10/22/2004: Advance payments and year-end deductions: Working the rules Most taxpayers know that year-end tax planning can reduce their income tax bite. By paying doctors' bills or making contributions to charity by December 31, taxpayers can bump up their itemized deductions and reduce their taxable income. But what about expenses you expect to pay but haven't been billed for? Can you increase your interest deduction by paying your mortgage for the next three months? How about next year's property taxes, if the government hasn't sent you a bill? Maybe you can overpay your estimated state income taxes. And medical expenses - you're planning to have a major operation next year. Can't you deduct an advance payment?
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10/22/2004: Business owners need to start planning for new manufacturing tax deduction If you own a business, you've probably heard of the new tax deduction for manufacturers. When Congress repealed a special tax regime for America's exporters, it created a new deduction for manufacturers. The new deduction is broad and applies to many businesses that may not otherwise be thought of as traditional manufacturers.
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10/22/2004: Buy an SUV -- or give one away -- before the year ends Last minute changes in the tax law have put the brakes on writeoffs for SUVs used by a business or donated to charity. If your company plans to purchase an SUV or give one away, you can take a higher deduction if you do it by the end of the year.
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10/22/2004: Client FAQ – Gifts to employees The holidays are approaching and I would like to consider giving gifts of appreciation to my employees. What kinds of gifts can I give my employees that they would not have to declare as income on their tax returns?I also would like to make sure my company would be able to deduct the costs of these gifts.
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10/22/2004: Client FAQ: Hiring your spouse I have a professional services firm and am considering hiring my wife to help out with some of the administrative tasks in the office. I don't think we'll have a problem working together but I would like to have more information about the tax aspects of such an arrangement before I make the leap. What are some of the tax advantages of hiring my spouse?
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10/22/2004: Could you be personally liable for your company's employment tax obligations? Employers are required by the Internal Revenue Code to calculate, withhold, and deposit with the IRS all federal employment taxes related to wages paid to employees. Failure to comply with these requirements can find certain "responsible persons" held personally liable. Who is a responsible person for purposes of employment tax obligations? The broad interpretation defined by the courts and the IRS may surprise you.
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For Immediate Release
Advance payments and year-end deductions: Working the rules
Most taxpayers know that year-end tax planning can reduce their income tax bite. By paying doctors' bills or making contributions to charity by December 31, taxpayers can bump up their itemized deductions and reduce their taxable income. But what about expenses you expect to pay but haven't been billed for? Can you increase your interest deduction by paying your mortgage for the next three months? How about next year's property taxes, if the government hasn't sent you a bill? Maybe you can overpay your estimated state income taxes. And medical expenses - you're planning to have a major operation next year. Can't you deduct an advance payment?
Most taxpayers know that year-end tax planning can reduce their income tax bite. By paying doctors' bills or making contributions to charity by December 31, taxpayers can bump up their itemized deductions and reduce their taxable income. But what about expenses you expect to pay but haven't been billed for? Can you increase your interest deduction by paying your mortgage for the next three months? How about next year's property taxes, if the government hasn't sent you a bill? Maybe you can overpay your estimated state income taxes. And medical expenses - you're planning to have a major operation next year. Can't you deduct an advance payment?
Well, generally not. The Tax Code, the IRS, and the courts have all said that taxpayers cannot take a current deduction for an advance payment, whether it's for interest, taxes, or medical expenses. There are limited exceptions, but they are carefully spelled out.
Interest. If a cash-basis taxpayer prepays interest that will be owed in the following year, Code Sec. 461(g) treats the payment as if it were a capital asset and denies the deduction until the interest is due. The IRS can recharacterize the payment as an additional payment of principal or a nondeductible deposit. The main exception to this rule is the payment of points on a home mortgage. However, if the points exceed usual and customary rates, the Tax Code requires that the excess be deducted over the term of the mortgage. In any event, the interest on a regular mortgage payment due January 1 is deductible in that year, even if it is paid at the end of December. Generally, to avoid audit problems, the Form 1098 statement sent by your mortgage institution should be followed; if you disagree with it, you should convince your bank to issue a corrected information return statement.
State/Local Income and Property Taxes. A cash-basis taxpayer can deduct prepaid state or local taxes if the advance payment is treated as a payment by the government, the payment is not a deposit, and the payment is made in good faith. The IRS and the courts have allowed deductions for advance payments made in good faith and accepted by the governmental authority, even where the amount owed had not been determined, or the taxpayer received a refund subsequently. Taxpayers can of course deduct estimated payments of state income taxes. But a taxpayer who overpays estimated taxes, without a reasonable basis for believing the amount will be owed, has not acted in good faith and cannot deduct the payment. This fine point becomes especially important for those considering whether to opt for an itemized sales tax deduction rather than a state income tax deduction. This election may be made starting in 2004, thanks to the recently-passed American Jobs Creation Act of 2004.
Medical Expenses. A cash-basis taxpayer cannot deduct prepaid medical expenses until the expenses are actually incurred. No deduction is allowed for advance payments of medical expenses that the taxpayer expects to incur in a later year, unless:
the payment is for prepaid medical insurance,
the taxpayer is contractually obligated to make the advance payment, or
the payment is for lifetime care, such as an advance payment to a retirement or nursing home.
Prepaid medical insurance is defined in the Code Sec. 213(d)(6) and (7) as a payment by a taxpayer under age 65 for insurance that will cover the taxpayer, spouse or dependents after the taxpayer turns 65. The payments must be made on a level basis over at least 10 years, or until the taxpayer turns 65, if less than 10 years.
Example. Benton, who is age 55, enters into a contract with a medical insurance company to obtain coverage that will apply to Benton and his spouse after Benton turns 65. Benton agrees to pay $1,000 a year for 10 years. The payments are deductible each year as they are paid. If Benton entered into the contract when he was 58 and was required to pay $1,000 a year for 7 years, each payment would be deductible as a medical expense.
Business Expenses. Are the rules any different for business expenses? In some cases, a cash-basis taxpayer can deduct prepayments. The payment must be for an item that would normally be expensed, like farmers' prepaid costs for feed and supplies. If the item is capital in nature, it must be amortized over the appropriate period.
Example. A business taxpayer signs a three-year lease on December 1. The taxpayer will pay monthly rental of $1,000, plus an additional payment of $18,000. The $18,000 is paid to secure the lease and must be amortized over the lease term. The taxpayer can deduct $1,500 for December (monthly rent plus $18,000 divided by 36).
If you are thinking of prepaying some deductible expenses by the end of this year, or if you'd like any further advice on how to do so, please feel free to contact this office.
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