Unknowingly engaging in fraudulent transactions or learning you are the victim of a scam is never a good thing. When you’ve lost some of your hard-earned money due to theft, fraud, or a scam, you may be able to deduct the amount at tax time. However, state laws have three criteria that must be met to deduct losses resulting from these situations, as the taxpayer in the next situation unfortunately had to learn.

The Situation

At a local swap meet, the taxpayer met Eugene McCullough when interested in his gold clubs and accessories. After forming a quick friendship, McCullough mentioned an old Navy-mate, known as Lawyer Stanley, and claimed he had a troubled past. However, according to McCullough, Stanley was currently doing well in the diamond industry. Since the taxpayer wanted a small pair of diamond earrings, McCullough contacted Stanley, who could not make a sale because he only did wholesale.

Within a few weeks, McCullough told the taxpayer that Stanley had contacted him with an interesting offer, and that the taxpayer should consider. With an adequate initial investment, Stanley could offer her $1 million after he had acquired the diamonds and resold them. Because of her friendship and trust of McCullough, the taxpayer didn’t sign any contracts or documents, and was expecting a ROI within 10 to 30 days.

The taxpayer sent $320,000 via wire transfer to Africa World Trade, LLC, and within days McCullough told her that Stanley emailed him, excited about the millions she could make if she continued to provide capital. She could own a bank! She reacted to the immediacy of the emails, and wired $60,000 more. (more…)

Custodial Parent Rules

For purposes of deductions and exemptions, a custodial parent can claim a child as a dependent in many cases. The tax law has very specific rules about who can qualify as a custodial parent. The following describes a specific situation in which the rules of custodial parents needed to be examined closely to determine which taxpayer had the right to claim the child.

The Situation

Married in 2001, a taxpayer had a rocky relationship with his wife and was often splitting up and getting back together again. In 2013, the entire family – the husband, wife, and children – were living in the same public housing, however come 2014, the couple splits again and chooses to proceed with divorce.

When filing his 2013 tax return, the husband claimed an exemption for each of his children, along with the Earned Income Tax Credit, the child tax credit while using the Head of Household status. He didn’t include Form 8332, Release/Revocation of Release of Claim to Exemption for Child by Custodial Parent with his 2013 return.

Because of his error in not including the form, the IRS didn’t permit the dependency exemption deduction, Earned Income Tax Credit or the child tax credit for 2013. He was also ineligible to file as Head of Household, so the IRS switched his status to Single. (more…)

When planning for the next tax year, taxpayers should keep accurate records and receipts of any expenses they plan to deduct. However, if no records exist, the Cohan Rule may benefit the taxpayer in such that it states expenses may be reasonably and credibly estimated. The taxpayer in the next situation benefited from the Cohan Rule in combination with appropriate testimony.

The Situation:

A sole-proprietor of a restaurant was able to devote a small portion of the day to the business, as he had other full-time employment. His employees included a part-time chef, a dishwasher, and a minimum of one waitress, all who were paid in cash. At the time, his current girlfriend was responsible for maintaining the books, along with a little manual work around the restaurant. When they broke up, she took the business records with her.

On his tax return, the restauranteur reported $21,280 on a Schedule C, with no cost goods sold. He claimed a deduction of $9, 258 in supplies, and $5,620 in contract labor, though he reported no wages. Both deductions were denied by the IRS, citing lack of substantial proof.

In court, the taxpayer could not provide substantiation for the amounts deducted, due to his ex-girlfriend having the appropriate paperwork. His supplies deduction consisted of food and other items that would have been calculated in his cost of goods sold. He admitted that the deduction he claimed regarding contract labor was the amounts he paid to his dishwasher, cook, and waitress. (more…)

Once known as the Hope College credit, the American Opportunity tax credit can save taxpayers up to $2,500 on their 2016 return.

Remember: A tax credit is a dollar-for-dollar reduction of your taxable income. In theory, the AOTC translates to $2,500 from the government each year for each qualifying college student in your household.

While the previous credit – the Hope College Credit – was only available during the first two years of college, the AOTC is an option for taxpayers during all four years of post-secondary education. To receive the maximum credit amount, you’ll have to spend at least $4,000 in qualifying expenses. Currently, book fees, tuition, and other enrollment costs are considered qualified expenses.

High and Low Income Effects

Low-income taxpayers are happy to learn that up to 40% of the credit (around $1,000) is refundable should the credit be worth more than your tax liability. This is different form the former credit, which could reduce your tax bill to zero, but offered no refund.

Higher-income earners benefit from the expansion of families who meet the qualifications for the credit. Previously, the Hope Credit phased out at AGI over $50,000 for single taxpayers, and was eliminated completely at $60,000. For joint filers, the phase-out ranged between $100,000 and $120,000 AGI.

The new rules expanded the phase-out limits to $80,000 and $160,000 AGI for single and joint filers respectively. The credit is now eliminated at $90,000 and $180,000.

If you claimed the Hope Credit for your student’s first two years of college, you can still use the AOTC if the student is currently a junior or senior in 2016.

Qualifications

To qualify for the credit, students must be enrolled at least half-time while pursuing an undergraduate degree or other recognized credential. The credit can be used for expenses paid by you, your spouse, or your dependent child. Even if the student pays the expense, if they are listed as a dependent on your tax return, you will get the credit.

Lifetime Learning Credit

Available to those enrolled in graduate school or any other post-secondary class, the Lifetime Learning Credit is worth up to $2,000. The credit is 20% of the first $10,000 of expenses. The income limits are lower than the AOTC, however.

For 2016:

Single taxpayers experience phase-out between $55,000 and $65,000 AGI

Joint filers experience phase-out between $110,000 and $130,000 AGI

If your spouse and children are U.S. citizens, it is easy to claim them on your tax returns. You just provide their name and Social Security numbers. It can be a bit more difficult to claim a non-U.S. citizen spouse or children on your return. But, you’re still able to claim them and take advantage of the tax benefits.

Each person that you claim on your tax return will impact your taxable income. This amount is referred to as an exemption and for 2016 you get $4,050 per person. An example of this: if you claim yourself, your spouse and two children, your taxable income would be reduced by $16,200. This would lessen your tax bill, and depending on your total income, might abolish it.

Resident and nonresident aliens

Your spouse’s residency status will determine how you can claim them as an exemption. Your spouse can either be a resident alien or a non-resident alien. Here are two ways to tell if your spouse qualifies as a non-resident alien.

  1. Your spouse has a green card which gives them government clearance to live and work in the United States on a permanent basis. This is referred to as the green card test by the IRS.
  2. Your spouse spent at least 31 days in the year in the United States and at least 183 days for the previous three years. This is referred to as the substantial presence test by the IRS.

If your spouse doesn’t meet these criteria then they are considered a non-resident alien.

Your Spouse’s Tax Status

Generally, all resident aliens are taxed just like U.S citizens. You would just list your resident alien spouse on your tax return and provide their Social Security Number. If your spouse does not qualify for a social security number they will have to get an Individual Taxpayer Identification Number (ITIN) from the IRS.

You have two options if your spouse is a non-resident alien.

  1. You can treat your spouse as a resident alien on your taxes. If you decide to do this you can file a joint tax return with your spouse. You will get an exemption for your spouse but any income earned, anywhere in the world will be taxed by the United States.
  2. You can also treat your spouse as a non-resident alien on your taxes. Doing this will not allow you to file a joint tax return and you must file married filing separately. There is still a possibility you can claim your spouse as a dependent on your return if they have no income in the United States and they cannot be claimed as a dependent by someone else.

Dependent Children that are Non-Citizens

If your non-citizen children meet the IRS definition of a qualifying child, you can claim them on your tax return as a dependent. This rule is the same that applies to children who are citizens. Your child qualifies if all the below apply:

  • The dependent is your son, daughter, stepchild, foster child, brother, sister, half-sibling, step-sibling, an adopted child or a descendant of one of these people such as a grandchild. Both biological and adopted children are treated the same.
  • On the final day of the year your child is either under the age of 19, a student enrolled full-time under the age of 24 or they are permanently and totally disabled.
  • The dependent lived with you for more than half of the year.
  • You provided over half the financial support of the dependent throughout the year.
  • Your child did not file a joint return with their spouse, if they are married, except only the claim a refund of taxes withheld or estimated taxes paid.
  • The child is a U.S. resident alien, U.S. National or a resident of Canada or Mexico.

If your non-citizen child dependent does not have a Social Security number (SSN), you’ll need to obtain an Individual Taxpayer Identification Number (ITIN) from the IRS for him or her.

 

 

Higher Ed Deductions

After 2016, the Tuition and Fees Deduction will expire. Currently, you are eligible to deduct up to $4,000 from your taxable income for tuition expenses that you paid for either yourself, your spouse, or your dependents.

Expenses paid in 2016 can be deducted if they were paid for one of the following purposes:

  • Education during the tax year
  • Education beginning during the tax year
  • Education that starts within the first three months of the next year

Qualifying Expenses

Expenses that include enrollment fees and tuition qualify for the deduction, if they are used to attend an accredited post-secondary institution of higher education. Expenses that do not count toward the deduction include:

  • Room and board
  • Transportation
  • Student health insurance and other personal expenses
  • Books and supplies, unless required to buy them from the school
  • Courses related to sports, games, or hobbies, unless mandatory as part of the degree program

Should you receive any assistance with these expenses, in the form of scholarships, grants, or other nontaxable income in regards to educational use, you’ll need to subtract them before taking the deduction. As an example, an employer sponsored tuition reimbursement plan covers $1,000 of a course that costs $1,500 total. For the deduction, only $500 qualifies.

Qualifying Persons

The deduction can be taken for expenses you paid for either yourself, your spouse, or your dependent. The only two exceptions to this rule are:

  1. if you are claimed as a dependent on another taxpayer’s return, you can’t take the deduction for higher education expenses
  2. if you are married but file a separate return, you can’t claim the deduction

Deduction Amount

Depending on your modified adjusted gross income (MAGI) the deduction amounts are $0, $2,000 or $4,000.

The income limits for different filing status are as follows:

Single

  • $65,000 or less nets a $4,000 deduction
  • $65,001 to $80,000 nets a $2,000 deduction
  • $80,0001 and greater – the deduction is eliminated

Joint

  • $130,000 or less is a $4,000 deduction
  • $130,001 to $160,000 is a $2,000 deduction
  • $160,001 and greater – the deduction is eliminated

You can’t deduct the same expense twice.

That means if you use another provision of the tax rules to deduct an expense, you aren’t able to use it for the Tuition and Fees deduction either. Additionally, you are unable to deduct expenses you paid using money that is tax-free. Expenses are ineligible to deducted if paid by:

  • Tax-free savings bond interest
  • Tax-free earnings from Section 529 plans and qualified state tuition programs
  • Tax-free earnings from Coverdell Education Savings Accounts

This deduction cannot be combined with educational credits such as the American Opportunity or Lifetime Learning credits when applied to the same student in the same year.

 

Adjusted Gross Income (AGI)

Adjusted Gross Income can impact the credits and deductions you are able to claim, this can lead to a reduction in the amount of taxable income reported on your tax return.

You are probably paying more attention to your taxable income then your adjusted gross income when you are preparing your tax return. You should also be paying attention to your adjusted gross income as it will directly impact the credits and deductions you are eligible for, this can reduce the amount of taxable income you report on your return.

Calculating AGI

There are certain deductions that will reduce your total income and help you figure out your adjusted gross income. Adjustments may change each year when you file your taxes, but several these deductions will show up on your taxes year after year. Some of the adjustments include, alimony payments to a former partner, contributions to certain retirement accounts such as traditional IRA’s, half of self-employment taxes that you are required to pay and deductions for tuition and school fees.

You will have to use Form 1040 to claim every possible adjustment, if you use Form 1040A it will reduce the number of available adjustments you can take. If you are filing a 1040EZ your AGI is the same as your totally income as the form does not allow you to take any adjustments to income.

How it affects deductions

Most common deductions taken every year by tax payers are subject to limitations by AGI. If you itemize for example you should reduce your medical and dental expenses by 10% of your Adjusted Gross Income. This means that you are only allowed to deduct the amount that exceeds 10% of your AGI. If you have a lower AGI you would be able to deduct more medical and dental expenses.

All adjustments to income are subject to an AGI limitation, even if those deductions are used to calculate AGI. If you are eligible to deduct education expenses your Modified Adjusted Gross Income will determine if you qualify.

AGI Implications

If your state requires that you file an annual tax return your AGI may also impact your taxable state income. Many states use your Federal Adjusted Gross Income as the starting point to calculate your taxable state income. If you claim tax credits, like the lifetime learning credit for school expenses, the IRS requires that your Modified Adjusted Gross income is below a certain amount to take the credit.

Explaining the 1099-MISC Form

The amount of payments you receive through a year either from a single person or a entity are reported on the 1099-MISC for the year your provided them with service

The IRS requires that any company or person who makes payments to report them on a Form 1099-MISC to both the IRS and the payee. This covers a large range of payments such as rent, royalties, prizes and awards and payments that are substituted in lieu of dividends. Although the most common use of this form is to report wages and earnings when you work as a contractor.

Who prepares the 1099-MISC?

Each payer much prepare a 1099-MISC for any non-employee payee through the year. If you work as a contractor, you may receive more than one 1099-MISC. A payer must complete the 1099-MISC if it has paid you more than $600. Although if you make $500 from 10 different payers in many cases you may not receive one 1099-MISC, but you are still required to report your earnings to the IRS. A payer must provide you with a copy of the 1099-MISC by the last day of January each year and are required to have a copy to the IRS by the last day of February.

What do you do with a 1099-MISC?

If you work as an independent contractor, you must report all your earnings on your tax return just like any employee would do. But there are a few different ways you can report your 1099-MISC earnings. If you work sporadically through the year and it is generally not your main income source you can just include the payments in the other income category on the first page of your return.

If your 1099-MISC work is your main source of income throughout the year the you will be treated as self employed by the IRS and you must report your wages on a Schedule C attachment to your return.

You are also responsible to pay any Social Security and Medicare taxes, which will you calculate and file on Schedule SE.

The 1099-MISC Bonus

If you are considered self-employed and receive a 1099-MISC, you have the advantage of claiming more deductions on your taxes that are related to your profession.

 

Do you have a student loan in which you make payments, some of which is applied to interest accrued on the loan? If so, you may be eligible to deduct some of the interest when you file your federal tax return. Your lender will report the amount of interest you paid using IRS Form 1098-E, of which both you and the IRS will receive a copy.

Form 1098-E and Loan Servicers

1098-E is distributed by loan “servicers”, otherwise known as the people who collect the payments. In some cases, this may be the actual lender of the loan, although sometimes an outside company is hired to collect payments. In either case, the servicer is required to send a Form 1098-E to anyone who pays $600 or more in student loan interest. Typically, the forms must be sent by the end of January. If you have multiple loans with different companies, you might receive multiple forms. (more…)

State Income Taxes

Each state independently determines their own income tax for residents. Depending on which state you live in, you’ll pay a percentage of the amount you earn at your job to the state government.

What are State Income Taxes

States can tax your income if you are a resident or have some other significant connection to the state. States have the option of developing their own system of taxation, though many chose to follow a structure that’s similar to the federal government. There are some states that opt to tax income on a flat rate, while other states completely forgo an income tax at all.

Flat Tax States

The following seven states tax residents’ incomes at a flat rate:

  1. Colorado
  2. Illinois
  3. Indiana
  4. Massachusetts
  5. Michigan
  6. Pennsylvania
  7. Utah

For the 2016 tax year, the flat tax rates ranged between 3.3 in Indiana to 5.1% in Massachusetts. So, whether you earn $100,000 or $1 million in earnings from Indiana, you’ll still only pay 3.3% of your income.

No-Tax States

Additionally, there are also seven states that don’t tax income at all. They are:

  1. Alaska
  2. Florida
  3. Nevada
  4. South Dakota
  5. Texas
  6. Washington
  7. Wyoming

States Using Federal Framework

Thirty-six other states along with the District of Columbia use an income tax system like the federal government. In doing so, state residents fall into specific tax brackets with different percentages that increase as they earn more. AT the state level, income tax code is usually simpler than that of the federal government. There’s less brackets and tax rates that are lower, and in some cases, states adjust taxation for inflation.

State Tax Deduction

If you live in a state that requires payment of income taxes, you may be eligible to claim a deduction of these state taxes on your federal return. You must be able to itemize your deductions in order to claim state income taxes.

To be eligible to itemize deductions, the sum of all your deductible expenses must be greater than the standard deduction allotted to your filing status. That means a single taxpayer with a standard deduction of $6,300 must have deductible expenses over $6,300 in order to itemize expenses, and claim state income tax deduction. The eligibility requirements allow you to combine your entire amount of deductible expenses into one sum to meet the standard deduction.