Tax Saving Strategies: A Helpful Checklist
Travel and Entertainment: Maximizing the Tax Benefits
The “Nanny Tax” Rules: What To Do If You Have Household Employees
Higher Education Costs: How To Get The Best Tax Treatment
Selling Your Home: How To Minimize the Tax On the Gain
The Deductibility of Points

Tax Saving Strategies: A Helpful Checklist

This Financial Guide provides tax saving strategies for deferring income and maximizing deductions, and includes some strategies for specific categories of individuals, such as those with high income and those who are self-employed.

Before getting into the specifics, however, we would like to stress the importance of proper documentation. Many taxpayers forgo worthwhile tax deductions because they have neglected to keep receipts or records. Keeping adequate records is required by the IRS for employee business expenses, deductible travel and entertainment expenses, and charitable gifts and travel. But don’t do it just because the IRS says so. Neglecting to track these deductions can lead to overlooking them. You also need to maintain records regarding your income. If your receive a large tax-free amount, such as a gift or inheritance, make certain to document the item so that the IRS does not later claim that you had unreported income.

The checklist items listed below are for general information only and should be tailored to your specific situation. If you think one of them fits your tax situation, we’d be happy to discuss it with you.

 

Avoid or Defer Income Recognition

Deferring taxable income makes sense for two reasons. Most individuals are in a higher tax bracket in their working years than they are during retirement. Deferring income until retirement may result in paying taxes on that income at a lower rate. Additionally, through the use of tax-deferred retirement accounts you can actually invest the money you would have otherwise paid in taxes to increase the amount of your retirement fund. Deferral can also work in the short term if you expect to be in a lower bracket in the following year or if you can take advantage of lower long-term capital gains rates by holding an asset a little longer.

Tip: You can achieve the same effect of deferring income by accelerating deductions, for example, by paying a state estimated tax installment in December instead of at the following January due date.

 

Max Out Your 401(k) or Similar Employer Plan

Many employers offer plans where you can elect to defer a portion of your salary and contribute it to a tax-deferred retirement account. For most companies these are referred to as 401(k) plans. For many other employers, such as universities, a similar plan called a 403(b) is available. Check with your employer about the availability of such a plan and contribute as much as possible to defer income and accumulate retirement assets.

Tip: Some employers match a portion of employee contributions to such plans. If this is available, you should structure your contributions to receive the maximum employer matching contribution.

 

If You Have Your Own Business, Set Up and Contribute to a Retirement Plan

If you have your own business, consider setting up and contributing as much as possible to a retirement plan. These are allowed even for sideline or moonlighting businesses. Several types of plans are available which minimize the paperwork involved in establishing and administering such a plan.

Related Guide: For details on Keogh plans and other retirement plans benefiting self-employed owners, see the Financial Guide: EMPLOYEE BENEFITS: How To Handle Them.

 

Contribute to an IRA

If you have income from wages or self-employment income, you can build tax-sheltered investments by contributing to a traditional or a Roth IRA. You may also be able to contribute to a spousal IRA -even where the spouse has little or no earned income. All IRAs defer the taxation of IRA investment income and in some cases can be deductible or be withdrawn tax free.

Related Guide: For details on how Roth IRAs work and how they compare in other respects with traditional IRAs, please see the Financial Guide: ROTH IRAs: How They Work and How To Use Them.

Related Guide: For details on the Coverdell Education Savings Account (formerly the Education IRA) – special purpose vehicles for higher education – please see the Financial Guide: HIGHER EDUCATION COSTS: How To Get The Maximum Deduction.

Tip: To get the most from IRA contributions, fund the IRA as early as possible in the year. Also, pay the IRA trustee out of separate funds, not out of the amount in the IRA. Following these two rules will ensure that you get the most possible tax-deferred earnings from your money.

 

Defer Bonuses or Other Earned Income

If you are due a bonus at year-end, you may be able to defer receipt of these funds until January. This can defer the payment of taxes (other than the portion withheld) for another year. If you’re self employed, defer sending invoices or bills to clients or customers until after the new year begins. Here, too, you can defer some of the tax, subject to estimated tax requirements. This may even save taxes if you are in a lower tax bracket in the following year. Note, however, that the amount subject to social security or self-employment tax increases each year.

 

Accelerate Capital Losses and Defer Capital Gains

If you have investments on which you have an accumulated loss, it may be advantageous to sell it prior to year-end. Capital losses are deductible up to the amount of your capital gains plus $3,000. If you are planning on selling an investment on which you have an accumulated gain, it may be best to wait until after the end of the year to defer payment of the taxes for another year (subject to estimated tax requirements). For most capital assets held more than 12 months (long-term capital gains) the maximum capital gains tax is 15 percent. However, make sure to consider the investment potential of the asset. It may be wise to hold or sell the asset to maximize the economic gain or minimize the economic loss.

 

Watch Trading Activity in Your Portfolio

When your mutual fund manager sells stock at a gain, these gains pass through to you as realized taxable gains, even though you don’t withdraw them. So you may prefer a fund with low turnover, assuming satisfactory investment management. Turnover isn’t a tax consideration in tax-sheltered funds such as IRAs or 401(k)s. For growth stocks you invest in directly and hold for the long term, you pay no tax on the appreciation until you sell them. No capital gains tax is imposed on appreciation at your death.

 

Use the Gift-Tax Exclusion to Shift Income

You can give away $14,000 ($28,000 if joined by a spouse) per donee in 2013 (up from $13,000 in 2012), per year without paying federal gift tax. You can give $14,000 to as many donees as you like. The income on these transfers will then be taxed at the donee’s tax rate, which is in many cases lower.

Note: Special rules apply to children under age 18. Also, if you directly pay the medical or educational expenses of the donee, such gifts will not be subject to gift tax.

 

Invest in Treasury Securities

For high-income taxpayers, who live in high-income-tax states, investing in Treasury bills, bonds, and notes can pay off in tax savings. The interest on Treasuries is exempt from state and local income tax. Also, investing in Treasury bills that mature in the next tax year results in a deferral of the tax until the next year.

 

Consider Tax-Exempt Municipal Bonds

Interest on state or local municipal bonds is generally exempt from federal income tax and from tax by the issuing state or locality. For that reason, interest paid on such bonds is somewhat less than that paid on commercial bonds of comparable quality. However, for individuals in higher brackets, the interest from municipal bonds will often be greater than from higher paying commercial bonds after reduction for taxes. Gain on sale of municipal bonds is taxable and loss is deductible. Tax-exempt interest is sometimes an element in computation of other tax items. Interest on loans to buy or carry tax-exempts is non-deductible.

 

Give Appreciated Assets to Charity

If you’re planning to make a charitable gift, it generally makes more sense to give appreciated long-term capital assets to the charity, instead of selling the assets and giving the charity the after-tax proceeds. Donating the assets instead of the cash prevents your having to pay capital gains tax on the sale, which can result in considerable savings, depending on your tax bracket and the amount of tax that would be due on the sale. Additionally you can obtain a tax deduction for the fair market value of the property.

Tip: Many taxpayers also give depreciated assets to charity. Deduction is for fair market value; no loss deduction is allowed for depreciation in value of a personal asset. Depending on the item donated, there may be strict valuation rules and deduction limits.

 

Keep Track of Mileage Driven for Business, Medical or Charitable Purposes

If you drive your car for business, medical or charitable purposes, you may be entitled to a deduction for miles driven. For 2013, it’s 56.5 cents per mile for business, 24 cents for medical and moving purposes, and 14 cents for service for charitable organizations. You need to keep detailed daily records of the mileage driven for these purposes to substantiate the deduction.

 

Take Advantage of Your Employer’s Benefit Plans to Get an Effective Deduction for Items Such as Medical Expenses

Medical and dental expenses are generally only deductible to the extent they exceed 7.5% of your adjusted gross income (AGI). For most individuals, particularly those with high income, this eliminates the possibility for a deduction. You can effectively get a deduction for these items if your employer offers a Flexible Spending Account, sometimes called a cafeteria plan. These plans permit you to redirect a portion of your salary to pay these types of expenses with pre-tax dollars. Another such arrangement is a Health Savings Account. Ask your employer if they provide either of these plans.

 

Check Out Separate Filing Status

Certain married couples may benefit from filing separately instead of jointly. Consider filing separately if you meet the following criteria:

  • One spouse has large medical expenses, miscellaneous itemized deductions, or casualty losses.
  • The spouses’ incomes are about equal.

Separate filing may benefit such couples because the adjusted gross income “floors” for taking the listed deductions will be computed separately. On the other hand, some tax benefits are denied to couples filing separately. In some states, filing separately can also save a significant amount of state income taxes.

 

If Self-Employed, Take Advantage of Special Deductions

You may be able to expense up to $500,000 in 2011 for qualified equipment purchases for use in your business immediately instead of writing it off over many years. Additionally, self-employed individuals can deduct 100% of their health insurance premiums as business expenses. You may also be able to establish a Keogh, SEP or SIMPLE plan, or a Health Savings Account, as mentioned above.

 

If Self-Employed, Hire Your Child in the Business

If your child is under age 18, he or she is not subject to employment taxes from your unincorporated business (income taxes still apply). This will reduce your income for both income and employment tax purposes and shift assets to the child at the same time; however, you cannot hire your child if he or she in under the age of 8 years old.

 

 

Take Out a Home-Equity Loan

Most consumer related interest expense, such as from car loans or credit cards, is not deductible. Interest on a home-equity loan, however, can be deductible. It may be advisable to take out a home-equity loan to pay off other nondeductible obligations.

 

 

Bunch Your Itemized Deductions

Certain itemized deductions, such as medical or employment related expenses, are only deductible if they exceed a certain amount. It may be advantageous to delay payments in one year and prepay them in the next year to bunch the expenses in one year. This way you stand a better chance of getting a deduction.

 

Travel and Entertainment: Maximizing the Tax Benefits

This Financial Guide shows you how to take advantage of all of the travel and entertainment expenses you’re legally entitled to and offers guidance on which expenses are deductible and what percentage of them you can deduct. It also discusses the importance of following IRS rules for keeping records and substantiating your expenses in order to avoid an audit.

Travel Expenses

Tax law allows you to deduct two types of travel expenses related to your business, local and what the IRS calls “away from home”.

  1. First, local travel expenses. You can deduct local transportation expenses incurred for business purposes, for example the cost of getting from one location to another via public transportation, rental car, or your own automobile. Meals and incidentals are not deductible as travel expenses, although as you will read later in this guide, you can deduct meals as an entertainment expense as long as certain conditions are met.
  2. Second, you can deduct away from home travel expenses-including meals and incidentals; however, if your employer reimburses your travel expenses, your deductions are limited.

LOCAL TRANSPORTATION COSTS

The cost of local business transportation includes rail fare and bus fare, as well as the costs of using and maintaining an automobile used for business purposes. For those whose main place of business is their personal residence, business trips from the home office and back are considered deductible transportation and not non-deductible commuting.

Note: Please see the special section below for the most effective ways of deducting auto expenses.

You generally cannot deduct lodging and meals unless you stay away overnight. Meals may be partially deductible as an entertainment expense, as discussed below.

AWAY FROM-HOME TRAVEL EXPENSES

You can deduct one-half of the cost of meals (50%) and all of the expenses of lodging incurred while traveling away from home. The IRS also allows you to deduct 100% of your transportation expenses–as long as business is the primary reason for your trip.

To be deductible, travel expenses must be “ordinary and necessary”, although “necessary” is liberally defined as “helpful and appropriate”, not “indispensable”. Deduction is also denied for that part of any travel expense that is “lavish or extravagant”, though this rule does not bar deducting the cost of first class travel, or deluxe accommodations or (subject to percentage limitations below) deluxe meals.

What does “away from home” mean?
To deduct the costs of lodging and meals (and incidentals-see below) you must generally stay somewhere overnight. In other words, away from your regular place of business longer than an ordinary day’s work and you need to sleep or rest to meet the demands of your work while away from home. Otherwise, your costs are considered local transportation costs, and the costs of lodging and meals are not deductible.

Where is your “home” for tax purposes?
The general view is that your “home” for travel expense purposes is your place of business or your post of duty. It is not where your family lives. (Some courts say it’s the general area of your residence).

Example: George’s family lives in Boston and George works in Washington, DC. George spends the weekends in Boston and the weekdays in Washington, where he stays in a hotel and eats out. For tax purposes, George’s “home” is in Washington, not Boston, therefore, he cannot deduct any of the following expenses: cost of traveling back and forth between Washington and Boston, cost of eating out in Washington, cost of staying in a hotel in Washington, or any costs incurred traveling between his hotel in Washington and his job in Washington (the latter are considered non-deductible commuting costs).

There are some rules in the tax law concerning where a taxpayer’s “home” is for purposes of deducting travel expenses that are less clear such as when a taxpayer works at a temporary site or works in two different places.

We’ll cover these rules briefly in these two examples:

Example #1: Joe, who lives in Connecticut, works eight months out of the year in Connecticut (from which he usually earns about $50,000) and four months out of the year in Florida (from which he usually earns about $15,000). Joe’s “tax home” for travel expense purposes is Connecticut. Therefore, the costs of traveling to and from the “lesser” place of employment (Florida), as well as meals and lodging costs incurred while working in Florida, are deductible.

Example #2: Susan works and lives in New York. Occasionally, she must travel to Maryland on temporary assignments, where she spends up to a week at a time. Assuming Susan’s employer does not reimburse her for travel expenses, she can deduct the costs of meals and lodging while she’s in Maryland, as well as the costs of traveling to and from Maryland. This holds true because her work assignments in Maryland are considered temporary, since they will end within a foreseeable time. If an assignment is considered indefinite, that is, expected to last for more than a year, under the tax law, travel, meal, and lodging costs are not deductible.

Here’s a list of some deductible away-from-home travel expenses:

  • Meals (limited to 50%) and lodging while traveling or once you get to your away-from-home business destination.
  • The cost of having your clothes cleaned and pressed away from home.
  • Costs for telephone, fax or modem usage.
  • Costs for secretarial services away-from-home.
  • The costs of transportation between job sites or to and from hotels and terminals.
  • Airfare, bus fare, rail fare, and charges related to shipping baggage or taking it with you.
  • The cost of bringing or sending samples or displays, and of renting sample display rooms.
  • The costs of keeping and operating a car, including garaging costs.
  • The cost of keeping and operating an airplane, including hangar costs.
  • Transportation costs between “temporary” job sites and hotels and restaurants.
  • Incidentals, including computer rentals, stenographers’ fees.
  • Tips related to the above.

However, many away-from-home travel expenses are not deductible or are restricted in some way. These include:

  • Commuting expenses. The costs of traveling between your home and your job are not deductible.
  • Travel as a form of education. Trips that are educational in a general way, or improve knowledge of a certain field but are not part of a taxpayer’s job, are not deductible.
  • Costs of looking for a first job. If you are looking for a new job in your current field, you can deduct the travel expenses. Otherwise, you may not deduct them.
  • Seeking a new location. Travel costs (and other costs) incurred while you are looking for a new place for your business (or for a new business) must be capitalized and cannot be deducted currently.
  • Luxury water travel: If you travel using an ocean liner, a cruise ship, or some other type of “luxury” water transportation, the amount you can deduct is subject to a per-day limit.
  • Seeking foreign customers: The costs of traveling abroad to find foreign markets for existing products are not deductible.

Tip: Starting in 2008, travel (and other) costs incurred in unsuccessfully trying to acquire a specific business are currently deductible.

 

““

 

Entertainment Expenses

There are limits and restrictions on deducting meal and entertainment expenses. Most are deductible at 50%, there are a few exceptions. Meals and entertainment must be “ordinary and necessary” and not “lavish or extravagant” and directly related to or associated with your business. They must also be substantiated. (We’ll cover this below.) For employees who are “fully reimbursed” (see below), the limits are imposed on the employer, not the employee.

Your home is considered a place conducive to business. As such, entertaining at home may be deductible providing there was business intent and business was discussed. The amount of time that business was discussed does not matter. Likewise, if you hold a small party (less than 12 people) at your home and discuss business with your guests it may be deductible as well.

Reasonable costs for food and refreshments for year-end parties for employees, as well as sales seminars and presentations held at your home are 100% deductible.

If you rent a skybox or other private luxury box for more than one event, say for the season, at the same sports arena, you generally cannot deduct more than the price of a non-luxury box seat ticket. Count each game or other performance as one event. ). Deduction for those seats is then subject to the 50% entertainment expense limit.

If expenses for food and beverages are separately stated, you can deduct these expenses in addition to the amounts allowable for the skybox, subject to the requirements and limits that apply. The amounts separately stated for food and beverages must be reasonable.

Deductions are disallowed for depreciation and upkeep of “entertainment facilities”-yachts, hunting lodges, fishing camps, swimming pools, and tennis courts. Costs of entertainment provided at such facilities are deductible subject to entertainment expense limitations.

Dues paid to country clubs or to social or golf and athletic clubs are not deductible. Dues that you pay to professional and civic organizations are deductible as long as your membership has a business purpose. Such organizations include business leagues, trade associations, chambers of commerce, boards of trade, and real estate boards.

Tip: To avoid problems qualifying for a deduction for dues paid to professional or civic organizations, document the business reasons for the membership-the contacts you make and any income generated from the membership.

Entertainment costs, taxes, tips, cover charges, room rentals, maids and waiters are all subject to the 50% limit on entertainment deductions.

 

““

 

How Do You Prove Expenses Are “Directly Related”?

Expenses are directly related if you can show:

  • There was more than a general expectation of gaining some business benefit other than goodwill.
  • You conducted business during the entertainment.
  • Active conduct of business was your main purpose.

There is a presumption (in the eyes of the IRS) that events that take place in what it considers places non-conducive to doing business are not directly related to your business. These places include nightclubs, theaters, sporting events or cocktail parties. It also includes meetings with a group of people who are not business associates, at cocktail lounges, country clubs, or athletic clubs. However, you can overcome the presumption by showing that you engaged in a business discussion or otherwise conducted business during the event.

 

““

 

How Do You Meet The “Associated With” Test?

Even if you can’t show that the entertainment was “directly related” as discussed above, you can still deduct the expenses as long as you can prove the entertainment was “associated” with your business. To meet this test, the entertainment must directly precede or come after a substantial business discussion. Further, you must have had a clear business purpose when you took on the expense.

 

““

 

For Whom Can You Get The Deduction?

The person entertained must be a business associate. That is, someone who could reasonably be expected to be a customer or conduct business with you, including an employee or professional advisor.

In circumstances where it’s customary to entertain a business associate with his or her spouse, and your spouse also attends, entertainment of both spouses is deductible, thanks to the “closely connected rule”.

 

““

 

Recordkeeping and Substantiation Requirements

Tax law requires you to keep records that will prove the business purpose and amounts of your business travel, entertainment, and local transportation costs.

WHICH RECORDS YOU MUST KEEP

You must substantiate the following business expenses:

  • Travel expenses while away from home (including meals and lodging).
  • Entertainment and arranging recreational activities, and
  • Business gifts.

To substantiate these items, you must prove:

  • The amount.
  • The time and place of the travel, entertainment, or recreation, or the date and a description of the business gift.
  • The business purpose, and
  • The business relationship of the recipient of entertainment or gifts.

Tip: The most frequent reason for IRS’s disallowance of travel and entertainment expenses is the failure to show the place and business purpose of an item .Therefore, pay special attention to these aspects of your record-keeping.

Keeping a diary or log book–and recording your business-related activities at or close to the time the expense is incurred–is one of the best ways to document your business expenses.

Here’s how these rules apply to your record-keeping for travel expenses, entertainment expenses, and business gifts.

Away-from-home travel expenses. You must document the following for each trip:

  • The amount of each expense-e.g., the cost of each transportation, lodging and meal. (You can group similar types of incidentals together-i.e., “meals,” “taxis.”)
  • The dates of your departure and return and the number of days you spent on business.
  • Your destination.
  • The business reason for the travel or the business benefit you expect.

Entertainment expenses. You must prove the following for each claimed deduction for entertainment expenses:

  • The amount of each separate expense, though incidentals may be totaled on a daily basis.
  • The date of the entertainment.
  • The name, address, and type of entertainment-e.g., “dinner,” or “show”-but only if the type of entertainment is not obvious from the place name.
  • The business reason for the entertainment and the nature of any business discussion that took place. Note: For business meals, you do not have to write down the nature of the discussion, but you or your employee must be present.
  • The name, title, and occupation (showing business relation) of the people you entertained.

Business gifts. You must keep the following documentation for a business gift to substantiate the deduction:

  • The cost of the gift and the date it was made.
  • The business reason for the gift.
  • The name, title, and occupation of the recipient.
  • A description of the gift.

 

““

 

Employees “Fully Reimbursed”

Employees who are “fully reimbursed” by their employers are not subject to the deduction limits discussed in this Financial Guide-their employers are. “Fully reimbursed” means that all the following occur:

  • You adequately account to your employer (see below).
  • You receive full reimbursement.
  • You were required to, and did, return any excess reimbursement.
  • In your Form W-2, Box 13 shows no amount with a Code L.

You adequately account to your employer by means of an expense account statement. If you are covered by (and follow) an “accountable plan,” and your reimbursements don’t exceed your expenses, you won’t have to report the reimbursements as gross income. Some per diem arrangements (by which you receive a flat amount per day) and mileage allowances can avoid detailed expense financial record keeping to the employer, but proof of time, place and business purpose is still required.

However, if your employer’s reimbursement plan is not “accountable,” you must report the reimbursements as income, and you can then deduct the expenses you paid-but you must deduct them as employee business expenses, subject to the 2%-of-adjusted-gross-income floor.

If you are reimbursed under an expense account for travel, transportation, entertainment, gifts, and other business expenses, here are the record-keeping and reporting rules that apply. If you received an advance, allowance, or reimbursement for your expenses, how you report this amount and your expenses depends on whether the reimbursement was paid to you under an accountable plan or a non-accountable plan.

If you are covered by (and follow) an “accountable plan,” and your reimbursements don’t exceed your expenses, you won’t have to report the reimbursements as gross income.

However, if your employer’s reimbursement plan in not “accountable,” you must report the reimbursements as income, and you can then deduct the expenses you paid. You must deduct them as employee business expenses, subject to the 2%-of-adjusted-gross-income floor. An accountable plan is one in which (1) your expenses are business related, (2) you adequately account for these expenses to your employer within a reasonable time and (3) you return any excess reimbursement within a reasonable time.

 

““

 

Auto Expenses

Self-employed individuals and employees who use their cars for business but either don’t get reimbursed, or are reimbursed under an employer’s “non-accountable” reimbursement plan can deduct auto expenses. In the case of employees, expenses are deductible to the extent that auto expenses (together with other “miscellaneous itemized deductions”) exceed 2% of adjusted gross income.

If you use a car for business, you have two choices as to how to claim the deductions:

  1. You can deduct the actual business-related costs of gas, oil, lubrication, repairs, tires, supplies, parking, tolls, chauffeur salaries, and depreciation, or
  2. You can use the standard mileage deduction, which is an inflation-adjusted amount that is multiplied by the number of business miles driven.

Tip: Parking fees and tolls may be deducted no matter which method you use.

For some, the standard mileage rate produces a larger deduction. Others fare better tax-wise by deducting actual expenses. After we tell you about limits on auto depreciation, we’ll tell you how to determine which of these two methods is better for you tax-wise.

Expensing and depreciating vehicle costs. Deduction options and amounts depend on the percentage used for business. Also, if the car is used more than 50% for business, it can be included as business property and qualify for Section 179 expensing in the year of purchase. The deduction is reduced proportionately to the extent the car is used for personal purposes. If you take this deduction you can’t use the actual mileage for that vehicle in any year.

Depreciation. Assuming the car cost more than the Section 179 limit, or Section 179 is not available or is not claimed, depreciation is also allowed. Several depreciation options are available, but there are limits to the amount of depreciation that can be claimed per year. Depreciation otherwise allowable is reduced by the proportion of personal use (for example, a car used 20% for personal use is depreciated at 80% of the amount otherwise allowed). Accelerated depreciation–depreciation at a rate higher than that resulting from dividing the vehicle’s cost by the number of years it will be used–is not allowed where personal use is 50% or more.

Finally, if you claimed accelerated depreciation in a prior year and your business use then falls to 50% or less, you become subject to “recapture” of the excess depreciation (i.e., it’s included in income).

Of course, using the standard mileage deduction allows you to avoid these limits.

Determining whether to use the standard mileage deduction. If you opt for the standard mileage rate, you simply multiply current cents-per-mile rate by the number of business miles you drive for the year.

Be aware, however, that the standard mileage deduction may understate your costs. This is especially true for taxpayers who use the car 100% for business, or close to that percentage.

Caution: Once you choose the standard mileage rate, you cannot use accelerated depreciation even if you opt for the actual cost method in a later year. You may use only straight line.

Tip: The standard mileage method usually benefits taxpayers who have less expensive cars or who travel a large number of business miles. To determine which method is better for you, make the calculations each way during the first year you use the car for business.

You may use the standard mileage for leased cars if you use it for the entire lease period. Or, you can deduct actual expenses instead, including leasing costs.

Recordkeeping. This is best thing you can do to make the most of your auto deductions, not to mention essential to have this documentation in case of an audit. You won’t be able to determine which of the two options is better if you don’t know the number of miles driven and the total amount you spent on the car. Furthermore, the tax law requires that you keep travel expense records and that you give information on your return showing business versus personal use. If you use the actual cost method, you’ll have to keep receipts as well.

Tip: Consider using a separate credit card for business to simplify your record-keeping.

Tip: Don’t forget to deduct the interest you pay to finance a business-use car if you’re self-employed.

 

““

 

The “Nanny Tax” Rules: What To Do If You Have Household Employees

This Financial Guide will help you decide whether you have a “household employee,” as defined by the IRS, and, if you do, whether you need to pay federal employment taxes. It explains the rules for determining, paying, and reporting Social Security tax, Medicare tax, federal unemployment tax, federal income tax withholding, and state unemployment tax for your household employee. It also explains what records you need to keep. In addition, it provides you with the information you need to find out whether you need to pay state unemployment tax for your household employee.

While many people disregard the need to pay taxes on household employees, they do so at the risk of stiff tax penalties. As you will see below, these rules are quite complex and professional tax guidance is highly recommended.

A basic familiarity with these rules will make it easier to work with your tax advisor, saving you time, reducing tax costs, and avoiding tax penalties and interest charges.

Who is a Household Employee?

The “nanny tax” rules apply to you only if (1) you pay someone for household work and (2) that worker is your employee.

    1. A household employee is someone who does work in or around your home. Examples of household employees include baby sitters, nannies, health aides, private nurses, maids, caretakers, yard workers, and similar domestic workers.
    1. A household worker is your employee if you can control not only what work is done, but how it is done. If the worker is your employee, it does not matter whether the work is full time or part time, or that you hired the worker through an agency or from a list provided by an agency or association. It also does not matter whether you pay the worker on an hourly, daily, or weekly basis, or by the job.On the other hand, if only the worker can control how the work is done, the worker is not your employee, but is self-employed. A self-employed worker usually provides his or her own tools and offers services to the general public in an independent business. If an agency provides the worker and controls what work is done and how it is done, the worker is not your employee.

Example: You pay Betty to babysit your child and do light housework four days a week in your home. Betty follows your specific instructions about household and child care duties. You provide the household equipment and supplies that Betty needs to do her work. Betty is your household employee.

Example: You pay John to care for your lawn. John also offers lawn care services to other homeowners in your neighborhood. He provides his own tools and supplies, and he hires and pays any helpers he needs. Neither John nor his helpers are your household employees.

 

 

How Do You Verify That an Employee Can Legally Work in the United States?

It is unlawful for you to knowingly hire or continue to employ a person who cannot legally work in the United States.

When you hire a household employee to work for you on a regular basis, he or she must complete USCIS Form I-9 Employment Eligibility Verification. It is your responsibility to verify that the employee is either a U.S. citizen or an alien who can legally work and then complete the employer part of the form. Keep the completed form for your records. Do not return the form to the U.S. Citizenship and Immigration Services (USCIS).

Two copies of Form I-9 are contained in the UCIS Employer Handbook. Visit the USCIS website http://www.uscis.gov or call 800-767-1833 to order the handbook, additional copies of the form, or to get more information.

 

 

Do You Need to Pay Employment Taxes?

If you have a household employee, you may need to withhold and pay Social Security and Medicare taxes, or you may need to pay federal unemployment tax, or you may need to do both. To find out, read the table below.

IF YOU:

THEN YOU NEED TO:

Pay cash wages of $1,800 or more in 2013 to any one household employee.Do not count wages you pay to:

  • Your spouse,
  • Your child under age 21,
  • Your parent, or
  • Any employee under age 18 during 2013.
Withhold and pay Social Security and Medicare taxes.

  • The combined taxes are generally 15.3% of cash wages.
  • Your employee’s share is 7.65%.

(You can choose to pay the employee’s share yourself and not withhold it.)

  • Your share is 7.65%.
Pay total cash wages of $1,000 or more in any calendar quarter of 2012 or 2013 to household employees.Do not count wages you pay to:

  • Your spouse,
  • Your child under age 21, or
  • Your parent.
Pay federal unemployment tax.

  • The tax is 0.6% of cash wages.
  • Wages over $7, 000 a year per employee are not taxed.
  • You also may owe state unemployment tax.

Note: If neither of these two columns applies, then you do not need to pay any federal unemployment taxes. However, you may still need to pay state unemployment taxes.

You do not need to withhold federal income tax from your household employee’s wages. But if your employee asks you to withhold it, you can choose to do so.

Tip: If your household employee cares for your dependent under the age of 13 or your spouse or dependent who is not capable of self-care, so that you can work, you may be able to take an income tax credit of up to 35% (or $1,050) of your expenses for each qualifying dependent. For two or more qualifying dependents, you can claim up to 35% (or $2,100). For higher income earners the credit percentage is reduced, but not below 20%, regardless of the amount of AGI. If you can take the credit, then you can include your share of the federal and state employment taxes you pay, as well as the employee’s wages, in your qualifying expenses.

 

 

State Unemployment Taxes

To find out whether you need to pay state unemployment tax for your household employee contact your state unemployment tax agency. You’ll also need to determine whether you need to pay or collect other state employment taxes or carry workers’ compensation insurance.

Note: If you do not need to pay Social Security, Medicare, or federal unemployment tax and do not choose to withhold federal income tax, the rest of this publication does not apply to you.

 

 

Social Security and Medicare Taxes

Note: As of January 1, 2013, the 4.2% employee social security tax rate in effect for 2012 has reverted to 6.2%. The Medicare rate remains unchanged at 1.45%; however, beginning January 1, 2013, Additional Medicare Tax applies to an individual’s Medicare wages that exceed a threshold amount based on the taxpayer’s filing status. Employers are responsible for withholding the 0.9% Additional Medicare Tax on an individual’s wages paid in excess of $200,000 in a calendar year. An employer is required to begin withholding Additional Medicare Tax in the pay period in which it pays wages in excess of $200,000 to an employee. There is no employer match for Additional Medicare Tax.

Both you and your household employee may owe social security and Medicare taxes. Your share is 7.65% (6.2% for social security tax and 1.45% for Medicare tax) of the employee’s social security and Medicare wages. Your employee’s share is 6.2% for social security tax and 1.45% for Medicare tax for wages below the Additional Medicare Tax threshold (see above).

You are responsible for payment of your employee’s share of the taxes as well as your own. You can either withhold your employee’s share from the employee’s wages or pay it from your own funds.

SOCIAL SECURITY AND MEDICARE WAGES

You figure Social Security and Medicare taxes on the Social Security and Medicare wages you pay your employee. If you pay your household employee cash wages of $1,800 or more in 2013, all cash wages you pay to that employee in 2013 (regardless of when the wages were earned) up to $113,700 are social security wages and all cash wages are Medicare wages. However, any non-cash wages (food, lodging, clothing, and other non-cash items) you pay do not count as social security and Medicare wages. If you pay the employee less than $1,800 in cash wages in 2013, none of the wages you pay the employee are Social Security and Medicare wages, and neither you nor your employee will owe Social Security or Medicare tax.

WAGES NOT COUNTED

Do not count wages you pay to any of the following individuals as Social Security and Medicare wages:

    1. Your spouse.
    2. Your child who is under age 21.
    3. Your parent.

Note: However, you should count wages to your parent if both of the following apply: (a) your child lives with you and is either under age 18 or has a physical or mental condition that requires the personal care of an adult for at least 4 continuous weeks in a calendar quarter, and (b) you are divorced and have not remarried, or you are a widow or widower, or you are married to and living with a person whose physical or mental condition prevents him or her from caring for your child for at least 4 continuous weeks in a calendar quarter.

    1. An employee who is under age 18 at any time during the year.

Note: However, you should count these wages to an employee under 18 if providing household services is the employee’s principal occupation. If the employee is a student, providing household services is not considered to be his or her principal occupation.

Also, if your employee’s Social Security and Medicare wages reach $113,700 in 2013, do not count any wages you pay that employee during the rest of the year as Social Security wages to figure Social Security tax. (But continue to count the employee’s cash wages as Medicare wages to figure Medicare tax.)

You figure federal income tax withholding on both cash and non-cash wages (based on their value). However, do not count as wages any of the following items:

  • Meals provided at your home for your convenience.
  • Lodging provided at your home for your convenience and as a condition of employment.
  • Up to $240 a month in 2013 for transit passes that you give your employee or, in some cases, for cash reimbursement you make for the amount your employee pays to commute to your home by public transit. A transit pass includes any pass, token, fare card, voucher, or similar item entitling a person to ride on mass transit, such as a bus or train.
  • Up to $240 a month in 2013 to reimburse your employee for the cost of parking at or near your home or at or near a location from which your employee commutes to your home.

WITHHOLDING THE EMPLOYEE’S SHARE

You should withhold the employee’s share of Social Security and Medicare taxes if you expect to pay your household employee Social Security and Medicare wages of $1,800 or more in 2013. However, if you prefer to pay the employee’s share yourself; see “Not Withholding the Employee’s Share” in the next section.

You may withhold the employee’s share of the taxes even if you are not sure your employee’s Social Security and Medicare wages will be $1,800 or more in 2013. If you withhold the taxes but then actually pay the employee less than $1,800 in Social Security and Medicare wages for the year, you should repay the employee.

You pay withheld taxes as part of your regular income tax obligation. You don’t deposit them periodically-subject to an exception for business owners. See “Payment Options for Business Employers” below.

Withhold 7.65% (6.2% for Social Security tax and 1.45% for Medicare tax) from each payment of Social Security and Medicare wages. Wages exceeding the $200,000 (single filer) threshold amount are subject to the additional Medicare tax or 0.9%. Instead of paying this amount to your employee, you will pay it to the IRS 7.65% for your share of the taxes. Do not withhold any social security tax after your employee’s social security wages for the year reach $113,700 (2013).

If you make an error by withholding too little, you should withhold additional taxes from a later payment. If you withhold too much, you should repay the employee.

Example: You hire a household employee (who is an unrelated individual over age 18) to care for your child and agree to pay cash wages of $100 every Friday. You expect to pay your employee $1,800 or more for the year. You should withhold $7.65 from each $100 wage payment and pay your employee the remaining $92.35. The $7.65 is the sum of $6.20 ($100 x 6.2%) for your employee’s share of Social Security tax and $1.45 ($100 x 1.45%) for your employee’s share of Medicare tax (for wages under $200,000 for single filers). You will pay $7.65 you withhold with $7.65 from your own funds when you pay the taxes.

NOT WITHHOLDING THE EMPLOYEE’S SHARE

If you prefer to pay your employee’s Social Security and Medicare taxes from your own funds, you do not have to withhold them from your employee’s wages. The Social Security and Medicare taxes you pay to cover your employee’s share must be included in the employee’s wages for income tax purposes. However, they are not counted as Social Security and Medicare wages or as federal unemployment (FUTA) wages.

Example: You hire a household employee (who is an unrelated individual over age 18) to care for your child and agree to pay cash wages of $100 every Friday. You expect to pay your employee $1,800 or more for the year. You decide to pay your employee’s share of Social Security and Medicare taxes from your own funds. You pay your employee $100 every Friday without withholding any Social Security or Medicare taxes. For each wage payment you will pay $15.30 when you pay the taxes. This is $.65 ($6.20 for Social Security tax plus $1.45 for Medicare tax) to cover your employee’s share plus the $7.65 for your share. For income tax purposes, your employee’s wages each payday are $107.65 ($100 plus the $7.65 that you will pay to cover your employee’s share of Social Security and Medicare taxes).

 

 

Federal Unemployment (FUTA) Tax

The federal unemployment tax is part of the federal and state program under the Federal Unemployment Tax Act (FUTA) that pays unemployment compensation to workers who lose their jobs. Like most employers, you may owe both the federal unemployment tax (the FUTA tax) and a state unemployment tax. Or, you may owe only the FUTA tax or only the state unemployment tax. To find out whether you will owe state unemployment tax, contact your state’s unemployment tax agency. See the list of state unemployment agencies at the end of this Guide for the address.

The FUTA tax is 6.0% of your employee’s FUTA wages. However, you may be able to take a credit of up to 5.4% against the FUTA tax, resulting in a net tax rate of 0.6%. Your credit for 2013 is limited unless you pay all the required contributions for 2013 to your state unemployment fund by April 15, 2014. The credit you can take for any contributions for 2013 that you pay after April 15, 2014, is limited to 90% of the credit that would have been allowable if the contributions were paid by April 15, 2014.

WARNING: Do not withhold the FUTA tax from your employee’s wages. You must pay it from your own funds.

 

You figure the FUTA tax on the FUTA wages you pay. If you pay cash wages to all of your household employees totaling $1,000 or more in any calendar quarter of 2012 or 2013, the first $7,000 of cash wages you pay to each household employee in 2013 is FUTA wages. (A calendar quarter is January through March, April through June, July through September, or October through December.) If your employee’s cash wages reach $7,000 during the year, do not figure the FUTA tax on any wages you pay that employee during the rest of the year. For a discussion of “cash wages,” see the section on Social Security Wages, above.

 

If you pay less than $1,000 cash wages in each calendar quarter of 2013, but you had a household employee in 2012, the cash wages you pay in 2012 may still be FUTA wages. They are FUTA wages if the cash wages you paid to household employees in any calendar quarter of 2012 totaled $1,000 or more.

Do not count wages you pay to any of the following individuals as FUTA wages:

  1. Your spouse.
  2. Your child who is under age 21.
  3. Your parent.

Example: You hire a household employee (not related to you) on January 1, 2013, and agree to pay cash wages of $200 every Friday. During January, February, and March, you pay the employee cash wages of $2,600. Because you pay cash wages of $1,000 or more in a calendar quarter of 2013, the first $7,000 of cash wages you pay the employee (or any other employee) in 2012 or 2013 is FUTA wages. The FUTA wages you pay may also be subject to your state’s unemployment tax.

 

During 2013, you pay your household employee cash wages of $10,400. You pay all the required contributions for 2013 to your state unemployment fund by April 15, 2014. Your FUTA tax for 2013 is $42 ($7,000 x 0.6%).

 

 

Do You Need to Withhold Federal Income Tax?

You are not required to withhold federal income tax from wages you pay a household employee. You should withhold federal income tax only if your household employee asks you to withhold it and you agree. The employee must give you a completed Form W-4, Employee’s Withholding Allowance Certificate.

If you agree to withhold federal income tax, you are responsible for paying it to the IRS.

WAGES

You figure federal income tax withholding on both cash and non-cash wages you pay. Measure wages you pay in any form other than cash by the value of the non-cash item.

Do not count as wages any of the following items:

  • Meals provided at your home for your convenience.
  • Lodging provided at your home for your convenience and as a condition of employment.
  • Up to $240 a month in 2013 for bus or train tokens (passes) you give your employee, or for any cash reimbursement you make for the amount your employee pays to commute to your home by public transit.
  • Up to $240 a month in 2013 for the value of parking you provide your employee at or near your home or at or near a location from which your employee commutes to your home.

PAYING TAX WITHOUT WITHHOLDING

Any income tax you pay for your employee without withholding it from the employee’s wages must be included in the employee’s wages for federal income tax purposes. It is also counted as Social Security and Medicare wages and as federal unemployment (FUTA) wages.

 

 

How Do You Handle the Earned Income Tax Credit (EITC)?

Certain workers can take the earned income tax credit (EITC) on their federal income tax return. This credit reduces their tax or allows them to receive a payment from the IRS if they do not owe tax. You may have to make advance payments of part of your household employee’s EITC along with the employee’s wages. You also may have to give your employee a notice about the EITC.

NOTICE ABOUT THE EITC

The employee’s copy (Copy B) of the IRS 2013 Form W-2, Wage and Tax Statement has a statement about the EITC on the back.

Tip: If you give your employee that copy by January 31, 2014 (as discussed under Form W-2), you do not have to give the employee any other notice about the EITC.

Otherwise, you must give your household employee a notice about the EITC only if you agree to withhold federal income tax from the employee’s wages but the income tax withholding tables show that no tax should be withheld. Even if not required, you are encouraged to give the employee a notice about the EITC if his or her 2013 wages are less than the amount shown in the instructions to 2014 Form W-5.

If you do not give your employee Copy B of the IRS Form W-2, your notice about the EITC can be any of the following:

  • A substitute Form W-2 with the same EIC information on the back of the employee’s copy that is on Copy C of the IRS Form W-2,
  • Notice 797, Possible Federal Tax Refund Due to the Earned Income Credit (EIC), or
  • Your own written statement with the same wording as Notice 797.

If you give your employee a substitute Form W-2 on time which lacks the required EIC information, you must give notice about the 2013 EIC to the employee within one week of the date you gave him or her the substitute Form W-2. If Form W-2 is required, but not given on time, you must give the employee notice about 2013 EIC by January 31, 2014. If Form W-2 is not required, you must give your notice to the employee by February 7, 2014.

 

 

How do You Make Tax Payments?

When you file your 2013 federal income tax return in 2014, attach Schedule H, Household Employment Taxes. Use this Schedule, discussed further below, to figure your household employment taxes. You will add the federal employment taxes on the wages you pay to your household employee in 2013, less any advance earned income credit payments you make to the employee, to your income tax. The amount you owe with your return is due to the IRS by April 15, 2014.

Tip: You can avoid owing tax with your return if you pay enough federal income tax before you file to cover the employment taxes for your household employee, as well as your income tax. If you are employed, you can ask your employer to withhold more federal income tax from your wages in 2013. If you get a pension or annuity, you can ask for more federal income tax withholding from your benefits. Or you can make estimated tax payments for 2013 to the IRS, or increase your payments if you already make them.

ASKING FOR MORE FEDERAL INCOME TAX WITHHOLDING

If you are employed and want more federal income tax withheld from your wages to cover the employment taxes for your household employee, give your employer a new Form W-4, Employee’s Withholding Allowance Certificate. Complete it as before, but show the additional amount you want withheld from each paycheck on line 6.

If you get a pension or annuity and want more federal income tax withheld to cover the employment taxes for your household employee, give the payer a new Form W-4P, Withholding Certificate for Pension or Annuity Payments (or a similar form provided by the payer). Complete it as before, but show the additional amount you want withheld from each benefit payment on line 3.

PAYING ESTIMATED TAX

If you want to make estimated tax payments to cover the employment taxes for your household employee, get Form 1040-ES, Estimated Tax for Individuals. Use its payment vouchers to make your payments. You can pay all of the employment taxes at once or in installments. If you have already made estimated tax payments for 2013, you can increase your remaining payments to cover the employment taxes. Estimated tax payments for 2013 are ordinarily due April 15, June 17, September 16, 2013 and January 15, 2014.

PAYMENT OPTION FOR BUSINESS EMPLOYERS

If you own a business as a sole proprietor or your home is on a farm operated for profit, you can choose either of two ways to pay the 2013 federal employment taxes for your household employee. You can pay them with your federal income tax as described above, or you can include them with your federal employment tax deposits or other payments for your business or farm employees.

If you pay the employment taxes for your household employee with business or farm employment taxes, you must report them with those taxes on Form 941 or Form 943 and on Form 940 (or 940-EZ).

 

 

What Forms Must You File?

You must file certain forms to report your household employee’s wages and the federal employment taxes for the employee if you pay the employee:

  1. Social Security and Medicare wages,
  2. FUTA wages, or
  3. Wages from which you withhold federal income tax.

The employment tax forms and instructions you need for 2013 will be sent to you automatically in January 2014 if you reported employment taxes for 2012 on Schedule H (Form 1040), Household Employment Taxes.

EMPLOYER IDENTIFICATION NUMBER (EIN)

You must include your employer identification number (EIN) on the forms you file for your household employee. An EIN is a 9-digit number issued by the IRS–not the same as a Social Security number.

Tip: You ordinarily will have an EIN if you previously paid taxes for employees, either as a household employer or in a business you own as a sole proprietor, or if you have a Keogh Plan. If you already have an EIN, use that number. If you do not have an EIN, get Form SS-4, Application for Employer Identification Number. The instructions for Form SS-4 explain how you can get an EIN immediately by telephone or in about 4 weeks if you apply by mail.

FORM W-2

A separate 2013 Form W-2, Wage and Tax Statement, must be filed for each household employee to whom you pay:

  • Social Security and Medicare wages of $1,800 or more, or
  • Wages from which you withhold federal income tax.

You must complete Form W-2 and give Copies B, C, and 2 to your employee by January 31, 2013. You must send Copy A of Form W-2 with Form W-3, Transmittal of Wage and Tax Statements, to the Social Security Administration by February 28, 2013 (April 1, 2013, if you file your Form W-2 electronically).

SCHEDULE H

Use Schedule H (Form 1040), Household Employment Taxes, to report the federal employment taxes for your household employee if you pay the employee:

  1. Social Security and Medicare wages of $1,800 or more in 2013,
  2. FUTA wages, or
  3. Wages from which you withhold federal income tax.

File Schedule H with your 2013 federal income tax return by April 15, 2014. If you get an extension to file your return, the extension will also apply to your Schedule H.

If you are not required to file a 2013 tax return, you must file Schedule H by itself. See the Schedule H instructions for details.

BUSINESS EMPLOYMENT TAX RETURNS

Do not use Schedule H (Form 1040) if you choose to pay the employment taxes for your household employee with business or farm employment taxes. Instead, include the Social Security, Medicare, and withheld federal income taxes for the employee on the Forms 941, Employer’s Quarterly Federal Tax Return, that you file for your business or on the Form 943, Employer’s Annual Tax Return for Agricultural Employees, that you file for your farm. Include the FUTA tax for the employee on your Form 940 (or 940-EZ), Employer’s Annual Federal Unemployment (FUTA) Tax Return.

If you report the employment taxes for your household employee on Form 941 or Form 943, file Form W-2 for the employee with the Forms W-2 and Form W-3 for your business or farm employees.

 

 

What Records Must You Keep?

Keep your copies of Schedule H or other employment tax forms you file and related Forms W-2, W-3, W-4, and W-5. You must also keep records to support the information you enter on the forms you file. If you are required to file Form W-2, you will need to keep a record of your employee’s name, address, and Social Security number.

WAGE AND TAX RECORDS

On each payday you should record the date and amounts of:

  • Your employee’s cash and non-cash wages,
  • Any employee Social Security tax you withhold or agree to pay for your employee,
  • Any employee Medicare tax you withhold or agree to pay for your employee,
  • Any federal income tax you withhold,
  • Any advance EIC payments you make, and
  • Any state employment taxes you withhold.

EMPLOYEE’S SOCIAL SECURITY NUMBER

You must keep a record of your employee’s name and Social Security number exactly as they appear on his or her Social Security card if you pay the employee:

  • Social Security and Medicare wages, or
  • Wages from which you withhold federal income tax.

You must ask for your employee’s Social Security number no later than the first day on which you pay the wages. You may wish to ask for it when you hire your employee.

An employee who does not have a Social Security number must apply for one on Form SS-5, Application for a Social Security Card. An employee who has lost his or her Social Security card or whose name is not correctly shown on the card should apply for a new card. Employees may get Form SS-5 from any Social Security Administration office or by calling l-800-772-1213.

HOW LONG TO KEEP RECORDS

Keep your employment tax records for at least four years after the due date of the return on which you report the taxes or the date the taxes were paid, whichever is later.

 

 

State Unemployment Tax Agencies

Alabama
Department of Industrial Relations
649 Monroe St.
Montgomery, AL 36131-0099
(334) 242-8830

Alaska
Employment Security Tax
Department of Labor and Workforce Development
PO Box 11509
Juneau, AK 99811-5509
(888) 448-3527

Arizona
Unemployment Tax – 911B
Department of Economic Security
PO Box 6028
Phoenix, AZ 85005-6028
(602) 771-6601

Arkansas
Department of Workforce Services
PO Box 2981
Little Rock, AR 72203-2981
(501) 682-3798

California
Account Services Group, MIC-90
PO Box 942880
Sacramento, CA 94280
(888) 745-3886

Colorado
Unemployment Insurance Operations
Department of Labor and Employment
PO Box 8789
Denver, CO 80201-8789
(800) 480-8299

Connecticut
Connecticut Department of Labor
200 Folly Brook Blvd.
Wethersfield, CT 06109-1114
(860) 263-65504

Delaware
Division of Unemployment Insurance
Department of Labor
PO Box 9950
Wilmington, DE 19809-0950
(302) 761-8484

District of Columbia
Department of Employment Services
Office of Unemployment Compensation Tax Division
609 H Street, NE, 3rd Floor
Washington, DC 20001-4347
(202) 698-7550

Florida
Unemployment Compensation Services
Agency for Workforce Innovation
107 E. Madison Street MSC 229
Tallahassee, FL 32399-0180
(800) 482-8293

Georgia
Department of Labor
148 Andrew Young International Blvd., Suite 800
Atlanta, GA 30303
(404) 232-3301

Hawaii
Department of Labor and Industrial Relations
830 Punchbowl Street, Rm. 437
Honolulu, HI 96813
(808) 586-8913

Idaho
Department of Employment
317 Main Street
Boise, ID 83735-0002
(800) 448-2977

Illinois
Department of Employment Security
33 South State Street
Chicago, IL 60603
(800) 247-4984

Indiana
Department of Workforce Development
10 North Senate Avenue
Room SE 106 Indianapolis, IN 46204-2277
(317) 232-7436

Iowa
Workforce Development
1000 East Grand Avenue
Des Moines, IA 50319-0209
(515) 281-5339

Kansas
Department of Human Resources
401 SW Topeka Blvd.
Topeka, KS 66603-3182
(785) 296-5027

Kentucky
Division for Employment Services
PO Box 948
Frankfort, KY 40602-0948
(502)564-2272

Louisiana
Louisiana Workforce Commission
PO Box 94094
Baton Rouge, LA 70804
(225) 342-2944

Maine
Department of Labor
PO Box 259
Augusta, ME 04332-0259
(207) 621-5120

Maryland
Department of Labor, Licensing & Regulation
1100 North Eutaw Street
Baltimore, MD 21201-2201
(800) 492-5524

Massachusetts
Division of Employment and Training
19 Staniford Street
Boston, MA 02114-2589
(617) 626-5050

Michigan
Department of Labor & Economic Growth
3024 W. Grand Boulevard
Detroit, MI 48202-6024
(313) 456-2180

Minnesota
Department of Employment & Economic Development
332 Minnesota Street
Suite E200
St. Paul, MN 55101-1351
(651) 296-6141

Mississippi
Department of Employment Security
PO Box 1699
Jackson, MS 39215-1699
(866) 806-0272

Missouri
Division of Employment Security
PO Box 59
Jefferson City, MO 65104-0059
(573) 751-3340

Montana
Unemployment Insurance Division
PO Box 6339
Helena, MT 59604-6339
(406) 444-3834

Nebraska
Department of Labor
PO Box 94600
State House Station
Lincoln, NE 68509-4600
(402) 471-9940

Nevada
Department of Employment Training and Rehabilitation
500 East Third Street
Carson City, NV 89713-0030
(775) 684-6300

New Hampshire
Department of Employment Security
32 South Main Street
Concord, NH 03301-4857
(603) 228-4033

New Jersey
Department of Labor & Workforce Development
P.O. Box 947
Trenton, NJ 08625-0947
(609) 633-6400

New Mexico
Department of Workforce Solutions
PO Box 2281
Albuquerque, NM 87103-2281
(505) 841-8576

New York
Department of Labor
State Campus, Building 12
Room 500
Albany, NY 1224-03390
(518) 457-4179

North Carolina
Employment Security Commission
PO Box 26504
Raleigh, NC 27611-6504
(919) 707-1150

North Dakota
Job Service of North Dakota
PO Box 5507
Bismarck, ND 58506-5507
(701) 328-2814

Ohio
Department of Job & Family Services
PO Box 182404
Columbus, OH 43218-2404
(614) 466-2319

Oklahoma
Employment Security Commission
PO Box 52003
Oklahoma City, OK 73152-2003
(405) 557-5362

Oregon
Employment Department
875 Union Street, NE
Room 107
Salem, OR 97311-0030
(503) 947-1488

Pennsylvania
Department of Labor and Industry
7th and Forster Street
Room 915
Harrisburg, PA 17121-0001
(717) 787-7679

Puerto Rico
Department of Labor and Human Resources
PO Box 1020
San Juan, PR 00919-1020
(787) 754-5818

Rhode Island
Division of Taxation
One Capitol Hill, Suite 36
Providence, RI 02908-5829
(401) 574-8700

South Carolina
Employment Security Commission
PO Box 995
Columbia, SC 29202-0995
(803) 737-3075

South Dakota
Department of Labor
PO Box 4730
Aberdeen, SD 57402-4730
(605) 626-2312

Tennessee
Department of Labor and Workforce Development
220 French Landing Drive
Nashville, TN 37243-1002
(615) 741-2486

Texas
Workforce Commission
PO Box 149037
Austin, TX 78714
(512) 463-2700

Utah
Department of Workforce Services
PO Box 45288
Salt Lake City, UT 84145-0288
(801) 526-9400

Vermont
Department of Labor
PO Box 488
Montpelier, VT 05601-0488
(802) 828-4252

Virgin Islands
Department of Labor
PO Box 302608
St. Thomas, VI 00803-2608
(340) 776-1440

Virginia
Employment Commission
PO Box 1358
Richmond, VA 23218-1358
(804) 371-7159

Washington
Employment Security Department
PO Box 9046
Olympia, WA 98507-9046
(360) 902-9360

West Virginia
Bureau of Employment Programs
112 California Avenue
Charleston, WV 25305-0016
(304) 558-2676

Wisconsin
Department of Workforce Development
PO Box 7942
Madison, WI 53707-7942
(608) 261-6700

Wyoming
Unemployment Tax Division
PO Box 2760
Casper, WY 82602-2760
(307) 235-3217

 

 

Household Employers Checklist

You may need to do the following things when you have a household employee: When you hire a household employee:

  • Find out if the person can legally work in the United States.
  • Find out if you need to pay state taxes.

When you pay your household employee:

  • Withhold Social Security and Medicare taxes.
  • Withhold federal income tax.
  • Make advance payments of the earned income credit.
  • Decide how you will make tax payments.
  • Keep records.

BY JANUARY 31, 2014:

  • Get an employer identification number, if needed.
  • Give your employee Copies B, C, and 2 of Form W-2, Wage and Tax Statement.

BY FEBRUARY 28, 2014:

  • Send Copy A of Form W-2 to the Social Security Administration.

BY APRIL 15, 2014:

  • File Schedule H (Form 1040), Household Employment Taxes, with your tax return.

 

 

Higher Education Costs: How To Get The Best Tax Treatment

Many tax benefits are available to help you pay higher education costs, whether for your children or yourself. Because of the variety of benefits and programs, this area is one of the most complex that an individual can face. This Financial Guide discusses strategies you can use to build savings for higher education, and tax credits currently available to help ease the financial burden of paying for education.

Eligibility rules vary for education credits and savings plans and most are subject to income limitations.

Related Financial Guide: For more information about saving and investing to cover education costs, please see the Financial Guide: YOUR CHILD’S EDUCATION: How To Finance It.

Coverdell Education Savings Accounts (Section 530 Programs)

Starting in 2013, you can contribute up to $2,000 to a Coverdell Education Savings account (a Section 530 program formerly known as an Education IRA) for a child under 18. These contributions are not deductible, but they grow tax-free until withdrawn. Contributions for any year, for example 2013 can be made through the (un-extended) due date for the return for that year (April 15, 2014).

Note: There is no adjustment for inflation; therefore the $2,000 contribution limit is expected to remain at $2,000 for tax years 2012 and beyond.

Only cash can be contributed to a Section 530 account and you cannot contribute to the account after the child reaches his or her 18th birthday.

Anyone can establish and contribute to a Section 530 account, including the child. You may establish 530s for as many children as you wish, but the amount contributed during the year to each account cannot exceed $2,000. The child need not be a dependent, and in fact does not even need to be related to you. The maximum contribution amount for each child is subject to a phase out limitation with a modified AGI between $190,000 and $220,000 for joint filers and $95,000 and $110,000 for single filers.

Note: A 6% excise tax (to be paid by the beneficiary) applies to excess contributions. These are amounts in excess of the applicable contribution limit ($2,000 or phase out amount) and contributions for a year that amounts are contributed to a qualified tuition program for the same child. A qualified tuition program (QTP), sometimes called a Section 529 program, is a tax-favored state program to prepay education costs (see below). The 6% tax continues for each year the excess contribution stays in the 530 account.

The child must be named (designated as beneficiary) in the Coverdell document, but the beneficiary can be changed to another family member (for example, to a sibling where the first beneficiary gets a scholarship or drops out). And funds can be rolled over tax-free from one child’s account to another’s. Funds must be distributed not later than 30 days after the beneficiary’s 30th birthday (or 20 days after the beneficiary’s death if earlier). For “special needs” beneficiaries the age limits (no contributions after age 18, distribution by age 30) don’t apply.

Withdrawals are taxable to the person who gets the money, with these major exceptions: Only the earnings portion is taxable (the contributions come back tax-free). Also, even that part isn’t taxable income, as long as the amount withdrawn doesn’t exceed a child’s “qualified higher education expenses” for that year. The definition of “qualified higher education expenses” includes room and board and books, as well as tuition. In figuring whether withdrawals exceed qualified expenses, expenses are reduced by certain scholarships and by amounts for which tax credits (see Educational Credits, below) are allowed. If the amount withdrawn for the year exceeds the education expenses for the year, the excess is partly taxable under a complex formula. There’s another formula if the sum of withdrawals from this 530 program and from the qualified tuition (Section 529) program exceed education expenses.

As the person who sets up the Section 530 account, you may change the beneficiary (the child who will get the funds) or roll the funds over to the account of a new beneficiary, tax-free, if the new beneficiary is a member of your family. But funds you take back (for example, withdrawal in a year when there are no qualified higher education expenses, because the child is not enrolled in higher education) are taxable to you, to the extent of earnings on your contributions, and you will generally have to pay an additional 10% tax on the taxable amount. However, you won’t owe tax on earnings on amounts contributed that are returned to you by June 1 of the year following contribution.

INVESTMENT POLICY

In contrast to Section 529 programs and Series EE bonds, you are able to choose and change Section 530 investments as you see fit.

Tip: Check with your financial adviser about using both the Section 530 program, which has wide investment options but limited ($2,000 or less) contribution/investment amounts, and the Section 529 program, which has limited investment options but allows higher contribution/investment amounts.

ELEMENTARY AND SECONDARY SCHOOLS

 

Section 530 programs can be used to build up funds for primary and secondary education. The tax rules are similar to those for higher education: withdrawals taxable to the extent of earnings on contributions, except tax-free up to the child’s qualified elementary and secondary education expenses. These expenses qualify whether the child attends a private, religious or public school. Expenses such as room, board, tuition, transportation and uniforms will qualify only where connected with private or religious schools, but some expenses – books, computers, educational software and internet access – apply as well to children in public school living at home.

The age limits for higher education apply here too: no contribution after child reaches age 18, distribution at age 30 except for special needs beneficiaries. Withdrawals in excess of qualified education expenses are taxable under a special formula.

 

 

Qualified Tuition Programs (Section 529 Programs)

Every state now has a program allowing persons to prepay for future higher education, with tax relief. There are two basic plan types, with many variations among them:

  1. The prepaid education arrangement. Here one is essentially buying future education at today’s costs, by buying education credits or certificates. This is the older type of program, and tends to limit the student’s choice to schools within the state. Private colleges and universities may now offer this type.
  2. Education savings accounts. Here, contributions are made to an account to be used for future higher education.

In approaching state programs one must distinguish between what the federal tax law allows and what an individual state’s program may impose.

You may open a Section 529 program in any state, but when buying prepaid tuition credits (less popular than savings accounts), you will want to know to what institutions the credits will be applied.

Unlike certain other tax-favored higher education programs, such as the American Opportunity Tax Credit (formerly the Hope Credit) and Lifetime Learning tax credits, federal tax law doesn’t limit the benefit to tuition, but can also extend it to room, board, and books (individual state programs could be narrower).

The two key individual parties to the program are the Designated Beneficiary (the student-to-be) and the Account Owner, who is entitled to choose and change the beneficiary and who is normally the principal contributor to the program. There are no income limits on who may be an account owner. There’s only one designated beneficiary per account. Thus, a parent with three college-bound children might set up 3 accounts. (Some state programs don’t allow the same person to be both beneficiary and account owner.)

Contributions must be in cash, and must not total more than reasonably needed for higher education (as determined initially by the state). Neither account owner nor beneficiary may direct investments, but the state may allow the owner to select a type of investment fund (e.g., fixed income securities), and to change the investment annually, and when the beneficiary is changed. The account owner decides who gets the funds (can pick and change the beneficiary) and is legally allowed to withdraw funds at any time, subject to tax and penalty discussed later.

Funds in the account not yet distributed at the account owner’s death pass as part of the probate estate under state law-though this is not the result for federal estate tax purposes, see below.

FEDERAL TAX RULES

Income tax. Contributions made by the account owner or other contributor are not deductible for federal income tax purposes. Earnings on contributions grow tax-free while in the program.

Distributions from the fund are tax-free to the extent used for qualified higher education expenses. Distributions used otherwise are taxable to the extent of the portion which represents earnings.

A Section 529 distribution can be tax-free even though the student is claiming an American Opportunity Tax Credit (formerly the Hope Credit) or lifetime learning credit, or tax-free treatment for a Section 530 Coverdell distribution, if the programs aren’t covering the same specific expenses.

Distribution for a purpose other than qualified education is taxed to the one getting the distribution. In addition, a 10% penalty must be imposed on the taxable portion of the distribution, comparable to the 10% penalty in Section 530 Coverdell plans.

The account owner may change beneficiary designation from one to another in the same family. Funds in the account roll over tax-free for the benefit of the new beneficiary.

Gift Tax. For gift tax purposes, contributions are treated as completed gifts even though the account owner has the right to withdraw them. Thus they qualify for the up-to-$14,000 annual gift tax exclusion in 2013 (up from $13,000 in 2012). One contributing more than $14,000 may elect to treat the gift as made in equal installments over the year of gift and the following 4 years, so that up to $56,000 can be given tax-free in the first year.

A rollover from one beneficiary to another in a younger generation is treated as a gift from the first beneficiary, an odd result for an act the “giver” may have had nothing to do with.

Estate tax. Funds in the account at the designated beneficiary’s death are included in the beneficiary’s estate, another odd result, since those funds may not be available to pay the tax. Funds in the account at the account owner’s death are not included in the owner’s estate, except for a portion thereof where the gift tax exclusion installment election is made for gifts over $14,000. For example, if the account owner made the election for a gift of $56,000 in 2013, a part of that gift is included in the estate if he or she dies within 5 years.

Tip: A Section 529 program can be an especially attractive estate-planning move for grandparents. There are no income limits, the account owner giving up to $56,000 avoids gift tax, and estate tax by living 5 years after the gift, yet has the power to change the beneficiary.

State Tax: State tax rules are all over the map. Some reflect the federal rules, some quite different rules. For specifics of each state’s program, see College Savings Plans Network (CSPN).

Professional guidance: Considering the wide differences among state plans, the federal and state tax issues, and the dollar amounts at stake, professional tax guidance is advised.

 

 

Traditional and Roth IRAs

You can use a traditional IRA or Roth IRA as a savings plan to pay qualified higher education expenses. Withdrawals before age 59 1/2 to pay qualified higher education expenses are not subject to the additional tax on early withdrawals. To escape the 10% tax however, you must pay education costs that at least equal your withdrawal amount. The education costs must be “qualified”, that is, used for tuition, fees, books, room and board, supplies, or equipment at a qualified institution of learning and they must be for yourself, your spouse, or the children or grandchildren or yourself or your spouse. The qualified institution of learning may be any college, university, vocational school, or other post-secondary school that is eligible to participate in federal Department of Education aid programs.

Tip: You do not actually have to use the IRA funds to pay education costs. That is, the tax relief doesn’t require you to trace the IRA withdrawal dollars to a specific education expense payment. You can pay the costs with your own earnings or savings, with a loan, or with a gift or inheritance received by the student or the person making the withdrawal. You can use savings accumulated in a Section 529 (state sponsored) program.

However, you cannot count education costs paid with proceeds from the following in determining whether your IRA withdrawal is to be free of the 10% tax:

  • Tax-free distributions from a Coverdell education savings account (Section 530 program);
  • Tax-free scholarships, such as a Pell grant;
  • Tax-free employer education assistance program;
  • Any tax-free payment (other than a gift or bequest) that is due to enrollment at the qualified institution.

 

 

Education Savings Bonds

You can exclude from your gross income interest on qualified U.S. savings bonds if you have qualified higher education expenses during the year in which you redeem the bonds. In 2012, the exclusion begins phasing out at $72,850 modified adjusted gross income and is eliminated for adjusted gross incomes of $87,850 and above. For married taxpayers filing jointly, the tax exclusion begins to be reduced with a $109,250 modified adjusted gross income and is eliminated for adjusted gross incomes of $139,250 and above. The exclusion is unavailable to married filing separately.

The education must be of the bondholder, his or her spouse or dependent. Qualified higher education expenses are tuition and fees, and contributions to Section 529 and 530 programs, reduced for tax-free scholarships and other relief.

A qualified U.S. savings bond means a Series EE bond issued after 1989. The bond must be either in your name or in the names of both you and your spouse, and you must be at least 24 years old before the bond’s issue date.

 

 

Education Credits

Two tax credits are available for education costs – the American Opportunity Credit (formerly the Hope Credit) and the Lifetime Learning credit. These credits are available only to taxpayers with adjusted gross income below specified amounts (see Income Phase-Outs below).

HOW THESE CREDITS WORK

The amount of the credit you can claim depends on (1) how much you pay for qualified tuition and other expenses for students and (2) your adjusted gross income (AGI) for the year.

You must report the eligible student’s name and Social Security number on your return to claim the credit. You subtract the credits from your federal income tax. If the credit reduces your tax below zero, you cannot receive the excess as a refund. If you receive a refund of education costs for which you claimed a credit in a later year, you may have to repay (“recapture”) the credit.

Caution: If you file married-filing separately, you cannot claim these credits.

Which costs are eligible? Qualifying tuition and related expenses refers to tuition and fees, and course materials required for enrollment or attendance at an eligible education institution. They now include books, supplies and equipment needed for a course of study whether or not the materials must be purchased from the educational institution as a condition of enrollment or attendance.

“Related” expenses do not include room and board, student activities, athletics (other than courses that are part of a degree program), insurance, equipment, transportation, or any personal, living, or family expenses. Student-activity fees are included in qualified education expenses only if the fees must be paid to the institution as a condition of enrollment or attendance. For expenses paid with borrowed funds, count the expenses when they are paid, not when borrowings are repaid.

Tip: If you pay qualified expenses for a school semester that begins in the first three months of the following year, you can use the prepaid amount in figuring your credit.

Example: You pay $1,500 of tuition in December 2013 for the winter 2014 semester, which begins in January 2014. You can use the $1,500 in figuring your 2013 credit. If you paid in January instead, you would take the credit on your 2014 return.

Tip: As future year-end tax planning, this rule gives you a choice of the year to take the credit for academic periods beginning in the first 3 months of the year; pay by December and take the credit this year; pay in January or later and take the credit next year.

Eligible students. You, your spouse, or an eligible dependent (someone for whom you can claim a dependency exemption, including children under age 24 who are full-time students) can be an eligible student for whom the credit can apply. If you claim the student as a dependent, qualifying expenses paid by the student are treated as paid by you, and for your credit purposes are added to expenses you paid. A person claimed as another person’s dependent can’t claim the credit. The student must be enrolled at an eligible education institution (any accredited public, non-profit or private post-secondary institution eligible to participate in student Department of Education aid programs) for at least one academic period (semester, trimester, etc.) during the year.

No “double-dipping.” The tax law says that you can’t claim both a credit and a deduction for the same higher education costs. It also says that if you pay education costs with a tax-free scholarship, Pell grant, or employer-provided educational assistance, you cannot claim a credit for those amounts.

Income Limits. To claim the American Opportunity Credit your modified adjusted gross income (MAGI) must not exceed $90,000 ($180,000 for joint filers). To claim the Lifetime Learning Credit, MAGI must not exceed $60,000 ($120,000 for joint filers). “Modified AGI” generally means your adjusted gross income. The “modifications” only come into play if you have income earned abroad.

THE AMERICAN OPPORTUNITY TAX CREDIT

The American Opportunity Tax Credit (AOC) was extended through tax year 2017 by the American Taxpayer Relief Act of 2012. The maximum credit, available only for the first four years of post-secondary education, is $2,500 for tax years 2013 to 2017. You can claim the credit for each eligible student you have for which the credit requirements are met.

Special Qualification Rules. In addition to being an eligible student, he or she:

  • Must be enrolled in a program leading to a degree, certificate, or other recognized credential;
  • Must be taking at least half of a normal full-time load of courses, for at least one semester or trimester beginning in the year for which the credit is claimed; and
  • May not have any drug-related felony convictions.

Amount of credit. The maximum amount of the AOC credit is $2,500. Generally, 40% of the AOC is now a refundable credit for most taxpayers, which means that you can receive up to $1,000 even if you owe no taxes.

THE LIFETIME LEARNING CREDIT

You may be able to claim a Lifetime Learning credit of up to $2,000 (20% of the first $10,000 of qualified expense) for eligible students (subject to reduction based on your AGI). Only one Lifetime Learning Credit can be taken per tax return, regardless of the number of students in the family.

  • The credit can help pay for undergraduate, graduate and professional degree courses, including courses to improve job skills.
  • For courses taken to acquire or improve job skills, there are no requirements as to course loads, so that even one or two courses can qualify.
  • The number of years for which this credit can be claimed is not limited.

Choosing the Credit. You can’t claim both credits for the same person in the same year. But you can claim one credit for one or more family members and the other credit for expenses for one or more others in the same year – for example, an AOC for your child and a lifetime learning credit for yourself.

Electing Not To Take the Credit. There are situations in which the credit is not allowed, or not fully available, if some other education tax benefit is claimed – where the higher education expense deduction is claimed for the same student, see below, or where credit and tax exemption (under a Section 529 or 530 program) are claimed for the same expense. In that case the taxpayer – or, more likely, the taxpayer’s tax adviser – will determine which tax rule offers the greater benefit and if it’s not the credit, elect not to take the credit.

 

 

Qualified Tuition and Related Expenses Deduction

A limited deduction is allowed for “qualified higher education expenses” — tuition and related expenses under the same definition as for tuition credits, above. A $4,000 above the line deduction (Form 8917) is allowed for qualified tuition expenses in 2013. Deduction up to $4,000 is allowed on if taxpayer’s (modified) adjusted gross income is $65,000 or less ($130,000 or less on a joint return). If taxpayer’s modified adjusted gross income is more than $65,000 but not more than $80,000 (more than $130,000 but not more than $160,000 on a joint return), deduction is allowed up to $2,000. The tax deduction reduces your amount of income, reducing amount of tax you pay. You do not need to itemize deductions on Schedule A (Form 1040) in order to take this deduction, which benefits higher earners who cannot take the Lifetime Learning Credit because their income exceeds the limits.

Business expense deduction is allowed, without dollar limit, for education that serves the taxpayer’s business, including employment. Deduction is also allowed for student loan interest, but a taxpayer may not take more than one deduction for the same item. In addition, you cannot claim this deduction if your filing status is married filing separately or if another person can claim an exemption for you as a dependent on his or her tax return.

 

“Qualified higher education expenses” must be reduced by any such expense paid with an amount treated as tax-free under the rules for excluding income from Series EE bonds, or Section 529 or 530 programs.

 

 

Employer-Provided Education Assistance

If your employer paid education assistance benefits (e.g., reimbursements of tuition), part or all of them may be tax-free. You can exclude up to $5,250 per year of the benefits you receive under a qualified educational assistance program. But you can’t both exclude and deduct the same item, even if it’s otherwise deductible. In order to qualify, your employer must have established an educational assistance plan that does not discriminate in favor of highly paid employees or owners. The exclusion applies to undergraduate level courses other than those involving sports, game and hobbies. The courses do not need to relate to your job. The exclusion is available for tuition, fees, books and supplies but not meals, lodging or transportation. And it applies to benefits for graduate level courses.

In addition to the exclusion for qualifying education plans, your employer can provide reimbursement for business related courses, including graduate courses. If your employer does not reimburse you for these expenses, you may be entitled to deduct them as a miscellaneous itemized deduction subject to the 2% deduction floor. To qualify, the expense must meet the requirement of your employer or the law or maintain or improve skills in your current job. The course must not meet minimum education requirements for your job or qualify you for a new trade or business.

 

 

Student Loans

You may be able to deduct interest on student loans. You may also be able to exclude income that you would otherwise have to report if a student loan is cancelled.

Interest Deduction. You may deduct student loan interest you pay, including interest paid that’s not currently due because payment is deferred.

Deduction is allowed even though it would otherwise be nondeductible personal interest. But you may deduct only if you are the one legally bound to pay the interest, and only on loans solely for qualified expenses (so not under open credit lines).

The student-loan deduction (up to $2,500 starting in 2013), was made permanent by AFTRA, but only to taxpayers whose AGI is below $150,000 (joint filers) or $75,000 (single filers). Married couples filing separately can’t take the deduction.

The student-loan interest deduction is an “above the line” deduction. In other words, you don’t have to itemize in order to claim it. The loan must have been taken out to cover education expenses of at least half-time study for yourself, your spouse, or a person who was your dependent when you took out the loan.

Caution: You cannot deduct interest on a loan from a related person, for example, a relative, or a business entity in which you have an ownership interest as defined by the tax law. And you can’t deduct if you are claimed as a dependent.

Tip: Where interest fails to qualify under these tests, consider a home equity loan, interest on which is generally deductible.

Cancellation of Student Loan. If certain requirements are met, cancellations of student loans that are intended to induce students to perform certain services do not increase the student’s gross income. This relief extends to certain private programs, as well as government and public programs.

 

 

Selling Your Home: How To Minimize the Tax On the Gain

The IRS allows an exclusion of up to $250,000 of the gain on the sale of your main home ($500,000 if you are married and file a joint return. Most taxpayers can take advantage of the exclusion and will not have to pay any tax on the sale of a main home as long as they meet the IRS ownership and use tests (see below).

Note: If you do have a loss from the sale, it is a personal loss. You cannot deduct the loss.

If you don’t qualify for exclusion, your gain exceeds the exclusion, or you used part of the property in business or for rent, you have a taxable gain and must report the sale of your main home on your tax return on IRS Form 8949 and Schedule D.

 

 

PRINCIPAL RESIDENCE

Usually, the home you live in most of the time is your main home. In addition to a standard dwelling unit, your home can also be a houseboat, mobile home, cooperative apartment, or condominium.

Example: You own and live in a house in town. You also own beach property, which you use in the summer months. The town property is your main home; the beach property is not.

Example: You own a house, but you live in another house that you rent. The rented home is your main home.

Tip: Where a second residence has soared in value and you want to sell, some tax advisors have suggested moving to the second residence for the required period to qualify for exclusion on its sale. If this is your situation, please consult with a tax professional.

 

 

HOW TO FIGURE GAIN OR LOSS

Key information for determining gain or loss is the selling price, the amount realized, and the adjusted basis.

The selling price is the total amount you receive for your home. It includes money, all notes, mortgages or other debts assumed by the buyer as part of the sale, and the fair market value of any other property or any services you receive. Next, you deduct the selling expenses such as commissions, advertising, legal fees, and loan charges paid by the seller from the selling price.

The difference is the “amount realized”. If the amount realized is more than your home’s “adjusted basis,” discussed later, the difference is your gain. If the amount realized is less than the adjusted basis, the difference is your loss.

However, it does not include amounts you received for personal property sold with your home. Personal property is property that is not a permanent part of the home, such as furniture, draperies, and lawn equipment.

 

 

NON-TRADITIONAL SALES

The following discussion covers how to determine your gain or loss if you trade one home for another, if your home is foreclosed on or repossessed or if you transfer a jointly owned home.

Jointly owned home. If you and your spouse sell your jointly owned home and file a joint return, you figure and report your gain or loss as one taxpayer. If you file separate returns, each of you must figure and report your own gain or loss according to your ownership interest in the home. Your ownership interest is determined by state law.

If you and a joint owner other than your spouse sell your jointly owned home, each of you must figure and report your own gain or loss according to your ownership interest in the home. Each of you applies the exclusion rules individual basis.

Trading homes. If you trade your old home for another home, treat the trade as a sale and a purchase.

Foreclosure or repossession. If your home was foreclosed on or repossessed, you have what the IRS calls a disposition and will need to determine if you have ordinary income, gain, or loss. The amount of your gain or loss depends on whether you were personally liable for repaying the debt secured by the home and whether the outstanding loan balance is more than the fair market value (FMV) of the property.

 

If you were not personally liable for repaying the debt secured by the home, the amount you realize includes the full amount of the outstanding debt immediately before the transfer. This is true even if the FMV of the property is less than the outstanding debt immediately before the transfer.

If you were personally liable for repaying the debt secured by the home and the debt is canceled, the amount realized on the foreclosure or repossession includes the smaller of the outstanding debt immediately before the transfer reduced by any amount for which you remain personally liable immediately after the transfer, or the Fair Market Value (FMV) of the transferred property.

In addition to any gain or loss, if you were personally liable for the debt you may have ordinary income. If the canceled debt is more than the home’s fair market value, you have ordinary income equal to the difference. However, the income from cancellation of debt is not taxed to you if the cancellation is intended as a gift, or if you are insolvent or bankrupt.

Example: You owned and lived in a home with an adjusted basis of $41,000. A real estate dealer accepted your old home as a trade-in and allowed you $50,000 toward a new house priced at $80,000 (its fair market value). You are considered to have sold your old home for $50,000 and to have had a gain of $9,000 ($50,000 minus $41,000). If the dealer had allowed you $27,000 and assumed your unpaid mortgage of $23,000 on your old home, $50,000 would still be considered the sales price of the old home (the trade-in allowed plus the mortgage assumed).

Transfer to spouse. If you transfer your home to your spouse, or to your former spouse incident to your divorce, you generally have no gain or loss, even if you receive cash or other consideration for the home. Therefore, the rules explained in this Guide do not apply.

If you owned your home jointly with your spouse and transfer your interest in the home to your spouse, or to your former spouse incident to your divorce, the same rule applies. You have no gain or loss.

If you buy or build a new home, its basis will not be affected by your transfer of your old home to your spouse, or to your former spouse incident to divorce. The basis of the home you transferred will not affect the basis of your new home.

 

 

BASIS

You will need to know your basis in your home as a starting point for determining any gain or loss when you sell it. Your basis in your home is determined by how you got the home. Your basis is its cost if you bought it or built it. If you acquired it in some other way, its basis is either its fair market value when you received it or the adjusted basis of the person you received it from.

While you owned your home, you may have made adjustments (increases or decreases) to the basis. This adjusted basis is used to figure gain or loss on the sale of your home.

 

Cost as Basis

 

The cost of property is the amount you pay for it in cash or other property.

Purchase. If you buy your home, your basis is its cost to you. This includes the purchase price and certain settlement or closing costs. Your cost includes your down payment and any debt, such as a first or second mortgage or notes you gave the seller in payment for the home.

Seller-paid points. If you bought your home after April 3, 1994, you must reduce the basis of your home by any points the seller paid, whether or not you deducted them. If you bought your home after 1990 but before April 4, 1994, you must reduce your basis by the amount of seller-paid points only if you chose to deduct them as home mortgage interest in the year paid.

Settlement fees or closing costs. When buying your home, you may have to pay settlement fees or closing costs in addition to the contract price of the property. You can include in your basis the settlement fees and closing costs that are for buying the home. You cannot include in your basis the fees and costs that are for getting a mortgage loan. A fee is for buying the home if you would have had to pay it even if you paid cash for the home.

Settlement fees do not include amounts placed in escrow for the future payment of items such as taxes and insurance.

Some of the settlement fees or closing costs that you can include in the basis of your property are:

  • Abstract fees (sometimes called abstract of title fees),
  • Charges for installing utility services,
  • Legal fees (including fees for the title search and preparing the sales contract and deed),
  • Recording fees,
  • Surveys,
  • Transfer taxes,
  • Owner’s title insurance, and
  • Any amounts the seller owes that you agree to pay, such as back taxes or interest, recording or mortgage fees, charges for improvements or repairs, and sales commissions.

 

Some settlement fees and closing costs not included in your basis are:

  • Fire insurance premiums.
  • Rent for occupancy of the house before closing.
  • Charges for utilities or other services relating to occupancy of the house before closing.
  • Any item that you deducted as a moving expense (settlement fees and closing costs incurred after 1993 cannot be deducted as moving expenses).
  • Fees for refinancing a mortgage.
  • Charges connected with getting a mortgage loan, such as mortgage insurance premiums (including VA funding fees), loan assumption fees, cost of a credit report, and fee for an appraisal required by a lender.

 

Real estate taxes. Real estate taxes for the year you bought your home may affect your basis, as follows:

If you pay taxes that the seller owed on the home up to the date of sale and the seller does not reimburse you, then the taxes are added to the basis of your home.

If you pay taxes that the seller owed on the home up to the date of sale and the seller does reimburse you, then the taxes do not affect the basis of your home.

If the seller pays taxes for you (taxes owed beginning on the date of sale) and you do not reimburse the seller, then the taxes are subtracted from the basis of your home.

If the seller pays taxes for you (taxes owed beginning on the date of sale) and you reimburse the seller, then the taxes do not affect the basis of your home.

Construction. If you contracted to have your house built on land you own, your basis is the cost of the land plus the amount it cost you to complete the house. This amount includes the cost of labor and materials, or the amounts paid to the contractor, and any architect’s fees, building permit charges, utility meter and connection charges, and legal fees directly connected with building your home. Your cost includes your down payment and any debt, such as a first or second mortgage or notes you gave the seller or builder. It also includes certain settlement or closing costs. You may have to reduce the basis by points the seller paid for you. If you built all or part of your house yourself, its basis is the total amount it cost you to complete it. Do not include the value of your own labor, or any other labor you did not pay for, in the cost of the house.

Cooperative apartment. Your basis in the apartment is usually the cost of your stock in the co-op housing corporation, which may include your share of a mortgage on the apartment building.

Condominium. Your basis is generally its cost to you. The same rules apply as for any other home.

 

 

BASIS OTHER THAN COST

If your home was acquired in a transaction other than a traditional purchase (such as gift, inheritance, trade, or from a spouse), you may have to use a basis other than cost, such as fair market value.

Note: Fair market value is the price at which the property would change hands between a willing buyer and a willing seller, neither having to buy or sell, and both having reasonable knowledge of the relevant facts. Sales of similar property, on or about the same date, may be helpful in figuring the fair market value of the property.

Home received as gift. If your home was a gift, its basis to you is the same as the donor’s adjusted basis when the gift was made. However, if the donor’s adjusted basis was more than the fair market value of the home when it was given to you, you must use that fair market value as your basis for measuring any loss on its sale.

If you use the donor’s adjusted basis to figure a gain and get a loss, and then use the fair market value to figure a loss and get a gain, you have neither a gain nor a loss on the sale or disposition.

If you received your home as a gift and its fair market value was more than the donor’s adjusted basis at the time of the gift, you may be able to add to your basis any federal gift tax paid on the gift. If the gift was before 1977, the basis cannot be increased to more than fair market value of the home when it was given to you. On the other hand, if you received your home as a gift after 1976, you would add to your basis the part of the federal gift tax paid that is due to the home’s “net increase” in value (value less donor’s adjusted basis).

Home received from spouse. You may have received your home from your spouse or from your former spouse incident to your divorce.

  • If you received the home after July 18, 1984, you had no gain or loss on the transfer. Your basis in this home is generally the same as your spouse’s (or former spouse’s) adjusted basis just before you received it. This rule applies even if you received the home in exchange for cash, the release of marital rights, the assumption of liabilities, or other consideration.
  • If you owned a home jointly with your spouse and your spouse transferred his or her interest in the home to you, your basis in the half interest received from your spouse is generally the same as your spouse’s adjusted basis just before the transfer. This rule also applies if your former spouse transferred his or her interest in the home to you incident to your divorce. Your basis in the half interest you already owned does not change. Your new basis in the home is the total of these two amounts.
  • If you received your home before July 19, 1984, in exchange for your release of marital rights, your basis in the home is generally its fair market value at the time you received it.
  • Home acquired from a decedent who died before or after 2010. If you inherited your home from a decedent who died before or after 2010, your basis is the fair market value of the property on the date of the decedent’s death (or the later alternate valuation date chosen by the personal representative of the estate). If an estate tax return was filed or required to be filed, the value of the property listed on the estate tax return is your basis. If a federal estate tax return did not have to be filed, your basis in the home is the same as its appraised value at the date of death, for purposes of state inheritance or transmission taxes.
  • Surviving spouse. If you are a surviving spouse and you owned your home jointly, your basis in the home will change. The new basis for the interest your spouse owned will be its fair market value on the date of death (or alternate valuation date). The basis in your interest will remain the same. Your new basis in the home is the total of these two amounts.

Example: Your jointly owned home had an adjusted basis of $50,000 on the date of your spouse’s death, and the fair market value on that date was $100,000. Your new basis in the home is $75,000 ($25,000 for one-half of the adjusted basis plus $50,000 for one-half of the fair market value).

In community property states (Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin), each spouse is usually considered to own half of the community property. When either spouse dies, the fair market value of the community property becomes the basis of the entire property, including the portion belonging to the surviving spouse. For this to apply, at least half of the community interest must be included in the decedent’s gross estate, whether or not the estate must file a return.

Home received in trade. If you acquired your home in a trade for other property, the basis of your home is generally its fair market value at the time of the trade. If you traded one home for another, you have made a sale and purchase. In that case, you may have realized a gain.

 

 

ADJUSTED BASIS

Adjusted basis is your cost or other basis increased or decreased by certain amounts.

Increases to basis include:

  • Additions and other improvements that have a useful life of more than 1 year.
  • Special assessments for local improvements.
  • Amounts spent after a casualty to restore damaged property.

Decreases to basis include:

  • Discharge of qualified principal residence indebtedness that was excluded from income (but not below zero).
  • Gain from the sale of your old home before May 7, 1997 on which tax was postponed.
  • Insurance payments for casualty losses.
  • Deductible casualty losses not covered by insurance.
  • Payments received for granting an easement or right-of-way.
  • Depreciation allowed or allowable if you used your home for business or rental purposes.
  • Residential energy credit (generally allowed from 1977 through 1987) claimed for the cost of energy improvements that you added to the basis of your home.
  • Adoption credit you claimed for improvements that you added to the basis of your home.
  • Nontaxable payments from an employer’s adoption assistance program that you used for improvements you added to the basis of your home.
  • Nonbusiness energy property credit (allowed beginning in 2006 but not for 2008) claimed for making certain energy saving improvements you added to the basis of your home.
  • Residential energy efficient property credit (allowed beginning in 2006) claimed for making certain energy saving improvements you added to the basis of your home.
  • First-time home buyer’s credit (allowed to certain first-time buyers in the District of Columbia–beginning on August 5, 1997).
  • Energy conservation subsidy excluded from your gross income because you received it (directly or indirectly) from a public utility after December 3l, 1992, to buy or install any energy conservation measure. An energy conservation measure includes an installation or modification that is primarily designed either to reduce consumption of electricity or natural gas or to improve the management of energy demand for a home.

Discharges of qualified principal residence indebtedness. You may be able to exclude from gross income a discharge of qualified principal residence indebtedness. This exclusion applies to discharges made after 2006 and before 2013. If you choose to exclude this income, you must reduce (but not below zero) the basis of your principal residence by the amount excluded from gross income.

Amount eligible for the exclusion. The exclusion applies only to debt discharged after 2006 and before 2013. The maximum amount you can treat as qualified principal residence indebtedness is $2 million ($1 million if married filing separately). You cannot exclude from gross income discharge of qualified principal residence indebtedness if the discharge was for services performed for the lender or on account of any other factor not directly related to a decline in the value of your residence or to your financial condition.

Improvements. These add to the value of your home, prolong its useful life, or adapt it to new uses. You add the cost of improvements to the basis of your property.

Example: Putting a recreation room in your unfinished basement, adding another bathroom or bedroom, putting up a fence, putting in new plumbing or wiring, installing a new roof, or paving your driveway are improvements.

Here are some other examples:

  • Additions: Bedroom, bathroom, deck, garage, porch, patio
  • Lawn and grounds: Landscaping, driveway, walkway, fence, retaining wall, sprinkler system, swimming pool
  • Miscellaneous: Storm windows or doors, new roof, central vacuum, wiring upgrades, satellite dish, security system
  • Heating and air conditioning: Heating system, central air, furnace, duct work, central humidifier, filtration system
  • Plumbing: Septic system, water heater, soft water system, filtration system
  • Interior: Built-in appliances, kitchen modernization, flooring, wall-to-wall carpet
  • Insulation: attic, walls, floor, pipes, duct work
  • Improvements no longer part of home. Your home’s adjusted basis does not include the cost of any improvements that are no longer part of the home.

Example: You put wall-to-wall carpeting in your home 15 years ago. Later, you replaced that carpeting with new wall-to-wall carpeting. The cost of the old carpeting you replaced is no longer part of your home’s adjusted basis.

Repairs. These maintain the good condition of your home. They do not add to its value or prolong its life, and you do not add their costs to the basis of your property.

Example: Repainting your house inside or outside, fixing your gutters or floors, repairing leaks or plastering, and replacing broken window panes are examples of repairs.

Tip: The entire job is considered an improvement, however, if items that would otherwise be considered repairs are done as part of an extensive remodeling or restoration of your home.

Recordkeeping. You should keep records of your home’s purchase price and purchase expenses. Furthermore, you should also save receipts and other records for all improvements, additions, and other items that affect the basis of your home.

Tip: You must keep records for 3 years after the due date for filing your return for the tax year in which you sold, or otherwise disposed of, your home. But if the basis of your old home affects the basis of your new one, such as when you sold your old home before May 7, 1997 and postponed tax on any gain, you should keep those records forever.

The records you should keep include:

  • Proof of the home’s purchase price and purchase expenses;
  • Receipts and other records for all improvements, additions, and other items that affect the home’s adjusted basis;
  • Any worksheets or other computations you used to figure the adjusted basis of the home you sold, the gain or loss on the sale, the exclusion, and the taxable gain;
  • Any Form 982 you filed to exclude any discharge of qualified principal residence indebtedness;
  • Any Form 2119, Sale of Your Home, you filed to postpone gain from the sale of a previous home before May 7, 1997;
  • Any worksheets you used to prepare Form 2119

 

 

EXCLUSION FOR SALES AFTER MAY 6, 1997

If you sell your main home after May 6, 1997, you may qualify to exclude up to $250,000 of the gain ($500,000 if married filing jointly) on the sale of your main home; however, to claim the exclusion, you must meet the ownership and use tests. This means that during the 5-year period ending on the date of the sale, you must have:

    • Owned the home for at least 2 years (the ownership test)
    • Lived in the home as your main home for at least 2 years (the use test)
    • During the 2-year period ending on the date of the sale, you did not exclude gain from the sale of another home.

Exception. If you owned and lived in the property as your main home for less than 2 years, you can still claim an exclusion in some cases. However, the maximum amount you may be able to exclude will be reduced.

 

If you sell the land on which your main home is located, but not the house itself, you cannot exclude any gain you have from the sale of the land.

If you have more than one home, only the sale of your main home qualifies for excluding the gain. If you have two homes and live in both of them, your main home is the one you live in most of the time.

Note: If you owned and used the property as your main home for less than 2 years, you may be able to claim a reduced exclusion.

The two years of ownership and use during the five-year period don’t have to be continuous. You meet the tests if you can show that you owned and lived in the property as your main home for either 24 full months or 730 days during the five-year period. Short temporary absences, e.g., for vacations, are counted as periods of use, even if you rent out the property during that time.

Example: From 1994 through August 2007, Anne lived with her parents in a house that her parents owned. On September 29, 2007, she bought this house from her parents. She continued to live there until December 15 of 2007, when she sold it at a gain. Although Anne lived in the property as her main home for more than 2 years, she did not own it for the required 2 years. Therefore, she cannot exclude any part of her gain on the sale, unless she sold the property due to a change in health or place of employment.

Example: Professor Moore bought and moved into a house on January 4, 2005. He lived in it as his main home continuously until October 1, 2006, when he went abroad for a one-year sabbatical. During part of the leave, the house was unoccupied, and during the rest of the time he rented it out. On October 1, 2007, he sold the house. Because his leave was not a short temporary absence, he cannot include the period of leave to meet the 2-year use test.

Ownership and Use Tests Met at Different Times. You can meet the ownership and use tests during different 2-year periods. However, you must meet both tests during the 5-year period ending on the date of the sale.

Example: In 1996, Harry was 60 years old and lived in a rental apartment. When the apartment building went co-op, he bought his apartment on December 1, 1999. Harry then went to live with his daughter on April 14, 2001 because he became ill. On July 10, 2003, he sold his co-op while still living with his daughter. Harry can exclude gain on the sale of his co-op because he met the ownership and use tests. His 5-year period runs from July 11, 1998, to July 10, 2003, the date he sold the co-op. Even though, he only owned the co-op from December 1, 1999 to July 10, 2003–over two years, he lived in the apartment from July 11, 1997 (the beginning of the five-year period) to April 14, 2001 (over two years).

Special Situations. There are a number of special situations that may result in exceptions to the general rules.

Individuals with Disabilities. There is an exception to the 2-out-of-5-year use test if you become physically or mentally unable to care for yourself at any time during the 5-year period. You qualify for this exception to the use test if, during the 5-year period before the sale of your home:

      • You become physically or mentally unable to care for yourself, and
      • You owned and lived in your home as a main home for a total of at least one year during the 5-year period before the sale of your home.

Under this exception, you are considered to live in your home during any time that you live in a facility (including a nursing home) that is licensed by a state or political subdivision to care for persons in your condition.

If you meet this exception to the use test, you still have to meet the 2-out-of-5-year ownership test to claim the exclusion.

Gain postponed on sale of previous home. For the ownership and use tests, you may be able to add the time you owned and lived in a previous home to the time you lived in the home on which you wish to exclude gain. You can do this if you postponed all or part of the gain on the sale of the previous home because of buying the home on which you wish to exclude gain.

Tip: Also, if buying the previous home enabled you to postpone all or part of the gain on the sale of a home you owned earlier, you can also include the time you owned and lived in that earlier home.

Previous home destroyed or condemned. For the ownership and use test, you add the time you owned and lived in a previous home that was destroyed or condemned to the time you owned and lived in the home on which you wish to exclude gain. This rule applies if any part of the basis of the home you sold depended on the basis of the destroyed or condemned home. Otherwise, you must have owned and lived in the same home for 2 of the 5 years before the sale to qualify for the exclusion.

Members of the uniformed services or Foreign Service, employees of the intelligence community, or employees or volunteers of the Peace Corps. You can choose to have the 5-year test period for ownership and use suspended during any period you or your spouse serve on qualified official extended duty (defined later) as a member of the uniformed services or Foreign Service of the United States, or as an employee of the intelligence community.

You can choose to have the 5-year test period for ownership and use suspended during any period you or your spouse serve outside the United States either as an employee of the Peace Corps on qualified official extended duty (defined later) or as an enrolled volunteer or volunteer leader of the Peace Corps. This means that you may be able to meet the 2-year use test even if, because of your service, you did not actually live in your home for at least the required 2 years during the 5-year period ending on the date of sale.

Note: The period of suspension cannot last more than 10 years. Together, the 10-year suspension period and the 5-year test period can be as long as, but no more than, 15 years. You cannot suspend the 5-year period for more than one property at a time. You can revoke your choice to suspend the 5-year period at any time.

 

Married Persons

 

If you and your spouse file a joint return for the year of sale, you can exclude gain (up to $500,000) if either spouse meets the ownership and use tests.

Example: Mary sells her home in June of this year and marries John later in the year. She meets the ownership and use tests, but John does not. Emily can exclude up to $250,000 of gain on a separate or joint return for this year.

Example: Now assume that John also sells a home. He meets the ownership and use tests on his home. Mary and John can each exclude $250,000 of gain.

Death of spouse before sale. If your spouse died before the date of sale, you are considered to have owned and used the property as your main home during any period of time when your spouse owned and used it as a main home.

Home transferred from spouse. If your home was transferred to you by your spouse (or former spouse if the transfer was incident to divorce), you are considered to have owned it during any period of time when your spouse owned it.

Use of home after divorce. You are considered to have used property as your main home during any period when you owned it and your spouse or former spouse is allowed to use it under a divorce or separation instrument. Such use is added to your own use before or after divorce.

 

Special Exceptions Affecting Exclusions

 

Home destroyed or condemned. If your home is destroyed or condemned after May 6, 1997, any gain (e.g., due to insurance proceeds) qualifies for the exclusion.

Expatriates. You cannot claim the exclusion if the expatriate tax applies to you because you have renounced their citizenship and one of the primary purposes was to avoid U.S. taxes.

More Than One Home Sold During the Two-Year Period. You cannot exclude gain on the sale of your home if, during the two-year period ending on the date of the sale, you sold another home at a gain and are excluding all or part of that gain. If you cannot exclude the gain, you must include it in your income.

However, you can claim a reduced exclusion if you sold the home due to a change in health or place of employment or experienced unforeseen circumstances such as natural disasters, death, or unemployment (eligible unemployment compensation). When counting the number of sales during a two-year period, do not count sales before May 7, 1997.

The $250,000 (or $500,000) exclusion is reduced according to a formula whose numerator is the number of days of qualified ownership or use (or between sales of the homes) and the denominator is 730 days (for 2 years). If married filing jointly, duplicate the same calculation for your spouse’s ownership and use (or days between sales).

Example: You owned and used your main home for 400 days before selling it at a $150,000 gain following your move to a new job location. Your exclusion is $136,986, that is, 400/730 x $250,000.

Change in Place of Employment. You may qualify for a reduced exclusion if the primary reason for the sale of your main home is a change in the location of employment of a qualified individual.

Health. You may qualify for a reduced exclusion if the sale of your main home is because of health if your primary reason for the sale is to obtain, provide, or facilitate the diagnosis, cure, mitigation, or treatment of disease, illness, or injury of a qualified individual, or to obtain or provide medical or personal care for a qualified individual suffering from a disease, illness, or injury.

Unforeseen Circumstances. You may qualify for a reduced exclusion if the sale of your main home is because of an unforeseen circumstance if your primary reason for the sale is the occurrence of an event that you could not reasonably have anticipated before buying and occupying that home. You are not considered to have an unforeseen circumstance if the primary reason you sold your home was that you preferred to get a different home or because your finances improved.

Home used in business. So long as the business use takes place in the same dwelling unit as your main home, the exclusion is not affected by business use, with this exception: You cannot exclude the part of your gain that is equal to any depreciation allowed or allowable for the business use of your home after May 6, 1997. The 2 out of 5 year use-as-the-main-home test is not applied to deny exclusion for gain allocable to business use in the same dwelling unit, except for allowable depreciation.

Example: You bought a home in 1997 and used it throughout 3/4 as your residence and 1/4 as your home office. On December 30, 2002 you sold it. The gain qualifies for exclusion except that you cannot exclude the part of your gain that is equal to any depreciation allowed or allowable for the business use of your home after May 6, 1997.

 

 

RECAPTURE OF FEDERAL SUBSIDY

If you financed your home under a federally subsidized program (loans from tax-exempt qualified mortgage bonds or loans with mortgage credit certificates), you may have to recapture all or part of the benefit you received from that program when you sell or otherwise dispose of your home. You recapture the benefit by increasing your federal income tax for the year of the sale. You may have to pay this recapture tax even if you can exclude your gain from income under the rules discussed earlier; that exclusion does not affect the recapture tax.

 

 

GLOSSARY

Adjusted basis: This is your basis in the property increased or decreased by certain amounts. See Adjusted Basis, earlier in this Guide, for a list of items that increase or decrease your basis in the property.

Amount realized: This is the selling price of your old home minus your selling expenses.

Basis: Your basis in the property is determined by how you got it. If you bought or built the property, your basis is what it cost you. If you got the property in some other way, your basis will be determined differently. See Cost as Basis and Basis Other Than Cost earlier in this Guide for more information.

Date of sale: If you received a Form 1099-S, Proceeds From Real Estate Transactions, the date should be shown in box 1. If you did not receive this form, the date of sale is the earlier of (a) the date title transferred or (b) the date the economic burdens and benefits of ownership shifted to the buyer. In most cases, these dates are the same.

Fair market value: Fair market value is the price at which property would change hands between a willing buyer and a willing seller, neither having to buy or sell, and both having reasonable knowledge of the relevant facts. Sales of similar property, on or about the same date, may be helpful in figuring the fair market value of the property.

Fixing-up expenses: These are costs you pay for decorating or repairing your home to make it easier to sell. You may be able to deduct fixing-up expenses from the amount realized on the sale of your old home.

Gain: Your gain on the sale of your home is the amount realized minus the adjusted basis of the home you sold.

Improvements: These add to the value of your home, prolong the life of the property, or allow the property to be used for new purposes. The cost of improvements increases your basis in the property.

Main home: This is the home you live in most of the time. It can be a house, houseboat, cooperative apartment, condominium, etc.

Repairs: These maintain your property in good condition. They differ from Improvements in that they do not add much to the value or life of the property and their cost does not increase your basis in the property.

Seller-financed mortgage: This is a mortgage from the buyer of your home. The buyer makes mortgage payments to you.

Selling expenses: Selling expenses include items such as sales commissions, and advertising and legal fees you pay to sell your home. Selling expenses also usually include loan charges you pay on the buyer’s behalf as an aid in selling your home, such as loan placement fees or “points.”

Settlement fees (or closing costs): These are amounts paid in purchasing your property in addition to the contract price. Some of these amounts are added to the basis of the property and some are deductible as itemized deductions. Certain amounts are neither deductible nor added to the basis of the property. See Settlement fees or closing costs under Basis, earlier in this Guide, for more details.

 

 

The Deductibility of Points

What Are Points?

The term “points” is used to describe certain charges paid, or treated as paid, by a borrower to obtain a home mortgage. Points may also be called loan origination fees, maximum loan charges, loan discount, or discount points.

Points are prepaid interest and may be deductible as home mortgage interest, if you itemize deductions on Form 1040, Schedule A. Generally, if you can deduct all of the interest on your mortgage, you may be able to deduct all of the points paid on the mortgage. If your acquisition debt exceeds $1 million or your home equity debt exceeds $100,000, you cannot deduct all the interest on your mortgage and you cannot deduct all your points.

A borrower is treated as paying any points that a home seller pays for the borrower’s mortgage. See “Points Paid by Seller,” later.

 

 

Tests for Deductibility

Generally, you cannot deduct the full amount of points in the year paid. Because they are prepaid interest, you generally must deduct them over the life (term) of the mortgage.

However, you can fully deduct points in the year paid if you meet all of the following tests.

  1. Your loan is secured by your main home (the one you live in most of the time).
  2. Paying points is an established business practice in the area where the loan was made.
  3. The points paid were not more than the points generally charged in that area.
  4. You use the cash method of financial record keeping (the method used by most individual taxpayers).
  5. The points were not paid in place of amounts that ordinarily are stated separately on the settlement statement, such as appraisal fees, inspection fees, title fees, attorney fees, and property taxes.
  6. You use your loan to buy or build your main home.
  7. The points were computed as a percentage of the principal amount of the mortgage.
  8. The amount is clearly shown on the settlement statement (such as the Uniform Settlement Statement, Form HUD-1) as points charged for the mortgage. The points may be shown as paid from either your funds or the seller’s.
  9. The funds you provided at or before closing, plus any points the seller paid, were at least as much as the points charged. The funds you provided do not have to have been applied to the points. They can include a down payment, an escrow deposit, earnest money, and other funds you paid at or before closing for any purpose. You cannot have borrowed these funds from your lender or mortgage broker.

Home improvement loan. You can also fully deduct in the year paid points paid on a loan to improve your main home, if statements (1) through (5) above are true.

 

 

Non-Deductible Amounts

Amounts charged by the lender for specific services connected to the loan are not interest. Examples of these charges are:

  1. Appraisal fees
  2. Notary fees
  3. Preparation costs for the mortgage note or deed of trust
  4. Mortgage insurance premiums
  5. VA funding fees.

You cannot deduct these amounts as points either in the year paid or over the life of the mortgage.

 

 

Points Paid by Seller

The term “points” includes loan placement fees that the seller pays to the lender to arrange financing for the buyer. The seller cannot deduct these fees as interest. But they are a selling expense that reduces the seller’s amount realized. The buyer reduces the basis of the home by the amount of the seller-paid points and treats the points as if he or she had paid them. If all the tests explained earlier are met, the buyer can deduct the points in the year paid. If any of those tests is not met, the buyer deducts the points over the life of the loan.

 

 

Funds Provided Are Less than Points

If you meet all the tests referred to earlier; except that the funds you provided were less than the points charged to you (test 9), you can deduct the points in the year paid, up to the amount of funds you provided. In addition, you can deduct any points paid by the seller.

Example: When you took out a $100,000 mortgage loan to buy your home in December, you were charged one point ($1,000). You meet all the nine tests for deducting points in the year paid, except the only funds you provided were a $750 down payment. Of the $1,000 charged for points, you can deduct $750 in the year paid. You spread the remaining $250 over the life of the mortgage.

Example: The facts are the same as in Example 1, except that the person who sold you your home also paid one point ($1,000) to help you get your mortgage. In the year paid, you can deduct $1,750 ($750 of the amount you were charged plus the $1,000 paid by the seller). You must reduce the basis of your home by the $1,000 paid by the seller.

 

 

Excess Points

If you meet all the tests except that the points paid were more than generally paid in your area (test 3), you deduct in the year paid only the points that are generally charged. You must spread any additional points over the life of the mortgage.

 

 

Points Paid on Second Home

The general rule of instant deductibility does not apply to points you pay on loans secured by your second home. You can deduct these points only over the life of the loan.

 

 

Mortgage Ends Early

If you spread your deduction for points over the life of the mortgage, you can deduct any remaining balance in the year the mortgage ends. However, if you refinance the mortgage with the same lender, you cannot deduct any remaining balance of spread points. Instead, deduct the remaining balance over the term of the new loan.

A mortgage may end early due to a prepayment, refinancing, foreclosure, or similar event.

Example: Dan paid $3,000 in points in 2006 that he had to spread out over the 15-year life of the mortgage. He had deducted $1,200 of these points through 20011. Dan prepaid his mortgage in full in 2008. He can deduct the remaining $1,800 of points in 2012.

 

 

Points Paid on Refinancing

Generally, points you pay to refinance a mortgage are not deductible in full in the year you pay them. This is true even if the new mortgage is secured by your main home.

However, if you use part of the refinanced mortgage proceeds to improve your main home and you meet the first five tests listed earlier; you can fully deduct the part of the points related to the improvement in the year paid. You can deduct the rest of the points over the life of the loan.

Example: In 1999, Bill Fields got a mortgage to buy a home. The interest rate on that mortgage loan was 11%. In 2008, Bill refinanced that mortgage with a 15-year $100,000 mortgage loan that has an interest rate of 7%. The mortgage is secured by his home. To get the new loan, he had to pay three points ($3,000). Two points ($2,000) were for prepaid interest, and one point ($1,000) was charged for services, in place of amounts that ordinarily are stated separately on the settlement statement. Bill paid the points out of his private funds, rather than out of the proceeds of the new loan. The payment of points is an established practice in the area, and the points charged are not more than the amount generally charged there. Bill’s first payment on the new loan was due July 1. He made six payments on the loan in 2008 and is a cash basis taxpayer.

Bill used the funds from the new mortgage to repay his existing mortgage. Although the new mortgage loan was for Bill’s continued ownership of his main home, it was not for the purchase or improvement of that home. For that reason, Bill does not meet all the tests, and he cannot deduct all of the points in 2008. He can deduct two points ($2,000) ratably over the life of the loan. He deducts $67 [($2,000 ÷ 180 months) x 6 payments] of the points in 2008. The other point ($1,000) was a fee for services and is not deductible.

Example 2: The facts are the same as in Example 1, except that Bill used $25,000 of the loan proceeds to improve his home and $75,000 to repay his existing mortgage. Bill deducts 25% ($25,000 ÷ $100,000) of the $2,000 prepaid interest in 2008. His deduction is $500 ($2,000 x 25%).

Bill also deducts the ratable part of the remaining $1,500 ($2,000 – $500) prepaid interest that must be spread over the life of the loan. This is $50 [($1,500 ÷ 180 months) x 6 payments] in 2008. The total amount Bill deducts in 2008 is $550 ($500 + $50).

 

 

Limits on Home Mortgage Interest Affect Points

You cannot fully deduct points paid on a mortgage that exceeds the limits on home mortgages for purposes of the home mortgage interest deduction.

 

 

Form 1098

The mortgage interest statement (Form 1098) you receive should show not only the total interest paid during the year, but also your deductible points.

The statement will show the total interest you paid during the year. If you purchased a main home during the year, it also will show the deductible points paid during the year, including seller-paid points. However, it should not show any interest that was paid for you by a government agency.

As a general rule, Form 1098 will include only points that you can fully deduct in the year paid. However, certain points not included on Form 1098 also may be deductible, either in the year paid or over the life of the loan. See the earlier discussion of Points to determine whether you can deduct points not shown on Form 1098.