The new tax season brings no earth-shattering tax law changes. The big news, of course, is the election of Donald Trump. His tax plan does call for modifications, anticipated for 2017. He certainly wants to reduce tax rates. Therefore, those with the ability to “income shift” should do so. That means arranging to earn less this year and more next year to take advantage of next year’s lower rates. If you are self-employed, for example, you could delay collecting money from your customers until January. You could also pay all outstanding expenses in 2016 that are not due until 2017, which will lower your profit this year. Since income taxes are only levied against profit, you will save. This strategy is for the wealthy, who are the ones really affected by this.
The other major piece of his plan calls for limiting itemized deductions. According to one version, these deductions would be capped at $200,000. That sounds like a lot of money, but for the wealthy, such a cap would make a big difference. In 2016, they can deduct up to 50% of their income as charity. In 2017, it will be deductible at a lower rate – if it is deductible at all! (If the Trump plan goes forward as currently proposed, this charity would not be deductible when past the threshold!) So, the wealthy should for sure give charity now and not wait until 2017. Experts expect a surge in charitable giving before the end of this year. Ditto for pre-paying state income taxes.
Earned Income Credit
The earned income credit is the magical government handout program, in which the government gives the working poor with children extra refunds. How much? It can be over $6,000 if you have three children. And that is just the federal government. The state of Maryland will add to that upwards of $1,500. Your children must have a social security number. But there is a new law: If that number was issued after your return was due, you will not get a dime. Let’s say your child is born in December 2016 and you do not have the SS number. You file your return without a number for the baby. You finally get the number in May. You could lose your entire credit! If the SS number is held up, you had better make sure you have filed a valid extension for your income tax! And, as I have written in the past, make sure that you put the baby’s name on the birth certificate in the hospital so you get an SS number right away and do not get caught up in delays.
Claiming College Tax Credits
Here is an important issue that really affects our community. If you pay college tuition, you get some big tax savings. Here is the new “but.” You have to receive a 1098-t tax form to claim it. This sounds simple since this form is sent to every student automatically from the college. So why would you not receive it? Well, many of our kids are in dual programs. They might be enrolled in a college in the U.S. but be attending yeshivas in Israel, which are overseas programs of these American schools.
If you are in yeshiva and not enrolled in an American college, you certainly cannot claim this tax credit. The law is clear you need to be enrolled in an eligible educational institution. However, if you are enrolled in the yeshiva program of an American college, you need to get that tax form from the college. Now it gets complicated. Yes, you are enrolled in an American school, but most of your checks are written to yeshiva. Are those deemed to have been paid to the American college? Do they need to be? Pretty unclear. I have always maintained that they are allowable. Here is why: One can deduct all tuition and fees required to attend college. This word fees seems to certainly include Israeli yeshiva tuition. This is because the American college requires you to be attending one of their partner yeshivas in Israel. Therefore, the money paid to Israel is like a fee paid to the American college overseeing this. Some accountants, however, might say that these yeshiva payments do qualify. Furthermore, room and board do not count, and we need to figure out how much of the yeshiva tuition is for tuition and how much is for room and board.
Let’s review: You need a 1098-t to claim this credit, but your deduction doesn’t have to equal the dollar amounts printed on this 1098-t. The 1099-t can be confusing for many reasons: first, because, for various reasons, the numbers will often not match what you’ve paid. The reason for this is beyond the scope of this article. This one issue regarding yeshiva tuition means that you absolutely need a frum accountant who is used to dealing with this issue. Yes, that is self-serving but is an honest statement.
More about College
If any of your dependents is in college, you can get a valuable tax credit. The more valuable one is called the American Opportunity tax credit. Planning can be critical here, as you are juggling various expenses and various years. It is very easy to blow a few thousand dollars. There is a lot to say here, but basically, the credit is limited to four years. For the first four years, you can get a credit worth $2,500 if you spend at least $4,000 on tuition, fees, and supplies. Spending over $4,000 is not helpful, so watch your expenses and the timing.
You need to be enrolled at least half-time for any one semester during the year. This is easy, since there is a check box on the tax form that the college gives out. Actually, it is not so simple. What about mini-mesters and summer college? Can those credits be added to spring or fall to make you half-time, or are those stand-alone semesters?
You also need to be pursuing a degree. This is an unclear rule, if you ask me. What does that requirement demand of you? Is it a question of what you are thinking when you enroll? No one knows; even the official IRS form, called a 1098-T, which is filled out by the college, does not have a check box for the pursuing a degree question. However, be warned, because the rules do read that you must be “pursuing a degree, certificate, or any other recognized credential.”
Some further confusion: There are two separate four-year rules here. The simple rule is that you can claim the credit for a maximum of four tax (calendar) years. The second rule is that you can claim it for the first four years of college. This is not clear. What if you went to college 20 years ago and are now going back to a college that does not accept the credits you earned at that time? Do your four years start over? It seems they do. What about high schoolers taking college courses? What if it takes you seven years to get a four-year degree? Could you claim it for the last four years if you did not claim it for the first three years? I assume that this four-year rule is another way of saying “enough credits to get a bachelor’s degree.” Furthermore, it is clear that one looks at the student’s status as of January 1 of the year. Therefore, if A graduated with a bachelor’s in June 2016 and immediately starts a masters program, the cost of the master’s program would count, since, as of Jan 1, 2016, he was still an undergraduate. Bear in mind that this money can be used for school supplies, including a laptop. Imagine buying a top-of-the-line $2,000 Mac book and getting it for free due to this credit. Wow!
There is another college credit called the Lifetime Learning credit, which saves you 20% of college tuition of $10,000 per family. It does not include books and supplies. For this one, you do not need to be half-time nor is it limited to four years.
The tax fundamentals remain the same. Here are some general pointers:
1) Plan ahead. For example, if you are married on the last day of the year, you are considered married for tax purposes. Check how marriage effects your taxes and schedule the wedding accordingly.
2) Obviously, the lower your income, the better. Pensions, daycare, work expenses, and health expenses can be paid for with pretax dollars.
3) Sign up for your company’s pension plan. Not participating is a big mistake, especially if the company matches your contribution. You save taxes now and prepare for old age down the road.
1) Claiming older children (over 18) as dependents might depend on their income. Keep an eye on their earnings. If it goes over $4,000 they would have to be students to be claimed. This can get complex. Warning: I have seen college kids walk into storefront tax preparers and file taxes without telling their parents: “Look, Ma – no hands!” The IRS then rejects the parents’ tax return when they file claiming that same child. Folks, no family tax moves without getting everybody on the same page!
2) Itemizing: As usual, you can deduct charity, mortgage interest, real estate taxes, and state income taxes. Here in Maryland, itemizing deductions can reduce your tax bite significantly. If you are close to the itemizing limit, up your charity to get over the limit.
3) Remember that a charity donation of $250 or more needs a receipt. Also, if you drive as a volunteer (for NWCP or Bikur Cholim, etc.) you can deduct for each mile driven.
4) Those who cannot itemize (because the total comes to less than the standard deduction) can work a strategy called “bunching.” Essentially, you give all your charity and real estate taxes every other year. It sounds complicated, but it’s not and it can mean serious savings every two years.
5) If you sold stocks this year, you need to know the “cost.” This means let’s-hope-you-have records. If a stock became worthless, the entire cost is deductible.
6) Another tip: Clean up the house and donate your unwanted stuff to Goodwill! Photograph the stuff, make a careful list, and get a receipt.
7) Daycare and summer camp are eligible for a tax credit if both parents work. This caps at $6,000 per year if two children are receiving care. (That means you save 28% of $6,000). The money does not have to be evenly spent on the children. Spending over the $6,000 a year is a waste; try to save it for next year!
8) If your investment expenses added to your job expenses are over 2% of your income, the excess is an itemized deduction. This is not very common. If you are close, bunching can work here as well.
9) Maryland follows the federal deductions but adds a few of its own. Deductions are allowed for part of your pension and social security income, and there are credits for long-term care insurance as well as for continuing education for public school teachers.
10) You can participate in the Maryland College Investment Plan. You open a special account at T. Rowe Price that allows you to put aside $2,500 for each child, and you can get a tax deduction – on your Maryland tax return only. If you are paying for college, this might make sense, but it is complicated, because doing this will make the federal tax credits more complex. Those of you who pay a lot in college tuition should for sure look into this.
Here are some other things to think about:
1) If debt is forgiven, you will receive a 1099-C, usually taxable. This happens if a credit card company writes off a balance. You had better get advice, as this can be a major ouch!
2) A “nanny tax” applies to all household employees. Most people would love to skirt this one. One legal way to do that is to pay under the limit: for example, if you pay less than $1,900 per year to any one employee, and do not top $1,000 per quarter in total payment to all employees.
3) If you are eligible for the earned income tax credit (for the “working poor” with children), your investment income cannot exceed $3,400. This is a big headache if you own mutual funds, since you never know – nor can you control – when they create capital gains. You can blow this credit by going just one dollar over the limit. The earned income credit is a massive money handout that you do not want to lose.
4) If you are an employee and spend money for your job, these expenses can be tax free if your employer reimburses you. Better keep good records and be sure that you are being reimbursed for what you spend and no more.
5) Lawsuit awards for nonphysical damages are generally taxable.
6) Open a bank account called an HSA (health savings account) if your health insurance policy makes you eligible (high deductible) for one. This is an important deduction and often overlooked!
7) If you refinanced your home, the settlement sheet needs to be analyzed for deductions. It might contain deductions for interest, points, and real estate taxes.
Obamacare means that you are required to buy health insurance. If you don’t, you have to pay a penalty. That is the bad news. The good news is that it is not too hard to get health insurance or Medicaid. In addition, there are many exceptions to the penalty.
The cost of health insurance is now tied to your income. Yes, folks, if your income is low, you get a premium credit. This is the main “money grab” of Obamacare. It means that a massive welfare system is built into the tax system. Let’s say the monthly premium is $1,200. If your income is low, the government will chip in $500 per month. If your income rises, they may only chip in $300. Clearly, Obamacare makes it much more important to keep your income low! As your income goes up, four things increase: federal taxes, state taxes, your social security contribution, and your health insurance cost! Again, planning is important.
A Few More Pointers
1) If children earn money, they may have to pay at their parents’ tax rate. This is called the kiddie tax and applies through age 23 for students!
2) Long-term care insurance might be deductible.
3) IRA accounts can give money directly to a charity. This can help in various ways.
4) If you have a financial account overseas, you have to file some important papers each year: big penalties if you ignore this one.
5) Be certain that a person is named as beneficiary in all your retirement accounts.
6) Do not put money into your IRA until you find out if you are allowed to under tax laws.
7) Get advice before any significant financial move, especially if you are creating income. If grandma is giving you stock which you will sell, you need advice. This is because grandma could sell the stock herself at a lower tax rate and give you the money instead. The more money involved, the bigger the question. If grandma is giving you her house, the question is really complex.
Folks, all the details discussed in this article are very important: First, doing it correctly keeps your taxes down. Second, keeping your income low might increase your eligibility for government handout programs. Hopefully, with a little planning you will not have to pay any more than you have to.
Eli Pollock CPA can be reached at firstname.lastname@example.org.