Personal Finance

The Details of Claiming the Home Office Deduction

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

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

Copious Write-offs

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

Alternatively, you can use the simplified method for claiming the deduction — $5 per square foot for up to 300 square feet. Although you won’t be able to depreciate the portion of your home that’s used as an office, you can claim mortgage interest, property taxes and casualty losses as an itemized deduction to the extent otherwise allowable, without needing to apportion them between personal and business use of the home.

Deduction Tests

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

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

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

Limitations Apply

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

Why the New Child Tax Credit Is so Valuable

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

An Expanded Tax Break

Before the Tax Cuts and Jobs Act (TCJA) kicked in, the child tax credit was $1,000 per qualifying child. But it was reduced for eligible married couples filing jointly by $50 for every $1,000 (or part of $1,000) by which their adjusted gross income (AGI) exceeded $110,000 ($75,000 for unmarried taxpayers).

Starting with the 2018 tax year, and applying through the 2025 tax year, the TCJA doubled the child tax credit to $2,000 per qualifying child under 17. It also created a $500 credit per dependent who isn’t a qualifying child under 17. There’s no age limit for the $500 credit, but IRS tests for dependency must be met.

The TCJA also substantially increased the thresholds at which the credit begins to phase out. Starting with the 2018 tax year, the total credit amount allowed to a married couple filing jointly is reduced by $50 for every $1,000 (or part of a $1,000) by which their AGI exceeds $400,000. The threshold is $200,000 for other taxpayers. So, many taxpayers who were once ineligible for the credit because their AGI was too high are now eligible to claim it.

SSN Requirement

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

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

Don’t Miss Out on the Child Tax Credits

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

6 Key Tax Q&As for 2021

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

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

1. How much can I contribute to an IRA for 2021? 

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

2. I have a 401(k) plan through my job. How much can I contribute to it? 

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

3. I sometimes hire a babysitter and a cleaning person. Do I have to withhold and pay FICA tax on the amounts I pay them? 

In 2021, the threshold for when a domestic employer must withhold and pay FICA for babysitters, house cleaners and other domestic employees is increasing to $2,300 from $2,200 for 2020.

4. How much do I have to earn in 2021 before I can stop paying Social Security tax on my salary? 

The Social Security tax wage base is $142,800 for 2021, up from $137,700 for 2020. That means that you don’t owe Social Security tax on amounts earned above that. (You must pay Medicare tax on all amounts that you earn.)

5. What’s the standard deduction for 2021? 

The Tax Cuts and Jobs Act eliminated the tax benefit of itemizing deductions for many people by significantly increasing the standard deduction and reducing or eliminating various itemized deductions. For 2021, the standard deduction amount is $25,100 for married couples filing jointly (up from $24,800 for 2020). For single filers, the amount is $12,550 (up from $12,400) and, for heads of households, it’s $18,800 (up from $18,650).

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

6. How much can I give to one person without triggering a gift tax return in 2021? 

The gift tax annual exclusion for 2021 is $15,000, unchanged from last year. This amount is only adjusted in $1,000 increments, so it typically increases only every few years.

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

How COVID-19 Legislation May Affect Your Taxes

The Consolidated Appropriations Act (CAA), signed into law Dec. 27, 2020, provides extensive relief in response to the COVID-19 pandemic, such as another round of “recovery rebate” payments to individuals and an expansion of the Paycheck Protection Program (PPP) for businesses and other employers. The legislation includes some tax relief as well.

A Brief Overview

Here’s a brief overview of some of the tax-related provisions that may affect you or your business:

Individuals:

  • Permanent reduction of adjusted gross income (AGI) floor to 7.5% for medical expense deductions
  • Extended nonitemizer deduction for up to $300 of cash donations ($600 for married couples filing jointly) to qualified charities through 2021
  • Extended 100% of AGI deduction limit for cash donations to qualified charities through 2021
  • Extended exclusion for certain employer payments of student loans through 2025

Businesses & Other Employers:

  • Clarification of tax treatment for PPP loans, certain loan forgiveness and other financial assistance under COVID-19 legislation
  • Extended payroll tax credits for paid leave required under the Families First Coronavirus Response Act (FFCRA) through March 2021
  • Extended and expanded tax credits for retaining employees under the Coronavirus Aid, Relief and Economic Security (CARES) Act through June 2021
  • 100% business meals deduction for food and beverages provided by restaurants in 2021 and 2022
  • Extended Work Opportunity credit through 2025
  • Extended New Markets credit through 2025
  • Extended family medical leave credit through 2025

More Details

This is just a brief look at some of the most significant tax-related provisions in this 5,500+ page legislation. Contact Maggart for more details on how the CAA may affect you.

Estate Planning through Intrafamily Loans & Family Banks

Among the primary goals of estate planning is to put in writing how you want your wealth distributed to loved ones after your death. But what if you want to use that wealth to help a family member in need while you’re still alive? This has become an increasingly common and pressing issue this year because of the COVID-19 pandemic and changes to the U.S. economy.

One way to help family members hit hard by job loss or increased debt is through an intrafamily loan or even by establishing a full-fledged family bank.

Structure Loans Carefully

Lending can be a way to provide your family financial assistance without triggering unwanted gift taxes. As long as a loan is structured in a manner similar to an arm’s-length loan between unrelated parties, it won’t be treated as a taxable gift.

This means, among other steps, documenting the loan with a promissory note and charging interest at or above the applicable federal rate (which is now historically low). You’ll also need to establish a fixed repayment schedule and ensure that the borrower has a reasonable prospect of repaying the loan.

Even if taxes aren’t a concern, intrafamily loans offer important benefits. For example, they allow you to help your family financially without depleting your wealth or creating a sense of entitlement. Done right, these loans can promote accountability and help cultivate the younger generation’s entrepreneurial capabilities by providing financing to start a business.

Maybe Open a Family Bank

Too often, however, people lend money to family members with little planning or regard for potential unintended consequences. Rash lending decisions may lead to misunderstandings, hurt feelings, conflicts among family members and false expectations. That’s where a family bank comes into play.

A family bank is a family-owned and funded entity — such as a dynasty trust, a family limited partnership or a combination of the two — designed for the sole purpose of making intrafamily loans. Often, family banks can offer financing to family members who might have difficulty obtaining a loan from a bank or other traditional funding sources, or lend at more favorable terms.

By “professionalizing” family lending activities, a family bank can preserve the tax-saving power of intrafamily loans while minimizing negative consequences. The key to avoiding family conflicts and resentment is to build a strong governance structure that promotes communication, decision making and transparency.

Establishing guidelines regarding the types of loans the family bank is authorized to make — and allowing all family members to participate in the decision-making process — ensures that family members are treated fairly and avoids false expectations.

Learn More

More than likely, someone in your extended family has faced difficult financial circumstances this year. Contact Maggart to learn more about intrafamily loans.

Handle Mutual Funds Carefully at Year End

As we approach the end of the year, now is a good time to review any mutual fund holdings in your taxable accounts and take steps to avoid potential tax traps. Here are some tips.

Avoid Surprises

Unlike with stocks, you can’t avoid capital gains on mutual funds simply by holding on to the shares. Near the end of the year, funds typically distribute all or most of their net realized capital gains to investors. If you hold mutual funds in taxable accounts, these gains will be taxable to you regardless of whether you receive them in cash or reinvest them in the fund.

For each fund, determine how large these distributions will be and get a breakdown of long-term vs. short-term gains. If the tax impact will be significant, consider strategies to offset the gain. For example, you could sell other investments at a loss.

Buyer Beware

Avoid buying into a mutual fund shortly before it distributes capital gains and dividends for the year. There’s a common misconception that investing in a mutual fund just before the ex-dividend date (the date by which you must own shares to qualify for a distribution) is like getting free money.

In reality, the value of your shares is immediately reduced by the amount of the distribution, so you’ll owe taxes on the gain without actually achieving an economic benefit.

Seller Beware, Too

If you plan to sell mutual fund shares that have appreciated in value, consider waiting until just after year end so you can defer the gain until next year — unless you think you’ll be subject to a higher rate next year. In that scenario, you’d likely be better off recognizing the gain and paying the tax this year.

When you do sell shares, keep in mind that, if you bought them over time, each block will have a different holding period and cost basis. To reduce your tax liability, it’s possible to select shares for sale that have higher cost bases and longer holding periods (known as the specific identification method), thereby minimizing your gain (or maximizing your loss) and avoiding higher-taxed short-term gains.

Think Beyond Taxes

Investment decisions shouldn’t be driven by tax considerations alone. You also need to know your risk tolerance and keep an eye on your overall financial goals. Nonetheless, taxes are still an important factor. Contact Maggart to discuss these and other year-end strategies for minimizing the tax impact of your mutual fund holdings.

Catching Up on Retirement Catch-up Contributions

When it comes to retirement planning, many people tend to focus on two things: opening a retirement savings account and then eventually drawing funds from it. However, there are other important aspects to truly doing everything you can to grow your nest egg.

One of them is celebrating your 50th birthday. This is because those age 50 or older on December 31 of any given year can start making “catch-up” contributions to their employer-sponsored retirement plans that year (assuming the plan allows them). These are additional contributions to certain accounts beyond the regular annual limits.

Maybe you haven’t yet saved as much for retirement as you’d like to. Or perhaps you’d just like to make the most of tax-advantaged savings opportunities. Whatever the case may be, now is a good time to get caught up on the 2020 catch-up contribution amounts because you might be able to increase your contributions for the year.

401(k)s & SIMPLEs

Under 401(k) limits for 2020, if you’re age 50 or older, you can contribute an extra $6,500 after you’ve reached the $19,500 maximum limit for all employees. That’s a total of $26,000.

If your employer offers a Savings Incentive Match Plan for Employees (SIMPLE) instead, your regular contribution maxes out at $13,500 in 2020. If you’re 50 or older, you’re allowed to contribute an additional $3,000 — or $16,500 in total for the year.

But be sure to check with your employer because, while most 401(k) plans and SIMPLEs offer catch-up contributions, not all do.

Self-Employed Plans

If you’re self-employed, retirement plans such as an individual 401(k) — or solo 401(k) — also allow catch-up contributions. A solo 401(k) is a plan for those with no other employees. You can defer 100% of your self-employment income or compensation, up to the regular 2020 aggregate deferral limit of $19,500, plus a $6,500 catch-up contribution in 2020. But that’s just the employee salary deferral portion of the contribution.

You can also make an “employer” contribution of up to 20% of self-employment income or 25% of compensation. The total combined employee-employer contribution is limited to $57,000, plus the $6,500 catch-up contribution.

IRAs, too

Catch-up contributions to non-Roth accounts not only can enlarge your retirement nest egg, but also can reduce your 2020 tax liability, generally if made by Dec. 31, 2020.

Keep in mind that catch-up contributions are available for IRAs, too. The deadline for 2020 IRA contributions isn’t until April 15, 2021, but deductible contributions may be limited or unavailable based on your income and whether you (or your spouse) is covered by a retirement plan at work. Please contact Maggart for more information.

Beware of “Wash Sales” When Selling Securities

If you’re planning to sell capital assets at a loss to offset gains that have been realized during the year, it’s important to beware of the “wash sale” rule. Under this tax rule, if you sell stock or securities for a loss and buy substantially identical stock shares or securities back within the 30-day period before or after the sale date, the loss can’t be claimed for tax purposes.

The Wash Sale Rule

The wash sale rule is designed to prevent taxpayers from benefiting from a loss without parting with ownership in any significant way. Note that the rule applies to a 30-day period before or after the sale date to prevent “buying the stock back” before it’s even sold. (If you participate in any dividend reinvestment plans, the wash sale rule may be inadvertently triggered when dividends are reinvested under the plan, if you’ve separately sold some of the same stock at a loss within the 30-day period.)

Although the loss can’t be claimed on a wash sale, the disallowed amount is added to the cost of the new stock. So, the disallowed amount can be claimed when the new stock is finally disposed of (other than in a wash sale).

An Example

Assume you buy 500 shares of XYZ Inc. for $10,000 and sell them on November 5 for $3,000. On November 30, you buy 500 shares of XYZ again for $3,200. Since the shares were “bought back” within 30 days of the sale, the wash sale rule applies. Therefore, you can’t claim a $7,000 loss. Your basis in the new 500 shares is $10,200: the actual cost plus the $7,000 disallowed loss.

If only a portion of the stock sold is bought back, only that portion of the loss is disallowed. So, in the above example, if you’d only bought back 300 of the 500 shares (60%), you would be able to claim 40% of the loss on the sale ($2,800). The remaining $4,200 loss that is disallowed under the wash sale rule would be added to your cost of the 300 shares.

No Surprises

The wash sale rule can come as a nasty surprise at tax time. Contact us at Maggart for assistance.

529s vs. Roth IRAs, which Is Better for College Savings?

Many people assume that a 529 plan is the ideal college savings tool, but other vehicles can help parents save for college expenses, too. Take the Roth IRA, for example. Whether you should use one or the other (or both) depends on several factors, including how much you intend to contribute and how you’ll use the earnings.

Plan Snapshots

A 529 plan allows participants to make substantial nondeductible contributions — up to hundreds of thousands of dollars, depending on the plan and state limits. The funds grow tax-free, and there’s no tax on withdrawals, provided they’re used for “qualified higher education expenses” such as tuition, fees, books, computers, and room and board. Other qualified expenses include up to $10,000 of primary or secondary school tuition per student per year and, new under last year’s SECURE Act, up to $10,000 of student loans per beneficiary. If you use the funds for other purposes, you’ll generally be subject to income taxes and a 10% penalty on the earnings portion. Some 529 plans are also eligible for state tax breaks.

Roth IRA contributions also are nondeductible and grow tax-free. And you can withdraw those contributions anytime, tax-free and penalty-free, for any purpose. Qualified distributions of earnings — generally, after age 59½ and more than five years after your first contribution — are also tax- and penalty-free.

Advantages & Drawbacks

The main advantages of 529 plans are generous contribution limits and the ability to accept contributions from relatives or friends. Roth IRAs, on the other hand, are subject to annual contribution limits of currently $6,000 ($7,000 if you’re 50 or older). So, even if you and your spouse each set up Roth IRAs when your child is born, the most you’ll be able to contribute over 18 years is $216,000 (not taking into account any future inflation increases to the contribution limit). Additional drawbacks are that you must have earned income at least equal to the contribution, and you can’t contribute to a Roth IRA if your adjusted gross income exceeds certain limits.

Funds in a 529 plan that aren’t used for qualified education expenses will eventually trigger taxes and penalties when they’re withdrawn. However, with a Roth IRA, you can use contributions, as well as qualified distributions of earnings, for any purpose without triggering taxes or penalties. This includes items that wouldn’t be qualified expenses under a 529 plan, such as a car or off-campus housing expenses that exceed the college’s room and board allowance. Plus, if you don’t need all your Roth IRA funds for college expenses, you can leave them in the account indefinitely.

Consider Your Financial Goals

Before selecting a plan, consider your overall financial, retirement, and estate planning goals. Our firm can help.

Alternative Minimum Tax Less “Toothy” But May Still Take a Bite

For many years, the alternative minimum tax (AMT) posed a risk to many taxpayers in the middle- to upper-income brackets. The Tax Cuts and Jobs Act (TCJA) took much of the “teeth” out of the AMT by raising the inflation-adjusted exemption. As a result, middle-income earners have had less to worry about, but those whose income has substantially increased (or remains high) should still watch out for its bite.

Basic AMT Rules

The AMT was established to ensure that higher-income individuals pay at least a minimum tax, even if they have many large deductions that significantly reduce their “regular” income tax. If your AMT liability is greater than your regular income tax liability, you must pay the difference as AMT — in addition to the regular tax.

As mentioned, the TCJA substantially increased the AMT exemption for 2018 through 2025. The exemption reduces the amount of AMT income that’s subject to the AMT. The 2020 exemption amounts are $72,900 (for single filers), $113,400 (for married joint filers) and $56,700 (for married separate filers).

AMT rates begin at 26% and rise to 28% at higher income levels. That top rate is lower than the maximum regular income tax rate of 37%, but fewer deductions are allowed for the AMT. For example, you can’t deduct state and local income or sales taxes, property taxes and certain other expenses.

AMT Risk Factors

The AMT exemption phases out when your AMT income surpasses the applicable threshold, so high-income earners remain susceptible. However, even some taxpayers who consider themselves middle-income earners may trigger the AMT by exercising incentive stock options or incurring large capital gains.

For example, because the exemption phases out based on income, realizing substantial capital gains could cause you to lose part or all of that exemption and, thus, subject you to AMT liability. If it looks like you could get hit by the AMT this year, you might want to delay sales of highly appreciated assets until next year (if you don’t expect to be subject to the AMT then) or use an installment sale to spread the gains (and potential AMT liability) over multiple years.

Also, be aware that claiming substantial itemized deductions for expenses that aren’t deductible for AMT purposes used to be a major risk factor for falling into the AMT net. However, because the TCJA limited or eliminated some of these deductions for regular income tax purposes (such as the deduction for state and local taxes and miscellaneous itemized deductions subject to a 2% of adjusted gross income floor, respectively), this is now much less of a risk.

Appropriate Strategies

Since passage of the TCJA, the AMT may have become an afterthought for many people. However, it’s still worth a look to see whether it could create undesirable tax consequences for you. Please contact Maggart for help assessing your exposure to the AMT and, if necessary, implementing appropriate strategies for your tax situation.