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Written by: Julie Welch, CPA, CFP

Published: 26 January 2016

You can offset the costs of higher education with two credits: the Lifetime Learning credit and the American Opportunity tax credit. The Lifetime Learning credit provides for a broader range of learners than the American Opportunity tax credit, since the American Opportunity tax credit is only available for the first four years of postsecondary education. Full-time or part-time students in undergraduate, graduate, professional, or continuing education programs at a higher education institution may use the Lifetime Learning credit.

The Lifetime Learning credit provides a nonrefundable credit equal to 20% of up to $10,000 of qualified expenses you pay. This credit is per taxpayer return, not per student like the American Opportunity tax credit.

[This article is course content for the Tax Season 2016 CPE quiz, worth 3 CPE credits! Reach the quiz and additional content HERE.]

Qualified expenses include tuition and fees necessary for the enrollment or attendance of you, your spouse, or any of your dependents at a higher education institution. Expenses do not include books, sports fees (unless they are part of the degree program), activity fees, insurance expenses, transportation costs, or room and board. You must reduce your qualified expenses by scholarships, grants, and other tax-free educational benefits, but you do not need to reduce your qualified expenses by gifts, bequests, or inheritances. Higher education institutions include accredited postsecondary educational institutions that offer degree programs and are eligible to participate in student financial aid programs, i.e., colleges, community colleges, and many vocational schools.

There are limitations on using the Lifetime Learning credit. First, the credit is phased out if you are single with adjusted gross income (AGI) between $55,000 and $65,000 or married filing jointly with AGI between $111,000 and $131,000 ($110,000 and $130,000 for 2015). These amounts may be adjusted annually for inflation.

Second, if you are married filing separately, you cannot claim either the Lifetime Learning credit or the American Opportunity tax credit.

Third, you may elect either the American Opportunity tax credit or the Lifetime Learning credit with respect to one student. However, if you have more than one student at the same time, you can use the American Opportunity tax credit to offset the expenses of one student and the Lifetime Learning credit to offset the expenses of the other student. You may claim the American Opportunity tax credit or the Lifetime Learning credit for some educational expenses and use tax-free Coverdell Education Savings Account earnings for educational expenses for which no credit is taken.

NOTE: The effective rate of the Lifetime Learning Credit is 20%. If you are in the 25% tax rate bracket or higher, you may receive a greater tax benefit by claiming your education expenses as a business deduction on Schedule C or an employee business expense on Schedule A, if applicable to you. Education expenses you deduct as employee business expenses are subject to the 2% floor. Because of the credit phase-outs, self-employment tax, and miscellaneous itemized deduction limitations, you must decide the best way for you.

Julie Welch (Runtz) is the owner of Meara Welch Browne. She graduated from William Jewell College with a BS in Accounting and obtained a Masters in Taxation from the University of Missouri- Kansas City. She serves as a discussion leader for the AICPA National Tax Education Program. She is co-author of 101 Tax Saving Ideas.

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Written by: Julie Welch, CPA, CFP

Published: 26 January 2016

Generally dividends you receive on stock you own are taxable. Most dividends are taxed similar to capital gains at a rate of 15% (20% if clients are in the 39.6% tax rate bracket).

Dividends that qualify for this reduced tax rate include most dividends received from domestic corporations and some foreign corporations. This includes dividends received from mutual funds if the distribution is otherwise a qualified dividend.

[This article is course content for the Tax Season 2016 CPE quiz, worth 3 CPE credits! Reach the quiz and additional content HERE.]

Dividends that do not qualify for this reduced tax rate include dividends from stocks owned for fewer than 60 days in the 120-day period surrounding the ex-dividend date, dividends that you include in investment income for purposes of claiming the investment interest deduction, and certain other dividends in special circumstances.

The benefit of this reduced tax rate on dividends only applies to dividends received. Any amounts received in individual retirement accounts or retirement plans are taxed at ordinary income tax rates when they are withdrawn. Recommend a review of investment allocation between taxable accounts and retirement plan accounts.

The Following Dividends are Taxable:

• Some dividends are really interest income. Some income on deposits that are called dividends should be reported on Schedule B as interest income. Examples include dividends from:

         • Cooperative banks

         • Credit unions

         • Savings and loans

         • Mutual savings banks

On the other hand, the income from money market fund accounts, which is often called interest income, should be reported as dividend income although such amounts will not qualify for the lower tax rate on qualifying dividends. The proper reporting of interest and dividend income is important because misreporting this income can trigger a notice from the IRS when the IRS cannot match what is reported with the information they have received. Responding to these notices is time consuming.

• Capital gain distributions. These are distributions you get from your mutual funds. They are taxable as long-term capital gains. Many mutual funds make these payments in December. Capital gain distributions are taxable even if reinvested and do not actually generate cash.

• Reinvested dividends. Many publicly held corporations maintain dividend reinvestment plans which permit additional share purchases through reinvestment of dividends and, in some cases, through optional cash payments. The amount of dividends reinvested is treated as a dividend received and is taxable. The dividends are taxable even though the client does not physically receive cash or the stock.

Some Dividends are Not Taxable. The Most Common Taxable Dividends are:

•  Stock dividends and stock splits. These are additional shares of stock received from a corporation. They are not taxable if they do not increase the percentage of ownership in the corporation. If the client receives a stock dividend or stock split, the client must allocate the basis of the old shares between the client’s old shares and the new shares. The holding period for the stock received from a stock dividend or a stock split goes back to the time when the client bought the original shares. The holding period is important because it determines if the client qualifies for the 15% (0% if in the 10% or 15% tax rate bracket) long-term capital gain tax rate. If the stock dividend or stock split is taxable, then the basis in the new shares is the fair market value of the stock when it is received. The holding period for the new stock would then start on the date of receiving the new stock.

• Insurance policy dividends. These are rebates from premiums paid on life insurance policies. They are not taxable unless the total rebates received are more than the premiums paid for the policy.

• Return of investment and liquidating dividends. Return of investment dividends are amounts received on stock owned when the company has no accumulated earnings. They are not taxable since taxable dividends must be paid from a corporation’s earnings. Public utility stocks, besides paying dividends at a high rate of return, often distribute return of investment dividends that are not currently taxable. Liquidating dividends are distributions received in a partial or complete liquidation of the company. Both return of investment dividends and liquidating dividends are treated as a nontaxable recovery of capital and reduce the basis in the stock. Once the basis is reduced to zero, any future distributions are taxed as capital gains.

• Patronage dividends. These are dividends received from cooperatives. The most common recipients are farmers and students. The dividends are treated as purchase rebates and reduce the cost of items purchased from the cooperative, such as feed or books. They may be taxable if the client previously deducted the cost of the items.

Julie Welch (Runtz) is the owner of Meara Welch Browne. She graduated from William Jewell College with a BS in Accounting and obtained a Masters in Taxation from the University of Missouri- Kansas City. She serves as a discussion leader for the AICPA National Tax Education Program. She is co-author of 101 Tax Saving Ideas.

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Written by: Julie Welch, CPA/PFS, CFP

Published: 13 July 2015

“How long should my client keep his/her tax returns and supporting documentation?” is a frequently asked question. The safe, quick answer is keep old tax returns, W-2’s, and information with tax planning relevance permanently. Keep less important supporting documentation for seven years.

Generally, the IRS has three years from the due date of the return to audit and adjust the return. Similarly, your client has three years following the due date to amend his return.

 
Sometimes the IRS has longer than three years to audit a return. For example, the IRS has six years to audit a return if a person fails to report over 25% of gross income. If a return is not filed, or a fraudulent return has been filed, the IRS can audit records for that tax year at any time.

All supporting documentation should be kept, including summaries, cancelled checks, receipts, and 1099’s for at least the three years following the due date of the tax return. To be safe, many advisers recommend these records be kept for seven years.

Tax returns and W-2s should be kept permanently. Keeping a tax return permanently provides support if the IRS contends your client did not file a return or filed a fraudulent return. Furthermore, you may need to refer to an old return to obtain information about:

• Home purchases and sales
• Depreciation of a home office, rental property, or business equipment
• Individual retirement account (IRA) contributions
• The purchase price of stocks, bonds, and mutual funds
• The taxability of pensions and annuities          

Keep W-2s permanently because they include important information about Social Security wages and withholdings and income tax withholdings. If you ever need to prove earnings or Social Security and Medicare contributions, you will have the records if W-2s are kept.

Supporting Documentation

Generally, most records can be destroyed after seven years. For tax planning support, however, there are countless situations when it is desirable to have records from earlier years. For example, when a client sells a home, it is necessary to calculate their gain. To calculate the gain, you need records of the cost of the home, improvements to the home, and depreciation of the home. For some people, this information may go back forty years or more. Furthermore, if you rolled over the gain on the pre-1998 sale of your prior home, it is necessary to have records for the prior home.

Another example of when earlier records are helpful is when your client sells mutual funds. There are several planning strategies you can use to reduce your client’s gain in this situation. To use them, however, it is necessary to have information about purchases, distributions, and sales from earlier years.

In summary, you should never throw out tax returns, W-2s, and records might have future tax relevance. In particular, you should keep all home records, brokers’ statements for securities you still own, and retirement plan information. You should keep other tax-related records for seven years.

NOTE: A current Earnings and Benefit Statement can be requested on the Internet at www.socialsecurity.gov. Earnings records should be verified frequently. Errors discovered after three years have passed are difficult to correct. Also, socialsecurity.gov can be used to get an estimate of future Social Security benefits based on an actual Social Security earnings record.

Julie Welch (Runtz) is the owner of Meara Welch Browne. She graduated from William Jewell College with a BS in Accounting and obtained a Masters in Taxation from the University of Missouri- Kansas City. She serves as a discussion leader for the AICPA National Tax Education Program. She is co-author of 101 Tax Saving Ideas.

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Written by: Julie Welch

Published: 13 July 2015

Health Savings Accounts (HSAs) are similar to individual retirement accounts (IRAs) for medical expenses. Both individuals and employers can contribute to HSAs for eligible individuals.

If you are eligible, you can make deductible contributions to an HSA that is administered by a financial institution or insurance company. The money in the plan, which you may invest in certificates of deposit, stocks, bonds, mutual funds, and similar investments, grows tax-free. Distributions you take to pay for qualified medical expenses are tax-free. If you take a distribution that you do not use to pay for qualified medical expenses, you must pay tax plus a 10% penalty on the distribution amount. The 10% penalty will not apply if you die, become disabled, or reach age 65.

To be eligible for an HSA, you must meet several conditions. First, you must be covered under a high-deductible health insurance plan. For self-only coverage for 2015, the plan must have an annual deductible of at least $1,300 and annual out-of-pocket expenses (deductibles, copayments, and other amounts, but not premiums) not exceeding $6,450. For family coverage for 2015, the plan must have an annual deductible of at least $2,600 and annual out-of-pocket expenses not exceeding $12,900. Except for preventive care, the plan may not pay benefits until you or your family has incurred annual covered medical expenses in excess of the minimum annual deductible.

Second, you may not be covered by any other health plan that is not a high-deductible health plan, including your spouse’s plan, your parent’s plan, or Medicare. However, you may still be covered under workers’ compensation laws, insurance for your auto and home, insurance for a specified disease or illness, insurance that pays a fixed amount per day of hospitalization, and insurance covering accidents, disability, dental care, vision care, or long-term care.

Third, you may not be claimed as a dependent on another person’s tax return.

Qualified medical expenses that you can pay using your HSA are those that would be deductible for tax purposes as medical expenses. These expenses may be for you, your spouse, or your dependents, but they cannot be covered by insurance. You cannot have your HSA pay your health insurance premiums, since they are not qualified medical expenses. However, your HSA can pay for qualified long-term care insurance, COBRA health care continuing coverage, and your spouse’s or dependents’ premiums for Medicare Part A or B coverage.

You may deduct your contribution to your HSA up to $3,350 for 2015 for self-only coverage ($6,650 for 2015 for family coverage). If you are 55 or older, you can contribute $1,000 extra to your HSA.

Similar to IRAs, you have until April 15th to make an HSA contribution for the previous year. If you make your HSA contribution between January 1st and April 15th of the following year, you must indicate that you want your contribution to apply to the prior year or it will automatically be applied to the current year.

Once during your lifetime, you may fund your HSA with a tax-free rollover from your IRA. The rollover amount is limited to the maximum deductible contribution to your HSA. This may be beneficial if you do not have the cash to put into your HSA. You may also be able to roll over amounts in your Flexible Spending Accounts and Health Reimbursement Accounts into your HSA in certain circumstances.

NOTE: Your employer may contribute to your HSA and can pay the premiums for your high-deductible health plan on a deductible basis. Your employer’s contributions are not taxable to you. This approach provides income tax and employment tax savings to you and your employer.

Julie Welch (Runtz), CPA, CFP, and Randy Gardner, LLM, CPA, CFP, are the authors of 101 Tax-Saving Ideas, 10th edition.