Here in our Chicago South Loop Tax Preparation, and our Homewood Il, Tax preparation offices, we specialize in helping taxpayers legally reduce their taxable income, claim every tax deduction they are entitled to, and maximize tax credits. Through our work of helping taxpayers, we’ve come to find that many people often miss the Federal Child and Dependent Care Credit. The Federal child and dependent care tax credit refunds taxpayers a portion of the expenses paid for the care of dependent children and other dependents (qualifying persons).
Since summer is almost here, we wanted to give you some tips on what you need to do to claim the federal Child and Dependent Care credit if you have children (or disabled siblings/parents that you care for) that you plan on enrolling into a summer DAY camp program (so that you can work, or look for work). You’ll notice that we’ve put emphasis on summer DAY camp programs, as overnight summer camp programs are not eligible for the credit. Below please find some key points to claiming the Federal Child and Dependent Care Credit.
🔶The credit is equal to a percentage (from 35%-20%) of the amount you paid for daycare or summer camp attendance, and daycare throughout the year (up to $6,000 for 2 children, & $3,000 for 1 child). However, if you have 2 qualifying children, and paid expenses of $6,000 for only 1 child, you would be able to use the entire $6,000 to figure your credit, even though you only paid expenses for 1 child. To illustrate, Susan is a single mother earning $40,000 a year and has 2 children ages 8 & 12. The local park district is offering an 8-week summer day camp for $100 a week per child totaling $1,600 ($800 per child). Throughout the year, the 8-year-old goes to an afterschool daycare that charges $85 a week for 40 weeks totaling $3,400. At tax time Susan calculates that she paid a total of $5,000 in dependent care expenses, and her income level entitles her to a 22% reimbursement ($1,100) of the amount paid for care. If Susan has a $4,000 tax liability and was receiving a $500 refund, the $1,100 dollar-or-dollar tax credit will reduce her tax liability to $2,900 and increase her tax refund to $1,600.
đź”·You must have earned income. Earned income is defined as W2 Income, rideshare driving, food delivery person, MLM business, self-employment, etc.
🔶The provider must provide you with their name, EIN (unless it’s a tax-exempt organization like a church or school), and address.
đź”·You must provide your tax professional with the amount paid to the provider PER CHILD.
🔶The dependent(s) must be age 13 or under.
đź”·You must be the custodial parent.
🔶There are no minimum or maximum income limits on this credit.
🔷If your filing status is married filing separately, you must have lived apart from your spouse for the last 6 months of the year. You don’t have to be legally separated, but you must be able to prove that you lived apart from your spouse.
🔶 Sometimes you can file married filing separately, and the person may not qualify as your dependent for head of household status, earned income credit, etc., but they can still qualify as your person for the Federal Child and dependent care credit tax credit. For example, you left your cheating spouse in May, and you’re the primary caregiver for your disabled sister. Your disabled sister receives a monthly dividend check of $400 from her ownership of Ford stock (left to her by your parents). While your sister isn’t your qualifying dependent because her gross income is more than $4,400, you can still claim the child and dependent care credit for any dependent care expenses that you pay on her behalf.
Although we’ve given you the basics, this article is not all-inclusive. Should you have questions, or need business tax preparation, business entity creation, business insurance, or business compliance assistance please contact us online, or call our office at 855-743-5765. Make sure to join our newsletter for more tips on reducing taxes, and increasing your wealth.
Here in our Chicago South Loop Tax Preparation, and our Homewood Il, Tax preparation offices, we specialize in helping business owners and real estate investors reduce their tax liability. One topic that always comes up is the topic of self-employment taxes. Regardless of age, all individuals with self-employment income must pay self-employment taxes. Even if you have a regular W2 job, if you earn additional income through a side gig, then you have self-employment income. Self-employment income can be earned through rideshare (Uber or Lyft) driving, delivery driver (Doordash, GrubHub, Instacart, etc.) work, independent contractor work (construction, life insurance sales, cleaning business, etc.) selling things online (Mercari, Eba, Amazon, etc.) or simply selling dinners out of your home.
The government claims that the reason self-employed workers need to pay self-employment taxes (in addition to income taxes), is so that when business owners reach retirement age, they’ll be able to collect Social Security and Medicare part A (hospital insurance) benefits if they paid self-employment taxes for at least 10 years (40 quarters). It is important to note that self-employment taxes are paid on your net earnings from self-employment, not your entire business income. In this article, we will discuss:
What is the self-employment tax
How Much Are Self-Employment Taxes?
Do employees pay less in tax than self-employed people?
Individuals Subject to Self-Employment Taxes.
Net Earnings from Self-Employment.
What happens if I own two businesses?
What happens if you work a job and have side self-employment income?
Will having self-employment income allow me to write off everything?
Income Not Subject to Self-Employment Taxes.
If you own an unincorporated business, you likely pay at least three different federal taxes. These three taxes are:
Federal income taxes.
Social Security taxes.
Medicare taxes.
Social Security taxes and Medicare taxes are collectively called self-employment taxes.
The self-employment tax totals 15.3% and has two parts:
1.) 12.4 percent Social Security tax up to an annual income ceiling adjusted for inflation each year ($147,000 for 2022) 2.) 2.9 percent Medicare tax on all net earnings from self-employment.
If your self-employment income is more than $200,000 (if you’re single) or $250,000 (if you’re married filing jointly), you must pay an additional 0.9 percent Medicare tax on self-employment income over the applicable threshold for a total 3.8 percent Medicare tax.
Do employees pay less in taxes than self-employed people?
Excluding the additional Medicare tax that’s levied solely on employees, the self-employment tax rate is the same as the combined Social Security and Medicare payroll tax paid by employees and employers. But with employment, employers pay half of the taxes while withholding the other half from their employees’ wages.
At first glance, it looks as if W-2 employees personally pay half as much as the self-employed. But that’s not so. The tax code allows the self-employed to make up for some of this unfairness by allowing them to reduce net income subject to self-employment taxes by 7.65 percent and deduct on their Form 1040 half of their self-employment taxes.
Individuals Subject to the Self-Employment Tax.
You pay self-employment tax if you:
operate as a single-member LLC.
earn income on a 1099-NEC.
operate as a single-member LLC.
do business as a sole proprietor.
are a general partner in a partnership.
are an LLC member in a multi-member LLC.
or are a co-owner of any other business entity taxed as a partnership (there is an exemption for limited partners).
You determine if your activity is a business under the same rules you use for deducting business expenses. The general rule is that a business is an activity you engage in regularly and continuously to earn a profit. You don’t have to work at a business full-time, but it can’t be a sporadic activity.
Net Earnings from Self-Employment.
The self-employment tax is not a progressive tax. It starts immediately—on dollar one, once you have over $433 in Schedule C, E, or F net income from a business ($433 x 92.35 activity = $400 which is the starting amount that requires reporting of self-employment income, & the payment of self-employment taxes).
Example. Nancy earns $1,000 from her single-member LLC, and reports this income on Schedule C. Her net earnings from self-employment are $935 ($1,000 x 92.35 percent). Her self-employment tax is $143 ($935 x 15.3 percent).
Your net earnings from self-employment start with the gross income from your trade or business minus valid allowable business deductions. Because you get to deduct valid business expenses, it makes it even more important to keep up with your bookkeeping, so that you can identify the expenses that will allow you to lower your income tax and self-employment tax. It’s important to note that, personal itemized deductions (charity donations, property taxes, medical expenses, etc.) and “above-the-line” adjustments to income don’t decrease net earnings from self-employment.
What happens if I own two businesses?
If you have more than one business (say two Schedule Cs), you combine the net income or loss to determine your net earnings from self-employment. Thus, a loss from one business offsets the income from another profitable business. But all is not roses: when calculating net earnings from self-employment, you may not deduct:
Net operating loss carryovers from past years,
Deduction for health insurance premiums for the self-employed,
Contributions to a self-employed retirement plan such as an IRA, SEP-IRA, or 401(k).
Section 199A qualified business income deduction.
Deduction for one-half of your self-employment taxes.
What if I Have Both W-2 Wages and Self-Employment Income?
If you earn both W-2 wages and self-employment income, you count your W-2 first as if you had no self-employment income. If your W-2 wages exceed the annual ceiling ($147,000 in 2022), no Social Security taxes are due on any of your self-employment income. In this case, you pay less in taxes under the ordering rule because it allows you to use all or part of the Social Security wage ceiling with your employee income (taxed at 6.2 percent).
Will having self-employment income allow me to write off everything?
Despite what some may believe, becoming self-employed will NOT allow you to
Write off all your meals as a business expense.
Write off all the utility bills in your home.
Write off 100% of your cell phone usage.
Deduct the cost of taking your friends to sporting events or bars.
Deduct all your travel and transportation expenses.
Write off the entire cost of owning or renting a residence that contains your home office.
Some types of income are not subject to self-employment tax at all, including:
most rental income,
most dividend and interest income,
gain or loss from sales and dispositions of business property, and
S corporation distributions to shareholders.
S Corporation Distributions
The income earned by anS corporation passes through the business to the individual shareholders as dividends or distributions. Such pass-through S corporation income is not trade or business income to the shareholders and is not subject to self-employment taxes.
Key point. The S corporation is the one business form that can save its owners substantial self-employment taxes, which is why it is so popular. However, most first starting out don’t need a S-Corp as the cost to maintain the S-Corp, payroll, and bookkeeping will outweigh the benefits until you net at least $35,000-$40,000.
Example Jason owns a landscaping business that generates $100,000 in net profit. If he operates as a sole proprietor, 92.35 percent of his $100,000 net business income is net earnings from self-employment subject to self-employment taxes. Instead, he incorporates his business with him as the sole shareholder and works full-time in the business as the corporation’s employee. Jason has his corporation pay him $60,000 as employee salary, on which payroll taxes must be paid. In addition, the corporation distributes $40,000 to Jason during the year as a distribution. The $40,000 is not subject to self-employment taxes, saving $5,652 in taxes ($40,000 x 92.35 percent x 15.3 percent)
Here are five things to know from this article:
The self-employed must pay a 12.4 percent Social Security tax and a 2.9 to 3.8 percent Medicare tax on their net earnings from self-employment.
The 12.4 percent Social Security tax is subject to an annual income ceiling ($147,000 for 2022).
You must pay self-employment taxes if you earn income from a business, side hustle, or side gig that you report on Schedule C or F, co-own as a general partner in a partnership, or own as a member in a multimember LLC, or if you co-own any other business entity taxed as a partnership.
Net earnings from self-employment do not include real estate rental income (unless you provide services to tenants), dividend or interest income, or gain or loss from business property other than inventory.
Distributions from S corporations are not subject to self-employment taxes. S corporations must ordinarily treat shareholders who work in the corporate business as employees and pay them a reasonable W-2 salary
Although we’ve given you the basics, this is not an all-inclusive article. Should you have questions, or need business tax preparation, business entity creation, business insurance, or business compliance assistance please contact us online, or call our office at 855-743-5765. Make sure to join our newsletter for more tips on reducing taxes, and increasing your wealth.
Here in our South Loop of Chicago Tax Preparationoffice, and our Homewood, Il tax preparation office, we specialize in tax preparation for real estate investors, and small business owners. Working with this client base, we come across many general contractors that operate 95% in cash. Although cash only taxpayers are entitled to tax deductions, they (like every other taxpayer) must have proof of income received, and proof of expenses incurred. While in most cases we can help taxpayers reconstruct their income and expenses, in some cases the IRS will deny the expenses due to lack of documentary (paper) evidence. In the tax court case of NNABUGWU C. EZE, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, not only did the taxpayer lack documentary evidence for expenses, he also didn’t have proof of income received.
In 2015, and 2016 NNABUGWU C. EZE, owned and operated 2 sole proprietor businesses: a consulting business, and a residential construction business (while we’ll touch on issues related to the consulting business, the main focus of this article will be the residential construction business). “For 2015 he reported taxable income of $3,314 and claimed a refund of $774. For 2016 he reported taxable income of zero and claimed a refund of $744.”1 For his consulting business, Eze claimed to have generated $142,675 in gross revenue, $30,533 in auto expenses, 2,815 in business travel, and $9,662 in other expenses.2 While his auto expenses were high, the return might have avoided audit had Mr. Eze not reported that his construction business spent $99,275 (business expenses) to generate $27,875 in gross revenue. In the court opinion, the court noted that Mr. Eze:
Described his Schedule C2 business as “home improvement.”
Allegedly “did handyman, construction, and residential rehabilitation projects for individual customers.”
Claimed to have written contracts with his customers, but never produced the contracts into evidence.
Didn’t specify how he was paid by his customers, or what type of arrangements he had with his customers.
The court also noted that:
There was no proof of electronic or paper (documentary evidence) invoices being submitted to customers.
There were no bank statements to prove the income or expenses claimed on his schedule C profit and loss.
None of his alleged customers reported payments to him on Forms 1099-MISC, Miscellaneous Income.
As in typical fraudulent tax return behavior, the expenses reported on the tax return far exceeded the reported income.
Auto Deductions
When it comes to the business use of a vehicle, one of the best tax deductions for business owners is the ability to deduct either mileage, or actual expenses. In this case, Mr. Eze owned 3 vehicles: “a 2008 Mercedes Benz, a 2002 Ford SUV, and a 2004 Chrysler.”3 Mr. Eze testified that the Mercedes was used 100% in his consulting business; the Ford was used 100% in his residential construction business, and that he used the Chrysler “exclusively for personal and family purposes.” To prove that he drove the business mileage, Mr. Eze submitted a calendar with the places that he allegedly drove to for his consultation business, and a second calendar with drives for his construction business. Although Mr. Eze created the calendars, he couldn’t explain how he was able to remember information from 3-4 years ago. “When asked asked how he kept track of start and finish odometer readings for hundreds of trips, Mr. Eze said that he jotted them down on scraps of paper (since discarded)”4 to which the IRS responded kick rocks (okay, they actually said “we do not find that testimony credible”, but we like our version better). Since Mr. Eze couldn’t prove his business mileage (see our video here on how to prove business mileage), the mileage deduction wasn’t allowed.
Construction Expenses
To prove his construction material expenses, Mr. Eze submitted receipts from Home Depot, Lowes, and 84 lumber. While under oath, Mr. Eze stated that all of the purchases were not made by him, but some were made by his wife, and “maybe somebody else.”5 We find it odd that Mr. Eze can remember all of his business mileage locations from 4 years prior, but he can’t remember who the “somebody else” was that purchased materials from Home Depot. Some of the issues the court took with Mr. Eze material purchases were as follows:
All receipts are for cash purchases in excess of $5,000. Mr. Eze said he withdrew the money from his bank, yet he didn’t provide any bank statements, or record that would prove that. 6
He claimed to spend $175,000 for materials for a business that was unprofitable, and he somehow still paid his mortgage, private school tuition, and took care of 2 children. 7
The receipts for materials often show large-volume purchases- on the order of 200 pieces of lumber, 50 sheets of gypsum wallboard, and 100 gallons of paint. These volumes vastly exceeded what would have been needed for the projects shown on petitioner’s mileage log.8
The receipts often show purchases of items that petitioner could not possibly have used in any project that he allegedly undertook during the ensuing months. For example, the receipts show purchases of bathtubs, shower units, and refrigerators, but petitioner could not identify any project that would have required installation of such items. He testified that he made advance purchases of these materials and stored them in his garage until he needed them.9
Petitioner allegedly spent more than $21,000 on tools, but he was unable to explain the function or intended operation of many machines and tools listed on the receipts. He said that he could not remember what these things were used for, having purchased them years ago.10
As we read further into this case, it was clear to us that Mr. Eze thought that the IRS, and the courts were either stupid, or that they wouldn’t look at the documentation he provided. To illustrate, in one instance, Mr. Eze tried to claim the tuition that he paid for his daughter’s tuition as a business education expenses. He also claimed AT&T cellphone expenses of over $2,000, but the AT&T bills submitted covered tv and internet service. Mr. Eze also submitted payments to cricket wireless, claiming that although he didn’t receive invoices from the company “he knew what he owed each month.”
While social media (TikTok, YouTube, & Facebook video’s) will have you believing that you can magically turn personal expenses into business tax deductions (by simply creating a LLC), the truth is that taxpayers have to prove that they are entitled to any business or personal tax deductions claimed. Although courts do have the power to allow approximations (under the Cohan rule if an expense is reasonable), there must be some factual basis for the estimate, and the deduction must not be subject to increased substantiation rules.
Here in ourChicago south loop tax preparationoffice, and ourHomewood Illinois tax preparation office, we often work with clients that want to legally reduce their tax bill, without triggering an audit. For our self-employed clients that realize a net profit of $35,000-$40,000 we sometimes recommend that they utilize the S-Corp taxation option (rather than a disregarded entity taxation status), as the S-Corp option will allow them to take advantage of some pretty awesome tax deductions. Below are 3 end of the year things that S-Corps must make sure to have done.
MAKE SURE THAT YOU HAVE PAID YOURSELF A REASONABLE COMPENSATION VIA PAYROLL, AND THAT YOU HAVE PAID YOUR PAYROLL TAXES.
You likely formed an S corporation to save on self-employment taxes. If so, is your S corporation salary
nonexistent?
too low?
too high?
just right?
Getting the S corporation salary right is important. First, if it’s too low and you get caught by the IRS, you will pay not only income taxes and self-employment taxes on the too-low amount, but also both payroll and income tax penalties that can cost plenty. Second, in most cases, the IRS is going to expand the audit to cover three years and then add the income and penalties for those three years. Third, after being found out, you likely are now stuck with this higher salary, defeating your original purpose of saving on self-employment taxes. Make sure to work with your accountant to help figure out your salary. You should also make sure that you corporate minutes name your salary, and have documents that prove your salary is reasonable (you can use the market approach, the income approach, or the cost approach).
RENTAL OF PERSONAL RESIDENCE FOR UP TO 14 DAYS FOR TAX FREE INCOME.
If your S-Corp is paying you (or your spouse) as an individual rent to use your residential space for hosting business meetings, please do the following:
Research the going rate for conference/meeting room rental in your area. Please view our detailed YouTube video on how to use the 14 day free rental income tax rule, & find the rental rates that your S-Corp can pay individuals.
Invoice your corporation for room conference/meeting rental.
Create a conference/meeting room rental agreement, or order one from Howard Tax Prep LLC.
Write a check, send a zelle, cash app, etc. from your corporate bank account, to your personal bank account.
Document the business purpose with meeting minutes, & resolutions.
HOME OFFICE & CELLPHONE REIMBURSEMENT
If you operate as a corporation, your home-office deduction does not show on either your personal return or your corporate return if you have the corporation reimburse the office as an employee business expense. To reimburse as an employee business expense, you must do the 5 things listed below.
Have a written corporate reimbursement policy. We offer plans for home office, travel, and cellphone usage reimbursement.
Have employee (you) submit a reimbursement sheet, and keep track of cost for reimbursement.
Pay employee (you) from the corporation’s bank account.
Document business use of home office. For example, accounting, marketing, emailing clients, creating policies, planning meetings, etc.
LIST OF 12 MEETING IDEAS
Annual Meeting Minutes.
Recent Accomplishments.
Next Quarters Sales Goals.
Industry News.
Process Updates.
Customer/Client Feedback.
Design/Branding Review.
Marketing Plan.
Annual Budget Meeting.
Review of compliance records.
Board of Directors Decisions.
Annual Financial Performance Review.
Although we’ve given you the basics, this is not an all-inclusive article. Should you have questions, or need business tax preparation, business entity creation, business insurance, or business compliance assistance please contact us online, or call our office at 855-743-5765. Make sure to join our newsletter for more tips on reducing taxes, and increasing your wealth.
In our South Loop Chicago tax preparation office, and in our Homewood, Il tax preparation office, we often receive calls from people that have not filed taxes in years, and they want to know how the IRS knows how much income they have receive. So how does the IRS know when a small business owner is POTENTIALLY hiding income? The IRS has many methods to detect the underreporting of income such as: taxpayer interviews, income probes, Indirect methods, accounting records; QuickBooks files, cash expenditures, bank deposits, net worth, and more; however, this article will be covering a method called the vertical analysis.
The vertical analysis method identifies the differences between gross income, and net profit reported by the business owner, and the industry standards gross income and net profit. In plain English, the IRS compares what businesses owners say their profit is in relation to expenses, to what other people in the same industry say their profit is in relation to expenses. So what data, or statistics does the IRS use to create the comparison? The IRS uses a website called Bizstats.
Information in Bizstats expresses expense categories as a percentage of revenue. Per the IRS “Potential underreporting of income which equals 10% or more of the reported income should be resolved with the taxpayer’s assistance.”
To give an example, let’s say that we have a caterer that reports $65,000 in gross sales, and $50,000 in expenses, leaving them with a profit of $15,000. The caterer’s expenses to sales ratio is 77% ($50,000 in cost to make sales (expenses)/revenue brought in.) If the industry standard is 60%, the IRS might believe that the taxpayer is hiding an additional $18,333 in revenue (50,000/60%=$83,333. $83,333-$65,000=$18,333).
So who is Bizstats? Per their website, “BizStats is owned and operated by Bizminer of Camp Hill, PA, a leader in online data analysis since 1998. Bizminer also publishes more than 9 million local and national industry statistical reports at its own web site at www.bizminer.com” Bizstats has business statistics and financial ratios for Sole proprietors, Corporations, S-Corporations, & Partnerships.
Where does Bizstats get it’s information? Per their website, Bizstats get it’s data from “the latest available IRS financial information in a useful, readable format.”
What are some drawbacks to Bizstats data? Bizstats are only available for 1 year, and the information is typically 3 years old. At the time of publication, the current stats were showing data from 2017.
How can I protect myself from a vertical analysis?
#1 Always report the GROSS income generated in your business. An accounting mistake that we often see in our Chicago South Loop tax preparation office, is that people don’t do bookkeeping, so instead of reporting their gross receipts, they report gross income less returns, refunds, etc. in the gross receipts area, which is not correct. Gross receipts are gross receipts, and you account for returns in a separate line item.
#2. Invoice clients, or keep copies of receipts if you’re in a business that doesn’t use invoicing.
#3. NEVER COMMINGLE YOUR FUNDS. Your business income and expenses need to be kept separate
In our South Loop Chicago tax preparation office, and in our Homewood, Il tax preparation office, we often receive calls from people that have made an error (or errors) on their tax return. The tax law is complicated and constantly changing, so it’s easy to make a small, or large error that causes you to:
1.) underpay your tax, leaving you open to IRS penalties, or 2.) overpay your tax, meaning you gave a gift to the government.
However, if you made an error on your tax return, don’t worry; there’s good news: you can undo your mistake! Here’s even better news: there are two special ways to fix your incorrect tax return that will save you from paying more to the IRS than you would otherwise. We’ll tell you all about them in this article. —there are two easy ways to fix it:
A superseding return
A qualified amended return
A superseding return is an amended or corrected return filed on or before the original or extended due date. The IRS considers the changes on a superseding return to be part of your original return.
A qualified amended return is an amended return that you file after the due date of the return (including extensions) and before the earliest of several events, but most likely when the IRS contacts you with respect to an examination of the return. If you file a qualified amended return, you avoid the 20 percent accuracy-related penalty on that mistake.
Superseding Return Example
You file a joint Form 1040 tax return electronically on February 21, 2022, for tax year 2021, but you later decide you want to file a separate return. Since the joint-filing election is irrevocable, on or before April 15, 2022 (which is the unextended due date for your 2021 Form 1040), you must file a superseding return to undo the joint election.
IRS electronic filing rules for amended returns do not permit you to file this superseding return electronically, because you are changing your filing status (from married, filing jointly, to married, filing separately). That being said, your only other option is to use “snail mail.” Using a paper return via snail mail, you’ll submit either:
1.) A second original Form 1040 return using the married-filing-separately filing status, or 2.) An amended Form 1040X showing the change from joint to separate filing status. Be sure to write “SUPERSEDING RETURN – IRM 21.6.7.4.10” in red at the top of page 1 of either Form 1040 or Form 1040X.
Qualified Amended Return Example
You realize your return preparer left a $30,000 IRA distribution off your 2019 tax return. Ouch! Let’s assume you are in the 32 percent tax bracket and had no federal income tax withholding on the distribution: you owe an additional $9,600 in federal income tax on your 2019 tax return due to this distribution.
If you file an amended return before the IRS contacts you about the missing income, then it’s a qualified amended return, and you avoid $1,920 (20percent of $9,600) in audit penalties.
If you don’t file the amended return, and if the IRS contacts you about the missing income, the IRS will propose the $1,920 penalty. You may be able to request penalty relief, but you’ll have to make your case, and the facts may or may not be on your side.
In both circumstances, you’ll also pay interest on the $9,600 back to July 15, 2020 (the COVID-19-postponed 2019 Form 1040 due date). Of course, the earlier you pay the tax, the less interest you’ll accrue. You’ll pay less interest with a qualified amended return because you’re paying the tax sooner.
If you are married like many of our clients in our Chicago south loop tax preparation office, most likely you’ve always filed a joint tax return with your spouse. Most of the time, a joint return shows less overall tax than two separate tax returns do, because the married-filing-separately status has many tax disadvantages.
Fast-forward to the 2020 tax filing season, however—and nothing is as it was. This year, four tax provisions will be key to determining whether you’ll be better off filing a joint tax return or separate tax returns for tax year 2020:
Tax-free unemployment
Recovery rebate, round 1
Recovery rebate, round 2
Recovery rebate, round 3
Tax-Free Unemployment
TheAmerican Rescue Plan Act of 2021, which was signed into law on March 11, 2021, excludes from tax the first $10,200 of 2020 unemployment benefits paid to an individual with 2020 modified adjusted gross income (MAGI) of less than $150,000.
Recovery Rebate, Round 1
The recovery rebate, round 1, is a refundable tax credit on the 2020 tax return, equal to
$1,200 ($2,400 on a joint return), plus
$500 for each dependent under age 17.
Your credit decreases by 5 percent of the amount your adjusted gross income (AGI) exceeds
$150,000 if married, filing a joint return;
$112,500 if head of household; or
$75,000 if single or if married, filing separately.
The IRS gave you an advance payment of this credit based on either your 2018 or 2019 AGI and dependents. And now the IRS looks at your 2020 tax return and does the following:
Smiles on you if the tax credit based on your 2020 tax return exceeds the advance payment. What do we mean by “smiles on you”? You get the additional amount as a refundable tax credit.
Smiles on you (again!) if your actual credit is less than the advance payment. You keep the money. You don’t have to pay back any excess received.
Recovery Rebate, Round 2
This is a refundable tax credit on the 2020 tax return, equal to
$600 ($1,200 on a joint return), plus
$600 for each dependent under age 17.
Your credit decreases by 5 percent of the amount your AGI exceeds
$150,000 if married, filing jointly;
$112,500 if head of household; or
$75,000 if single or if married, filing separately.
The IRS gave you an advance payment of this credit based on your 2019 AGI and dependents. And now the IRS looks at your 2020 tax return and
Smiles on you if the tax credit based on your 2020 tax return exceeds the advance payment. What do we mean by smiles on you? Once again, you get the additional amount as a refundable tax credit.
Smiles on you (again!) if your actual credit is less than the advance payment. You keep the money. You don’t have to pay back any excess received.
Recovery Rebate, Round 3
This is a refundable tax credit on the 2021 tax return, equal to
$1,400 ($2,800 on a joint return), plus
$1,400 for each dependent, regardless of age.
Your credit phases out over the following AGI ranges:
$150,000 to $160,000 if married, filing jointly;
$112,500 to $120,000 if head of household; or
$75,000 to $80,000 if single or if married, filing separately.
The IRS will give you an advance payment of this credit based on your 2019 or 2020 AGI and dependents. If your first advance payment used your 2019 return information, then the IRS will send an additional payment based on your 2020 tax return if the IRS processes your 2020 tax return by August 15, 2021.
You then reconcile your advance payment(s) on your 2021 tax return:
If your actual credit amount exceeds the advance payment, you get the difference as a refundable credit.
If your actual credit is less than the advance payment, you keep what you have. You don’t have to pay back the excess benefit.
There are two main reasons you may have net lower federal tax with separate returns versus a joint return.First, if your MAGI is $150,000 or more on a joint return, but the spouse who received the unemployment compensation earns under $150,000 on a separate return, then that spouse can take the full exclusion up to $10,200 (except possibly in a community property state).
Second, if one spouse has AGI of $75,000 or less, but your joint AGI is over $150,000, then that spouse can claim the dependents and get all the available round 1 and round 2 credits on the 2020 tax return as well as the entire round 3 advance payment.
When considering the above, keep two important notes in mind:
For a couple that got joint advance payment(s), the law says you allocate 50 percent of the payment to each spouse. The higher-earning spouse doesn’t pay back any of his or her allocated advance payment, while the lower-income spouse will get the difference as a refundable tax credit.
Married taxpayers who agree how to allocate dependents on separate returns do not have to use the “tiebreaker” rules and can choose who claims which dependents.
Important note. You may lose other deductions and credits on a separate return. The only way to know which is better in light of these temporary provisions is to run your tax returns both ways and see which puts you ahead. For example, separate returns can change your health insurance premium tax credit and perhaps some non-tax items such as your Medicare premiums.
We’re finally getting closer to the end of a tumultuous 2020, and (almost daily) in our South Loop Chicago tax preparation office, we’re handling phone calls from clients asking for more ways to save on their tax bills.
Here’s an easy question: Do you need more 2020 tax deductions? If yes, continue on.
Next easy question: Do you need a replacement business vehicle?
If yes, you can simultaneously solve or mitigate both the first problem (needing more deductions) and the second problem (needing a replacement vehicle), but you need to get your vehicle in service on or before December 31, 2020.
To ensure compliance with the “placed in service” rule, drive the vehicle at least one business mile on or before December 31, 2020. In other words, you want to both own and drive the vehicle to ensure that it qualifies for the big deductions. Now that you have the basics, let’s get to the tax deductions.
1. Buy a New or Used SUV, Crossover Vehicle, or Van
Let’s say that on or before December 31, 2020, you or your corporation buys and places in service a new or used SUV or crossover vehicle that the manufacturer classifies as a truck and that has a gross vehicle weight rating (GVWR) of 6,001 pounds or more. This newly purchased vehicle gives you four big benefits:Â
The ability to elect bonus depreciation of 100 percent (thanks to the Tax Cuts and Jobs Act)
No luxury limits on vehicle depreciation deductions
Example. On or before December 31, 2020, you buy and place in service a qualifying used $50,000 SUV for which you can claim 90 percent business use. Your business cost is $45,000 (90 percent x $50,000). Your maximum write-off for 2020 is $45,000.
2. Buy a New or Used Pickup
If you or your corporation buys and places in service a qualifying pickup truck (new or used) on or before December 31, 2020, then this newly purchased vehicle gives you four big benefits:
No luxury limits on vehicle depreciation deductions
To qualify for full Section 179 expensing, the pickup truck must have
a GVWR of more than 6,000 pounds, and
a cargo area (commonly called a “bed”) of at least six feet in interior length that is not easily accessible from the passenger compartment.
Short bed. If the pickup truck passes the more-than-6,000-pound-GVWR test but fails the bed-length test, tax law classifies it as an SUV. That’s not bad. The vehicle is still eligible for either expensing of up to the $25,900 SUV expensing limit or 100 percent bonus depreciation.
Congress let many tax provisions expire on December 31, 2017, making them dead for your already- filed 2018 tax returns.
In what has become much too common practice, Congress resurrected the dead provisions retroactively to January 1, 2018. That’s good news. The bad news is that we have to amend your tax returns in our Chicago south loop tax preparation office to make this work for you.
And you can relax when filing your 2019 and 2020 tax returns, because lawmakers extended the “extender” tax laws for both years. Thus, no worries until 2021—and even longer for a few extenders that received special treatment.
Back from the Dead
The big five tax breaks that most likely impact your Form 1040 are as follows:
Exclusion from income for cancellation of acquisition debt on your principal residence (up to $2 million)
Deduction for mortgage insurance premiums as residence interest
7.5 percent floor to deduct medical expenses (instead of 10 percent)
Above-the-line tuition and fees deduction
Nonbusiness energy property credit for energy-efficient improvements to your residence
Congress extended these five tax breaks retroactively to January 1, 2018. They now expire on December 31, 2020, so you’re good for both 2019 and 2020. or click here to call us 1-855-743-5765.
Other Provisions Revived
Congress also extended the following tax breaks retroactively to January 1, 2018, and they now expire on December 31, 2020 (unless otherwise noted):
With the start of a new tax year, you’re probably looking for new tax savings opportunities, like our Chicago South Loop Tax Preparation clients.
As you probably know, establishing a home office for your Schedule C or corporate business creates valuable tax deductions.
But it’s not available only for your proprietorship,partnership, or corporate business. If you have rental properties, you can establish a home office to manage your rental properties and deduct the cost on your Schedule E. or click here to call us 1-855-743-5765.
Rentals as a Business
The first hurdle is that your rental activities have to qualify as a “trade or business” under the tax law.
Luckily for you, that’s relatively simple—you’ll need regular and continuous involvement with your rental activities to meet this requirement.
Whether or not your rental activities are a trade or business depends on the facts and circumstances of your particular situation, and tax court cases give us guidance on that.
Qualifying Area
Your second hurdle is setting aside space in your home that qualifies for the home-office deduction.
For this to work, you need to use that space in your residence regularly and exclusively as the principal place of business for your rental activities. or click here to call us 1-855-743-5765.
This sounds hard, and it was hard—before lawmakers changed the rules to include, as a principal place of business, the space you use for administrative or management activities, provided there is no other fixed location where you conduct substantial administrative or management activities.
Home-Office Deduction
Establishing a rental property home office does two things to your household expenses:
Turns non-deductible household expenses into tax deductions.
Moves household expenses normally deductible on Schedule A to your rental properties on Schedule E.
The latter is especially important after passage of the Tax Cuts and Jobs Act
put a $10,000 limit on your Schedule A state and local tax deductions, and
lowered the amount of your mortgage on which you deduct mortgage interest from $1 million to $750,000.
Eliminate Commuting
Without a qualifying home office, your mileage from home to your first business stop and then from your last business stop back home is non-deductible commuting mileage.
But here is what happens with the rental property’s principal office in your home:
You have no commuting mileage from your home to and from your rentals, if the rentals are in the area of your tax home (say, within 50 miles).
You establish your rental property tax home, and if your rentals are outside the area of your tax home, then the mileage from your home to and from the rentals is deductible business mileage because you are traveling outside the area of your tax home.
Real Estate Professional
If you qualify as a real estate professional under the tax law, then you can deduct 100 percent of your rental losses in the year you incur them.
But there’s a big hurdle to the tax law classification as a real estate professional. You must show that you spend
more than 50 percent of your personal service work time in real property trades or businesses in which you materially participate, and
more than 750 hours of service during the tax year in real property trades or business in which you materially participate.
Having a rental property home office that qualifies as a tax-code-defined principal place of business makes it easier to qualify as a real estate professional, because your time spent on deductible travel to and from your rental properties counts toward the time requirements.
Claiming Your Deduction
The Schedule E instructions not only fail to provide any explanation about where to put your home-office deduction, but they also do not even mention a home office.
But the instructions do say that you can deduct ordinary and necessary business expenses, and the home office meets that rule. Also, as established in Curphey (a precedent-setting case), the home office is allowable as an expense against income from a rental business.
SMALL BIZ TAX LADY 