Frequently Asked Questions

General Information

Introduction. We endeavor to offer high quality tax preparation services for a modest price based almost exclusively on three factors—complexity, time commitment, and risk.

  • Complexity refers to the amount of various forms and the difficulty of preparing them in our tax software. While some forms are simple, others are inherently complicated and require a higher level of skill to properly enter the information.
  • Time Commitment refers to the fact that client preparation can wildly differ. Two clients may both have a similar rental property, but if the one comes in with a Schedule E filled out based on their excellent process of internal account, and the other brings a shoebox full of receipts and says “here’s my rental information,” those scenarios will require a very different time commitment. By charging a premium for doing a client’s bookkeeping for them, we reward those who are well prepared and have documentation for their forms.
  • Risk plays into this as well, as we may take on differing amounts of risk in preparing each particular return. Some returns are very straightforward and are basically form-to-software entry, but many returns involve uncertain tax positions and require us to make calculated judgement calls. Other returns require us to certify information to be used in various schedules. Both the taxpayer(s) and the tax preparer sign the form that is sent to the IRS, and in submitting a return, we are stating that we believe the return is materially correct based on the information provided from our client.

Free tax preparation. According to the IRS Free File site,

…you can electronically prepare and file your federal individual income tax return for free using tax preparation and filing software. IRS Free File lets you prepare and file your federal income tax online using guided tax preparation, at an IRS partner site or Free File Fillable Forms. It’s safe, easy and no cost to you for a federal return…

However, our clients’ experiences have been mixed when using IRS Free File. It’s not the IRS who provides the software—they partner with various commercially available tax preparation software, including TaxSlayer Simply Free, H&R Block Free Online, Credit Karma, and others. TurboTax withdrew from the Free File program prior to the 2021 tax season. A taxpayer would access the free software via the IRS website, and would not have an account directly with that provider.

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Filing Status and Dependents

Introduction. There are five filing statuses:

  • Single (common; 2022 standard deduction of $12,950);
  • Married filing jointly (common; 2022 standard deduction of $25,900);
  • Head of household (fairly common; 2022 standard deduction of $19,400);
  • Married filing separately (rare; 2022 standard deduction of $12,950); and
  • Qualifying surviving spouse (very rare; 2022 standard deduction of $25,900).

Single. You would file using this status if:

  • You were never married; or
  • You were legally divorced as of December 31, 2022; or
  • Your spouse passed away in 2021 or before, and you didn’t remarry during calendar year 2022. But if this was the case and you had a child together which you are still supporting, you may be able to use the qualifying surviving spouse filing status—see next page.

Married filing jointly. You would file using this status if:

  • You were legally married as of December 31, 2022, even if you didn’t live with your spouse on that date due to pending legal separation or divorce; or
  • Your spouse died in 2022 and you didn’t remarry in 2022; or
  • You were married as of December 31, 2022 and your spouse died in 2023 before filing a 2022 return.

A married couple filing jointly report their combined income and deduct their combined allowable expenses on one return. They can file a joint return even if only one had income or if they didn’t live together all year. However, both persons must sign the return. Once you file a joint return, you can’t choose to file separate returns for that year after the due date.

A married couple has “joint and several tax liability,” which means if you file a joint return, both you and your spouse are generally responsible for the tax and interest or penalties due on the return. This means that if one spouse doesn’t pay the tax due, the other may have to. Or, if one spouse doesn’t report the correct tax, both spouses may be responsible for any additional taxes assessed by the IRS.  In either case, you will generally receive two identical letters notifying you of any balance due.

Head of household. This one requires a two-part test. You would file using this status if:

  • You were considered unmarried for purposes of this status; and
  • You provided a home for certain other persons.

First, any one of these three situations would qualify you as “unmarried”:

  • You were legally separated according to state law under a decree of divorce or separate maintenance at the end of 2022, but the divorce isn’t final yet; or
  • You were legally married but lived apart from your spouse from July through December 2022; or
  • You are married to a nonresident alien at any time during the year.

Second, you must meet the “provide a home” qualification, which is met one of two ways:

  • You paid over half of the cost of your parents’ home, and you claim them on your return; or
  • You paid over half of the cost of your own residence, and someone lived with you for over half of the year. That someone can be any of the following:
    • Your dependent whom you claim on your return; or
    • Your dependent who lives with you, but you can’t claim because of a divorce decree; or
    • An unmarried qualifying child who isn’t your dependent.

It should be noted that kids (whom you would normally claim) who are away at school, on a religious mission, or aren’t living with you for some other reason, would still meet this test.

Married filing separately. This is generally considered to be a punitive filing status and should be avoided if possible. Some tax credits are disallowed when filing separately, including the Earned Income Credit and the American Opportunity/Lifetime Learning educational tax credits. Other credits are cut in half, including the Child Tax Credit, Child Care Credit, and the SALT tax deduction (if itemizing deduction). However, there are circumstances where you might need to file this way regardless:

  • You believe your spouse isn’t reporting all of their income; or
  • You don’t want to be responsible for any taxes due if your spouse doesn’t have enough tax withheld or doesn’t pay enough estimated tax; or
  • Your spouse has previous tax obligations from before you were married and you don’t want the IRS to take your part of the refund to satisfy the liability (innocent spouse rules may apply here); or
  • You are in the process of a divorce and are unable to sign a joint return with your soon-to-be ex; or
  • You don’t qualify for any credits and just want to keep your finances separate.

A couple of important things to note is that Washington State is one of the nine community property states, and community income may need to be allocated to each partner’s return if applicable. Additionally, if you are on Medicare Parts B or D, this filing status has a very low-income threshold for the “Income Related Monthly Adjustment Amount,” meaning that if your income exceeds $91,000, you will get hit with a large monthly surcharge on these costs, and rather than pay $170 per month, you would pay $544 per month.

Qualifying surviving spouse. (Note: this was previously called the Qualifying widow/er). You would file using this status if all of the following apply:

  • Your spouse passed away in 2020 or 2021, and you weren’t remarried by the end of 2022;
  • You have a child or stepchild (not a foster child) whom you claim as a dependent;
  • This child lived in your home for all of tax year 2022;
  • You paid over half of the cost of keeping your home; and
  • You could have filed a joint return with your spouse the year your spouse died, even if you didn’t actually do so.

Note: if your spouse passed away in 2022, you would file married filing jointly, which has the same standard deduction as this status.

For additional information, please visit the source(s) for this article:

Introduction. As discussed in What should my filing status be?, married filing separately is generally considered to be a punitive filing status and should be avoided if possible. There are circumstances where it is necessary, including while going through the divorce process and not being on speaking terms, or having a spouse who is a tax cheat to whom you don’t want to be tied at the IRS. But there are plenty of reasons it should be a status of last resort. Nevertheless, 2.3% of all returns filed in 2020 used this status.

Circumstances where this filing status may be bad. This is not an exhaustive list, but includes some of the primary detriments to this filing status, in no particular order:

  • Ineligible to claim the earned income credit;
  • Ineligible to claim the adoption credit;
  • Ineligible to claim either of the higher education credits;
  • Ineligible to claim a deduction for student loan interest;
  • State and local tax (itemized) deduction of $5,000 instead of the usual $10,000;
  • Highest Medicare IRMAA at just $97,000 of income (an additional $4,351 per year) while a single taxpayer can make up to $500,000 before triggering that amount;
  • Income threshold to recognize mortgage interest premiums was $50,000 in 2021—but for all other filing statuses it was $100,000;
  • Taxpayer is required to file a return if their income is over just $5—this is a bit lower than the lowest threshold for the other filing status—$12,950;
  • Triggers both the Additional Medicare Tax (Form 8959) and Net Investment Tax (Form 8960) at $125,000 of total Medicare compensation—it’s $200,000 for single taxpayers;
  • If one spouse itemizes deductions, both must do so. This can cause real problems;
  • Highest marginal rate reached first;
  • Taxability of Social Security;
  • You would hit the contribution limit for Traditional IRAs at $10,000 if your spouse is covered by a workplace plan—it’s $218,000 for status married filing jointly.

Circumstances where this filing status doesn’t matter. Since both the standard deduction and tax tables for married filing separately are the same as single—which are both exactly half of married filing jointly—there are instances where any difference would be immaterial. A married couple who are in the same tax bracket, don’t itemize deductions, and have no credits, won’t really notice a difference. The tax bill for Spouse A plus Spouse B would be the same as married filing jointly. But even in that case, you would have to pay for two tax returns.

Circumstances where this filing status may be good. Investopedia has an article titled “Happily Married? You May Still Want to File Taxes Separately”. The article is almost entirely made up of trashing the status and the reasons why it is bad. But at the very end, the writer provides the “primary” example where it made sense, related to diverse pay and itemized deductions:

…Consider a situation in which one spouse is a doctor earning $200,000 a year, while the other is a teacher earning $45,000. The teaching spouse has had surgery during the year and paid $12,000 in unreimbursed medical expenses. The IRS rule for deducting… medical expenses dictates that only expenses in excess of 7.5% of the filer’s AGI… can count as (an) itemized deduction. If the couple files jointly, only expenses in excess of $18,375 will be deductible. Therefore, none of the teacher’s medical expenses could be deducted because they total less than $18,375. But if the couple filed separately, the cost would easily exceed the teacher’s threshold for medical deductions, which would be $3,375 ($45,000 x 7.5%), based only on the teacher’s AGI. This would leave an eligible deduction of $8,625 for the teaching spouse to claim on Schedule A of Form 1040 (the tax return).

At the teacher’s marginal rate of 12%, the difference could be $1,035—but it also assumes they would itemize to begin with. The standard deduction is $12,950.

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Introduction. The IRS instructions are unnecessarily complex when it comes to whom you can claim as a dependent. The flowchart they provide is almost impossible to follow through, but the concept is easy. TurboTax Online has a good summary of it:

“For tax purposes, a dependent is someone ‘other than the taxpayer or spouse’ who qualifies to be claimed by someone else on a tax return. More generally speaking, a dependent is someone who relies on another person for financial support, such as for housing, food, clothing, necessities, and more. Typically, this includes your children or other relatives, but it can also include people who aren’t directly related to you, such as a domestic partner. Once you identify someone as a dependent on your tax return, you’re informing the IRS that you met the requirements to claim them as a dependent.”

Benefit of claiming a dependent. A taxpayer would benefit from claiming a dependent due to the various credits available, including the Child Tax Credit or Other Dependent Care Credit, and also might qualify for the head of household filing status (assuming you’re not already benefiting from the more generous status of married filing jointly).

For additional information, please visit the source(s) for this article:

Gross Income: Wages, Investment, and Retirement

Introduction. There are several different types of income, and the taxation of these various income streams can widely vary. For the purpose of this introduction, let’s consider that there are four primary types of income: earned (active) income, investment (passive) income, retirement income, and other income. Following are the common types of income in each category, with notes of how those forms of income are taxed in the parenthesis.

Earned (active) income, which partially includes:

  • W-2 income (ordinary)
  • Business income/(loss) on Schedule C (ordinary, plus the SE tax, and one-half of the SE tax as an adjustment to income, with likely QBI offset)
  • Pass-through income from partnerships for which you are actively involved (ordinary, plus the SE tax, and one-half of the SE tax as an adjustment to income, with likely QBI offset)
  • Pass-through income from an S-Corp for which you are actively involved (ordinary, with likely QBI offset)
  • Short-term rental income/(loss) on Schedule C (ordinary, with possible QBI offset)

Investment (passive) income, which partially includes:

  • Interest income (ordinary)
  • Tax-exempt interest income (non-taxable, but is included in modified adjusted gross income)
  • Qualified dividends (favorable long-term capital gains rate)
  • Ordinary dividends (ordinary)
  • Tax-exempt dividends (non-taxable, but is included in modified adjusted gross income)
  • Short-term capital gains/(losses) (ordinary)
  • Long-term capital gains/(losses) (favorable long-term capital gains rate)
  • Rental income/(loss) on Schedule E (ordinary, with possible QBI offset)
  • Royalties on Schedule E (ordinary)
  • Pass-through income from estates or trusts (ordinary or long-term capital gains rate—it would depend on the type of income being passed through)
  • Pass-through income from partnerships for which you are not actively involved (ordinary, with unlikely QBI offset)
  • Pass-through income from an S-Corporation for which you are not actively involved (ordinary, with unlikely QBI offset)

Retirement income, which partially includes:

  • Social Security income (ordinary, but between 0%-85% of it is taxable, depending on other income)
  • IRA distributions (ordinary from traditional, non-taxable from a Roth, depending on circumstances)
  • Pensions and annuities (ordinary, though some may not be taxable, depending on circumstances)

Other income, which partially includes:

  • Gaming income (ordinary, and can be offset by losses—but only if you itemize deductions)
  • Farm income (ordinary, with possible QBI offset)
  • Alimony received (ordinary)
  • Cancellation of debt (ordinary)
  • Foreign income (ordinary, with a possible partial offset for the foreign tax credit)

For additional information, please visit the source(s) for this article:

Introduction. There are various forms of investment income, and the taxation of those income streams can widely vary. Following is a summary of the most common types of investment income, along with a brief discussion of how that income is taxed.

More common.

  • Interest income generally includes bank/credit union interest, and possibly some interest income passed through a K-1 or from an installment sale. This income is taxed as ordinary income.
  • Qualified dividends include dividends which your investment company classifies as “qualified,” based on two primary factors:
    • the payer is a US company or a qualified foreign entity, and
    • the underlying stock was held “for more than 60 days during the 121-day period that begins 60 days before the ex-dividend date.” These dividends qualify for the more generous long-term capital gains rate.
  • Ordinary dividends include dividends which your investment company classifies as being not qualified. These may be paid in cash or in fraction shares of stock, and are taxable as ordinary income whether or not the money is transferred out of your investment account and spent.
  • Short-term capital gains/(losses) includes taxpayer or broker trades of stocks or mutual funds held less than one-year. These gains are taxed as ordinary income.
  • Long-term capital gains/(losses) includes taxpayer or broker trades of stocks or mutual funds held for one-year or more. As is the case with both short-term and long-term capital losses, the losses can offset your capital gains first, plus an additional $3,000. Any losses beyond $3,000, net, are not permitted on your current year return and will be carried forward to future periods.
  • Capital gain distributions will show up in lines 2a-2d of the 1099 consolidated report from your broker, and are taxed as long-term capital gains unless otherwise noted on the form.
  • Rental income/(loss) or royalties on Schedule E includes income from your rental properties or passive income from oil wells or other royalties. This income is taxed as ordinary, but if you are actively involved with the rental property and meet other qualifications, you could qualify for the qualified income business deduction (QBI), which allows for 20% of the net income to be tax-free.

Less common.

  • Series EE or I savings bond interest is ordinary income, but if it was used for higher education costs for yourself or your dependents, you may be able to exclude part or all of the interest.
  • Tax-exempt interest and dividend income includes municipal bond interest, and other forms of interest income from organizations which qualify as a 501(c)(3).
  • Pass-through income from estates or trusts for which you receive a K-1 will be taxed as ordinary or long-term capital gains rate—it would depend on the type of income being passed through.
  • Pass-through income from partnerships or S-Corporations for which you are not actively involved is taxed as ordinary income, but won’t be subject to the self-employment tax. It is unlikely to qualify for QBI however.
  • Gains from installment sales includes the current year portion of a gain on an installment agreement, and would be taxed as ordinary income or the long-term capital gains rate, depending on whether the underlying asset was held for a year. This gain would be presented on Form 6252 on your return.

For additional information, please visit the source(s) for this article:

Introduction. If you are on Medicare Parts B and/or D and your modified adjusted gross income (MAGI) is higher than limits set by the Social Security Administration (SSA), you may be subjected to a surcharge for your monthly Medicare cost which is referred to as the “Income-Related Monthly Adjustment Amount,” or IRMAA. It is important to note that while the SSA gets a copy of your tax return from the IRS, this is in arrears (or money that is owed and should have been paid earlier), so your 2022 IRMAA would be based on your 2020 tax return. Therefore, if your MAGI was above the threshold during tax year 2021, you would see the increased Medicare cost starting in January 2023.

IRMAA Income Limits. The following table shows the income thresholds by filing status and the monthly and annualized increase to the amount of Medicare Parts B and D—which is on top of the actual plan cost ($164.90 per month for Part B, while the plan cost for Part D depends on the plan):

A couple of things to note. First, while married filing jointly, the surcharge would apply to both taxpayer and spouse, if both are on Medicare (the column “Annualized Cost” for Married Filing Separately assumes this is the case—if not, the impact would be the same as filing status Single or Head of Household). Second, note that filing status Married Filing Separately is incredibly punitive. At a MAGI of $97,000, your surcharge would be the same as a Single taxpayer who has a MAGI of $450,000. This wouldn’t be the case if the taxpayer lived apart from their spouse for the entirety of the tax year in question. In that case, the taxpayer would qualify as Single for purposes of the IRMAA calculation.

Appealing the IRMAA. If your MAGI is typically below the thresholds, and you had a one-time bump to taxable income, it’s possible you can appeal the IRMAA. Remember that the IRMAA charges start in the second year following the high income, and perhaps something changed. Per the SSA, “If you had a major life-changing event and your income has gone down, you may use this form to request a reduction in your income-related monthly adjustment amount.” We can help you submit an appeal on Form SSA-44 if you had one of the following life-changing events:

  • Change in marital status—marriage, divorce or death of a spouse;
  • Change in work—layoff, retirement or reduction; or
  • Loss of passive income—rental sale, pension income reduction, etc.

For additional information, please visit the source(s) for this article:

Introduction. There is an old joke that occasionally makes the rounds on the internet. It goes something like this:

  • Guvment: You owe us money. It’s called taxes.
  • Taxpayer: Well, how much do I owe?
  • Guvment: You have to figure that part out.
  • Taxpayer: So I can just pay whatever I want?
  • Guvment: Oh, no. We know exactly how much you owe, but you still have to figure it out on your own.
  • Taxpayer: And what happens if I get it wrong?
  • Guvment: You go straight to prison.

It’s a joke of course. You don’t go straight to prison—you’re fined first, and then you go to prison. But the federal government really can (and does) prepare basic returns for taxpayers using the informational forms sent to them every year (W-2s, 1099s, K-1s, etc.). Though it’s hard to fathom, some taxpayers don’t need to file at all.

Who doesn’t need to file—general rule for most people. The general rule of thumb is that if your gross income is below the standard deduction for your filing status, you would have no taxable income—and assuming you don’t have any federal income taxes withheld—you don’t need to file at all. The IRS won’t be looking for a return, since they will prepare a return for you and will know that you have no taxable income and no tax due. If you are over 65, the following thresholds received a bump up of $1,750. The thresholds for the filing statuses are:

  • Single: $12,950;
  • Married filing jointly or qualifying surviving spouse: $25,900;
  • Head of household: $19,400; and
  • Married filing separately: $5 (not a typo—the IRS really does shaft taxpayers who use this status).

Who doesn’t need to file—children or other dependents. Since dependents are typically on your return since they don’t support themselves, the income thresholds to be under are much lower for people in this category, plus it introduces unearned income. The same $1,750 bump exists here for taxpayer 65 or older, and the thresholds to be under are the same for single or married dependents (on an individual basis):

  • Unearned income must be below $1,150; and
  • Earned income must be below of $12,950; and
  • If there is some of both types of income (but you are below the $1,150 unearned income filing trigger), gross income must be below $12,550 plus $400.

Situations where you always have to file. There are lots of reasons to file of course, and you have to if any of the following situations apply:

  • You had any federal income taxes withheld (so you can get back any overpayments);
  • You owe any special taxes, such as AMT, early withdrawal penalty, etc.;
  • You (or your spouse if filing jointly) received any health savings account distributions;
  • You had net earnings from self-employment of at least $400;
  • You were enrolled in health insurance through the state, and premium tax credits were present; or
  • You just feel like filing because not doing so makes you uncomfortable.

For additional information, please visit the source(s) for this article:–dft.pdf

Gross Income: Self-employed and Business

Introduction. Self-employment income reported on a tax return is increasingly common, and for tax year 2020, 28.4 million returns were filed with a Schedule C attached. The IRS says,

An activity qualifies as a business if your primary purpose for engaging in the activity is for income or profit and you are involved in the activity with continuity and regularity. For example, a sporadic activity, a not-for-profit activity, or a hobby does not qualify as a business” (underlines added for emphasis).

Schedule C is thus titled “Profit or Loss From Business,” and would be used whether you are a sole proprietor, or have incorporated as a limited liability company (LLC), and didn’t elect to be taxed in a different way. Due to how self-employment income on Schedule C is taxed (it’s pretty brutal), tracking all of your expenses is critical to avoid an unnecessarily high tax bill.

Joint venture with your spouse. Most often, self-employed income is in the name of either the taxpayer or the spouse. But sometimes, both taxpayer and spouse may run a business together. Per the IRS,

Generally, if you and your spouse jointly own and operate a… business and share in the profits and losses, you are partners in a partnership, whether or not you have a formal partnership agreement. You generally have to file Form 1065 instead of Schedule C for your joint business activity…

That is problematic due to the complexities of filing Form 1065—refer to My buddy and I formed a business together. What do we need to watch for? for more information. However, this can be avoided if both of the following stipulations are met:

  • You and your spouse wholly own the unincorporated business as community property and treat the business as a sole proprietorship (and not an LLC); and
  • You and your spouse elect to be treated as a “qualified joint venture,” which means:
    • Each person materially participates in the business; and
    • You are the only owners of the business; and
    • You file a joint tax return for the tax year. 

Joint venture with someone other than your spouse. If your business includes anyone other than just you, or you and a spouse, you won’t use Schedule C to report the income or loss and it will be taxed as a partnership, unless the partnership elects to be taxed as an S-Corporation.

Ownership of the income matters. Special attention is paid by the IRS to whose income is being recorded on a Schedule C. We don’t see this kind of attention paid on retirement income or investment income. This nuance is due to the fact that the self-employment tax (SE tax) is 15.30% of net business income, comprised of the following four pieces:

  • 20% for the employee’s share of the Social Security tax;
  • 20% matched by the employer for the Social Security tax;
  • 45% for the employee’s share of the Medicare tax;
  • 45% matched by the employer for the Medicare tax.

So like wages on a W-2, business income recorded on Schedule C requires payments into both Social Security and Medicare. And since a self-employed person is both the employee and employer, they are paying both sides. A retiree’s Social Security benefit is determined in part by the amount of Social Security tax paid in over the course of an individual’s career—both the employee themselves via tax withholding, and their employer’s share via payroll taxes. Hence, the IRS pays close attention to who should get credit for the self-employment tax paid as a result of Schedule C business activity.

Income. This is alternatively referred to as simply “income,” or “gross receipts,” or “revenue,” etc. It refers to money received from the customers of your self-employment activities and does not include any personal money which you put into the business. This is sometimes reported to you on a Form 1099-NEC from the company who paid you. NEC stands for “non-employee compensation.” Previously this was Form 1099-MISC, but in 2020, the IRS split out the two forms (the 1099-MISC still exists but is not used for these payments). If a company who wants to pay you previously asked you to fill out a Form W-9, that’s what it is for. Filling out a W-9 will generally result in you receiving a Form 1099-NEC.

Think of Form 1099-NEC as being the company tattling on you to the IRS. But it’s not by choice—if you pay an individual $600 for goods or services during any given tax year, you are required to tattle on them to the IRS by submitting a 1099-NEC—and if you don’t, the non-tattling company may be fined between $50-$280 for forms not submitted. Additionally, this year’s companies like PayPal and Square will be sending out Forms 1099-K if transactions in (not out) totaled more than $600 during the year. Of course, not all companies will send out these required forms, and individual taxpayers almost never send them—but regardless of whether you receive a 1099-NEC, all business revenue from all sources is required to be reported on this schedule.

Cost of goods sold (COGS). Some companies would like to track their operating margin and gross profit before expenses. This allows for the matching principle of accounting to be effective. The IRS doesn’t have a preference for how you track these expenses, but they do require you to be consistent. If you would like to track COGS rather than expense your COGS as a business expense, use Parts I and III of the Schedule C. This method is not recommended for service entities or very small entities, but is generally recommended for retail or manufacturing entities. The calculation for COGS is as follows:

  • Inventory at the beginning of year; plus
  • Purchases, cost of labor, materials and supplies and other costs; less
  • Inventory at the end of the year.

For example, if you are a bookseller and start the year with an inventory of $10,000 (your cost), spend $100,000 buying books from wholesalers over the course of the year, and end the year with an inventory of $20,000 (your cost), your COGS would be $90,000. If instead you expensed materials and supplies as you purchased them, the deduction would be $100,000. But your profit margins wouldn’t make a lot of sense and running your business may be more difficult over time.

Business Expenses. Alternatively referred to as “business deductions,” these would be costs which the IRS considers “ordinary and necessary” to running your business. The Agency is less concerned with the categorization of the expenses than they are with the expenses being valid and directly allocable to your business. While we don’t require full documentation to enter a Schedule C, in a tax audit, the IRS would require you to substantiate all business expenses. Failure to do so could result in the agency disallowing those expenses. Documentation is generally comprised of receipts and invoices, but in some cases, could be a handwritten log of expenses and proof of payment.

For more information on business expenses, please refer to What are the common Schedule C expenses?

Bookkeeping services are available. If you would like to consult with a member of our bookkeeping team to see if we can be of assistance in tracking your business income and expenses, please visit our website at: and click on the “Book Now” button. This will allow you access to the calendars of our bookkeeping team where you can set up a free consultation. Our bookkeeping team is designed to help as much—or as little—as you would like, and can work within every budget.

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Introduction. Alternatively referred to as “business deductions,” business expenses can help offset the income you report on a Schedule C. These would be costs which the IRS considers “ordinary and necessary” to running your business. Necessary in the context does not mean required. For example, if your industry is holding a conference out of state, and you attend that conference, it would be an ordinary expense, and necessary in the sense that you judged that conference to be a wise use of your funds. That being the case, all related expenses to the conference—the cost of the conference, airfare, hotels, Uber charges, meals while away, etc.—would be deductible. That could be one line item called “Conference expenses,” or the expenses can be broken out into the various categories of travel, conference price, meals, etc.

The IRS is less concerned with the categorization of the expenses than they are with the expenses being valid and directly allocable to your business, and will require documentation in the event of an audit. An automatic red flag for expenses lacking documentation would be expenses that end in “000”—in other words, occasionally we see Schedule C’s with expenses such as “Travel $2,000, Supplies $10,000, Number of business miles 12,000” and so forth. Expenses such as that definitely appear to be made up and would likely lack proper documentation. Don’t make up numbers on your Schedule C.

Common expenses. Schedule C expenses which we see on most returns include the following:

  • Advertising, including marketing expenses and print or online ads;
  • Insurance other than health, auto, or home (i.e., liability insurance or a specialty bond);
  • Legal and professional services, including tax preparation, bookkeeping services, legal costs, etc.;
  • Office expenses, including computer and printing costs, software, postage, etc.;
  • Supplies, which can include items sold (if retail), or used for the production of goods, or purchased for the use of your clients;
  • Taxes and licenses, including payroll taxes (if applicable), B&O taxes, business licenses, etc.;
  • Travel expenses, including airfare, hotels, and other transportation costs away from home; and
  • Utilities, including cell phone, internet, and other utilities if you are paying rent in a space.

Less common expenses. Other Schedule C expenses which are less common, but we see regularly:

  • Commissions and fees paid or contract labor—payments to outside sources for whom you must submit a Form 1099-NEC if total payments to them were more than $600 during all of 2022;
  • Rent or lease, including rents paid for office space, or for equipment used by your business;
  • Repairs and maintenance, including repairs on office space which you own or lease;
  • Wages, if you have W-2 employees (note: you would need to have an EIN if this was the case);
  • Depreciation—see What is depreciation (Sch C, E, or F) and how does it work?;
  • Business interest, including interest on business loans or the business portion of you auto loan, but not on any personal debt; and
  • Any of the countless other types of expenses. Line 27a is a summation of all other expenses which can be listed out at in Part V of the Schedule C.

Again, what matters more than the categorization of the expenses is consistency of categorization.

Car and truck expenses. There are two methods for deducting business use of your personal car or truck. Per the IRS, “You can deduct the actual expenses of operating your car or truck or take the standard mileage rate. This is true even if you used your vehicle for hire (such as a taxicab)” (underlines added for emphasis).

  • If you take the actual method, expenses would include the business portion of gas, repairs, car insurance, licensing costs, and lease payments, with depreciation accounted for separately. Your business miles divided by total miles would provide the ratio for business usage. Tolls and parking for business purposes would be 100% deductible and not subject to this ratio.
  • In order to take the standard mileage rate, you must have owned the vehicle and used the standard mileage rate for the first year you placed the vehicle in service, or leased the vehicle and used the standard mileage rate for the entire lease period. The standard mileage rate is broken down in the first half of 2022 ($0.58/mile) and the second half of 2022 ($0.625/mile). If you take the standard mileage rate, you can’t recognize depreciation expense as well—that would be double counting the expense as the standard rate includes the impact of “wear and tear”—which is accounted for via depreciation.

Note: car depreciation can be tricky, and is addressed in a separate topic. If you previously recognized depreciation on a car, when you trade it in or sell it, you may have a taxable gain on that transaction.

Business use of your home. Colloquially referred to as the “home office deduction,” this is a common expense, and yet, an often misunderstood one. The IRS addresses all the ins-and-outs in Publication 587, a 35-page monstrosity written in Greek. The deduction is for the part of the home which is “exclusively and regularly as your principal place of business… or exclusively and regularly as a place where you meet or deal with patients, clients, or customers in the normal course of your trade or business.” Many business owners don’t meet with their clients at their homes—but their homes still fill the role of an office, where they transact and track their business activities. It is important to note that a multipurpose room (sometimes for business and sometimes for the family) would not qualify, so ensure that each area you are claiming has a single purpose.

There are two methods for taking the deduction:

  • The Simplified Method is just that—simple. You can take an annual deduction of $5 per square foot (up to 300 square feet) for the business use of your home. If your home (or apartment or whatever) is 1,500 square feet, and you have an office comprising 240 square feet, your deduction would be $1,200. Documentation requirements are fairly low, but so is the benefit.
  • The Actual Method is far more complex, but can offer a better benefit in most cases. The allowable area definition is the same as the simplified method, but rather than be multiplied times $5 per square foot, it creates a ratio—in the example above (240 square feet of home office space divided by 1,500 square feet for the total for home) the ratio would be 240/1500, or 16.0%. There are three types of expenses for the actual method:
    • Direct expenses—expenses related only to the business portion of the home (e.g. painting the 240-square-foot office)—are deductible in full;
    • Indirect expenses—expenses for keeping up and running your entire home (e.g. mortgage interest, property taxes, homeowners’ insurance, HOA dues, furnace repair, or utilities such as water, sewer, garbage and electric)—are deductible at that ratio, or 16.0% of them; and
    • Unrelated expenses—expenses related only to the non-business portion of the home (e.g. painting the other rooms in the house)—are not deductible. 

With the actual method, you can also take depreciation on the percentage of your home used for the business. See What is depreciation (Sch C, E, or F) and how does it work? for more information on this component. Internet and cell phones should be deducted on Schedule C rather than as part of the home office deduction.

For additional information, please visit the source(s) for this article:

Introduction. Many taxpayers run a unique kind of business out of their homes—daycares. It is unique and receives special treatment from the IRS for the home office deduction (see I have self-employment income. What should I be tracking? and What are common Schedule C expenses? for an introduction to self-employment income and the home office deduction). However, unlike a normal home business where one space is used exclusively for business, daycares often have the entire house used for business during certain hours each day (or several days a week). Additionally, there are special rules regarding food that you provide to your daycare children.

Enhancements to the home office deduction. Daycares can generally take a much larger home office deduction than other Schedule C businesses, but only daycares registered with the state qualify. Per IRS Publication 587,

If you use space in your home on a regular basis for providing daycare, you may be able to claim a deduction for that part of your home even if you use the same space for nonbusiness purposes. To qualify for this exception to the exclusive use rule, you must meet both of the following requirements:

  • You must be in the trade or business of providing daycare for children, persons age 65 or older, or persons who are physically or mentally unable to care for themselves; and
  • You must have applied for, been granted, or be exempt from having a license, certification, registration, or approval as a daycare center or as a family or group daycare home under state law.”

Let’s assume an entire 1,500-square-foot home is used for the daycare 5 days a week, 12 hours a day, 50 weeks a year. Indirect expenses would be multiplied by the entire 1,500, and then by a number of hours rate. In this example, we have 3,000 hours (5 x 12 x 50) divided by 8,760 (the total number of hours in a year), so 34.2% of all indirect expenses (mortgage interest, property taxes, repairs, utilities, etc.) would count towards the home office deduction in this scenario. If some rooms aren’t available for the daycare, you would adjust for those.

Providing food to the daycare children—actual method. If you provide food for your daycare recipients, don’t include it as part of the home office deduction. Instead, it would be a separate line item on your Schedule C. There are two methods for accounting for this food cost, using one of two methods: actual expenses or standard rates from the tables. Actual expenses would include the cost of food purchased for the daycare kids, and would include 0% of food costs for members of your family and 50% of food costs for your employees. You would need to keep tight records (including receipts) showing the food purchased for your family, and that purchased for the daycare kids, so it is recommended to make those purchases separately. If you receive food reimbursement from the state, any reimbursement in excess of actual cost would count as taxable income.

Providing food to the daycare children—from the tables. As an alternative to tracking the individual meal costs and keeping them separate from your family’s personal use, you can use the tables from Publication 587. (Note: standard meal rates include beverages, but do not include non-food supplies used for food preparation, service, or storage, such as containers, paper products, or utensils.) These expenses can be claimed as a separate deduction on your Schedule C. Multiply the number of each meal provided by these rates:

For additional information, please visit the source(s) for this article:

Gross Income: Other (rental, gaming, etc.)

Introduction. Gambling income is fairly common, and is usually reported on a Form W2-G, Certain Gambling Winnings. Occasionally, it may be reported on a Form 1099-MISC instead, which is typical for prizes. The trigger for receiving a form is $1,200 from a slot machine or bingo game, $1,500 from a keno game, or $5,000 from a poker tournament. Prize money reported on the Form 1099-MISC has a reportable threshold of $600. The IRS wrote a topic on this (Topic No. 419), the intro of which says,

The following rules apply to casual gamblers who aren’t in the trade or business of gambling. Gambling winnings are fully taxable and you must report the income on your tax return. Gambling income includes but isn’t limited to winnings from lotteries, raffles, horse races, and casinos. It includes cash winnings and the fair market value of prizes, such as cars and trips.

Professional gamblers have a different set of rules; this question deals with the casual gambler—even those who have dozens (or hundreds) of reportable transactions. At issue is whether the gambling is your livelihood, so slot machine users would not be in this category.

Report full income and offsetting losses—but not the net amount. Again per the IRS (Publication 529),

You must report the full amount of your gambling winnings for the year on your Schedule 1 (Form 1040). You deduct your gambling losses for the year on your Schedule A (Form 1040). Gambling losses include the actual cost of wagers plus expenses incurred in connection with the conduct of the gambling activity, such as travel to and from a casino. You can’t deduct gambling losses that are more than your winnings.

An example of the unspoken gambling tax. This creates an unfair situation for people who have calculations based on adjusted gross income (AGI), since the winnings count in AGI, but the losses are an itemized deduction. Here’s an example to illustrate this inequity. Assume you have a single senior citizen on a fixed income who owns your home, and has pension income of $1,000 a month and Social Security income of $2,100 a month. Their income would be $38,000 per year, and they would qualify for a reduced property tax bill. In this scenario, none of their Social Security income would be taxable (see I have retirement income. How is that taxed?), and their AGI would be just $12,000—fully offset by their standard deduction of $14,700. Therefore they would have zero taxable income and owe nothing.

Take this same scenario and introduce gambling income of $50,000 and gambling losses of $53,000 (not an uncommon scenario). Since the gross winnings would count in AGI, it would cause 85% of their Social Security to be taxable, and their AGI would now be a whopping $83,420. They would no longer qualify for the reduced property tax bill which could cost them perhaps $2,800, and even after deducting losses up to the amount of the winnings (just $50,000 in this case rather than $53,000 in actual losses), they would still have taxable income of around $30,000—and a tax bill of around $3,400. So winning $50,000 and losing $53,000 cost them the $3,000 in losses plus around $3,800 in property taxes and around $3,400 in income taxes. Those winnings have a net cost of $9,200—far greater than the stated loss of $3,000.

You may feel this was unfair, but this is how the tax code is written and it’s important to understand that prior to having gambling as a retirement hobby. At higher levels of winnings and losses (say $100,000 in winnings and $105,000 in losses), the impact can actually be much worse due to the increased Medicare costs which will be paid for a full year—see Why is my Medicare cost so high? for more information.

Tax withholding. If permitted by the casino, we recommend having federal taxes withheld from your winnings. Some local casinos (such as the Emerald Queen) don’t permit tax withholding, but many others do. Due to the unfair secret taxation of gambling winnings as discussed above, withholding 15%-20% helps cushion the impact at tax time, and at the time of the jackpot euphoria, you would still keep 80%-85% of the winnings.

For additional information, please visit the source(s) for this article:

Introduction. The IRS has had an increasing interest in crypto currency over the past few years. In 2014, they released their first notice on crypto currency, stating that “virtual currency is treated as property for Federal income tax purposes and… longstanding tax principles (are) applicable to transactions involving property apply to virtual currency.” In tax year 2020, the first page of the Form 1040 had a question added right in the middle of the form—the first addition to that first page in a generation: “At any time during 2020, did you receive, sell, send, exchange, or otherwise acquire any financial interest in any virtual currency?” That question remained in place for tax year 2021, and that same year, the IRS created a new anti-tax fraud initiative called “Operation Hidden Treasure,” intended to go after crypto transactions. As recently as September 2022, they have obtained court orders allowing for a summons of customer records and blockchain transaction histories.

Continued lack of clarity. Despite the seeming certainty that the IRS uses to address this issue (see their Q&A referenced below), there remains a huge amount of uncertainty on how to report the transactions themselves. Gains and losses on individual stocks or mutual funds are pretty easy to track—your broker does it for you in most cases. But with crypto currency, there can be a constant churn between currencies and digital wallets, and determining a specific gain or loss (and knowing whether that gain or loss was short-term or long-term) has proved beyond possible for most taxpayers. If an average active crypto user had to report every time value was transferred between a tether or coin A and coin B, their Schedule D could be hundreds of pages long. There are several online crypto portfolio trackers (Pionex, CoinSmart, Bitstamp, etc.), but our experience with them—so far—has been that the capital gains and losses are inaccurate and make assumptions about the prices of previously purchased assets.

What the IRS is looking for now. The 2022 1040 instructions do provide a little more clarity this year. It says that you don’t have to answer “yes” to the page one question, or report anything if you:

  • Hold crypto in a wallet or account;
  • Transfer crypto from one of your wallets or accounts to another one of your wallets or accounts; or
  • Purchase crypto using U.S. currency, including through the use of electronic platforms.

What would cause a “yes” to the page one question—and the subsequent Schedule D (capital gains and losses) would be if you did any of the following:

  • Received crypto as payment for property or services provided or as a reward or award;
  • Received new crypto as a result of mining, staking, and similar activities;
  • Used crypto to pay for any goods or services;
  • Traded one kind of crypto for another kind of crypto;
  • Sold a crypto or gave away crypto for free as a gift (without receiving any consideration); or
  • Otherwise disposed of any other financial interest in any crypto or other digital asset.

In other words, it’s all about the disposition. And if you have any kind of disposition, you’ll have a gain or a loss. Leading up to tax year 2021, the value of cryptocurrency had almost exclusively been up, with a total global market capitalization of December 31, 2018, 2019, 2020 and 2021 of $125 billion, $191 billion, $772 billion and $2.3 trillion, respectively. That kind of increase caught the attention of the IRS, and they wanted a cut. With a total capitalization of closer to $869 billion at the end of November 2022, investors are wondering how they can deduct losses. In either case, we can try and help piece together any gains or losses, but until the industry is regulated like stocks, crypto will remain a wild card on many, many tax returns.

For additional information, please visit the source(s) for this article:

Adjustments to AGI

Introduction. Adjustments to income, sometimes referred to as “Adjustments for AGI,” function like itemized deductions in that they reduce your taxable income, and thus your tax bill. But unlike itemized deductions, you don’t need to file a Schedule A to claim them. Instead, they are the connection between your gross income and your adjusted gross income (AGI), and include fairly common adjustments and some that are far less common. These adjustments only work in your favor—in no case would adjustments cause AGI to be higher than gross income, but in many cases in can lower your AGI and thus your taxable income.

Student loan interest deduction. The maximum amount of the student loan interest deduction is $2,500. A couple of rules in order to qualify for this deduction (note: married filing separately don’t qualify):

  • You paid interest on a qualified student loan, generally reported on a Form 1098-E;
  • The underlying loan was used to pay education (tuition, books, etc.), and wasn’t from a related source;
  • It was for the taxpayer, spouse, or someone you claim on your tax return in the current year; and
  • You didn’t make too much money:
    • Single and head of household: phase out starts at $70,000 of AGI—$0 benefit at $85,000; and
    • Married filing jointly: phase out starts at $145,000 of AGI—$0 benefit at $175,000.

Educator expenses. Per the IRS,

if you were an eligible educator in 2022, you can deduct on line 11 up to $300 of qualified expenses you paid in 2022 ($600 if married filing jointly and both of you were eligible educators). An eligible educator is a kindergarten through grade 12 teacher, instructor, counselor, principal, or aide who worked in a school for at least 900 hours during a school year.”

Qualified expenses include standard and customary expenses which you actually paid for (and were not reimbursed for) such as the following:

  • Professional development courses you have taken related to the curriculum you teach; or
  • Books, supplies, equipment, computers, software, and other materials used in the classroom.

Tuition and fees deduction. This is commonly considered a tax credit for higher education, but…

HSA contributions. See Can I contribute to an HSA plan to lower my tax bill?

IRA contributions. See What is the difference between a Traditional IRA and a Roth IRA?

Deductible part of the self-employment (SE) tax. If you have self-employment income and pay the SE tax, you can take one-half of that tax as an adjustment to income. While that may like a very generous benefit, remember that the adjustments to income are a benefit at your marginal tax rate, while the SE tax (or any other tax) are dollar for dollar. So a self-employed, single taxpayer who has $50,000 of net business income would have an SE tax of $7,065 and an adjustment to income of half of that, or $3,532. But that adjustment would be at their marginal rate (12% in this case), meaning it reduces the tax bill by $424—not all that much compared to the tax itself of $7,065.

Self-employed health insurance deductions. In addition to part of the self-employment tax, if a self-employed individual pays health insurance premiums (but not co-pays, co-insurance, prescriptions, etc.), those would also be an adjustment to income—and not a business expense recognized on Schedule C. This adjustment is limited to the net income of the Schedule C, and can’t take the business income below zero.

Less common adjustments for AGI include:

  • Moving expenses, but starting in 2018, the only group that can take this deduction are members of the Armed Forces who are on active duty and receive a military order to move;
  • Alimony payments, but only if the divorce was final on December 31, 2018 or before. Alimony payments stemming from divorces after that date are neither includable nor excludable from income.

For additional information, please visit the source(s) for this article:–dft.pdf

Introduction. There are seven primary types of individual retirement accounts (IRA). The rules and purposes for each are a little different, as outlined below.

Traditional and Roth IRAs. For more information on these IRA types, please refer to What is the difference between a Traditional IRA and a Roth IRA?

SEP IRA. Short for “Simplified Employee Pension” plan, these traditional (i.e. not Roth) plans are available to any size small business, the contributions are made by the employer for each eligible employee (21 years old, has worked 3 of the past 5 years, and received $650 in compensation). There are pros and cons for this plan:

  • Pro. Easy to set up and operate—no filing requirement by the employer.
  • Pro. Huge contribution limits—the lower of $61,000 or 25% of net business income.
  • Pro. Flexible annual contributions—annual participation isn’t required if things are tight.
  • Con. Employer must contribute equally (in terms of percentage) to all eligible employees.

SIMPLE IRA. Short for “Savings Incentive Match Plan for Employees,” these traditional (i.e. not Roth) plans are available to small businesses with fewer than 100 employees, and must be the only plan the employer offers. Unlike a SEP, which is entirely funded by the company, for a SIMPLE IRA, a company can either match an employee’s contribution to their own account (up to 3%), or make a 2% nonelective contribution for each eligible employee. The reporting requirement for these plans are a bit more onerous, but it does force employees to participate in their own retirement. Plus, there are larger overall contribution limits—$14,000 per employee (plus $3,000 more if 50 or over).

Spousal IRA. Per the article linked below,

IRS rules state that a person must have earned income to be eligible to contribute to an IRA. But there’s a workaround for married taxpayers: If one half of the twosome isn’t working—or brings in a very low income—you still can both contribute to your own separate IRAs (either Roth or traditional)”

The contribution limits are the same as the traditional or Roth IRA and while the money may come from spouse #1, the IRA is in the name and Social Security number of spouse #2.

Self-directed IRA. This IRA type is distinguished from the others because it can hold a variety of alternative investments normally prohibited from regular IRAs. It can be either a traditional or a Roth. Although administered by a custodian/trustee, the account holder manages the account. Hence, it is best suited for qualified and experienced investors who understand the risks and benefits of various alternative investments.

Educational IRA. For more information on an Educational IRA (sometimes referred to as a Coverdell ESA or 529 plan), please see My kid is in college and received a distribution from a 529 plan. Is it taxable?

A note about non-deductible IRAs. If you are offered a retirement plan at your W-2 job, such as a 401(k) or 403(b), and your income exceeds a set limit, your traditional IRA contributions may be nondeductible. This creates a basis for you which must be tracked. The contributions can still earn tax deferred, but as money is withdrawn from the plan, the basis amount is nontaxable.

For additional information, please visit the source(s) for this article:

Standard Deductions or Itemized Deductions

Introduction. In 2017, Congress passed the Tax Cuts and Jobs Act, which re-wrote the tax code for the first time in a generation for tax year 2018 and beyond. In addition to eliminating the personal exemption deduction, the standard deductions for all filing statuses were nearly doubled. As the standard deduction represents the amount of income a taxpayer can earn without having to pay federal taxes, this was generally welcomed news. But it significantly reduced the number of taxpayers itemizing deductions, which dropped from 32.0% of all returns in 2017 to just 12.7% of returns in 2018—and has remained at that level.

Filing statuses. Here are the five statuses, along with the 2022 standard deduction, and percentage of all returns filed in the most recently available year:

  • Single ($12,950, 50.9% of all returns);
  • Married filing jointly ($25,900, 33.7% of all returns);
  • Head of household ($19,400, 13.0% of all returns);
  • Married filing separately ($12,950, 2.3% of all returns); and
  • Qualifying surviving spouse ($25,900, less than 0.1% of all returns).

Itemized deductions. If the total of your itemized deductions exceeds your standard deduction, you can itemize deductions, which would allow for more tax-free income. Itemized deductions come in five categories:

  • Medical and dental expenses, discussed in depth in I have a lot of medical expenses. Are they deductible?, are subject to a 7.5% floor of adjusted gross income. So depending on your level of income and other itemized deductions, they may provide a lot of value to you.
  • State and local taxes, discussed in depth in What kinds of taxes can I count as itemized deductions?, have a ceiling of $10,000. So while it may provide value, the value may be limited.
  • Mortgage interest includes any loan which is secured by your main home or second home, which can include anything which has three components: a sleeping space, a toilet, and cooking facilities. So a boat or RV would qualify as a second home if these components are present. And unlike medical and dental costs (with its floor), and state and local taxes (with its ceiling), this line item is a primary driver, with a limitation high enough that it is rarely reached. Deductibility requires two qualifications:
    • The loan in question was used to buy, build, or substantially improve your home. If you took out a mortgage secured by your home to take a trip or give a gift, the interest isn’t deductible.
    • For mortgages taken out prior to December 15, 2017, you can only recognize interest on the first $1.0 million. For mortgages taken out after that point, the limit is $750,000.

Two other considerations for mortgage interest. One, the mortgage insurance premium deduction expired in 2021, and unless Congress extends it (as they have for a few years now), it won’t be deductible. And even if it was deductible, the AGI limitation was fairly low—$100,000 for most filing statuses ($50,000 for taxpayers married filing separately). Two, points paid on the refinance of a mortgage are deductible over the life of the loan—on a purchase, you can deduct them up-front. The points may appear on your Form 1098, or on the mortgage settlement statement, called the HUD-1.

Charitable contributions, discussed in depth in How do charitable contributions work?, would include both cash and non-cash contributions.

For additional information, please visit the source(s) for this article:

Introduction. If you itemize deductions on Schedule A, you may be able to deduct expenses you paid that year for medical and dental care for yourself, your spouse, and your dependents. The IRS says “medical care expenses include payments for the diagnosis, cure, mitigation, treatment, or prevention of disease, or payments for treatments affecting any structure or function of the body.” But there is a catch—you can only deduct amounts paid which exceed 7.5% of your adjusted gross income (AGI). It’s the so-called “medical floor,” and precludes most taxpayers from being able to deduct medical expenses on their tax returns.

What can be included. Provided that one, you itemize deductions, and two, the total amount of your medical expenses are in excess of 7.5% of your AGI, the following expenses would qualify for the deduction:

  • Payments for prescription medications;
  • Payments for medical and dental insurance premiums (Note: if you’re an employee, don’t include in medical expenses premiums paid by your employer, or provided to you on a pre-tax basis); 
  • Payments for insurance premiums for qualified long-term care insurance policy covering qualified long-term care services (Note: these premiums may be subject to limitations);
  • Payments of fees to doctors, dentists, surgeons, chiropractors, psychiatrists, psychologists, and nontraditional medical practitioners;
  • Payments for inpatient hospital care or residential nursing home care, if the availability of medical care is the principal reason for being in the nursing home, including the cost of meals and lodging charged by the hospital or nursing home. (Note: if the availability of medical care isn’t the principal reason for residence in the nursing home, the deduction is limited to that part of the cost that’s for medical care.)
  • Payments for medical equipment and supplies, including dentures, eyeglasses, contact lenses, hearing aids, crutches, wheelchairs, and for a guide dog or other service animal to assist disabled persons;
  • Payments for other less common medical expenses such as acupuncture, inpatient treatment at a center for alcohol or drug addiction, participation in a smoking-cessation or weight-loss program; and
  • Payments for transportation primarily for and essential to medical care. In addition to the actual cost of tolls, parking, taxi, etc., you can also deduct 16 cents per mile driven. 

What cannot be included. You can’t deduct funeral or burial expenses, nonprescription medicines, toothpaste, toiletries, cosmetics, gym memberships, a trip for the general improvement of your health, or most cosmetic surgery. You also can’t deduct amounts paid for nicotine gum/patches unless they require a prescription. You can only include the medical expenses you paid during the year, and you have to reduce your total deductible medical expenses for the year by any reimbursement (from any source) of deductible medical expenses.

A practical example. To see the impact of the medical floor, consider the following example. A married couple are both retired, and own their home without a mortgage. They paid sales and property taxes of $2,500 and $5,000, respectively, and have charitable contributions of $2,000. Their AGI for 2022 is $100,000, including income from interest and dividends, Social Security, IRA distributions and pensions. Between their prescriptions, Medicare Part B and Medicare supplemental policies, doctor and dental visits, and two stays in the hospital, they paid $25,000 in medical costs during the year. That would sound like an incredible amount—a quarter of their annual income. However, the first $7,500 of expenses gets them to the medical floor, and the remaining $17,500 would count towards their itemized deductions. But without mortgage interest, their other itemized deductions total just $9,500, taking their itemized deductions to $27,000—below the standard deduction they would qualify for of $28,700. The value and benefit of their paying $25,000 of medical expenses in this scenario was $0.

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Introduction. The deduction for state and local taxes (SALT) paid is limited to $10,000 for most filing statuses ($5,000 for taxpayers married filing separately). Per the IRS, “to be deductible, the tax must be forced on you, and you must have paid it during the year”. There are four types of deductible (non-business) state and local taxes:

  • Income taxes;
  • Sales taxes;
  • Real estate taxes; and
  • Personal property taxes.

Income taxes or sales taxes. You can elect to deduct state, local and foreign income taxes—or state and local sales taxes—but not both. If you live in a state with an income tax (such as Idaho or California), your income tax will almost always be higher. If you live in a state without an income tax (such as Washington or Texas), sales tax will almost always be the better option.

  • Income taxes paid include state and local taxes withheld from your salary on Forms W-2, 1099-G, 1099-R, etc. and mandatory contributions made to state programs, such as California’s SDI tax, Washington’s workers compensation fund, and state family leave programs. Don’t adjust the amounts for any refunds you received during the year—that happens elsewhere.
  • Sales taxes paid include a state portion and local portion. The combined total is the rate to determine this deduction. Unless you want to count sales tax paid from every receipt during the year, the IRS has generic values to use from their tax tables to determine what your deduction will be—below is a link to that calculator. The inputs include filing status, household size, income, and zip code. In addition, sales taxes paid on any large or unusual items (car, large-scale home improvement projects, etc.) can be added to the sales tax from the tables.

Real estate (“property”) taxes. Per the IRS, “deductible real estate taxes are generally any state or local taxes on real property levied for the general public welfare. The charge must be uniform against all real property in the jurisdiction at a like rate.” Therefore, if your property tax payment includes things such as repayment for energy saving improvements via a government program, or charges for LIDS (local improvement district benefits)—that portion of the payment is not deductible. The nuance is whether the charge is really paying for improvements to the property (not deductible), or it is a general rate charged to everyone (deductible). And while property taxes paid on any foreign property are not deductible, you can deduct property taxes paid on a second home or raw land which you own, provided it meets the other qualifications listed here.

Personal property taxes. This category includes any ad valorem tax—or a tax based on the value of an asset. The best example is the annual auto registration. While some of the cost of renewing your vehicle is a licensing fee (not deductible), and perhaps a vehicle weight fee (not deductible), part of it is based on the vehicle value—and that part is deductible in this category. Your vehicle registration form should have the breakout.

Nondeductible taxes. Any taxes imposed at a federal level are nondeductible, including federal income tax, most excise taxes, Social Security and Medicare taxes, customs duties, federal estate and gift taxes and things such as gas taxes or license fees (e.g. marriage or driver’s licenses).

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Introduction. Charitable contributions of cash and/or property is reported on Schedule A, which requires the taxpayer to itemize deductions. For tax years 2020 and 2021, there was a small amount which would be an adjustment for income for those who didn’t itemize, but that adjustment is expired for tax year 2022. People sometimes ask if there is a limit to cash contributions, and there is—albeit one that is rarely hit—60% of your adjusted gross income each tax year (contributions in excess of 60% can be carried over to future years).

Types of organizations which qualify. Gifts to individuals are not deductible. Only qualified organizations are eligible, and in a similar vein, contributions using GoFundMe (or a similar organization) are only tax-deductible if made to a qualified charitable organizations—not to individuals in need. The IRS has a non-profit lookup to verify that the organization has been granted charitable status (see sources below), and examples include:

  • Churches, mosques, synagogues, temples, and other religious organizations;
  • Organizations such as Boy Scouts and Girl Scouts, Boys and Girls Clubs, Goodwill Industries, Red Cross, Salvation Army, Deseret Industries, United Way, and similar organizations;
  • Veterans’ and certain cultural groups, nonprofit hospitals and medical research organizations;
  • Most nonprofit educational organizations, such as colleges (but only if your contribution isn’t a substitute for tuition or other enrollment fees); and
  • Federal, state, and local governments if the gifts are solely for public purposes.

Documentation for the deduction. Per the IRS,

For any contribution made in cash, regardless of the amount, you must maintain as a record of the contribution a bank record or a written record from the charity. The written record must include the name of the charity, date, and amount of the contribution… For contributions of $250 or more, you must also have a contemporaneous written acknowledgment from the charitable organization.”

Non-cash contributions also require documentation, and if the gift is $500 or less, the documentation can be as simple as a receipt from Goodwill listing the date, what was donated, and how you figured what the value is. For non-cash contributions between $500 and $5,000, the documentation requirement is heightened, and there is an expectation of a complete list, including a description and pictures. For non-cash contributions over $5,000, there is an expectation of an appraisal or other independent valuation of the items donations. If an automobile is donated, a special form (1098-C) must accompany your return.

What can’t be deducted. Among payments made to organizations which are not deductible as charity include:

  • Value of your time or services;
  • Payments which gave you a benefit (you can deduct the difference between your donation and value);
  • Travel expenses (including meals and lodging) while away from home performing donated services, unless there was no significant element of personal pleasure, recreation, or vacation in the travel;
  • Dues, fees, or bills paid to country clubs, lodges, fraternal orders, or similar groups;
  • Cost of raffle, bingo, or lottery tickets;
  • Gifts to foreign organizations (though some exceptions apply);
  • Political contributions, or gifts to organizations engaged in political or lobbying activities; or
  • Gifts to civic leagues, social and sports clubs, labor unions, and chambers of commerce.

Charitable mileage. The standard mileage rate allowed for operating expenses for a car to do volunteer work for qualified charitable organizations is 14 cents a mile.

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Taxable Income, Taxation Tracks, and Other Taxes

Introduction. As was taught on my first day of my college federal taxation class at UW Tacoma, the tax code in the United States isn’t fair. It isn’t intended to be fair. It serves two and a half purposes—collect money for the federal government, encourage behaviors the federal government wants its citizens to engage in, and reward the friends of those writing the tax code. Well, that last part isn’t officially true, but as we have seen with certain tax carve-outs and loopholes, it is very obviously one of the purposes of the tax code.

Marginal tax system. Our federal tax system is progressive (instead of regressive), so rather than a flat tax rate applied uniformly at all levels of income, there are different tax brackets, which apply a progressively higher tax rate to higher levels of income. “Marginal” refers to the focus on the next unit—or dollars earned in this case. A couple of common rates used in tax are your statutory marginal rate (AKA “tax bracket”) and your effective rate (think of this as the average rate on all income). For more information on tax rates, see What do all these rates mean and why do they matter?

Multiple tax “tracks”. There are actually two separate sets of marginal rates—one for ordinary income and one for long-term capital gains. The ordinary income brackets include seven rates: 10%, 12%, 22%, 24%, 28%, 32%, 35%, and 37%. The long-term capital gain brackets (which are taxed favorably) include just three rates: 0%, 15%, and 20%. For examples, see What are some examples of how income is taxed?

More than just marginal rates. Because the tax code was in part written to encourage behavior, there are a number of additions and subtractions between income and your ultimate tax bill, including:

  • Adjustments to income, including student loan interest, IRA and HSA contributions, etc.;
  • Itemized deductions (if more than the standard deduction), including mortgage interest, charity, etc.;
  • Various tax credits, such as the child tax credit, higher education credits, etc., which can be either:
    • Refundable—i.e. limited to the amount of taxes you must pay on your return; or
    • Nonrefundable—i.e. can be paid out as a refund even beyond your tax bill; and
  • Various additional taxes, such as the self-employment tax, net investment tax, etc.

The flow chart. It might be easier to see the general flow-through of the tax code graphically:

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Example 1. Taxpayer, age 63, is a retired electrical contractor. His income is from the following sources: four separate pensions totaling $78,995 (federal tax withholding of $14,212), interest and ordinary dividends of $3,397, qualified dividends of $7,274, and a long-term capital gain distribution from his Merrill Lynch account of $23,948. He owns his home without a mortgage, and doesn’t have enough other itemized deductions in order to exceed the standard deduction. His only tax credit was a very small foreign tax credit of $4. He had adjusted gross income is $113,614, taxable income of $101,064, and a tax bill of $15,793. Since his 1099-R federal tax withholding was $14,212 (plus the foreign tax credit), he owed $1,577. His marginal rate (i.e. the tax on his last dollar of taxable income) was 24%, and his effective (overall) rate was 13.90%:

Example 2. Taxpayer, age 48, is self-employed in an S-Corporation which qualifies for QBI. Spouse, age 50 is a homemaker. They claim taxpayer’s elderly parents who live with them and have three children under the age of 17. During 2021, the IRS made advanced child tax credit payments totaling $4,500. They have income from three sources: a W-2 for $60,000 (federal tax withholding of $10,000), passthrough income from the S-Corporation of $75,707, and $537 in long-term capital gains in an E*Trade account. Student loan interest totaled just $71, and they itemized deductions due to mortgage interest ($11,613), charitable contributions ($9,580), sales and property taxes (capped at $10,000), and medical expenses ($6,169 after the 7.5% of AGI floor). Finally, they had income-based insurance through the State, but received too much in credits—and have to pay back $2,700. Hence, they had adjusted gross income of $136,173, taxable income of $85,957, a tax bill of $10,453, and a refund of $2,347. Their marginal rate (i.e. the tax on their last dollar of taxable income) was 22%, and their effective (overall) rate was 5.56%:

Introduction. As part of the 2012 law known as the Affordable Care Act (ACA), Congress implemented a new tax on certain income above a threshold amount for tax years starting in 2013. The tax is 0.90% on Medicare wages and is used to pay for the ACA and the Advanced Premium Tax Credit. Medicare wages are typically the highest reported wage, without the impact of pre-tax deductions. See What is the difference between gross and taxable income on my W-2? for a breakdown of some of the common differences between Medicare wages and taxable wages.

Types of income which apply. This tax applies to three types of income: Medicare wages (very common, and includes all W-2 income), self-employment income (quite common), and Railroad Retirement Tax Act compensation (rare). Per the IRS, “Medicare wages and self-employment income are combined to determine if your income exceeds the threshold. A self-employment loss shouldn’t be considered for purposes of this tax. RRTA compensation should be separately compared to the threshold.”

Income thresholds. This tax applies to total Medicare compensation which exceeds the following thresholds for the various filing statuses:

  • $250,000 for married filing jointly;
  • $200,000 for single, head of household, or qualifying surviving spouse; and
  • $125,000 for married filing separately.

How it gets paid. You typically don’t feel the impact of this tax if you are a W-2 employee at one job for the year, since your employer is responsible for withholding it and submitting it along with your other payroll taxes. You will see the tax on Schedule 2, but your federal withholding should match that amount. However, if household income is comprised of multiple W-2 jobs during a year, or you have self-employment income in addition to W-2 income, the tax shown on Schedule 2 will only partially by offset by additional taxes withheld on a W-2. It is also possible that this tax will be over withheld, since “your employer must withhold Additional Medicare Tax on wages it pays to you in excess of $200,000 for the calendar year, regardless of your filing status and regardless of wages or compensation paid by another employer.”

A practical example. Let’s assume there is a married couple who are filing jointly, and spouse A has W-2 income of $240,000 and spouse B has retirement and investment income totaling $50,000 (i.e. no income subject to Medicare). While their adjusted gross income is above the $250,000 threshold, their Medicare income is only $240,000—below the threshold. Despite this, Spouse A’s employer will withhold $3,840 for Medicare taxes ($3,480 based on the standard rate of 1.45% on all $240,000, which the employer would match, plus $360 based on 0.90% times the $40,000 above the $200,000 auto-withholding threshold). In this instance, the couple is not subject to the Additional Medicare Tax, and the line item “Federal income tax withheld from… Other forms” will show $360. This would go in as an additional tax payment, and offset $360 of the couple’s tax liability.

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Introduction. As part of the 2012 law known as the Affordable Care Act (ACA), Congress implemented a new tax on certain investment income above a threshold amount for tax years starting in 2013. The tax is 3.80% on net investment income above certain thresholds and quite negatively affect returns which report large capital gains or have material amounts of other passive income.

Types of income which apply. Per the IRS, this tax applies to “investment income… (including): interest, dividends, capital gains, rental and royalty income, non-qualified annuities, (and) income from businesses… that are passive activities to the taxpayer.” It does not apply to earned income (wages, self-employed income, etc.) or certain kinds of passive income (unemployment compensation, Social Security benefits, alimony, tax-exempt income, etc.). Additionally, there are carve outs for a few types of passive investment income, such as a gain on the sale of your primary residence, income passed through to you from a charitable trust, or income from estates and trusts which have very low levels of adjusted gross income.

Deductions against investment income. Per the IRS, investment income can be

reduced by deductions (which may) include investment interest expense, investment advisory and brokerage fees, expenses related to rental and royalty income, tax preparation fees, fiduciary expenses (in the case of an estate or trust) and state and local income taxes

—hence the “net” in “net investment income.”

Income thresholds. This tax applies to net investment income where the taxpayer’s modified adjusted gross income (MAGI) exceeds the following thresholds for the various filing statuses:

  • $250,000 for married filing jointly or qualifying surviving spouse;
  • $200,000 for single or head of household; and
  • $125,000 for married filing separately.

The calculation for MAGI starts with adjusted gross income, and adds back deductions for IRA contributions, nontaxable of Social Security payments, tax-exempt interest, and a few other rare items. The tax itself is paid on the lesser of the net investment income, or the amount over the MAGI threshold.

How it gets paid. Unlike federal income tax and the Additional Medicare tax which are typically withheld on Form W-2 or 1099-R, there is no withholding for the Net Investment Tax. Instead, it will be listed as an additional tax on Schedule 2 of your personal tax return. It is subject to the estimated tax provisions, so taxpayers should know what this tax will be, include the impact on any estimated tax payments if needed.

An example from the IRS.

Taxpayer, a single filer, has $180,000 of wages. Taxpayer also received $90,000 from a passive partnership interest, which is considered Net Investment Income. Taxpayer’s MAGI is $270,000. Taxpayer’s MAGI exceeds the threshold of $200,000 for single taxpayers by $70,000. Taxpayer’s Net Investment Income is $90,000. The Net Investment Income Tax is based on the lesser of $70,000 (the amount that Taxpayer’s MAGI exceeds the $200,000 threshold) or $90,000 (Taxpayer’s Net Investment Income). Taxpayer owes $2,660 ($70,000 x 3.8%).”

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Introduction. Tax-favored accounts allow taxpayers to defer some of their income until retirement, when (in theory) household income will be less, and marginal rates lower. Additionally, the investments in these accounts can grow and earn on a tax-deferred basis. Tax-favored accounts include qualified retirement plans such as pensions, 401(k) plans, 403(b) plans, qualified annuities, and all types of IRAs which are on a pre-tax basis (i.e. not Roth IRAs). In addition to distributions from these plans counting as taxable income in the year of distribution, there may be other taxes associated with them. Below is a brief discussion on some of these.

Early withdrawal penalty. In general, if you receive an early distribution from one of these plans—defined as a distribution before you reach the age of 59 ½—the part of the distribution included in income is generally subjected to a 10% additional tax. There are several exceptions to this penalty, including distributions:

  • Which are rollovers from one tax-favored plan to another tax-favored plan;
  • Made to your beneficiary or estate on or after the IRA holder’s death (though those distributions are taxable to your beneficiaries, if they withdraw the money rather than roll it into an inherited IRA;
  • Made because you’re totally and permanently disabled;
  • Made to pay health insurance premiums, after you have received unemployment compensation for twelve consecutive weeks (including self-employed persons who are unemployed for that long);
  • To extent you have deductible medical expenses that exceed 7.5% of your adjusted gross income whether or not you itemize your deductions for the year; or
  • Made for qualified higher education expenses (the statute does not list limit here), a qualified first-time home purchase (not to exceed $10,000) or for a qualified birth or adoption distribution (not to exceed $5,000, and doesn’t count if the adoption is of your spouse’s child).

Early withdrawal penalty on Roth IRAs. You can withdraw contributions you made to your Roth IRA anytime, tax- and penalty-free. However, you may have to pay taxes and penalties on the earnings in your Roth IRA.

  • If you are under the age of 59 ½, and you’ve had the account for more than five years, the earnings may be subject to taxes and penalties, unless you meet one of the exceptions listed above, If you’ve had the account for less than five years just a couple of those exceptions apply; and
  • If you over the age of 59 ½, and had the account for less than five years, your earnings will be subject to taxation, but not the early withdrawal penalty. If over five years, you are good to go.

Excess accumulation tax. Per the IRS, “You can’t keep funds in (a tax advantaged IRA) indefinitely. Eventually, they must be distributed. If there are no distributions, or if the distributions aren’t large enough, you may have to pay a 50% excise tax on the amount not distributed as required”. During the year a taxpayer turns 72 years old, they must start taking distributions from tax advantaged IRAs known as the required minimum distribution (RMD). A taxpayer may opt not to take an RMD that first year, but if they don’t, they need to take two during the year they turn 73—one during the first quarter of that year, and another by the end of that year. You can always take out more than the RMD, but taking extra in one year does not count towards the RMD in the next year. The amount of each RMD is determined by dividing the prior December 31 balance of that IRA (as reported on Form 5498) by a life expectancy factor which the IRS publishes in Publication 590-B.

For additional information, please visit the source(s) for this article:–dft.pdf–dft.pdf

Introduction. In addition to regular income taxes at marginal rates, taxes calculated using the more favorable long-term capital gains rates, tax relating to self-employment income and taxes related to IRAs or other tax-favored accounts, there are additional (though less common) taxes including the following.

Alternative minimum tax (AMT). In 1966, it was reported that 155 ultra-high-income households didn’t pay any federal tax that year because of tax loopholes. This pissed everyone off, so the IRS jumped into action and created the AMT. As could expected on something like this, the execution was half-cocked and the tax was never indexed to inflation. The major tax overhaul starting in 2018 fixed some of this issue (over 5 million households paid AMT in 2017 compared to closer to 150,000 in 2018). So today, while the tax is still pretty rare, it can catch normal taxpayers, and not just the billionaires. Per the IRS,

Under the tax law, certain tax benefits can significantly reduce a taxpayer’s regular tax amount. The alternative minimum tax (AMT) applies to taxpayers with high economic income by setting a limit on those benefits. It helps to ensure that those taxpayers pay at least a minimum amount of tax.”

It generally shows up on returns which have a massive long-term capital gain, huge amounts of accelerated depreciation, have high incomes, and even higher itemized deductions, or have a significant amount of tax-exempt interest and dividends. Each of these scenarios will cause your tax to be well below the marginal rates and could trigger the AMT.

Household employment tax. Sometimes called the “nanny tax,” this tax relates to anyone you have as a household employee, which can be a babysitter or nanny, caretaker, drivers, housekeepers, yard workers, etc. But the IRS says,

if only the worker can control how the work is done, the worker isn’t your employee but is self-employed. A self-employed worker usually provides his or her own tools and offers services to the general public in an independent business. A worker who performs childcare services for you in his or her home generally isn’t your employee.”

This tax (mercifully) does not apply to them. Employees who would be subject to this tax (paid by you, but part of which can be withheld from the employee’s paychecks) are those:

  • To whom you paid cash wages of $2,400 or more during the year (FICA applies); or
  • To whom you paid cash wages of $1,000 or more in any calendar quarter (FICA and FUTA applies).

The tracking and reporting on household employees can be difficult—please let us know if we can help.

Repayment of first-time homebuyers credit. If you were allowed the first-time homebuyer credit for a qualifying home purchase made between April 9, 2008, and December 31, 2008, you generally must repay the credit over 15 years. The payment is 1/15th per year, so a $7,500 credit would be repaid at a rate of $500 per year for 15 years. The repayment is accelerated if the home is sold prior before the end of the repayment period. You can use the tool linked below to determine how much is left on your repayments.

APTC repayment. See I have health care through the State. How does that work?

Additional Medicare tax. See What is the Additional Medicare Tax (Form 8959) and why is it on my return?

Net investment tax. See What is the Net Investment Tax (Form 8960) and why is it on my return?

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Tax Credits

Introduction. Taxpayers with lower incomes can benefit from most of the tax credits, but two in particular are very beneficial and phase out at low levels of income—the Earned Income Tax Credit (“EITC”) and the Retirement Savings Contributions Credit (usually referred to as the “Saver’s Credit”). As is the case with most credits, these two are designed to encourage certain behaviors—getting jobs and contributing to retirement.

EITC. In terms of total potential dollar value, the EITC is one of the best tax credits (up to $6,935 for tax year 2022), and unlike credits with higher values—such as the adoption credit or certain energy credits—you don’t have to spend tens of thousands to qualify for it. In fact, if you make too much, the credit gets fully phased out. There are some basic general qualifications, including:

  • Your adjusted gross income must be under specified levels (more on that later);
  • You must have a Social Security number and be a U.S. citizen or resident alien all year;
  • Your investment (or passive) income must be less than $10,300; and
  • Most importantly, you must have earned income, which includes wages, self-employment income, or side hustle income. If you are disabled and not yet at retirement age, disability payments are considered earned income for this credit—even if not considered taxable income.

Assuming you meet the basic qualifications, the amount of the EITC is based on three factors—the amount of your income, your filing status, and how many qualifying children you are claiming. The number of kids caps at 3, so you either claim zero qualifying children, one, two, or three. If you have ten, congrats, but no extra credit.

Saver’s Credit. The dollar value of the saver’s credit is lower than the EITC, but it’s huge for very low-income individuals who contribute to their retirement plans. Eligible retirement plans include traditional and Roth IRAs, SEP or SIMPLE plans, or workplace plans such as a 401(k), 457(b), 403(b), etc. The qualifications are straightforward: you have to be at least 18 years old, you can’t be claimed as dependent on another person’s return, and you can’t be a student (defined as being enrolled full-time for five months of the year at a college or trade school). The maximum credit is $2,000 for married filing jointly and $1,000 for other filing statuses. But notice in the chart below how fast you move from a huge benefit (50%) to no benefit at all:

A practical example. Assume taxpayer is single and has physical custody of his two-year-old child (and thus files as head of household). He receives government assistance including cash from TANF, food stamps, and Section 8 housing. Taxpayer has no earned income, and doesn’t qualify for either credit. But let’s make two small changes: one, taxpayer works the year at a minimal part-time job (15 hours a week) at Washington State’s 2022 minimum wage ($14.49 per hour, or $11,300 for the year). Two, taxpayer contributes $2,000 to a Roth IRA. In this scenario, his federal tax due is zero, the EITC is $3,733 and the Saver’s Credit is $1,000. In other words, earning $11,300 is rewarded with $4,733 in additional credits—equivalent to a 42% pay raise. And he has $2,000 in an after-tax Roth IRA which can grow over his lifetime and be completely distributed tax-free.

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Introduction. There are two educational credits—the American Opportunity Tax Credit (AOTC) and the Lifetime Learning Credit (LLC). The credits can be claimed for anyone on your return—taxpayer, spouse or dependents. However, if you are claimed as a dependent by someone else, you wouldn’t be eligible to claim the credit—but the taxpayer claiming you might be able to.

Phase out of credits. At higher levels of modified adjusted gross income (MAGI), both of the credits will be reduced or fully phased out. In previous years, the phase out limits were different between these two credits (the AOTC was more generous), but starting in tax year 2022, the phase out levels are the same:

  • Married filing jointly: Phase out starts at $160,000 of MAGI, fully phased out at $180,000;
  • Single/head of household: Phase out starts at $80,000 of MAGI, fully phased out at $90,000; and
  • Married filing separately: There’s no phase out, since this status doesn’t qualify for any credit.

Summary table based on IRS instructions for Form 8863. The following table compares the two credits:

Other benefits related to education. I addition to these two credits, there is an adjustment to income related to higher education called the Tuition and Fees Deduction—see What are “Adjustments to Income,” and how can they help me? Plus, if a distribution from an educational IRA was used to pay for qualified higher education expenses (which include tuition and fees, books, room and board, transportation, etc.), the growth of the after-tax dollars in that account are tax-free. For more information, see My kid is in college and received a distribution from a 529 plan. Is it taxable?

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Summary of Dollars and Rates

Introduction. Federal taxation is often treated like a mysterious black box. Each year, you dump all of your tax forms into the box, shake it a few times, and out of the bottom will plop either a refund or a balance due. We endeavor to help taxpayers understand the “why” behind their returns, to see each of the inputs and calculations, and to know what levers are available at each stage of the return to change their bottom line for future periods if desired. To help with this, there are three rates presented in our tax analysis: marginal rate, “all-in” effective rate, and effective paid-in rate.

Marginal rate. Otherwise known as your “tax bracket,” this rate gets the most attention since it’s the most commonly discussed in the media. It’s fairly common for taxpayers to know what tax bracket they’re in, but they often misunderstand what it means. Simply put, your marginal rate is the rate at which your last dollar of ordinary income was taxed. Depending on your own tax situation, that stand-alone rate may mean something—but in most cases, it really doesn’t. If you are one dollar into the 22% tax bracket, you will have had just one dollar taxed at 22%—the rest was taxed at 0%, 10% and 12%.

“All-in” effective rate. This is a term and rate which we made up. But it’s the most important ratio we can present, since it takes an actual term (effective rate), and modifies it to account for two other things on your return: additional taxes and tax credits. Your effective rate is simple to calculate: total federal tax divided by adjusted gross income. Taking it to an “all-in” rate adds or subtracts from the numerator to come up with your full tax burden, after any negative impact of other taxes (self-employment tax, net investment tax, etc.) and/or positive impact of credits (child tax credit, educational credits, etc.). Therefore, this rate takes everything on your return into account, and will tell you what your actual withholding needs to be in order to “breakeven” for your return—neither a refund nor a balance due.

Effective paid-in rate. This term and rate are also made up, but have their basis in something simple to understand. How much federal tax did you either 1) have withheld on a W-2, 1099-R, etc., and/or 2) pay in via some other way (estimated tax payments, applied refund from a previous year, etc.). Compare this to your total taxable income and you have a measure of what you paid in.

Practical example. A single taxpayer has just one W-2 with a taxable amount of $55,000 and a 7.25% federal withholding rate (for total withholding of $3,988). With a standard deduction of $12,950, this taxpayer has $42,050 of taxable income ($55,000-$12,950), which is taxed at a rate of 10% for the first $10,275, 12% for the next $31,500, and a rate of 22% for the remaining $275. The total federal tax burden is $4,868. In this case, the taxpayer’s marginal rate is 22%, but that doesn’t mean much to the return—only a tiny amount of income was subject to this rate. Since taxpayer has neither additional taxes nor tax credits, the effective rate and “all-in” effective rate are the same—8.85% ($4,868 tax burden divided by $55,000 of adjusted gross income). This 8.85% represents the taxpayer’s average federal tax burden. Since their effective paid-in rate was 7.25%—less than the breakeven rate of 8.85%—they will be in a balance due position of $880. What could the taxpayer do to change this for future periods? They could have make pre-tax deferrals to a 401(k), or have an adjustment to income or tax credits or have more withheld on their W-2 or make an estimated tax payment or any number of other actions which would either decrease their all-in effective rate or increase their effective paid-in rate.

For more examples, see What are some examples of how income is taxed?

Introduction. While most e-filed returns are processed by the IRS very quickly (5-7 business days), about one in twenty gets held up in their system for no discernible reason. Additionally, there are several types of returns which just take forever to process, including paper-filed returns, returns for a decedent where there is a refund, and amended returns. While our firm doesn’t have access to the IRS back-office records, there are some publicly available sites on the IRS which allow taxpayers to look up the status of their returns.

Where’s my refund. Using the first link below, you can check the refund status of a filed tax return. This page usually populates within a week of filing and requires just a few inputs: tax year, social security number (of either party if married filing jointly), filing status, and expected refund amount:

Where’s my amended refund. Using the second link below, you can check on the status of an amended return. You have to click through the Authorized Use screen and make sure the date of birth includes the dashes:

If none of this works, give us a call and we can try other methods of checking your status.

Disclaimer: The above articles are intended for general educational purposes only and are not as an exhaustive definition of the tax code in whole or in part. LC Miller CPA holds no responsibility for generalized, outdated, and/or incorrect information.

This page is still a work in progress.