Green Vehicles Tax Credits

As we discussed in the previous blog post, there is a great tax credit available for individuals who install qualified energy efficient property, such as solar panels, to their homes.  You will be happy to know there are also great tax credits available to purchasing "green vehicles."

Currently, there are 2 different tax credits available depending upon the type of "green vehicle" you are purchasing:

1. Alternative Motor Vehicle Tax Credit.  This tax credit is available to individuals who purchase a qualifying fuel cell motor vehicle.  These vehicles are propelled by the power derived from one or more cells that convert chemical energy directly into electricity.  At this time, there are only 2 vehicles that qualify for this credit: 1) the Mercedes-Benz F-Cell; and 2) the Honda FCX Clarity Fuel Cell. However, as this technology continues to advance more vehicles may qualify and will be listed here.
   
   The value of this tax credit depends upon both the weight of the vehicle and when it is placed in service.  For instance, the base credit for vehicles under 8,500 pounds is $4,000 while the credit for heavy vehicles ranges from $10,000 to $40,000.
   
2. Plug-In Vehicle Tax Credit.  This tax credit is available to individuals who purchase or lease a qualifying, four-wheeled plug-in electric vehicle manufactured primarily for use on public streets.  The value of this credit ranges from $2,500 to $7,500.  The base credit is $2,500, and an additional $417 for each kilowatt hour of battery capacity starting at 5 kilowatt hours, up to a maximum of $7,500.
   
   This credit will begin to phase out for a manufacturer's vehicles when at least 200,000 qualifying vehicles have been sold for use in the United States, determined on a cumulative basis.  However, at this time no manufacturer has come close to selling 200,000 qualifying vehicles.  Click here for the IRS's list of cumulative sales by manufacturer.
   
   To qualify for this credit, the vehicle must: 1) be manufactured primarily for use on public roads; 2) weigh less than 14,000 pounds; and 3) be able to exceed a speed of 25 miles per hour.

If you are interested in learning more about "green energy" tax credits, please do not hesitate to contact me.

As always, I appreciate your feedback.  Please leave your thoughts in the comment section below.

Residential Energy Efficient Property Tax Credit

Have you considered installing solar panels to your home?  Have you heard that there is a tax "rebate" and want to know how that works?

The Residential Energy Efficient Property Tax Credit is available to taxpayers who install qualified equipment to their home.  It does not have to your main residence (it can be on a second/vacation home).  Qualified equipment includes:

• Solar Electric Equipment (i.e., solar panels);
• Wind Turbines; and
• Solar Hot Water Heaters.

The tax credit is equal to 30 percent of the cost of the alternative energy equipment that you have installed at your principal residence.

Unlike most other tax credits, there is no limit on the amount of credit available for most types of property.  However, this tax credit is non-refundable.  That means if you are not able to use the entire tax credit, then the unused portion is carried forward to the next year.

The Residential Energy Efficient Property Tax Credit is available for any qualified equipment that is installed before December 31, 2016.  However, it is currently unclear whether any unused portion of the credit will be allowed to be carried forward past the 2016 tax year.

Example
Gary and Karen had solar panels installed on their principal residence on June 1, 2014 for a total installation cost of $90,000.  They are entitled to a tax credit of $27,000 (30% of the $90,000 installation cost).

Every year, Gary and Karen have a total federal income tax due of $12,000.

For the 2014 tax year, their usual $12,000 federal income tax bill was reduced to $0.  Gary and Karen will be receiving a tax refund from the IRS for any income tax withholdings or estimated tax payments that they made during the year.  They also have an unused tax credit of $15,000 that will be carried forward to 2015.

For the 2015 tax year, again their usual $12,000 federal income tax bill was reduced to $0.  Again, instead of writing a check to the IRS they will be receiving a refund for any income tax withholdings or estimated tax payments they made during the year.  They have an unused tax credit of $3,000 that will be carried forward to 2016.

For the 2016 tax year, they will finally exhaust their remaining tax credit but only have to pay $9,000 of federal income tax.

If you are interested in learning more about the Residential Energy Efficient Property Tax Credit, or other tax credits, please do not hesitate to contact me.

As always, I appreciate your feedback.  Please leave your thoughts in the comment section below.

Casualty Losses and Insurance Reimbursement

Due to yesterday's wildfires, many of which are still burning as I write this, a large number of people have been evacuated from their homes and sadly a few people have lost their homes. Therefore, today I will be writing about the tax consequences of casualty losses and insurance reimbursement. 

However, I would first like to encourage everyone to begin to prepare now for future disasters by talking to an insurance agent about renter's insurance, home owner's insurance (which covers fires), earthquake insurance, and flood insurance.  Hopefully you will never need it, but I would urge everyone to at least consider it just in case.

A casualty loss, for tax purposes, is the damage, destruction, or loss of property resulting from an identifiable event (such as a fire) that is sudden, unexpected, or unusual.

Deductible Casualty Losses

The deductible portion of your casualty loss equals the lesser of:

• The adjusted basis in the property before the casualty or theft; or
• The decrease in the fair market value of the property as a result of the casualty or theft,
  Minus  any insurance or other reimbursement received or that is expected to be received.

Personal Use Property

For personal use property, like your home, there are 2 limitations applied to your deductible casualty loss.

1. There is a $100 reduction applied to each event that causes the casualty or theft.  This means that if your house and two cars are damaged in an earthquake, there would be a $100 reduction to the deductible casualty loss (not $300 because it was only one event).  However, if you were having a bad day and you got into a car accident and later there was an earthquake damaging your home, there would be two events so the reduction would be $200.
2. The aggregate of all your casualty losses must be reduced by 10% of your Adjusted Gross Income.  This reduction is applied after the $100 per casualty reduction.

Business and Income-Producing Property

Business and income-producing property does not have the same limitations placed on it that personal use property does.  If business property is completely destroyed, the deductible casualty loss is generally the cost of the property minus any accumulated depreciation.  If the property is damaged but not destroyed, then the loss is generally the decrease in the property's fair market value.

Employee Business-Use Property

An employee's business use property, such as an employee's personal laptop that is used exclusively for business purposes, may be deducted without any of the personal-use property limitations listed above, but it is only deductible as a miscellaneous itemized deduction.

Insurance Reimbursement

Any deductible casualty loss is reduced by the amount of actual insurance reimbursements received and any expected reimbursements.  If the property is covered by insurance, an insurance claim must be filed or the casualty loss will not be allowed.  If the insurance reimbursement exceeds the casualty amount, then the profit is taxable income unless the insurance reimbursement is reinvested in similar-use property.  Reinvestment generally must occur by the end of the second year following the insurance reimbursement.  However, taxpayers have 4 years to replace a principal residence in a federally declared disaster area.

Because the casualty losses are reduced both by the amount of actual insurance reimbursements and any expected reimbursements, occasionally there is a need to made adjustments in the following year.

If the actual reimbursement received was greater than the expected reimbursement, the excess amount is treated as ordinary income in the year received unless the prior year's casualty loss deduction did not reduce the taxpayer's tax liability.

If the actual reimbursement was less than expected, the difference is treated as a casualty loss in the year the taxpayer can reasonably expect no more reimbursement.

Federally Declared Disasters

There are special tax provisions that apply if the President declares a disaster to be eligible for federal assistance under the Disaster Relief and Emergency Assistance Act.  Those provisions are outside the scope of this blog, but be sure to ask your tax preparer about them if you are ever affected by a federally declared disaster.

So as you can see, the federal government does provide some support through the form of tax deductions if you are affected by a disaster.  However, it should also be clear to you that the tax relief that you would be eligible for generally does not compare to what you would receive through an adequate insurance policy.

If you have any questions about deducting casualty losses, please do not hesitate to contact me.

Also, please feel free to contact me if you would like a referral to a great insurance agent.

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

Self-Directed IRAs

Did you know it is possible to hold real estate and business entities through an IRA?  You can if your IRA's custodian is open to having "nontraditional" investments.

What is a Self-Directed IRA?

A self-directed IRA is simply an IRA whose custodian permits a wide array of investments beyond bonds and securities and provides for maximum control by the account holder.  Self-directed IRAs can include any investment, other than life insurance and collectibles, that are not specifically prohibited by federal law.

As with all other IRAs, self-directed IRAs must comply with various rules and regulations, including a rule against "prohibited transactions".

What is a Prohibited Transaction?

There are several types of transactions that the federal government have determined to be improper if conducted with the IRA account holder, his or her beneficiaries, or any disqualified person.

Disqualified Persons

The Internal Revenue Code defines disqualified persons as:

1. A fiduciary of the plan (an IRA owner who exercises discretionary control over an IRA's investments is a fiduciary);
2. A person providing services to the plan;
3. An employer whose employees are covered by the plan;
4. An employee organization whose members are covered by the plan;
5. A direct or indirect owner of 50% or more of any entity that is described in numbers 3 or 4 above.
6. A family member of any of the above;
7. A corporation, partnership, trust, or estate that is more than 50% owned directed or indirectly by any person described in numbers 1 through 5 above;
8. An officer, director, 10% or more shareholder, or highly compensated employee (earning 10% or more of the employer's yearly wages) of a person described in numbers 3, 4, 5, or 7 above;
9. A 10% or more partner or joint venture of a person described in numbers 3,4, 5, or 7 above; or
10. Any disqualified person who is a disqualified person with respect to any plan to which a multiemployer plan trust is permitted to make payments under Section 4223 of ERISA.

Prohibited Transactions

There are several types of transactions that are prohibited if done between the self-directed IRA and a disqualified person.  Here are a few examples (this is by no means a comprehensive list):

• Selling property to or from the IRA;
• Lending money to or borrowing money from the IRA;
• Receiving unreasonable compensation for managing the IRA;
• Using the IRA as security for a loan; or
• Buying property for personal use with IRA funds.

What are the consequences if there is a prohibited transaction?

The penalties for engaging in a prohibited transaction are severe!  The Internal Revenue provides that if any prohibited transaction occurs, the account is no longer an IRA and it will be treated as if the assets within the account were distributed on the first day of the taxable year in which the prohibited transaction occurs.  This will trigger a 10% early withdrawal penalty, tax on the constructive distribution, and often an accuracy-related penalty for each of the tax years affected.

Let's look at an example.

In 2010, Mark decided to roll over all $2,000,000 from his 401(k) plan to a self-directed IRA.  On July 1, 2011, the IRA purchased a rental property for $400,000 and left the remaining assets invested in securities. The IRA then hired Mark to manage the property and agreed to pay him 10% of the total rents received. Mark managed the property until late 2013 when the IRA sold it for $450,000.  For the years 2011 through 2013, Mark reported his "management fee" as income, but did not report any of the rental income or the gain on the sale of the property because he knew that income earned by an IRA is tax-deferred.

In 2014, Mark received a notice from the IRS informing him that he was being audited for the tax years 2011, 2012, and 2013.  After its audit, the IRS concluded that the IRA's hiring of Mark and providing him compensation were prohibited transactions.  As a result, there was a deemed distribution of all of the IRA's assets on January 1, 2011 (not only the $400,000 used to purchase the rental property).  Mark was assessed the following penalties:

• Tax on $2,000,000+ deemed distributed to him on January 1, 2011 (plus penalties and interest);
• 10% early withdrawal penalty on the $2,000,000+ deemed distributed;
• 20% accuracy related penalty in 2011;
• Tax on the 2011, 2012, and 2013 rental income (plus penalties and interest)
• Tax on any interest, dividends, and capital gains from securities in 2011, 2012, and 2013 (plus penalties and interest);
• Tax on the capital gains from the sale of the rental property in 2013 (plus penalties and interest); and
• 20% accuracy related penalty in 2013.

It is not my intent to discourage anyone from using a self-directed IRA as an investment vehicle.  However, it is very important to understand that it can be very easy for someone to engage in a prohibited transaction and incur very severe penalties as a result.  Therefore, if you are thinking about utilizing a self-directed IRA, talk to a tax professional to ensure that everything is done properly.

If you have any questions about self-directed IRAs, please do not hesitate to contact me.

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

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.