Richard J. Harris, CPA – Newport Beach, CA

I was just reading about a new thing called Health Savings Accounts.  What these accounts do is allow a self-employed person or someone working for a smaller employer to have less expensive health coverage.

 

These Health Savings Accounts (also called Archer MSA’s) have two facets.  The first thing needed is a high deductible health insurance policy.  The second need is to open a HSA (which is tax sheltered just like an IRA.)  An HSA can be funded by individuals to the tune of up to $3,050 and up to $6,150 for families. 

 

The HSA contributions are “pre-tax”, meaning they are deducted from one’s gross wages before computing taxes – just like an IRA.  Also like an IRA, the account earnings are not taxed.  When withdrawals are made the amounts are not taxed if used for qualified medical expenses. 

 

The experience of some HSA families has been savings of around $3,100 per year.  This savings is due to the higher deductible amount being assumed by the insured.  A nice bonus is that the annual savings goes a long way in covering the plan contributions needed to keep the account “topped up” to the maximum limit mentioned above.

 

The people who benefit the most from HSA plans are individuals and families that enjoy generally good health.  Now they can better afford coverage against catastrophic health problems without suffering under the burden of high cost, low deductible health plans.  One problem in switching to a high deductible plan is it may not be possible for those with preexisting conditions such as cancer or diabetes.

 

While the HSA’s have been criticized for taking healthy people out of the health insurance pool, those enjoying good health are now rewarded for their stay-healthy live styles.

Rick Harris Good Advice Income Tax Advice, personal money management

Since many of us have children ready, in or just out of college, I wanted to discuss the income tax deductions available for educational expenses. 

The following is meant to be generally informative.  This area of taxation law is both confusing and complicated.  Please call or come in to see me with your questions.  Or, if you really want to go straight to the source, down load Publication 970 at www.irs.gov. 

Child & Dependent Care Credit: 

A nonrefundable credit is allowed for a portion of qualifying child or dependent care expenses paid for the purpose of allowing the taxpayer to be gainfully employed. 

How this relates to education expenses is that pre-school expenses incurred when both parents work qualify for this credit.  Additionally, after school and summer programs may also qualify for children under age 13. 

Also of note here, if your dependent or spouse is disabled and can not care for themselves, care costs may also be counted toward this credit. 

Scholarships and Fellowships: 

A scholarship or fellowship is tax free only if you are a candidate for a degree at an eligible institution and the money is used for qualified education expenses. 

• Candidate for a degree – attend a primary or secondary school or are pursuing a degree at a college or university, or are attend an accredited educational institution that is authorized to provide a program that is acceptable for full credit toward a bachelor’s or higher degree, or a program of training to prepare students for gainful employment in a recognized occupation.
• Eligible institution – is one that maintains a regular faculty and curriculum and normally has a regularly enrolled body of students.
• Qualified education expenses - are expenses for tuition and fees and course related expenses such as fees, books, supplies and equipment.  These expenses must be required of all students in your course of instruction. 

Other Types of Educational Assistance: 

• Fulbright Grants – are generally treated as scholarships
• Pell Grants & Other Title IV Need-Based Grants - are generally treated as scholarships
• Payment to Service Academy Cadets - are fully taxable
• Veteran’s Benefits - received for education, training or subsistence are tax free
• Qualified Tuition Reduction - if provided by an eligible educational institution to one of its employees can be tax free. 

There are two tax credits available in regards to educational expenses – the Hope Credit and the Lifetime Learning Credit. 

Hope Credit: 

Using the Hope Credit you may be able to claim credits up to $1,800 per eligible student for qualified education expenses.  (Note the “may be able” phrase – there are income and other limitations and other qualifications that must be met for this credit.) 

• Eligible student - an eligible student has to have not used the Hope Credit in the last two years, is either a freshman or sophomore, is at least a half-time student and does not have a felony drug conviction.
• Qualified education expenses - are tuition and certain related expenses paid for yourself, your spouse or a dependent. 

Also regarding the Hope Credit – there is a whole bunch of small print, exceptions and provisos, so come to me with specific cases and questions. 

Lifetime Learning Credit: 

Lifetime learning credit qualifications are almost the same as those for the Hope Credit.  Generally, a student eligible for this credit is not limited to freshmen and sophomores.  This lack of limitation means that an eligible student with qualified education expense can always take the Lifetime Learning Credit of up to $2,000. 

Student Loan Interest Deduction: 

There is a special deduction allowed for paying interest on a student loan.  This deduction hit a maximum of $2,500 in 2008. 

• Student loan interest - includes interest and loan fees and origination fees.
• Qualified education expenses - are tuition and fees, room and board, books, supplies and equipment and other necessary expenses – such as transportation.
• Qualified loans – are from loan sources other than related personal or qualified employer plans. 

Note the inclusion of loan fees and origination costs above.  This is new and you may want to call your loan company and ask if your loan includes these costs.  And, if these costs are big enough to warrant doing so, you may amend prior year’s tax returns and get a refund. 

Cancellation of a Student Loan: 

Normally cancellation of a debt is taxable to the amount of forgiven debt.  However, cancellation of a student loan may not be income.  To qualify for this exclusion the following two requirements must be present. 

The loan must contain a provision that it may be cancelled if you work for a certain period of time in certain professions and for any of a broad class of employers.  And, the loan must be from a qualified lender to assist the borrower in attending an eligible educational institution.

• Qualified lenders - include the federal, state or local government; certain tax-exempt public benefit corporations; an eligible educational institution (with certain provisions) or a Section 501(c)(3) organization
• Eligible Educational Institutions – are educational institutions that maintain a regular faculty and curriculum and normally has a regularly enrolled body of students in attendance. 

Tuition and Fees Deduction: 

The Tuition and Fees Deduction can reduce the amount of your income subject to tax by up to $4,000.  This deduction may be beneficial to you if you cannot take either the Hope or lifetime learning credit because your income is too high. 

Generally, you can claim the tuition and fees deduction if all three of the following requirements are met:

 You pay qualified education expenses of higher education

• You pay the education expenses for an eligible student, and
• The eligible student is either yourself, your spouse or a dependent for whom you claim an exemption on your tax return 

Who can not take this deduction – those filing as married, filing separately; another person can take you as a dependent; your adjusted gross income is over $65,000 for singles or $130,000 for married filing jointly; you are a nonresident alien or you took the Hope or lifetime learning credit.  (Note: The income levels are the starting amounts for a faze out of the deduction.) 

Coverdall Education Savings Account (ESA): 

You may be able to establish a Coverdell ESA to finance the qualified education expenses of a designated beneficiary.  Total annual contributions can not exceed $2,000 and the beneficiary must be under 18 years of age. 

Note that the contributions are not deductible, however the account income is tax free. 

Note also that the benefit applies not only to higher education expenses, but also to elementary and secondary education expenses. 

Qualified Tuition Program (QTP) aka Section 529 Plans: 

State may establish and maintain programs that allow you to contribute to an account for paying a student’s qualified education expenses.  These Section 529 plans are often used by grandparents as a way to distribute fairly large amounts of their estates to their grandchildren.  Talk to your financial advisor as too which state’s plan best suits your needs.  

Note that you may contribute to a QTP plan and to a Coverdell ESA in the same year for the same beneficiary. 

Education Savings Bond Program ( EE Bonds ): 

One of the longest standing education expense benefits are the U.S. “EE” Savings Bonds.  These bonds are purchased at half their face value and the interest accumulated tax free.  If the bond proceeds are used for qualified education expenses and certain income limits are met, the accumulated income is not taxed.  These bonds are safe and secure and may be purchased in small denominations.  Ask the relatives to skip the usual birthday and Christmas presents, and instead give an “EE” bond instead.  Sure it’s boring, however, just how may Barbies do your kids need anyway? 

Employer-Provided Educational Assistance: 

If you receive educational assistance benefits from your employer under an educational assistance program, you can exclude up to $5,250 of those benefits each year from your Form W-2 income.  Note that the educational expenses must be incurred for the benefit of the employee, not their dependents.  Ask your employer is these benefits are available.  If your employer does not have a qualified plan, ask them to establish one.  Not only are the employer contributions not taxed to you, your employer does not pay employment taxes or workman’s compensation insurance on the contribution amounts.  These benefits are will worth the cost and effort for setting up the plan. 

Business Deduction for Work-Related Education: 

Work related education expenses can be deducted if you itemize your deductions, if an employee or file Schedules C or F, if self-employed and have qualified work-related education expenses. 

Qualified Work-Related Education expenses must meet at least one of the following tests: 

• The education is required by your employer or the law to keep your present salary, status or job.
• The education maintains or improves skills needed in your present work 

However, even if the education meets one of the above tests, if is not qualifying if: 

• The education expenses is needed to meet the minimum educational requirements of your job
• The education expense qualifies you for a new trade or business

Rick Harris Income Tax Advice Income Tax Advice

The Long & the Short of It – In any one calendar year you are allowed to give business gifts of $25 per person.  Note also that gifts to, say a client’s wife, are imputed to that client.  Also, if you and your wife are in business together, the $25 limit is shared by both you on a per client basis.

 

In the “not gifts” category are those free pens with the company name and logo.  (That is as long as the pens don’t cost you more than $4.00.) 

 

Also note that any item that can be considered either a gift or entertainment, is generally considered as entertainment and subject to the 50% rule. 

 

If you give a customer tickets to an event it can be treated as either entertainment or a gift.  If you take a customer to an event, it is considered entertainment and subject to the 50% rule.

 

When is a gift not a gift?  Answer, when it’s Advertising and Promotion.  Example – trade show give away items.

Rick Harris Income Tax Advice Income Tax Advice

You may deduct business-related entertainment expenses (if both ordinary and necessary) for entertaining clients, customers or employees.  There are two tests:

 

Directly Related Test    1.) The main purpose was the active conduct of business.   2.) You actually discussed business .   3.)  You had more than a general expectation of benefiting business-wise.

or,

Associated Test   1.)  The entertainment was associated with the active conduct of your trade or business.  2.)  And, directly before or after a substantial business discussion.

 

As has been the case for the last several years, only 50% of your entertainment expense is deductible.  Also of note is the rule that the expense can not be lavish or extravagant.

 

Additionally, a “clear business setting” rule must be met.  Examples of non- “clear business settings” are nightclubs, theaters, sporting events, cocktail parties and meetings that include persons who are not business related people – such as spouses, other golfers, etc.

 

Lavish or Extravagant Expenses.  (Quoted from IRS Pub. 463)  You can not deduct expenses for entertainment that are lavish or extravagant.  An expense is not considered lavish or extravagant if it is reasonable considering the facts and circumstances.  Expenses will not be disallowed just because they are more than a fixed dollar amount or take place at deluxe restaurants, hotels, nightclubs or resorts.

 

Entertainment Expenses That Are Not Deductible.  Club dues and membership fees paid to Business, Pleasure, Recreational or Other Social Clubs.  This group includes the likes of Country, Golf, Athletic, Airline, Hotel and Other Clubs.  The bottom line – dues and membership fees are almost never deductible.

 

Seems easy enough.  If only.

Rick Harris Income Tax Advice Income Tax Advice

Thinking of fixing up the old digs?  Doing so may save you some taxes.  Here’s the deal.

 

This thing called ARRA (The American Recovery and Reinvestment Act) Section 25C tells me that if you install new qualifying insulation or exterior windows and doors, metal roofs (including skylights) and various and sundry way efficient heating and cooling systems you can garner yourself up to a $1,500 federal credit.  (Inquire about possible state credits based upon where your home is located.)  Well the dollars aren’t huge, however remember, you will be saving on the monthly utility bills.  And oh-by-the-way, you will sleep the sleep of the righteous and true.

 

Also exciting is ARRA Section 25D. (I live for this!)  Here you are going to get credit for state-of-the-art residential green energy systems such as solar- and wind-generated power systems.  Note too that these credits apply to rental and vacation homes as well.  Some of the systems that qualify are geothermal heat pumps, solar panels, solar water heaters, small wind energy systems and fuel cells.  My buddy who lives up in the Sierras tells me that solar water heaters (he uses them to heat his floors as well) work just fine through most winters.

 

If you’re thinking of building a new home or doing a major remodel, ask your architect about LEED (Energy and Environmental Design) standards and what credits and advantages can be had for “going green.”

 

Let’s talk electric meters.  That thing with all the funny dials that no one knows how to read has been up-dated.  Go digital!  If monitoring how much electricity you’re using impresses you as a good thing, digital is the way to go.  By evening out your electricity usage, your utility bills will go down.  This because the power companies often charge according to the maximum demand made during each billing period.  Lower the maximum and you lower the bill.

 

It’s all good (and green too).

Rick Harris Income Tax Advice energy tax credits, Income Tax Advice

A few of my more astute California clients have noticed that other states have lower or no personal income taxes. A few of my better off clients have homes in several states and foreign countries. If you have or are planning to change your legal domicile, be sure you do it right. And oh-by-the-way, even if you do everything right, the State of California will aggressively pursue taxation of some intangible asset income – such as pension benefits.

If you are involved with a residency audit you will be asked to fill out an extensive questionnaire. Warning! Do not fill out the questionnaire without professional help.

Here’s a check list for establishing a new legal domicile. The list is not complete and not all items need be present to establish residency. Again beware, fulfilling all of the following items will still not guarantee your residency status.

* Sell old residence and buy or lease one in your new state
* Obtain a homestead exemption in your new state
* Move physical assets to new state
* Sever business relationships in old state
* Sell real property and real property investments in your old state
* Close bank and brokerage accounts and open new ones
* Rent a safe deposit box in your new state
* Have an attorney redraft trusts and wills indicating your new residency
* File an affidavit of domicile in new state with the county clerk’s office
* Register to vote in new domicile
* File all tax returns as a resident of the new state
* Register all automobiles in new state
* Cancel your old drivers licenses and get a new ones
* Change the billing address on all bills
* Terminate all church or temple affiliations and establish new ones
* Terminate club memberships and establish new ones
* Join the local library
* Purchase a cemetery plot in new state
* Keep a log of time spent in your new state, in your old state and on vacations
* Try not to use credit cards when in your old sate
* Talk and dress like the locals. If you are moving to Idaho, buy at least two automatic
weapons. If moving to certain areas of Arizona, buy and carry a six shooter.

Rick Harris Income Tax Advice Income Tax Advice, state residency

People are living longer than ever. What this means for a healthy, active person is whether they think they can outlive the average life expectancy for their age group. If you are willing to gamble that you will do just that, postponing your Social Security benefits until age 70 may return substantial benefits.

Say you were born in 1950. If you take SS benefits at age 62 you will receive about $1,600 per month. Waiting until age 66 gets you $2,200 and at age 70 you get $3,000. After doing all the fancy calculations and estimations, it looks to me that around age 82 those who postponed their benefits until age 70 will have already won on the bet. Living longer than age 82 (not unusual as far as I can see) will garner you substantially more money that if you had taken the money at age 62 and ran to the bank.

The bottom line – if you feel good and feel lucky, wait to draw your Social Security.

Rick Harris Retirement Advice Income Tax Advice

Thank you for visiting rjharriscpa.com, the website of Richard J. Harris, CPA. This site will provide my clients with quick answers to common tax related questions and issues as well as keep you up to date on all news related to your personal and business income tax needs.

Rick Harris Uncategorized Income Tax Advice, Money skills, personal money management