expenses increases from 7.5 percent to 10 percent of AGI for taxpayers 64 and under. Taxpayers 65 and older can continue to use the 7.5 percent threshold through 2016.

Effective Jan. 1, 2014


Penalty for not having medical insurance

For individuals who do not have health insurance coverage, a penalty will be assessed at the greater of $95 a year or up to 1 percent of income. The penalty increases to the greater of $325 or 2 percent of income by 2015, and the greater of $695 or 2.5 percent of income by 2016.

For families, the penalty will be capped at 300 percent of the annual flat dollar amount.

The requirement can be waived for several reasons, including financial hardship or religious beliefs. If the tax would exceed 8 percent of your income (in 2014), you are exempt. Some religious groups are also exempt. The tax cannot exceed the cost of a “bronze plan” bought on the exchange.

While some states, including Alabama, Wyoming and Montana, have passed laws to block the requirement to carry health insurance, those provisions do not override federal law.

For businesses with more than 50 full-time employees who do not offer health insurance coverage to all employees, a penalty of $2,000 per employee will be assessed. The first 30 employees are not counted in the calculation of this penalty.

Enhanced Small Business Health Insurance Credit

For businesses with fewer than 25 employees that pay an average wage to their employees of less than $50,000 per year and pay for more than 50 percent of the employees’ health insurance premiums, a credit is currently allowed equal to 35 percent of the cost of the health insurance. Starting in 2014, the credit jumps to 50 percent for employers who participate in a health exchange. 

Federal agencies strive to counter identity theft

There are always plenty of reasons to speed up the process of filing your individual return.

The primary reason has always been that, if you’re expecting a refund, you shouldn’t wait any longer than necessary to receive it.

Well, you can add identity theft to your reasoning now.

Identity thieves have found ways to fraudulently prepare tax returns and steal refunds from taxpayers, and they’re doing it at exponential rates. Many times, these stolen numbers have been those of deceased individuals, children or those not otherwise required to file tax returns. However, anyone can be targeted.

Many families have suffered the passing of a loved one only to find that the decedent’s tax refund was stolen by identity thieves. Ironically, much of the information used by identity thieves is received from the federal government.

Every year the Social Security Administration releases the names and Social Security numbers of individuals when it learns of their deaths in a Death Master File. The file is meant to be confidential, but it has proven to be easily accessible. In a 2012 letter to the Office of Management and Budget, Senator Bob Casey (D-PA) called on the administration to finalize rules that would bolster privacy protections and better protect Americans’ Social Security numbers.

The method of delivery of the fraudulent refunds also facilitates the theft. Direct deposit and debit cards are often used by identity thieves.

Unfortunately, the Internal Revenue Service was found not to be in compliance with direct deposit regulations that require tax refunds to be deposited to an account only in the name of the individual listed on the tax return. In just one case, there were 590 direct deposits to the same bank account totaling over $900,000.

In July of this year, the Treasury Inspector General for Tax Administration (TIGTA) issued an audit report on this subject. The agency was established in 1999 to provide independent oversight of IRS activities.

While the problem of identity theft and fraudulent tax returns has been around for a while, it seems to have exploded for the tax years 2010 and 2011, and it looks like 2012 may be even worse. Florida has been an epicenter, where gang activity actually declined in some areas during January and February because the thugs found fraudulent tax return filing more profitable than drug deals.

In analyzing 2010 tax returns filed in 2011, the most recent TIGTA report found that the IRS may have delivered more than $5 billion in fraudulent refunds in addition to what it had already detected.

During the 2011 filing season, the IRS reported that it prevented $6.5 billion in fraudulent returns (938,664 tax returns). Even more troubling, the TIGTA report estimates that the IRS could issue approximately $21 billion in fraudulent tax refunds over the next five years.

The IRS disagrees with this determination. It believes the filters it recently added to prevent some of this fraud were not taken into consideration in the estimate.

There are several problems contributing to this situation. For one, the IRS allows refunds to be issued before matching data used to verify the numbers are submitted.

For example, someone could file a tax return requesting a refund on Jan. 16, while the wages and related federal income tax withholding shown on that tax return are not reportable to the IRS on a W-2 form until Jan. 31.

Another problem is the level of the refund. Even if a filter is in place to flag a return as potentially fraudulent, a refund that is small enough often gets through. The IRS simply does not have enough resources to investigate all of these occurrences.

Any tax refund that is stolen from a taxpayer will ultimately be refunded to a taxpayer once the IRS is convinced of a taxpayer’s identity (see But this can be a long and arduous process.

The better news is that the IRS has recently issued Form 14039, which is available to taxpayers who have been or may be victims of identity theft. The form essentially puts the IRS on notice of a taxpayer’s identity (or a decedent’s if the taxpayer is an executor).

After a taxpayer files Form 14039, the IRS will not send refunds, etc., to the addresses of others claiming the same identity. The form is filed with appropriate photocopies of identification.

To lessen the chance of stolen refunds, the following actions are recommended:

�         File individual returns, especially those with large anticipated refunds, as soon as practicable.

�         Don’t ignore an IRS notice that indicates you’ve received wages from a job you’ve never held.

�         File Form 14039 if you have been an actual victim of identity theft.

�         File Form 14039 if you feel you are a potential victim of identity theft, e.g., if you’ve had a lost or stolen purse or wallet or questionable credit card activity.

�         File Form 14039 if you’re the executor for a decedent with a potential refund, and recommend that this action be taken for friends and loved ones who have recently died.

If taxpayers fall victim to identity theft, they may feel that their IRS information is safe and refunds are not at risk. And if taxpayers don’t feel the need to share identity theft issues with their accountants, opportunities to protect refunds may be missed.

In addition to helping identity theft victims clear up problems with their IRS accounts, the IRS works proactively to help ensure that these taxpayers do not encounter delays in processing their future returns.

In January 2011, the IRS launched a pilot program for Identity Protection Personal Identification Numbers (IP PIN). The IP PIN is a unique identifier establishing that a particular taxpayer is the rightful filer of the return. This program continues to be in place.

There has been a 200 percent increase in ID theft phone calls, reported Peggy Bogadi, the commissioner of the IRS Wage and Investment Division, at the November 2012 National Tax Conference of the American Institute of CPAs in Washington. She also said that the IRS will issue more than 600,000 IP PINs for filing 2012 returns.

In December 2012, the IRS will mail IP PINs to ID theft victims to be used in filing their 2012 tax returns. The IRS provides answers to some frequently asked questions about IP PINs on its website at,,id=249368,00.html.

Taxpayers who use these IP PINs when filing their 2012 returns should not have any processing issues. If anyone tries to file a tax return without the IP PIN, the refund will not be issued without further investigation, according to Bogadi.

For those who receive an IP PIN, it’s critical that they put it in a safe place so they will have it for their tax return preparation.

All victims of identity theft should let their tax advisers know as soon as possible.

Additional Medicare tax looms on the horizon

If you and your spouse have self-employment earnings or wages in excess of $250,000, you should be aware of the new tax increase starting in 2013.

The Health Care and Education Reconciliation Act of 2010, which was signed into law on March 30, 2010, created two methods of raising revenue by increasing Medicare taxes by 0.9 percent on wages and self-employment income and by 3.8 percent on net investment income (as discussed previously in the Sept./Oct. issue of Federal Tax Watch).

Prior to 2013, wages were subject to a Medicare tax of 2.9 percent – half (1.45 percent) paid by the employee and the other half paid by the employer. In addition to Social Security tax, self-employment earnings were subject to the 2.9 percent Medicare tax, which equaled the combined rate. Starting in 2013, an additional 0.9 percent tax will be assessed on wages and self-employment income in excess of certain limits, depending on filing status.

It’s important to note that the 0.9 percent additional tax is imposed on the employee only, not on the employer. Accordingly, self-employment income is subject to 0.9 percent, not 1.8 percent. Self-employment income is generally income earned by owners of sole proprietorships and partners in a trade or business partnership.

For those who are self-employed, a deduction of one-half of the self-employment tax (Social Security and Medicare portion) is allowed in determining adjusted gross income on page 1 of their tax return. Note that the new 0.9 percent tax on wages/self-employment income is not eligible for the 50 percent deduction in calculating adjusted gross income.

The structure of the new tax also imposes a marriage penalty because it is assessed on the joint wages in excess of $250,000. Thus, if each spouse earns $200,000, the tax will be paid on the excess wages of $150,000 ($400,000 – $250,000). But if they had remained single and each had earned $200,000, no additional tax would have been due.

Taxpayers may be subject to underpayment penalties in addition to the new tax. This factor is of particular importance when the taxpayer has investment income that is subject to the previously mentioned additional 3.8 percent tax. Employers are required to withhold the new tax only on wages they pay in excess of $200,000. Therefore, a married couple’s earnings may be subject to the additional tax, but their respective employers may not withhold the extra amount.

For example, if each spouse earns $200,000, no withholding would be incurred, but their additional liability would be $1,350 ($400,000 – $250,000 = $150,000 * 0.9% = $1,350).

The same result occurs when an individual changes jobs or has multiple employers. According to the withholding requirements, only wages paid by the specific employer are subject to the additional tax regardless of other employment.

As with many other items in the recent tax changes, the tax thresholds are not subject to inflation adjustments, so the tax burden will increase as time and inflation march on.

Where do you live – for state tax purposes?

Dual state residency issues are becoming more frequent audit issues as states seek to increase their revenue.

In the digital data-sharing world, it’s very important to maintain good tax records. If you own property such as a vacation home in a state where you work, and you reside in another state, you may find yourself in a tax dilemma. Your records may or may not assist you in proving your “tax” residency is accurate.

Your residency is defined by tax law or statute, which in most states is based on how many days you spend in the state and whether you maintain a living space. If you own a house and work in New York but believe that you reside in a neighboring state, you may be subject to dual residency taxes. Dual residency would mean you owe taxes in two states on your entire income, with no offsetting tax credit for taxes paid to another state.

If your EZ-pass, credit card statements, cell phone and other records do not support your being out of the state for more than the statutorily defined period, you may find yourself in a tax problem. Alternatively, if your records show you were in a state for the required number of days, you are also in a tax dilemma.

In the case of New York, you’re considered a resident even if you are domiciled outside New York but maintain a permanent place of abode in New York and spend 184 or more days there. Generally, a permanent place of abode is a residence you or your spouse maintains, whether you own it or not, that is suitable for year-round use. The residence must have basic facilities, such as for cooking, bathing, sleeping, etc.

If the living quarters cannot be used all year, they may not be considered a “residence.” A few examples are given in New York State Tax Bulletin TB-IT-690, “Permanent Place of Abode.” As an example, consider an individual who owns a fishing cabin in the mountains. If the cabin is suitable for use only during the warmer months of the year because it doesn�t have adequate insulation or heating for winter use, it isn’t judged to be a permanent place of abode.

Alternatively, even if someone doesn’t own or lease premises within the state, it’s possible for the individual to be judged a resident by virtue of “maintaining” the property.

The state provides an example: Lisa lives in a condominium with Mark during the workweek. Although only Mark’s name is on the lease, Lisa regularly gives Mark money to pay for her share of the household expenses. Lisa has lived in the apartment for three years. Since Lisa makes monetary contributions to maintain her living arrangement in the apartment, the apartment would be considered a permanent place of abode for Lisa.

A corporate apartment suitable for permanent year-round use may also be considered a person’s permanent place of abode if the dwelling is principally available to that person. Even if others use the apartment on occasion, it may still be defined as the person’s permanent place of abode.

A corporate apartment may not be considered a permanent place of abode for the taxpayer if the primary purpose or use of the corporate apartment is other than as living quarters of the taxpayer or the taxpayer’s family. An example would be making the apartment available on a first-come, first-served basis to exec­utives, salesmen or important clients when they’re visiting the corporation.

Tax Impact of Health Care Reform Law

Dear Client,


Many clients (like yourself) have asked us about the tax impact of the health care reform law now that the U.S. Supreme Court has indicated that the law is largely constitutional. The following paragraphs provide a broad outline of some of the key individual tax provisions in that law.

 The Personal Responsibility Tax Penalty

 The U.S. Supreme Court found that the personal responsibility “penalty” is a tax and thus constitutional. This tax provision is found in Section 5000A of the tax code. It starts in 2014 and “ramps up” (increases) quickly. In 2016, the penalty is equal to the greater of $695 or 2.5% of household income (a family cap of $2,085 applies). This provision applies to all clients irrespective of income level.

 The personal responsibility penalty tax is aimed at individuals who fail to maintain health insurance coverage. To avoid the penalty, the individual must maintain minimum essential coverage.

 Medical Deduction

 It is very hard to obtain an itemized deduction for out-of-pocket medical care costs. Under current law, a taxpayer must exceed a 7.5% of AGI (adjusted gross income) threshold to obtain a deduction. Under the health care reform, a 10% of AGI threshold will apply.

 This rule will generally come into effect in 2013. However, individuals age 65 and older will be able to use the existing 7.5% through 2016.

 Health FSA Cafeteria Plan Contributions 

The new law limits health flexible spending account contributions to $2,500 in 2013. This significantly restricts these benefits for individuals.

 Remember, the pre-tax nature of a health FSA contribution is a major benefit to individuals. Many individuals work for companies that sponsor “cafeteria plans” (pre-tax plans) that contain such pre-tax health FSA type benefits.

 Other Individual Tax Provisions In The Affordable Care Act 

  • Individuals who take a non-qualified distribution from a health savings account (HSA) (or Archer MSA) will incur a 20% (up from a 10%) additional tax (effective 2011).
  • In 2018, the new law imposes a 40% excise tax on “cadillac” health care policies (health coverage). It is an “indirect tax.” The excise tax is imposed on the insurers on a pro rata basis. Thus, either policies will be modified to avoid the tax or there will be higher costs for these types of policies. Stay tuned. 
  • There are other provisions that may directly or indirectly impact a particular individual client. For example, there is an excise tax on manufacturers and importers of certain medical devices. This cost may be passed on to the individual consumer. 

Please contact our CPA firm if you have any questions regarding the tax impact of the Affordable Care Act.

Estate planning with trusts: Availability limited?

With the looming expiration of the $5 million estate and gift tax exemptions and the current favorable top tax rate of 35 percent, estate tax planning has become a significant area of focus among many tax advisers.

Possible expiration of these provisions has fueled the emphasis on the importance of addressing the impact on individuals and on the transfer of assets to future generations.

Many advisers have focused on employing grantor trusts to help meet clients’ objectives. Grantor trusts have been the target of legislators over the years, and current proposals would eliminate many of the benefits of using these trusts in estate planning.

Most commentators agree that it is highly unlikely that current proposals will be adopted. However, their approval would close the window on these estate tax planning opportunities, making it crucial to act now if you could benefit from these techniques.

To create a grantor trust, a donor transfers property to a trust but retains powers that cause the grantor to be treated as the trust owner under the grantor trust rules. The trust is disregarded as an entity under federal income tax law, and the grantor must account for all items of income and deduction attributable to the trust property.

Because the grantor is required to pay this tax, it is not treated as a gift to the trust, and the grantor effectively transfers additional wealth to trust beneficiaries without affecting the exemption amount or incurring additional gift tax.

In addition, due to differences in the grantor trust and the estate and gift tax rules, as long as the transfer is properly structured as a completed gift, the property will be excluded from the grantor’s estate for estate tax purposes.

When the trust document is drafted as a trust that purposely invokes the grantor trust rules, it is commonly referred to as an intentionally defective grantor irrevocable trust. Although this can be achieved in a number of ways, one of the more aggressive and complicated planning strategies involves structuring an installment sale to a grantor trust.

Using this strategy, the donor sets up a trust in which he retains the power to replace trust assets with assets of equal value. The transaction is structured as a combination gift and sale.

The grantor first makes a gift to the trust, usually cash, and then sells an appreciating asset to the trust in exchange for cash and a promissory note providing for installment payments over time. The interest is based upon the required minimum IRS interest rate.

Because the grantor is treated as the owner of the trust, no gain or loss is recognized on the sale of the asset to the trust or on the note’s interest.

A grantor retained annuity trust (GRAT) is another type of grantor trust. It can provide a unique estate planning opportunity because of the manner in which the remainder interest is valued for gift tax purposes.

To establish a GRAT, the grantor transfers appropriate property to an irrevocable trust. The grantor retains the right to receive an annual payment of a fixed amount for a specified term of years. Then the property passes to the remainder beneficiaries.

The creation of the GRAT is treated as a taxable gift to the extent of the present value of the remainder interest, which can often have de minimis, or minor, value. The trust property is assumed to appreciate at the federally established rate, while the property in the trust is expected to appreciate at a higher rate.

Proper planning should result in the value of the property received by the trust beneficiary substantially exceeding the value on which the donor was required to pay gift tax.

Although these trusts can be an effective planning tool for some taxpayers, they are not appropriate for everyone. If your estate is less than $10 million joint ($5 million single), you can likely accomplish your planning goals through lifetime gifts and less complicated trusts.

With the help of your CPA, you should assess your long-term objectives, personal and financial situation, and the assets that will be held by the trust to determine the most suitable approach. After this assessment, if you believe that a GRAT or grantor trust may be appropriate, you should consider the advantages and disadvantages of each.