Small Business Tax Credit

Small business owners need every tax credit that they can get.  One tax credit that you are likely entitled to but may not know about is the Small Business Health Insurance Premiums tax credit.

For tax years 2010 through 2013, the federal income tax credit was worth a maximum 35% of premiums paid by small business employers.

Starting in 2014, the federal income tax credit is worth a maximum 50% of premiums paid by small business employers.

 

There are a few qualifications that you must meet in order to claim this credit:

1. Starting in 2014, the premiums must be paid on a qualified health plan offered through a Small Business Health Options Program (SHOP) Marketplace.
   
   In California, there are, currently, 6 health insurance companies that are available for year-round enrollment in the SHOP program.  To view the list of qualifying health insurance companies and the available plans, click here.
   
   
2. There must be fewer than 25 full-time equivalent employees.
   It is important to understand that this does not mean less than 25 employees.  The number of full-time equivalent employees is a calculated figure that is determined by taking the total number of hours worked by all non-owner employees and dividing that number by 2,080.  The resulting figure is then rounded down to the nearest whole number.
   
   For example, if you had 13 employees and they all worked for a total of 1,500 hours during the year, you would have 9 full-time equivalent employees (13 x 1,500 = 19,500; 19,500 / 2,080 = 9.38; 9.38 rounded down is 9).
   
   
3. The average wages must be less than $50,000.
   
   To determine this number, you divide the total wages of the non-owner employees by the number of full-time equivalent employees.
   
   For example, if you paid your employees a total of $390,000 during the year, you would have average wages per full-time equivalent employee of $43,333 ($390,000 / 9).
   
   
4. The health insurance premiums must be paid through a qualifying arrangement.
   To be considered a "qualifying arrangement", the employer must pay at least 50% of the single-coverage insurance for its employees.  The IRS has ruled that the employer does not have to pay for the premiums covering the employee's spouse or children.  Generally, an employer must pay a uniform percentage of the premium cost for each enrolled employee's health insurance coverage.  However, exceptions exist for businesses who utilize either composite billing (uniform premiums paid rather than a uniform percentage) or list billing (differences in premiums exist for each employee based upon age or other factors).

The maximum credit is for 50% of the premiums paid in 2014 (35% in prior years).  However, it may be less than 50% if: 1) there are more than 10 full-time equivalent employees; 2) the average wages exceeds $25,000; or 3) actual health insurance premiums exceed average premiums paid for health coverage in the employer's area.

This tax credit can be carried back or forward to other tax years. 

In addition to the tax credit, an employer is entitled to claim a deduction for the excess health insurance premiums.  For example, if an employer pays $10,000 in health insurance premiums and claims a $5,000 tax credit, the employer would be entitled to take a $5,000 deduction for the remaining health insurance premiums.

If you have any questions about the Small Business Health Insurance Premiums tax credit, or if you would need assistance in claiming this tax credit, please do not hesitate to contact me.

As always, I appreciate you leaving your feedback in the comments section below.

Business or Hobby?

Are you living the dream?  Do you have a business that you are passionate about and that you cannot wait to get back to everyday?  You may think it is a business, but the IRS may think that it is your hobby.

What is the difference?

The main difference is that you are entitled to deduct all the ordinary and necessary expenses associated with operating a business.  However, your hobby related expenses may not be deductible, and to the extent they are the deduction is limited.

There are 9 factors used to determine if the taxpayer is engaged in a business or a hobby.

1. Whether the activity was conducted in a business-like manner.  Basically, did you have a business plan and keep financial records?  Did you keep a separate bank account for the activity?  Are you doing the types of things that a prudent business person would do?
2. The taxpayer's expertise or that of his advisors.  You need to have sufficient expertise to show that you know how to make that activity profitable.
3. The time and effort expended.  Essentially, is this activity something that you do during your free time, or are you devoted to it full-time?
4. The taxpayer's expectation that assets used in the activity may appreciate in value.  If your hobby involves the accumulation of assets, like coin collecting, you must show that you purchased the assets with the intention of eventually selling them for a profit.  A coin collector who knows that the coins will go up in value but has no intention of ever selling his coins is involved in a hobby, not a business.
5. The taxpayer's success in similar or dissimilar activities.  If you have been very successful in related ventures, then even if this activity is losing money it is likely a business.  On the other hand, if all your similar activities have lost money it is more difficult to prove that you are engaged in the activity with the hope of making money.
6. The taxpayer's history of income or loss.  This is similar to the prior factor, except that it looks only at this one activity.  If you made consistent income in the past it is more likely to be considered a business than if you had only sporatic income or consistent losses.
7. The amount of occasional profits.  The more income you earn from the activity, the more likely it is that it will be considered a business.
8. The taxpayer's financial status.  If most of your income is derived from other sources, then this activity will look like a hobby.  On the other hand, if most of your income comes from this activity it looks like a business.
9. The personal pleasure the taxpayer derives from the activity. This is a subjective factor.  You can love your job (and I would hope that you do), but if it looks like that is a greater motivation for you than money it will likely be deemed a hobby.

Outside of these factors, there is a safe harbor available to taxpayers.  If the activity has been profitable for 3 out of the last 5 tax years, including the current year, then the IRS will presume that the activity is carried on for profit (i.e., that it is a business).  If you breed, show, train, or race horses, you only have to be profitable for 2 out of the past 7 years in order to qualify for this safe harbor.

If you need help determining whether you are engaged in a business or a hobby, or if you have any other questions related to this please do not hesitate to send me an e-mail.

As always, I appreciate any feedback you have.  Please leave it in the comments section below.

Estate Tax Planning: QTIP Trusts

Do you care what happens to your assets after you die?

I suspect that it is very important to you.  You may want to make sure that your spouse is provided for, or that your children will be the ones that inherit your property.  What you probably do not want is to pay a penny more in estate taxes than you have to.

Everyone's situation is different, and an estate planning tool that may work for someone else may not work for you.  Therefore, it is very important that you work closely with an estate planning attorney and a CPA to come up with a plan that will best fit your needs.

A few months ago we discussed one estate tax planning tool, the portability election.  Today, I am going to go over the basics of the Qualified Terminal Interest Property (QTIP) trust.

What are the goals of a QTIP Trust?

While there are potential estate tax minimization benefits to this type of trust, the primary benefits to making the QTIP election are in maintaining control of the assets after death.  Specifically, it allows you to provide for your spouse during the remainder of his/her life, but ensure that ultimately the assets will go to the beneficiaries that you choose.

Because of this, QTIP trusts are very popular in situations where one spouse has children from a different relationship or where remarriage after the death of the first spouse is likely.

How does the QTIP Trust work?

Under the terms of the QTIP trust, all of the income earned by the assets placed in the trust goes to the surviving spouse.  In addition, most QTIP Trusts allow for the trustee to give the surviving spouse some of the trust principal (the assets) in addition to the income if it serves a specific purpose.  For example, if there is a medical emergency and the surviving spouse does not have enough money to pay for treatment, the trustee may be allowed by the trust to take assets out of the trust to pay the medical bill.

Upon the death of the surviving spouse, all of the trust assets will go to the beneficiaries named by the first to die (the spouse who originally funded the QTIP trust).

What are the estate tax benefits?

The assets placed into a QTIP trust qualify for the unlimited marital estate tax deduction.  This means that they will not be subject to the estate tax at the time of the first spouse to die's death.  However, these assets will be included in the surviving spouse's estate and subject to the estate tax at the surviving spouse's death.  If the portability election is made at the time of the first spouse to die's death, the surviving spouse will be able to use his/her prior deceased spouse's unused exclusion amount in addition to his/her own exclusion.

If you think that the QTIP trust is an estate planning tool that may work for you, I would be happy to refer you to a great estate planning attorney.

I would also be happy to answer estate tax planning questions that you have. Please just send me an e-mail.

As always, please leave your feedback in the comments section below.

Forced to do a Short Sale of Your Home?

In a letter to Senator Barbara Boxer, the IRS took the position that when a California homeowner sells the property through a "short sale" the mortgage will be treated as a non-recourse debt.

I know, you are wondering what that means, let alone if it is in English.

Let me try to break it down for you.

Under the Internal Revenue Code, when you owe someone money and that person forgives the debt, you are treated as having received income equal to the amount of forgiven debt.  This is known as "cancellation of indebtedness (COD) income".

Example:  Jill loans John $20.  A week later Jill tells John that he does not have to repay her the $20.  The IRS considers that $20 income to John because he would not have had it unless there was first a loan and then the loan was forgiven.

Why would a lender, like a bank, forgive your debt?  Typically, it is because the lender is convinced that you are unable to repay it.  In a housing situation, it may be because the house is "under water" and the bank has decided that it makes more financial sense to allow the homeowner to do a short sale (in which the bank approves a sale for less than the mortgage on the property, and forgives the debt on the excess mortgage) than risk having the homeowner stop making mortgage payments and be forced into a foreclosure.

For the past few years, Congress and California had an exception to the normal COD income rules.  The exception was that if the cancellation of indebtedness is for a mortgage on a person's principal residence, the COD income would be excluded from the person's taxes.  However, this exception expired in California on December 31, 2012, and it expired for the federal government on December 31, 2013.

The expiration of this exception was alarming to many.  It meant that not only would people be losing their homes, but they would have to pay the IRS and California significant amounts in taxes in order to lose their homes.  Senator Boxer reacted and sent the IRS a letter asking how it intended to treat California short sales.

The IRS responded (IRS Letter) that because under California law a lender cannot attempt to collect the excess mortgage from the seller in a short sale, the short sale effectively converts the mortgage into a non-recourse debt.

What does all this mean to you?

It means that, in California, a taxpayer who participates in a short sale does not have to recognize "cancellation of indebtedness" income.  The debt is forgiven and there are no adverse tax consequences as a result of the short sale.

California has indicated that they will follow the IRS's position on this issue.

Are you considering doing a short sale of your home?  If so, I would be happy to discuss this more with you.  Just send me an e-mail.

Also, I would be happy to refer you to a great realtor that specializes in short sales.

As always, please leave your feedback in the comments section below.

Update: The IRS has reversed its position and now does require taxpayers to recognize the cancellation of indebtedness income unless they fall into another exclusion.

Selling Your Home?

Are you looking to sell your home?  Then you may be able to take advantage of a major tax benefit!

You may be entitled to exclude $250,000 of gain from the sale of your personal residence.  If you are married, you may be entitled to exclude $500,000 of gain!

In order to exclude this gain, you must meet 3 tests.

1. Ownership Test.   You must have owned the home as a principal residence for at least 2 of the 5 years prior to the sale.  If married, either or both spouses can meet this test.
2. Use Test.  You must have used the home as a principal residence for at least 2 of the 5 years prior to the sale.  If married, both spouses must meet this test.
3. Frequency Test.  The exclusion applies to only one sale every 2 years.  If married, this test is not met if either spouse has claimed this exclusion within the past 2 years.

If both spouses do not meet the use and frequency test, then a portion of the exclusion may still be claimed.  In this case, instead of being able to claim the full $500,000 exclusion, the couple would only be able to claim the $250,000 if one spouse meets all 3 tests.

Even if you do not meet these tests, you may be able to claim a reduced exclusion!  A reduced exclusion is available if you sold your principal residence because of:

• A change in your place of employment;
• Health reasons; or
• Unforeseen circumstances.

There is a safe harbor rule defining what qualifies under each of these three exceptions.

Lets look at an example.  In April 2012, John and Jane Smith purchased a small, 2 bedroom house for $500,000.  In September 2013, Jane gave birth to twins and they decided that they needed a larger home to accommodate their larger family.  In October 2013, with the help of a great realtor, the Smiths sold the same house for $800,000.

The Smiths have $300,000 of gain on the sale of their home.  They are afraid they will have to pay taxes on the full $300,000, but they talk to a CPA and learn that they do not have to.  Although they did not meet the 2 year ownership and use tests, they qualified for a reduced exclusion because the birth of multiple children from the same pregnancy is considered an "unforeseen circumstance."  Because they owned and lived in the house for 18 months, they are able to take a reduced exclusion of $375,000 which is enough to eliminate their entire taxable gain.  They do not have to pay any tax on the sale and can use the extra $300,000 to buy a bigger house!

If you are considering selling your home and would like to learn more about this exclusion, please do not hesitate to send me an e-mail.  I would also be happy to talk to you about how having a home office or converting the house into a rental property will affect this exclusion.

Also, I would be happy to refer you to a great San Diego realtor.

As always, please leave your feedback in the comments section below.

Organizing Your Taxes

For many people, the most daunting part of having their annual income tax returns prepared is simply getting themselves organized.

 

 

At Reid, Sahm, Isaacs & Schmelzlen, LLP, we attempt to make this process easier on our clients by providing them with a tax organizer in early January.  The tax organizer simply reminds the client of the various tax forms that they will receive, and also provides a space for clients to provide other necessary information, such as how many business miles they drove during the year or what their total medical expenses were.

 

Just in case your CPA has not provided you with a tax organizer and you are feeling overwhelmed, here is some advice on how to organize your documents.  I would suggest creating 3 separate "piles".

1. Tax Documents

   Over the next month, you will be mailed a number of tax documents.  These include your W-2, and a number of documents that start with either the numbers "1098" or "1099".  It may also be a K-1 if you are a partner in a partnership or a shareholder in an S-Corporation.   To keep it simple, I would simply group these by type (all the W-2s together, etc.)  Your CPA will gather the necessary information from these forms directly, so unless there is something missing there is no need for you to do anything further with them.
   
   
2. Financial Statements
   

   If you own a business (as a sole proprietor) or rental property, you most likely are already keeping track of your income and expenses.  You may receive some tax documents, like a 1098 for the mortgage interest, but the most important numbers are located within your "books".  Just check these statements to make sure that they are accurate, and then provide them to your CPA.

    
3. Other Records
   

   In order to claim your deductions and credits, it is up to you to find the records proving that you are entitled to the deduction.  This means keeping track of your property tax statements, medical expenses, charitable contributions (you need to keep the acknowledgement letters you receive), and the amounts you spent as part of your job that you were not reimbursed for.  Don't forget to check your credit card statements because a lot of your deductions may be listed there for you.  This is the most challenging part of getting your documents ready for your CPA, but try to think of it as the most rewarding part because the receipts you find potentially mean the less taxes you will have to pay.

If you have any questions or need help preparing your 2013 income taxes, please do not hesitate to send me an e-mail.

 

As always, I appreciate all the feedback you leave in the comments section below.

Company-Provided Life Insurance

Does your company provide you with life-insurance?

If your employer sponsors a group term-life insurance policy, you can receive up to $50,000 of coverage tax-free.

Any coverage in excess of $50,000 is taxable to the employee, and the taxable amount is based upon an IRS formula.

Your spouse and dependents may also be covered by the group life insurance policy.  Up to $2,000 of coverage is tax-free.  An IRS formula is used to determine the amount of taxable income you will treated as earning for any coverage in excess of the $2,000 amount.

When the life insurance proceeds are eventually paid due to the death of the insurance, the life insurance proceeds are not subject to taxation.  This is even true if the benefits are received before death if the insured is terminally or chronically ill.

Your employer may even take a tax deduction for a portion of the premiums paid as long as the plan does not discriminate between employees and your employer is not a beneficiary under the life insurance contract.

All this sounds great, right?

There are significant limitations for self-employed individuals (which general includes sole proprietors, partners, members of an LLC, and more than 2% S-corporation shareholders).  As a self-employed individual, you are not treated as an employee for these purposes, and therefore you are not allowed to take a business deduction for the life insurance premiums relating to coverage on you or your family.

Also, if the employer owns the life-insurance contract, the business must include the death benefit proceeds paid (to the extent they exceed the premiums paid) in its gross income.  There are 3 exceptions to this:

1. The insured individual was an employee within 12 months before death;
2. The proceeds are paid to buy back an equity interest; or
3. The insured was a highly compensated employee at the time the contract was issued.

If you have questions about employer provided life insurance coverage, please do not hesitate to send me an e-mail.

If you would like a referral to talk to someone licensed to sell life insurance policies, I would be happy to do that as well.

As always, please do not hesitate to leave your feedback in the comments section below.