Home’s where a tax break might be

If you own a home, the interest you pay on your home mortgage may provide a tax break in the form of the mortgage interest deduction. However, you must itemize deductions on your tax return and follow a few other rules.

Acquisition debt

A personal interest deduction generally isn’t allowed, but one type of interest that is deductible is interest on mortgage “acquisition debt.” This means debt that’s: 1) secured by your principal home and/or a second home, and 2) incurred in acquiring, constructing or substantially improving the home. You can deduct interest on acquisition debt on up to two qualified residences: your primary home and one vacation home or similar property.

The deduction for acquisition debt comes with a stipulation. From 2018 through 2025, you can’t deduct the interest for acquisition debt greater than $750,000 ($375,000 for married filing separately taxpayers). So, if you buy a $2 million house with a $1.5 million mortgage, only the interest you pay on $750,000 of the total debt is deductible. The rest is nondeductible personal interest.

Higher limits on the way

Beginning in 2026, you’ll be able to deduct the interest for acquisition debt up to $1 million ($500,000 for married filing separately), barring any further legislative changes.

The higher $1 million limit also applies to acquisition debt incurred before December 15, 2017, and to debt arising from the refinancing of pre-December 15, 2017, acquisition debt, to the extent the debt resulting from the refinancing doesn’t exceed the original debt amount. Thus, taxpayers can refinance up to $1 million of pre-December 15, 2017, acquisition debt, and that refinanced debt amount won’t be subject to the $750,000 limitation.

The limit on home mortgage debt for which interest is deductible includes both your primary residence and your second home, combined. Some taxpayers believe they can deduct the interest on $750,000 for each mortgage. But if you have a $700,000 mortgage on your primary home and a $500,000 mortgage on your vacation place, the interest on $450,000 of the total debt will be nondeductible personal interest.

“Home equity loan” interest

“Home equity debt,” as specially defined for purposes of the mortgage interest deduction, means debt that is secured by the taxpayer’s home, and isn’t “acquisition indebtedness” (meaning it wasn’t incurred to acquire, construct or substantially improve the home).

From 2018 through 2025, there’s no deduction for interest on a home equity loan unless you use the loan proceeds to buy, build or substantially improve your main home or second home. Other requirements apply. Interest on the home equity loans that are used to pay personal living expenses, such as credit card debts, is not deductible.

More information

Your home is valuable in many ways. Contact us with questions or if you’d like more information about the mortgage interest deduction.

Reconsidering your personal emergency fund

When the COVID-19 pandemic first hit, many people’s emergency funds were suddenly put to the test — if the funds existed at all. Now, about a year later, and presumably with the benefit of some hindsight, you might want to reconsider your savings for a rainy day. You’ve probably heard that, to guard against an emergency, you need to save enough to cover three to six months of living costs. But this rule isn’t as straightforward as it may sound.

An emergency cushion is indeed important — and it’s certainly better to be conservative rather than cavalier when estimating your financial requirements. However, believe it or not, there may be a danger to saving too much in certain vehicles. For example, if you put away substantially more than you’ll reasonably need in a low-interest savings account, you may lose money to inflation over time. Plus, you might miss out on opportunities to invest those funds in tax-advantaged retirement accounts or other assets.

Rather than blindly following a rule of thumb, tailor your emergency savings to your financial situation. A smaller emergency fund may suffice if, for instance, your spouse has a reasonably secure job; you have relatives who can provide financial assistance in an emergency; or you have reason to believe that you’d be able to find other work quickly should you lose your job. Conversely, if you’re the sole breadwinner or you simply have a low tolerance for risk, a bigger emergency fund is likely appropriate. Our firm can help you find the right balance.

Why the child tax credit is so valuable

If you’re a parent, or soon will be, you’re no doubt aware of how expensive it is to pay for food, clothes, activities, and education. Fortunately, the federal child tax credit is available to help many taxpayers with children under the age of 17, and there’s a dependent credit for those who are eligible for older children.

An expanded break

Before the Tax Cuts and Jobs Act (TCJA) kicked in for the 2018 tax year, the child tax credit was $1,000 per qualifying child. But it was reduced for eligible married couples filing jointly by $50 for every $1,000 (or part of $1,000) by which their adjusted gross income (AGI) exceeded $110,000 ($75,000 for unmarried taxpayers). To the extent the $1,000-per-child credit exceeded a taxpayer’s tax liability, it resulted in a refund of up to 15% of earned income (wages or net self-employment income) above $3,000. For taxpayers with three or more qualifying children, the excess of the taxpayer’s Social Security taxes for the year over the taxpayer’s earned income credit for the year was refundable. In all cases, the refund was limited to $1,000 per qualifying child.

Starting with the 2018 tax year, and applying through the 2025 tax year, the TCJA doubled the child tax credit to $2,000 per qualifying child under 17. If you’re eligible, it also allows a $500 credit (per dependent) for any of your dependents who aren’t qualifying children under 17. There’s no age limit for the $500 credit, but tax tests for dependency must be met. Under the TCJA, the refundable portion of the credit is increased to a maximum of $1,400 per qualifying child. In addition, the earned income threshold is decreased to $2,500 (from $3,000 under prior law), which has the potential to result in a larger refund. The $500 credit for dependents other than qualifying children is nonrefundable.

The TCJA also substantially increased the “phaseout” thresholds to qualify for the credit. Starting with the 2018 tax year, the total credit amount allowed to a married couple filing jointly is reduced by $50 for every $1,000 (or part of a $1,000) by which their AGI exceeds $400,000 (up from the prior threshold of $110,000). The threshold is $200,000 for other taxpayers. So, if you were previously prohibited from taking the credit because your AGI was too high, you may now be eligible to claim the credit.

Don’t miss out

The changes made by the TCJA generally increase the value of these credits and widen their availability to more taxpayers. Please contact us for further information or ask about it when we prepare your tax return.

Sidebar: A qualifying child must have an SSN

In order to claim the child tax credit for a qualifying child, you must include the child’s Social Security number (SSN) on your tax return. Under previous law, you could also use an individual taxpayer identification number (ITIN) or adoption taxpayer identification number (ATIN).

If a qualifying child doesn’t have an SSN, you won’t be able to claim the $2,000 (or $1,400 refundable) credit. However, you can claim the $500 dependent credit for that child using an ITIN or an ATIN. The SSN requirement doesn’t apply for non-qualifying-child dependents but, if there’s no SSN, you must provide an ITIN or ATIN for each dependent for whom you’re claiming a $500 credit.

Claiming the home office deduction

Many people have found themselves working from home during the COVID-19 pandemic. If you’re one of them, you might wonder, “Can I claim the home office deduction on my 2020 tax return?”

The short answer is: Only if you’re self-employed. Employees can no longer claim home office expenses, and even self-employed taxpayers must follow strict rules to claim a deduction.

Copious write-offs

If you qualify, you can deduct the “direct expenses” of the home office. This includes the costs of painting or repairing the home office and depreciation deductions for furniture and fixtures used there. You can also deduct the “indirect” expenses of maintaining the office. This includes the allocable share of utility costs, depreciation and insurance for your home, as well as the allocable share of mortgage interest, real estate taxes and casualty losses.

In addition, if your home office is your “principal place of business,” the eligible costs of traveling between your home office and other work locations are deductible transportation expenses, rather than nondeductible commuting costs.

Deduction tests

You can deduct your expenses if you meet any of these three tests:

  1. Principal place of business. You’re entitled to deductions if you use your home office, exclusively and regularly, as your principal place of business. Your home office is your principal place of business if it satisfies one of two tests. You satisfy the “management or administrative activities test” if you use your home office for administrative or management activities of your business, and you meet certain other requirements. You meet the “relative importance test” if your home office is the most important place where you conduct business, compared with all the other locations where you conduct that business.
  2. Meeting place. You’re entitled to home office deductions if you use your home office, exclusively and regularly, to meet or deal with patients, clients or customers. The patients, clients or customers must physically come to the office.
  3. Separate structure. You’re entitled to home office deductions for a home office, used exclusively and regularly for business, that’s located in a separate unattached structure on the same property as your home. For example, this could be in an unattached garage, artist’s studio or workshop.

You may also be able to deduct the expenses of certain storage space for storing inventory or product samples. If you’re in the business of selling products at retail or wholesale, and if your home is your sole fixed business location, you can deduct home expenses allocable to space that you use to store inventory or product samples.

Limitations apply

The amount of home office deductions for self-employed taxpayers is subject to various limitations. Proper planning is key to claiming the maximum deduction for your home office expenses. Contact us if you’d like to discuss your situation.

Consider taxes before moving out of state

With so many people working remotely these days, it’s become common to think about moving to another state — perhaps for better weather or to be closer to family. Many retirees also look at an across-the-border move to better control living expenses. If you’ve found yourself harboring such notions, be sure to consider taxes before packing up your things.

Identify applicable taxes

It may seem like a no-brainer to simply move to a state with no personal income tax, but you must consider all taxes that can potentially apply to state residents. In addition to income taxes, these may include property taxes, sales taxes, and estate or inheritance taxes.

If the states you’re considering have an income tax, look at what types of income they tax. Some states, for example, don’t tax wages but do tax interest and dividends. And some states offer tax breaks for pension payments, retirement plan distributions and Social Security payments.

Prepare for domicile

If you make a permanent move to a new state and want to escape taxes in the state you came from, it’s important to establish a legal domicile in the new location. Generally, your domicile is a fixed and permanent home location where you plan to return, even after periods of residing elsewhere.

Each state has its own rules regarding domicile. You don’t want to wind up in a worst-case scenario: Two states could claim you owe state income taxes if you established a domicile in the new state but didn’t successfully terminate the domicile in the old one. Additionally, if you die without clearly establishing a domicile in just one state, both the old and new states may claim that your estate owes income taxes and any state estate tax.

The simplest and most obvious way to establish a domicile is to buy or lease a home in the new state and sell your previous home (or rent it out at market rates to an unrelated party). Then change your mailing address on passports, insurance policies, and other important documents. Getting a driver’s license in the new state and registering your vehicle there also helps. Be sure to take these and other steps as soon as possible after moving.

Do the research

When looking into whether the grass is greener in another state, do some research and contact us. We can help you avoid unpleasant tax surprises.

What’s your financial personality?

We all want to keep our finances on track, but doing so can be difficult without a clearly expressed plan. Everyone’s strategy doesn’t have to be complex, but it does generally need to cover two major facets: paying down debt and saving money.

If you’re like most Americans, you probably have multiple credit cards, as well as perhaps a mortgage and student loan debt. The inevitable question becomes: Which facet should take priority? Should you pay off your debts first, then focus on saving for the short and long term? Or should you create a cash reserve before you tackle debt? Can you do both at the same time? The answer depends on you and your situation.

Often, the best first step in figuring out how to develop a personal financial plan for saving versus paying down debt requires an honest, introspective look at how you deal with money. Everyone has a financial personality that has developed over time based on factors such as how you learned about money as a child, current occupational status, and risk tolerance.

Think about what you do when you want something you don’t have the cash to buy. Do you buy it anyway using credit, deny yourself the purchase entirely or wait until you’ve saved up the money? Your approach to spending and saving should point the way to developing a sound strategy that balances controlling debt — or, preferably, eliminating it — and building savings.

6 key tax Q&As for 2021

Right now, you may be more concerned about your 2020 tax bill than you are about how to handle your personal finances in the new year. However, as you deal with your annual tax filing, it’s a good idea to also familiarize yourself with pertinent amounts that may have changed for 2021.

Not all tax figures are adjusted for inflation and, even if they are, they may be unchanged or change only slightly each year because of low inflation. In addition, some tax amounts can only change with new tax legislation. Here are six commonly asked (and answered) Q&As about 2021 tax-related figures:

1. How much can I contribute to an IRA for 2021? If you’re eligible, you can contribute $6,000 a year into a traditional or Roth IRA, up to 100% of your earned income. If you’re age 50 or older, you can make another $1,000 “catch up” contribution. (These amounts are the same as they were for 2020.)

2. I have a 401(k) plan through my job. How much can I contribute to it? For 2021, you can contribute up to $19,500 to a 401(k) or 403(b) plan. You can make an additional $6,500 catch-up contribution if you’re age 50 or older. (These amounts are also the same as they were for 2020.)

3. I sometimes hire a babysitter and a cleaning person. Do I have to withhold and pay FICA tax on the amounts I pay them? In 2021, the threshold for when a domestic employer must withhold and pay FICA for babysitters, house cleaners and other domestic employees is increasing to $2,300 from $2,200 for 2020.

4. How much do I have to earn in 2021 before I can stop paying Social Security on my salary? The Social Security tax wage base is $142,800 for 2021, up from $137,700 for 2020. That means that you don’t owe Social Security tax on amounts earned above that. (You must pay Medicare tax on all amounts that you earn.)

5. I didn’t qualify to itemize deductions on my last tax return. Will I qualify for 2021? The Tax Cuts and Jobs Act eliminated the tax benefit of itemizing deductions for many people by increasing the standard deduction and reducing or eliminating various deductions. For 2021, the standard deduction amount is $25,100 for married couples filing jointly (up from $24,800 for 2020). For single filers, the amount is $12,550 (up from $12,400) and, for heads of households, it’s $18,800 (up from $18,650).

So, if the amount of your itemized deductions (such as charitable gifts and mortgage interest) are less than the applicable standard deduction amount, you won’t itemize for 2021.

6. How much can I give to one person without triggering a gift tax return in 2021? The annual gift exclusion for 2021 is $15,000, unchanged from last year. This amount is only adjusted in $1,000 increments, so it typically increases only every few years.

These are only some of the tax figures that may apply to you. For more information about your tax picture, or if you have questions, don’t hesitate to contact us.

© 2020

Business bartering is taxable

During the COVID-19 pandemic, many cash-challenged businesses have bartered for goods and services instead of paying dollars for them. If your company gets involved in such a transaction, remember that the fair market value of goods that you receive is taxable income. And if you exchange services with another business, the transaction results in taxable income for both parties.

A couple of examples

Let’s say a computer consultant agrees to exchange services with an advertising agency. Both parties will be taxed on the fair market value of the services received. This is the amount they’d normally charge for the same services. If the parties agree to the value of the services in advance, that will be considered the fair market value unless contrary evidence exists.

In addition, if services are exchanged for property, income is realized. Say a construction company does work for a retail business in exchange for unsold inventory. The contractor will incur income equal to the inventory’s fair market value.

Barter exchanges

Many businesses join barter clubs that facilitate these transactions. Generally, these clubs use a system of “credit units” that are awarded to members who provide goods and services. The credits can be redeemed for goods and services from other members.

Bartering is generally taxable in the year it occurs. If you participate in a barter club, however, you may be taxed on the value of credit units at the time they’re added to your account — even if you don’t redeem them for actual goods and services until a later year.

By January 31 of each year, a barter club will send participants a Form 1099-B, “Proceeds from Broker and Barter Exchange Transactions,” which shows the value of cash, property, services and credits that they received from exchanges during the previous year. The IRS will also receive this information.

If you join a barter club, expect to provide your Social Security number or employer identification number. You’ll also be asked to certify that you aren’t subject to backup withholding. Unless you make this certification, the club will withhold tax from your bartering income.

Potentially beneficial

So long as you’re aware of the federal and state tax consequences, business bartering transactions can be beneficial. Contact us if you need assistance or would like more information.

© 2020

Are you at risk for investment fraud?

Perpetrators of investment fraud know how to push the right psychological buttons to entice their “marks” to buy worthless or nonexistent securities. You can mitigate your risk by asking a few questions, performing some research and consulting with trusted advisors.

Watch out

Be alert for these common scams:

Pyramid and Ponzi. The con artist promises high returns, often in a short period, yet there’s no actual investment product. Instead, the scheme relies on continually recruiting new participants whose money is used to pay “returns” to earlier participants. As the scheme grows, it becomes increasingly difficult to attract enough new investors and pay old ones. Eventually it collapses and most participants lose everything.

Pump and dump. Fraudsters use false or misleading statements to recruit investors and boost the price of an obscure and usually low-priced stock. When the stock rises to a certain level, the crooks dump their shares and disappear. The stock price plummets, leaving investors with nearly worthless holdings.

Advance fee. These schemes usually target individuals holding a failed investment. A fraudster may offer, for example, to take a losing stock off your hands for an attractive price provided you pay an up-front fee. Once you pay the fee, the thief vanishes.

Look for signs

Be suspicious of investments that offer guaranteed returns or remarkably consistent returns even during turbulent times. Avoid unregistered securities sold by unlicensed individuals or investments that lack documentation (for example, a prospectus).

You can verify a professional’s credentials with the U.S. Securities and Exchange Commission (SEC), the Financial Industry Regulatory Authority (FINRA) and state securities agencies. If you’re tempted to invest with an unknown “broker” or buy an unfamiliar stock, FINRA’s website (finra.org) offers a variety of points to double-check before engaging in the transaction.

Most investments must be registered before they can be sold to the public, so plug the security’s name into the SEC’s EDGAR database (sec.gov/edgar.shtml). Keep in mind that registration alone doesn’t guarantee that an investment is legitimate or appropriate.

Rely on good advice

Ultimately, the best defense against investment fraud is to work with financial advisors you know and trust. If you’ve received a “hot tip,” always run it by at least one trusted advisor before plunking down any money.

© 2020