Carol McAtee's Blog

Reporting Virtual Currency Transactions

With the price of Bitcoin hitting record highs in 2017, many Bitcoin holders cashed out not realizing the impact it could have on their tax bill. Many people, for example, did not understand that it was a reportable transaction and found themselves with a hefty tax bill–money they may have been hard-pressed to come up with at tax time. Others may have been unaware that they needed to report their transactions at all or failed to do so because it seemed too complicated.

The good news is that if you failed to report income from virtual currency transactions on your income tax return, it’s not too late. Even though the due date for filing your income tax return has passed, taxpayers can still report income by filing Form 1040X, Amended U.S. Individual Income Tax Return.

Taxpayers should also be aware that forgetting, not knowing, or generally pleading ignorance about reporting income from these types of transactions on your tax return is not viewed favorably by the IRS. Taxpayers who do not properly report the income tax consequences of virtual currency transactions can be audited for those transactions and, when appropriate, can be liable for penalties and interest.

In more extreme situations, taxpayers could be subject to criminal prosecution for failing to properly report the income tax consequences of virtual currency transactions. Criminal charges could include tax evasion and filing a false tax return. Anyone convicted of tax evasion is subject to a prison term of up to five years and a fine of up to $250,000. Anyone convicted of filing a false return is subject to a prison term of up to three years and a fine of up to $250,000.

Virtual Currency Taxed as Property

Virtual currency, as generally defined, is a digital representation of value that functions in the same manner as a country’s traditional currency. There are currently more than 1,500 known virtual currencies. Because transactions in virtual currencies can be difficult to trace and have an inherently pseudo-anonymous aspect, some taxpayers may be tempted to hide taxable income from the IRS.

Virtual currency is treated as property for U.S. federal tax purposes. The same general tax principles that apply to property transactions also apply to transactions using virtual currency such as:

-A payment made using virtual currency is subject to information reporting to the same extent as any other payment made in property.

-Payments using virtual currency made to independent contractors and other service providers are taxable, and self-employment tax rules generally apply. Normally, payers must issue Form 1099-MISC.

-Wages paid to employees using virtual currency are taxable to the employee, must be reported by an employer on a Form W-2 and are subject to federal income tax withholding and payroll taxes.

-Certain third parties who settle payments made in virtual currency on behalf of merchants that accept virtual currency from their customers are required to report payments to those merchants on Form 1099-K, Payment Card and Third-Party Network Transactions.

-The character of gain or loss from the sale or exchange of virtual currency depends on whether the virtual currency is a capital asset in the hands of the taxpayer.

If you have any questions about this topic or other tax related questions, please do not hesitate to contact us at 727-327-1999.

ANY TAX ADVICE IN THIS COMMUNICATION IS NOT INTENDED OR WRITTEN TO BE USED, AND CANNOT BE USED, BY A CLIENT OR ANY OTHER PERSON OR ENTITY FOR THE PURPOSE OF (i) AVOIDING PENALTIES THAT MAY BE IMPOSED ON ANY TAXPAYER, OR (ii) PROMOTING, MARKETING OR RECOMMENDING TO ANOTHER  PARTY ANY MATTERS ADDRESSED HEREIN.

It’s Time for a Premium Tax Credit Checkup
If you or anyone in your family receive advance payments of the premium tax credit, now is a good time to check on whether you need to adjust your premium assistance.

Because advance payments are paid directly to your insurance company (thereby lowering out-of-pocket cost for your health insurance premiums), changes to your income or family size may affect your credit. Therefore, you should report changes that have occurred since the time that you signed up for your health insurance plan.

Changes in circumstances include any of the following and should be reported to your Marketplace when they happen:

Increases or decreases in your household income including, lump sum payments; for example, lump sum payment of Social Security benefits
Marriage
Divorce
Birth or adoption of a child
Other changes affecting the composition of your tax family
Gaining or losing eligibility for government sponsored or employer-sponsored health care coverage
Moving to a different address

Reporting the changes when they happen helps you to avoid getting too much or too little advance payment of the premium tax credit. Getting too much may mean that you owe additional money or receive a smaller refund when you file your taxes. Getting too little could mean missing out on premium assistance that reduces your out-of-pocket monthly premiums.

Changes in circumstances also may qualify you for a special enrollment period to change or get insurance through the Marketplace. In most cases, if you qualify for the special enrollment period, you generally have 60 days to enroll following the change in circumstances. Information about special enrollment can be found by visiting HealthCare.gov.

You can use the Premium Tax Credit Change Estimator to help you estimate how your premium tax credit will change if your income or family size changes during the year; however, this estimator tool does not report changes in circumstances to your Marketplace. To report changes and to adjust the amount of your advance payments of the premium tax credit you must contact your Health Insurance Marketplace.

Please call if you have any questions about the Premium Tax Credit.

If you have any questions about this topic or other tax related questions, please do not hesitate to contact us at 727-327-1999.

ANY TAX ADVICE IN THIS COMMUNICATION IS NOT INTENDED OR WRITTEN TO BE USED, AND CANNOT BE USED, BY A CLIENT OR ANY OTHER PERSON OR ENTITY FOR THE PURPOSE OF (i) AVOIDING PENALTIES THAT MAY BE IMPOSED ON ANY TAXPAYER, OR (ii) PROMOTING, MARKETING OR RECOMMENDING TO ANOTHER  PARTY ANY MATTERS ADDRESSED HEREIN.

Business Entertainment Expenses

As a business owner, you are entitled to deduct certain expenses on your tax return such as those relating to entertaining clients. Entertainment is considered any activity that provides entertainment, amusement, or recreation. It may also include meeting the personal, living, or family needs of individuals including providing meals, a hotel suite, or a car to customers or their families.

A meal that you provide to a customer or client may also be considered a form of entertainment. The meal may be part of other entertainment or stand alone. Meal expenses are defined as the cost of food, beverages, taxes, and tips for the meal. To deduct an entertainment-related meal, you or your employee must be present when the food or beverages are provided, and you cannot deduct a meal as both a travel and entertainment expense.

Limits and Restrictions

Entertainment expenses are generally deductible at 50 percent. Entertainment costs, taxes, tips, cover charges, room rentals, maids, and waiters are all subject to the 50 percent limit on entertainment deductions.

Entertainment expenses are also subject to certain limits and restrictions such as whether they qualify as “ordinary and necessary” and not “lavish or extravagant.” They must also be directly related to or associated with, your business and you must keep detailed records substantiating your expenses (more on this below). Furthermore, the person you entertained must be a business associate; that is, someone who could reasonably be expected to be a customer or conduct business with you such as an employee, client, or professional advisor.

If it is customary to entertain a business associate with his or her spouse and your spouse also attends, entertainment expenses for both spouses are deductible, thanks to something called the “closely connected rule.” For more information about this topic, please contact the office.

Note: If you are an employee who is reimbursed in full by your employer different tax rules apply (e.g. you are not subject to the deduction limits).

Location must be Conducive to Business

Your Home

Entertainment expenses are only deductible when they take place in a location conducive to business. A nightclub or theater is not considered a place conducive to business, but your home is. For example, if you hold a small (less than 12 people) party for clients and business associates at your home during the summer it may be deductible as long as you discussed business with your guests. The amount of time that business was discussed is not significant.

Year-end parties for employees, as well as sales seminars and presentations held at your home, are generally 100 percent deductible provided costs for food and refreshments are reasonable and not lavish.

Entertainment Facilities

Out-of-pocket expenses for food and beverages, catering, gas, and fishing bait provided at facilities you own or are a member of such as a yacht, hunting lodge, fishing camp, swimming pool, and tennis court are deductible subject to entertainment expense limitation of 50 percent. However, you may not deduct expenses related to the depreciation and upkeep of the facility or for rent and utilities.

Note: Dues paid to country clubs, social, or golf and athletic clubs are not deductible.

Skybox

If you rent a skybox or other private luxury box for more than one event at the same sports arena, you generally can’t deduct more than the price of a nonluxury box seat ticket. You can, however, count each game as one event. Deduction for those seats is then subject to the 50 percent entertainment expense limit. If the cost of food and beverages are on a separate receipt, you are allowed to deduct those expenses (as long as they are reasonable) in addition to the amounts allowable for the skybox, subject of course, to the requirements and limits that apply.

Expenses must be “Directly Related” or “Associated With”

Expenses are directly related if you can show that there was more than a general expectation of gaining some business benefit, rather than simply goodwill. In addition, you must show that you conducted business during the entertainment and that the active conduct of business was your main purpose.

Even if you cannot show that the entertainment was “directly related” you may still be able to deduct the expenses as long as you can prove the entertainment was “associated with” your business. To meet this test, you must have had a clear business purpose when you took on the expense, and the entertainment must directly precede or come after a substantial business discussion.

Substantiating your Expenses

Tax law requires you to keep records that will prove the business purpose and amounts of your business entertainment as well as other business expenses. The most frequent reason that the IRS disallows entertainment expenses is the failure to show the place and business purpose of an item. Therefore it is paramount that you keep excellent records.

To substantiate entertainment expenses you must show the following:

• The amount of each separate expense.
• The date, time, place, and type of entertainment (e.g. dinner).
• The business purpose and nature of any business discussion that took place.
• The business relationship and the name, title, and occupation of the person or people you entertained.

Don’t Miss Out

Tax law is complicated, and this article only touches on a few of the deductions for entertainment expenses you might be entitled to. If you have any questions about entertainment expenses or need assistance setting up a recordkeeping system to document your business-related activities, don’t hesitate to call.

If you have any questions about this topic or other tax related questions, please do not hesitate to contact us at 727-327-1999.

ANY TAX ADVICE IN THIS COMMUNICATION IS NOT INTENDED OR WRITTEN TO BE USED, AND CANNOT BE USED, BY A CLIENT OR ANY OTHER PERSON OR ENTITY FOR THE PURPOSE OF (i) AVOIDING PENALTIES THAT MAY BE IMPOSED ON ANY TAXPAYER, OR (ii) PROMOTING, MARKETING OR RECOMMENDING TO ANOTHER  PARTY ANY MATTERS ADDRESSED HEREIN.

Tax Tips for Those Affected By Natural Disasters

Every year, hurricanes, tornadoes, floods, wildfires, and other natural disasters affect people throughout the US. The bad news is that recovery efforts after natural disasters can be costly. For instance, when hurricanes strike they not only cause wind damage but can cause widespread flooding. Many homeowners are not covered for damage due to flooding because most standard insurance policies do not cover flood damage. Fortunately, tax relief is available–but only if you meet certain conditions. For business owners and self-employed individuals who may owe estimated taxes, for example, the IRS typically delays filing deadlines for taxpayers who reside or have a business in the disaster area.

Deducting Casualty Losses: Tips for Homeowners

Fortunately, personal casualty losses are deductible on your tax return as long as the property is located in a federally declared disaster zone (please call the office if you are not sure). You must also meet the following four conditions:

Note: Some of the casualty loss rules for business or income property are different than the rules for property held for personal use.

1. The loss was caused by a sudden, unexplained, or unusual event. 
Natural disasters such as flooding, hurricanes, tornadoes, and wildfires all qualify as sudden, unexplained, or unusual events.

2. The damages were not covered by insurance.

You can only claim a deduction for casualty losses that are not covered or reimbursed by your insurance company. Keep in mind that timing is important. If you submit a claim to your insurance company late in the year, then your claim might not be processed before it is time to prepare your taxes. One solution is to file for a 6-month extension on your taxes. If you have any questions about this, please call the office.

3. The dollar amount of you losses were greater than the reductions required by the IRS.

To claim casualty losses on your tax forms, the IRS requires several “reductions,” the first of which is referred to as the $100 loss limit and requires taxpayers to subtract $100 from the total loss amount.

Next, you need to reduce the loss amount by 10 percent of your adjusted gross income (AGI). Here is an example: Let’s say your AGI is $35,000 and your insurance company paid for all of the losses except $5,800 that you incurred as a result of tornado damage. First, you would first subtract $100 and then reduce that amount by $3500. The amount you could deduct as a loss would be $2,200.

4. You must itemize.

To claim a deduction for the loss, you must itemize your taxes. If you normally don’t itemize but have a large casualty loss, you can calculate your taxes both ways to figure out which method gives you the lowest tax bill. Please call if you need help figuring out which method is best for your particular circumstances.

Two options for deducting casualty losses on your tax returns.

You can deduct the losses in the year in which they occurred or claim them for the prior year’s return. For example, if you were affected by a natural disaster this year, you can claim your losses on your 2017 tax return or amend your 2016 tax return and deduct your losses. If you choose to deduct losses on your 2016 tax return, then you have one year from the date the tax return was due to file it.

Tip: Do not consider the loss of future profits or income due to the casualty as you figure your loss.

Figuring Amount of Loss

Figure the amount of your loss using the following steps:

• Determine what your adjusted basis in the property was before the casualty occurred. For property you buy, your basis is usually its cost to you. For property you acquire in some other way, such as inheriting it or getting it as a gift, you must figure your basis in another way. Please call the office for more information.
• Determine the decrease in fair market value (FMV) of the property as a result of the casualty. FMV is the price at which you could sell your property to a willing buyer. The decrease in FMV is the difference between the property’s FMV immediately before and immediately after the casualty.
• Subtract any insurance or other reimbursements that you received or expect to receive from the smaller of those two amounts.

Tax Relief for Small Business Owners

Individuals, as well as businesses affected by severe storms, tornadoes, straight-line winds, and flooding in Arkansas and Missouri with an estimated income tax payment originally due on or after April 26, 2017, and before Aug. 31, 2017, will not be subject to penalties for failure to pay estimated tax installments as long as such payments are paid on or before Aug. 31, 2017.

If you have been affected by a natural disaster, please call the office immediately and receive assistance figuring out when your tax payments are due.

Have you been affected by a natural disaster this year? Are you wondering if you qualify for tax relief? Help is just a phone call away.

If you have any questions about this topic or other tax related questions, please do not hesitate to contact us at 727-327-1999.

ANY TAX ADVICE IN THIS COMMUNICATION IS NOT INTENDED OR WRITTEN TO BE USED, AND CANNOT BE USED, BY A CLIENT OR ANY OTHER PERSON OR ENTITY FOR THE PURPOSE OF (i) AVOIDING PENALTIES THAT MAY BE IMPOSED ON ANY TAXPAYER, OR (ii) PROMOTING, MARKETING OR RECOMMENDING TO ANOTHER  PARTY ANY MATTERS ADDRESSED HEREIN.

Tax Breaks for Hiring New Employees

If you’re thinking about hiring new employees this year, you won’t want to miss out on these tax breaks.

1. Work Opportunity Credit

The Work Opportunity Tax Credit (WOTC) is a federal tax credit for employers that hire employees from the following targeted groups of individuals:

• A member of a family that is a Qualified Food Stamp Recipient
• A member of a family that is a Qualified Aid to Families with Dependent Children (AFDC) Recipient
• Qualified Veterans
• Qualified Ex-Felons, Pardoned, Paroled or Work Release Individuals
• Vocational Rehabilitation Referrals
• Qualified Summer Youths
• Qualified Supplemental Security Income (SSI) Recipients
• Qualified Individuals living within an Empowerment Zone or Rural Renewal Community
• Long Term Family Assistance Recipient (TANF) (formerly known as Welfare to Work)

The tax credit (a maximum of $9,600) is taken as a general business credit on Form 3800 and is applied against tax liability on business income. It is limited to the amount of the business income tax liability or social security tax owed. Normal carry-back and carry-forward rules apply.

For qualified tax-exempt organizations, the credit is limited to the amount of employer social security tax owed on wages paid to all employees for the period the credit is claimed.

Also, an employer must obtain certification that an individual is a member of the targeted group before the employer may claim the credit.

Note: The Protecting Americans from Tax Hikes Act of 2015 (the PATH Act) retroactively allows eligible employers to claim the Work Opportunity Tax Credit (WOTC) for all targeted group employee categories that were in effect prior to the enactment of the PATH Act, if the individual began or begins work for the employer after December 31, 2014 and before January 1, 2020.

For tax-exempt employers, the PATH Act retroactively allows them to claim the WOTC for qualified veterans who begin work for the employer after December 31, 2014, and before January 1, 2020.

2. Payroll Tax Deduction – R & D Tax Credit

Starting in 2016, startup businesses (C-corps and S-corps) with little to no revenue that qualify for the research and development tax credit can apply the credit against employer-paid Social Security taxes instead of income tax owed. Sole proprietorships, as well as Partnerships, C-corps and S-corps with gross receipts of less than $5 million for the current year and with no gross receipts for the previous year, can take advantage of the credit. Up to $250,000 in payroll costs can be offset by the credit.

3. Disabled Access Credit and the Barrier Removal Tax Deduction

Employers that hire disabled workers might also be able to take advantage of two additional tax credits in addition to the WOTC.

The Disabled Access Credit is a non-refundable credit for small businesses that incur expenditures for the purpose of providing access to persons with disabilities. An eligible small business is one that earned $1 million or less or had no more than 30 full-time employees in the previous year; they may take the credit each, and every year they incur access expenditures. Eligible expenditures include amounts paid or incurred to:

1. Remove barriers that prevent a business from being accessible to or usable by individuals with disabilities;2. Provide qualified interpreters or other methods of making audio materials available to hearing-impaired individuals;

3. Provide qualified readers, taped texts, and other methods of making visual materials available to individuals with visual impairments; or

4. Acquire or modify equipment or devices for individuals with disabilities.

The Architectural Barrier Removal Tax Deduction encourages businesses of any size to remove architectural and transportation barriers to the mobility of persons with disabilities and the elderly. Businesses may claim a deduction of up to $15,000 a year for qualified expenses for items that normally must be capitalized. Businesses claim the deduction by listing it as a separate expense on their income tax return.

Businesses may use the Disabled Tax Credit and the Architectural/Transportation Tax Deduction together in the same tax year if the expenses meet the requirements of both sections. To use both, the deduction is equal to the difference between the total expenditures and the amount of the credit claimed.

4. Indian Employment Credit

The Indian Employment Credit provides businesses with an incentive to hire certain individuals (enrolled members of an Indian tribe or the spouse of an enrolled member) who live on or near an Indian reservation. The business does not have to be in an empowerment zone or enterprise community to qualify for the credit, which offsets the business’s federal tax liability.

The credit is 20 percent of the excess of the current qualified wages and qualified employee health insurance costs (not to exceed $20,000) over the sum of the corresponding amounts that were paid or incurred during the calendar year of 1993 (not a typo).

5. State Tax Credits

Many states use tax credits and deductions as incentives for hiring and job growth. Employers are eligible for these credits and deductions when they create new jobs and hire employees that meet certain requirements. Examples include the New Employment Credit (NEC) in California, the Kentucky Small Business Tax Credit, and Empire Zone Tax Credits in New York.

Wondering what tax breaks your business qualifies for?

Call today and speak to a tax and accounting professional you can trust.

If you have any questions about this topic or other tax related questions, please do not hesitate to contact us at 727-327-1999.

ANY TAX ADVICE IN THIS COMMUNICATION IS NOT INTENDED OR WRITTEN TO BE USED, AND CANNOT BE USED, BY A CLIENT OR ANY OTHER PERSON OR ENTITY FOR THE PURPOSE OF (i) AVOIDING PENALTIES THAT MAY BE IMPOSED ON ANY TAXPAYER, OR (ii) PROMOTING, MARKETING OR RECOMMENDING TO ANOTHER  PARTY ANY MATTERS ADDRESSED HEREIN.

Tax Implications of Crowdfunding

Crowdfunding websites such as Kickstarter, GoFundMe, Indiegogo, and Lending Club have become increasingly popular for both individual fundraising and small business owners looking for start-up capital or funding for creative ventures. The upside is that it’s often possible to raise the cash you need, but the downside is that the IRS might consider that money taxable income. Here’s what you need to know.

What is Crowdfunding?

Crowdfunding is the practice of funding a project by gathering contributions online from a large group of backers. Initially used by musicians, filmmakers, and other creative types to raise small sums of money for projects that were unlikely to turn a profit, now it is used to fund a variety of projects, events, and products–and has even become an alternative to venture capital for some.

Are Funds I receive Taxable?

All income you receive, regardless of the source, is considered taxable income in the eyes of the IRS–and that includes crowdfunding dollars.

Say you develop a prototype for a product that looks promising. You run a Kickstarter campaign to raise additional funding, setting a goal of $15,000 and offer a small gift in the form of a t-shirt, cup with a logo or a bumper sticker to your donors.

Your campaign is more successful than you anticipated it would be and you raise $35,000–more than twice your goal. Let’s look at how the IRS might view your crowdfunding campaign:

Taxable sale. Because you offered something (a gift or reward) in return for a payment pledge it is considered a sale. As such, it may be subject to sales and use tax.

Taxable income. Since you raised $35,000, that amount is considered taxable income. But even if you only raised $15,000 and offered no gift, the $15,000 is still considered taxable income and should be reported as such on your tax return–even though you did not receive a Form 1099-K from a third party payment processor (more about this below).

Generally, crowdfunding revenues are included in income as long as they are not:

• Loans that must be repaid;
• Capital contributed to an entity in exchange for an equity interest in the entity; or
• Gifts made out of detached generosity and without any “quid pro quo.” However, a voluntary transfer without a “quid pro quo” isn’t necessarily a gift for federal income tax purposes.

Income offset by business expenses. You may not owe taxes however, if your crowdfunding campaign is deemed a trade or active business (not a hobby) in that your business expenses might offset your tax liability.

Factors affecting which expenses could be deductible against crowdfunding income include whether the business is a start-up and which accounting method you use (cash vs. accrual) for your funds. For example, if your business is a startup you may qualify for additional tax benefits such as deducting startup costs or applying part or all of the research and development credit against payroll tax liability instead of income tax liability.

Timing of the crowdfunding campaign, receipt of funds, and when expenses are incurred also affect whether business expenses will offset taxable income in a given tax year. For instance, if your crowdfunding campaign ends in October but the project is delayed until January of the following year it is likely that there will be few business expenses to offset the income received from the crowdfunding campaign since most expenses are incurred during or after project completion. As such, you would not be able to offset any income from funds raised during your crowdfunding campaign in one tax year with business expenses incurred the following tax year.

Non-Taxable Gift. If money is donated or pledged without receiving something in return, it may be considered a “gift,” and the recipient does not pay any tax. Up to $14,000 per year per recipient may be given by the “gift giver.”

How do I Report Funds on my Tax Return?

Companies that issue third party payment transactions (e.g. Amazon if you use Kickstarter or PayPal if you use Indiegogo) are required to report payments that exceed a threshold amount of $20,000 and 200 transactions to the IRS using Form 1099-K, Payment Card and Third Party Network Transactions.

These minimum reporting thresholds apply only to payments settled through a third-party network; there is no threshold for payment card transactions.

Form 1099-K includes the gross amount of all reportable payment transactions and is sent to the taxpayer by January 31 if payments were received during the prior calendar year. Include the amount found on your Form 1099-K when figuring your income on your tax return, generally, Schedule C, Profit or Loss from Business for most small business owners.

Don’t Get Caught Short.

If you’re thinking of using crowdfunding to raise money for your small business startup or for a personal cause, consult a tax and accounting professional first.

Don’t make the mistake of using all of your crowdfunding dollars on your project and then discovering you owe tax and have no money with which to pay it.

If you have any questions about this topic or other tax related questions, please do not hesitate to contact us at 727-327-1999.

ANY TAX ADVICE IN THIS COMMUNICATION IS NOT INTENDED OR WRITTEN TO BE USED, AND CANNOT BE USED, BY A CLIENT OR ANY OTHER PERSON OR ENTITY FOR THE PURPOSE OF (i) AVOIDING PENALTIES THAT MAY BE IMPOSED ON ANY TAXPAYER, OR (ii) PROMOTING, MARKETING OR RECOMMENDING TO ANOTHER  PARTY ANY MATTERS ADDRESSED HEREIN.

Minimizing Tax on Mutual Fund Activities

Tax law generally treats mutual fund shareholders as if they directly owned a proportionate share of the fund’s portfolio of securities and you must report as income any mutual fund distributions, whether or not they are reinvested. Thus, all dividends and interest from securities in the portfolio, as well as any capital gains from the sales of securities, are taxed to the shareholders.

Whether you’re new to mutual funds or a seasoned investor who wants to learn more, these tips will help you avoid the tax bite on mutual fund investments.

Taxable Distributions

First, you need to understand how distributions from mutual funds are taxed. There are two types of taxable distributions: (1) ordinary dividends and (2) capital gain distributions.

Ordinary Dividends. Distributions of ordinary dividends, which come from the interest and dividends earned by securities in the fund’s portfolio, represent the net earnings of the fund. They are paid out periodically to shareholders. Like the return on any other investment, mutual fund dividend payments decline or rise from year to year, depending on the income earned by the fund in accordance with its investment policy. These dividend payments are considered ordinary income and must be reported on your tax return.

In 2017 (same as 2016), dividend income that falls in the highest tax bracket (39.6%) is taxed at 20 percent. For the middle tax brackets (25-35%) the dividend tax rate is 15 percent, and for the two lower ordinary income tax brackets of 10% and 15%, the dividend tax rate is zero.

Qualified dividends. Qualified dividends are ordinary dividends that are subject to the same the zero or 15 percent maximum tax rate that applies to net capital gain. They are subject to the 15 percent rate if the regular tax rate that would apply is 25 percent or higher; however, the highest tax bracket, 39.6%, is taxed at a 20 percent rate. If the regular tax rate that would apply is lower than 25 percent, qualified dividends are subject to the zero percent rate.

Dividends from foreign corporations are qualified where their stock or ADRs (American depositary receipts) are traded on U.S. exchanges or with IRS approval where U.S. tax treaties cover the dividends. Dividends from mutual funds qualify where a mutual fund is receiving qualified dividends and distributing the required proportions thereof.

Capital gain distributions. When gains from the fund’s sales of securities exceed losses, they are distributed to shareholders. As with ordinary dividends, these capital gain distributions vary in amount from year to year. They are treated as long-term capital gain, regardless of how long you have owned your fund shares.

A mutual fund owner may also have capital gains from selling mutual fund shares.

Capital gains rates. The beneficial long-term capital gains rates on sales of mutual fund shares apply only to profits on shares held more than a year before sale. Profit on shares held a year or less before sale is considered ordinary income, but capital gain distributions are long-term regardless of the length of time held before the distribution.

Starting with tax year 2013, long term capital gains are taxed at 20 percent (39.6% tax bracket), 15 percent for the middle tax brackets (25%, 28%, 33%, and 35%), and 0 percent for the 10% and 15% tax brackets.

At tax time, your mutual fund will send you a Form 1099-DIV, which tells you what earnings to report on your income tax return, and how much of it is qualified dividends. Because tax rates on qualified dividends are the same as for capital gains distributions and long-term gains on sales, these items combined in your tax reporting, that is, qualified dividends added to long-term capital gains. Capital losses are netted against capital gains before applying the favorable capital gains rates, and losses will not be netted against dividends.

Medicare Tax. Starting with tax year 2013, an additional Medicare tax of 3.8 percent is applied to net investment income for individuals with modified adjusted gross income above $200,000 (single filers) and $250,000 (joint filers).

Minimizing Tax Liability on Mutual Fund Activities

Now that you have a better understanding of how mutual funds are taxed, here are seven tips for minimizing the tax on your mutual fund activities.

1. Keep Track of Reinvested Dividends

Most funds offer you the option of having dividend and capital gain distributions automatically reinvested in the fund–a good way to buy new shares and expand your holdings. While most shareholders take advantage of this service, it is not a way to avoid being taxed. Reinvested ordinary dividends are still taxed (at long-term capital gains rates if qualified), just as if you had received them in cash. Similarly, reinvested capital gain distributions are taxed as long-term capital gain.

Tip: If you reinvest, add the amount reinvested to the “cost basis” of your account, i.e., the amount you paid for your shares. The cost basis of your new shares purchased through automatic reinvesting is easily seen from your fund account statements. This information is important later on when you sell shares.

2. Be Aware That Exchanges of Shares Are Taxable Events

The “exchange privilege,” or the ability to exchange shares of one fund for shares of another, is a popular feature of many mutual fund “families,” i.e., fund organizations that offer a variety of funds. For tax purposes, exchanges are treated as if you had sold your shares in one fund and used the cash to purchase shares in another fund. In other words, you must report any capital gain from the exchange on your return. The same tax rules used for calculating gains and losses when you redeem shares apply when you exchange them.

Note: Gains on these redemptions and exchanges are taxable whether the fund invests in taxable or tax-exempt securities.

3. Do Not Overlook the Advantages of Tax-Exempt Funds

If you are in the higher tax brackets and are seeing your investment profits taxed away, then there is a good alternative to consider: tax-exempt mutual funds. Distributions from such funds that are attributable to interest from state and municipal bonds are exempt from federal income tax (although they may be subject to state tax).

The same applies to distributions from tax-exempt money market funds. These funds also invest in municipal bonds, but only in those that are short-term or close to maturity, the aim being to reduce the fluctuation in NAV that occurs in long-term funds.

Many taxpayers can ease the tax bite by investing in municipal bond funds for example.

Note: Capital gain distributions paid by municipal bond funds (unlike distributions of interest) are not free from federal tax. Most states also tax these capital gain distributions.

Although income from tax-exempt funds is federally tax-exempt, you must still report on your tax return the amount of tax-exempt income you received during the year. This is an information-reporting requirement only and does not convert tax-exempt earnings into taxable income.

Your tax-exempt mutual fund will send you a statement summarizing its distributions for the past year and explaining how to handle tax-exempt dividends on a state-by-state basis.

4. Keep Records of Your Mutual Fund Transactions

It is crucial to keep the statements from each mutual fund you own, especially the year-end statement.

By law, mutual funds must send you a record of every transaction in your account, including reinvestments and exchanges of shares. The statement shows the date, amount, and number of full and fractional shares bought or sold. These transactions are also contained in the year-end statement.

In addition, you will receive a year-end Form 1099-B, which reports the sale of fund shares, for any non-IRA mutual fund account in which you sold shares during the year.

Why is recordkeeping so important?

When you sell mutual fund shares, you realize a capital gain or loss in the year the shares are sold. You must pay tax on any capital gain arising from the sale, just as you would from a sale of individual securities. (Losses may be used to offset other gains in the current year and deducted up to an additional $3,000 of ordinary income. Remaining loss may be carried for comparable treatment in later years.)

The amount of the gain or loss is determined by the difference between the cost basis of the shares (generally the original purchase price) and the sale price. Thus, to figure the gain or loss on a sale of shares, it is essential to know the cost basis. If you have kept your statements, you will be able to figure this out.

Example: In 2012, you purchased 100 shares of Fund JKL at $10 a share for a total purchase price of $1,000. Your cost basis for each share is $10 (what you paid for the shares). Any fees or commissions paid at the time of purchase are included in the basis, so since you paid an up-front commission of two percent, or $20, on the purchase, your cost basis for each share is $10.20 ($1,020 divided by 100). Let’s say you sell your Fund JKL shares this year for $1,500. Assume there are no adjustments to your $ 1,020 basis, such as basis attributable to shares purchased through reinvestment. On this year’s income tax return, you report a capital gain of $480 ($1,500 minus $1,020).

Note: Commissions or brokerage fees are not deducted separately as investment expenses on your tax return since they are taken into account in your cost basis.

One of the advantages of mutual fund investing is that the fund provides you with all of the records that you need to compute gains and losses–a real plus at tax time. Some funds even provide cost basis information or calculate gains and losses for shares sold. That is why it is important to save the statements. However, you are not required to use the fund’s gain or loss computations in your tax reporting.

5. Re-investing Dividends & Capital Gain Distributions when Calculating

Make sure that you do not pay any unnecessary capital gain taxes on the sale of mutual fund shares because you forgot about reinvested amounts. When you reinvest dividends and capital gain distributions to buy more shares, you should add the cost of those shares (that is, the amount invested) to the cost basis of the shares in that account because you have already paid tax on those shares.

Failure to include reinvested dividends and capital gain distributions in your cost basis is a costly mistake.

6. Don’t Forget State Taxation

Many states treat mutual fund distributions the same way the federal government does. There are, however, some differences. For example:

• If your mutual fund invests in U.S. government obligations, states generally exempt, from state taxation, dividends attributable to federal obligation interest.
• Most states do not tax income from their own obligations, whether held directly or through mutual funds. On the other hand, the majority of states do tax income from the obligations of other states. Thus, in most states, you will not pay state tax to the extent you receive, through the fund, income from obligations issued by your state or its municipalities.
• Most states don’t grant reduced rates for capital gains or dividends.

7. Don’t Overlook Possible Tax Credits for Foreign Income

If your fund invests in foreign stocks or bonds, part of the income it distributes may have been subject to foreign tax withholding. If so, you may be entitled to a tax deduction or credit for your pro-rata share of taxes paid. Your fund will provide you with the necessary information.

Tip: Because a tax credit provides a dollar-for-dollar offset against your tax bill, while a deduction reduces the amount of income on which you must pay tax, it is generally advantageous to claim the foreign tax credit. If the foreign tax doesn’t exceed $300 ($600 on a joint return), then you may not need to file IRS form 1116 to claim the credit.

Questions?

If you have any questions about the tax treatment of mutual funds, please call.

If you have any questions about this topic or other tax related questions, please do not hesitate to contact us at 727-327-1999.

ANY TAX ADVICE IN THIS COMMUNICATION IS NOT INTENDED OR WRITTEN TO BE USED, AND CANNOT BE USED, BY A CLIENT OR ANY OTHER PERSON OR ENTITY FOR THE PURPOSE OF (i) AVOIDING PENALTIES THAT MAY BE IMPOSED ON ANY TAXPAYER, OR (ii) PROMOTING, MARKETING OR RECOMMENDING TO ANOTHER  PARTY ANY MATTERS ADDRESSED HEREIN.

Hobby or Business? Why It Matters

Millions of Americans have hobbies such as sewing, woodworking, fishing, gardening, stamp and coin collecting, but when that hobby starts to turn a profit, it might just be considered a business by the IRS.

Definition of a Hobby vs. a Business

The IRS defines a hobby as an activity that is not pursued for profit. A business, on the other hand, is an activity that is carried out with the reasonable expectation of earning a profit.

The tax considerations are different for each activity, so it’s important for taxpayers to determine whether an activity is engaged in for profit as a business or is just a hobby for personal enjoyment.

Of course, you must report and pay tax on income from almost all sources, including hobbies. But when it comes to deductions such as expenses and losses, the two activities differ in their tax implications.

Is Your Hobby Actually a Business?

If you’re not sure whether you’re running a business or simply enjoying a hobby, here are nine factors you should consider:

• Whether you carry on the activity in a businesslike manner.
• Whether the time and effort you put into the activity indicate you intend to make it profitable.
• Whether you depend on income from the activity for your livelihood.
• Whether your losses are due to circumstances beyond your control (or are normal in the startup phase of your type of business).
• Whether you change your methods of operation in an attempt to improve profitability.
• Whether you, or your advisors, have the knowledge needed to carry on the activity as a successful business.
• Whether you were successful in making a profit in similar activities in the past.
• Whether the activity makes a profit in some years, and how much profit it makes.
• Whether you can expect to make a future profit from the appreciation of the assets used in the activity.

An activity is presumed to be for profit if it makes a profit in at least three of the last five tax years, including the current year (or at least two of the last seven years for activities that consist primarily of breeding, showing, training, or racing horses).

The IRS says that it looks at all facts when determining whether a hobby is for pleasure or business, but the profit test is the primary one. If the activity earned income in three out of the last five years, it is for profit. If the activity does not meet the profit test, the IRS will take an individualized look at the facts of your activity using the list of questions above to determine whether it’s a business or a hobby. It should be noted that this list is not all-inclusive.

Business Activity: If the activity is determined to be a business, you can deduct ordinary and necessary expenses for the operation of the business on a Schedule C or C-EZ on your Form 1040 without considerations for percentage limitations. An ordinary expense is one that is common and accepted in your trade or business. A necessary expense is one that is appropriate for your business.

Hobby: If an activity is a hobby, not for profit, losses from that activity may not be used to offset other income. You can only deduct expenses up to the amount of income earned from the hobby. These expenses, with other miscellaneous expenses, are itemized on Schedule A and must also meet the two percent limitation of your adjusted gross income in order to be deducted.

What Are Allowable Hobby Deductions?

If your activity is not carried on for profit, allowable deductions cannot exceed the gross receipts for the activity.

Note: Internal Revenue Code Section 183 (Activities Not Engaged in for Profit) limits deductions that can be claimed when an activity is not engaged in for profit. IRC 183 is sometimes referred to as the “hobby loss rule.”

Deductions for hobby activities are claimed as itemized deductions on Schedule A, Form 1040. These deductions must be taken in the following order and only to the extent stated in each of three categories:

• Deductions that a taxpayer may claim for certain personal expenses, such as home mortgage interest and taxes, may be taken in full.
• Deductions that don’t result in an adjustment to the basis of property, such as advertising, insurance premiums, and wages, may be taken next, to the extent gross income for the activity is more than the deductions from the first category.
• Deductions that reduce the basis of property, such as depreciation and amortization, are taken last, but only to the extent gross income for the activity is more than the deductions taken in the first two categories.

If your hobby is regularly generating income, it could make tax sense for you to consider it a business because you might be able to lower your taxes and take certain deductions.

If you’re still wondering whether your hobby is actually a business, help is just a phone call away.

If you have any questions about this topic or other tax related questions, please do not hesitate to contact us at 727-327-1999.

ANY TAX ADVICE IN THIS COMMUNICATION IS NOT INTENDED OR WRITTEN TO BE USED, AND CANNOT BE USED, BY A CLIENT OR ANY OTHER PERSON OR ENTITY FOR THE PURPOSE OF (i) AVOIDING PENALTIES THAT MAY BE IMPOSED ON ANY TAXPAYER, OR (ii) PROMOTING, MARKETING OR RECOMMENDING TO ANOTHER  PARTY ANY MATTERS ADDRESSED HEREIN.