Categories
Federal Income Tax

Small Landlords Not Required To File Form 1099

Photo of 384 Court Street Auburn, ME 04210There is significant confusion surrounding whether or not landlords need to file form 1099s for the amounts that they pay for services.  Owning a rental property is an activity carried on regularly and continuously for profit, and many landlords consider themselves to be in business.  However, the IRS considers most rental activities to be passive activities, rather than active businesses.  If that is the case, are landlords exempt from filing form 1099?

Congress sought to clear up the confusion in 2010 when they passed a law that explicitly defined receiving rental income as conducting the trade or business of renting out property, subject to 1099 reporting requirements.  Congress later repealed that part of the law before it took effect (Hill).  Repeal aside, the IRS continued to include questions about 1099s on page 1 of Schedule E, the form individuals use to report rental income.   One question asks if the taxpayer is required to file form 1099, and the other asks if they have done so.  The has caused many small landlords to wonder if they needed to file 1099s for any service providers that they’ve paid more than $600 during the year.  These questions on schedule E have even confused a number of CPAs and other tax professionals on the issue.

The AICPA tried to clear up the confusion among its members  with an article about 1099 requirements for rental properties and also wrote a open letter to the IRS in 2013 to express its position and request further guidance.  It is the position of the AICPA that landlords only need to file form 1099 when their rental activities rise to the level of a trade or business (Porter).  This means that most owners of rental properties who are not engaged in other real estate businesses do not need to file 1099 forms.  In the letter, the AICPA proposes changes to the language of the form and instructions that would clarify this point.

The specific criteria used to determine if a landlord is running a business or merely investing are discussed here, but it is the position of the AICPA and this author that most small landlords remain exempt from the requirement to file 1099 forms for their service providers, despite the recently-added questions on Schedule E.

 

Resources

American Institute of Certified Public Accountants. (17, January, 2013).  Letter to the IRS.  http://www.aicpa.org/interestareas/tax/resources/individual/toolsandaids/pages/rentalproperties1099-miscrequirements.aspx.  Retreived 6, January, 2013.

Hill, Claudia.  (2013, March 6). Should Landlords be Filing 1099s for Service Providers. Forbes.com.  Retrieved 6, January, 2014 from http://www.forbes.com/sites/irswatch/2013/03/06/should-landlords-be-filing-1099s-for-service-providers/

Internal Revenue Service.  (2013).  Schedule E (Form 1040) Supplemental Income and Loss – Draft.  Retrieved from http://www.irs.gov/pub/irs-dft/f1040se–dft.pdf

Categories
Federal Income Tax

Federal 1099 Filing Deadline is Today (Feb. 28)

If your business has a 1099 filing requirement, today (February 28) is the deadline to file those on paper with the IRS.  The payee copies of 1099s were due at the end of January, but the federal copies are due today.  Electronic filers have until March 31, 2014 to file their 1099s.  Taxpayers who are not filing electronically and are unable to file today can file form 8809 to extend the due-date for 1099s by 30 days – but that form must be filed by the due date.  Remember, that’s today, unless you’re filing electronically.

While I don’t happen to have any clients bumping up against that deadline, the IRS has made things a little bit difficult for those who do need to find information about filing 1099s.  They’ve already given the 2014 instructions a prominent spot on their website, for forms due in 2015.  This means it takes a little digging to find the instructions for the forms due this year.  I did a little bit of searching and found an archived copy on a different site.  Click here to get the 2013 General Instructions for Certain Information Returns.

 

 

Categories
Federal Income Tax

Don’t miss the Earned Income Credit

The IRS estimates that as many as 4 out of 5 working families may qualify for the Earned Income Credit, and that about 1 in 4 taxpayers who qualifies for the credit fails to claim it.  This means about 1 in 5 working families who qualify are needlessly missing out on a refundable credit that can be worth thousands of dollars a year!

Categories
Federal Income Tax

Tax-Advantaged Plans for Doctors

Tax-Advantaged Savings for Doctors

Doctors and other high-earning professionals can be some of the most challenging clients to find tax savings for.  Their incomes are too high for them to claim a lot of common deductions and credits, but because that income comes in the form of wages, they don’t have access to all of the the tax planning opportunities that are available to business clients.   Retirement plans offer some of the easiest opportunities for tax savings, and doctors do have many of the same options as other taxpayers.

Despite what some would consider to be a very good income, doctors often don’t have the cash flow, especially early in their careers, to maximize all of their available savings options. Because some plans offer more tax savings than others, the best tax savings can often be had for the fewest dollars by maximizing contributions in the following order:

  1. 401(k) to the company match
  2. HSA if enrolled in a compatible health plan
  3. IRA or Spousal IRA
  4. 401(k) with no match
  5. Non-deductible IRA with Roth rollover
  6. Other Options

401(k) with Company Match
Contributing enough to a 401(k) ( or similar plan) to get the company match will almost always get the best possible tax savings for a doctor’s retirement dollars. Employers will often match 50% to 100% of the first 3% an eligible employee saves in an employer-sponsored plan. The employee contribution comes out after payroll taxes but before income tax. The employer contribution goes in with no tax at all.  With the new top Federal tax rate of 39.6% and the top Maine state income tax rate of 7.95%, the very highest earners could find themselves saving about 44 cents on every dollar that they contribute to the plan.  Once you factor in the tax that they save on the employer contribution, high-earning doctors stand to save about 92 cents in tax for every dollar they contribute, up to the company match.  The income tax piece of this savings is a deferral, but most doctors can expect to be in a lower tax bracket during retirement, making some of the savings permanent.

HSA (Health Savings Account) Contributions

HSAs are one of this author’s favorite forms of retirement savings because they can be kept for retirement or used to pay current medical expenses.  An HSA is an account, similar to an IRA, that taxpayers can contribute to if they have certain high- deductible health insurance plans.  Unlike an IRA, there are no income limites on HSA eligibility, making HSAs a great way for doctors to defer tax on additional income.   Contributions made to an HSA go in before income tax and payroll taxes, but they come out tax free if used to pay for medical expenses.  If there’s money in an HSA when the taxpayer reaches retirement age, it can be withdrawn.  Money taken from an HSA in retirement is subject to income tax, but not to early withdrawal penalties.    A word of caution, however – HSA funds withdrawn early for non-medical expenses are subject to a 20% penalty, in addition to being fully taxable.

IRAs and Spousal IRAs

IRAs and Spousal IRAs are only occasionally an option for doctors because most doctors have an employer-sponsored retirement plan available.  A taxpayer who is not eligible to participate in an employer-sponsored can conttibute to an IRA and claim a tax deduction no matter how high their income, but when an employer plan is available, the deduction passes out at certain income levels.  Single taxpayers earning more than $59,000 and married taxpayers who earn more than $95,000 begin to lose their IRA deductions if they are able to participate in an employer plan

The idea behind a spousal IRA is that a homemaker married to a higher earning tax payer ought to be able to save for retirement based on his or her spouse’s earned income, even if they have no earned income of their own. Married couples with only one wage earner have a higher income cap on IRA deductions than couples where both workwork and are eligible.  The spousal IRA is available to married couples with adjusted gross incomes under $188,000 in 2013 and $191,000 in 2014 if the working spouse is covered by another retirement plan.  There is no income limit on the IRA deduction if neither spouse is covered by a company plan.

The reason why a deductible IRA can be better than an unmatched 401(k) contribution is that the fees in an IRA trend to be lower than on a 401(k), and with a wider range of investments available, there are more low cost investment options. Asset allocation and cost control are among the most important factors in building wealth over time.

Unmatched 401(k) Contributions

Additional retirement savings after the spousal IRA has been funded (or is not available) should go into a 401(k) or similar plan, even if no match is available. The primary advantage to continuing to fund the 401(k) comes from being in a different tax bracket in retirement – it allows money to be put aside now with a net tax rate around 44% and later withdrawn with a marginal rate that’s likely to be below 30%.

Nondeductible IRA with Roth rollover

Roth IRAs were created as a vehicle to help people who expected to be in a higher tax bracket during retirement.  Money goes into a Roth IRA after taxes, and comes out tax-free during retirement.  The principal of a Roth can also be withdrawn tax and penalty free at any time.  This makes it an ideal investment vehicle for a lower wage-earner who may need some of the money before retirement.  Its main advantage to a doctor or other high-earning professional is the growth each year is not taxed.  This means that its still usually a better option than a taxable account.

Technically, high-income taxpayers are not allowed to contribute to a Roth IRA.  The income limit to contribute prohibits Roth contributions for taxpayer with an AGI at or above $188,000 in 2013 for a married couple, but there’s a catch.  Taxpayers can contribute to a traditional IRA at any income level, they just lose the deduction if their incomes are too high.

There has been a substantial loophole surrounding Roth IRA conversions since 2010.  Previously, higher-earners were barred from contributing to a Roth or converting a traditional IRA to a Roth.  This means that a doctor or other high-earner who doesn’t have other balances in a traditional IRA can fund one with a non-deductible contribution, and immediately convert it to a Roth IRA, tax-free. 

Other Tax Advantaged Savings Options

Once contributions to retirement  accounts have been maximized, there are many other options that provide some tax advantages, each with their own rules and benefits.  Some options include:

  • College savings plans for children and other relatives
  • Municipal bonds or municipal bond funds
  • Annuities and similar products

Conclusion

Investors should not let tax consideration rule their investment decisions, but when the amount of money as available to invest is less than the available limits on tax advantaged around, choosing the right account types to invest in can yield significant savings.

 

Categories
Federal Income Tax

Marriage, Income Tax, and Obamacare

Living together for an extended time without marriage is an increasingly popular choice in Maine, but the decision to marry or not to marry can have significant financial consequences.   Marriage in the United States provides a number of economic benefits that couples don’t get when they choose to start and raise families as legally single people living under one roof.  These benefits can include income tax savings, access to additional social security income, and insurance savings.  Younger couples may reap financial aid benefits if attending college, and families who have accumulated some wealth may save money on estate tax or administrative costs.  Without the benefits of a legal marriage, Mainers who choose to co-habitate are likely to grow poorer over time than than their married counterparts, but there are some major exceptions to that rule.  This post will focus on the tax effects of remaining unmarried.

The tax effects of marriage can break either way, but, but they tend to be favorable.  The bottom tax brackets for married couples filing jointly are twice as wide as the brackets for single people.  The limits for most deductions and credits are also twice as high for married taxpayers filing jointly.  If both spouses have the same income, their taxes filing jointly are generally no worse than if they not gotten married, but if one spouse earns much more than the other, being married will usually yield a lower tax.  In extreme cases, the difference might be over ten thousand dollars for a high earner and a homemaker.   However, there are circumstance when the opposite is true.  When there’s a child involved, social security benefits, or another complicating factor, staying single may provide an edge over being married.

When incomes are unequal, marriage provides the greatest benefit.  This is because the higher earning spouse gets to make use of the higher married-filing-jointly  tax brackets and credit phase outs that would otherwise been wasted.  Consider a family whose only income comes from wages, and who earns the median family income for Auburn, Maine of about $41,000.  We’ll keep things simple by also having them take the 2013 standard deduction of $12,200.    Whether this income is earned by one spouse or earned equally by both, the taxpayers would pay a total of $2,261 in tax if filing jointly.  If they were not married and each filed their own returns, the split of the income would matter.  Two single taxpayers, each earning $20,500 would pay $1,133 each – basically half of the married couple’s tax.

Where they start to run into trouble is when they don’t both earn the same income.  If once spouse earns all of the money and the other is a homemaker, the earner faces a tax bill of $4,208.  When everything else about the couple remains the same, the decision not to get legally married costs them about $2,000 in unnecessary federal tax.  

If the couple has a child and the  earner qualifies as a head of household, he or she can use different tax brackets, and the  tax after considering the child tax credit drops to $2004.  If that same couple were married, they would receive both the child tax credit and the earned income credit, which would bring their net tax all the way down to $349.  This means that an unmarried couple with these facts would be giving up $1,650 in tax savings by raising a family and choosing to avoid marriage.

As I mentioned previously, the tax effects of marriage can break either way.  Consider a family with both adults working at a job that pays perhaps a little over $10 per hour, but which doesn’t give quite 40 hours a week.  This family might still earn $41,000, but that amount is now split evenly.  If they are not married, then only one gets to claim the child and file as a head of household.  That taxpayer would have both a refundable child credit and the earned income credit, for a net refund of $3,109 plus any amounts they might previously have had withheld during the year.  Their significant other would still be paying $1,133 as shown in one of the earlier examples above.  This family would have a net tax benefit, not cost, of about $2000, instead of the $350 they would have paid if they were married.  From a pure income tax basis, they would come out ahead, and that’s before factoring in the Affordable Care Act and the related tax credits.

Marriage and Obamacare

The unmarried couple where both adults earn $20,500 and have one child comes out ahead of a married couple when it comes to figuring their net tax or credit, but that’s before considering Obamacare.   If both adults were age 26, they would have an affordable care act premium around $5,792, and a tax credit of about $3,066 to drop the cost of health insurance down to $2,726 for the year.

Here’s what it would look like if they weren’t married.  The adult without the dependent would pay $3,251 for a silver-level plan, get a credit of $2,163 and have a net premium of $1,088.  The adult with the dependent would pay $5,266 for a year of health insurance, but would receive a tax credit of $4,856, bringing the cost down to just $410.  The net cost of insurance for this unmarried couple would be a mere $1,498.  That’s over $1,200 less than than if they were married.

For the couple with a child who both earn about 20,500, the cost of being married, after factoring in Obamacare, would be about $3,200 compared to staying single.

Similarly, the Affordable Care Act would amplify the price of remaining unmarried for the couple with uneven earnings.  Obamacare does not include a tax credit for individuals with no earnings, so there would be no tax credit for the homemaker.  He or she would pay $3,251 for health insurance with no tax credit.   The adult with the earnings and dependent would pay $5,266 for health insurance and have a tax credit to bring that down to $3,471.  Their combined premiums as an unmarried couple with a child would be $6,722.  That’s about $3,000 more than if they were married.  For the unequal earners, the total cost of staying single, including income taxes and lost ACA subsidies would be  around $4,700.  For the example of uneven earners without a child, the total difference would be around $5,000.

Summary

Few people base the decision on whether or not to marry on financial considerations, nor should they.  However, the financial impact of that decision can be significant and should not be overlooked.  The financial impact of choosing to marry or not has been amplified by the Affordable Care Act.  Generally, marriage has better tax and ACA subsidy effects for couples who have uneven incomes, and staying single is sometimes the better financial decision for couples with similar incomes and children.  There are also social security and other considerations, which will be topics for a different post.

This post is meant solely to provide information and is not a substitute for individualized advice, no matter how close any of the examples may be to a reader’s own tax situation.  When you are dealing with a complex tax question, there’s really no substitute for working with a qualified tax professional.  

Resources

These examples were developed using the Kaiser Family Foundation’s affordable care act calculator located at http://kff.org/interactive/subsidy-calculator/.  

The tax calculations were preformed using Drake Tax Software.