For 2013 the standard mileage rates have been increased.
For business miles the deductible mileage rate is 56.5 cents per mile for business miles driven. For medical purposes the rate is 24 cents per mile and for charitable purposes it remains the same at 14 cents per mile.
This once cent per mile increase or about half a percent in business and medical mileage rates come after 2012 which was the year we saw the highest percentage increase in gasoline prices in history. Over the past 4 years gas prices have increased more than 100% while the mileage rate has decreased 2% from the 58.5 cents at the end of 2008.
For those who pay per diem rates or receive per diem rates for reimbursement of expenses while traveling rather than have an accountable plan for those reimbursements, the standard rate for lodging is $77 and for meals and incidental expenses is $46. As a typical practice most businesses I am familiar with pay lodging expenses directly and pay the per diem for meals and incidental expenses. The $46 is the standard rate and is often used as a company standard, but most locations have a rate specific to that location which you can use when traveling to those specific locations. You can find rates by location at:
For travel OCONUS (Outside the Continental US) the rates are set by the State Department and you can find those rates at:
Congress has once again waited until the last minute to pass a tax law which has supposedly saved us from falling off a fiscal cliff. And it is supposed to get the wealthy to pay more of the burden. Since we have a new law, I should mention it here and will probably mention in a couple of future posts as well, but right now I want to point out who really gets to pay more taxes. There are some increases on the wealthy, but the fact is that there is pretty much nobody who will not suffer an increase. I thought it would be a good idea to take a look at how those of us with normal incomes will fare with the new tax law. Here are a few illustrations from the Tax Policy Center.
1. Single Unemployed person with an Income of under $10,000. You will pay taxes at a rate of 6.9%. This is a 20.9% increase in your taxes.
2. College Student with income of $10,000 to $20,000. You will pay a rate of 6.4%. This is a 14.7% increase.
3. Lower income working couple with an income from $20,000 to $30,000. You will pay only 1.3% of your income in federal taxes. But this is a 446% increase. Yes, really. This is an income level which has generally paid nearly no taxes.
4. Retiree with $30,000 to $40,000 income. You will pay 40%. That is up 5.1%.
5. Higher income earner making about $150,000. You will pay about 22% in taxes which is up about 6.5%
6. High income family making $350,000. Your tax rate will be 25.6% which is an increase of about 3.9%.
7. Very High income with income above $1 million. The tax rate is 38.50 providing a 15.5% increase in taxes.
So what we see is that the very rich get a hefty increase and it will no doubt be a lot of money to those individuals. But those of us at all income levels will suffer an increase and despite the rhetoric, those of us hit hardest from a percentage viewpoint are those of us in the lower income brackets.
I am a big fan of planning for the future and when new children are born we often think more about planning for their and our own future. I want to discuss the possibilities of 529 plans (usually called qualified tuition programs by the IRS) as part of that planning. 21 percent of all Americans have taken some college courses. Where I live the percentage is among the highest in the country at over 50%. Right now 63% of high school graduates go directly to college. A substantial number of people are now going to college well after high school. So there is a fairly high chance that one or more of your children or grandchildren will participate in some level of higher education.
We all know that college costs are unreasonably high and to pay for college you should do some advance planning. While there are many ways to put money aside for college, there are few as versatile as 529 plans.
The basic concept is simple. You put money in this plan which earns income tax free . The plan is for the benefit of a specific individual. Here are a few of the benefits of 529 plans:
• Funds earn income tax free.
• Distributions are not taxable as long as they are used for the beneficiary’s qualified educational expenses
• There is a state tax deduction when the contribution is made in many states.
• The funds remain in your name and under your control.
• If the beneficiary gets scholarships, you may transfer the funds to a different beneficiary like a sibling or a different grandchild. If the beneficiary gets scholarships you also have the option of withdrawing the funds and paying tax on them but no penalty.
• If the beneficiary does not go to college, you may transfer the funds to a different beneficiary, or continue to save it for the beneficiaries children, or cash it out and pay taxes but no penalty as mentioned above.
• If the money is put in a plan by a grandparent who controls it, when the child is 18 and has to fill out financial aid forms, the FAFSFA forms do not require them to list the 529 as a resource. (It may be required for some other programs or applications).
• You can contribute up to $13,000 per person for each beneficiary each year up to a total of $100,000 to $335,000 or up for each account depending on your state.
• Anyone can contribute to the account.
• There are no income limitations.
So you can see there are good reasons to put some of the funds you were planning on saving anyway into 529 plans for children or grandchildren and in several cases it may be even more advantageous for grandparents to put money into 529 plans than parents. If you think there is a chance your any of your children or grandchildren may go to college, you should consider several options for saving and paying for their college with 529 plans taking a high priority in those options.
Newt Gingrich also released his tax returns recently. His returns are slightly more interesting to look through than Romney’s even though they are much simpler and he is not nearly as rich as Romney. He is still very rich and has a much larger income than most of us can ever expect.
Newt’s revelation that his first name is Newton is nowhere near as interesting as Romney’s first name revelation. Newt pays a tax rate of 32%, more than double Romney’s, but Newt’s company is owned by Newt and pays no income taxes on its own. All it’s income flows through and is taxed only once directly to Newt, whereas Romney’s company is taxed at both the corporate and individual levels.
Newt’s tax returns are fairly simple and he does not appear to take too many aggressive tax positions. Except one. His corporation is an S corporation and most of the income of the corporation is related to personal services of Newt and his wife. He takes what you and I think is a substantial salary from the corporation of about $252,000. He also paid taxes on the $2.5 million of income the corporation had. But he effectively avoided paying 2.9% in medicare taxes on the income of the corporation. The IRS states that an S corporation for which most of the gross receipts and income are related to personal services of the owners should pay most of the profit as salary rather than have it taken as income avoiding the 2.9% medicare tax.
This issue has been the subject of numerous audits and several tax court cases and the IRS has prevailed consistently. This is the one issue that opens Newt up to audit and a potential significant liability. Newt did take distributions from the corporation of around $2.5 million during the year, so he cannot argue that the corporation needed to retain those profits to help in building the business. This indicates that the IRS could argue that Newt underpaid his federal income taxe liability by about $72,500 plus penalties and interest.
Newt’s tax advisors are good accountants and argue that this is a perfectly legal method of accounting for Newt’s income and taxes. It may be. Many tax preparers and businesses use similar tactics although I have rarely seen the difference between salary and distributions as significant in a high income taxpayer. And it would be unusual for a situation where the largest part of the income of the business is derived from personal services of the owner to have such a significant difference. It has been my experience that the IRS has become much more aggressive on this issue in recent years. It would be interesting to see Newt take this to tax court and find out how they would rule in a high profile case.
When income tax returns are released by political figures it is always interesting to look at what is in them and what the press says about them. I thought it might be interesting to comment on some of these returns when they are released and if it generates interest I may comment on past releases of tax returns.
Mitt Romney’s return was recently released and there were remarkably few surprises. The biggest surprise was the revelation that his first name is Willard. We heard a lot of complaining from the press that he is paying only around 15% in taxes when the top tax rate is closer to 39%. We discovered that Mitt pays around a 14% federal income tax rate, but we knew it was around 15% already. In fact that 14% rate is somewhat deceptive. Much of his income (around 20%) is from dividends from corporations which pay taxes at a 35% rate. The media never points out that his effective tax rate on that portion of his income is closer to 49%. He also had about half of his income in capital gains which was also previously taxed at the corporate level. In a Wall Street Journal OpEd article on January 24, 2011, John Berlau and Trey Kovacs computed the effective tax rate paid on this income as totaling 44.75%.
We discovered Mitt was very wealthy, but we knew that also. His investments were very profitable for the past couple of years.
We discovered he has a lot of investments, some of which are foreign. Nothing there which is unusual for a very wealthy person. We also discovered that even though he has a 200+ page income tax return and some forms that most of us tax preparers have never seen in use, it is a reasonably simple and conservative tax return. He does not take aggressive tax positions.
The IRS has become more and more strict over the last few years regarding what can be deducted for charitable contributions. Here are a few tidbits of information you need to be aware of when planning your charitable contributions and when you get your charitable contribution information together for your tax returns.
• The organization must be a “qualified” charity. There is a list which can be found on IRS.gov in IRS publication 78. Churches, synagogues, temples, mosques and government agencies are eligible even if they are not listed.
• Donations in cash may be deducted IF you have a bank record or a receipt from the charity. Small amounts put in collection plates or donation jars or buckets cannot be deducted unless you have a receipt or a cancelled check.
• Donations of over $250 must have a receipt from the charity. A cancelled check is not enough.
• For donations of property you must maintain a written record of what the property is, its condition, and the name of the charity and the date, along with the fair market value at the date you gave it. You should get a receipt from the charity as well. There is a good worksheet to use on the forms page on my website http://johngallocpa.com/forms/.
• If your contributions of property exceed $500 you must fill out an additional form to file with your tax return. Form 8283 Non Cash Charitable Contributions.
• If your contributed property is worth more than $5,000, you must also have an appraisal from an appraiser qualified to value that type of property.
• Your time or labor donated to a charitable organization is not deductible.
• Your mileage is deductible at .14 per mile, but you must maintain records and if it is more than $250 you must have a receipt from the charity.
• Items you purchase for a charity must also have a receipt from the charity to be deducted if they exceed $250.
• Vehicles donated are limited to the gross proceeds from the sale by the charity if over $500. You should receive a statement (1098-C) from the charity.
• All receipts from charities must state on them that you did not receive anything of value in return for the contribution, or it is not deductible.
Forbes magazine published a top ten list of the states with the highest individual income tax rates. Hawaii and Oregon were the winners with the highest rates of 11%. California was number 3 at 10.3 percent. The surprise on the list is Iowa at number 4 with a highest rate of 8.98 percent. Finishing out the list is New Jersey, New York, Vermont, Maine, Washington D.C., and Minnesota all with highest individual income tax rates ranging from 8.97 percent down to 7.85 percent.
Since I work mostly in Colorado the top tax rate in Colorado (a flat tax state) is 4.63 percent, well out of the top ten. There are 15 states with a lower income tax rate than Colorado. That puts us in 36th place. There are seven states with no individual income tax and two which tax only dividend and interest income.
Alaska is the most tax friendly state with no income or sales tax.
If you do the comparison of actual tax burden combining income taxes and sales taxes, Colorado has the 15th highest sales tax burden. So if you combine the income tax and sale tax burden Colorado rates 39th. That makes Colorado one of the least “taxing” states.
The average Colorado resident pays $4,011 in income and sales taxes per year.
Economic conditions often dictate that many of us work out or our homes. This creates an opportunity for a home office deduction which could reduce your tax burden if you qualify for it. Usually the home office deduction applies to self employed individuals. Here are some things to be aware of if you think you might be able to take a home office deduction:
The home office must be used in a trade or business activity. It must be used in operations which are intended to be profit making. Usually these operations would be reported on Schedule C or Schedule F of your federal tax return. You cannot take a home office deduction to manage your personal investments or finances.
The home office must be used regularly and exclusively for business. It must be in a separate room or space which is specifically identifiable. You cannot conduct any personal activities within that area. All activities must be business related. The equipment and computers located in that area must only be used for business purposes.
The home office must meet one of the following three qualifications:
1. Principal place of business. That means where nearly all business activity takes place or where the focus of your business activity occurs. It can also qualify as the principal place of business if you have no other fixed location where you conduct administrative activities; or
2. Meet with customers. Occasional meetings or phone calls is insufficient. It should be the place where a large portion of your contact with customers, clients, or patients takes place; or
3. Separate structure. If your home office is a separate structure not attached to your dwelling, it does not have to be the principal place of business or a place where you meet customers.
If you store inventory or product samples the storage space does not have to meet the exclusive use test to qualify for the home office deduction. If your home is used as a day care center, you do not have to meet the exclusive use test. If you are an employee, the home office must be for the convenience of the employer which generally means the employer does not have another place of business where the employee could have an office. If you are an employee the home office deduction is taken via form 2106 and would show up on your Schedule A as an itemized deduction subject to various limits.
Note that even if you qualify for the home office deduction, your deduction may be limited by a variety of factors. In particular it is limited to income from the business prior to the home office deduction.
If your use a vehicle for business, you must keep track of your mileage. It does not matter if you use actual expenses or the mileage rates. You must still be able to document the vehicle was used for business purposes or what percentage was business use. Your business or employer can also reimburse you for business mileage without it being taxable income to you.
If you use the mileage rates the new rates for 2012 will be 55.5 cents per mile. The rates for all four categories of mileage last year and this year are below:
January through June, 2011
July Throuth December, 2011
Jan Through December, 2011
So last year (2011) you must keep track of your business or moving/medical miles as separate totals up to June 30 and after July 1. This happens some years when gas prices increase or decrease and the IRS sees fit to make an adjustment to the mileage rates.
We strongly recommend that you use a mileage log to keep track of your business and non-business mileage. While any method which is accurate, documentable, and is done at the time the mileage is driven is acceptable, the most consistently acceptable method to an IRS agent is a well kept log.
Everyone needs to be aware of a few 1099 related issues this year. If you have a business and you paid more than $600 to any individual, partnership, or sole proprietorship during the you must issue a 1099 form to that person and report the information to the IRS. You must give the 1099 to the person by 1/31/2012 and file with the IRS by 2/29/2012. Failure to do so will cause you to incur penalties starting at $30 per 1099 form which should have been filed and can go to $100 per form.
You must obtain a federal identification number or social security number from the person you paid or will pay money to. You may have to withhold 20% from amounts paid to these individuals or subcontractors, generally if they do not give you their identification number or if you did not previously obtain it and cannot now get it from them.
There are now questions on your income tax return if you have rental property or a business which ask if you should have filed 1099 forms and if so if you did. These questions must be answered truthfully. There are additional penalties if they are not.