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ACA Increases Penalties for Uninsured Americans

Millions of previously uninsured Americans have obtained health insurance coverage, thanks to the Affordable Care Act – commonly known as Obamacare. However, many individuals and households remain uninsured. Many of those taxpayers face significant financial penalties from the IRS for failing to obtain insurance under the individual mandate of the ACA – unless they can claim an exemption.AffordableCareAct

The Penalty Wasn’t Really $95 

During 2014, the first year health insurance coverage was required under the ACA, many individuals chose to remain uninsured. They figured that paying $95 as a penalty for failing to obtain and maintain coverage would be far less expensive than the premium for any policy they could obtain. Many people experienced sticker shock when they realized how large their penalties would be.

That’s because the penalty for 2014 wasn’t $95. The actual penalty was $95 for each adult age 18 or over plus $47.50 for each child under 18, with a maximum penalty of $285 — or 1% of the total household income above the threshold for filing federal tax returns, whichever was larger. The maximum penalty for all households was capped at the national annual cost of an individual bronze tier insurance plan in 2014, which was $2,448, regardless of income and household size.

For example, the penalty for a single taxpayer who earned $45,000 in 2014 and remained uninsured for the entire year would be $348.50. That’s the result of subtracting the minimum income for being required to file a federal income tax return ($10,150 in 2014) from $45,000, for a result of $34,850, and then multiplying that figure by 1%. Ouch.

Penalty Increases for 2015 and 2016

afforadable-care-act-penaltiesIndividual mandate penalties for 2015 are even higher, increasing to $325 per adult plus $162.50 per child, for a maximum of $975 – or 2% of household income, whichever is larger. As in 2014, the maximum penalty for all households has been capped at the 2015 national annual cost of an individual bronze tier plan.

Remaining uninsured in 2016 will take an even bigger financial bite out of taxpayers’ pocketbooks. The penalty has been set for a hefty $695 per adult and $347.50 per child, with a maximum per household of $2,085 dollars. As an alternative, the penalty will be 2.5% of household income, with a maximum of the average annual premium of an individual Bronze tier health insurance plan sold through the marketplace. Taxpayers will pay whichever calculation results in the higher penalty.

Exemptions to the Individual Mandate Penalty

Taxpayers hoping to avoid the individual mandate penalty by obtaining health insurance coverage late in the year will most likely only be able to reduce the penalty rather than eliminate it. However, there are a number of exemptions based on personal circumstances and financial hardships that allow some taxpayers to avoid the penalty. To claim total or partial exemptions, taxpayers must file an application with Healthcare.gov. Taxpayers whose applications are approved receive an Electronic Confirmation Number (ECN) to claim the exemption on their federal income tax returns.

Personal Exemptionsexempt-tax-penalty

The list below represents an overview of personal exemptions to the individual mandate penalty. A full list of exemptions is available at Healthcare.gov.Unaffordable Coverage: Lowest-price Marketplace plans exceed 9.5% of adjusted gross income, or employer-provided healthcare plans exceed 8% of AGI.

  • Low Income: Individuals or households with incomes below the minimum threshold for filing federal income tax returns are automatically exempt.
  • Short Coverage Gap: Gaps in coverage of less than three consecutive months are exempt. Taxpayers who purchased coverage anytime during open enrollment in 2014 are also exempt; even they remained uninsured until May 1.
  • Religious Conscience: This exemption is administered through the Social Security Administration.
  • Health Care Sharing Ministry: Members of recognized health care sharing ministries are also exempt.
  • Citizens Living Abroad: U.S. citizens who reside abroad at least 330 days during a 12 month period are exempt.
  • Participants in AmeriCorps State and National, VISTA, or NCCC: Participants with short term program provided coverage or self-funded coverage are exempt.
  • Undocumented: Undocumented residents are not eligible to purchase insurance through the exchanges and are exempt from the penalty.affordable-care-act
  • Incarcerated: Incarcerated individuals are exempt.
  • Native Americans: Members of federally recognized tribes are exempt.

Hardship Exemptions

For most hardship exemptions, taxpayers must file supporting documentation; others are automatic. Some taxpayers who qualify for hardship exemptions may be allowed to purchase catastrophic health insurance policies; others may qualify for a special enrollment period outside of open enrollment. The list below briefly describes hardship exemptions along with required documentation. A complete description of hardship exemptions and relevant forms are available through Healthcare.gov.

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Dealing with Penalties Now – and Avoiding Future Penalties

maxresdefaultThe best way to avoid the individual mandate penalty is to obtain health insurance coverage – either through the Marketplace, an employer or another health insurance plan that meets the minimum guidelines for the ACA. Many taxpayers who obtain insurance through the Marketplace are eligible for tax subsidies that significantly reduce premium payments or provide refundable tax credits. Other taxpayers will qualify for an additional cost-sharing subsidy that can be applied to Silver tier plans to lower the overall cost of deductibles, copays and coinsurance.

Individuals who have questions about their eligibility for tax credits, the individual mandate or any penalties they might owe can obtain assistance through Healthcare.gov.   Specially trained Navigators can also assist individuals one-on-one, either in person or over the phone, with selecting appropriate coverage. Taxpayers facing large individual mandate penalties should consult with an accountant or with an attorney specializing in tax law.

Suffered a Loss Due to Theft or Catastrophe? Uncle Sam Will Give You a Break

Losing your property through theft or catastrophe is tough. If your losses were extensive, you may wonder if you will ever recover.

While nothing can completely negate the effects of a natural disaster or theft, you may be able to get some relief from Uncle Sam. Even if your losses are greater than your income for the year, you might still qualify for a tax break.

Determining Your Loss

During the past year a hurricane or tornado blew through your town and pretty much leveled everything. Fortunately you and your family were all right, but you lost everything. And you have insurance, but your policy only covers the fair market value of your items.

The fair market value means you’ll only get the depreciated value of your items rather than what you paid for them, or what you would have to pay to replace them with new items.

In this case, it would be unlikely that you would qualify for an additional tax deduction. The IRS only allows deductions that equal the value of your items at the time that they were stolen or destroyed rather than the replacement value for new items. (IRS.gov)

But if you had no insurance, or if your insurance carried a very high deductible, then you most likely would qualify for a tax deduction. Likewise, if your car was stolen or your house was burglarized and your family’s heirloom jewelry was stolen, you would likely qualify if you were not otherwise compensated for your loss.

Calculating Your Deduction

Once you have calculated the fair market value of your lost or stolen items, less any reimbursement you may have received from your insurance company, your work is not done.

You must deduct $100 from the total amount of your losses for each incident of catastrophe or theft. For instance, if your house suffered major damage from a tornado and your car was stolen during the same calendar year, you would subtract $100 for each incident from amount of your losses for a total of $200.

To claim a tax deduction for theft or catastrophic loss, you must itemize rather than taking the standard deduction. This means completing a separate Form 4684 for each incident of theft or catastrophic loss and entering the appropriate total amount on Schedule A, which you would then file with your federal income tax return.

Even then, you will only be able to claim the amount of your losses that exceed 10 percent of you adjusted gross income for the year. As you can see, your losses would truly have to be substantial to qualify for the deduction.

Net Operating Losses (NOL)

If your losses from a natural disaster were truly catastrophic, or if a burglar cleaned out your entire house, it is conceivable that your losses could actually exceed your income. In such cases, you would record a Net Operating Loss (NOL) for the year. Under ordinary circumstances, reporting an NOL is limited to earnings from business or self employment. But this limitation is waived for losses that occur due to a casualty such as a natural disaster.

Any NOL that you have would first apply to the tax year in which your losses occurred. Any amount that exceeds your taxable income for the year can be carried forward or carried backward to reduce your taxable income for past or future years. NOLs resulting from natural disasters can be applied up to three years prior to the present tax year and up to 20 years forward from the current tax year. (IRS.gov)

Getting Back What You Have Lost

Properly calculating your losses from a natural disaster or theft can be complex. If you have questions, consult with a tax professional. Our experts at Optima Tax Relief can make sure that you receive the largest deduction to which you are entitled.

3 Easy Ways To Teach Kids About Taxes

Actor and comedian Bill Murray joked that “the best way to teach your kids about taxes is by eating 30 percent of their ice cream.” While the line is funny, actually removing a third of the ice cream from your child’s dish is not the best way to educate your children about how taxes work. In fact, you’ll probably just upset them.

You can help your kids understand how the tax system operates through simple explanations, shared activities – and by imposing your own “income” tax system at home.

1. Use Receipts to Explain Sales and Property Tax

Help your kids understand that taxes make it possible for your town to have a library, or that money from taxes pays for fire trucks. For instance, if you have small children, save the receipt the next time you buy them a treat. Show your kids the receipt and point out the price of the treat along with the smaller number. Explain that the smaller number represents sales tax, and that that money allows states, counties and cities to pay for important things like schools and playgrounds.

2. Charge Your Kids “Income” Tax on Their Allowance

Explain the concept of collecting money for a fixed period of time, and then spending that money on something specific. No, you don’t have to force your kids to help you complete your income tax return or drag them along to your accountant’s office. Instead, use examples that relate to their lives.

For example, does your teen want to do something expensive, like share a limo with friends on prom night? Collect a small amount of “taxes” – say, 10 percent – from your child’s allowance for from money he earns doing chores. When the time comes for your child to pay for his share of the limo, return the money you have collected as a tax “refund.” Remind him that the windfall is actually his own money, not a gift.

With a younger child, come up with a goal to work towards together, like a surprise gift for Mom or Dad. As they earn money through chores, put their earnings in a clear jar with the tax in a separate jar right next to it. Say, for every dollar earned, 10 cents goes to the tax jar. Once the earnings jar reaches the target amount and it’s time to go shopping, let her spend the tax money on herself. Again, make sure she knows it’s always been her money.

3. Collect Taxes as Punishment, Then Reap the Rewards Together

A tax jar can accomplish dual purposes by helping kids of all ages understand how taxes work and as a form of discipline. Establish a set amount of “taxes” children must pay for failing to clean their rooms or swearing.

Put the money collected in a clear location so that your kids know that you’re not just taking their money away and spending it on yourself. Every few months, use the money collected in the tax jar for a family activity, such as a special dinner. Point out to kids that different governments collect taxes to improve everyone’s lives.

Teach Kids Now, so They Aren’t Surprised Later

Many young people have their first encounter with taxes when they receive their first paychecks from their first “real” jobs. They may be disappointed or even angry about the money that is missing from their paychecks. The activities above can prepare your kids for the reality of payroll taxes and help them avoid that particular form of sticker shock.

How to Use Tax Breaks to (Re) Establish Financial Independence

In the United States, approximately half of all households pay no federal income tax because their income is too low to trigger tax liability. If you or your family has experienced catastrophic setbacks such as serious illness, extended unemployment, bankruptcy or foreclosure or if you have always been poor, you may find it difficult to envision a future without deprivation or hardship.

But with hard work and determination, you can begin to establish or rebuild a financial foundation. The IRS provides tax credits that reduce the amount of income tax that you owe and deductions that reduce the amount of income you must declare on your tax return. The tax credits and deductions described below represent credits that may be an option for you. For specific questions about your tax situation, contact Optima Tax Relief for a consultation.

Child-Related Tax Credits

Ensuring the health and welfare of your children and finding reliable, affordable child care are essential components of re-establishing stability. The IRS provides three child-related tax breaks: Child Tax Credits, Child and Dependent Care Credits and Additional Child Tax Credits. The first two credits are nonrefundable – which means that you won’t receive a payment from the IRS. Additional Child Tax Credits are refundable – but only if you qualify. Even if you cannot receive a refund, you can significantly reduce your federal income tax burden.

Related article: Kid-Friendly Tax Breaks

Child Tax Credits allow you to reduce your federal income tax by up to $1,000 for each qualifying child. Originally set to expire at the end of 2012, Child Tax Credits were extended permanently through the American Taxpayer Relief Act of 2012, or the “fiscal cliff” deal. The IRS imposes maximum annual income limits above which Child Tax Credits begin to phase out: $55,000 for married taxpayers filing separately, $110,000 for married taxpayers filing jointly and $75,000 for all other taxpayers. (Source: IRS.gov)

There are also six criteria that determine whether a child qualifies for the credit: age, relationship, dependency, citizenship, residence and support.

  • Age: under age 17 at the end of the tax year
  • Relationship: child by birth or adoption, stepchild, foster child, sibling or offspring of any of the previous relatives
  • Dependency: claimed as a dependent on your federal income tax return
  • Citizenship: U.S. citizen, resident national or legal resident alien
  • Residence: lived with you for more than half of the previous year
  • Support: child cannot have provide more than half of his or her own financial support during the previous year

Additional Child Tax Credits. If you had earned income of at least $3,000 during the previous year, would qualify for the full Child Tax Credit but cannot claim the full credit because you don’t owe enough in income tax and filed Form 8812 with your federal income tax return, you may be able to get Additional Child Tax Credits as refundable cash. Under certain circumstances, families with three or more children may claim the credit even if they don’t meet the $3,000 income threshold.

Families with one or two children can collect the lesser of either:

  • Leftover funds from Child Tax Credits;
  • 15 percent of earned income over $3,000;
  • Leftover funds from Child Tax Credits;
  • 15 percent of earned income over $3,000;
  • Total Social Security and Medicare taxes paid minus refunds received from the Earned Income Tax Credit (EITC).

Families with three or more children can collect the greater of either:

  • Leftover funds from Child Tax Credits;
  • 15 percent of earned income over $3,000;
  • Total Social Security and Medicare taxes paid minus refunds received from the Earned Income Tax Credit (EITC).

Child and Dependent Care Credits allow you to exclude at least part of the costs paid for child and dependent care so that you may work or look for work. The IRS allows taxpayers to apply to $3,000 annually for expenses related to the care of one qualifying dependent, $6,000 for costs applied to care for two or more qualifying dependents or $5,000 for dependent care benefits supplied by an employer toward figuring the credit. Depending on your annual adjusted gross income, you may claim up to 35 percent of qualifying expenses.

Taxpayers must also meet the following criteria to qualify for Child and Dependent Care tax credits:

  • Caretaker cannot be a spouse or parent to the dependent child, to your own child under age 19 or a dependent of you or your spouse.
  • Married taxpayer must file a joint income tax return.
  • Taxpayer identification numbers must be provided for each dependent named on your tax forms.
  • Name, address and taxpayer identification number for care providers must be provided.

Earned Income Tax Credit

The EITC is widely recognized is one of the most effective mechanisms for eliminating poverty ever put in place by the American government. Created in 1975, the EITC allows low-wage earners earn more throughout the year or receive a refund by filing their federal income tax returns. According to a 2005 study from the Center for Budget Priorities, the EITC is especially effective in encouraging single parents to seek work.

Related article: Get Tax Relief With Earned Income Tax Credit

Households with dependent children and single workers between the ages of 25 and 65 with earned income below certain levels may qualify for the EITC. Eligible households may receive cash refunds even if they had no federal tax liability but must file a federal income tax return for the current year. Taxpayers may also claim the EITC for up to three prior years by filing Form 1040X.

Wage earners and self-employed workers with valid Social Security numbers may qualify for the EITC, but individuals in the following categories are not eligible:

  • Married filing separately
  • Filing as a nonresident alien
  • A dependent to another taxpayer
  • Taxpayers filing Form 2555 or Form 2555-EZ related to foreign income
  • Taxpayers with adjusted gross income above specified levels (subject to annual change)
  • Taxpayers with investment income above specified levels (subject to annual change)
  • Taxpayers denied EITC credits since 1996 for reasons other than math errors, unless they filed Form 8862 and received clearance from the IRS

Work-Related Education Credits and Deductions

For many individuals, education and job-related training provides the key to escaping poverty. Some states (such as California) provide work-related tax breaks. The IRS also treats scholarships, grants and qualified employer provided assistance applied toward tuition, books and other educational expenses (but not room and board) as tax-free income.

American Opportunity Credits provide partially refundable credits for the first four years of post-secondary education. Eligible taxpayers may receive up to $2,500 in credits and up to $1,000 in refundable credits. These credits, extended through 2017 by the fiscal cliff deal, replaced the Hope Credit.

Lifetime Learning Credits provide up to $2,000 (up to $4,000 for students in Midwestern disaster areas) in credits per tax return for undergraduate, graduate or professional education or job training. There is no limit in how many years you may claim Lifetime Learning Credits. But you may not claim American Opportunity Credits and Lifetime Learning Credits during the same academic year for a single student.

529 College Savings Plans. In addition to tuition payments, funds from 529 College Savings plans may be used to purchase computers or pay for high-speed Internet access.

Tuition and Fees Deductions can be used to reduce income subject to tax through deductions of up to $4,000 for tuition and related expenses. You may also deduct the lesser of $2,500 or the amount you actually paid in interest for student loan debt from your federal income tax returns.

To qualify for student loan interest deductions you must meet all of the following requirements.

  • Paid student loan interest in the previous tax year
  • Legally obligated to pay student loan interest
  • Did not claim married filing separately status
  • Earned less than the specified maximum gross adjusted income (subject to annual change)
  • Neither you nor your spouse (if married) can be claimed as a dependent by another taxpayer

Business Deductions for Educational Expenses. These allow wage earners who itemize deductions  to deduct educational expenses, including industry-related conventions that exceed 2 percent of their adjusted gross income. Self-employed taxpayers may deduct business-related educational and training expenses even without itemizing deductions. Educational expenses must either be required to keep your present job or improve your skills in your present line of work. You may qualify for the deduction even if your program leads to a degree, but not if the program is designed to qualify you for a new line of work.

Deductions for Job Search Expenses

Job hunting can be expensive. Résumés, travel-related expenses, employment agency fees and relocation costs can add up to hundreds or even thousands of dollars. Job hunting expenses related to seeking employment within your present line of work are deductible if they exceed 2 percent of your adjusted gross income. We’ve got an article full of tips on how to deduct job search expenses here.

If you seek employment far from where you live, your travel expenses, lodging and 50 percent of the amount that you spend on meals may be tax deductible. Relocation expenses may also be tax deductible. You cannot deduct job search expenses if you wait too long after leaving your previous job to start looking for a new job, or if you are looking for your very first job. How long is too long? There’s no set time, but if you decide to be a stay at home mom for a few years, then want to get back in the saddle, that’s too long.

As will all deductions and credits, qualifying is complicated and the rules are complex. Get professional advice if you need it; we at Optima Tax Relief are just a call away.

Photo courtesy: StockMonkeys.com

Facebook Takes on Money Transferring Services

Have you received an appeal from a Nigerian prince, promising you his undying gratitude if you would deposit a large sum of his money into your bank account? As a reward for your kindness, you would only be obliged to return a portion of the deposit, retaining the rest as payment for services rendered. Scams like these are why it is so difficult to do business even with honest individuals in places like Nigeria.

The Sound of Money

If Facebook has its way, more than 4 million Nigerian users could enjoy the convenience of money transfers that citizens in the US, Europe and the rest of the developed world take for granted. Along with scams, corruption and money laundering have scared many mainline banks away from doing business in places like Nigeria, regardless of potential profit.

Related: The IRS is on Facebook, spying on your profiles.

And the potential profit is indeed huge. Taavet Hinrikus, co-founder of London based TransferWise, commented to the Guardian that the World Bank estimates the remittance market alone to be valued at $500 billion. Add transfers between the developed and developing worlds, and the potential value jumps to between $5 trillion to $10 trillion.

Not So Far Fetched

Facebook already has skin in the monetary transfer game, through having achieved vested status as a bank in Luxembourg. Facebook is also involved in money transfers within the US through its system of payments between users through popular apps such as Candy Crush and Farmville. Transactions to games publishers and other apps utilized within Facebook generated $2.1 billion in 2013, of which Facebook claims a hefty 30 percent.

Given these circumstances, it is not so far fetched to consider that Facebook may well be close to achieving regulatory approval for “e-credit” status in tax-friendly Ireland. Obtaining “e-credit” status there would allow Facebook to facilitate credit transfers between users throughout Europe, which the recipients could exchange for cash. This system would reportedly use “passporting,” which allows digital payments to be made to and from users in European Union member states. The potential for profit seems to be attractive enough for Facebook to be willing to subject itself to regulation as a bank in Ireland to achieve a foothold in the market.

In addition to TransferWise, Facebook has reportedly been involved in discussions with Azimo and Moni Technologies. These two companies are, like TransferWise, London based startups operating in the money transfer arena. And what about developing markets like India and Africa, where infrastructure for mobile phones has far outstripped the capacity for land lines? The potential reach of that market – nearly 2 billion, according to Brian Blau, a director from the research firm Gartner.

Slicing the Pie

All of this would put Facebook in direct competition with firms like PayPal, Google Wallet and Amazon. But concentrating on money transfers rather than payment systems would allow Facebook to operate more like Western Union while avoiding the competition of a crowded European field. There are no disclosed plans at present by Facebook to extend money transfer services to Nigeria. But that Nigerian prince may have a proper means o dispensing his funds world wide, sooner rather than later.

How to Spot a Shady Tax Preparer

According to the IRS, about 60 percent of taxpayers use tax professionals each year. While most are honest and well-trained, this is an area ripe for fraud if you choose poorly. After all, getting your taxes done by someone else means handing over a lot of personal information, your Social Security number (the Holy Grail for thieves), and those of your spouse and dependents, possibly your birth date, and your bank account information. The IRS wants you to remember, even if you hire someone to do your taxes, you bear the responsibility for what is in your return.

Until recently, anyone could hang out a shingle calling themselves a tax/financial professional, with zero experience or qualifications.  That’s why the IRS now requires tax preparers to get an IRS-issued Preparer Tax Identification Number (PTIN).  This helps, but where thieves smell money, there will always be unscrupulous people who slither past the rules. No determined thief is going to let a little thing like an IRS requirement stop him or her from scamming you.

But it’s not too difficult nowadays to spot a shady tax preparer and avoid them altogether.

Here are three red flags the IRS wants you to watch for:

  1. Is the preparer willing to provide you with his or her PTIN?
  2. Is the preparer willing to sign your return and provide his/her PTIN?
  3. Will the preparer ask you to sign an incomplete return? The IRS warns, a reputable preparer will never do this.

If the answers to any of these questions are unsatisfactory, don’t walk away. Run!

Others Points to Watch For

Ask the preparer about his or her qualifications.

  • Where did you get your training, and have you stayed up with the tax changes through continuing education?
  • How long have you been doing this?
  • What professional groups do you belong to?

Get a full list of the fees you will pay.

  • A reputable preparer will be upfront about fees.  You need to be upfront too, by explaining the extent of your return. If you have multiple small businesses, special credits which require extra forms, or a fistful of W-2s, say so.
  • Your fee should never be a percentage of your expected refund.  That encourages unscrupulous preparers to fraudulently jack up your refund. The preparer may initiate the fraud, but again, you are ultimately responsible and will be left holding the bag.
  • What is the expected time frame till your return is done?
  • Will the preparer review the completed return with you?
  • Will he/she be available for questions after the tax season?
  • If you are due a refund, will it be issued in your name?  Beware a preparer who says the refund will be issued to him/her, and you will be paid in cash. There’s no way for you to know if the refund was actually much larger than what you are paid.  If it’s a cash-only set up, say no and find another preparer.

Your prospective tax preparer needs to pass your inspection. If you feel uncomfortable during the initial meeting, trust your instincts and go elsewhere. You can do a simple background check of a preparer by contacting your local Better Business Bureau. If you have doubts, check the standing of a CPA by contacting the state board of accountancy. For attorneys, contact your state bar association, and for Enrolled Agents, check with the IRS Office of Enrollment.

You can read more about how to spot a shady tax preparer by checking with the IRS. If you feel you have stumbled upon a bad apple tax preparer, you can report the individual with the IRS by clicking here.

“If you feel that you have been a victim of a bad tax preparer or you feel that the IRS may flag a return you filed for inaccuracies, you may want to contact a professional to review your situation,” says David King, President of Optima Tax Relief. “Remember, the IRS is much more accommodating to individuals/businesses that voluntarily amend a past return as opposed to them amending it themselves.”

Photo: Commercial Appeal

3 Special Gifts That Will Earn You Money Back

It’s better to give than to receive, except when it comes to taxes.

Fortunately, the holiday season provides the perfect opportunity to give more to those you care about and less to greedy Uncle Sam. Here are a few options for tax-deductible gifts.

Build a Child’s College Fund

A great gift that fits the bill is a contribution to a 529 plan. These plans allow a child’s college fund to grow tax free, and reduce state income taxes for contributors across the country.

Under federal law, individuals can contribute up to $14,000 a year to a 529 plan, and married couples can give as much as $28,000 a year. When their child is ready for college, parents can withdraw money from the plan and pay no taxes on it. They just have to be sure to use the money for tuition and other expenses required to attend college.

Parents and grandparents are the ones who most often contribute to the plans, and they can receive multiple tax breaks. Working parents are able to avoid paying a federal gift tax and in many states, can deduct the contribution from their state income tax. Retired grandparents can reduce the estate tax their children will have to pay.

There is even the opportunity for married parents or grandparents to contribute a lump sum of $140,000 for the next five years. This lump sum option can generate a much larger return on investment. But it could also leave money on the table if the IRS increases the maximum allowable contribution during the next five years.

Send Gifts to your Business Contacts

Parents and grandparents, though, aren’t the only ones who can benefit from giving money during the holidays. The federal government allows individuals to deduct as much as $25 per gift to business associates and customers during the holidays. That means if you want to give to those who have helped you at your job this year, feel free. And you will also receive something special: a reduction in income taxes. Just remember that the maximum deduction is $25 per recipient each year, so if you sent someone a $25 business gift earlier in the year, you won’t be able to deduct your holiday gift to them.

Donate to Charity

Making a donation to charity, whether it’s giving a bag of old clothes or some cash, is often a tax write-off. Of course, not every charitable gift will give back to you. Donating to political causes and candidates, purchasing raffle tickets for a fundraiser and in-kind donations of your talent and expertise are not tax deductible.

So when you make your list this Christmas, check it twice. Once to make sure you bought all the gifts for your family, and again to make sure you’ve set yourself up for every tax break tyou can get. After all, it is the giving season.

Photo: Oxclock

Tax Tips for Lottery Winners (And the Rest of Us)

Who wins after every lottery draw? The taxman does, of course!

Not only is the lottery a tax on people who are bad at math –US lotteries generally only pay out 60% of the money players bet. The chances of winning a large lottery, such as the Powerball, is one in 175 million and the lucky winner actually has to give the IRS and state tax revenue agencies a big chunk of the prize, every time.

How big a chunk? The taxman’s share could be anything from 40% to 60%, depending on how the winner decides to cash in the prize and if they live in a state that taxes lottery winnings. The same applies even if you win a small prize, win on a game show, or participate in a community raffle.

Lottery Winners: What’s Next?

So how does paying taxes on lottery winnings work? And if you do happen to win the lottery, what is the smartest way to minimize your tax burden?

Lump Sum Vs. Annuity

The first tax decision lottery winners have to make is whether to receive their prize as a lump sum or have it paid out in yearly installments. If you win a $10 million prize with the New York State Lottery, for instance, you get to choose between $10 million over 26 yearly payments of approximately $250,000 or a lump sum of a little less than $5 million. The full prize is only for those who choose the annual payments.
Those who choose the lump sum get the cash value in bonds that the lottery would have had to buy in order to pay $10 million over 25 years.

From a tax perspective, choosing annual payments will keep you in a much lower tax bracket, which will reduce the amount of tax you have to pay. As of 2013, taxpayers with an income between $183,251 and $398,350 pay 33 cents on the dollar to the IRS. Those with an income of more than $400,000 have to pay nearly 40 cents on the dollar, which doesn’t even include state taxes.

Similarly, business owners whose profits swing dramatically from one year to the next may benefit from spreading taxable income over multiple years.

However, there is strong likelihood that taxes will continue to go up over time and negate the tax benefit of annuities. Also, if you choose the lump sum, you could invest the entire amount and put those lottery winnings to work, which — if your investments go well — could more than compensate for the higher initial lump sum tax rate.

“When deciding upon a lottery payment option it ultimately depends on the unique situation,” says Harry Langenberg, Managing Partner at Optima Tax Relief, who points out winners of big jackpots will be in the highest bracket either way. “If you’re a wise investor, it makes sense to take it all at once.”

Set Up a Trust

A smart move for lottery winners is to set up a trust. In states that permit it, creating a trust allows you to collect your winnings anonymously, which can avoid a lot of unsolicited attention from scammers and opportunistic long-lost friends and relatives. A well-designed trust can also allow for tax-free growth of assets, as well as reduce estate taxes for married couples.

Trusts are not just a good idea for lottery winners and the ultra-wealthy. Even families with a moderate income can reap the benefits from setting up a trust. For instance, trusts allow you to specify how and when your children inherit your estate, which can help them use their inheritance more wisely. You can also use trusts to provide funds for particular purposes, like for education and health care or to allocate monies for a favorite charity.

Pay Taxes Like a Millionaire

Sadly, lottery winners often end in financial ruin due to bad investment choices, greedy relatives and friends, misjudging the cost of taxes or the costs of maintaining the stuff they buy. This trap can be avoided by investing all winnings in a low-risk mutual fund and living off the interest. For example, if you invest a $250 million dollar windfall in bonds and a diversified mutual fund, you could easily generate $4 million a year after taxes.

Even investing a more modest $1 million lottery prize could earn you $50,000 a year, assuming your portfolio yields a 5% interest. Earning a living from your investments, as opposed to owning a business or working for a salary is the reason ultra-wealthy people like Mitt Romney and Warren Buffet pay a lower tax rate than their secretaries. Capital gains, or the money you generate from investing in stocks and bonds, is taxed differently than regular income. This is particularly true if you avoid the trap of trying to time the stock market and hold on to your shares and bonds for the long haul. As of 2013, the long-term capital gain tax rate is 15% for taxpayers with incomes in the 25% to 33% tax brackets.

Lottery as Voluntary Taxation

The words of John Fielding, the 18th century English satirist, hold true today.

A Lottery is a Taxation,
Upon all the Fools in Creation;
And Heav’n be prais’d,
It is easily rais’d,
Credulity’s always in Fashion;
For, Folly’s a Fund,
Will never lose Ground;
While Fools are so rife in the Nation

The quip that lotteries are a taxation on people who are bad at math is not a joke. According to The Tax Foundation, a non-partisan tax research group based in Washington, D.C., lotteries are not just a controversial way to fill state coffers, they are an actual tax. The use of lotteries to finance the government is nothing new. In 1892, A.R. Spofford, Librarian of Congress, described lotteries as the kind of voluntary tax the most reputable citizens would engage in — as part of their civic duty — to help with the financing of schools, hospitals and courthouses.

Today, lotteries have lost most of their patriotic component, although some lotteries are centered around charities, but they still are a significant component of state revenue. As with property taxes, lottery tax can be avoided altogether by refraining from buying a ticket.

Photo: pirateyjoe

New Flexible Spending Account (FSA) Carryover Rules for 2013

Flexible spending accounts (FSAs), often called a flex plans, are not new, but they are improved.

Participants use them to set aside money pre-tax, to pay for out-of- pocket medical costs such as co-pays and other expenses not covered by insurance. Employers like FSAs because they don’t have to pay employment tax on the amounts employees use to fund their accounts. It’s a win/win, but despite the name, one thing these accounts have not always been is flexible. A few years ago the IRS added an optional “grace period” to make FSAs better, and now they’ve improved them again, by allowing a carryover.

For now, let’s start with the basics.

What is an FSA?

A flexible spending account is an employer-sponsored pre-tax (or “tax free”) account that you can use to set aside money to cover eligible health and/or dependent care expenses.

At the beginning of the plan year, January 1st, your employer will ask how much you’d like to contribute to the account. Total any expenses that you predict won’t be covered by your insurance, like the braces your child will need or on-going rehabilitation treatment. This amount is then taken out of your paycheck in equal installments each pay period, and put into a special account by your employer. Although there are limits to how much you can set aside, and up until now, any excess leftover after the plan year was forfeited, the benefits of having an FSA money are numerous.

Benefits of an FSA

An FSA is included in your employer’s benefits package for a reason–it reduces your income taxes. The contributions you make to your flex plan are deducted from your pay before any Federal, State, or Social Security taxes are calculated, and are never reported to the IRS. In other words, you’re reducing your taxable income while at the same time increasing your spendable income. Making the most of your FSA could save you hundreds of dollars in taxes per year.

A basic example of this would be if, say, you were in the 15% tax bracket. You know you’ll spend $1000 on eligible health care expenses, so you set it aside in a flex account for the year. Your “take home” pay is $1000. If you opt out of putting it into an FSA, but still spend that $1000, you’ll have paid $150 in taxes to the IRS. Your “take home” pay is then only $850.

Without an FSA, you’d still pay the amount not covered by your insurance, but you’d be using money from your paycheck after taxes have already been taken out. The chart below, from FSA Feds, gives a real example of the tax benefits of an FSA.

FSA Chart

“This example illustrates tax savings based on 25% Federal and 7.65% FICA taxes, resulting in a 32.65% discount on eligible expenses paid through an FSA. State and local taxes are not included. Actual savings will vary based on your individual tax situation, and on whether you are covered under Civil Service Retirement System (CSRS) or Federal Employees Retirement System (FERS). You may wish to consult a tax professional for more information on the tax implications of an FSA.” – FSAFeds.com

What Can Be Deducted

If it’s considered an eligible deductible expense, and isn’t reimbursed by your current insurance, it can be reimbursed through a Flexible Spending Account. Some deductible expenses for a health care FSA (HSA) include:

  • Fees in excess of reasonable and customary amounts allowed by your insurance
  • Non-elective cosmetic surgery
  • Stop-smoking programs and any prescribed drugs to help with nicotine withdrawal
  • Acupuncture treatments
  • Inpatient treatment at a center for alcohol or drug addiction
  • False teeth, hearing aids, crutches, wheelchairs, and guide dogs for the blind or deaf
  • Co-payments on covered expenses
  • Deductibles

With a dependent care FSA, you can save money for expenses used to care for dependents while you’re at work, like day care costs for children under the age of 13, or adult care programs for senior citizens that live with you. Also, some adoption costs can be included as expenses.

The IRS lists the ins and outs of the various FSAs and HSAs here, but take note: If you’re single and don’t expect to incur any health costs besides a few $25 copays, an FSA may not be worth it.

New FSA Rules for 2013

So, FSAs allow employees who participate to pay for medical costs with pre-tax savings. Employees decide how much to put into the accounts through payroll deductions. As they incur an eligible expenses, they are reimbursed from the funds in their FSAs. The maximum a participant can put into an account is $2,500, although employers can set lower limits.

There has been one potential drawback with FSAs. Originally, they were inflexible, as in, use-it-or-lose-it. Any funds left in an individual’s account at year end were forfeited.

This restriction caused some problems.

  • Many employees were leery of participating, for fear of losing their hard earned money.
  • Some participated, but underfunded their FSAs to avoid forfeiting money if they failed to spend it.
  • Or if they got to the end of the year with an unspent balance, they would go out and make purchases they wouldn’t ordinarily make, like an extra pair of prescription sunglasses, just to use up the money.

The “Grace Period”

A few years ago, a grace period was added to FSAs to encourage greater participation. The grace period is 2 and ½ months, after the end of the year during which employees could spend out the balance of their FSA funds. A grace period is not automatic, and must be elected by the employer. This feature improved FSAs, but the newest addition should prove even better.

The Carryover

Now FSA participants who do not spend out their fund balances by the end of the year, may carry over up to $500 into the following year. So an employee who ends the year with $400 in his or her FSA and has chosen to set aside $2,000 into the new year’s plan will have $2,400 to spend in the new year.

Again, the carryover is not automatic. An employer must make the election to allow the carryover. The upper limit to carryover is $500, but employers may choose to allow a smaller carryover.

Note: A plan cannot allow both the carryover and the grace period. Employers must choose one or the other. So, if you have a plan in place which currently allows a grace period, you must elect to end the grace period in order to choose the carryover.

When does this kick in? It can begin now for employers who amend their plans to allow it. Normally such an election would have to be made before a plan year starts, but because this law is new, employers can choose it for 2013 and going forward.

For more information on the tax savings of an FSA, contact Optima Tax Relief today.

This article was co-written by Teresa Ambord and Brenda Harjala, staff writers for Optima Tax Relief.

Photos: New Mexico State UniversityFSAFeds

Claiming Tax Deductions for Charitable Donations

It’s that time of year again, when the spirit of the season inspires charitable giving. Of course, you make charitable donations because you want to benefit those less fortunate. But if you can get a tax deduction too, why not? But be careful–some charitable donations are NOT tax deductible. And for those that are, you must follow the correct procedures or risk having the Internal Revenue Service disallow your deduction.

What which charitable donations are tax deductible? Read on.

The Recipient Is Important

If you make a donation to a particular political cause or individual candidate, you may feel good inside, but the IRS will not allow you to claim a charitable deduction. That’s because gifts to political and lobbying organizations, individuals or candidates running for public office are not tax deductible. You also cannot claim a charitable deduction for donations made for church raffles, bingo games or gifts made with the expectation of receiving a financial benefit.

Fundraising dinners and similar events are tricky. You might have noticed that organizations frequently include a small print notification that $X of your donation may be counted as a charitable deduction, where $X is an amount smaller than the actual price of the event. That’s because you can only claim a deduction for the amount you donate over and above the value the dinner or entertainment event that charities offer to entice attendees to fundraising events.

You Can Only Give So Much

If you’re feeling especially charitable, you may decide to give away 90 percent of your income to your local church and take a vow of poverty. While your ambitions may be admirable, don’t expect to write off your entire donation. The IRS limits deductions to public charities, institutions of higher education and religious organizations to 50 percent of your adjusted gross income (AGI). Limits are lower for gifts to other types of charitable institutions.

However, if you make a large gift that exceeds your AGI limit for one year, you can carry over the excess deduction for the following year, provided that your donations for that year do not exceed your AGI limits.

Giving Your Time

If you’re a doctor working six hours per week in a free clinic, you may draw satisfaction from the fact that you are improving, and maybe even saving people’s lives. However, you cannot deduct the value of your work hours at the clinic on your federal income tax returns. On the other hand, all that money you spent on equipment used for your charitable work, parking and bus fare to and from the site where you performed your work is a legitimate tax deduction. And if you drive your car to and from your volunteer work site, you can deduct 14 cents per mile on your federal income tax return for each round trip.

Non-Cash Contributions

You’ve lost weight and bought a whole new wardrobe. As an incentive to keep off the weight, you want to give away all your “fat” clothes. Before you pack up your old jeans, dresses and sweaters, take an objective appraisal their condition. If your clothing could be classified as being in “good” condition or better, your donation to your local Goodwill or Salvation Army can be claimed as a charitable deduction. However, you must obtain a receipt stating the name of the charity, a general description of your donation, the date of the donation and the fair market value of the donated items.

But don’t expect to include the “value” of your underwear and socks, even if they’re laundered. And that ratty sweatshirt you’ve had since college is likely not to be deductible either. Items in less-than-good condition can only be claimed as charitable deductions if the items are valued at more than $500 AND you obtain an appraisal for each item, which you must attach to your federal income tax return. If you decide to give away your Aunt Mildred’s graduated pearl necklace which has been appraised at $1500, you will need to complete Form 8283 and attach it to your return. The form includes spaces for the description of each item that was donated, the charity to which you made the donation and the value of each donated item.

The Special Case of Cars

In Notice 2005-44 the IRS outlines the circumstances, listed below, under which you may deduct the fair market value of a vehicle donated to an eligible charitable institution:

  • The charity actively uses the vehicle, such as using it to deliver meals to seniors or books for shut-ins.
  • The charity makes substantial improvements to the vehicle, not just cleaning and painting, e.g repairing the transmission.
  • The charity donates or sells the vehicle at a deeply discounted price to a needy individual or family as part of its mission of helping poor people obtain reliable transportation.

Keep Your Receipts

The importance of obtaining and retaining written documentation of your charitable donations cannot be overstated. No matter how large or small, you must be able to document your gift, or the IRS will disallow it. However, the documentation allowed by the IRS is fairly liberal. As long as the name of the organization, a general description of the donation, the date and the amount of your donation are included, you’re generally OK.

For instance, copies of cancelled checks are fine for cash donations valued under $250. And if you donated $10 to victims of the Oklahoma tornadoes to the Red Cross by text message on your cell phone, you can print out a copy of your phone bill that includes your donation as documentation to include with your federal income tax return.

Perfect Timing

In nearly all cases, you claim charitable deductions in the same year that donations are made. You may make a donation as late as December 31 and count the deduction on this year’s tax returns. If you make a donation by credit card, you can still claim the donation this year, even if the bill for your donation is not generated until after January 1. As 2014 is fast approaching, making charitable donations now, not later can be a very savvy move.

Photo: Silicon Prairie News