Repaying Income - Can You Deduct This?

There may come a time when you receive income only to find out later that you have to repay it. This can happen for any number of reasons, and often the repayment is made in a later tax year. For example, when this happens, a deduction or credit for the repayment may be allowed in the year of repayment. The deduction is taken as an itemized deduction on Schedule A. A credit will result in a dollar-for-dollar reduction of your tax liability.

If the repayment was $3,000 or less, you are out of luck. Prior to 2018, this amount was generally deducted as a miscellaneous itemized deduction on Schedule A. However, recent tax law changes suspended all miscellaneous itemized deductions subject to 2% of your total adjusted gross income until after 2025.

If the repayment was more than $3,000, you have two choices. You can either deduct the total amount you repaid as an itemized deduction, or you may choose a tax credit for the year of repayment equal to the difference in the tax you paid on the income and the amount you would have paid if the income were not included on your tax return in the prior year.

Will You Owe Taxes This Year?

Remember that two-year comparison included in your tax package this year? The one that showed your 2017 tax situation in comparison to the impact that the Tax Cuts and Jobs Act would have if everything stayed 100% the same. Most of you saw a positive outcome - despite the loss of some itemized deductions and personal exemptions. This is due to the change in the tax brackets, the increase in the child tax credit, the pending qualified business deduction and other factors. But as I mentioned, these positive outcomes were contingent on your estimated payments and/or withholding remaining the same.

Most of the time, if you were required to pay estimated payments, I assessed these payments to remain the same, or even increased them, to make up for other areas of lost deductions or credits. But the withholding is an issue. At the beginning of the year, the withholding tables were adjusted for the new tax laws, which means that your employer may have not been withholding enough tax based on your overall tax situation.

The U.S. tax system is a pay-as-you-go process. Taxes must be paid as income is earned or received during the year. With the new tax laws, the way tax is calculated for most taxpayers has changed. In addition, any change in your tax situation for the year (e.g., selling stock, changing marital status, working multiple jobs, etc.) can affect how much tax needs to be paid during the year. 

If you receive salaries, wages, pensions, unemployment compensation and any taxable Social Security, you can adjust the amount of tax withheld. Some income is not subject to withholding, including income from self-employment or rental activities. Therefore, some of you may need to make estimated tax payments unless you expect to owe less than $1,000 when you file or if you had no tax liability in the prior year (subject to certain conditions). 

Making an adjustment to withholding or making an estimated tax payment may help you avoid an unexpected year-end tax bill and a potential penalty. I am happy to run some numbers from now to the middle of January to make sure you are on track, or to advise you to send a payment in for the fourth quarter. Bottom line: Let’s try to avoid a big (and costly) surprise!

Renting Your Home - A Hidden Source of Tax-Free Income

Have you ever thought of your home as a source of untapped income? Consider this: Your home is located in an area that has a lot of tourism or large events that attract many people. Sometimes hotel space is limited or fills quickly. You prefer to be out of town while these events are taking place. If you rent your home for less than 15 days during the year, you just earned some tax-free income.

If you itemize deductions, your mortgage interest and real estate taxes are deducted on your Schedule A. None of the income you collect is taxable, nor is it reported on your tax return. The key to keeping the income tax-free is the number of days you rent your home. You must keep it to less than 15 days during the year. If you rent your home for 15 days or more, tax reporting becomes a bit more complex. Since you also use your home for personal purposes—meaning you live there—you must divide your expenses between the rental use and the personal use based on the number of days used for each purpose. If, after you reduce your rental income by allowed expenses, you have a profit, that profit is taxable. Deductions are limited to rental income.

If you are considering renting your home to others, regardless of the number of days, consult with me first so we can discuss all potential tax consequences.

Unreimbursed Employee Business Expenses And The Accountable Plan

Beginning in 2018, employees are no longer able to deduct out-of-pocket business expenses, including professional dues and licenses, tools and equipment, uniforms, continuing education, and work-related travel, meals and lodging. 

Instead of footing the bill for these business expenses, ask your employer to consider setting up an accountable reimbursement plan. If your employer sets up an accountable plan, you can submit proper documentation for required expenses and subsequently receive tax-free reimbursement. In addition, the employer gets a tax deduction for the payment.

If your employer does not want to set up an accountable plan, you could request an expense allowance to help cover your costs. The employer will need to include this allowance on your W-2; however, it would help reduce your out-of-pocket total.

According to IRS rules, under an accountable plan, expenses are reimbursed if they are business-related and can be substantiated. In addition, amounts paid in excess of actual costs must be returned to the company. Business-related expenses incurred by employees can include such things as travel, meals, lodging, entertainment, transportation, or many other costs. Employees are required to account adequately for expenses with records and to return any excess reimbursement within a reasonable period of time.

Are you an employer? Accountable plans can benefit employees. Since the Tax Cuts and Jobs Act eliminated many deductions for employees, you can establish an accountable plan where the employees are required to submit documentation establishing the time, place and business purpose for the expenses to you. Your reimbursement to the employee is deductible on your business return and not taxable income to the employee.

If you choose not to reimburse your employees, but instead give your employees an expense allowance that can be used without substantiation, you must include the amount on their W-2. You still get a deduction for the amount paid as a wage expense, but your employee is required to pay tax on the money. Having an accountable plan in place will save you the payroll taxes on the amounts required to be included on the employee’s W-2.

Love Letters from the IRS and Estimated Payments

Love letters from the IRS.  Every year, a handful of our clients receive correspondence from the IRS and/or state agencies regarding discrepancies with their tax filing. Normally, a client has forgotten to include a 1099 or W2, and being that the IRS is primarily on an electronic audit system, they know if something is missing, and are usually quick to notify you. But sometimes it can be a couple years before the error is discovered, which can lead to a balance of tax due, including penalties and interest.

Forgetting you worked that side job for a couple weeks, or that you sold some investments, happens. The tax document could have gotten lost in the mail, or went to a wrong address. Or you may have filed it away and forgotten about it. Whatever the reason, the answer is not to ignore the letter, but to call us immediately and provide us with a copy of the letter, so that we can assess the situation and rectify it quickly.

However, the number one reason we find our clients receive a correction notice is that the IRS’s record of estimated payments received are different than what was reported. Taxlink has tried to figure out the best way to ensure we have the right information. Usually when we ask the question “Did you make estimated payments last year?”, the response is “I did whatever you told me to.”

You would be surprised how often this is NOT the case! So, what happens is that the IRS sends a letter, you (angry, confused) call us, and we try to figure out what happened, sometimes calling the IRS which, if you’ve ever called the IRS, could leave you on hold for an hour or more. In most cases, we find that the information our clients provided us with is inaccurate, and the IRS and/or state agency is correct in their adjustment.

The other issue is applied overpayments. If you had an overpayment from the current tax filing that was applied to the following year, we automatically record that in our system. However, if the IRS makes an adjustment to that amount for whatever reason, we need to know in order to update our files. This can also cause a discrepancy when we finalize the return.

So, what to do? At this time, the IRS and most state agencies do not offer a “checks and balances” mechanism to look up payments on-line. We’ve decided that the best way to ensure we have the right information is to request copies of the cancelled checks that you send. In addition, if you receive any type of adjustment letter from the IRS for a previous year overpayment, we need to know that as well.

Why are estimated payments necessary? From the IRS website:

“The United States income tax system is a pay-as-you-go tax system, which means that you must pay income tax as you earn or receive your income during the year. You can do this either through withholding or by making estimated tax payments. If you didn't pay enough tax throughout the year, either through withholding or by making estimated tax payments, you may have to pay a penalty for underpayment of estimated tax. Generally, most taxpayers will avoid this penalty if they either owe less than $1,000 in tax after subtracting their withholding and refundable credits, or if they paid withholding and estimated tax of at least 90% of the tax for the current year or 100% of the tax shown on the return for the prior year, whichever is smaller.”

If you are one of our clients who make estimated payments, please feel free to send over copies of your payments for our files throughout the year.