Individual Tax

When it comes to filing taxes, married couples have the option to file either jointly or separately. Deciding which filing status to choose can significantly impact your tax liability and potential refunds. Understanding the benefits and drawbacks of each option is crucial for making an informed decision. Here’s a comprehensive guide to help you determine the best filing status for your situation.

Understanding the Basics

Married Filing Jointly (MFJ):

• Combines the incomes of both spouses on a single tax return.
• Both spouses share responsibility for the tax liability.
• Offers higher standard deductions and beneficial tax rates.

Married Filing Separately (MFS):

• Each spouse files their own tax return, reporting individual income and deductions.
• Spouses are responsible for their own tax liabilities.
• May result in higher tax rates and reduced eligibility for certain deductions and credits.

Benefits of Filing Jointly

• Higher Standard Deduction: For the 2023 tax year, the standard deduction for joint filers is $27,700, compared to $13,850 for separate filers. This higher deduction can reduce taxable income significantly.
• Tax Brackets and Rates: Joint filers generally benefit from more favorable tax brackets. For instance, in 2023, the 22% tax bracket applies to incomes up to $190,750 for joint filers, compared to $95,375 for separate filers.
• Eligibility for Credits and Deductions: Filing jointly can increase eligibility for tax credits such as the Earned Income Tax Credit (EITC), the Child Tax Credit, and education credits. These credits are often reduced or unavailable for separate filers.
• Simplified Filing Process: Filing jointly simplifies the tax preparation process by consolidating income, deductions, and credits on a single return.

Drawbacks of Filing Jointly

• Joint and Several Liability: Both spouses are equally responsible for the tax liability, including any penalties or interest. This can be a concern if one spouse has questionable financial activities.
• Potential for Higher Combined Income: Combining incomes can push the couple into a higher tax bracket, potentially increasing overall tax liability compared to separate filings with lower individual incomes.

Benefits of Filing Separately

• Separation of Liabilities: Each spouse is only responsible for their own tax liability. This can be beneficial if one spouse has significant deductions, unpaid taxes, or legal issues.
• Deduction of Medical Expenses: Medical expenses are deductible only to the extent they exceed 7.5% of adjusted gross income (AGI). Filing separately can make it easier to exceed this threshold if one spouse has high medical expenses relative to their individual AGI.
• Protection from Tax Issues: Filing separately can protect one spouse from potential tax issues of the other, such as audits or underpayment penalties.

Drawbacks of Filing Separately

• Lower Standard Deduction: The standard deduction for separate filers is half that of joint filers, which can lead to higher taxable income.
• Higher Tax Rates: Separate filers face less favorable tax brackets, potentially resulting in higher tax liability.
• Reduced Credits and Deductions: Many tax credits and deductions are reduced or unavailable for separate filers. For example, the Earned Income Tax Credit and the Child and Dependent Care Credit are significantly limited for MFS status.
• Phase-Outs and Limits: Income limits for phase-outs of deductions and credits are typically lower for separate filers, reducing eligibility.

When to Consider Filing Separately

• High Medical Expenses: If one spouse has significant medical expenses, filing separately might make it easier to meet the deduction threshold.
• Income-Based Repayment Plans: For student loans, filing separately can lower the AGI used to calculate repayment amounts under income-driven repayment plans.
• Legal and Financial Protection: If one spouse has potential legal issues or significant debt, filing separately can protect the other spouse from associated liabilities.

Conclusion

Deciding whether to file jointly or separately requires careful consideration of your financial situation. While filing jointly generally provides more tax benefits, there are circumstances where filing separately might be advantageous. Evaluate your income, deductions, credits, and potential liabilities to make the best decision for your family. Consulting with a tax professional can provide personalized advice and ensure you choose the optimal filing status for your unique circumstances.

You may have a teen in your family who holds down a part-time job or works full-time during the summer. You can help your child lay the groundwork for future retirement security early on by encouraging your child to open an individual retirement account (IRA).

You may, or may not, get some resistance, especially if your child has other plans for spending the money. However, you should persist since the benefits can be significant over the long term. Here are some points you can bring up as you make your case.

Savings Can Grow Over Time

When it comes to building savings, your child’s age is a major advantage. Given enough time, even a relatively small investment could grow into a significant sum due to the power of compounding. For example, a one-time investment of $6,000 could grow to $110,521 in 50 years, assuming a hypothetical 6% annual return. Invest $6,000 every year for 50 years at 6%, and your child could accumulate over $1.7 million. Of course, investment returns can vary from year to year and are not guaranteed.

IRAs Offer Tax Advantages

As long as your teen does not participate in an employer’s retirement plan, contributions to a traditional IRA will be fully tax deductible. (With plan participation, income limits may apply.) Any earnings that investments in the IRA make will grow tax deferred. Your child won’t have to pay any income taxes on the IRA funds until they are withdrawn from the IRA.

Contributions to a Roth IRA are not tax deductible, but they can be withdrawn tax free at any time for any purpose. Earnings accumulate tax deferred and can be withdrawn tax free once your child reaches age 59½ and has had a Roth IRA for at least five tax years. Tax-free withdrawals are also available after five years for first-time home buying expenses (to a maximum of $10,000) or on account of disability or death.

Your teen can contribute up to $6,500 to one or more IRAs in 2023 or the amount of his or her annual compensation, if less. The IRS adjusts this IRA contribution limit periodically for inflation. Your child has until the April tax-filing deadline to contribute to an IRA for the prior tax year.

If you would like some help deciding which type if IRA may make the most sense for your teen child, be sure to get in touch with your financial professional.

You may not think about taxes often, but they can prove to be a large expense. That’s why it’s important to make the most of any opportunities you may have to lower your tax liability. Here’s a look at some of the factors you may want to consider in your planning.

Standard Deduction or Itemizing

The Tax Cuts and Jobs Act (TCJA) contained many provisions that will be in place through the 2025 tax year. For example, there are significantly higher standard deductions for each filing status and various itemized deductions have been reduced or eliminated. As a result, many people who previously itemized are now better off taking the standard deduction. But don’t automatically rule out itemizing, especially if you expect to make a large charitable contribution or will have a lot of medical and dental expenses. By bunching these items in one tax year, to the extent possible, you may have enough to make itemizing worthwhile that year.

Home/Work Tax Breaks

If you are a traditional full-time employee and work from home, home office expenses are not deductible, even if you itemize. The deduction for unreimbursed employee business expenses (and various other miscellaneous expenses) won’t be restored until 2026. However, if you are a self-employed/gig worker, you may qualify to deduct your home office expenses. Certain requirements apply.

Moving Expenses

Work-related moving expenses may now be deducted only if you are an active-duty member of the Armed Forces and the move is per a military reassignment. This deduction is available whether you itemize or claim the standard deduction.

Health Savings Accounts (HSAs)

HSAs continue to offer tax breaks. If you are covered by a qualified high-deductible health plan and meet other requirements, you can contribute pretax income to an employer-sponsored HSA or make deductible contributions to an HSA you open on your own. An HSA can earn interest or be invested, growing in a tax-deferred manner similar to an individual retirement account (IRA). And HSA withdrawals for qualified medical expenses are tax free. You can also carry over a balance from year to year, allowing the account to grow.

Family Related Tax Credits

The TCJA expanded tax credits for families, doubling the child credit and adding a family credit for dependents who don’t qualify for the child credit. Credits include one for each child under age 18 at the end of the tax year and another for each qualifying dependent who isn’t a qualifying child. The latter category includes an older dependent child or a dependent elderly parent.

The adoption credit and the income exclusion for employer adoption assistance are still in place. You’ll want to check into the details if you are adopting a child.

Section 529 Plans*

These tax-advantaged savings plans assist in paying for education. While initially used to pay for a college education, 529 plans may now cover elementary through high school education as well. Some states offer tax breaks for 529 plan contributions. However, contributions are not deductible on your federal return. Growth related to 529 contributions is tax deferred, and withdrawals for qualified education expenses — including elementary and secondary school tuition of up to $10,000 per year per student — are free of federal income taxes.

A special break allows you to front-load five years’ worth of gift tax annual exclusions and make up to a $85,000 contribution per beneficiary in one tax year free of federal gift tax. If you make the contribution with your spouse, the total can be extended to $170,000. (These limits may be inflation adjusted.)

Other Education Tax Breaks

As before, you may be able to take advantage of either the American Opportunity credit or the Lifetime Learning credit for higher education costs. The first credit can be up to $2,500 per student per year for the first four years of college. The second credit is limited to $2,000 per tax return and is available for qualified expenses of any post-high school education at an eligible educational institution, including graduate school.

In addition, if you are paying off your student loans, you may be able to deduct the interest, up to $2,500 per year. This deduction is available whether you claim the standard deduction or itemize.

Keep in mind that there are income limits for these tax breaks.

Investments

To help reduce the taxes you pay on investment gains in taxable accounts, you may want to consider:

• Selling securities with unrealized losses before year end to offset realized capital gains.
• Choosing mutual funds** with low portfolio turnover rates that tend to generate long-term capital gains, since the lower long-term rates offer a tax savings.
• Factoring in that you can deduct only $3,000 of net capital losses per year against other income ($1,500 if you’re married filing separately), but you can carry forward excess losses to subsequent tax years.

You should also be aware that if you have modified adjusted gross income of over $200,000 ($250,000 if married filing jointly; $125,000 if married filing separately), you may owe a 3.8% “net investment income tax,” or NIIT.

Retirement

While the TCJA made only minimal changes in the area of retirement planning, there are still issues to consider. The main one is whether you want to pay taxes on your retirement account contributions later (when you eventually take distributions from your account) or pay taxes on them now (which means potentially tax-free distributions when you retire). It all depends on the type of savings vehicle you use.

Traditional 401(k), 403(b), and 457 plans and traditional IRAs allow you to save for retirement on a tax-deferred basis. Your employer may also choose to make contributions to your plan account. Salary deferrals to 401(k) and similar plans are generally pretax, while traditional IRA contributions are tax deductible under certain circumstances.

Roth alternatives — available in some employers’ 401(k), 403(b), and 457 plans, as well as through a Roth IRA you open on your own — provide no tax break on contributions. However, investment earnings accumulate tax deferred. And, when requirements are met, distributions from your account are tax free. Since Roth accounts in employer plans lack income restrictions, you may be able to make larger contributions to an employer’s Roth plan than to a Roth IRA.

As always, make sure that you obtain professional advice before making tax-related decisions. Your tax professional can provide detailed information and help you evaluate what might be appropriate for your personal tax situation.

Once you’ve filed your income tax return, you may be ready to put some distance between you and the IRS and turn your attention to other things. If you’re employed, you probably can take a breather, since your employer will handle ongoing income tax payments for you through the wage withholding process. But it’s a different story if you receive other forms of taxable income — from self-employment, rental property, or investments, for example. When that’s the case, you’ll typically be required to make estimated tax payments during the year.

Generally, you must pay estimated tax for 2021 if you expect to owe at least $1,000 in tax for 2021, after subtracting withholding and refundable tax credits.

When Are Estimated Taxes Due?

Estimated taxes generally should be paid in four equal quarterly installments. The due dates for the four 2021 estimated tax payments are April 15, June 15, September 15, and January 15, 2021. If you receive income unevenly during the year, your required estimated tax payments may not be the same for each period under the IRS’s “annualized income installment method.”

How Much Is Enough?

The IRS can charge an underpayment penalty if you don’t pay enough estimated tax for the year or if you don’t make your payments on time or in the required amount. The IRS generally requires payments of 2021 estimated tax to total at least (1) 90% of your 2021 tax liability or (2) 100% of your 2020 tax liability, whichever amount is smaller. However, if your 2020 adjusted gross income was more than $150,000 ($75,000 if your filing status was married filing separately), your 2021 payments should be at least (1) 90% of your 2021 tax liability or (2) 110% of your 2020 tax liability, whichever amount is smaller.

If you or your spouse is employed, it may be possible to avoid the need to make estimated tax payments by having more tax withheld from your wages. To adjust your withholding, file a new Form W-4 with your employer. Taxpayers who had no tax liability for the 2020 tax year (the full 12-month period) and were U.S. citizens or residents for the whole year don’t have to make 2021 estimated payments.

If you’re self-employed, understanding what’s deductible and recording all of your business expenses should be priorities.

When you work for yourself, accurate accounting is critical. The IRS pays special attention to tax returns prepared by sole proprietors. Not only does the agency try to determine whether all taxable income has been recorded, but they also scrutinize business expenses that are claimed, since some taxpayers blur the lines between personal and business purchases.

We’re not suggesting you hold anything back when you’re tracking your tax-deductible business expenses. We want you to claim every penny that the IRS says is permissible. This is especially important if your company makes a lot of money. You’ll need to document everything you can to offset your income and minimize your tax obligation.

How do you ensure that all of the money you’re spending to make money ends up somewhere on your IRS Schedule C? Let’s look at steps you can take.

Review the Schedule C

The actual IRS Schedule C form contains broad expense categories. You may need to dig into deeper explanations of them.

If you’ve never completed a Schedule C before, it’s especially important that you familiarize yourself with it. You can view a copy of the 2020 version here. Pay special attention to Part II Expenses. The form breaks down business expenses into specific categories. But what’s the difference between Office expenses and Supplies? What does Other business property mean? Not only do you have to know which expenses are deductible, but you must be sure to include them in the right category.

The IRS has a special publication devoted to discussion of deductible business expenses. You’ll find links to it here. It’s a lengthy document, but there’s an interactive table of contents that lets you jump right to the section you want. You don’t have to read the whole thing, but you might bookmark it so you can consult it when you have a question. There are many questions on the Schedule C that may require additional explanation.

You might want to visit the IRS instructions online. This page displays a detailed outline of the form, section by section and line by line, so you can find what you’re looking for easily and click a link to get there.

Keep Detailed Records

This will be challenging if you’re doing your bookkeeping manually. You’ll need to set up a system of folders or envelopes or whatever works for you and separate receipts by either month or Schedule C category. If you know your way around Excel, you could set up a spreadsheet divided by category and enter receipt information as it comes in. This will make calculations easier, too.

Do make notes on your receipts so you’ll know why you thought the purchases would be deductible. You might also indicate whether the receipt was already entered in your master list, so you don’t have duplicate entries. Don’t forget about credit card charges and checks you’ve written for tax-deductible purchases that didn’t generate a receipt. Enter them in your master list as you go. If you’re ever audited, you’ll need copies of them for documentation. If you get electronic receipts in email, save them in a folder on your computer and record them.

You can categorize your tax-related business expenses using personal finance or accounting applications.

There are numerous personal finance and small business accounting applications that allow you to import your online banking transactions and categorize them. These include QuickBooks (online and desktop), Mint, Quicken, and Simplifi by Quicken. Their category lists can often be modified, so you can make sure your tax-related expenses are organized accurately.

Don’t Dismiss the Unusual

There are some legitimate tax deductions that the IRS doesn’t necessarily include in the Schedule C instructions, but which it will accept. For example, H&R Block reported on a case where the cost of cat food was considered a business deduction (a scrapyard was trying to attract wild cats to keep snakes away). A professional bodybuilder was able to claim his purchase of ProTan Muscle Juice Professional Posing Oil as an acceptable business expense.

We’re not recommending that you spend a great deal of time looking for obscure tax deductions. But think about your purchases as you make them to see if they’re tax-worthy.

All of these suggestions may sound time-consuming. They can be, until you get into the habit of tracking all of your tax-related business expenses, but it does require constant diligence. We can help ensure that you’re only claiming legitimate deductions and advise you on those you might question. We can also prepare and file your return for you and/or help with year-round tax planning. Contact us for a consultation.

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If 2021 is your first year as a sole proprietor, you’re likely to find income tax preparation challenging. Contact us for help with this.

Filing an IRS Schedule C requires careful, year-round bookkeeping. We can help you set up a system for tracking business expenses.

Before you can file an IRS Schedule C, you need to understand this complex form. Let us help you learn what’s needed.

There are numerous financial applications that let you import bank transactions and categorize them for tax purposes. Ask us.

Are you an individual or business owner who’s interested in lowering your tax burden? Call us at 631-474-2500 and ask to speak to a tax accountant now or request a consultation online and we’ll contact you.