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.

01 October 2017

IRS Form 1040 (the individual tax return) can be monstrous to understand if you try to take it in all at once. That’s how most people do it, though. Once a year they look at their entire tax return, get confused and frustrated, and then ignore it for another year.

It’s important for your overall financial well-being to understand your taxes, so let’s look at just a piece of the tax return today. A small bite we can comprehend in one sitting. Specifically, we are looking at the section at the beginning of the form where all your income is listed. Even more specifically, we are going to look at the income line items that are split into segment a and segment b.

Virginia Beach Tax Preparation Form 1040 Income

If you use tax software to prepare your taxes you might not have noticed some of the income categories are split into two parts. It is much more apparent if you look at the form 1040 income section.
• Line 8a is for taxable interest and line 8b is for tax-exempt interest.
• Line 9a is for ordinary dividends and line 9b is for qualified dividends.
• Line 15a is for IRA distributions and line 15b is for the taxable amount of the IRA distribution.
• Line 16a is for pensions and annuities, and line 16b is for the taxable portion of the distribution.
• Line 20a is for your Social Security benefits received, and line 20b is for the taxable amount of your Social Security benefits.

If It’s Tax-Exempt, Why Do I have to List It on My Tax Return?

The answer to that (very reasonable) question varies with the source of the income. Get comfortable while I explain it to you.

Line 8 Interest Income. Interest income typically comes from the interest on your bank accounts, or from owning bonds. Some interest, such as the interest on municipal bonds (bonds issued by city and state governments to raise revenue), is not taxed by the federal government. If you have interest income over $10 you should be issued a 1099-INT from the institution holding your account(s). The 1099-INT will tell you how much of your interest is taxable and how much in tax-exempt. The reason you must report tax-exempt interest is it might influence your tax situation, even if it isn’t being taxed directly. (Such as when figuring how much of your Social Security is taxable. More on that later.)

Line 9 Dividend Income. Dividends are paid by stocks and mutual funds. Virtually all dividends are known as Ordinary dividends. This amount goes on line 9a. Dividends paid more than 60 days before or after the stock was purchased are known as Qualified dividends. Qualified dividends receive preferential tax treatment – they are taxed at a lower rate than ordinary income. You are being rewarded for assuming the risk of holding the stock for at least 60 days and not just buying right before the dividend is paid and selling right after it is paid. Qualified dividends are a subset of ordinary dividends. The portion of your dividends that are not qualified will be taxed at ordinary tax rates.

Line 15 IRA Distributions. When you take money out of your IRA it is known as a distribution. Your distribution may or may not be taxable. It is usually, but not always, easy to figure out how much of your IRA distribution is taxable. If it came from a Roth IRA, then none of it is taxable. If it came from a traditional IRA where all the contributions were tax deductible, then all the distribution is taxable. Where it gets tricky is when a taxpayer has made contributions to a traditional IRA and did not receive a tax deduction for it. In that case the withdrawal of the contribution is not taxed, but the withdrawal of the earnings is taxable. If you made non-deductible contributions to an IRA you should have been tracking these contributions on form 8606. Dig up your last form 8606 and it should tell you your total IRA contributions, and how much was deducted when the contributions were made.

Line 16 Pensions and Annuities. This is similar to the situation for IRA distributions. If you are receiving a pension or annuity that you paid for, then the portion of your pension that represents your contribution is not taxable. The portion you did not pay for is taxable. My Navy pension is 100% taxable because I did not pay into a pension fund to earn that pension. Federal civilian employees earning a pension under the Federal Employee Retirement System (FERS) are paying into the pension fund. When they receive a payment from the pension fund the portion of that payment that is a return of their contribution is not taxable.

Line 20 Social Security Benefits. One of the most difficult questions clients ask me is how the taxable portion of their Social Security benefits is calculated. There is no simple way to explain it. There are 4 different worksheets used to figure the taxable portion of your Social Security, and you use the one specific to your situation. The shortest answer is that the more income you have from NON-Social Security sources, the more your Social Security benefits will be taxed. 

The Reader’s Digest condensed version goes like this: For 2016, if the total of half your Social Security plus all your other income was greater than $34,000 ($44,000 if married filing jointly), then 85% of your Social Security is exposed to tax. All your other income includes your tax-exempt interest. So even though your tax-exempt interest is not directly taxable, it can make more of your Social Security taxable (which is why you have to report your tax-exempt interest, as explained above).

If your only source of income is Social Security, then your Social Security benefits will not be taxed. Unless you are married filing separately and you lived with your spouse for even 1 day. In that case 85% of your Social Security is taxable regardless of your other sources of income. (I think I mentioned that figuring the taxable portion of social security is frightfully complex.)

Congratulations for making it through that article. It was a bit of a slog to write, so it was undoubtedly a slog to read as well. Your commitment to learning about taxes should be rewarded. The first person to tell me they read this entire article will get 50% off their next tax preparation bill at PIM Tax Services. If you have questions, please contact me.



26 September 2017

Note:A tax conference and a vacation interrupted my blogging for a few weeks. Happy to be getting back on track. The conference gave me dozens of article ideas!

virginia beach tax prep pay the IRSEveryone I know has had a bill they couldn’t pay at some point during their life. Sometimes it’s due to a work interruption. Sometimes it’s a wake-up call to get a grip on your budget. Sometimes it’s caused by circumstances beyond your control. Whatever the reason, most of us have ‘been there and done that’.

When Tade and I were just starting out together it seemed like we never had enough money. We were living pretty well while we were dating, but then she quit her good-paying job to follow this sailor around the country and we got behind in a hurry. There were many months when I had to decide which of our creditors wasn’t going to get paid. I never pre-coordinated any of this with them, of course. I was too proud and embarrassed to tell them they weren’t getting paid. I would just not send them a payment and then catch it up whenever I could. It isn’t the best way to approach this situation, but it worked out OK.

This worked because my creditors were credit card companies and utilities. Can you handle a tax debt in this same manner – bobbing and weaving, dodging bills some months and sending some money the next? What do you do when it’s the IRS you can’t pay? You figure your taxes for the year and you discover you owe an amount you cannot pay? Do you treat the IRS like any other creditor – just sort of ignore and avoid them until you can afford to make it up later?


The IRS is NOT just any creditor. The IRS is the most potent creditor on the planet. Congress has granted them collection superpowers. Your credit card company has to prove to a judge that you owe them money before they can put a lien on your property. The IRS does not. If the IRS says you owe them money, they are presumed to be correct. They can levy your bank account, garnish your wages, and put a lien on your property without going through the courts. Fortunately, it is easy to avoid these harsh measures by staying as compliant with the tax laws as possible, even if you can’t afford to pay your entire tax bill.

What to Do If You Can’t Pay Your Taxes

1. File your tax return. The IRS can charge penalties for failing to file your tax return, and those penalties are initially TEN TIMES HIGHER than the penalties for failing to pay your taxes. 5% of the tax owed per month up to 25% of the total tax can be charged for failing to file your tax return. Failing to pay your taxes is only a 0.5% penalty per month. Trying to hide from the IRS by avoiding filing your tax return will end up costing you more in the long run.

2. Pay as much as you can at the time you file. I see news stories from time to time about the IRS confiscating someone’s home or bank account, shuttering their business, or some other draconian method of enforcing a tax bill. The press does a good job of making the IRS look like a bunch of power-drunk cowboys, but this is rarely the case. The IRS will work with you to get your tax bill paid with the minimum disruption possible to your life, but you have to make some effort to cooperate. Paying part of your tax bill when you file demonstrates your intent to be cooperative.

3. Apply for an installment agreement. The IRS can authorize a payment plan (installment agreement) for paying your tax bill. There is an application fee and you will be charged interest until the balance is paid in full, but it allows the taxpayer some breathing space to pay down the tax bill over time. The application fee varies by how you file the application and how you intend to pay. Paper applications cost $225, or $107 if you agree to make the payments via direct debit of your bank account. Online applications are $149, but only $31 if you agree to pay via direct debit. If your tax bill is over $50,000 you cannot apply online. Your request for an installment agreement cannot be denied if:

a. You owe less than $10,000
b. You propose to pay it back within 3 years
c. You are not delinquent on any other tax year
d. You do not already have an installment agreement for another tax year
e. All your tax returns have been filed

4. Make your payments. If you default on the installment plan the IRS can elect to call the entire debt. If you are having difficulty making the payments you may be able to restructure your installment agreement to reduce the amount of your monthly payments. The IRS charges $89 for restructuring an installment agreement. (They charge the same amount to reinstate and agreement if you let it lapse, so you may as well as for restructuring.)

5. Offer in Compromise. The IRS must collect taxes owed within ten years from the time the tax return assessing the tax is filed. If there is no way for you to be able to pay your tax bill within this time frame you can request an offer in compromise. An offer in compromise is a negotiation between you and the IRS to reduce the tax you owe to an amount you can afford to pay. Essentially, you present the IRS with an amount you are able to pay, and they will determine whether to accept or reject your offer. The IRS will evaluate your ability to pay by analyzing your financial status; your assets, income, and expenses. If the amount you offer to pay represents the most the IRS believes they can collect from you within a reasonable time period they can approve your offer.

Death and taxes are certain. If you can’t pay your tax bill don’t try to hide from the IRS. Be proactive and engage with the IRS. Things will often go better for you if you do. If that seems too stressful or too much bother, hire someone to represent you. You will most likely be happy you did. If you have any questions, please contact me.



19 August 2017

Virginia Beach Tax Preparation Military Tax 800x538Active duty military members and reservists from the same branch of the service look and act similarly. They wear the same uniforms, attend the same schools, get the same basic training, have the same grooming standards, etc. It can be hard to tell them apart.

Until you gave me their tax returns. I could probably tell them apart in just a few seconds by looking at their tax returns. Active duty and reserve military personnel are treated very differently by some aspects of our tax code. Nowhere is this more pronounced than in the tax treatment of travel related expenses.

I was active duty Navy for nearly 24 years, and during that time I never paid for any of the travel associated with my job. From my first day until my retirement day, if the Navy wanted to send me somewhere they paid for my tickets and lodging and gave me money for meals. I never even had to think twice about it. Little did I know my brothers and sisters in the reserves did not always have it so good. When they need to travel for training or drill they often must pay for that travel out of their own pockets.

That puts reservists in the position of having unreimbursed employee business expenses. Those expenses are deductible on their tax return, but there are two pre-conditions associated with deducting employee-related business expenses:

1. You must itemize your deductions in order to claim them
2. The unreimbursed employee business expenses must exceed 2% of your adjusted gross income (AGI) before they start to count

Those conditions make difficult obstacles for most reservists to be able to claim the tax deduction for their travel expenses. Many young reservists don’t yet own a home, so it is more advantageous to them to claim the standard deduction than to itemize their deductions. Conversely, many older reservists have climbed the private sector ladder to decent salaries, meaning the 2% over adjusted gross income threshold would have them paying quite a lot out of pocket for their travel before receiving any benefits from deducting their unreimbursed employee business expenses.

That’s Why There Are Separate Rules for Military Reservists

Fortunately, Congress carved out a loophole for reservists to bypass the pre-conditions mentioned above. Travel expenses for reservists can take a ‘shortcut’ to the front of the form 1040 individual income tax return, allowing reservists to receive a tax benefit for their travel related expenses without having to itemize or worry about that 2% of AGI threshold.

There is one little hitch, though – that ‘shortcut’ can only be used for travel that takes you more than 100 miles from your home.

There’s a paragraph in IRS Pub 3 on page 9 that explains how this shortcut works. It is so confusingly worded I was tempted to reprint it here just for comedic value. I’m a tax professional and I had to read it 4 times before I understood it. Let me attempt to explain it in terms I hope will be easier to understand.

If you are a reservist, you report ALL your unreimbursed travel expenses (those go on form 2106) just like everyone else. However, if you had a mix of short (less than 100 miles) travel and long (more than 100 miles) you must be able to figure these separately. You add all your travel expenses together on form 2106, then the expenses for travel over 100 miles are carried over to form 1040 line 24. The expenses for the short travel are carried to Schedule A.

Schedule A is for listing your itemized deductions. If you do not itemize your deductions you won’t have a schedule A, and your travel expenses for trips less than 100 miles are not going to get deducted even if they are clearly related to your employment as a reservist.

If you do itemize, the total of your unreimbursed employee business expenses will need to exceed 2% of your adjusted gross income before they start to count as deductions.

The portion of your reservist travel expenses that moved straight to line 24 on your form 1040 goes to work right away. That’s the section of the tax return for special deductions known as adjustments. Like deductions, adjustments reduce the amount of your income exposed to taxation. Adjustments also have two big advantages over regular deductions:

1. You can use them even if you use the standard deduction. You don’t need to itemize your deductions in order to use an adjustment. 
2. They are deducted from income before your AGI is calculated. This is an important benefit because eligibility for many other deductions and tax credits are based on your AGI. An adjustment can help make you eligible for additional tax breaks.

A Real Example From My Practice

“John and Rita” were new clients of mine this year. They moved to Virginia Beach from the DC area during 2016. John is a Navy reservist who drills with a reserve unit down in Texas. They brought their 2015 tax return with them when they dropped off their 2016 tax documents. While reviewing their 2015 return I noticed that all of John’s travel was documented on form 2106, but it was all carried to Schedule A as an itemized deduction. None of it made it to the front of their form 1040. After talking to John and Rita I determined all $6,000 of John’s travel expenses were related to travel more than 100 miles from home, and qualified for the special reservist rules.

John and Rita’s 2015 AGI was about $145,000, so 2% of their AGI was $2,900. Moving the reservist travel expenses to their correct location on the tax form lowered their 2015 taxable income by $2,900. As they were in the 25% top marginal rate, this lowered their tax bill by $725. But wait, there’s more!

John and Rita had a son in college in 2015. They claimed the American Opportunity Tax Credit, but their AGI at $145,000 reduced the amount of the credit they could claim. By moving the $6,000 in travel expenses to the front of form 1040 we reduced their AGI from $145,000 to $139,000. This increased the value of their American Opportunity Credit by more than $500. When combined with the $725 in lower taxes from the reduced taxable income, John and Rita shaved nearly $1,250 off their 2015 taxes by using the full value of the reservist travel expense deduction. We filed an amended 2015 tax return and the IRS sent John and Rita a refund.

If you are a reservist make sure you are getting the proper tax deduction for your travel, and make doubly sure your expenses for reservist-related travel over 100 miles are showing up on the front page of your form 1040. It can make a significant difference when figuring your tax bill.

If you have any questions, please contact me.



13 August 2017

Virginia beach tax preparation 401K loansI am a big fan of employer-sponsored retirement plans (401K, 403B, TSP, etc.). They are a great way to save for your retirement. You can take a current year tax break for the money you save (traditional) or you can take your tax break in the future (Roth). Whether you should choose traditional or Roth is usually a combination of personal preference and your current circumstances, but either provides advantages over saving in a non-qualified account.

Most employer-sponsored retirement plans have some provision for the employee to take out a loan. The theory is you are in a financial bind and need temporary access to your money. You borrow it from your retirement account and then pay it back over a period of time – typically with a payroll deduction. I am not such a big fan of these loans. I suppose it is good to be able to access the money in the event of an emergency, but all too often I find people are using them for situations that are not emergencies. This degrades the account’s primary purpose of retirement savings. Even though the amount borrowed must be paid back, money taken from the account as a loan loses some very valuable compound growth potential. Borrowing the money now nearly guarantees having less money in retirement.

The rules on 401K loans are also very strict. You could even call them draconian. (I have Game of Thrones fever as I am writing this!) 401K loans are governed by both the Department of Labor and the IRS, and neither is very forgiving as government agencies go. The money borrowed has to be repaid in relatively equal increments over the period of the loan. If a payment is missed it must be made up within a fixed “cure” period. If just one loan payment falls outside the cure period the entire loan is considered to be in default and is no longer a loan. It is now a distribution (withdrawal) from the retirement account – and all applicable taxes and penalties will apply.

If you have taken, or are considering taking, a loan against your 401K, you need to be very careful. You will be held accountable for the loan payments even if it isn’t your fault the loan payment isn’t made. Just ask Mrs. F from New York.

Mrs. F and Her 401K Loan

Mrs. F worked for 'Company G'. She was a participant in Company G’s 401K plan, which was administered by 'MOA'. In 2012 Mrs. F arranged for 12 weeks of maternity leave from Company G. She had enough leave time accrued to be paid for the first 5 weeks, but the last 7 weeks would be without pay. Just prior to her maternity leave she also took a loan from her 401K. She arranged to repay the loan by having money withheld from her Company G paychecks over the period of the loan.

Mrs. F went on maternity leave. Someone in Company G payroll neglected to set up the withholding for the 401K loan repayment from Mrs. F’s pay. While on leave Mrs. F received her paychecks via direct deposit, but did not notice the loan repayment amount was NOT being withheld. She did not notice the loan payments were not being withheld until after she returned to work following her maternity leave. At that time she made a triple-sized payment followed by several over-sized payments until the amount repaid was caught up to the amount that should have been withheld from the beginning. Once caught up she continued repaying the loan through payroll withholding per the loan agreement.

It was too late. When she missed the initial payment, and did not make it up during the cure period, MOA declared the loan in default. Unfortunately, they didn't tell Mrs. F. In January 2012, they issued Mrs. F a 1099-R, but didn’t mail it to her. They posted an electronic version to their website. Mrs. F did not routinely check the MOA website, so she was unaware the 1099-R had been issued. In fact, she continued to repay the loan into 2014 – and MOA continued to receive the payments without telling her the loan had defaulted and she was not required to repay it.

In 2014 the IRS notified Mrs. F she had not declared all her income from 2012. They charged her taxes on the amount of the defaulted loan from her 401K, a 10% penalty for early withdrawal, interest on the above, and a 20% accuracy penalty for negligence. Mrs. F petitioned the US Tax Court for relief.

Things did not go well for Mrs. F at Tax Court. The judge ruled it was her responsibility to ensure the payments were made before the cure period expired, and she did not. Therefore the tax, 10% penalty, and interest must be paid. It didn’t matter that Company G screwed up on the withholding for the loan repayment. It didn’t matter that MOA never made sure she knew her loan had defaulted. It was her responsibility and she did not follow through.

Fortunately for Mrs. F, the judge found there was a reasonable basis for Mrs. F to believe she did not owe tax on her loan. Therefore, he removed the 20% accuracy-related penalty for negligence.

In my opinion Mrs. F got a raw deal. She was at home birthing a baby. I think it is a reasonable expectation on her part to assume her employer is going to get the pay withholding correct and the 401K administrator would make a little effort to ensure she knew the payment was late. It was their negligence, not hers, that caused this situation. Perhaps she can get some restitution from Company G or MOA via other legal channels.

But the rest of us should learn a valuable lesson from Mrs. F’s experience. 401K loans come with tax rules attached.The IRS is unforgiving. Tax rules are tax rules – and it is the responsibility of every taxpayer to ensure they are compliant with those rules. Failure to do so can have expensive consequences.

If you have questions about taking a 401K loan, please contact me.


30 July 2017

Virginia beach tax prep military homecomingMilitary personnel who pay taxes in Virginia often overlook a very helpful tax benefit afforded by the Virginia tax code. It is called the Military Basic Pay Subtraction. It doesn’t apply to everyone, but thanks to a ruling by the Virginia Tax Commissioner, it applies to a much larger segment of the military population than is commonly thought.

As a guy who prepares a lot of tax returns every year I appreciate that Virginia closely follows the federal model for computing adjusted gross income (AGI). To get to your Virginia adjusted gross income you start with your federal adjusted gross income and then apply a handful of Virginia-specific rules for adding to or subtracting from the federal AGI to determine your Virginia AGI. I like that Virginia uses the term ‘subtractions’ to identify the things that can be subtracted from your federal AGI. Nice, simple, clean language. So rare in the tax business!

The Subtraction’s the Thing

One of the subtractions you can apply under Virginia’s tax laws is the Military Basic Pay Subtraction. Using this subtraction, military personnel can subtract up to $15,000 of their basic pay received during the taxable year, provided they were on active duty for more than 90 consecutive days.

Note that “up to $15,000” part. You only get the full $15,000 if you made exactly $15,000 in basic pay. Here’s why – you can subtract every dollar of basic pay you earn up to $15,000, but once you go over $15,000 you reduce the maximum subtraction by a dollar for every dollar you are over $15,000. In other words, if you earn $15,001 of basic pay, you get a $14,999 subtraction on your Virginia tax return. If you earned $20,000 of basic pay, you get a $10,000 subtraction. At $30,000 the benefit of the subtraction is completely gone.

virginia beach tax preparation military basic pay subtraction

Looking at the military basic pay charts for 2017 it appears only very junior enlisted personnel earn less than $30,000 per year in basic pay. This limits this Virginia tax benefit to a small (although highly deserving) portion of the military population if they are on active duty and collecting basic pay for the entire year.

Fortunately, the law does not stipulate that you have to earn basic pay for the entire year. This opens up the potential for a benefit to people who enter active duty during the year, people who leave active duty during the year, and reservists. Let’s look at some examples:

1. Master Chief Grit (a Virginia resident) retires at the end of February 2017. He earned $14,230 of military basic pay in 2017. All $14,230 could be subtracted on his Virginia income tax return.

2. Master Chief Grit and his spouse, Chief Grit, (both Virginia residents) both retire at the end of February 2017. Master Chief Grit earned $14,230 of military basic pay in 2017. Chief Grit earned $9,133 of military basic pay in 2017. Even if they jointly file their 2017 Virginia income tax return they can subtract all $23,363 of their combined military basic pay. Virginia allows each spouse to qualify for (and claim) the subtraction separately on joint returns.

3. Sergeant Hammer (a Virginia resident) decides to return to the Marine Corps after several years as a civilian. He goes back on active duty on 01 July 2017. From July – December he earns $19,282 in military basic pay. He can subtract $10,718 ($15,000 – ($19,282 - $15,000)) from his 2017 Virginia income tax return.

4. Captain Junker (a Virginia resident) is a USAFR officer who does a six month tour of active duty from September 1, 2016 until March 1, 2017. In January and February 2017, he earns $11,882, all of which can be subtracted from his 2017 Virginia income tax return. (He may have also qualified for a Military Basic Pay Subtraction in 2016.)

Something important to note in that last example is that Captain Junker was not on active duty for 90 consecutive days in 2017, but he still qualifies for the subtraction. The Virginia Tax Commissioner ruled last year that the 90 consecutive days of active duty time can cross over multiple tax years and the taxpayer will still qualify for the Military Basic Pay Subtraction in an individual tax year.

It’s a nifty way to lower your Virginia taxes if you qualify to use it, but there are a few additional rules to be aware of:

1. Do not confuse this with the Virginia subtraction for Virginia National Guard Income – it is not the same subtraction.
2. You can’t use this subtraction on income that is already not taxable – such as if your income was not subject to taxation because of the combat zone tax exclusion.
3. If you claim this subtraction you cannot also claim the Virginia Credit for Low-Income Individuals or the Virginia Earned Income Credit.
4. You do not need to be stationed inside Virginia to claim this subtraction.

The Wrong Way to Apply This Subtraction

I will sometimes see this subtraction incorrectly used by someone to remove a military member’s income from a jointly filed Virginia tax return because the spouse is required to file in Virginia, but the military member is not. They file their federal return jointly, and their software automatically prepares a joint Virginia return with both spouses on it. They realize the military member’s salary is not taxable in Virginia, so they use the military basic pay subtraction to remove it from the joint Virginia return. That’s not the right way to file, and will likely get you some letters from Virginia asking you for more money.

If one spouse has to file in Virginia, but the other does not, the correct method is to create a married filing separately return for Virginia and only include the income and deductions for the spouse required to file. I think by the time people get to that point in the tax prep process they are getting a little anxious to wrap it up and start looking for short cuts. Don’t try that one, though. Virginia will ‘fix it’ by adding the military member’s income back into the return and sending you a bill for the taxes on it. Then you end up paying someone like me to fix it for you.

If you are filing your own Virginia tax return, use code 38 when claiming the Military Basic Pay Subtraction. If you have any questions, please contact me!



23 July 2017

Omer FriedaI was very fortunate to have grandparents until I was 50. My grandparents were hard-working, stayed healthy, and lived long lives. By the end, however, my grandfather’s legs were not working very well and he was falling frequently. He had lived in his house for more than 60 years. The family knew he was most comfortable there and would have preferred to spend his final months there. We tried, probably for too long, to make staying in his home work. In the end the halls and doors were just too narrow to accommodate walkers or wheelchairs. The tub and shower were not safe enough. No one could bear picking him up again. We were forced to move him into a nursing home.

This is the kind of heartbreak millions of families are currently dealing with. Not only can it be heartbreaking, it can be wallet-breaking as well. Those nursing homes aren’t cheap. It cost more than twice as much for my grandfather’s nursing home care than it cost to bring someone in every day to help care for him in his own home. It was literally costing more for him to be in a place he liked less. It’s the kind of thing that makes you shake your head in disbelief.

A solution may have been to make his home safer and more accommodating for him to stay in. If his doors could have been widened for wheelchair access, and his bathroom remodeled with a safer tub and some grab bars, perhaps he could have stayed in his own home until the end. He was on a tight budget, though, so coming up with the money to make those home improvements would have been a challenge.

Residents of Virginia have access to a program my grandfather in Ohio didn’t have. A tax credit that can help make houses more livable for seasoned citizens. The Commonwealth has implemented the Livable Homes Tax Credit. This tax credit is designed to improve the accessibility and “universal visitability” in Virginia’s residential units. The credit is for up to $5,000 and can be used to either purchase a new place to live or to pay 50% of the cost (up to $5,000) to retrofit your current residence.

You Can’t Just Claim the Credit. Pre-Approval is Required.

Virginia’s legislature got a little fancy with this program, so don’t just retrofit your home and then try to claim the credit when you file your Virginia income tax return. You must be pre-approved by Virginia’s Department of Housing and Community Development. Essentially, the Department of Housing and Community Development has been given authority to grant this tax credit, so unless your retrofitting project meets with their approval, you won’t be able to claim the credit from the Department of Taxation.

It’s a government program involving tax credits, so the rules are complex. I’m going to hit the highlights on how to get approval, but if you’re interested in pursuing this I encourage you to do your own research into the nuances of the program.

For your retrofit of an existing residence to qualify you must have installed at least one of the following:
• Accessible route to a zero-step entrance to a residence (i.e. a wheelchair ramp)
• Zero-step entrance to the residence
• 32-inch-wide doorways
• 36-inch wide hallways
• Accessible light switches, electrical outlets, or climate controls
• Accessible bathroom
• Accessible kitchen
• Lift/elevator
• Sensory modification (i.e. timer on stove with flashing light for hearing impaired)

Additionally, your modifications must meet existing government standards for utility of the accessibility feature. (Think ‘Americans with Disabilities Act’ compliant)

You complete the application available on the Department of Housing and Community Development website. You must include copies of purchase contracts, invoices, cancelled checks, construction contracts, and proof that the person applying for the tax credit actually paid for the retrofitting work. You send all your documentation to the Department of Housing and Community Development not later than 28 February of the year after the construction/retrofitting was completed. You will be notified by 01 April if your Livable Homes Tax Credit is approved. If it is, you can file for the credit on your Virginia income tax return.

If your Livable Homes Tax Credit is larger than your tax owed to Virginia you can carry over any unused portion of the credit for up to seven years.

I don’t want to get too schmaltzy, but I hope as many Virginians as possible take advantage of this tax credit. My Grandfather was from The Greatest Generation of Americans. When his country called, he kissed his pregnant bride goodbye and sailed across the Atlantic Ocean to liberate Europe with Patton’s Third Army. He came home in 1946 and introduced himself to the daughter he had not yet met – my mother. He raised his family, worked hard, went to church, paid his taxes, and was as extraordinary as all the other parents and grandparents out there. All of whom deserve to leave this world in the quiet comfort of their own homes if that is what they want. Hopefully this Virginia tax credit will make it possible for a few more of them to live out their days as they choose. If you have any questions about how to apply for this tax credit, please contact me.



15 July 2017

Virginia beach tax preparation accidental Virginia resident militaryThere is a provision in the Servicemembers Civil Relief Act (SCRA) that creates a nice loophole allowing many military personnel to avoid paying state income taxes. The provision wasn’t placed in the SCRA for the purpose of creating a tax loophole. It was put there to prohibit the states from taxing the incomes (and personal property) of military personnel who are living in the state only to comply with military orders. However, many military servicemembers are using this provision to avoid paying any state income taxes. Congress added a paragraph to the SCRA in 2009 that extended this same benefit to qualifying military spouses.

I don’t refer to it as a “loophole” to imply that people who use this provision are being sneaky or dishonest. This is a completely legal and legitimate tax maneuver. I used this tactic when I was in the Navy, and I encourage military personnel (and their spouses) to use it whenever possible. In fact, the point of this article is make sure no one inadvertently disqualifies themselves from being able to use it!

How It Works:

Here is what the first 2 paragraphs of SCRA (Section 571) say:

(1) In general. A servicemember shall neither lose nor acquire a residence or domicile for purposes of taxation with respect to the person, personal property, or income of the servicemember by reason of being absent or present in any tax jurisdiction of the United States solely in compliance with military orders.
(2) Spouses. A spouse of a servicemember shall neither lose nor acquire a residence or domicile for purposes of taxation with respect to the person, personal property, or income of the spouse by reason of being absent or present in any tax jurisdiction of the United States solely to be with the servicemember in compliance with the servicemember’s military orders if the residence or domicile, as the case may be, is the same for the servicemember and the spouse.

In short, if you are in the military and under orders to work in another state (not your home state), that state can’t make you pay taxes there just because you are present in their state. The same goes for the spouse, if the spouse is a resident of the same state as the servicemember.

I think these are fair and reasonable protections to afford military families. They work hard, move often, and sacrifice much. It is not unreasonable to allow them to maintain their tax home in the location of their choice.

Here’s the Loophole: It doesn’t prevent the servicemember from establishing residency in a state where the tax laws are advantageous – such as in a state without a state income tax. So, that is exactly what I did...

I enlisted in the Navy in 1987 from my home state of Ohio. Under the SCRA I retained my status as an Ohio resident even though the Navy had relocated me to Florida. At that time Ohio was taxing the incomes of military personnel who claimed status as Ohio residents. It didn’t take me long to figure out that Florida had no income tax and it would benefit my wallet to become a Florida resident. I marched my Buckeye behind down to the Duval County Courthouse and declared Florida as my legal domicile. Then I took the certificates they gave me to my personnel office and they changed me over to Florida for pay purposes. Despite multiple moves, I retained my status as a Florida resident throughout my Navy career.

SCRA Protections are Limited.

Many servicemembers falsely believe the SCRA gives them total immunity from the taxing authority of the states in which they live and serve. This is simply not true. What the SCRA says is that the state can’t consider them a resident for tax purposes solely because they are stationed/posted there under military orders. This presumes the servicemember intends to return to their state of legal residence after their military career. If the servicemember (or spouse) takes other actions indicating they intend to stay in the new state, then that state can legally consider them a resident even if they are still serving in the military.

Let’s look specifically at Virginia.

Virginia uses the term domicile. Under Virginia tax law your domicile is the place where you permanently live, even if you are currently not residing at your domicile. It is the place you intend to return to at some point in the future. If you are a member of the armed forces and move to Virginia to comply with military orders you are presumed to maintain your legal domicile as indicated in your military records. In this situation, Virginia cannot tax your military income or your personal property.

There are things you could do, however, to change this situation. If you take actions consistent with establishing your domicile in Virginia, then Virginia has the legal right to declare you a resident of Virginia and make your military income subject to Virginia taxes.

While there is no precise formula for establishing a domicile in Virginia, the Tax Commissioner of Virginia has consistently used the following factors to determine whether or not a servicemember has crossed the line and established a Virginia domicile:

1. Obtaining a Virginia Driver’s License. This tends to be a showstopper. The Virginia Code section 46.2-323.1 requires all applicants for a Virginia driver’s license furnish a statement certifying they are a resident of Virginia. Furthermore, members of the armed forces stationed in Virginia are not required to obtain a Virginia driver’s license. Doing so is completely voluntary and shows strong intent to remain in Virginia.
2. Voter Registration. Another showstopper. Federal law requires all states to provide absentee ballots to military members who cannot be present in their home state to vote. To be qualified to vote in Virginia you must be a resident of the precinct in which you vote. Thus, a servicemember registering to vote in Virginia is committing a voluntary act that indicates intent to establish domicile in Virginia.
3. Maintaining Contacts in Your Home State. Do you still own property, have family, a business, registered cars, driver license, and maintain your voting registration in your home state? These indicate continued connections to your home state and intent to return there someday.
4. Other Indicators. Have you purchased property in Virginia, registered your cars in Virginia, or exercised other benefits of being a Virginia resident? These are not showstoppers, but may indicate a pattern of intent to remain in Virginia.

If your intent is to retain your residence in your home state outside Virginia, then you need to make an effort to maintain ties to that state. On the flip side, if you voluntarily make ties to Virginia, then Virginia has the right to claim you have abandoned your previous domicile and established a new domicile in Virginia – making you a Virginia resident subject to Virginia income taxes.

As always, if you have questions, please contact me.

03 July 2017

Tax Court(This could so easily have happened to one of my clients...)

Decisions of the US Tax Court are made available to the public online, and I read them whenever I get a chance. They are a great source of information on how the courts are interpreting the Internal Revenue Code, and I often learn things I can apply to the benefit of my clients.

All Tax Court opinions, memos, and summaries are formatted similarly. They start with a narrative on the pertinent facts of the case, discuss any evidence presented to the court, discuss the pertinent articles of the Internal Revenue Code and any precedents in case law, and then the Judge renders his or her judgment.

This format allows me to make a bit of a learning game out of reading the court documents. I can read the narrative of the case and try to predict how the judge will rule. After dozens of cases I am getting rather good at guessing the outcome, but I read one last week that I missed by a mile.

Taxpayers wind up in Tax Court because they dispute a determination of the IRS. In Tax Court the taxpayer is always The Petitioner – that is, the taxpayer initiates the case against the IRS by petitioning the court to hear their case. The Commissioner of the IRS is The Respondent. This arrangement exists because the IRS has told a taxpayer they owe taxes (and possibly penalties) and the taxpayer disagrees. After exhausting other options to get the IRS to stop trying to impose the taxes, the taxpayer has the right to petition the Tax Court to resolve the dispute.

However, with rare exceptions, the IRS is presumed to have determined the correct amount of tax on the taxpayer. Therefore, the burden is on the taxpayer to prove to the Tax Court the IRS has made a mistake.

In this case, the taxpayer, Mr. Z., was employed as an event organizer for a software company. He made a good wage travelling around setting up conferences and training seminars for his employer. In 2013, he got the idea to start a side business that would hold small film festivals in different college towns. There were a lot of startup costs and the idea was slow to catch on. For tax year 2013 Mr. Z claimed his new business on Schedule C of his individual income tax return, showing gross receipts of $690 and expenses of $32,747.

The IRS audited Mr. Z’s 2013 tax return and disallowed the $32,747 in business expenses because they determined Mr. Z’s activities were better classified as a hobby, not a business. Hobby losses cannot be written off against any income other than hobby income, so Mr. Z’s expenses in excess of $690 were disallowed. Mr. Z petitioned the Tax Court for relief.

After reading the narrative I was convinced Mr. Z had started a business (not a hobby) and would be granted relief from the IRS determination by the Tax Court. So convinced, in fact, that I skipped over the judicial arguments section and went straight to the end of the document to read the ruling. When I discovered Mr. Z had lost his case I scrolled back up to read more and find out how the Judge could come to such a different conclusion.

In the Opinion, Judge Guy lays out 9 points to ponder when determining whether an activity is a business or a hobby. They are:

1) Manner in which the taxpayer carries on the activity
2) Expertise of the taxpayer
3) Time and effort expended by the taxpayer on the activity
4) Expectation assets used in activity will appreciate in value
5) Taxpayer’s success in carrying on similar activities
6) History of income or losses with respect to the activity
7) Amount of occasional profits earned
8) Financial status of the taxpayer
9) Elements of personal pleasure

Judge Guy then goes point-by-point (for a dozen or so paragraphs) in creating a scorecard for Mr. Z with respect to each of these determining factors. (As there were no assets in the business to appreciate, point 4 was not considered.)

Remember, in Tax Court the burden is on the taxpayer to prove the IRS determination is not correct. In this case the IRS determined Mr. Z’s business was a hobby. Therefore, Mr. Z had to provide evidence to support his claim that his activities were a business and not a hobby.

Mr. Z was unable to provide such evidence. Like many of the small business owners I know, he did not keep good records. Judge Guy determined that only the amount of time and effort expended by Mr. Z (point 3) favored classifying the activity as a business. For everything else, there was insufficient evidence available to change the IRS determination the activity was a hobby.

Throughout the Opinion Judge Guy discusses the lack of records, business plans, profit projections, budgets, and the other documents business people are expected to produce when they start a business. Without those documents Mr. Z was unable to demonstrate his activities were those of a business. Without those documents Judge Guy was unable to change the determination of the IRS.

Most of the new business startups I see follow a similar pattern to Mr. Z. They have a good idea and they just want to run with it. The need to properly document their activities is barely considered. They do not generate budgets or business plans, and many are just horrible at keeping records. If the IRS determined their activities were a hobby instead of a business, they would not be able to provide sufficient evidence to get a Tax Court judge to overturn the IRS ruling. They could very easily find themselves in Mr. Z’s shoes, owing additional taxes and penalties years after they thought the matter was settled.

Mr. Z paid $13,028 in additional taxes and penalties for the luxury of not keeping good business records. How much are you willing to pay for that luxury? If your answer is $0, then you need to seriously consider getting professional assistance in establishing your record keeping standards and processes. You may need it to one day prove you are actually running a business.



Virginia Beach Tax Preparation adjusted basis in asset24 June 2017

My cultural reference du jour is a nod to Ms. Meghan Trainor’s very catchy 2014 tune about her backside. Whilst I have always been appreciative of such assets, this article is about appreciating assets of an entirely different nature. We are talking about assets that increase in value (specifically houses), making them taxable, and how you might mitigate or avoid paying the taxes on them altogether.

The first thing we need to do (after we stop with the 'basis' and 'assets' puns) is make sure we are all speaking the same language. I’m going to throw some words around and I want to make sure you know what I mean when I use them. I looked at the dictionary definitions, but I decided to explain these terms in my own words.

Appreciate – In this context appreciate means increase in value. If I say I have an appreciated asset that means I have an asset that is worth more now than when I acquired it.

Asset – that’s a thing I own that has monetary value. My house is an asset. My truck is an asset. My stock and bond funds are assets.

Basis – This is the dollar amount of your investment in the asset. This is often the purchase price of the asset – but not always. Sometimes things happen that adjust (change) your basis in the asset. (This can be confusing and it’s the reason I am writing this article.)

Capital Gain – When you sell an asset for more than you paid for it you have a capital gain.

Capital Gain Taxes - When I sell an asset that has appreciated I have a capital gain. Generally speaking, capital gains are considered income and are subject to income taxes. The tax rate on capital gains depends on the type of asset you own and the length of time you have owned it.

Depreciate – In this context depreciate means to decrease in value. It is the opposite of appreciate.

Fair Market Value (FMV) – The current value of the asset on the open market.

Tax Basis (or Taxable Basis) – This is your investment in the asset for tax purposes. This can be confusing because at times it appears to have nothing to do with the actual amount of your investment or the value of the asset.

Taxable Gain – Generally speaking, taxable gain is (Sale Price – Tax Basis)

Step-up in Basis – When someone dies all their assets are transferred to (inherited by) beneficiaries. The beneficiary’s basis in the inherited asset is the fair market value of the asset on the date the previous owner died. If the asset appreciated since it was acquired by the previous owner, then the beneficiary receives a “step-up in basis”.

Let’s Focus on Residential Real Property (like houses and condos).

As an asset class houses are large and complex. People tend to own them for long periods compared to other asset classes. They also do things with them that can change the tax basis of the asset. If a house owner improves the house (by, say, adding an additional room) s/he can increase their tax basis in the property. If the house owner uses the house in a business s/he can take a business expense for depreciating the property and lower their tax basis in the property.

While far from universal, houses tend to appreciate over time. Selling them generates a capital gain for the homeowner. Fortunately, Congress decided to give us a tax break on our homes. Capital gains up to $250,000 for single filers and $500,000 for couples filing jointly are excludable under section 121 of the tax code if the house is used as a primary residence.

Let’s look at a scenario in which these tax concepts come into play:

John and Mary purchased their house in 1971 for $80,000, and have lived in it ever since (original basis $80,000). They raised their 3 children in that house. In 1992 they spent $20,000 to add a mother-in-law suite so Mary’s elderly mother could move in with them. (Their adjusted basis is now $100,000 because they spent $20,000 to improve the property.)

Mary’s mother passed in 1998. John and Mary paid off the mortgage to the house in 2001 and now own it free and clear. By 2017 John and Mary are elderly and could use some assistance. Their house is now their most valuable asset, valued at $380,000. John and Mary want to stay in their house and would like their daughter Debbie to come over every day to help care for them. To entice Debbie they offer to transfer the house to her name.


There is a significant tax difference between transferring assets while you are alive and transferring them when you are dead. John and Mary’s tax basis in the house is $100,000. If they transfer the house to Debbie while they are still living, John and Mary’s tax basis transfers to Debbie. This house IS NOT Debbie’s primary residence. When she sells it she will have to pay taxes on any capital gain from the sale. If she were to sell the house for $380,000, her taxable gain would be $280,000. Even at the best capital gains tax rate, Debbie may owe somewhere in the neighborhood of $42,000 in taxes from the sale of the house.

If John and Mary want Debbie to receive the greatest possible financial benefit from the house they should keep it in their names and make sure it transfers to Debbie when they both pass. If they do that, when Debbie inherits the property she receives a step-up in basis to the FMV of the property as of the date of the last remaining parent’s death. Let’s assume this was still $380,000. If Mary has a tax basis of $380,000 and sells the property for $380,000, then she has no capital gain (and therefore owes no tax on the sale).

Let's continue with this scenario...

It’s 2020 and the house has appreciated to be worth $400,000. John and Mary have both passed and Debbie inherits the house with a step-up in basis to $400,000. Debbie sells the house to Paul for $400,000. Paul immediately places the house into service as a rental property. The county tax assessor has indicated that the value of the property is based on the land being worth $125,000 and the house being worth $275,000. Because the property is now being used in a business it can be depreciated for tax purposes. Per the Internal Revenue Code land does not depreciate, therefore the depreciable basis for the property is Paul’s basis in the building - $275,000.

For tax purposes residential real estate depreciates linearly over 27.5 years. Therefore, Paul is entitled to claim a $10,000 depreciation expense deduction for this rental property each year. Paul owns the rental property for 10 years and then decides to sell it. He never made any other capital improvements to the property.

Over the 10 years he has owned it Paul has taken a total of $100,000 of depreciation expense on this property. When he sells it he must adjust his basis in the property to reflect this depreciation deduction. His original basis was $400,000. With $100,000 of depreciation adjustments his adjusted basis is now $300,000.

Paul sells the property for $500,000. Paul has $200,000 of gains, but he actually has 2 different types of gains. The first $100,000 is essentially recapturing the depreciation expense. This is (confusingly) known as “unrecaptured section 1250 gain”. The second $100,000 of gain is a capital gain, and is taxed at the capital gains rate. (Paul never lived in this house, so he does not qualify for the section 121 exclusion.)

If you’ve read this far and your head hurts, you’re probably going to hate what I am about to say next. I have kept these examples very simplistic to highlight some of the concepts used in adjusting basis. I wanted to keep the math easy. In reality, there are several additional factors (such as selling/buying costs) that would need to be considered when figuring the adjusted basis on a house.

These can be difficult concepts, but they are also very important. The value of a house is typically significant relative to the total of a person’s assets. House sales can also have significant tax implications, so you want to make sure the basis is correctly calculated and you are paying the correct tax bill each year. As always, if you have questions, call me.




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 founding member of the Military Financial Advisors Association, as well as a 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 XY Planning Network. Paul is the Director of the CFP Board-Registered Program at The Regent University School of Law where he also teaches the Capstone Course in Financial Planning. 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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