Monthly Archives: May 2017

Ground rules for the home office deduction

Do you often work from the comfort of your own home? Depending on your circumstances, you may qualify for a home office deduction that can reduce your tax liability.

The tax law says you can claim a home office deduction only if you use at least part of your home exclusively as either (1) your principal place of business or (2) a place to meet or deal with customers, clients, or patients in the normal course of business. Furthermore, if you’re an employee of a company, the home office must be specifically used for the convenience of your employer.

In other words, if you’re a self-employed cabinetmaker and use your garage strictly for woodworking and storing tools, it’s likely that you will qualify for a deduction. Conversely, if you work in your den on nights and weekends but you have a main office in town, you won’t qualify, especially if you’re a corporate employee.

If you determine you qualify, what can you deduct? The write-off includes expenses directly related to your home office and a proportionate share of the overall expenses of maintaining a home. For example, if you paint the room you use as a home office, the cost is completely deductible. However, deductions for property taxes, mortgage interest, utilities, and the like are based on the percentage of business use of the home. (The remaining property taxes and mortgage interest are generally claimed as a personal deduction.) Finally, you may also claim a depreciation deduction for the home office, based on IRS tables.

To simplify matters, the IRS permits you to deduct a flat rate of $5 per square foot of the area used as an office, up to a maximum of $1,500. However, for most taxpayers, keeping detailed records of your actual home office expenses will produce a larger deduction. Don’t hesitate to call Carl Heinemann, your Chattanooga CPA, if you have questions about your situation.

A tax break for business travel with your spouse

Suppose you’re planning to take a business trip across the country. Are you eligible for tax benefits if you invite your spouse to accompany you? It depends on your circumstances. Specifically, the tax rules differ if your spouse is an employee of your company or is just going along for the ride.

If your spouse is an employee

Generally, if you’re traveling primarily for business reasons, you can deduct the costs of your business travel, including airfare, lodging and meals, qualified entertainment, and local transportation costs. Meals and entertainment are subject to a 50% limit. Therefore, if your spouse works for your company and legitimately performs business services on the trip, you can deduct the expenses both of you incur. Be aware, however, the expenses attributable to personal recreational activities are completely nondeductible.

If your spouse is not an employee

This is a different story. Although you can continue to write off the full amount of the expenses for your travel for business purposes, the portion of the cost allocated to your spouse can’t be deducted. It’s purely a personal expense.

However, you may be in line for a tax break. If your cost is reduced because your spouse is traveling with you, you can deduct what it would have cost to go alone. For example, if you pay for a double room at the hotel, you’re allowed to deduct the cost of a single room, even if that’s more than half the cost of a double.

Usually, business travel expenses are paid by the company via an accountable plan, with any reimbursements tax-free to employees. Give Carl Heinemann, your Chattanooga CPA, a call if you need help. We can help with the tax logistics of your business travel.

How to sidestep the wash sale tax rule

Usually if you sell securities and the transaction results in a loss, you can use the loss to offset capital gains, plus up to $3,000 of ordinary annual income. Any excess loss over that amount is then carried over and can be used to offset losses next year. Because of these tax benefits, investors often “harvest” losses from securities sales, especially at the end of the year.

But there’s a potential stumbling block. Under the “wash sale rule,” you can’t claim a loss from a securities sale if you acquire substantially identical securities 30 days before or after the date of the sale. The loss is disallowed for tax return purposes.

What is considered substantially identical? Clearly, if you buy back the same stock it will trigger the wash sale rule, but not necessarily if it’s the stock of a company that’s merely in the same industry. However, transactions involving mutual funds within the same family of funds could cause a loss to be disallowed.

Frequently, a wash sale occurs when you reacquire securities you just sold at a loss because you believe the price is about to rebound. There are two relatively easy ways to avoid a wash sale.

1. Wait until 30 days have passed before you buy the same or similar securities. This preserves the loss without any question.

2. Use a “doubling up” strategy. Buy the same amount of the security you want to sell for a tax loss, temporarily doubling your holdings. Wait at least 31 days, and then sell the original batch of shares for a loss. Now you have your deductible loss, still own the same amount of shares, and can benefit from future appreciation.

If your loss is disallowed because of the wash sale rule, you can still find some tax solace. The amount of the disallowed loss is added to your basis in the shares you reacquired. Thus, when you eventually sell those shares, either your tax loss will be increased or your taxable gain will be reduced.

The tax lowdown on paying mortgage points

Suppose you’re buying a home and searching for a mortgage. There are a myriad of choices in today’s marketplace with interest rates at near-record lows. In some cases, you may qualify for a rock-bottom rate if you agree to pay the lender “points” for the privilege.

Each point is equal to one percent of the amount you’re borrowing. For instance, if a lender charges two points on a $200,000 loan, it costs you $4,000. The extra expense might be worthwhile to obtain a lower interest rate that can save you much more while you own the home. However, you need to understand the tax consequences to know if paying for points will work in your favor.

Usually, you can deduct the full amount of points as mortgage interest on your tax return, defraying the actual out-of-pocket cost. To qualify, however, you must meet certain requirements spelled out by the IRS. For instance, the loan must be secured by your principal residence, and imposing points must be an established mortgage business practice in the area where you reside.

What happens if you refinance an existing mortgage? It gets a little trickier. Generally, you’re required to deduct the points over the life of the new loan. Let’s say that you’re replacing a 30-year mortgage with a 10-year loan with a lower rate. The loan principal is $200,000 and you’re required to pay one point — $2,000. Based on these facts, you can deduct $200 each year for the next ten years. If you refinance again in the future, you can then deduct the balance of the points remaining from the first refinancing and start anew deducting points over the life of this second refinancing.

The rules are similar to a refinancing if you pay points on a mortgage for a second home. You must deduct the points over the life of the loan.

Before agreeing to pay points, crunch all the numbers, including taxes and deductions for points. Call Carl Heinemann, your Chattanooga CPA, if you need help.

Tax refund — spend it quickly or use it prudently?

More than 70 percent of taxpayers will receive tax refunds this year, with refunds averaging $2,860. If you’re part of the fortunate majority, you may be wondering how to spend that extra cash. It’s tempting to use it for a down payment on a new car or a Hawaiian vacation. Before that currency flows out of your bank account, consider the following less exciting alternatives that may put you in a better financial place.

  • Pay down debt. According to the Federal Reserve, the average annual interest rate on credit card debt has been hovering around 13 percent. If you carry a balance of $5,000 for a full year and the bank charges the average rate, you’ll pay $650 in interest. Instead, why not use your refund to slash your credit card balance in half? You could save $325 this year and take one more step toward financial independence.
  • Pump up your emergency fund. Many American households carry thousands of dollars in credit card debt from month to month, and much of that debt stems from unexpected bills or reduced income. A well-funded emergency account can help you avoid high-interest debt when you’re faced with life’s inevitable struggles. Try to accumulate a balance covering three to six months’ living expenses.
  • Fund a retirement account. Hoping to retire some day? Contribute your tax refund to an individual retirement account (IRA). Again this year, you can set aside a combined $5,500 in Traditional and Roth IRA accounts ($6,500 if you’re age 50 or older). Consider this: If you contribute $5,500 every year from age 30 to age 65 and your account earns a relatively conservative 6% rate of return, your account balance when you retire at age 65 will total nearly $210,000.
  • Other ideas. Set up a 529 college savings plan for your toddler’s college tuition, allowing the money to grow tax-free for college bills. Fund a reserve for end-of-year holiday gifts. Donate all or a portion of the refund to your favorite charity. Take a college course to improve your career options.

Ultimately, the decision to spend your refund on something fun and a little more frivolous or something prudent is completely your own. But, if you have questions about what’s best for your financial situation, give Carl Heinemann, your Chattanooga CPA, a call.

Office equipment — lease or buy?

For many companies, the decision to lease or buy office equipment bears directly on cash flows and profits. Copiers, phones, computers, printers, and networking software all must be either purchased or rented. How do you decide which is the best option for your business?

Pros and cons of leasing. When you lease your equipment, you sign the lease agreement and start making payments. It’s simple. The company that leases equipment to you (the lessor) generally promises to maintain it. The lessor may even cover insurance and other costs during the lease term. With a lease, your business won’t need to take out a loan or make a down payment to use the equipment. Lease terms often roughly coincide with the expected service life of the leased assets. So by the time the equipment is returned to the leasing company, it may be fully depreciated. When the technology becomes obsolete, your firm won’t be stuck with equipment you can no longer use. You can return it.

Nevertheless, over the long run, leasing is often more expensive than buying. For example, you can buy desktop computers today for $1,000 each. Leasing the same equipment for three years at $50 per month will cost $1,800. Keep in mind, too, that your lease contract will likely require lease payments even if you stop using the equipment. (Breaking the lease may be an option, but often an expensive one.) Moreover, unless you establish the right to buy the equipment at a bargain price when the lease expires, your company won’t have equity in the leased items.

Pros and cons of buying. When purchasing a piece of equipment outright, you’re responsible for maintenance, insurance, loan payments and associated costs. But if the equipment retains its value, you can continue using it after any loans have been paid off. You don’t have to continue making lease payments and there’s no penalty for breaking a lease contract. When you no longer need the equipment, you may recover a portion of the cost by selling it to the highest bidder.

However, purchasing equipment requires cash today. To buy a telephone system, for example, you may need to deplete cash accounts or divert revenue to cover loan payments. That’s money that won’t be available for advertising, salaries, utilities, and all the other costs of operating your business.

The best way to determine if leasing or buying is right for your company is to determine the approximate net cost of the equipment, carefully including tax breaks and resale value. After this, consider other possibilities, like the product becoming obsolete or your need for the assets expiring before the lease does. If you would like to discuss the details, Carl Heinemann, your Chattanooga CPA, is here to help.