Tax Info Blog

We're Back Up!

One of my sidebar widgets has been crashing the page for the past couple of days, as many of you no doubt have noticed.  The widget has been removed, which seems to have solved the problem.  Thanks for your patience, and I'll have this week's post up later today.

Day Care Expenses of A Sole Proprietor

Q: My wife is a sole proprietor.  Can she deduct our day care expenses as a business expense, or are we limited to the dependent care tax credit?
Ray

A: Those not familiar with my posts on sole proprietors and the day care credit should read them first.

I'm afraid you're stuck with the conventional child care credit.  It's only C-corporations that can have the company pay for the care or offer a potentially more lucrative fringe benefit.  You can't get around the fact that this is not considered an ordinary and necessary business expense, but rather a personal expense.

E-filing Now Six in Ten Returns

The IRS reports today that e-filing is way up, which is good news all around.

• 88 million tax returns were e-filed, up 12% from 2007
• This represents 60% of all returns that were filed
• Free File, tax preparer, and self-prepared e-file were all up

Hold Onto Those Home State Munis

Investors already probably know that municipal bonds are usually free of federal income tax (even under AMT, unless the interest is derived from "private activity bonds" like sports facilities). States often don't tax municipal bond interest from their home state. Now the Supreme Court has upheld that practice.

What does this mean for investors? It pretty well locks in the favorable tax treatment at both the federal and state levels. With the possibility of rising tax rates on capital gains and dividends, this Supreme Court decision makes munis a more favorable investment over time.

Example

Consider a world with a 40% + 5% combined federal-state marginal tax rate (including on dividends), and a 20% + 5% capital gains tax.  Let's say you have a home-state muncipal bond with a yield of 4% and a stock that has a dividend yield of 2% and price appreciation of 7%.

Hey, no brainer, right?  The stock will get you over twice the return (9% vs. 4%).  Now let's look at the tax effects.

The muni bond's after-tax rate is the same as before: 4%.

The stock's 7% price appreciation will be nicked by 25%, and the stock's 2% dividend yield will be nicked by a whopping 45%.  Do the math, and that's an after-tax return of 6.35%.

The advantage of the stock has gone from over twice as much to only about 150% as much.  And the stock risk is the same as before.

This is why taxes matter in investment decisions.   

2009 HSA Limits Announced

The IRS released the 2009 HSA limits today.  Here are the new levels:

• Contribution Limit: $3000 ($5950 family)
• High-Deductible Health Plan Minimum Deductible: $1150 ($2300 family)
• Out-of-Pocket Maximum: $5800 ($11600 family)
• Over 55 Catch-Up Contribution: $1000 ($2000 if both spouses age 55 or older)

Most HSA plans have a deductible of at least $1200 single/$2400 family, so this shouldn't affect too many people.  The extra contribution amount is yet another incentive to save more tax-free for future health needs.

Depreciating Leasehold Improvements

Q: What happens if I'm leasing a business space, and make an improvement on it?  Can I get any sort of tax deduction for it?

A: Yes, assuming Congress extends this currently-expired "leasehold improvement" rule by the end of the year.  If you rent a business location and make an improvement to it (say, a new carpet), you can elect to depreciate the improvement over 15 years (instead of the 39 years you would have to for other non-residential business real property improvements).  The straight-line method must be used, usually with the half-year convention.

The improvement must be made by either the lessor or the lessee.  The area must be exclusively for the use of the lessee.  It has to happen at least three years after the overall building is placed in service as a business asset.  Additions, elevators and escalators, common area improvements, and structural improvements are not allowed.  Transfers to new owners have complicated rules.

IRS Releases FAQs on Stimulus Rebate

I've been getting quite a few questions about the stimulus rebate, so hopefully this new FAQ from IRS.gov will be a good resource.

Lifetime Learning Credit and the Economic Stimulus Payment

Q: Will a non-dependent who claims the Lifetime Learning Credit be eligible for the economic stimulus payment?
Rocky

A: Yes, assuming that the taxpayer is otherwise eligible.  Consult my post on this for eligibility rules.

Home Office Deduction for Partners and S-Corporation Owners

Q: What's the difference in the home office deduction for general partners and S-corporation owners?
Bonnie

A: Readers should first consult my posts on the home office deduction, partnerships, and S-corporations.  There are two very different treatments, indeed:

1. General partners can take a home office deduction as an unreimbursed partnership expense (UPE) on page 2 of the Schedule E, if they are required to do so under the partnership agreement.  Be sure to attach Form 8829, home office deduction.
2. S-corporation owners are considered to be employees of the S-corporation.  For them, the home office deduction is an unreimbursed business expense, and must be taken as an itemized deduction on Schedule A using Form 2106.  These expenses are considered to be miscellaneous itemized deductions, and as such are subject to the 2% of AGI haircut, the Pease phaseout, and a total AMT disallowance.

Ouch.  So how to make things more palatable for the S-corporation owner?  Simply have the S-corporation reimburse the owner for business use of the home under an accountable plan.  If 10% of the home is business use, have the S-corporation pay for 10% of costs that would be allowable as a home office deduction.  It's a straight deduction from S-corp profits.

The owner will have to then reduce the deduction he takes for mortgage interest and property taxes, and keep track of the depreciation on his home (for recapture upon sale).

Stimulus Payment and Railroad Retirees

Q: Does "Tier 1" railroad retirement income count toward "qualifying income" for the stimulus payment?
Nancy

A: If you need to know what the economic stimulus payment is, click here.

"Tier 1" railroad retirement income is (roughly speaking) the equivalent of Social Security for people who work in the railroad industry (why they weren't just looped into everyone else's Ponzi scheme--err, I mean "retirement plan"--is beyond me).

The IRS has a handy Q&A on their website.  In it, you will find that Railroad Retirement Income is, indeed, qualifying for the credit.  Of course, you have to file a tax return for 2007.