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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

Is Your Honest Face an Asset or a Liability at Tax Time?

Did you ever see the 90s sitcom,“ Taxi?” The lead taxi driver was Alex, a middle- aged, average looking guy. Then there was Woody, a much younger driver whose character was a country boy, naïve and fresh-faced. In one episode Alex and Woody needed to win the trust of a man and woman they had not met. So they went to the couple’s apartment and knocked.

The door opened, just enough for the couple to see only Alex, as Woody waited to the side. Based on nothing but Alex’s looks, they immediately distrusted him and refused to listen to his plea. Just as they were about to shut the door in his face. Alex realized what he needed to do. He said, “Wait… look at him!” he said, stepping aside so they could see Woody. They took one look at Woody’s innocent face and said, “oh, okay, come on in.”

It was a great scene. One study indicates that – unlike Alex who knew he didn’t appear trustworthy — most of us think we have honest faces and can use them to get away with fudging the facts a little, like about income tax.

What Does Your Face Tell People about You?

The study mentioned above was done in Germany and called “Dubious Versus Trustworthy Faces – What Difference Does it Make for Tax Compliance?” The players had various tax scenarios, and were told that half of them would be selected for an audit. Some were told the selection would be random. Others were told the auditors would choose their audit targets by looking at photos of the players’ faces.

In the end, those who believed their photos would be used had a much higher tendency to fudge the truth, try to hide income and exaggerate expenses, etc. The researchers concluded, these people may have believed their “honest faces” would inspire trust in the auditors which would let the players get away with a bit of dishonesty.

Who knows if that’s really true or not? But Forbes magazine says while American taxpayers overall report 99% of their W-2 income (which of course, is information the IRS already has), they often report only about 45% of income that is not verifiable, like side jobs for cash. If we’re counting on our honest faces to get us through a dreaded audit, we need to rethink that.

Most audit targets are selected by computer and by the last year of an audit. And of those, most are cleared up by correspondence. That is a good thing, unless you were hoping you could bat your eyelashes and blink your baby blues at the auditor to squeak by. Rest assured, if you should have a face-to-face audit, an honest face might hurt more than help.

Hire a Professional Face

Tax professionals urge clients not to represent themselves, for many of the reasons stated above. People who think they appear honest might try bend the truth just a little, expecting to be taken at their word. In the end, they might accidentally volunteer too much information and open up a whole new can of worms.

When dealing with the IRS, no matter how honest and trustworthy you think you loo, don’t go without a pro.

Photo: Wikimedia

Use Tax Loopholes like a Boss

By boss we mean Apple.

In May of 2013, Apple’s CEO Tim Cook got grilled by US Senators about Apple’s tax strategy of placing over a $100B in profits in offshore accounts to avoid paying corporate tax. Last week, after a four-month review of Apple’s finances, the Securities and Exchange Commission cleared the technology company from any wrongdoing in their accounting principles and tax strategies. For Apple, one of the largest and most profitable companies in the word, to come out squeaky clean from an in-depth IRS audit that scrutinized their complex tax avoidance machinery is worthy of admiration, regardless of your views on the moral issues involved.

So, what can the everyday taxpayer learn from Apple? Let’s look at three basic lessons we can all take home from Apple’s multinational tax mitigation operation.

Move Your Money like a Billionaire

The secret to Apple’s tax strategy is it moves money to where it is taxed the least (if at all). Take for instance the “Double Irish Arrangement,” the tax structure Apple is now infamous for pioneering. First, Apple used payments between related entities within their corporate structure to funnel income from countries with higher tax rates, such as the United Kingdom, to countries with lower tax rates, namely Ireland. Ireland was a particularly good choice because it uses a territorial taxation system, which means the Irish government does not tax income from offshore subsidiaries of Irish companies.

Lesson: Although you may not be able to take advantage of the same tricks corporations and billionaires have at their disposal to minimize your tax rate, you can still be smart about where you earn your money, how you invest it, and how you file your taxes. Can you move your business to a state with lower income tax? Can you ask your company to compensate you in stock options instead of a wage increase? Dividends are taxed at 0% if your income is lower than $36,250 and at 15% if your income is between $72,501 and $450,000. Your salary, on the other hand, is taxed at 25% if your income is over $72,501 and 33% if you make more than $223,051.

Keep on the Right Side of Tax Evasion

The key element of Apple’s tax strategy is that it was – strictly speaking — legal. Sure, they used the insanely complex American tax system to their advantage and – arguably – completely disregarded the spirit of the law. But they did so by meticulously following the letter of the law. There is a fine line between tax avoidance, which is legal, and tax evasion, which is not; but staying on the right side of that line is the difference between Tim Cook getting a passing grade by the SEC and Al Capone spending 7 years in prison.

Lesson: Minimize your tax liability by only using legal tax mitigating methods because the risk of an audit outweighs the benefits. Keep meticulous records of tax-related documentation and contribute as much as possible to tax-friendly accounts, such as contributing to retirement plans with pre-tax funds. This way you can defer paying taxes on your savings and they will grow at a much faster rate.

Use The Tax Code to Your Advantage

Tim Cook famously proposed US senators reform the current 7,500-page tax code and scrap all tax breaks (aka tax loopholes) in favor of a single digit corporate tax rate, even if this meant paying a little more. Mr. Cook may have meant what he said, but you can be sure he will be milking every tax break available until such tax reform occurs.

Lesson: Become a tax law expert or hire somebody who already is, so you can make existing tax breaks work to your advantage. For instance, If your employer offers a medical reimbursement account, also known as a flex plan, divert to it as much of your salary (up to $2,500) as you can. Medical reimbursement accounts sidestep income and Social Security tax, which means you can save 20% to 35% on your medical bills.

Conclusion
Paying taxes is the moral thing to do. We all enjoy having schools, a judiciary that enforces the rule of law, fire departments and hospitals. The least we can do is pay our fair share for them.

However, we do not have the responsibility of deciding what our fair share is. Lawmakers do that for us. It is rather amusing that Congress created countless tax loopholes and was shocked when Apple went ahead and used them. If lawmakers do not think existing tax breaks – which special interest groups spend millions lobbying for — are unfair, they can always change them. Until then, they can hardly blame taxpayers for using them.

Photo: marcopako

Taxed! Frequent Flyer Miles

In 2012, a Citibank customer received a 1099 tax form informing him he was liable to pay $625 in taxes for the 25,000 American Airlines miles he had received as a “gift” for opening a checking and savings account package. Needless to say, he was shocked to find out that as far the the IRS was concerned his frequent flyer miles were taxable income. He and others in his situation complained.

However, Citibank was not to blame; the bank was simply following IRS taxation rules. This story was enough to send droves of clients running for cover from credit card rewards programs altogether out of fear of being hit with unexpected tax bills. Even respectable finance advice outlets overreacted to these stories and provided inaccurate and unhelpful advice on how the IRS taxes credit card reward points. This is sad. Customers who ignore credit card reward points are missing out on a great way of getting free cash just by being smart about how they pay for their everyday living expenses.

If, like me, you carefully collect credit card points throughout the year to finance the lion’s share of your vacation expenses, you may have wondered – or even worried — whether you should declare your hard-earned points when it comes to filing your tax return. Although the IRS could be clearer on how it treats credit card rewards, it has published information on the matter. So finding out your tax liability is just a matter of digging into the murky waters of IRS tax regulations publications. I know, you’ve got better things to do; but I don’t. So I did all the heavy reading for you. You’re welcome.

Nontaxable Discounts and Rebates Vs. Taxable Interest and Bribes

IRS Publication 17 provides a detailed breakdown of which sources of income are taxable and which are not. I’m afraid there are no surprises here. Pretty much every type of income you can think of is taxable. This includes unemployment benefits, life insurance proceeds, alimony, gambling earnings, lotteries, raffles and even bribes. Yes, the IRS publication actually says: “If you receive a bribe, include it in your income.”

Nevertheless, there are two sources of income the IRS does not tax: rebates and rewards. Not surprisingly, there is a caveat when it comes to rewards: “If you receive a reward for providing information, include it in your income.” So does that include credit card rewards or not? This lack of clarity is what has created the current confusion, which is why the IRS published a specific statement on frequent flyer miles and credit card points in their 2002-18 Announcement.

The statement provided the following clarification:

“The IRS will not assert that any taxpayer has understated his federal tax liability by reason of the receipt of personal use of frequent flyer miles or other in-kind promotional benefits.” – IRS.gov

In classic IRS style the paragraph finishes with the tip “Any future guidance on the taxability of these benefits will be applied prospectively.” This means that, as of 2013, the IRS does not require you to declare the cash value of their credit card rewards and frequent flyer miles when you file your taxes; and even if they were to tax them in the future it will not be charged retroactively.

However, there is a big exception to this general rule when it comes to rewards you receive for making deposits or opening an account with a bank or other financial institution. In these cases the IRS considers the rewards as interest and therefore taxable. The IRS Publication 550 Investment Income and Expenses specifically says “for deposits of less than $5,000, gifts or services valued at more than $10 must be reported as interest. For deposits of $5,000 or more, gifts or services valued at more than $20 must be reported as interest.” This exception is what triggered the $625 tax bill for the Citibank customer mentioned at the outset.

The Bottom Line

In short, the IRS treats credit card rewards you earn when you purchase things, such as cash back, frequent flyer miles and points, as a reduction in the purchase price or as a rebate, which are not taxable. So you don’t have to worry about declaring your precious rewards as long as you don’t earn them by making a deposit (not a purchase) when opening an account.

One Last Caveat for Business Owners

The reason credit card rewards are not taxable income is because the IRS considers them a discount or price reduction, not as interest or as prize. Unfortunately, this also means you cannot claim as a business expense any item you buy or saving you receive with your credit card reward points. For instance, if a $2,000 business flight only costs you $1,000 after using your frequent flyer miles, you may only claim $1,000 toward travel expenses–not the full ticket value.

This article was written by staff writer Andrew Latham. His mission is to help fight your evil debt blob and get your personal finances in tip top shape.
Copyright © 2013 Andrew Latham
Photo: The-Lane-Team

Tax Tip: Move to a Cheaper State

Facebook co-founder Eduardo Saverin gave up his United States citizenship last year in favor of citizenship in Singapore to avoid the increase in federal income taxes mandated by the end of the Bush-era tax cuts for the top tier of income earners. You may not be willing to give up your American passport to avoid taxes, but what if you were to move to a cheaper state? Between 2000 and 2010, Illinois, New York and Ohio lost millions in population while Texas, Florida and Arizona all gained residents, according to the Tax Foundation.

During that period, New York State lost $45.6 billion in income as workers moved to other states. California lost $29.4 billion, Illinois lost $20.4 billion, New Jersey lost $15.7 billion and Ohio lost $14.7 billion. By contrast, during the same period, Florida gained a whopping $67.3 billion in income, Arizona gained $17.7 billion and Texas gained $17.6 billion in income as workers migrated into those states.

Cold Weather, Heavy Tax Burdens

No doubt, there were several factors involved, including the loss of heavy manufacturing jobs, along with cold weather climates in states like New York and Illinois, contrasted to warm-weather states like Florida, Arizona and Texas. Nonetheless, a primary motivator for many of these interstate moves was a desire to reduce state tax burdens.

Heavy regulatory burdens and a hostile business tax climate also figured into the equation. The Mercatus Center at George Mason University ranks New Jersey forty-eighth in business tax burden and last among the fifty states in freedom from excessive regulation. California ranks forty-fifth in tax burden and last in regulatory freedom and New York ranks dead last in tax burden and forty-seventh in freedom from excessive regulations, according to the Mercatus Center.

A Tax Deduction for Moving Expenses

If you decide to pull up stakes and move from your high-tax state to a state with a lower tax burden, you’ll incur significant expenses, not the least of which being the actual move to your new location. You may be able to reduce the financial bite through federal tax deductions. To be eligible for the deduction, you must satisfy two tests: the distance test and the time test.

The distance test requires your new workplace must be located at least fifty miles further away from your old home than the distance between your old workplace and your old home. If you were unemployed before the move, your new job location must be at least fifty miles away from your old home. This test is the same whether you work for an employer or you are self-employed.

The time test requires employees to work full-time at a job for at least thirty-nine weeks during the first twelve months immediately following the move. If you are self-employed or a small business owner, you must work full-time for at least thirty-nine weeks during the first twelve months after your move and a total of seventy-eight weeks during the first twenty-four months after your move.

To take the deduction, you will need to complete Form 3903 (Moving Expenses) and submit it with Form 1040. Your moving expenses will count as an adjustment to your income. Publication 521, Moving Expenses, distinguishes deductible from nondeductible expenses and provides instructions on how to properly complete Form 3903 so that you can claim the greatest amount of legitimate deductions.

If you live in a state with high taxes and heavy regulation for businesses and you’re ready to make a move, it’s clear that you’re in good company. If you are financially and personally able to move to a cheaper state, and doing so will improve your circumstances, few people would blame you for getting out of dodge. Just be smart about making your move. Besides scouting out job opportunities and neighborhoods, let Uncle Sam ease the financial burden of your relocation if possible.

Photo: Great Beyond

Tax Tip: Deductions for Travel and Business

Maybe you’re finally taking that long-awaited vacation, or your employer has assigned you to cover an out of town meeting. Or perhaps you’ve been invited to interview with a company in another state for a really great job. In all of these instances, you may be able to cut some of your travel costs with tax breaks from Uncle Sam.

Mixing Business with Pleasure

You’re traveling to Hawaii for your industry’s annual conference. If you’ve got the time, there’s not reason that you can’t add a few extra days onto your trip to enjoy the islands while you’re there. If you have a spouse and kids, why not make it a family vacation?

You can take a tax deduction for the cost of attending the conference, along with your round trip plane ticket and the hotel bill for the dates you were in attendance, including your arrival date. But be careful – you cannot deduct the cost of the hotel room for days added after the conference, or extra plane tickets for your family. Similarly, you cannot deduct the cost of leisure activities outside of the event. The money that you spend on meals and entertainment for your spouse and kids is strictly on you.

You can deduct only 50% of your business-related meal and entertainment expenses. If you are subject to the Department of Transportation’s “hours of service” limits, you can deduct 80%. – IRS.gov

Out on Business

If you are traveling out-of-town as an employee representative for your company, you may be able to deduct some of the costs incurred. However, if your company reimburses you for your expenses, you can’t double-dip and ask for a tax break again.

The Internal Revenue Service only allows you to deduct un-reimbursed costs that exceed 2 percent of your gross adjusted income. Once you’ve met that threshold, you can declare deductions for expenses such as travel and commuting costs, including travel in your personal vehicle, as well as dry cleaning, telephone calls and other related costs that you accumulate away from home.

If you’re self-employed or own a small business, you are not obliged to meet the 2 percent threshold. Instead, you can begin deducting your legitimate expenses from the first penny you spend. Maintain a home office? You may be able to deduct commuting costs from your home to a client’s office or any other work site.

Job Searching

If you are looking for a job in your present line of work, know that you can deduct some of your expenses on your tax returns, including travel expenses. Even if you don’t get the job, you’re entitled to legitimate travel-related deductions for your job search. It can get tricky though, because you cannot deduct job related travel costs to look for work in a different field.

There is no need to give up tax breaks to which you are legitimately entitled–deductions for travel and business aren’t just for the jet-setting rich and famous. The key is to keep good records of your expenses, hang on to your receipts, and to not go overboard. That way, if any red flags are raised and the IRS does question your deductions, you’re covered.

Photo: Kuster & Wildhaber Photography

No Pay-No Drive: New York Suspends Licenses for Back Taxes

It’s no secret, many states are broke and looking for ways to recoup revenue. Of course, most states have a long list of taxes owed by residents. New York state – which actually has an impressive collection rate of 96% — is in hot in pursuit of the those who haven’t paid up. The remaining 4% are on a list of 16,000 residents who each owe in excess of $10,000 in back taxes. Combined, they owe $1.1 billion. To collect, Governor Andrew Cuomo is pulling out a big hammer: he’s suspending their driver’s licenses until they make good on their tax debts.

This is part of the current year budget initiative passed by the state legislature back in March. It’s expected to increase collections this fiscal year (ending March 31, 2014) by $26 million, and another $6 million annually in subsequent years.

Governor Cuomo said in a press release: “Our message is simple: tax scofflaws who don’t abide by the same rules as everyone else are not entitled to the same privileges as everyone else. These worst offenders are putting an unfair burden on the overwhelming majority of New Yorkers who are hardworking, law-abiding taxpayers. By enacting these additional consequences, we’re providing additional incentives for the state to receive the money it is owed and we’re keeping scofflaws off the very roads they refuse to pay their fair share to maintain.”

Say what you will about equity, it’s a money thing. After all, not everyone who owes taxes drives a car, and not everyone who drives a car owes taxes.

“As more and more states experience cash shortfalls, they’re looking for ways to replenish their coffers,” observed CPA Robert A. Raiola. Raiola heads the Sports & Entertainment Group for the New Jersey–based accounting firm of Fazio, Mannuzza, Roche, Tankel, LaPilusa, LLC. “As a result, we may see more states following New York’s lead with stricter enforcement of existing laws.”

How the Suspension Works

Round one of warning notices gives recipients 60 days to pay up. For those who do not respond, round two warnings will be issued, with 15 days to comply. After that, the taxpayer’s license is suspended.

Anyone caught driving on a suspended license will pay a mandatory fine of $200 to $500, depending on the circumstances, and could face jail time or probation up to 30 days. Those caught in a second offense could be subject to much stiffer penalties, including the loss of a vehicle.

New York Commissioner of Taxation and Finance Thomas H. Mattox said in a press release: “It’s in every taxpayer’s best interest to pay all tax bills in full. If you can’t pay in full, our staff is available to help you arrange a payment plan that will satisfy your debt.”

Some may also be able to obtain restricted licenses which will allow them to continue commuting to and from work.

What’s the lesson?

Whether it’s a matter of a government desperate for revenue or out to achieve equity… states have big hammers. Nobody has to get to this point, but you’ll probably need the help of a trusted tax adviser early on.

Photo:  aftab