Deductions

Lower Tax Brackets = Higher Taxes?

The recent tax law changes have lowered the tax brackets starting in 2018, but that does not necessarily mean lower taxes. This is due to the elimination or reduction of items that are no longer deductible. Deductions that have disappeared include, but are not limited to:

Personal exemptions: This will have the most impact on taxpayers who claim their adult children or parents. However, this may be offset somewhat by a partial credit.

Miscellaneous deductions: Sales people who have to incur out of pocket expenses or who use a home office will be greatly affected.

State and local taxes: The deduction is now limited to $10,000 for property taxes and state income taxes. This mostly impacts us here in North Jersey because we have such high property and income taxes. However, many taxpayers in this area are subject to the Alternative Minimum Tax (AMT), so their deductions would normally have been limited anyway.

Mortgage interest and home equity loans: No deduction for home equity loans, and a lower threshold of $750,000 for new mortgages.

The list goes on and on, but includes either limitations or eliminations of moving expenses, alimony payments (for divorces after 2018), entertainment deductions, like-kind exchanges, business losses, etc.

On the plus side the child tax credit has been increased to $2,000, along with the thresholds to claim this credit. Also, the standard deduction has almost doubled. Every situation is different and must be looked at on a case by case basis.

What’s Your New Tax Bracket?

The recent tax laws have not only changed the income tax rates, but have also expanded the income that falls within each bracket. Here’s an example of the old rates vs. the new rates for married individuals filing a joint return:

Old Brackets:

Rate                       Taxable Income

10%                        $0 – $19,050

15%                        $19,051 – $77,400

25%                        $77,401 – $156,150

28%                        $156,151 – $237,950

33%                        $237,951 – $424,950

35%                        $424,951 – $480,050

39.6%                    $480,051 +

 

New Brackets:

Rate                       Taxable Income

10%                        $0 – $19,050

12%                        $19,051 – $77,400

22%                        $77,401 – $165,000

24%                        $165,001 – $315,000

32%                        $315,001 – $400,000

35%                        $400,001 – $600,000

37%                        $600,001 +

 

There are other numerous changes that will impact your overall tax liability, including but not limited to the suspension of personal exemptions, expansion of the standard deduction, itemized deduction limitations (especially for state and local taxes), and lastly, the change to corporate tax rates.

Simplify Your Home Office Deduction

The home office deduction is used by both small businesses and employees, which allows a deduction for using part of your home exclusively and regularly for business purposes. This allows a percentage of certain expenses to become tax deductible or at least more tax favorable such as mortgage interest, property taxes, rent, utilities, homeowners insurance, repairs and maintenance, and depreciation. The downside is that it can be both complex and time-consuming when taking this deduction.

The good news is that the you can use a simplified method for deducting home office expenses. This method allows taxpayers to deduct $5 per square foot of business use up to a maximum of 300 square feet for a total deduction of $1,500, as opposed to having to figure out all of your expenses.

Although this new method is simplified, you need to determine if it makes sense to use the simplified form or the traditional method of calculating home office expenses. You also want to make sure that you meet the criteria for having a qualified home office. Additionally, the rules for employees using a home office are more complex and need to be followed strictly.

Should You Buy a Home or Rent?

Several years back when the real estate market was red hot, it was almost a no-brainer to buy a home. A year or two later your home appreciated by thousands of dollars and was worth much more than you paid for it. We all know that this is not true now, so does it make sense to be a homeowner or a renter?

Let’s start with the benefits of owning a home. First, home prices are much more affordable than in the past. Combine this with historically low interest rates, and it makes home ownership much more enticing. Over time real estate does generally appreciate and over time it usually becomes one of the largest assets a person owns, especially for the middle class. Also, the interest paid on your mortgage and property taxes paid are generally tax deductible.

The drawbacks of owning a home are several. First, you must be able to afford and qualify for a mortgage. The combined mortgage and property tax payments are usually much higher than renting. Although, over time theoretically your rent will increase while your mortgage payment stays constant with hopefully only a small increase of property taxes. Also, you are responsible for all of the upkeep, improvements and repairs, utilities and all other expenses.

Renting can be beneficial for a variety of reasons. First, the payments are usually lower than a mortgage and property taxes. You do not need a large down payment, except for a security deposit. It is easier to move because you do not have to worry about selling a home and can take a job much farther than where you currently live. You also may be able to save more money because your housing costs are lower.

Renting can present a problem in the long-term though because it may prove to be more expensive over time. You also do not build any equity or have the benefit of real estate appreciation. Also, when you rent you obviously are more restricted by the rules of your landlord.

Many factors should be weighed before purchasing a home or choosing to continue renting. Home ownership is the American dream, but one thing to keep in mind is that you want to make sure that your monthly payments do not cause a financial strain. This even applies to existing homeowners.

My Customer/Tenant Didn’t Pay Me. Can I Deduct This on My Tax Return?

I get asked this question a lot, mostly from business owners. The answer to this question is that it depends. First a quick accounting lesson of cash vs. accrual. I promise not to keep it too technical!

If you are a cash basis taxpayer, then you record income or sales once you get paid, either by cash, check, or credit card. You also record expenses when you pay them, even if with a credit card.

For an accrual basis taxpayer, you record income when it is earned. For example, if you are a consultant and you sent an invoice to your client in January for December’s work, then you record the income from the invoice during December. The same goes for expenses, as it generally doesn’t matter when you paid your bill, but when you incurred the expense. This means that if you ordered supplies in December, but paid for them in January, you can deduct the expense in December.

Now to answer the original question: A cash basis taxpayer cannot deduct as an expense an outstanding invoice that was not paid by their customer, or tenant, if they are a landlord. Remember, the invoice was not included as income. On the other hand, an accrual basis taxpayer can deduct an expense for non-payment from a customer or tenant, as long as it is deemed uncollectible.

Most small business clients and landlords are on the cash basis method of accounting. It is much easier for record keeping purposes, and especially for income tax purposes.

But It’s Tax Deductible!

Paying mortgage interest, property taxes, equity loan interest, and business expenses are all generally tax deductible. But does it make sense to incur excessive expenses just to produce a tax benefit?

For example, if you are looking to move to a bigger house, you will save a lot of money in taxes, right? Yes, you may actually save income taxes, but at the same time you will have spent much more money. Spending a dollar to save a quarter doesn’t make much sense at all.

Just because qualified business meals and entertainment may be deductible (generally only 50% deductible), it may not make sense to spend excessively. I have seen some business owners spend so much on meals that they could have used this money to hire an assistant so they can work less. Now, that’s real savings!

Getting the Most from Your Deductions

No one likes to pay any more taxes than they have to. One simple way to avoid this is to get the most from your deductions and expenses. This means keeping track of all of your tax deductible expenses throughout the year. Once the last-minute rush to gather up all of your receipts begins, expenses are often overlooked that can reduce your tax liability.

Here is one strategy for charitable contributions: each time you make a charitable contribution, obtain a written receipt to acknowledge your donation, which should contain the name of the charity, the date, and the amount contributed. When donating household goods, such as clothing, you can use a guide, such as the one at www.salvationarmyusa.org to determine the value of your donations. Please note that the IRS does not allow a deduction for contributions without a proper receipt or a cancelled check (for amounts under $250).

Keep track of unreimbursed employee expenses. As always, you should keep your receipts for any business expenses that you pay out of pocket. These can include tolls, parking, gas, meals and entertainment, dues, subscriptions, advertising, and marketing. Additionally, if you use your vehicle for your job, keep track of your business and overall mileage. It will be well worth the savings come next tax season.

One more way to better keep track of expenses is to reconcile your bank statements to your checkbook. This is true whether you use QuickBooks, Quicken, or a pencil and paper. By reconciling your checkbook, it insures that you are capturing all of your expenses, such as bank fees, or checks that you forgot to record. Both businesses and individuals can benefit from reconciling their books.

Keep all of your receipts in one place or in an envelope – whatever works best for you. Usually the extra effort is worth the hassle, especially because it makes you more conscious of what you are doing with your money.