Small Business Guide

Keep Your Small Business Advantage

While your know-how is certain to make an important difference in your business' success, you're no doubt well aware that producing a winning combination for a smooth-running operation depends on many other factors as well.

High on the list of considerations for your business should be creating the ability to meet criteria imposed by Uncle Sam and the Internal Revenue Service. To help you avoid headaches that can go with trying to meet tax law requirements, this brochure highlights pitfalls to be aware of and provides some tips on how to overcome them.

"Material Participation" in Your Business:

"Material participation" has become a major issue for business people since Congress passed rules regarding "passive activities" in the late '80s. To show material participation, you as the owner must demonstrate that your activity in your business is continuous and substantial. The IRS has established several "tests" for measuring material participation. An owner who can't pass any one of the tests will most likely be considered just a passive investor in a company. Since deductible losses from passive activities can be limited to the amount of income from such activities, showing material participation in your business becomes doubly important.

If you work full-time in your business, you will have no trouble showing you materially participate. However, if you're an employee at another job and operate your business on a part-time basis, you need to make sure you pass one of the material participation tests. One way you can do this is to show that you spend 500 or more hours during the year running your business.

You can establish material participation in other ways too-e.g., based on your past years' involvement or how your work time compares with others working in the business (including employees).

Your Profit Motive:

The IRS sometimes questions profit motive of a business owner if an activity consistently shows tax losses. This is common with activities that lend themselves to personal enjoyment or hobby such as horse/dog breeding, arts and crafts, etc. You should be prepared to show that you entered your business with the intent to make a profit and that you are taking measures to realize that intent. How do you show profit motive? At least in part by establishing that you have expertise in your field and you are using businesslike practices in carrying on operations.

Your Recordkeeping Routine

The Recordkeeping System:

Give priority to establishing good recordkeeping practices for your business. Recordkeeping goes much farther than actual check writing, depositing income, keeping receipts, etc. Also involved are the choices you must make about accounting methods, dealing with inventory (if any) and other assets, complying with regulatory and tax requirements, and computerization. You will probably find taking care of all these details time-consuming and frustrating to say the least; many of the choices you have to make may require help from a financial or accounting professional.

When keeping your business records, though, try to follow a few basic "rules":

Don't Commingle Business and Personal Bank Transactions.

From the very outset have a separate bank account for your business in which you deposit only business gross receipts and from which you write checks for business expenses.

Keep Backup For Your Bank Deposits And Expenses.

Keep bank statements and supporting documents so you can trace your bank deposits, including those that aren't income (e.g., loan documents for loan proceeds deposited, insurance reimbursement, etc.)

If possible, pay all expenses by check or a business credit card. The payments should be supported with sales slips, invoices and any other available documents of explanation. The income and expenses should be recorded in an orderly manner (either by hand or on computer) so that the backup can be readily available if and when needed. 

Sometimes you can log your expenses in a timely manner so you don't have to keep receipts. Before you adopt a logging system though, it's best to check with your tax advisor because the rules for logs are quite strict.

Be Sure To Keep All Reports Filed With Government Agencies.

This includes personal income tax returns, sales tax returns, payroll returns, W-2s and 1099s filed for employees and other hired labor, etc.

Length of Time to Keep Records:

From a federal tax standpoint (some states may be different), you should retain books and records of your business for three years after the due date of your income tax return. There are some sections of the tax law where the statute of limitations is longer than three years, however. Because of these, it's wise to keep records at least six years. When it comes to the records that support cost basis of property, equipment or any item that you are depreciating, keep records for at least three years beyond the life shown on the depreciation schedule in your tax return.

Capital Expenses vs. Other Costs:

Costs of assets that will be used in your business for more than a year and the costs of improvements that add to the value of assets are "capital" expenditures. For tax purposes, these expenses are usually deducted over a number of years. However, the IRS has liberalized the regulations to allow businesses to make an election to write off in the year of the expense items that would have had to be capitalized and depreciated under the prior rules. This provision is termed the de minimis exception, and requires that you have an accounting procedure in place as of the beginning of the tax year that specifies the per item amount (from $0 to $2,500) that will be deductible for your business. For additional information about this exception, please contact this office.

Operating expenses, i.e., advertising, office supplies, etc., are currently deductible, as are the costs of getting started in your business (within limits). Try to keep records for capital expenses separate from those for the general operating expenses.

Expensing Normally Depreciable Costs:

Under some circumstances, and in lieu of the de minimis exception noted above, the costs of depreciable business assets can be deducted all in one year on your tax return (up to a yearly maximum). While this can be a real advantage tax-wise, it also has a negative side - if you dispose of the assets before the end of their normal depreciable life, you may have to "recapture" (i.e., report additional income for) some of the costs you expensed. Be sure to check with your tax advisor before you dispose of assets you previously expensed.

Automobile Expenses:

Many business people are uncertain about what car expenses they can deduct. Those expenses you have for traveling between business locations are deductible. However, COMMUTING expenses, i.e., the car costs of going between your home and your office each day, aren't deductible. But when you travel to TEMPORARY locations away from your regular business location, you can deduct the costs of those trips regardless of the distance. Be sure to keep good records of your business driving by logging for each trip: where you went, your business purpose for going there, who you met with, and the number of business miles you traveled.

You will only be able to deduct expenses for the business portion of your car expense. However, you can choose one of two ways to do this: (1) You can deduct your expenses using actual cost of gas, oil, insurance, repairs, depreciation, etc., or (2) You can multiply your business miles by a standard mileage rate to figure your expense (this rate varies from year-to-year).

"Ordinary and Necessary Expenses":

The tax law only allows you to deduct expenses that are "ordinary" and "necessary" for your business. Taxpayers and IRS auditors often dispute over the meaning of these two terms. The IRS' definitions are somewhat general:

An "ordinary" expense is one which is common and accepted in your type of business. On the other hand, a "necessary" expense is one that is helpful and appropriate in your business; it does not have to be indispensable.

By doing all you can to make certain that your expenses are ordinary, necessary, not overly lavish and are backed up with a good paper trail, you will have a head start on every year's tax return!

Other Issues

ndependents vs. Employees:

If you hire workers in your business, they will either be classed as independent contractors or employees. The employee-independent contractor issue has been a touchy one between business owners and the IRS for years, so think about this issue carefully when you classify workers. The amount of control you have over the job done determines worker status - the more control you have the more likely it is that a worker is an employee. Then you have to deal with employment taxes, withholding, payroll tax returns and W-2 filing. However, someone who performs services for you should not be classified as an independent contractor just so you can avoid the administrative hassles and costs of treating the individual as an employee; doing so can lead to monetary penalties and cause you and your business serious problems.

A Pension Plan:
Maintaining a pension plan offers you an excellent way to defer income from your business and plan for your retirement. Options include Simplified Employee Pension Plans, Keogh Plans, Simple Plans and Solo 401(k) Plans. Different plans have different rules about contributions, reporting, coverage, etc. Be sure to consult with your plan administrator so that you meet the specific requirements and limitations.

Estimated Tax Payments:

If your business is unincorporated, the income you earn from it is reported on your individual tax return and is subject to income and self-employment tax. Since no withholding is usually taken from self-employed income, you may need to pay estimated taxes to avoid getting hit with a penalty. Your tax advisor should be able to help you compute the amount you need to pay to ensure that no penalty is assessed. The usual due dates for estimates are April 15, June 15, September 15, and January 15.  However, if a due date falls on a Saturday, Sunday or holiday, the due date will be the next business day.

DISCLAIMER - The tax advice included in this online brochure is an overview of some complex tax rules and is not intended as a thorough in-depth analysis of the tax issues discussed. Do not act on the information included in this online brochure without first determining how these issues apply to your particular set of circumstances and if there are any special tax laws or regulations that might apply to your situation.


Keeping Your Tax Records

When it comes to your taxes, good records are the best protection you can have if the government decides to audit your returns. But just as important as your effective recordkeeping are the measures you take to make certain that your records are kept safe. While it may cause a chuckle to picture a mythical taxpayer confessing to an IRS auditor that tax records were destroyed by the family pet, it probably wouldn’t be nearly as funny to give a similar response in a real audit of your own.

The Advantage of Good Records:
  • A good set of records can help you cut your taxes. Detailed records reduce the chance that you will overlook deductible expenses when your tax return is prepared. After all, how many people remember the exact details of their expenditures months after the fact? Nothing is more frustrating than knowing you incurred deductions yet not being able to prove them. The ultimate consequence of poor recordkeeping is enforced payment of more tax than the law requires.

  • Explicit records provide the best assurance of a favorable outcome if you are audited. Oral testimony alone is seldom enough to prove the deductions you claim on your tax return—auditors want to see a paper trail of receipts, logs, etc.

  • When you’re missing adequate backup records, it can cost a great deal in time and effort to get duplicates. The unfortunate fact is that many businesses balk at hunting down receipts for past sales (you can’t really blame them since it raises their expenses). Your ongoing recordkeeping effort is your best remedy to counteract this problem.

  • Good records help others who might have to handle your financial affairs in an emergency — e.g., an illness. The better your records are, the easier it could be for someone else to temporarily “step into your shoes” to handle your monetary transactions.

Tracking Income

How you track your income is largely dependent on the type of income you are receiving. For certain kinds of income, you will receive statements from the income payers to tell you the amount. These statements are called “information returns” by the IRS. Examples include:

Type of Income Type of Information Return
Stock Sales
Real Property Sales
Miscellaneous Income
(e.g., rent, prizes, non-employee payments)
Gambling Winnings
Unemployment Comp
Tax Refund
Canceled Debts  
Form W-2
Form 1099-R
Form 1099-INT
Form 1099-DIV
Form 1099-B
Form 1099-S
Form 1099-MISC

Form W-2G
Form 1099-G
Form 1099-G
Forms 1099-A, -C

When you receive an information return, you should compare it to your own records, and if there is a discrepancy in the amount of income reported, you should determine whether your records or the payer’s are in error. If you find your records are accurate, contact the payer to issue a corrected information return or explain to you how they determined the amount they have reported. Be sure to keep information returns you receive in a safe place so that the amounts reported on them can be shown accurately on your tax return. Payers must submit the data to the government as well as to you. The IRS will compare what they have received with your return to see that your reporting and their data match. If there’s a mismatch, you will get a letter asking ‘Why?’ or assessing additional tax. Since the IRS may misinterpret return reporting, check carefully before paying any extra tax they try to assess!

Income from Other Sources

Income not traceable to information returns also needs to be reported on your tax return. It could include such items as:

  • Receipts from a self-employed business,
  • Rental income,
  • Interest income on a personal loan.

Taxpayers who receive income from sources like these have a more complicated job in tracking it. It’s recommended that you record it in a separate ledger or through a computer spreadsheet program. In addition, you may want to deposit the funds in a separate bank account earmarked for that income alone.

Getting Organized

No one method is the only way to maintain your records. What’s important is to develop a system that is the most convenient and comprehensive for your situation, and then to stick to it. The IRS estimates that a non-business taxpayer who files a 1040 return will spend about eight hours doing recordkeeping. For a more complex return, such as one with rental properties or self-employment income, add at least another five hours. The following suggestions may help you organize your records, and also reduce the time you spend doing so.

Decide first if you will maintain your records manually or by computer.

  • Bookkeeping software - Some taxpayers, even though they aren’t operating a business, choose computerized “bookkeeping” software that uses their check register data to track their income and expenses by category. Monthly and yearly reports conveniently recap the income and expenses, especially if the accounts (income and expense categories) are consistent with how the information is reported for tax purposes.

  • Spreadsheet method - In lieu of purchasing bookkeeping software, a spreadsheet file (for example, in Excel) may be set up where you record your yearly income and expenses by tax return category. If you normally itemize your deductions, set up a separate sheet for each of the major deduction categories – medical, taxes, contributions, etc. – as found on Schedule A . For medical expenses, for example, record each expense by provider’s name, type, date, amount paid, and payment method. Note medically related auto mileage at the same time. At year’s end, sort income and expenses of the same type together to get a yearly total. For income items, a cross-check from the spreadsheet to the 1099 forms for all bank interest or other income sources is an accurate way to verify that all needed 1099s have been received. If your tax advisor gives you a “tax organizer” to help you prepare for your appointment, you can quickly transfer the totals from your spreadsheet to the organizer, or, instead, you can provide your advisor with a copy of the spreadsheet.

  • Manual lists - If you keep track of your records manually, the same type of system applies as for a spreadsheet, except you’ll set up a paper sheet for each category of income and expense that you normally have on your tax return. Write each payment you receive or expense you incur on the applicable list. At the end of the year, each list is ready to be totaled. If you make your entries no less frequently than monthly, you’ll find that the overall time you spend will be less, and the accuracy of the information will be greater, than if you wait until just before your tax appointment to put together the year’s lists.

  • Methods for retaining source documents - In addition to your lists of income and expenses, the receipts, canceled checks, credit card slips, income statements, etc., that back up the amounts need to be retained in case your tax return is audited. This is true whether you computerize or manually summarize your data. Choose from the following methods the one, or combination of methods, that suits you best:
  • Digital Files – A popular method with computer savvy individuals is to scan the records and store them as a digital file on their computer. This day and age, many records actually come from the provider already in digital form and can be added to the digital records without scanning. Some forms of hard copy records will fade over time and scanning these documents before they fade is a good way to preserve the record.
  • Envelopes – Using several blank envelopes, write the tax year and names of the income and expense categories that correspond to your spreadsheet or manual list of accounts. After you’ve recorded an item on your list, insert the corresponding receipt, canceled check, etc., into the envelope. By storing the source documents by category throughout the year, instead of throwing all of them in a box to get to “later,” you’ll not only save time but considerable frustration if you must search for a particular item. There is also less likelihood that a receipt or other document will be lost. Store the envelopes in a larger master envelope or box.

  • File folders – Some taxpayers prefer to use file folders labeled by income and expense categories. These work well for manually maintained records, as the lists can go right in the folders along with the substantiating receipts, checks, credit card slips, etc. Small-sized receipts should be taped or stapled to a letter-sized sheet of paper to prevent them from falling out of the folder.

  • Binders – A binder, set up with dividers labeled by income and expense categories, is also useful for keeping your lists and paper records. Three-hole plastic sheet protectors are convenient for keeping source documents together by category in the binder(s). Binders are especially useful for filing monthly or quarterly brokerage or bank account statements.

Start now – If you aren’t already in the habit of keeping your records organized and maintaining them contemporaneously, start now! The effort will be worth it in time saved when you prepare for your next tax return preparation appointment. And most likely your records will be more accurate than they’ve ever been before.

Knowing When to Discard Records

Taxpayers often question how long records must be kept and how long the IRS has to audit a return after it is filed. ANSWER: It all depends on the circumstances! In many cases, the federal statute of limitations can be used to help you determine how long to keep records. With certain exceptions, the statute for assessing additional tax is three years from the return due date or the date the return was filed, whichever is later. However, the statute of limitations for many states is one year longer than the federal. The reason for this is that the IRS provides state taxing authorities with federal audit results. The extra time on the state statute gives states adequate time to assess tax based on any federal tax adjustments.

In addition to lengthened state statutes clouding the recordkeeping issue, the federal three-year rule has a number of exceptions:

  • The assessment period is extended to six years instead of three if a taxpayer omits from gross income an amount that is more than 25 percent of the income reported on a tax return.

  • The IRS can assess additional tax with no time limit if a taxpayer: (a) doesn’t file a return; (b) files a false or fraudulent return in order to evade tax, or (c) deliberately tries to evade tax in any other manner.

  • The IRS gets an unlimited time to assess additional tax when a taxpayer files an unsigned return.

If no exception applies to you, for Federal purposes, you can probably discard most of your tax records that are more than three years old; add a year or so to that if you live in a state with a longer statute.

Sue filed her 2015 tax return before the due date of April 18, 2016. She will be able to safely dispose of most of her records after April 15, 2019. On the other hand, Don filed his 2015 return on June 2, 2016. He needs to keep his records at least until June 2, 2019. In both cases, the taxpayers may opt to keep their records a year or two longer if their states have a statute of limitations longer than three years. Note: In this example, we used April 15th as the deadline. In actual practice, if a due date falls on a Saturday, Sunday or holiday the due date becomes the next business day. 

Important note:
Even if you discard backup records, never throw away your file copy of any tax return (including W- 2 s ). Often, the return itself provides data that can be used in future return calculations or to prove amounts related to property transactions, social security benefits, etc.

Records to Keep Longer than Three Years

You should keep certain records for longer than three years. These records include:

  • Stock acquisition data. If you own stock in a corporation, keep the purchase records for at least four years after the year you sell the stock. This data will be needed in order to prove the amount of profit (or loss) you had on the sale.

  • Stock and mutual fund statements where you reinvest dividends. Many taxpayers use the dividends they receive from a stock or mutual fund to buy more shares of the same stock or fund. The reinvested amounts add to basis in the property and reduce gain when it is finally sold. Keep statements at least four years after final sale.

  • Tangible property purchase and improvement records. Keep records of home, investment, rental property, or business property acquisitions AND related capital improvements for at least four years after the underlying property is sold.
  • Capital or Net Operating Loss. If you have a capital loss from selling stock, bonds or investment property that exceeds the allowed annual deduction of $3,000 ($1,500 if filing married separate), you may carry the unused loss forward to the next year and as many future years as needed until you use up the loss. In this case, you should retain the records from the sale(s) until four years after the last year that you deduct any of the carryforward loss. The same holds true for a net operating loss that results from a business loss or a casualty loss: keep all of the tax returns and back-up documents from the loss year, the two years prior to the loss, and if any of the loss is carried forward, for four years beyond the last year when the loss is used up.

DISCLAIMER - The tax advice included in this online brochure is an overview of some complex tax rules and is not intended as a thorough in-depth analysis of the tax issues discussed. Do not act on the information included in this online brochure without first determining how these issues apply to your particular set of circumstances and if there are any special tax laws or regulations that might apply to your situation.

Home Ownership - Your Best Tax Shelter

Homeowners Receive Big Tax Breaks

Home ownership can provide you with several important tax benefits…
  • Deductions for real estate taxes and home mortgage interest, and

  • Gain exclusion if you meet certain occupancy and holding period requirements.

In fact, tax breaks are probably one of the biggest reasons you decided to buy your home in the first place. Unfortunately, some homeowners lose getting the most from their home’s tax advantages because they aren’t aware that certain limits apply. The purpose of this brochure is to highlight how you as a homeowner can best keep your home’s favorable tax edge.

Your Home's Basis

The amount of the gain exclusion permitted under current tax law tends to make most taxpayers forget about keeping track of their home improvements. Although inflation has been low in recent years, it could eventually take its toll, and in a few years the exclusion limits may not be as significant as they are today or the law may change again. In either case, it may be appropriate to keep a record of the improvements on your home.

Once you buy a home, you need to begin keeping records related to your home’s “ basis,” i.e., the amount you have spent on the property. If you acquired your home through purchase, your basis is what you paid for it originally, including purchase expenses PLUS improvement costs you incur while you own it. Keeping track of basis is extremely important in order to accurately compute gain or loss if you decide to sell.

For the purpose of computing basis, it’s important to distinguish between “improvements” and repairs; only improvement costs add to your basis. Minor repairs like replacing faucet washers, painting a bedroom or patching a hole in the roof don’t need to be tracked. In general, improvements are of a more permanent nature than repairs. They enhance the value of your home and are likely to last more than one year. If you make the same improvement more than once, only the most recent improvement adds to your basis.

You should log costs of items like the following in a home improvement record (be sure you keep your backup receipts and canceled checks):

Room additions
New driveway
Sprinkler system
Exterior lighting
Storm windows/doors
Central vacuum
Central air
Filtration system
Wiring upgrade
Soft water system
Built-in appliances
Bathroom upgrade
Wall-to-wall carpet
Retaining wall
Swimming pool
Satellite dish
Security system
Heating system
Light fixtures
Water heater
Kitchen upgrade

Whenever there’s doubt about whether an expenditure qualifies as an improvement, make a note of it in your record anyway. That way, the ultimate decision of qualification can be made later when (and if) you decide to sell.

Deductions Related to Your Home

Certainly not all costs related to your home are deductible. For example, unless you use your home for business (e.g., you have an office in your home), costs for insurance, repairs, utilities, condo or homeowner association fees, etc., aren’t deductible.

However, you generally will be able to deduct:

  • Real Estate Taxes
  • Home Mortgage Interest

Keep in mind, however, that home mortgage interest deductions can be limited. Generally, you can deduct the interest from mortgages up to $1 million on a combination of your first and second homes, provided they were the original loans. As the principal on these loans is paid down, the reduced loan amount becomes the new limitation. If you were to later refinance the home for more than the remaining balance on the original loan, the excess would have be used for home improvements or qualify under the provisions that allow a taxpayer to borrow up to $100,000 in home equity. If not, a portion of the interest would not be deductible.

The additional $100,000 of home equity can be borrowed from the primary residence and a second home. When used wisely, the $100,000 equity loan can be used to finance other purchases where the interest expense would normally not be deductible. An example of this would be a personal vehicle.

Equity debt interest is not deductible for AMT purposes, so taxpayers who are taxed by the AMT should consider carefully whether or not to incur home equity debt.

Because of the current strict home mortgage deduction limits and the complicated tax rules associated with this tax deduction, be sure to review any home financing plans with your tax advisor before finalizing loan deals.

Loan Points:

A question often comes up about the deduction for points on a home loan. Points are another name for prepaid interest – they may be called loan origination fees or some similar term. One point equals 1% of the loan amount. When points are paid for services a lender provides to set up a loan, the points aren’t deductible. However, when the points are paid as a charge for the use of money, the following rules apply:

  • As a general rule, points are only deductible over the life of a loan. Say, for example, you paid $3,000 in points on a 30-year refinance loan. Your tax deduction would be limited to $100 a year ($3,000/30 years). If you decided to pay your loan off early, say after 15 years, you could write off the balance of the points ($1,500) in that year.

  • An exception to the general rules lets you deduct in full, points you pay in connection with obtaining a mortgage to purchase, construct or improve your main home.

  • Seller-paid points can even be deducted by a home buyer, but the amount deducted reduces the home’s basis.

Reporting Gains/Losses

Exclusion of Gain:

When you sell your principal home at a gain, you can exclude all (or a portion) of the gain if you meet certain occupancy and holding period requirements. To qualify for this exclusion, you must have owned and occupied the residence for two years out of the five year period that ends on the date of the sale.  If you meet those qualifications and are filing a joint return with your spouse, you may exclude up to $500,000 ($250,000 for a single individual) of gain from the sale.

A partial exclusion may be allowed even if the two-of-five year ownership and occupancy tests aren't met if the sale is due to a job-related move, health, or certain unforeseen circumstances.  If you do not qualify for the full or partial exclusion, there is no deferral privilege and the gain not eligible for exclusion is fully taxable, but will be eligible for the beneficial maximum long-term capital gains tax rates if you owned the home over one year.

NOTE: A second home, such as a mountain cabin or lake cottage, doesn’t qualify for the exclusion of gain.

Caution: Gains in excess of any allowed exclusion are treated as investment income and may be subject to the 3.8% Net Investment Income Tax.

Previously Postponed Gain:

Under prior tax law (generally pre-'98), gain from the sale of a principal residence could be deferred into your replacement residence. Those gains were accumulated from home to home as long as each replacement home cost more than the adjusted selling price (i.e., sales price less expenses of sale and pre-sale “ fix-up” costs) of the previous home. Although gain deferral from a principal residence is no longer permitted under current law, the gains deferred under prior law into a home currently being sold must be accounted for.

Sales at a Loss:

Losses from the sales of business or investment properties are normally tax-deductible. However, a loss from the sale of your main home is considered personal in nature and therefore, unless the law changes, it is not allowed as a deduction. This rule also applies to second homes.

Reporting the Sale:

You do not need to report the sale of your main home on your tax return unless you have a gain and at least part of it is taxable - i.e., if the gain is greater than your allowed exclusion, the sale is reportable.  Otherwise, if the gain is totally offset by the exclusion, the sale need not be shown on your tax return.  However, to be certain that no reporting is required, you should provide your tax advisor with the sales documents, cost basis information, etc., to evaluate your situation.  You may receive Form 1099-S showing the gross proceeds from the sale, although settlement agents (escrow companies) are not required to issue a Form 1099-S for most sales of main homes.  If you do receive a Form 1099-S, let your tax advisor review it and determine if it is necessary to report the sale.

Exclusion Qualifications

Under prior law. . .
(generally pre-1998), individuals were entitled to a once-in-a-lifetime exclusion of gain from the sale of their principal residence. To qualify for that exclusion, the taxpayer or spouse must have reached the age of 55 prior to the sale and they must have resided in the home for three of the prior five years. Having exercised that exclusion does not bar a taxpayer from qualifying for the current law exclusion.

Under current law…there is no age requirement associated with the exclusion. The period of time the home must be owned and occupied as a principal residence is two out of the five years immediately preceding the sale date. The exclusion amount is $500,000 for married couples filing jointly and $250,000 for other individuals. Taxpayers are permitted to exclude a gain every two years if they meet all of the other conditions. There are no gain-deferral provisions in the current law for purchasing a replacement residence; thus, any gain not excludable is immediately taxable.

Five-Year Holding Period: If you originally acquired the home you intend to sell by means of a tax-deferred exchange (sometimes referred to as a 1031 exchange), the required ownership period to qualify for the home sale exclusion becomes five years as opposed to the normal two years.

Non-Qualified Use:
If the home was previously used as other than your main home (non-qualified use), for example, as a second home or a rental, and converted to your personal residence after December 31, 2008, the portion of the prorated gain attributable to the non-qualified use will not qualify for the home gain exclusion.

Special Military Rules: Generally, the five-year qualification period for the 2-out-of-5-year use test can be suspended for up to 10 years for persons on qualified extended duty in the U.S. Armed Services or the Foreign Service. Please call this office for more details.

Tax Planning and Your Home

The information outlined here is only a brief overview of the tax rules involving home ownership. Since the rules are complicated, if you’re thinking of buying or selling your home, or refinancing a home loan, it’s best to discuss the plans with your tax advisor to interpret closing documents and to make absolutely certain the transaction meets the necessary qualifications.

DISCLAIMER - The tax advice included in this online brochure is an overview of some complex tax rules and is not intended as a thorough in-depth analysis of the tax issues discussed. Do not act on the information included in this online brochure without first determining how these issues apply to your particular set of circumstances and if there are any special tax laws or regulations that might apply to your situation.


Household Employees and Your Taxes

Employment Tax Responsibilities for Employers of Household Workers

Household employees are workers you hire for “ domestic services,” i.e., those services performed in and about your home. Duties of cooks, butlers, housekeepers, governesses, maids, valets, babysitters, caretakers, gardeners, janitors, or personal chauffeurs all can qualify as “domestic services.”

Not everyone you hire for work at your home is considered a household employee, though. For example, a self-employed gardener may take care of your lawn and several others in your neighborhood, providing all his own tools and job assistants and setting his own work schedule. That gardener probably won’t be considered your household employee because he is running an independent operation over which you have no “say-so.”

You see, a worker at your home becomes an employee when you control what work that person is to do AND how and when the work is to be done. If you qualify as a household employer, you may have to pay certain federal payroll taxes, including social security and Medicare taxes and unemployment taxes. You withhold some of these taxes from your employee’s wages; others you must pay from your own funds. (Some states require certain taxes too, so be sure to check with the state employment department in your area.)

Taxes You Withhold from Wages

Social Security and Medicare Taxes:

If you pay cash wages in excess of a specified threshold amount during the year to a given employee, you must withhold social security and Medicare taxes from the employee’s wages. This threshold amount is $2,000 for both 2016 and 2017 and applies to each separate household employee you hire. Call for amounts applicable to other years.

Example: This year, Jane hired Louise, a housekeeper, and Rose, a babysitter. She withheld social security and Medicare taxes from their wages. Over the course of the entire year, however, she paid Louise only $500 and Rose $800. Since neither worker’s yearly wage equaled the threshold amount, Jane owes no social security or Medicare tax for them. That being the case, she must repay to the workers the taxes she already had withheld from their wages.

Federal Income Tax:

Household employees may also ask you to withhold income tax from their wages; you aren’t required to agree to the request. If you choose to withhold, however, you must collect the income tax from the employee’s wages (the IRS publishes tables to let you know how much to withhold) and you pay the amount withheld to the government.

Additional Taxes You Must Pay

Employer’s Share of Social Security and Medicare Taxes:

As an employer, you must match the amount of social security and Medicare tax you withhold from your employee’s wages. For instance, if you withheld $50 in social security from your housekeeper’s wages, you would be required to pay to the government $100 (the $50 withheld from your employee, plus another $50 from your own funds).

Federal Unemployment Tax (FUTA):

You are also responsible for FUTA taxes if you paid a total of $1,000 in 2016 (call this office for other years) or more in household employee wages during any calendar quarter of the current year or the previous year. FUTA tax isn’t a withholding tax but is paid by you alone on behalf of your employees. (Certain states also assess unemployment taxes – check with the appropriate agency in your area.)

Paying the Tax

You report and pay the required federal payroll taxes for your household employees along with your regular individual income tax return. Schedule H, Household Employment Taxes, is used to figure the amount of the tax that you owe.

Reporting Wages to Employees

You need to give your household employees Form W-2 ,Wage and Tax Statement, to report wages and tax withholding for the year. The W-2 is due to the employee by Jan. 31 of the year following the year in which you paid the wages . You must also file a copy of the W-2 with the Social Security Administration by Jan 31. 

To accurately prepare W-2s, you need certain information from your employee, including his/her name, address, and social security number. So that you have all the necessary information available for timely filing, you may want to have your workers fill out Form W-9, Request for Taxpayer Identification Number and Certification, when you hire them. That way you will have data on file to complete W-2s when the time comes.

Other Paperwork Chores

Form SS-4:

If you have household employees, you will need to obtain an employer identification number (EIN) for yourself. This number is not the same as your Social Security Number. The IRS issues the EIN and prefers that you apply online at their website – (type EIN in the search box) – or by filling out and faxing or mailing Form SS-4, Application for Employer Identification Number, to the IRS, which does not charge for an EIN; beware of web sites on the Internet that charge for this service.

Employee Form W–4:

If you agree to withhold income tax for an employee, ask him/her to complete Form W-4, Employee’s Withholding Allowance Certificate. The information on this form will help you determine the correct amount of income tax to withhold.

Payroll Journal:

You should record in a journal each payday the wages and withholding of household employees. Set up a separate record for each employee with room for the following information:

  • Payment date
  • Check number
  • Gross wages (before withholding)
  • Social security tax withheld
  • Medicare tax withheld
  • Federal withholding, if any
  • State withholding amounts (establish a column for each separate kind of tax withheld)

For computer users, an inexpensive payroll program may simplify the recordkeeping job.

Keep employment tax records for at least four years after the later of: the due date of the return on which you report the taxes, or the date you pay the taxes.

If You Have Other Employees

If, in addition to your household employees, you have employees in a sole proprietorship, you can choose whether to pay the employment taxes of your household workers with your personal tax return or along with your business payroll returns. If you choose the latter option, you file W-2s for you household employees along with those of all your business employees.

Have You Forgotten Anything?

Here’s a quick checklist of issues you should make sure you have considered when you hire and pay household employees:

  • Legality of worker’s employment in the United States - complete Form I-9, Employment Eligibility Verification. This is not a tax form but required by the U.S. Citizenship and Immigration Services and available at the USCIS web site (
  • Applicability of state employment taxes and state return filing requirements
  • Applicability of withholding social security and Medicare taxes
  • Income tax withholding agreements with employees
  • Recordkeeping system
  • Employer identification number application
  • W-2 filing with employees and Social Security Administration
  • Return filing and payment deadlines

Are the Payroll Taxes you Pay Deductible?

In most cases, the payroll taxes you pay in connection with your household workers’ wages are not deductible on your individual tax return. The IRS considers these taxes, and the wages on which they are based, to be personal, nondeductible expenses. However, there are a couple of circumstances when you may be eligible for a tax benefit for the payroll taxes you pay:

  • Child Care Credit – If you are eligible to claim a Child or Dependent Care Credit based on wages you pay a household employee who cares for your child, other dependent, or spouse, the payroll taxes you pay on the wages are counted as part of your eligible expenses when figuring the credit.
  • Medical Care Providers – The wages and associated payroll taxes you pay to a household worker who provides nursing services for you, your spouse, or your dependent are medical expenses that may be deductible on your return if you itemize your deductions. (Note that the same expense can’t be used both as a medical deduction and for the Child or Dependent Care Credit.)

In these two situations, the payroll taxes that you include are the FUTA (federal unemployment) tax, state unemployment tax, and your portion of the Social Security and Medicare taxes that you have actually paid during your tax year. For example, if you paid FUTA tax in January for medically deductible wages that you paid to a nurse in the prior year, you would include the FUTA tax as part of your medical expenses on your current year return (return for the year in which the FUTA tax was actually paid). (The wages paid in the prior year are deductible on your prior year return.) Do not include the Social Security and Medicare taxes, federal and state income taxes, or other state or local taxes you’ve withheld from the employee’s wages, since these amounts are already part of the gross wages for which you are claiming the credit or deduction.

Are 1099s Required for Non-Employees Working at Your Home?

If the person whom you paid during the year for household services is not your employee – as was the case of the gardener described at the beginning of this article – you would not issue a Form 1099-MISC to that individual. Form 1099-MISC is issued by a business to independent contractors who were paid $600 or more during the year for services performed for the business. You are not considered to be operating a business when you engage someone such as a self-employed gardener strictly to provide services at your home (unless, of course, you are operating a business at your home).

DISCLAIMER - The tax advice included in this online brochure is an overview of some complex tax rules and is not intended as a thorough in-depth analysis of the tax issues discussed. Do not act on the information included in this online brochure without first determining how these issues apply to your particular set of circumstances and if there are any special tax laws or regulations that might apply to your situation.

Charitable Giving & Your Taxes

Your Charitable Gifts Make a Difference for Others and for Your Taxes

When you give away cash or goods to qualified nonprofit organizations, you will probably be able to take a tax deduction as partial reward for your generosity. However, the IRS rules for deducting charitable contributions aren’t as simple as many people might think. For example, deduction limits can apply, and certain gifts require timely written acknowledgment from the recipient organizations.

Qualified Charitable Organizations

In order for a donation to be deductible, it must be given to a “qualified U.S. organization.” Not all nonprofit organizations qualify, but the IRS regularly publishes a list of the ones that do. In general, the qualifying groups can be categorized as:
  • governmental bodies;
  • nonprofit groups organized for religious, educational, scientific, or literary purposes;
  • war veterans’ groups;
  • fraternal societies and lodges; and
  • certain nonprofit cemetery companies.
Examples of typical qualified organizations include churches, nonprofit hospitals, colleges and universities, school booster clubs, libraries, public parks and recreation facilities, etc.

hen gifts are made to fraternal organizations and lodges, only the part of the gift that those organizations give away to other qualified charities is deductible. In addition, gifts to a cemetery company can’t be deducted if they are earmarked for the care of a specific cemetery lot.

Limits on Charitable Deductions

In general, deductions for charitable gifts are limited to 50% of a taxpayer's adjusted gross income. However, depending on the kind of organization and the type of property being given, that limit can dip as low as 20%. And if the individual's income is high enough, the partial benefit of his or her charitable deductions can be lost due to an overall limit the IRS imposes on itemized deductions.

Gifts That Return a Benefit to You

If a taxpayer is audited on his or her contributions, the IRS looks to see whether voluntary donations were made intentionally or whether it was just payment for services provided by a charitable organization. For example, payments to a parochial school for a child’s tuition or to a church for a family wedding give the taxpayer a benefit and don’t qualify as contributions. Payments to charities for raffle tickets, lotteries, or bingo also fall in this category and aren’t deductible - with these one is really purchasing the chance to win that new TV, trip to Hawaii, etc.

In certain situations, only a partial benefit may be received for what is given. In that case, one can generally deduct the amount of the gift that is over and above the value of what is received. Say you paid $50 to attend a fundraising dinner at your church. The church determines that the value of the dinner and program is $15. Your deductible charitable contribution is $35, i.e., the amount of your payment that exceeds $15.

Giving Your Time

Although you may volunteer many hours working for a charitable organization, the value of your time is not deductible. However, if you incur expenses (e.g., travel costs to and from the charity’s location) related to volunteer work, those costs are deductible. Other out-of-pocket costs incurred on behalf of the charity may be deductible as well.

Travel Away From Home for Charity

A charitable deduction can be taken for travel expenses (including meals and lodging) incurred while performing services for a charity in an out-of-town location. However, two important criteria need to be met in order to get this deduction:

1 . You must perform services for the organization in an official capacity while you’re away from home.

2 . No “significant element of personal pleasure” must be connected with the travel. Does this mean your trip can’t be enjoyable? No, but it does mean that the primary purpose of your travel must be related to your charitable duties and not be a personal vacation.

IRA to Charity Transfers

Those who are required to take a required minimum distribution (RMD) from their IRA because they are 70.5 or older are able to send up to $100,000 of their RMD directly to a qualified charity. This distribution, while not deductible as a charitable contribution, is tax-free and may result in the additional benefit of cutting the amount of Social Security income that is taxable. This technique essentially allows a charitable deduction to non-itemizers.  Call for additional information.

Non-Cash Donations

Donations don’t always have to be in cash. One can also deduct the “fair market value” (FMV) of donated items like used clothing, furniture, and appliances (FMV is the price goods are likely to sell for on the open market).

Condition of Contributed Items:

The condition of the contributed item is important, because except as noted below, tax law does not permit a charitable contribution for clothing or household items unless the contributed items are in "good used condition" or "better." 

They also do not allow a deduction for items with minimal monetary value, such as used socks or undergarments.

There is a provision that permits a deduction for clothing and household goods that are not in good used condition or better.  Under this provision, a deduction can be taken if (1) the amount claimed as a deduction is greater than $500, and (2) the taxpayer includes with the taxpayer's return a qualified appraisal with respect to the property.

Household items include furniture, furnishings, electronics, appliances, linens, and other similar items.  Food, paintings, antiques, and other objects of art, jewelry and gems, and collections are excluded from the definition of household items for this purpose.

Large Donations:

There are other rules that apply to certain types of non-cash contributions including limitations, appraisal requirements, deduction recapture, etc.  Therefore, when contemplating an unusual or substantial non-cash contribution, or a series of contributions, it is appropriate to consult with this office.

Valuing Your Donation:

Perhaps the most difficult part of making noncash donations is determining the value of the goods being given away. The decision about value is left to you and, unfortunately, there aren’t any cast-in-concrete formulas to give you the “right” answer.

Here are a few general guidelines that may help:

  • Consider the condition of each item being given away. Compare the style of your donation with current styles. Outdated and/or damaged property may have little or no market value. Categorize each item being given by its condition (e.g., poor, good, excellent, new, etc.)

  • Do a little detective work to find out what the item you are donating would sell for in the current market. A visit to the local thrift shop, perusing online sites selling used items, a quick glance through newspaper classified ads, or a stop at a neighborhood garage sale should provide you with a pretty good idea of the prices of goods like yours.

  • If your donation includes equipment or machinery, consult with publications of commercial firms or trade organizations to find out your property’s value. Many of these organizations regularly publish information about going sales prices for cars, boats, airplanes, etc. Caution: When donating used vehicles to charity, special rules apply. See paragraph on "Donating Vehicles to Charity."

    Your research will probably show that most used merchandise has a value that is considerably less than your property’s original cost!

    However, some items you give away may have actually gone up in value (e.g., antiques, jewelry, or artwork). To determine the value of these, hire a qualified appraiser. Regardless of whether the value of a donated item has gone up or down, if its current value is more than $5,000, a professional appraisal is mandatory (exception: most publicly-traded securities do not require an appraisal). Check with your tax advisor about the details that must be included in the appraisal and the IRS-required form.

Donating Used Vehicles to Charity:

Congress has imposed some tough rules that substantially limit the deduction for a car donation.  If the deduction exceeds $500, the deduction will generally be limited to the gross proceeds from the charity's sale of the vehicle.  In addition, a written acknowledgment from the charity is required and must contain the name of the donor, donor's tax ID number and the vehicle identification number (or similar number) of the vehicle.  The IRS provides Form 1098-C for this purpose.  There is an exception to these rules for donated vehicles that the charity retains for its own use "to substantially further the organization's regularly conducted activities."  Please call this office for more information.

Record of Noncash Donations:

Keep a list of the donated items and include a description of the property, its cost and FMV, how you determined the FMV, and when and how it was acquired. If the property has appreciated in value, be sure to get an appraiser’s report (since special rules apply to appreciated property, check with your tax advisor before you make your contribution). Request a receipt at the time of the donation and make sure it includes the date and the organization's name and address.

If the value of donated items is $250 more, in addition to the information noted above, a written acknowledgment from the organization must state whether the charity provided any goods or services in return for the gift, and if so, a good faith estimate of the value of the goods and services provided.  You must have written acknowledgment by the date you file your return or the extended due date of the return, whichever date is earlier.

Recordkeeping for Cash Donations

For monetary (cash, check) gifts, regardless of the amount, you should have a canceled check (bank record) or a written communication from the donee showing:

  • The name of the donee organization,
  • The date of the contribution, and
  • The amount of the contribution.

The recordkeeping requirements may not be satisfied by maintaining other written records.  This means that unless the charitable organization provides a written communication, cash donations put into a "Christmas kettle," church collection plate, and pass-the-hat collections at youth sporting events will not be deductible.  Donations by debit or credit card can be substantiated by bank records.

hile many organizations may take the responsibility of providing a receipt, the tax law actually places this responsibility of getting acknowledgment on the gift donor. “This provision does not impose an information requirement upon charities; rather it places the responsibility upon taxpayers who claim an itemized deduction of $250 or more to request (and maintain in their records) substantiation from the charity.”

The charity’s acknowledgment must contain the following:

  • The amount of money and a description of the value of other property, if any, contributed.

  • Whether the charity provided any goods or services in return for the gift.

  • A description and reasonable estimate of the value of the goods or services provided.

DISCLAIMER - The tax advice included in this online brochure is an overview of some complex tax rules and is not intended as a thorough in-depth analysis of the tax issues discussed. Do not act on the information included in this online brochure without first determining how these issues apply to your particular set of circumstances and if there are any special tax laws or regulations that might apply to your situation.

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