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Obamacare: How the Affordable Care Act Impacts Your Taxes

Jan 15

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Obamacare could affect your federal taxes this year and beyond. Beginning this tax season (2014), you may notice some changes on your tax return related to the Affordable Care Act, commonly referred to as just ACA or Obamacare.

In order to ensure that you understand how the ACA works, we have created the following guide in order to inform you about the potential impact to your tax situation this year. In this article, you’ll find specific information around:

(a) How the ACA might affect your taxes,
(b) Which new forms you’ll need to look for, and
(c) What documentation we’ll need from you in order to complete your tax return.

 

Did you have Minimum Essential Coverage during 2014?

It is important that your tax preparer is informed as to whether you had minimum coverage during the tax year. To avoid the penalty for being uncovered you must have insurance that qualifies as minimum Essential Coverage. Having Minimum Essential Coverage means you’re covered by any of the following types of plans:

 

  • Any Marketplace plan, or any individual insurance plan you already have
  • Any Marketplace plan, or any individual insurance plan you already have
  • Any employer plan (including COBRA plans, with or without “grandfathered” status)
  • Retiree health plans
  • Medicare
  • Medicaid
  • The Children’s Health Insurance Program (CHIP)
  • TRICARE (for current service members and military retirees, their families, and survivors)
  • Veterans health care programs (including the Veterans Health Care Program, VA Civilian Health and Medical Program (CHAMPVA), and Spina Bifida Health Care Benefits Program)
  • Peace Corps Volunteer plans
  • Self-funded health coverage offered to students by universities for plan or policy years that begin on or before Dec. 31, 2014

 

 

 What New Tax Forms Do you Expect?

 

  • Form 1095-C: Your employer may provide a separate Form 1095-C to you and to the IRS, which provides information about your plan and who was covered.
  • Form 1095-B: Private insurers and self-funded plans may provide each policyholder and the IRS with information summarizing the coverage provided on Form 1095-B.

 

Note:
It is important to note, however, that this year is  a transition period for Forms 1095-B and 1095-C, so these forms are not a requirement for tax year 2014.

 

What form do you need to get your taxes done?

  • All of the usual documentation you provide every year during taxes.
  • Form 1095-C or 1095-B, if you received it from your employer or private insurer.

 

 Did you purchase a health plan through a Health Insurance Marketplace?

It is important to let us know, prior to tax preparation that you purchased your plan through a Health Insurance Marketplace, also known as a Health Exchange.

If you overestimated your 2014 household income when you applied for the tax subsidy, you will receive the remainder of the subsidy in the form of a refundable credit, which will increase the refund amount or decrease the amount owed on your tax return. But if you earn more than you projected, you will have to pay a portion or “vomit” all of the subsidy back, which will decrease the refund amount or increase the amount owed on your tax return.

In addition to a change in income, make sure to report all life changes (i.e. getting married or having a child) through your Marketplace to ensure your subsidy is correct.

 

New Tax Forms to Expect

  • Form 1095-A: If you purchased insurance through the Health Insurance Marketplace you will receive a new form, Form 1095-A, which will show details of your insurance coverage including the effective date, amount of premium and the advance premium tax credit.
  • Form 8962: If you are eligible to receive a premium tax credit in 2014, information about your advance premium tax credit will be reported and the actual premium tax credit will be determined on Form 8962.

What I need from you

All of the usual documentation you provide

  • Form 1095-A, if you purchased health insurance through the Health Insurance Marketplace

 

 What If I don’t have health insurance?

Under the ACA, individuals who did not have health insurance for more than three months in 2014 must pay a tax penalty. However, according to Congressional Budget Office, an estimated 20 million Americans may qualify to waive that penalty this year. To find out if you qualify for an exemption, visit www.healthcare.gov.

 

How do I know if I qualify for an exemption?
The Affordable Care Act recognizes there are legitimate reasons people may be exempt from paying a tax penalty for not having health insurance.

Some of the common exemption reasons include:

  • Can’t afford health insurance; the lowest-priced coverage available would cost more than 8 percent of their household income
  • Had difficulty signing up for health insurance through a state or federal marketplace
  • Had medical expenses you couldn’t pay in the last 24 months that resulted in substantial debt
  • Had an individual insurance plan cancelled, and believe other marketplace plans are unaffordable
  • Received a shut off notice from a utility company

For the full list of exemptions, please check www.healthcare.gov/fees-exemptions/exemptions-from-the-fee/

If you’ve been uninsured for fewer than three consecutive months of the year, you don’t need to apply for an exemption. This will be handled when we file your 2014 taxes. Also, if you are not required to file a tax return because your income is too low, you don’t need to apply for an exemption.

If you believe you qualify for one of the exemptions, please notify us as soon as possible, so we will be able to let you know whether you can claim it on your tax return or apply through the Health Insurance Marketplace along with the required documentation in certain cases. Different exemptions require different forms, so be sure to apply with the correct document. You can find and print all of the forms at healthcare.gov/exemptions.

For those exemptions that should be filed through the Health Insurance Marketplace, the approval process can take a couple of weeks, so don’t wait until we file your taxes to apply for an exemption. Instead, submit your application as soon as possible. That way, it will be documented and processed in time, and we can file your tax return as soon as the IRS begins accepting returns in January.

 

What I need from you

All of the usual documentation you provide

  • If you are getting an exemption through the Health Insurance Marketplace (also called an exchange) and not claiming the exemption directly on the tax return, you will also need to provide the exemption certificate number.

 

What if I’m not exempt?
If you don’t have health insurance and don’t qualify for an exemption, you will have to pay a penalty when you file for your 2014 tax return. If that’s the case, don’t worry: We will help you calculate the exact amount of your tax penalty and work to identify any qualifying deductions that may help offset this fee.

The tax penalty, also referred to as the “individual shared responsibility payment”, is based on your family size and income. The penalty will be prorated based on the number of months you are uninsured and will increase each year.

For tax year 2014, the annual one-time tax penalty will be $95 per adult, or one percent of your total income, whichever is greater. For uninsured children in your family, the penalty is $47.50 per child, with a family maximum of $285 for the year. The tax penalty is assessed on your 2014 tax return.

Each year following 2014, the penalty increases — in 2015 the penalty is $325 per person, $162.50 per child — or two percent of your income. By 2016, the penalty rises to $695 per adult, $347.50 per child — or 2.5 percent of your household income.

We know that the tax filing process can sometimes be overwhelming and that the Affordable Care Act could potentially further complicate the process. Please know that we are here to help you navigate these changes.

 

PREMIUM TAX CREDIT (PTC)

  • The Premium Tax Credit applies to taxpayers who enrolled in a qualified health plan offered through a Marketplace.
  • Tax Payers will receive a Form 1095-A, Health Insurance Marketplace Statement, which must be provided to the tax preparer before being able to file a tax return.
  • Information included on Form 1095-A will flow to Form 8962 in order to reconcile the amount of premium tax credit.
  • Advance payment of the premium tax credit (APTC) is a payment made for coverage during the year to the insurance provider that pays for part or all of the premiums for the coverage of the taxpayer or an individual in their tax family.
  • The taxpayer must file Form 8962 to reconcile any Advance Premium Tax Credit (APTC) against the Premium Tax Credit (PTC) eligible for the tax year. If the APTC is more than the PTC, the taxpayer will have excess APTC and must repay the excess, subject to certain limitations. If PTC is more than the APTC, the taxpayer can reduce their tax payment or increase their refund by the difference.

 

INDIVIDUAL SHARED RESPONSIBILITY PAYMENT (SRP)

Beginning in 2014, your clients must have health care coverage, have a health coverage exemption, or make a shared responsibility payment with their tax return. (For clients subject to the individual shared responsibility payment, they may be eligible for the exemptions below.)

  • Minimum essential coverage is coverage under a government-sponsored program, coverage from an employer, a plan that they purchased in the individual market, or certain other coverage.
  • For 2014, the annual shared responsibility payment amount is the greater of: a) 1% of household income above filing threshold, or b) Family’s flat dollar amount, $95 per adult and $47.50 per child, limited to family maximum of $285

 

Contact FirstrateTaxes.com for any questions you may have.

 

Posted in Obamacare, TAX CREDITS, Uncategorized

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Health Savings Accounts

Feb 13

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rastewu's avatarFirst Rate Tax Services ®

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…

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Penalty on Early Distribution from your Retirement Account

Jan 22

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401K

Are you thinking of taking money from your retirement account to satisfy your ever growing thirst for additional money in your pocket? If so, then think again. Because Uncle Sam is going force you to report such distribution as income and even go further to slap you with a 10% Penalty during Tax Season.

Distributions from a 401K Plan, IRA (both Traditional and Roth) or any other Retirement Plans MUST generally be included in your Taxable Income. Additionally a 10% Tax Penalty is added if the distribution is made before you reach age 59 ½ years of age (Don’t ask me why the ½ or not making it just 60years).

The 10% Penalty on Early Withdrawal from Retirement Accounts

The additional tax on an early distribution is 10% of the taxable amount, which in itself is included to your Taxable Income. It is important to consider these consequences before tapping into your Retirement funds prematurely.

Avoiding the 10% Early Distribution Penalty
You can avoid the 10% Penalty under certain conditions outlined below but the inclusion of the distribution in your Taxable Income cannot be avoided.

Reporting the Early Distribution Penalty on your Tax Return
You figure out the additional tax on Form 5239 (Refer to Instructions for completing this form on irs.gov or talk to a qualified Tax Professional. Retirement Plan administrators usually issue Tax payers with a FORM 1099-R whenever they make distributions from their Retirement Accounts and the type of distribution is coded in Box-7. The code in Box-7 specifies the type of exception to the 10% penalty. The exceptions are listed below:

Exceptions to the Early Distribution Penalties
You are not required to pay the additional 10% penalty if you qualify for the following exceptions broken down by the type of Retirement Fund:

Exceptions for Early Distributions from an IRA:

Exceptions for Early Distributions from a 401(K) or 403(b) Plan:
  • You had a “direct rollover” to your new retirement account.
  • You received a lump-sum payment but rolled over the money to a qualified retirement account within 60 days.
  • You were permanently or totally disabled.
  • You paid for college expenses for yourself or a dependent.
  • You were unemployed and paid for health insurance premiums.
  • You bought a house
  • You paid for medical expenses exceeding 10% of your adjusted gross income. Or
  • The IRS levied your retirement account to pay off tax debts.
  • You had a “direct rollover” to your new retirement account.
  • Distributions upon the death or disability of the plan participant.
  • You received the distribution as part of “substantially equal payments” over your lifetime.
  • You paid for medical expenses exceeding 10% of your adjusted gross income.
  • The distributions were required by a divorce decree or separation agreement (“qualified domestic relations court order”).

Distribution Codes for 1099-R Box 7

Distribution Code

Meaning

1

 Early distribution, no known exception –Figure out using FORM 5329

2

 Early distribution, exception applies

3

 Disability

4

 Death

5

 Prohibited transaction

6

 Section 1035 exchange

7

 Normal distribution

8

 Excess contribution

9

 Cost of life insurance protection

A

 May be eligible for 10-year tax option

D

 Excess contribution

E

 Excess annual additions

F

 Charitable gift annuity

G

 Direct rollover

J

 Early distribution from Roth IRA

L

 Loans treated as deemed distributions

N

 Recharacterized IRA contribution

P

 Excess contribution

Q

 Qualified distribution from a Roth IRA

R

 Recharacterized IRA contribution

S

 Early distribution from a SIMPLE IRA in the first two years, no known exception

T

 Roth IRA distribution, exception applies

—Ras Tewu

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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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Retirement Plans

Jan 30

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What is an IRA?

There are several types of tax-advantaged Individual Retirement Accounts (IRAs) that you can use to save for your future retirement. Some are for individuals and others can be used if you’re self-employed or have a small business. You must have some amount of taxable earned income—from a job, business, alimony, or from your spouse if you file taxes jointly—to be eligible to contribute to an IRA.

Many people get confused by thinking that an IRA is an investment. An IRA is simply an account that gives your investments certain advantages while they’re owned inside the account.

For the purpose of this article, we shall discuss 2 types of IRAs. Traditional IRA & Roth IRA.

What is a Traditional IRA?

A  traditional IRA is the most basic type for individuals. If you have earned income and are younger than age 70½, you’re eligible to contribute to a traditional IRA. For 2011 and 2012 you can contribute an amount equal to your taxable income up to $5,000 or up to $6,000 if you’re age 50 or older.

The major advantage of a traditional IRA is that your contributions are tax-deductible, which means they reduce the amount of tax you have to pay. Here’s an example: If you contribute $4,000 to a traditional IRA and your average tax rate is 25%, you cut your tax bill by $1,000 ($4,000 x 0.25 = $1,000).

A traditional IRA allows you to defer tax until you make withdrawals at some future date. You can begin taking distributions from a traditional IRA once you reach the official retirement age of 59½, and you must take minimum distributions after you turn 70½. In general, early withdrawals are subject to income tax plus a 10% penalty.

What is a Roth IRA?

Roth IRAs are not tax deductible. In other words, you must pay tax on Roth contributions upfront, in the current year—but that’s where your taxation ends. When you retire and take distributions they’re completely tax free. There’s no requirement to take minimum distributions at age 70½, as there is with a traditional IRA. The funds in a Roth IRA can sit idle forever, which makes it a nice way to pass money to your children and grandchildren.

If you decide to take a withdrawal from a Roth IRA, you can tap your contributions at any time tax free. However, earnings in the account are subject to income tax plus an additional 10% penalty if you’re younger than age of 59½.

Just like with a traditional IRA, as long as you have earned income you can contribute up to $5,000 or up to $6,000 if you’re age 50 or older. However, when your income exceeds annual limits for your tax filing status, you become ineligible to contribute to a Roth IRA.

Eligibility

Generally, if you have earned income from a job or alimony, you can establish a Traditional IRA before the tax year when you reach age 70½. Contributions can be fully or partially tax-deductible depending on your individual circumstances. Contributions are fully deductible if you do not participate in an employer-sponsored retirement plan. (See below for other limits on deductibility.) Beginning in the calendar year in which you reach age 70½, you can no longer make contributions to a Traditional IRA.

 If I am covered by a retirement plan, am I eligible to open an IRA?

You may have a Traditional IRA even if you are covered by a qualified pension or other retirement plan e.g. 401K but you may be limited in the amount of the contributions that are tax-deductible. To be covered means that money is contributed to your account, whether or not you contribute yourself.

 When can I contribute?

You can open an IRA, or contribute to an existing IRA, at any time from January 1 of a given year up to the tax filing day of the following year. The tax filing day is the absolute deadline, even if you have received an extension beyond that date for filing your tax return. For tax year 2010, you can open or make contributions to a Traditional IRA until April 18, 2011.

How much can I contribute to IRAs each year?

You can currently contribute up to $5,000 or 100% of your taxable compensation* for the year, whichever is less. Alimony is counted as earned income, but pension and investment income are not. The $5,000 limit applies to total contributions to all IRAs (Traditional and Roth).

Is my IRA contribution tax-deductible?

If you or your spouse do not participate in a corporate, government, Keogh, or other retirement plan, then your Traditional IRA contribution is generally fully tax-deductible, whatever your income level. (Contributions to Roth IRAs are not deductible.)

If you do participate in an employer’s qualified retirement plan on any day during the tax year, you can still contribute to a Traditional IRA, but the deductibility of your contributions declines to zero between certain modified adjusted gross income (“MAGI”)* ranges.

 What if I don’t have $5,000?

The law doesn’t require a minimum contribution

What if both my spouse and I have earned income?

If both of you have earned income, you can establish separate Traditional IRAs and can contribute up to a total of $10,000 annually (up to $5,000 each). If your combined income is less than $10,000, the combined IRA contributions are limited to 100% of your income.

What if my spouse doesn’t work?

If one spouse has less than $5,000 of earned income, a Traditional IRA can be established based on the income of the higher-earning spouse. In this case, the combined total contributed may be up to $10,000 annually, divided between the two accounts in any way desired, so long as neither account receives more than $5,000.

Can I withdraw money from my Traditional IRA?

Beginning at age 59½, you can withdraw money from your IRA as desired without penalty. You can do this whether or not you are still employed. You may be taxed on these withdrawals.

Withdrawals before age 59½are called “early distributions,” and are subject to a penalty of 10%, in addition to any tax that may be due. There are several exceptions to the penalty on early distributions:

  • Unreimbursed medical expenses >7.5% of your adjusted gross income.
  • Health insurance, if unemployed and distributions are not more than the cost of your medical insurance.
  • You are disabled.
  • Qualified education expenses, and the distributions are not more than these expenses.
  • You use the distributions to buy, build, or rebuild a first home.
  • You are the beneficiaryof a deceased IRA owner.
  • You are receiving distributions in the form of an annuity.
  • The distribution is due to an IRS levy of the qualified plan.
  • You withdraw money in a series of “substantially equal period payments” based on your life expectancy.

Do I have to take distributions from my Traditional IRA between ages 59½ and 70½?

No, you have complete flexibility between ages 59½ and 70½.

Do I have to take distributions from my Traditional IRA after 70½?

Yes. By April 1 following the year in which you reach age 70½, and by December 31 thereafter, you must begin to withdraw a certain minimum amount annually. If by the applicable deadline the required minimum amount is not distributed, the amount not taken is subject to a 50% IRS excise tax. This tax may be waived by the IRS upon submission of a written request.

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Home Office Deduction

Jan 16

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If you use part of your home for business, you may be able to deduct expenses for the business use of your home. These expenses may include mortgage interest, insurance, utilities, repairs, and depreciation. The home office deduction is available for homeowners and renters, and applies to all types of homes, from apartments to mobile homes.

There are two basic requirements for your home to qualify as a deduction:

 1. Regular and Exclusive Use.

You must regularly use part of your home exclusively for conducting business. For example, if you use an extra bedroom to run your online business, you can take a home office deduction for the extra bedroom.

2. Principal Place of Your Business.

You must show that you use your home as your principal place of business. If you conduct business at a location outside of your home, but also use your home substantially and regularly to conduct business, you may qualify for a home office deduction. For example, if you have in-person meetings with patients, clients, or customers in your home in the normal course of your business, even though you also carry on business at another location, you can deduct your expenses for the part of your home used exclusively and regularly for business.

Generally, deductions for a home office are based on the percentage of your home devoted to business use. So, if you use a whole room or part of a room for conducting your business, you need to figure out the percentage of your home devoted to your business activities.

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 above 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.

Posted in Deductions

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