Category Archives: Tax Tips

Avoid “Nanny Tax” Pitfalls

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Remember Zoe Baird?  She was nominated for Attorney General.  Everything was going well until it was disclosed at her Senate confirmation hearings that she had failed to report money she paid to her domestic help.  The media called it “Nannygate”.   Years later, there was speculation that the issue influenced Caroline Kennedy’s decision to pull out of contention for New York’s vacant United States Senate seat and Timothy F. Geithner’s nomination for Treasury secretary hit a snag over an issue relating to a housekeeper.

The practice of paying domestic help off the books is still widespread. Did you pay a babysitter working in your home more than $1,700 in 2011? Unless that babysitter is your parent, spouse, under-age-21 child or someone under age 18 whose principal occupation is not household employment (a student, for example), then you owe the “Nanny” tax.

Any time you hire someone to work in your home that you pay directly AND whose total payments in the calendar year meets the IRS household employment threshold of $1,700, they must receive a W-2 from the employer (family) and the employer must pay the payroll taxes. It makes no difference whether the employee is full time, part time, or simply temporary. The employer payroll taxes include Social Security, Medicare, federal Unemployment and state unemployment taxes. The employee withholding includes Social Security and Medicare and possibly, federal, state and city income taxes.

If you’re thinking, “Why should I pay nanny taxes? No one else pays them and I’m not running for public office,” think again.

The IRS will catch you. Form 1040 requires you to check the box for Schedule H if you owe household employment taxes.  Schedule H asks “Did you pay anyone working in your home $1,700 or more?” If you check yes, the IRS looks for your nanny tax payments. If you say no, you compromise your federal income tax return and may be audited. Furthermore, if you pay an employee working in your home $1,000 or more per calendar quarter, you must pay nanny taxes and file them quarterly.

Of course, there are several other ways you can be “caught” by the IRS.

  • Your employee doesn’t work out and you fire her. The former employee may apply for unemployment benefits. If you haven’t paid nanny taxes, the state unemployment office will fine and penalize you, and report you to the IRS.
  • Your employee becomes disabled, cannot work and files for social security disability benefits. If you haven’t paid nanny taxes, the Social Security Administration will impose back taxes, interest and penalties.
  • Your employee files a tax return and includes the wages from your employment. If you have not provided a W-2 to the employee, the IRS will fine and penalize you for the back taxes.
  • Your employee retires and applies for Social Security benefits.

There is no statute of limitations for failing to report and pay federal payroll taxes.

You are not required to withhold income taxes unless your employee asks you to and you agree. If you do not withhold income taxes, your employee must pay these taxes. If your employee pays these taxes themself, they may need to make quarterly estimated tax payments.

The Internal Revenue Code maintains that the immigration status of your nanny or other employee has no bearing on your obligation for employment taxes.

Since so many households employ illegal immigrants as nannies, housekeepers or groundskeepers, noncompliance with the Nanny tax is high. With all of the various proposals being discussed in Washington with regard to immigration status include either a Guest Worker program, an amnesty program with a citizenship path for illegal immigrants already working in the U.S., or both, there is a greater likelihood that applicants for immigration legalization will be required to disclose their employment history in the U.S.

It is expected that all immigrants applying for a Green Card or other legalized status will be required to document tax compliance. All plans include an examination of tax return records going back a minimum of 3 years. The illegal immigrants will be highly incented by the promise of legal status, and it is expected there will be significant pressures on current employers who have been paying these immigrants ‘under the table’ to come clean and catch up on tax payments so the immigrant can take advantage of a legalization program. Remember, it is the household EMPLOYER who pays the employment taxes AND provides the W-2 forms.

Once you’re paying on the books, you can use a flexible spending account through your employer to cover up to $5,000 in eligible child or elder care expenses each year. If you don’t have access to such an account, you may also be eligible for the federal Dependent Care Tax Credit.

Getting it wrong can cost you serious money. We prepare back tax returns. Call for fees.  See our link in the Resource section

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What You Need to Know When Selling Your Home

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The Internal Revenue Service has some important information to share with individuals who have sold or are about to sell their home. If you have a gain from the sale of your main home, you may qualify to exclude all or part of that gain from your income. Here are ten tips from the IRS to keep in mind when selling your home.

  1. In general, you are eligible to exclude the gain from income if you have owned and used your home as your main home for two years out of the five years prior to the date of its sale.
  2. If you have a gain from the sale of your main home, you may be able to exclude up to $250,000 of the gain from your income ($500,000 on a joint return in most cases).
  3. You are not eligible for the exclusion if you excluded the gain from the sale of another home during the two-year period prior to the sale of your home.
  4. If you can exclude all of the gain, you do not need to report the sale on your tax return.
  5. If you have a gain that cannot be excluded, it is taxable. You must report it on Form 1040, Schedule D, Capital Gains and Losses.
  6. You cannot deduct a loss from the sale of your main home.
  7. Worksheets are included in Publication 523, Selling Your Home, to help you figure the adjusted basis of the home you sold, the gain (or loss) on the sale, and the gain that you can exclude.
  8. If you have more than one home, you can exclude a gain only from the sale of your main home. You must pay tax on the gain from selling any other home. If you have two homes and live in both of them, your main home is ordinarily the one you live in most of the time.
  9. If you received the first-time homebuyer credit and within 36 months of the date of purchase, the property is no longer used as your principal residence, you are required to repay the credit. Repayment of the full credit is due with the income tax return for the year the home ceased to be your principal residence, using Form 5405, First-Time Homebuyer Credit and Repayment of the Credit. The full amount of the credit is reflected as additional tax on that year’s tax return.
  10. When you move, be sure to update your address with the IRS and the U.S. Postal Service to ensure you receive refunds or correspondence from the IRS. Use Form 8822, Change of Address, to notify the IRS of your address change.
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Medicare Tax on Home Sale

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Contrary to reports and newspaper articles circulating widely on the Internet, there is not a 4.0% “sales tax” or “transfer tax” on the sale of a home included in the health care reform bill signed last year. The analysis underlying these reports is incorrect and fails to take into account the interplay of the bill’s provisions with already existing real estate tax laws that remain unchanged.

What was included in the health bill is a provision that imposes a new 3.8% Medicare tax for some high income households that have “net investment income.” Any revenue collected by the tax is dedicated to the Medicare hospital insurance program. This new tax will only apply to households with Adjusted Gross Income (AGI) of more than $200,000 for individuals or more than $250,000 for married couples. Since capital gains are included in the definition of net investment income, an additional tax obligation might result from the sale of real property.

In the case of the sale of a principal residence, the existing $250,000/$500,000 exclusion from capital gains on the sale of a principal residence remains unchanged. Consequently, even when the AGI limits are met, the new tax would not be applied to all capital gains that result from the sale of a home. Rather, it would only apply to any home sale gain realized in excess of the $250K/$500K existing primary home exclusion that pushes the filer’s AGI over the $200K/$250K adjusted gross income limit.

The new Medicare tax will not take effect until January 1, 2013.

If you have a client in need of assistance preparing their tax returns or facing an IRS audit, I would be happy to assist them.  Feel free to refer them to me using the information below.

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Basis of Rental Property vs. Fair Market Value

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It is not uncommon for homeowners to consider converting their current home to rental property when purchasing a new home.  The reasons are varied, such as hoping for a better sales price by holding on to the property for a few years, or the existence of a strong rental market and a desire for an income stream as well as tax savings derived from allowable depreciation and other deductions associated with ownership of investment property.  Sometimes, homeowners will rent their residence as the result of temporary employment relocation, with the expectation of returning in only a couple of years.

For tax purposes, the converted residence becomes depreciable as rental property when it is placed in service, meaning the date it is ready and available for rent.  Depreciation is based on the useful life of the asset from the date placed in service until it is retired from service (for example, you move back into the residence.)  The useful life for residential rental property (and any improvements) is 27.5 years using the straight-line method.

Generally, the basis of the property for depreciation is your original purchase price including most of the settlement charges on the HUD closing statement plus the cost of any capital improvements (not repairs) made up through the “placed in service” date minus the value of the land.  For example, you purchased the home in 1998 for $320,000, incurring capitalized settlement costs of $7,500, replaced the roof for $4,000 and refurbished the kitchen for $30,000 resulting in an adjusted basis of $361,500.  You rent the house out in 2011 at a time when the fair market value is $450,000.  If we assume the portion of the purchase price for the land was 20%, or $64,000, the depreciable basis is $297,500.

Sounds great, right?  But what if your rental property is in a part of the country where residential real estate prices have taken a severe nose dive from the economy the past few years and comparable values for houses similar to yours are selling for $250,000.  Do you still get to depreciate your adjusted basis?

Not according to Internal Revenue Code sections 167 and 168.  These sections say that you must use the lower of the fair market value at the time the rental property is placed in service or the adjusted basis.  Under this rule, and using the example above, the basis for depreciating the building would be $200,000.

If you’ve recently converted a residence to rental property, please review your tax records to make sure the transaction was properly handled.  If you or a friend is in need of assistance preparing your tax returns or facing an IRS audit, I would be happy to assist them.  Feel free to refer them to me using the information below.

 

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