Monthly Archives: February 2012

Health Savings Accounts

Feb 23

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What is an HSA?

An HSA or Health Savings Account is a bank account that you open at a financial institution in your name with your money. Like any other account money only comes out and goes in to the account per your instructions. In order to open and contribute to a Health Savings Account you have to meet the following eligibility requirements set by the IRS.

Eligibility to Make Contributions to HSA
In order to be eligible to make contributions to an HSA, an individual must meet the following requirements:

  1. He or she must be covered under a high deductible health plan (HDHP defined below),
  2. He or she cannot have any other health coverage except as permitted (see below),
  3. He or she cannot be claimed as a dependent on another person’s tax return, and
  4. He or she must be an eligible on the first day of the month to take an HSA deduction for that month. 

IRS FORM 8889 – Health Savings Account
This worksheet is used to report information and make calculations concerning the taxpayer’s Health Savings Account, including the following:

  • Report health savings account (HSA) contributions including those made on the taxpayer’s behalf and employer contributions,
  • Calculate the taxpayer’s HSA deduction,
  • Report distributions from the taxpayer’s HSA, and
  • Calculate the amount of contribution or distributions that is taxable and subject to an additional tax.  

HSA’s give you more control over how your healthcare dollars are spent. A higher deductible means that you will be paying for more of your medical expenses out of your own pocket. It also means that you will be paying a lower premium.

What are the Advantages and Disadvantages of an HSA?

Advantages

  • Low Premium
  • Comprehensive Insurance
  • Great Tax Benefits
  • Network prices for Medical Care

  Disadvantages

  • High Deductible means you’ll pay more when the time comes.

What is a Qualified High Deductible Health Plan?

HDHP
This is a health insurance plan that meets the following limits in 2011:

  Self-Only
Coverage		 Family
Coverage
Minimum Annual Deductible $1,200 $2,400
Maximum Annual Out-Of-Pocket Expenses (Other Than For Premiums) $5,950 $11,900

Contributions to an HSA
For 2011, the annual contribution and deduction limit is $3,050 if the taxpayer has a high deductible health plan with self-only coverage, or $6,150 if the taxpayer has family coverage. If the taxpayer is age 55 or older at the end of 2011, their additional allowable contribution amount is $1,000. A taxpayer cannot deduct any contributions to an HSA that were made in the same month in which the taxpayer was enrolled in Medicare.

Distributions from an HSA
If distributions from an HSA are used for qualified medical expenses for the account beneficiary, spouse, or dependents, the distributions are excludable from gross income. Any amounts not used for qualified medical expenses are includible in gross income and are subject to an additional 20% tax unless an exception applies.

Qualified Medical Expenses
Qualified medical expenses for HSA purposes are unreimbursed medical expenses that could otherwise be deducted on the Schedule A worksheet with the exception of the list below:

– The taxpayer may not deduct the costs of any non-prescription medicines with the exception of insulin.  

– The taxpayer may not treat insurance premiums as qualified medical expenses unless the premiums are for one of the following:

  • Long-term care (LTC) insurance,
  • Health care continuation coverage, or
  • Health care coverage while receiving unemployment compensation under Federal or state law.
  • Medicare and other health care coverage if the taxpayer was 65 or older, however, this does not apply to amounts paid for a Medicare supplemental policy.

NOTE: Distributions from an HAS is normally reported on FORM 1099-SA (Distributions from an HAS, Archer MSA, or Medicare Advantage MSA.

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Home Office Deduction (Part II)

Feb 4

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FORM 8829

Qualifying for a Deduction

Generally, you cannot deduct items such as mortgage interest and real estate taxes as business expenses. However, you may be able to deduct expenses related to the business use of part of your home if you meet specific requirements. Even then, your deduction may be limited. Use this section and Figure A, later, to decide if you can deduct expenses for the business use of your home.

To qualify to deduct expenses for business use of your home, you must use part of your home:

  • Exclusively and regularly as your principal place of business (defined later),
  • Exclusively and regularly as a place where you meet or deal with patients, clients, or customers in the normal course of your trade or business,
  • In the case of a separate structure which is not attached to your home, in connection with your trade or business,
  • On a regular basis for certain storage use.
  • For rental use (see IRS Publication 527), or
  • As a daycare facility

Additional tests for employee use.

If you are an employee and you use a part of your home for business, you may qualify for a deduction for its business use. You must meet the tests discussed earlier plus:

  • Your business use must be for the convenience of your employer, and
  • You must not rent any part of your home to your employer and use the rented portion to perform services as an employee for that employer.

If the use of the home office is merely appropriate and helpful, you cannot deduct expenses for the business use of your home.

Exclusive Use

To qualify under the exclusive use test, you must use a specific area of your home only for your trade or business. The area used for business can be a room or other separately identifiable space. The space does not need to be marked off by a permanent partition.

You do not meet the requirements of the exclusive use test if you use the area in question both for business and for personal purposes.

 Figuring the Deduction

After you determine that you meet the tests under Qualifying for a Deduction, you can begin to figure how much you can deduct. You will need to figure the percentage of your home used for business and the limit on the deduction.

Rental to employer.   

If you rent part of your home to your employer and you use the rented part in performing services for your employer as an employee, your deduction for the business use of your home is limited. You can deduct mortgage interest, qualified mortgage insurance premiums, real estate taxes, and personal casualty losses for the rented part, subject to any limitations. However, you cannot deduct otherwise allowable trade or business expenses, business casualty losses, or depreciation related to the use of your home in performing services for your employer.

Business Percentage

To find the business percentage, compare the size of the part of your home that you use for business to your whole house. Use the resulting percentage to figure the business part of the expenses for operating your entire home.

You can use any reasonable method to determine the business percentage. The following are two commonly used methods for figuring the percentage.

  1. Divide the area (length multiplied by the width) used for business by the total area of your home.
  2. If the rooms in your home are all about the same size, you can divide the number of rooms used for business by the total number of rooms in your home.

Example 1.

  • Your office is 240 square feet (12 feet × 20 feet).
  • Your home is 1,200 square feet.
  • Your office is 20% (240 ÷ 1,200) of the total area of your home.
  • Your business percentage is 20%.

Example 2.

  • You use one room in your home for business.
  • Your home has 10 rooms, all about equal size.
  • Your office is 10% (1 ÷ 10) of the total area of your home.
  • Your business percentage is 10%.

Part-Year Use

You cannot deduct expenses for the business use of your home incurred during any part of the year you did not use your home for business purposes. For example, if you begin using part of your home for business on July 1, and you meet all the tests from that date until the end of the year, consider only your expenses for the last half of the year in figuring your allowable deduction.

Deduction Limit

If your gross income from the business use of your home equals or exceeds your total business expenses (including depreciation), you can deduct all your business expenses related to the use of your home.

If your gross income from the business use of your home is less than your total business expenses, your deduction for certain expenses for the business use of your home is limited.

Your deduction of otherwise nondeductible expenses, such as insurance, utilities, and depreciation (with depreciation taken last), that are allocable to the business, is limited to the gross income from the business use of your home minus the sum of the following.

  1. The business part of expenses you could deduct even if you did not use your home for business (such as mortgage interest, real estate taxes, and casualty and theft losses that are allowable as itemized deductions on Schedule A (Form 1040)). These expenses are discussed in detail under Deducting Expenses , later.
  2. The business expenses that relate to the business activity in the home (for example, business phone, supplies, and depreciation on equipment), but not to the use of the home itself.

If you are self-employed, do not include in (2) above your deduction for half of your self-employment tax.

Example.

You meet the requirements for deducting expenses for the business use of your home. You use 20% of your home for business. In 2011, your business expenses and the expenses for the business use of your home are deducted from your gross income in the following order.

Gross income from business

$6,000
Minus:
Deductible mortgage interest
and real estate taxes (20%)

3,000
Business expenses not related to the use of your home (100%) (business phone, supplies, and depreciation on equipment)

2,000
Deduction limit

$1,000
Minus other expenses allocable to business use of home:
Maintenance, insurance, and utilities (20%)

800
Depreciation allowed (20% = $1,600 allowable, but subject to balance of deduction limit)

200
Other expenses up to the deduction limit

$1,000
Depreciation carryover to 2012 ($1,600 − $200) (subject to deduction limit in 2012)

$1,400

You can deduct all of the business part of your deductible mortgage interest and real estate taxes ($3,000). You also can deduct all of your business expenses not related to the use of your home ($2,000). Additionally, you can deduct all of the business part of your expenses for maintenance, insurance, and utilities, because the total ($800) is less than the $1,000 deduction limit. Your deduction for depreciation for the business use of your home is limited to $200 ($1,000 minus $800) because of the deduction limit. You can carry over the $1,400 balance and add it to your depreciation for 2012, subject to your deduction limit in 2012.

Deducting Expenses

If you qualify to deduct expenses for the business use of your home, you must divide the expenses of operating your home between personal and business use. This section discusses the types of expenses you may have and gives examples and brief explanations of these expenses.

Examples of Expenses

  • Real estate taxes.
  • Qualified mortgage insurance premiums.
  • Deductible mortgage interest.
  • Casualty losses.
  • Depreciation (covered under Depreciating Your Home , later).
  • Insurance.
  • Rent paid for the use of property you do not own but use in your trade or business.
  • Repairs.
  • Security system.
  • Utilities and services.

NOTE:

Insurance

You can deduct the cost of insurance that covers the business part of your home. However, if your insurance premium gives you coverage for a period that extends past the end of your tax year, you can deduct only the business percentage of the part of the premium that gives you coverage for your tax year. You can deduct the business percentage of the part that applies to the following year in that year.

Rent

If you rent the home you occupy and meet the requirements for business use of the home, you can deduct part of the rent you pay. To figure your deduction, multiply your rent payments by the percentage of your home used for business.

Security System

If you install a security system that protects all the doors and windows in your home, you can deduct the business part of the expenses you incur to maintain and monitor the system. You also can take a depreciation deduction for the part of the cost of the security system relating to the business use of your home.

Utilities and Services

Expenses for utilities and services, such as electricity, gas, trash removal, and cleaning services, are primarily personal expenses. However, if you use part of your home for business, you can deduct the business part of these expenses. Generally, the business percentage for utilities is the same as the percentage of your home used for business.

Telephone.

  The basic local telephone service charge, including taxes, for the first telephone line into your home (i.e., landline) is a nondeductible personal expense. However, charges for business long-distance phone calls on that line, as well as the cost of a second line into your home used exclusively for business, are deductible business expenses. Do not include these expenses as a cost of using your home for business. Deduct these charges separately on the appropriate form or schedule. For example, if you file Schedule C (Form 1040), deduct these expenses on line 25, Utilities (instead of line 30, Expenses for business use of your home).

Source: http://www.irs.gov/publications/p587/ar02.html

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Relationship Test for Qualifying Relatives

Feb 3

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To meet the relationship test, the dependent must either

  • be related to the taxpayer is one of the following ways, or
  • live with the taxpayer for an entire year, and the relationship must not violate local laws.

Qualifying Relationships with no residency requirement

The dependent will meet the relationship test for being claimed as a qualifying relative if the dependent is related to the taxpayer in one of the following ways:

  • son or daughter, grandson or granddaughter, great grandson or great granddaughter, stepson or stepdaughter, or adopted child,
  • brother or sister,
  • half-brother or half-sister,
  • step-brother or step-sister,
  • mother or father, grandparent, great-grandparent,
  • stepmother or stepfather,
  • nephew or niece,
  • aunt or uncle,
  • son-in-law, daughter-in-law, brother-in-law, sister-in-law, father-in-law, or mother-in-law, or
  • foster child who was placed in your custody by court order or by an authorized government agency.

TIPS

  • Qualifying relatives who are related in one of these ways need not live with the taxpayer. As long as you meet the other four tests (gross income, support, citizenship, joint return), you can claim these qualifying relatives as a dependent.
  • Relationships established by marriage do not end with death or divorce. So if you support your mother-in-law, you can claim her as a dependent even if you and your spouse are divorced.

WHAT’S NEW

  • You can claim a foster child starting with the year that the foster child was placed in your custody.

Qualifying Relationships with a mandatory residency requirement

The dependent will meet the test to be claimed as a qualifying relative if:

  • The person is a member of your household, and
  • The person lives with you for an entire year, and
  • The relationship between you and the dependent does not violate local law.

For example, you may be able to claim cousins, friends, boyfriend or girlfriend, or domestic partner as a dependent under the qualifying relative tests. These qualifying relatives must live with you for an entire year, and must meet all the other criteria for qualifying relatives(gross income, support, citizenship, joint return).

The relationship, however, must not violate local law. For example, if your state prohibits co-habitation with a married person, then you cannot claim that person as your dependent even if you meet the other criteria for claiming a dependent.

TIPS

  • Domestic partners may be claimed as a dependent under the qualifying relative tests.
  • Cousins may be claimed as a dependent under the qualifying relative tests.

Posted in Dependent Exemptions & Support

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Claiming Dependents

Feb 3

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Rules for claiming children and relatives as dependents

Being able to claim a dependent on a tax return is tied to a number of related tax benefits. Taxpayers who claim dependents can claim an additional personal exemption for each dependent. Also, taxpayers may be eligible to claim the child tax credit, the child and dependent care tax credit, and the earned income tax credit. Unmarried taxpayers who support a dependent may be eligible to file as head of household.

It is important to make sure that you really can claim the dependent on your tax return.

Basically, you can claim a dependent if the person meets one of two criteria:

  • qualifying child or
  • qualifying relative.

Note that the IRS will always audit tax returns where two or more taxpayers attempt to claim the same dependent. Only one taxpayer will win. The taxpayer who loses might also lose the related tax breaks such as child tax credit, earned income credit, or Head of Household filing status. What that means, is that the taxpayer who loses the IRS audit will have to pay additional taxes, plus penalties and interest. That makes dependent audits one of the most expensive audits that a taxpayer can endure.

These rules enable you claim a child as a dependent.

 Relationship — the person must be your child, step child, adopted child, foster child, brother or sister, or a descendant of one of these (for example, a grandchild or nephew).

Residence — for more than half the year, the person must have the same residence as you do.

Age — the person must be

  • under age 19 at the end of the year, or
  • under age 24 and a be a full-time student for at least five months out of the year, or
  • any age and totally and permanently disabled.

Support — the person did not provide more than half of his or her own support during the year.

You might still be able to claim the child as a qualifying relative if the child does not meet the criteria to be a qualifying child. But the qualifying child rules always prevail over the qualifying relative rules. So you’ll want to make sure the dependent would not qualify as a qualifying child for someone else before claiming a qualifying relative on your tax return.

Six Criteria for Qualifying Relatives

To be claimed as a qualifying relative, the person must meet all of the following criteria:

Not a qualifying child – The dependent cannot be a qualifying child of another taxpayer.

Gross Income – The dependent earns less than the personal exemption amount during the year. For 2011, this means the dependent earns less than $3,700.

Total Support – You provide more than half of the dependent’s total support during the year.

Relationship – You are related to the dependent in certain ways.

Joint Return – If the dependent is married, the dependent cannot file a joint return with his or her spouse.

Citizenship – The dependent must be a citizen or resident alien of the United States, Canada, or Mexico.

Posted in Dependent Exemptions & Support

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The Earned Income Credit

The EITC is a refundable federal income tax credit available to low to moderate income working individuals and families. Refundable means that even if the credit exceeds the tax liability, the taxpayer doesn’t lose the excess and is entitled to receive any overage as a refund.

The EITC, introduced in 1975 was designed to provide an incentive for people to work, since the credit is only available to workers who earn money from wages, self employment or farm income.

The IRS estimates an error rate of 23%-28% on EITC returns, or about $13 to $16 billion paid out in error. As part of the IRS’ efforts to reduce EITC fraud, all tax professionals are now required to practice EITC due diligence. Tax preparers who fail to comply with the due diligence rules can be assessed a $500 penalty for each failure plus other forms of punishment.

The amount of credit varies by income, family size and filing status.

 

What are the Earned Income Tax Credit Amounts for Year 2012?

The maximum earned income credit for 2012 is:

  • $5,891 with three or more qualifying children;
  • $5,236 with two qualifying children;
  • $3,169 with one qualifying child; and
  • $475 with no qualifying children.

 

What are the Earned Income & Investment Income Limitations in 2012?

To be eligible for EIC, both earned income and adjusted gross income (AGI) must each be less than the following amounts for 2012:

  • $45,060 ($50,270 married filing jointly) with 3 or more qualifying children
  • $41,952 ($47,162 married filing jointly) with 2 qualifying children;
  • $36,920 ($42,130 married filing jointly) with 1 qualifying child; or
  • $13,980 ($19,190 married filing jointly) with no qualifying children.

Investment income must less than $3,200 for the year 2012. Investment income includes interest, dividends, capital gains, and royalties.

Who is a Qualifying Child for EIC?

The rules for qualifying children for the purpose of claiming the earned income credit are slightly different than the rules for dependents. Thus it may be possible that a child qualifies as your dependent, but not for EIC; or might qualify you for EIC even though the non-custodial parent claims the dependent. Here are the qualifying children rules for the earned income credit:

  • Relationship test,
  • Age test,
  • Residency test, and
  • Joint return test.

Relationship Test: The child must be related to you by birth, marriage, adoption, or foster arrangement. The child can be your son, daughter, grandchild, niece, nephew, brother, sister, or eligible foster child. Adopted children are treated the same as children by birth. Foster children must be placed in your care by an authorized placement agency.

Age Test: The child must be age 18 or younger at the end of the year, or the child must be age 23 or younger and a full-time student. If you care for a person who is totally and permanently disabled, you can claim this person for the Earned Income Credit regardless of the person’s age.

Residency Test: The child must live with you for more than half the year and must live with you in the United States. More than half a year means six months and a day. The residency test means that two people are not able to claim the same child for the Earned Income Credit.

Joint return test: the child you claim for the earned income credit cannot file a joint return with his or her spouse. One exception is if their joint return is solely a claim for refund and the couple does not take any deductions or credits on their jointly-filed tax return.

Additionally, your child must have a valid Social Security Number. If your child does not have a valid SSN, then you cannot claim the child for the Earned Income Credit.

Finally, you cannot claim the earned income tax credit if your filing status is Married Filing Separately. However, if you and your spouse are separated and your spouse did not live with you at any time during the last 6 months of the year, you can file as Head of Household and claim the Earned Income Credit.

EIC Requirements for All Taxpayers

To be eligible for the earned income credit, taxpayers need to meet the follow criteria:

  • Must have valid Social Security Numbers;
  • Must be U.S. citizen or resident alien for the entire year;
  • Cannot use the the married filing separately filing status;
  • You and your spouse (if married) cannot be claimed as a qualifying child by someone else.
  • Cannot claim the foreign earned income exclusion (which relates to wages earned while living abroad)
  • You and your spouse (if married) are between the ages of 25 and 64.

Earned Income Credits available from State and Local Governments

Several state and local governments offer their own version of an earned income credit. Some of these are based on the federal earned income amounts, but other states have their own calculations.

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