Welcome to the Tax Blog

News, information, and opinions about:

  • Federal, State, and Virginia Beach Taxes
  • The Tax Preparation Business
  • Tax Planning

If you have a question or comment, please drop me a line. Paul @ PIM Tax.

13 October 2018

Video Blog:

Virginia taxes and the TCJAThe Tax Cuts and Jobs Act (TCJA) is the official name for the tax law changes enacted at the end of 2017 and became effective for 2018. Among the many changes within the TCJA there are two in particular that I want to focus on for this article:

  1. The federal standard deduction was significantly increased.
  2. The total amount that can be deducted on Schedule A for state and local taxes (SALT) from your federal taxes is limited to $10,000 per year.

I have been doing some modeling of the impacts of those two changes, and something I discovered is those changes have created situations in which tax payers filing Virginia tax returns have the potential to needlessly pay higher taxes than necessary. I want Virginia taxpayers to be aware of those potential risks so they can avoid them. My problem was figuring out how to communicate some relatively complex tax topics into something that can be understood before it puts the reader into a tax-knowledge-induced coma. My solution was to make a presentation, narrate it, and turn it into a video that can be viewed. Here it is:

 

 

 

While the video specifically addresses Virginia tax issues, taxpayers filing tax returns in other states may face similar potential risks. I have not analyzed the impacts of the new tax laws on other states. Taxpayers filing in other states should consult a tax professional if they have concerns.

If you have some questions after watching the video 3 times, please contact me. If you understood it the first time, let me know that, too, so I know how much effort I need to put into making my videos comprehensible. Thanks!

 

 

30 September 2018

Virginia Beach 529 Tax LoopholeThe Virginia ABLE-Now program allows you to deduct up to $2,000 of contributions per year from your Virginia income taxes. Or you could exploit a simple trick created by the Tax Cuts and Jobs Act to increase the amount you are able to deduct from your Virginia tax return!

I have made no secret over the years of my fondness for the Virginia 529 program. They provide a valuable product at a good price. The investment selections in the College Invest program are top notch index funds with low fees and expenses. On top of that, they manage to be one of the few government agencies I find less than dreadful to work with. It’s actually pretty slick. You can do almost everything online with very few hassles, and I never sign off angry. If only the Virginia 529 team could take over the DMV!

The latest and greatest addition to Virginia 529 is the ABLE-Now account. It isn’t for college savings, but rather a vehicle for persons with disabilities to be able to contribute to their own maintenance and care without jeopardizing their access to public support programs (MEDICAID). It’s a great program for people with disabilities, so if you know someone with a disability and you don’t know about the 529 ABLE program - go find out more! (The ABLE programs are state specific, so if you are not a Virginia resident, find the ABLE program for your state.)

Congress authorized the ABLE accounts under section 529 of the Internal Revenue Code, the same section of the code that authorizes states to implement college savings programs. In a rare moment of clarity, the Commonwealth of Virginia General Assembly determined section 529 linkage was sufficient to have the highly successful Virginia 529 college savings plan folks also take on implementation and management of the Virginia 529 ABLE program. Virginia calls their 529 ABLE program the Virginia 529 ABLE-Now program.

One of the provisions of the Tax Cuts and Jobs Act (TCJA) - the federal tax reform for 2018 - allows taxpayers to roll 529 college savings plan money into 529 ABLE accounts. This opens up some possibilities and opportunities because there are differences between the tax benefits of the Virginia 529 college savings program and the Virginia 529 ABLE-Now program. Let me list the salient ones for this tax tip I am about to share:

  • Contributions (from all sources) to a Virginia 529 ABLE-Now account are limited to $15,000 per year. (A beneficiary can only have one Virginia 529 ABLE Now account.)
  • Virginia taxpayers can deduct contributions to a Virginia 529 ABLE-Now account from their Virginia taxes, limited to $2,000 per account. In other words, if you wanted to fund a Virginia 529 ABLE-Now account, the most you could put into the account in a single year is $15,000, and then you could only deduct $2,000 of it from your Virginia taxes. You can carry the remaining $13,000 over to the next year (and the next year, and the next year...) until you have deducted the entire $15,000 contribution.

However...

  • Virginia taxpayers can deduct contributions to a Virginia 529 college savings plan from their Virginia taxes, limited to $4,000 per account. (There is no limit to the number of accounts a beneficiary can have, but an account owner can only have one account of each type of 529 college savings plan per beneficiary.)

This sets up an opportunity to make contributions to a Virginia 529 college savings plan, take the larger tax deduction for making the contribution, and then rolling the money over to the Virginia 529 ABLE-Now program to be used for a person with disabilities. Let’s look at an example of how this would work.

Helen and Dale have a son, Tim, with a qualifying disability for the Virginia 529 ABLE-Now program. They assist Tim with opening a Virginia 529 ABLE-Now account. They want to contribute $8,000 to it, but they know if they do they will only be able to deduct $2,000 of that contribution from this year’s Virginia tax return. The other $6,000 will be carried over to future years, but they are planning to put $8,000 per year into the account. At that contribution rate they’ll never be able to get the tax deduction for all their contributions. Instead, Helen opens a Virginia 529 College Invest account with Tim as the beneficiary and Dale opens a Virginia 529 College Invest account with Tim as the beneficiary. Helen puts $4,000 into the account she opened and Dale puts $4,000 into the account he opened. They can now deduct all $8,000 from this year’s Virginia taxes. Later they can roll the money from the two Virginia 529 College Invest accounts into Tim’s Virginia 529 ABLE-Now account. Helen and Dale can deduct their entire contribution, and Tim has money he can use for his own support without impacting his ability to access MEDICAID if he needs it.

What Helen and Dale want to watch out for here is this pesky thing called the Step Transaction Doctrine. In the event they were audited (by Virginia), the Commissioner could determine that putting the money in the the Virginia 529 college savings plan was only done to serve the second step of rolling the money over to the Virginia 529 ABLE-Now account - and therefore the entire process materially constitutes a contribution to the Virginia 529 ABLE-Now account, with it’s lower deduction limits.

Such a ruling would be easy to avoid by leaving the money in the Virginia 529 College Invest program for a year or two. The investment choices within the College Invest program are quite good, and you could build a portfolio to mirror the same investments available in the Virginia 529-ABLE-Now account. You’d get the same return for the same risk and eliminate the possibility of losing the deduction to the Step Transaction Doctrine.

Virginia’s income tax rate is essentially 5.75%. By deducting $8,000 vice $2,000 each year from their Virginia taxes Helen and Dale would decrease their Virginia income tax bill by $345. Is that life altering money? Probably not. It is, however, a great guaranteed return on an investment of 20 or 30 minutes of your time to set up the accounts and execute the plan each year.

You'd probably also want to think twice before using the College America verson of the Virginia 529 college savings plan for this maneuver. College America is implemented through financial advisers, so there may be additional fees charged that reduce the value of the tax savings.

If you would like more information or to discuss the tax benefits of the Virginia 529 plans in greater detail, please contact me for a free initial consultation.

 

 

19 August 2018

virginia beach tax preparation Virginia 12In most aspects Virginia laws conform to federal income tax laws. This is somewhat evident when you notice the first line on your Virginia tax return is your federal adjusted gross income. In essence, Virginia is just saying, “We accept all the federal definitions of income and adjustments as our opening argument.”

That said, there are distinct differences between the Virginia tax system and the federal tax system. These are sometimes confusing and I find myself frequently answering questions with the phrase, “That’s true on your federal tax return, but not on your virginia tax return.”

Here are twelve examples of the differences between Virginia tax law and federal tax law:

  1. Virginia tax return is due May 1. While your federal tax return is due on or about April 15, your Virginia return is not due until on or about May 1. I think that’s a nod to the first line on the Virginia return being your federal AGI. You can’t complete your Virginia return until you have completed your federal return, so Virginia gives you 2 weeks after you have completed your federal return to complete your Virginia return.
  2. There is no Head of Household filing status in Virginia. There isn’t a Qualifying Widow(er) status either. In Virginia you are Single or you are Married and filing jointly, or Married and filing separately. Just 3 filing statuses in Virginia compared to 5 for federal.
  3. Virginia does not tax Social Security benefits. While the federal government has a (difficult to understand) sliding scale that will tax somewhere between 0% and 85% of your Social Security, Virginia just subtracts it out of your income altogether. The Commonwealth has some good benefits for our seasoned citizens, and that is one of them!
  4. You can’t deduct state income taxes from your Virginia income taxes. (Although you may qualify for a credit known as the OSC.) State income taxes paid can be an itemized deduction on your federal income taxes, but not on your Virginia return. However, if you are paying taxes to another state you may qualify for the Other State tax Credit (OSC), which essentially prevents you from paying income tax to more than one state on the same income (provided one of those states is Virginia!)
  5. The standard deduction is $3,000 for single people and $6,000 for married filing jointly. Federal standard deductions went up significantly this year as part of the tax reform passed in December 2017. Not so in Virginia (not yet, anyway). This could be significant as your Virginia deduction method (standard or itemized) must match your federal tax return.
  6. There is only one set of ‘tax brackets’. For federal taxes the rate of taxation changes depending on your filing status. A taxpayer filing head of household will generally pay lower taxes on the same amount of income compared to a taxpayer filing as single. It’s one-size-fits-all in Virginia. No matter your filing status your tax rates are the same. Additionally, there are no preferential tax rates for different types of income. Capital gains and qualified dividends get taxed at the same rate as regular wages in the Commonwealth.
  7. Childcare is a deduction, not a credit. Both Virginia and the federal government provide a tax benefit for households where both parents are working and childcare is required for young children. While the IRS figures the benefit as a credit, Virginia does it as a straight up deduction. (And neither comes anywhere close to offsetting what people are actually paying for childcare!)
  8. No tax credits for children or education. After you figure the tax you owe on your taxable income, the federal government provides ‘family friendly’ tax credits for higher education and for having minor children living in your home. Virginia does not provide similar tax credits. (I find this is often the reason a client will receive a refund from the federal government, yet owe Virginia money.)
  9. No bonus depreciation. This is a complicated difference, but it can have a big impact on business owners and some landlords. The federal government currently allows for aggressive accelerated cost recovery of business equipment known as ‘bonus depreciation’. Virginia does not conform to this accelerated bonus depreciation regimen. This can result in the cost recovery (through depreciation expensing) for your business property occurring at different rates on your Virginia and federal returns. You should consult a tax professional if you think this may impact you.
  10. You can deduct 529 contributions. I am a big fan of the Virginia 529 plans, and one of the primary reasons is the tax deduction you can get on your Virginia tax return for your contributions. Both the federal government and Virginia give tax free treatment to the account if it is used for education, but only Virginia gives you the deduction for the contribution. 5.75% guaranteed return on my money via tax deductions? Sign me up!
  11. Military pay subtraction. Neither the federal government nor Virginia will tax military pay earned in a combat zone, but only Virginia provides the opportunity to avoid taxes on some or all of your military pay via the military pay subtraction. This allows you to subtract up to $15,000 of your military pay from your Virginia taxes. There are specific rules and limitations, but it’s a nice benefit for those who can use it!
  12. Extensions are automatic. If you can’t get your federal return filed by April 15 you can get an automatic 6-month filing extension by filing form 4868. If you can’t get your Virginia return filed by May 1 you can get an automatic 6-month filing extension by doing nothing! That’s right - if Virginia doesn’t receive your tax return by May 1, you are automatically granted a filing extension to November 1. You will be subject to penalties and interest if you don’t pay all the taxes you owe by May 1, but there is no penalty for late filing until November 1, and you don’t have to do anything to get it!

A Virginia income tax return is more like the federal return than it is different from it. The differences, however, can make a real impact on your bottom line. Hopefully this article shed some light on those differences. If you still have questions, don't hesitate to contact me!

 

 

09 July 2018

Virignia Beach Tax Preparation IRA Taxable BasisThe word basis can have many different meanings in tax and finance. When it comes to your IRA it refers to the portion of your IRA on which you will NOT have to pay tax. That makes it a really good thing to know (unless you enjoy paying taxes!). Unfortunately, IRA basis is one of the rare areas of the tax code where nobody else is keeping track of it for you.  The IRS doesn’t. Your bank or brokerage can’t. You have to do it for yourself - and if you aren’t then you could end out paying more taxes than you need to.

The Basics on IRA Basis

There are two types of IRAs. There’s the Traditional IRA, and there’s the Roth IRA. The primary difference between the two is the timing of when the money gets taxed. The concept of the Traditional IRA is that you don’t pay taxes on the money you contribute to the account, but you pay regular tax rates on the money when it comes out. The concept of the Roth IRA is that you pay tax on the money when it is contributed to the account, but then you don’t pay any taxes on the money coming out.

If those concepts were the only rules, then I wouldn’t be writing this article. If those were the only rules, the tax basis of a traditional IRA would be 0% of the account (none of it would be excluded from taxes) and the tax basis of the Roth IRA would be 100% of the account (all of it would be excluded from taxes). But, alas, nothing can ever be that simple in tax law. There are exceptions, and it’s those exceptions this article addresses.

Basis in Your Roth IRA

The IRS uses the term qualified when referencing IRA distributions (a.k.a. withdrawals). Qualified means the distribution/withdrawal meets all the rules to keep the tax benefits of the IRA. One of the things that makes a Roth IRA distribution qualified is the age of the account holder. If you are more than 59 ½ years old when you withdraw from the Roth IRA, then the distribution is deemed qualified (tax free).

Life happens to us all, though. For a variety of reasons people often need to tap into their retirement savings before the age of 59 ½. This can lead to non-qualified distributions from their Roth IRAs, and that means the distribution does not keep its tax-free characteristics. If you tap into your Roth IRA before the age of 59 ½ you’ll have to pay tax on the distribution. Maybe…

Because you received no tax benefits when you contributed money to your Roth IRA, you don’t have to pay tax on the contributed money when it comes out. This is similar to a bank account. I don’t get a tax break when I put money into my bank account, and I don’t pay taxes when I withdraw it from my bank account. It’s just my money. It is the same with the money you put into your Roth IRA.

The catch is this tax-free status is limited to the money you contribute to the account (which I am referring to as your tax basis). Any money that is in your Roth IRA due to growth (dividends, capital gains, interest, etc.) would be subject to taxes if withdrawn early. HOWEVER - when you make a withdrawal from your Roth IRA, the contributed money comes out first. So, you can take money out of your Roth IRA account up to the amount you contributed without a tax consequence. This can provide you with a valuable source of tax-free money if you need it in an emergency. Let’s look at an example.

Jimmy is 30 years old. Jimmy opens a Roth IRA and contributes $3,000 per year for 5 years. At the end of 5 years the Roth account has a value of $18,000. Jimmy contributed $15,000 and there is also $3,000 of growth in the account. Jimmy’s car was destroyed in a hurricane, and his insurance won’t pay for the loss. Jimmy needs a car, so he looks to his Roth IRA for money. Jimmy can take up to $15,000 out of his Roth IRA (the amount he contributed) and not have to pay any taxes on that withdrawal. If he takes more than $15,000 he will have to pay the taxes on the amount over $15,000, because that is from the growth of the investments in the account.

Knowing the amount of his basis in his Roth IRA was important to Jimmy. If he didn’t know how much he contributed he might have taken too large a distribution and given himself a tax problem for later. Or he may have been overly cautious and not withdrawn enough to buy reliable transportation, using a high-interest rate loan instead.

Jimmy’s basis was an easy number to know in my scenario. In real life it doesn’t normally work that way. In real life people are not quite as systematic. They put money in the Roth IRA when they can and don’t contribute when money is tight. After several years they aren’t really sure how much money they have contributed to their account. Which means they don’t know how much they can take out before they trigger a tax issue.

With a Roth IRA your bank or broker (whoever is holding your Roth IRA) may be able to help you determine your basis. If you’ve kept the account at the same bank or brokerage the entire time they may be able to provide you with a history of your contributions, as well as any previous withdrawals. If you’ve moved accounts, they may not have your full contribution history. It’s worth asking them, though.

I don’t advocate using your Roth IRA like a piggy bank. Just because you can take your contributed money out tax free does not mean you should. That account is designed to fund your retirement, and should not be used for anything else unless the need is great. But when the need is great, knowing your Roth IRA basis can be extremely useful knowledge.

Basis in Your Traditional IRA

The concept behind the Traditional IRA is you receive a tax benefit for contributing to the account, but you pay taxes on the money when it is withdrawn. This tax benefit is meant to encourage Americans to save for their retirement. Our government has decided, however, that not everyone needs to be provided with such an incentive. There are income limitations to claiming the tax benefits of contributing to a Traditional IRA. Those limitations change depending on whether your employer provides you with a retirement plan at work. If you have an employer-sponsored retirement plan (TSP, 401K, 403B, VRS, military pension, etc,) then you lose your right to claim the Traditional IRA tax benefit at a lower income level. If you do not have an employer-sponsored plan you are allowed to claim the Traditional IRA tax benefits until your income hits a higher level.

Note, these limitations are only on the tax break for contributing to the Traditional IRA. Regardless of your income level, you can always make contributions to your Traditional IRA, you just can’t always get the tax break for making the contribution. That’s how you start to form tax basis in your Traditional IRA - by making contributions that do not qualify for the tax break.

Just like the Roth IRA, any money you contribute to your Traditional IRA without getting a tax break for making the contribution can come out tax free. But - BIG DIFFERENCE ALERT - unlike the Roth IRA, your contributed money does not come out of your Traditional IRA first. Money distributed from your Traditional IRA comes out as a mix of qualified contributions, non-qualified contributions, and growth. You have to know the composition of that mix so you know how much of your withdrawal is taxable and how much is not taxable. Let’s look at another example.

Jane starts a Traditional IRA when she is 50 years old. She contributes $3,000 each year for 5 years, getting a tax break each year for those first 5 years. At age 55 Jane gets a promotion and a big pay raise at work. She increases her contributions to her Traditional IRA to $5,000 each year, but she is now unable to take the tax deduction for her contributions because her income is too high.

Jane is now 60 years old. Her Traditional IRA value is $60,000. Jane decides to take $10,000 from her Traditional IRA and go see New Zealand. How much of her withdrawal is taxable?

We know Jane’s taxable basis in her Traditional IRA is going to be the $25,000 (5 years times $5,000 per year) of contributions she made without getting a tax benefit. The $15,000 of qualified contributions and the $20,000 of growth in the account are all taxable.  So, $25k/$60K (41.67%) is not taxable. $35,000/$60,000 (58.33%) of her $10,000 distribution (or $5,833) is taxable.

Again, my example is simple to make it easier to demonstrate the concept. Real life is rarely this clear. In real life people who have made contributions to their Traditional IRAs without receiving a tax break usually do not know what their tax basis is in their account.

What shocks many people is that their bank or brokerage can’t help them figure it out! Here’s why: whether or not you received a tax break for your Traditional IRA contribution is a function of whether your employer offers a retirement plan and your adjusted gross income - and your bank/brokerage doesn’t have that information! They don’t know which years your contributions received a tax benefit and which years they did not. When you take a distribution from a Traditional IRA the bank/brokerage will issue a form 1099-R, and they will check the box that says “Taxable Amount Not Determined”. It’s on you to determine the taxable amount and report it to the IRS when you file your tax return.

Figuring Your Traditional IRA Basis

Ideally, you’d be like Jane and track your Traditional IRA basis. But, what do you do if you’re like the 99.99% of Americans who have a basis in their Traditional IRA, but don’t know how much it is? If you’ve been filing your taxes correctly you can go back through your old tax returns and review your form 8606 submissions. You should have been reporting your non-deductible Traditional IRA contributions on this form each year.

If you don’t have all your old tax returns you can request tax return transcripts from the IRS. The transcripts are free, and you can use them to piece together the information you need to determine your Traditional IRA basis in that way.

If you want help determining your basis in your IRA come see me. I have a nifty tool that can pull all your IRS transcripts going back to 1990. We can pull all your transcripts at once and cull them for the information we need.

 

 

24 June 2018

Tax Prep military virginia beach transition retireWith the thriving military bases in the region, Hampton Roads is blessed with many military retirees. (I find it ironic we are called ‘retirees’, since many of us work just as hard (or harder) after leaving the service as we did when we were on active duty!) Some interesting tax issues often arise in the year a member leaves military service. I lived a few of these issues, and see even more as a tax professional. Hopefully this article will help some of my newly retired (or about to retire) brothers and sisters in making transition to civilian life a little smoother.

That First State Tax Return Can Be a Doozy! Many of us took advantage of the Servicemembers Civil Relief Act (SCRA) to avoid paying state income taxes while we were on active duty. I sure did. At the beginning of my first duty station in Florida I marched down to the Duval County Courthouse and registered my domicile in Florida. Took that paper to my personnel office, and skipped out on paying state income taxes for the next 20 years.

Spouses weren’t covered by the SCRA back then, so my lovely wife Tade has been filing in Virginia since we moved here in 2001. I didn’t have to start filing here until I retired from the Navy in 2010. Even though many military spouses are now exempt from state taxes by the Military Spouse Residency Relief Act (MSRRA), I still see many couples in the situation Tade and I were in; one spouse is a Virginia resident, and the other is not.

In my opinion, Virginia handles this situation very sanely. Even if the married couple files their federal return jointly, Virginia allows them to file separately if one is a resident and the other is not. Not all states allow you to have a different filing status on your state return than you have on your federal return. Virginia makes it the only correct way to file if one of you is not a Virginia resident. I find that simple to comprehend. Unfortunately, most do-it-yourself tax software has a lot of trouble when you try to change filing status between your federal and state returns.  I've had a few clients successfully figure out how to do this, but not many.

The more difficult situation arises in the year of retirement. We can continue to use my situation as an example. Tade was a Virginia resident all of 2010. Paul became a Virginia resident on December 1, 2010. How did we file our 2010 Virginia taxes?

Tade filed the same way she always did - her status was married filing separately, and she was a full-year resident (form 760). Paul also filed in Virginia as married filing separately, but on a Virginia part-year resident return (form 760PY). We had to use two different forms to file in Virginia! Good luck getting your do-it-yourself tax software to help you get to that conclusion.

Worse still are the state returns for folks whose transition meant they were part year a resident of one state, and part year a resident of another state. It can be quite challenging to get the interplay between the state returns to be right in these situations. I pay $1,200 annually for my tax software, and I’ve been known to throw my hands up (mutter some sailor-like words about the parents of the people who designed my software), download blank forms from a state website, and fill them out by hand to get the correct tax result.

The bottom line on this issue is that your state tax return(s) in the year of your transition out of the military can be more challenging to prepare than usual. Don't expect your off-the-shelf software solution to walk you to the right answer. They don't deal with this problem very often. (Fortunately, you don't either!)

Increased Income Means Increased Taxes. Many military retirees experience increased income when they leave the military. They get a job for as much as (or more than) they were making while on active duty. They also begin receiving their military retired pay. The increased stability of not having a military move looming in the future means spouses may also see a bump in pay as well. It is not uncommon for me to see a family’s income double within a year of a military retirement.

As I have previously written, there is an income zone (that I call ‘the crease’) where your income taxes will increase significantly faster than your income.* This zone sits just above the income level of many military families. When their income increases right after a military retirement, they can shoot into (or through) that zone, and the tax impact can be dramatic. One couple saw a 70% increase in income, but their tax bill more than tripled!

Higher incomes can (and probably should) lead to higher taxes, but there are ways to be proactive about managing the situation to keep your tax bill from exploding. The solutions are unique to the individual situation, but nearly all require advanced planning. Very little can be done to mitigate taxes after the tax year is over. You need to plan and act ahead. Please contact me if you want assistance developing your tax strategy.

(* The revision of the federal tax laws that went into effect in 2018 (also known as the Tax Cuts and Jobs Act) made some changes that should help flatten out 'the crease' as described in my linked article from 2016. Notably, starting in 2018 the child tax credit does not begin phasing out for families until their adjusted gross income is more than $400,000.)

Your Military Pension is Taxable in Virginia. The Commonwealth offers some generous tax breaks to military personnel, but not much after you retire. Virginia will tax your military retired pay as regular income. The DoD will follow your instructions and/or the withholding tables provided to them by Virginia to determine how much to withhold for Virginia taxes. IT’S ALMOST NEVER ENOUGH.

Here’s how this scenario frequently plays out: You leave the military after 20+ years of service, having not paid state income taxes for decades. You get a civilian job. The pay is good, but there’s that new line on your pay stub/earnings statement for “Virginia Tax Withheld”. It isn’t much, but it’s a bit annoying since you never paid it before. You also start getting retirement pay (Woo hoo! Free money!) There’s that annoying line on your retiree statement for Virginia taxes, too. Then you file your first Virginia income tax return and find out you owe them thousands of dollars because neither your employer nor the DoD were withholding enough to cover your Virginia tax bill.  It happened to me, and I’m pretty knowledgeable about taxes!

Setting up your tax withholding is another area that requires a little prior planning. It can be tricky. See me if you want some assistance with that. I learned my lessons on that one the hard way, but I learned them well!

If you bothered reading this article it’s probably because you are recently retired from the military, or you are about to retire. It’s an exciting time. I remember feeling a bit anxious about the future during the year of my transition. (Not about taxes, but life in general.) If I could do it over again I would relax a little bit and dream bigger from the start. I learned more in my decades of service than I knew. You probably did, too. Congratulations on getting to this next stage, and thank you for your service!

 

 

13 May 2018

Virginia Beach Real Estate Tax Landlord RentI frequently encounter new landlords who are confused and/or frustrated by their tax situation. They decided to turn their house or condo into a rental business, but they didn't fully understand the tax implications of doing so. Now they are paying both financially and emotionally.

In an effort to save at least a few people from this fate, I am providing you with this quick “Top 5” list of tax issues you should consider before you decide to become a landlord.

1. Your Mortgage is Not Deductible. If life (or being a landlord) were simple, the mortgage on your rental property would be deductible. This would give you a simple formula to figure your rental income.

You take in $1200/month in rent;

You pay the bank $1,000/month for your mortgage

You make$200/month or $2,400 for the year

Boom - you’d be done!

In reality it’s not even close to being that simple!

A mortgage is typically paying 4 different things in one payment: (1) principal on the loan, (2) interest on the loan, (3) real estate taxes, and (4) insurance. You have to break out each of those expenses separately on your tax return. Interest, insurance, and real estate taxes are all deductible expenses as paid. The principal, however, is deducted through a cost recovery system that we typically refer to simply as ‘depreciation’. More on that later. For now just be aware you cannot directly deduct your mortgage payments on your tax return. It's not that simple.

2. You Must Track Everything. By renting your property you have opened a business. The IRS considers you to be operating a business. So does the Commonwealth of Virginia. If you aren’t treating it like a business, then you risk learning some expensive lessons down the road. Businesses need records, so get a record keeping system in place. (Hint: a box of receipts is NOT a record keeping system.) A spreadsheet will do if you just have 1 or 2 properties. More than that and you’re probably going to want some sort of accounting software.

Track all the expenses for the property. Once you’ve turned it into a business, everything you spend on the property is a business expense. Make sure it gets recorded in your spreadsheet (or bookkeeping system you adopt).

Get a separate bank account for your landlording activities. It’s a business, it deserves its own bank account. Don’t run personal expenses through the landlord account. Don’t run business expenses through your personal account. Keep them separate. It keeps the bookkeeping cleaner if you do, which makes it look like you’re treating your rental activities like a business. 

3. You Can Be Creative with Expenses. Within reason, of course. You can’t take your kids to a Taylor Swift concert and then write it off as a business expense. There are, however, some reasonable ways to save on taxes and meet multiple goals. Here is one of my favorite examples.

The grass needs to be cut at the rental property. You have a 14-year-old son. Pay him $50/week to mow the grass. That’s what you’d pay a professional service to do it. Over the course of the mowing season your kid makes $1,200. You have to issue him a W-2. However, his income is below the threshold for paying federal or state income tax. Because he is your child and under the age of 18, he does not have to pay Social Security or Medicare taxes, either. (So you don't have to bother with withholding these taxes.) He now has $1,200 of earned income tax free. You have a $1,200 deductible expense against your rental property business.

Open a  Roth IRA for him and put the $1,200 in it. He can contribute the entire amount of his earned income up to $1,200. When he is ready to go to college he can pull that $1,200 out and spend it on college with no tax consequences. Long story short - you just got a $1,200 tax deduction for saving money for your kid’s college.

If you think you have a creative idea on how to get the most out of the tax benefits of being a real estate investor, it’s probably best to get a professional opinion on them first. Creative is good, until it crosses the line into illegal. Nobody wants that.

4. If You Earn Over $150K, Your Losses are Suspended. Our beloved government has classified rental activity as passive activity. (Which I find ironic, because most landlords I know are working their tails off!) When you lose money at a passive activity it is known as passive activity losses (PAL). PAL are only deductible against passive incomes....UNLESS the PAL is from residential real estate and your modified adjusted gross income is less than $100,000. If that is the case, then you are able to deduct up to $25,000 of PAL against other income (like your wages from a job). If your income is above $100,000 then the amount of PAL you can deduct is reduced. At $150,000 of modified adjusted gross income you can not deduct any PAL against other (non-passive) sources of income. However...

The PAL isn’t lost if you can’t deduct it. It is suspended. Suspended passive losses are carried over to future years. You can use the suspended passive losses against future passive income, or you can use them when you sell the property. I’ve written about this extensively elsewhere, but for now just be aware that your passive losses are suspended if your modified adjusted gross income is greater than $150,000 and that you still need to track those losses so that you can use them in the future.

5. Depreciation & Recapture. This is a very complicated topic, so I am just going to give you the two highest points in this article.

A. You must depreciate your rental property. I know you don’t want the value of your property to actually decrease, but that isn’t what depreciation means in this context. Depreciation is used to represent a method of recovery for the cost of your property. Instead of deducting the principal part of your mortgage, you deduct the cost of your property by taking a depreciation expense for it. Four things to remember about taking the depreciation expense:

(1) Only the building depreciates. The land does not depreciate. The land value must be removed from the overall value of the property when figuring your depreciation expense.

(2) If your building is residential rental property it depreciates in a straight line over 27.5 years. (Why 27.5 years? Because Congress says so.)

(3) If you make capital improvements to the building before it is placed in service as a rental property, the cost of those improvements is added to the basis of the building and depreciated over 27.5 years with the rest of the building.

(4) If you make capital improvements to the building after it is placed in service as a rental property, those costs are capitalized and depreciated separately over 27.5 years.

B. You must REPAY the depreciation expenses when you sell the property. Unless the property actually depreciated (which is rare). There are two things you should know about this:

(1) You can escape repaying the ‘depreciation recapture’ only if you die owning the property, or you do a 1031 exchange for another property.

(2) Even though repaying the depreciation is unpleasant in  the year it is repaid, it is rare that taxpayers are net losers at the depreciation game. If you take the long view, even though you pay it back, you got an interest free loan from the IRS. How cool is that? 

Despite number 5 having multiple parts to it, I am still going to call this my “Top 5” list. Being a landlord can be profitable. A big chunk of those profits is tied to the tax breaks you get for investing in real estate. Know what those tax breaks (and pitfalls) are before you blindly leap into landlording. If you have any questions or want some assistance in developing a real estate investing tax strategy, please contact me.

 

 

23 April 2018

Virginia beach tax preparation baseball faceplantAnother tax season has officially come and gone. While I still have a couple dozen clients on extension to complete, I wanted to start blogging again. I like doing taxes, but only doing taxes for 12 hours a day, every day for weeks and weeks was starting to make me a little batty. I'm glad to mix it up a bit again.

I thought I’d kick things off with my annual tax season post mortem on the 5 biggest mistakes I saw taxpayers making during the tax season. These were either mistakes that were repeated often or mistakes that were so costly I want to ensure they remain very rare. Without further ado, let’s dig in!

1. Misunderstanding The Military Spouse Residency Relief Act

The military spouse residency relief act can be confusing, but I’m going to break down how Virginia implements it as simply as I can. If you are living in Virginia because your spouse is here on military orders, you have two options:

  1. You can be from the same state as your military spouse
  2. Welcome to Virginia!

Several times this year I had clients tell me the military member (stationed in Virginia) was from (pick any state) Montana, but the spouse was a resident of (pick any other state) Ohio.

No. That isn’t how it works.

In this example, the non-military spouse can be from Montana or Virginia. To be from Montana the non-military spouse must have lived in Montana with the spouse and established residency in Montana before moving to Virginia.

There are dozens of details and permutations I have left out of this explanation, but that should cover 90% of the military families I see. Bottom line - as the spouse of a military member you don't have to pay taxes in Virginia if you are from the same state as the military member. Otherwise, you are paying taxes in Virginia.

2. Virginia Returns with the Non-Resident Military Member on Them

Nearly all married couples file their federal returns jointly. They will often get the most advantageous tax result by doing so. The do-it-yourselfers know this, so they prepare a joint federal return. Then it comes time to file their state taxes. He’s active duty and from Florida, and she is not. They know she has to pay taxes in Virginia, but he doesn’t. Let the battle with the software begin!

The states have a variety of ways to handle this situation. Virginia’s solution is that if one spouse is a VA resident and the other is not, then the resident spouse files separately in Virginia - even if they file jointly on their federal return. Most tax software hates that. It will try to steer you toward filing jointly in Virginia. Then his income shows up on the Virginia return and it doesn’t belong there. That’s when people come up with inventive ways to remove the non-Virginian's income from the Virginia return.

The fine folks in Richmond have no idea what your state of residency is. They only know that if you put somebody on the Virginia tax return and then invent some creative way to remove that person’s income, it’s wrong. They add it back on and send you a bill.

You have to remove the non-Virginian from the Virginia tax return. You can play with your software until you figure it out - a few people have cracked the code on that. (Don't ask me how they did it, though, I don't use that software.) Alternatively, you can paper-file your Virginia return. You can get downloadable forms for free from the Virginia Department of Revenue site.

3.  Not Coordinating Withholding among Several Income Streams

Here is how this one normally goes: Martha earned $20,000 from her primary job during the year. She also started working a second job on nights and weekends, earning $20,000 from that. In addition, she receives $20,000 in pension benefits during the year. Altogether she has $60,000 of income. However, the HR folks at job 1, job 2. and the pension administrators don’t know about each other. As far as they know Martha is only earning the $20,000 per year they are paying her. They are withholding taxes as if her total tax bill is going to be based on $20,000 of income.

When Martha comes to see me and I figure her taxes based on the $60,000 she actually brought in, I am likely to find that she did not have enough taxes withheld and she is going to have to write checks to the IRS and VIrginia.

Getting your tax withholding right across multiple income streams can be tricky. The IRS online withholding calculator is pretty good at helping you figure it out. Just make sure you have pay stubs from all your income sources and your most recent tax return when you start. It will ask for a lot of data you won’t have at the ready in your memory banks.

4. Virginia Residents not Using VA529

I only saw this twice, but I hate to see any tax deductions go wasted, so I wanted to address it. Contributions to the Virginia 529 college savings plan are deductible from your Virginia income taxes. Despite this I noted 2 incidents where clients were paying taxes in Virginia and putting money into the 529 plan in another state.

There is no tax deduction for contributions to another state’s 529 plan. Virginia’s 529 plan has good choices, low fees, and can be used in other states, so I can’t think of a compelling reason not to use it if you are paying Virginia taxes. Unless, of course, you don’t like money. (Which would be a strange condition for somebody reading a tax blog!)

5. Charity Receipts

Those flimsy, blank receipts you get for donating items to Goodwill, The Salvation Army, Samaritan House, CHKD, DAV, etc. I have a real love-hate relationship with those things. I am glad the government is encouraging re-use of items, that people can get a tax break for donating their items to charity, and that poor people have access to a lot of used items at good prices to help them make ends meet. On the other hand many taxpayers are quite confused as to how to properly claim this deduction.  They hand me their blank receipt, but when I ask what they had donated they look downright bewildered. They look at me as if to say, I gave stuff to charity and they gave me this blank receipt. Do something with it!

I can see how some confusion might happen. I can’t think of any other place where they hand you a blank receipt and expect you to know what to do. The thrift shop never explains it, either. The guy who takes in your stuff isn’t giving tax advice any time soon. He just hands you the receipt and you’re on your own. (The Thrift Shop isn't allowed to fill it out for you, btw. That's your job!)

You should take a few minutes and fill that out as soon as it is handed to you. The store isn’t going to fill it out for you.  You aren’t going to remember what you donated 6 or 8 months later when it’s time to do your taxes. Take a little time to manage your taxes throughout the year. It is worth it!

 That's my top 5 for this year. I hope you enjoyed it and there were some useful knowledge nuggets in there for you to use. If you have any questions don't hesitate to contact me.

 

 

08 January 2018

Virginia Beach Tax Law Changes 2018My plan is to write a new article for this tax blog at least once a week. It doesn’t always work out that way. Some interruptions to this plan are predictable. For example, I anticipate my blogging schedule will get interrupted during tax filing season (mid-January to mid-April). But this year the interruptions came earlier than expected. One thing that happened is that all my children came home for Christmas – that was a happy interruption.

There were a few others, too, but the biggest interruption (disruption?) I encountered is that just before Christmas something happened I was not anticipating – our federal government accomplished something. Both houses of Congress passed tax reform bills, they worked out the differences in a joint conference, and put a bill in front of the President – who signed it! (It was almost as if there was no dysfunction in Washington for a few days.)

Time will tell if this something our government accomplished with the new tax laws was a good thing or a bad thing. There were quite a lot of changes in the tax law, and I suspect we will ultimately judge some to be good and some to be bad. But since these changes are in effect NOW, people (like me) who plan tax strategies aren’t too keen on waiting to see how things work out in the long run. We need answers now to be able to plan and make strategies.

I have been reading (and reading and reading…) about this new tax law. I have a reasonably good understanding of it now, but there are some things that are just not yet knowable. The IRS has not yet had time to develop rules, forms, and instructions for the implementation of the new laws Congress handed them. The manner in which the IRS implements the changes will have a significant impact on future strategy.

Knowing that more is yet to be revealed, I still want to get some practical information about the new changes in this blog. I have received enough phone calls in the past few weeks to know there is an appetite for it. Instead of trying to eat the entire elephant I am going to stick to the issues I think will be of most interest to my clients and readers. These are the topics with which my clients have dealt with, or may need to deal with in the future. So, without further ado, here is my take on the provisions in the new tax law that will likely have the greatest impact on my clients. Remember, these are new rules for 2018. These changes will not impact the tax return you are about to file for 2017.

  1. Personal Exemptions are gone. Previously you could subtract around $4,000 for each person you claimed on the tax return. This will no longer be the case starting in 2018. The new law compensates for this change by increasing the standard deduction and increasing and expanding the child tax credit.
  2. Increased standard deduction. The standard deduction has nearly doubled. This means that significantly fewer taxpayers will itemize their personal deductions. (This was the ‘simplification’ some politicians spoke of when discussing tax reform.) It is still legal to do either. You may claim the standard deduction or you may itemize your personal deductions. We will do whichever is most advantageous to the taxpayer. The increased standard deduction (coupled with lowered itemized deductions, explained later) means it will now be more advantageous for more people to use the standard deduction.
  3. Lower itemized deductions. Personal deductions are itemized on Schedule A. Many of the deductible items on Schedule A have been eliminated or limited.
    1. Mortgage interest on new mortgages for your personal residence (first and second home) is now limited to the first $750,000 borrowed. (This is down from $1,000,000.) Mortgages existing before December 15, 2017 are grandfathered at the $1,000,000 limit.
    2. Interest on home equity loans is no longer deductible just because the loan is secured by your residence. My recently written (and brilliant) article on interest tracing rules should be reviewed. Just be aware that home equity loans and lines of credit are now going to be subject to the interest tracing rules and not exempt from them. No grandfathering provisions were made for existing home equity loans.
    3. State and Local Tax Deduction limited to $10,000. These are your state income taxes, real estate taxes, and personal property (car) taxes. The limit for all these taxes combined is now $10,000. There was no limit to this deduction previously, so this will have a fairly significant impact to the people who itemize their deductions.
    4. Deductions for unreimbursed employee expenses – gone. Taxpayers used to be able to take deductions for expenses they incurred for being an employee. As I wrote about (again, brilliantly!) just a few months ago, these deductions were subject to a 2% of adjusted gross income (AGI) threshold. There were some exceptions made for military personnel, but these deductions are largely gone now.
  4. Expanded 529 Plan Usage. Named for Section 529 of the internal revenue code, state-run 529 programs (such as the Virginia 529 Program) have provided Americans a way to receive tax benefits for saving and paying for college. The new tax law expands the 529 program to allow families to use money in their 529 plan to pay for K-12 education as well. Up to $10,000 per year of 529 money can be used for expenses associated with K-12 education, even at private and religious schools.
  5. Provisions that will directly impact Real Estate Investors:
    1. Bonus depreciation increased to 100% on properties (tangible pesonal property - a.k.a "stuff" - not real property) with less than 20-year useful life. Landlords are frequently dealing with replacing appliances, carpeting, and other items of personal property. In the past this property could not be expensed in the current year, but had to be depreciated and expensed over multiple years. With 100% bonus depreciation real estate investors can deduct the entire cost of many properties. This includes USED property. Previously the bonus depreciation rules were 50% and only applied to NEW property.
      1. Note 1 – Buildings have a useful life of more than 20 years and are not eligible for bonus depreciation.
      2. Note 2 – This is accelerated depreciation, NOT a pure write off. If you sell the property before it has fully depreciated, you must pay back the excess depreciation expense to the IRS.
    2. 20% deduction on pass-thru income. Taxpayers receiving income as pass-thru from another source (Schedule C, Schedule E, a partnership, or an S-Corp) are entitled to deduct 20% of that income before figuring their taxes. Of all the parts of this new tax law this is the topic on which I’ve read the most, but understand the least. Along with phase outs for the deduction, there are also multiple ways to calculate it. Strategizing on this new tax break situation is also going to depend heavily on the IRS implementation rules – which we will not see for months. For now the best I can tell you is the deduction is there, I think it will be helpful in reducing taxes for some people, and I am waiting for additional information before I recommend a strategy to capitalize on this new tax provision.

That’s where I am going to stop. It’s already a lot to process, and I am just scratching the surface of the tax law changes. The actual document is 1097 pages long, so it will take a lot of smart people a long time to fully digest it.

Fortunately, we have a year to ease into the changes. If new strategies arise during the year you can expect to hear from me. If you have questions, please contact me or ask during your tax prep appointment. I look forward to seeing you this year!

 

 

17 December 2017

Virginia Beach Tax Preparation ChaosTax reform is in the news lately, and I have fielded more than a few questions about the anticipated impacts of the current proposals. I usually try to side-step the question. While I spend a lot of time analyzing tax laws I try not to spend too much time analyzing tax bills. I can’t predict what our government is going to do, and I don’t find a lot of value in trying to figure it out in advance. Hopefully you aren’t too distressed by that. If you are, look at it this way - if I could accurately predict what the government was going to do with tax laws and how that would impact each individual tax situation, you could not afford me.

I will make one observation on the flurry of activity coming out of the beltway, however; I believe we are about to see increased chaos at the state income tax level. Here’s why:
There are two bills floating around, one passed by the House and the other by the Senate. Our legislators are reportedly working to reconcile the differences between the two bills, so they can get something for the President to sign into law. Both bills contain the following provisions:

Standard deduction nearly doubles
• Personal exemptions are eliminated

Unless the states scramble to change their own laws, both of those changes at the federal level will have significant impacts on state income tax returns. Let’s look at the impacts they would have on a Virginia income tax return. If you’re in another state, you may be able to use this discussion to determine if it will apply to your state’s income taxes as well.

Virginia is what we call a ‘conformity state’, meaning many of the tax laws in Virginia conform to federal tax law. The first line on a Virginia income tax return is “Federal AGI”, which is line 38 from your federal form 1040. That means that everything the federal government counted as income, and everything the federal government counted as an adjustment to income is embedded in the first line of your Virginia income tax return. There may be subsequent additions or subtractions to your federal adjusted gross income to calculate your Virginia adjusted gross income, but they start from the same point because Virginia conforms to federal tax law unless the Virginia code expressly stipulates otherwise.

Let’s look at the personal exemptions issue. Virginia currently allows you to take a $930 personal exemption for each person listed on your tax return - you, your spouse, and your dependents. The Virginia definition of ‘dependent’ (for tax purposes) conforms to the federal definition of dependent. If the federal personal exemptions go away, how and where are dependents going to be defined for Virginia tax purposes? If you don’t need to enter dependent information for your federal return, is Turbo Tax going to ask you for that information for your state return? Will personal exemptions on Virginia tax returns also need to be eliminated if the federal personal exemptions are eliminated?

To compensate for the loss of personal exemptions, the federal bills double the standard deduction. There is no bill pending in Virginia to double the standard deduction. If the Virginia personal exemption goes away, Virginia taxable income goes up.

Under Virginia law, if you claim the standard deduction on your federal return, you must claim the standard deduction on your Virginia return. If you itemize deductions on the federal return you must itemize deductions on your Virginia return. With the doubling of the federal standard deduction, many more taxpayers will elect to use the standard deduction on their federal return. That means they will be forced to use the standard deduction on their Virginia return.

The Virginia standard deduction is $3,000 for single filers and $6,000 for married couples filing jointly. Not much. In this situation, it might be better for someone to use the federal standard deduction on the federal return, but significantly better to itemize deductions on their Virginia tax return. This puts taxpayers in the position of needing to figure their taxes both ways (using the standard and itemized deductions) to determine which gives the best overall result. Is it best for your wallet to pay a high federal tax bill and a low Virginia tax bill, OR is it better for your wallet to pay a low federal tax bill and a high Virginia tax bill. Good luck getting Turbo Tax to help you through that. (I’m not trying to knock TT, but they would literally have to program the software to calculate this using the tax laws in the 43 states that have an income tax. That’s a tall order.)

One of the stated intentions of tax reform is to simplify filing for Americans. I don’t see that happening in the short term if you are required to file a state income tax return. State legislators will undoubtedly move to adjust their state tax laws once the federal tax law is settled. That strikes me as something that will likely take a few years to sort out. That means we are likely looking at a few years of changes before things settle down again and people know the most advantageous way to file.

If greater income tax simplicity becomes a reality down the road, then it may be worth the temporary increase in chaos, but I think temporary increase in chaos is inevitable with this iteration of tax reform. There are too many moving parts and interactions between Virginia law and federal law, and the impact to state returns does not seem to have been fully analyzed.

I am not advocating for or against the federal income tax proposals currently making headlines. I just wanted to point out that tax simplification is not a simple process. All tax software, including my rather expensive professional version, starts with the federal tax return and then uses the data from the federal return to populate the state tax return. If there is a disconnect between federal and state law I expect to see more people in my office this year who have completed and filed their federal tax return, but need help with their state return(s). Hopefully I am wrong. Time will tell.

If you need help with your taxes, please contact me.

 

 

Disclaimer

Information in the Tax Blog is current as of the day it was posted. Tax laws change frequently, and it is likely that as time passes acts of Government will make some of the older blog content out of date.

The information provided is for education purposes only. It is general in nature and may not pertain to the Reader's situation. Every taxpayer's circumstances are unique. Reader's are urged to do some research or talk to a tax professional before acting on any of the information posted in this blog.

Paul D. Allen is a proud member of the National Association of Enrolled Agents, the National Association of Tax Professionals the Financial Planning Association of Hampton Roads, the National Association of Personal Financial Advisors (NAPFA), and The Tidewater Real Estate Investors Group. You can read more about Paul's background here.

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Common Acronyms

ACTC - Additional Child Tax Credit

AGI - Adjusted Gross Income

AMT - Alternative Minimum Tax

APTC - Advanced Premium Tax Credit

AOC - American Opportunity Credit

CTC- Child Tax Credit

EIC - Earned Income Credit

HoH - Head of Household

LLC - Lifetime Learning Credit

MFJ - Married Filing Jointly

MFS - Married Filing Separately

MAGI - Modified Adjusted Gross Income

PIM - Plan of Intended Movement

PTC - Premium Tax Credit

QC - Qualifying Child

QHEE - Qualifying Higher Education Expenses

QR - Qualifying Relative

QW - Qualifying Widow(er)

 

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