Thursday, March 30, 2006
Deducting Miles Driven on Behalf of a Charity
A taxpayer may usually deduct 14 cents per mile for all miles driven on behalf of a charity (Section 170(i)). The primary purpose of the travel must be to contribute to the mission of the charity. In addition, the travel must not provide the taxpayer with any significant amount of personal pleasure, recreation, or vacation (Section 170(j)). Further, a taxpayer may not deduct the miles driven on behalf of a charity, other than a church, if the purpose of the travel is to influence legislation (Section 170(f)(6)).
For example, if a taxpayer drove her personal automobile a total of 500 miles to procure and distribute wheelchairs on behalf of a qualified charitable organization such as LifeNets http://www.lifenets.org/, the taxpayer could deduct $70.00 (500 miles x 14 cents per mile). However, if a scoutmaster took a troop of Boy Scouts to summer camp and spent a week there with them, the scoutmaster may not deduct the miles because the trip to the summer camp has a significant element of personal pleasure, recreation, or vacation.
For miles for miles driven for relief efforts related to Hurricane Katrina after August 25, 2005, through December 31, 2006, a taxpayer may deduct 70 percent of the standard mileage rate in effect for business miles If a taxpayer receives a reimbursement from a charity for miles driven for relief efforts related to Hurricane Katrina after August 25, 2005, through December 31, 2006, the taxpayer may exclude the reimbursement from gross income up to 100 percent of the standard mileage rate for business miles.
The standard mileage rate for business miles was 40.5 cents per mile from August 25, 2005, through August 31, 2005. The standard mileage rate for business miles increased to 48.5 cents per mile from September 1, 2005, through December 31, 2005. The standard mileage rate for business miles driven in 2006 is 44.5 cents per mile (Rev. Proc. 2005-78).
If a taxpayer does not receive any reimbursement from a charity for miles driven for relief efforts related to Hurricane Katrina, the taxpayer may deduct 29 cents per mile for miles driven from August 25, 2005, through August 31, 2005; 34 cents per mile for miles driven from September 1, 2005, through December 31, 2005; and 32 cents per mile for miles driven in 2006 (Rev. Proc. 2005-78).
If a taxpayer receives reimbursement from a charity for miles driven for relief efforts related to Hurricane Katrina, the taxpayer may exclude from gross income up to 40.5 cents per mile for miles driven from August 25, 2005, through August 31, 2005; 48.5 cents per mile for miles driven from September 1, 2005, through December 31, 2005; and 44.5 cents per mile for miles driven in 2006 (Rev. Proc. 2005-78).
In addition to the standard mileage rate, a taxpayer may deduct the cost of parking fees and tolls incurred while driving an automobile on behalf of a qualified charitable organization (Rev. Proc. 2005-78).
If a taxpayer has any doubt about the status of an organization as a qualified charity, the taxpayer may consult IRS Publication 78 at the IRS Web site: http://www.irs.gov/.
A taxpayer claims the deduction for miles driven on behalf of a charity on Schedule A of Form 1040. The deduction for miles driven on behalf of a charity is included with the amounts for cash contributions on the same line of Schedule A of Form 1040.
A taxpayer should have good records such as a mileage log to document the deduction. The burden of proof is on the taxpayer to prove the amount of all deductions claimed.
If the taxpayer's total itemized deductions do not exceed the standard deduction amount, the taxpayer will usually not receive any benefit from the deduction for miles driven on behalf of a charity.
For example, if a taxpayer drove her personal automobile a total of 500 miles to procure and distribute wheelchairs on behalf of a qualified charitable organization such as LifeNets http://www.lifenets.org/, the taxpayer could deduct $70.00 (500 miles x 14 cents per mile). However, if a scoutmaster took a troop of Boy Scouts to summer camp and spent a week there with them, the scoutmaster may not deduct the miles because the trip to the summer camp has a significant element of personal pleasure, recreation, or vacation.
For miles for miles driven for relief efforts related to Hurricane Katrina after August 25, 2005, through December 31, 2006, a taxpayer may deduct 70 percent of the standard mileage rate in effect for business miles If a taxpayer receives a reimbursement from a charity for miles driven for relief efforts related to Hurricane Katrina after August 25, 2005, through December 31, 2006, the taxpayer may exclude the reimbursement from gross income up to 100 percent of the standard mileage rate for business miles.
The standard mileage rate for business miles was 40.5 cents per mile from August 25, 2005, through August 31, 2005. The standard mileage rate for business miles increased to 48.5 cents per mile from September 1, 2005, through December 31, 2005. The standard mileage rate for business miles driven in 2006 is 44.5 cents per mile (Rev. Proc. 2005-78).
If a taxpayer does not receive any reimbursement from a charity for miles driven for relief efforts related to Hurricane Katrina, the taxpayer may deduct 29 cents per mile for miles driven from August 25, 2005, through August 31, 2005; 34 cents per mile for miles driven from September 1, 2005, through December 31, 2005; and 32 cents per mile for miles driven in 2006 (Rev. Proc. 2005-78).
If a taxpayer receives reimbursement from a charity for miles driven for relief efforts related to Hurricane Katrina, the taxpayer may exclude from gross income up to 40.5 cents per mile for miles driven from August 25, 2005, through August 31, 2005; 48.5 cents per mile for miles driven from September 1, 2005, through December 31, 2005; and 44.5 cents per mile for miles driven in 2006 (Rev. Proc. 2005-78).
In addition to the standard mileage rate, a taxpayer may deduct the cost of parking fees and tolls incurred while driving an automobile on behalf of a qualified charitable organization (Rev. Proc. 2005-78).
If a taxpayer has any doubt about the status of an organization as a qualified charity, the taxpayer may consult IRS Publication 78 at the IRS Web site: http://www.irs.gov/.
A taxpayer claims the deduction for miles driven on behalf of a charity on Schedule A of Form 1040. The deduction for miles driven on behalf of a charity is included with the amounts for cash contributions on the same line of Schedule A of Form 1040.
A taxpayer should have good records such as a mileage log to document the deduction. The burden of proof is on the taxpayer to prove the amount of all deductions claimed.
If the taxpayer's total itemized deductions do not exceed the standard deduction amount, the taxpayer will usually not receive any benefit from the deduction for miles driven on behalf of a charity.
Monday, March 27, 2006
Second Homes--Tax Benefits and Potential Tax Pitfalls
Many people are buying a second home. They might do so to have a vacation home with the possibility of selling it at a substantial gain in the future. Another reason people buy a second home is to use it in the future as a primary home, perhaps in retirement. They might prefer to purchase the second home now to avoid the possibility of having to pay considerably more for it in the future.
What are the tax benefits and potential tax pitfalls in purchasing a second home? The first benefit is that the real estate taxes on a second home are deductible as an itemized deduction. However, a potential pitfall exists if the taxpayer is subject to the alternative minimum tax (AMT). Real real estate taxes are not deductible for AMT purposes.
The mortgage interest is also deductible as an itemized deduction on mortgage loans up to a maximum of $1,000,000 on loans used to acquire, construct, or substantially improve the taxpayer's primary home and the taxpayer's second qualified home. A refinancing of acquisition debt is considered acquisition debt to the extent that it does not exceed the balance before refinancing.
Another tax benefit for owning a second home is that the taxpayer may deduct interest on home-equity loans up to a maximum loan amount of $100,000. A home-equity loan is considered as an acquisition debt if the taxpayer uses it to make a substantial improvement to the primary home or second home. The loans may be secured by the primary residence and/or the second home. For tax purposes, a home-equity loan includes the excess of the balance of a refinanced acquisition loan over the balance before the refinancing unless the taxpayer uses the excess to make a substantial improvement to the home.
A tax pitfall is that the interest on a home-equity loan is generally not deductible for AMT purposes. An exception applies if the taxpayer uses the proceeds of the loan of the loan to make a substantial improvement to the property.
If a taxpayer rents a second home to a tenant for 14 or fewer days during the year, the rent income is not taxable. The taxpayer may still deduct the real estate taxes. The taxpayer may deduct the qualified mortgage interest as long as the taxpayer used the second home for personal purposes for a number of days that exceeds the greater of 14 days or 10 percent of the number of days the taxpayer rented the house to a tenant at a fair rental. If the taxpayer does not meet this test, the second home might be considered as rental property.
A potential tax pitfall on a second home is that any gain on the sale of a home that is not the taxpayer's principal residence is taxable. It would be taxable as a capital gain because a personal use asset such as a second home is a capital asset.
The exclusion of gain up to $250,000 ($500,000 on a joint return) on the sale of the taxpayer's home applies only to the sale of a home that that the taxpayer owned and used as the taxpayer's principal residence for at least two of the five years before its sale. A taxpayer may have only one principal residence at a time.
A good tax savings strategy would be for the taxpayer to sell the primary home and exclude the gain up to the limit. Then, the taxpayer would move into the second home and use it as a primary residence for at at least two of the five years before the taxpayer sells it. By doing so, the taxpayer could use the exclusion of gain provision on both homes. The potential to exclude the gain on the sale of both homes up to the limit using this strategy is a major tax benefit.
Another potential tax pitfall on owning a second home is that any loss on the sale of a home used as the taxpayer's residence, whether as a primary home or as a second home, is not deductible because the loss is on the sale of an asset used for personal purposes.
An individual should consider many factors before buying a second home, such as cost, convenience, and potential gain. The tax benefits and potential tax pitfalls are some other key factors to consider before buying a second home.
What are the tax benefits and potential tax pitfalls in purchasing a second home? The first benefit is that the real estate taxes on a second home are deductible as an itemized deduction. However, a potential pitfall exists if the taxpayer is subject to the alternative minimum tax (AMT). Real real estate taxes are not deductible for AMT purposes.
The mortgage interest is also deductible as an itemized deduction on mortgage loans up to a maximum of $1,000,000 on loans used to acquire, construct, or substantially improve the taxpayer's primary home and the taxpayer's second qualified home. A refinancing of acquisition debt is considered acquisition debt to the extent that it does not exceed the balance before refinancing.
Another tax benefit for owning a second home is that the taxpayer may deduct interest on home-equity loans up to a maximum loan amount of $100,000. A home-equity loan is considered as an acquisition debt if the taxpayer uses it to make a substantial improvement to the primary home or second home. The loans may be secured by the primary residence and/or the second home. For tax purposes, a home-equity loan includes the excess of the balance of a refinanced acquisition loan over the balance before the refinancing unless the taxpayer uses the excess to make a substantial improvement to the home.
A tax pitfall is that the interest on a home-equity loan is generally not deductible for AMT purposes. An exception applies if the taxpayer uses the proceeds of the loan of the loan to make a substantial improvement to the property.
If a taxpayer rents a second home to a tenant for 14 or fewer days during the year, the rent income is not taxable. The taxpayer may still deduct the real estate taxes. The taxpayer may deduct the qualified mortgage interest as long as the taxpayer used the second home for personal purposes for a number of days that exceeds the greater of 14 days or 10 percent of the number of days the taxpayer rented the house to a tenant at a fair rental. If the taxpayer does not meet this test, the second home might be considered as rental property.
A potential tax pitfall on a second home is that any gain on the sale of a home that is not the taxpayer's principal residence is taxable. It would be taxable as a capital gain because a personal use asset such as a second home is a capital asset.
The exclusion of gain up to $250,000 ($500,000 on a joint return) on the sale of the taxpayer's home applies only to the sale of a home that that the taxpayer owned and used as the taxpayer's principal residence for at least two of the five years before its sale. A taxpayer may have only one principal residence at a time.
A good tax savings strategy would be for the taxpayer to sell the primary home and exclude the gain up to the limit. Then, the taxpayer would move into the second home and use it as a primary residence for at at least two of the five years before the taxpayer sells it. By doing so, the taxpayer could use the exclusion of gain provision on both homes. The potential to exclude the gain on the sale of both homes up to the limit using this strategy is a major tax benefit.
Another potential tax pitfall on owning a second home is that any loss on the sale of a home used as the taxpayer's residence, whether as a primary home or as a second home, is not deductible because the loss is on the sale of an asset used for personal purposes.
An individual should consider many factors before buying a second home, such as cost, convenience, and potential gain. The tax benefits and potential tax pitfalls are some other key factors to consider before buying a second home.
Wednesday, March 22, 2006
How to Deduct Start-up Costs
A new business owner incurs start-up costs before beginning the business. Under Section 195(c)(1), start-up costs are costs the taxpayer incurs to investigate the creation or acquisition of a business or in creating a business. The costs must be costs that would be deductible as an ordinary and necessary business expense if the taxpayer was actively conducting the business.
In general, a taxpayer may not deduct start-up costs until the taxpayer sells the business. That is the default rule of Section 195(a). However, for start-up costs paid or incurred after October 22, 2004, a taxpayer may elect to deduct start-up costs to the extent allowed by Section 195(b)(1)(A). Under Section 195(d)(1), a taxpayer has until the due date of the tax return, including extensions, to make the election.
A taxpayer makes the election by claiming the deduction on the appropriate form. For example, a taxpayer who is a sole proprietor would claim the deduction on Schedule C of Form 1040. The taxpayer should attach a statement to the form showing the start-up costs for which the taxpayer is making the election.
If a taxpayer failed to make the election when the taxpayer filed a timely tax return, the taxpayer has six months to file an amended return and make the election under Regulations Section 301.9100-2(b). The IRS has no authority for allowing any other late elections.
If the taxpayer elects to deduct start-up costs, the taxpayer may deduct up to $5,000 of startup costs in the year the taxpayer begins the active conduct of the business. If the new business owner determines that start-up costs might exceed $5,000, the business owner might want to do what is necessary to begin the active conduct of the business more quickly. By doing so, more of the costs would be ordinary and necessary business expenses rather than start-up costs.
However, if the start-up costs exceed $50,000, the $5,000 limit on the deduction for start-up costs is reduced by the amount by which start-up costs exceed $50,000. For example, assume that the start-up costs are $52,000. The taxpayer may claim an immediate deduction of $3,000 [$5,000 - ($52,000 - $50,000)]. If the start-up costs are $55,000 or more, the taxpayer may not deduct any of the start-up costs in the year the taxpayer begins the active conduct of the business except as an amortization deduction as explained below.
The taxpayer may deduct the remaining start-up costs ratably over 180 months beginning in the month in which the taxpayer begins the active conduct of the business under Section 195(b)(2). For example assume that a taxpayer's start-up costs were $23,000. The taxpayer may deduct $5,000 immediately. In addition, the taxpayer deducts the remaining $18,000 of start-up costs at the rate of $100 a month [($23,000 - $5,000) / 180].
The ratable deduction of start-up costs over 180 months is called an amortization deduction. A taxpayer claims an amortization deduction on Form 4562 and then carries the total deductions on Form 4562 to the appropriate form.
If the taxpayer sells the business before deducting all of the start-up costs, the taxpayer may deduct the remaining start-up costs as a loss as allowed by Sections 165 and 195(b)(2).
A taxpayer should take advantage of these rules to ensure the highest possible tax deductions. Because the time for making the election is quite limited, a taxpayer should be sure to make the election in a timely manner.
In general, a taxpayer may not deduct start-up costs until the taxpayer sells the business. That is the default rule of Section 195(a). However, for start-up costs paid or incurred after October 22, 2004, a taxpayer may elect to deduct start-up costs to the extent allowed by Section 195(b)(1)(A). Under Section 195(d)(1), a taxpayer has until the due date of the tax return, including extensions, to make the election.
A taxpayer makes the election by claiming the deduction on the appropriate form. For example, a taxpayer who is a sole proprietor would claim the deduction on Schedule C of Form 1040. The taxpayer should attach a statement to the form showing the start-up costs for which the taxpayer is making the election.
If a taxpayer failed to make the election when the taxpayer filed a timely tax return, the taxpayer has six months to file an amended return and make the election under Regulations Section 301.9100-2(b). The IRS has no authority for allowing any other late elections.
If the taxpayer elects to deduct start-up costs, the taxpayer may deduct up to $5,000 of startup costs in the year the taxpayer begins the active conduct of the business. If the new business owner determines that start-up costs might exceed $5,000, the business owner might want to do what is necessary to begin the active conduct of the business more quickly. By doing so, more of the costs would be ordinary and necessary business expenses rather than start-up costs.
However, if the start-up costs exceed $50,000, the $5,000 limit on the deduction for start-up costs is reduced by the amount by which start-up costs exceed $50,000. For example, assume that the start-up costs are $52,000. The taxpayer may claim an immediate deduction of $3,000 [$5,000 - ($52,000 - $50,000)]. If the start-up costs are $55,000 or more, the taxpayer may not deduct any of the start-up costs in the year the taxpayer begins the active conduct of the business except as an amortization deduction as explained below.
The taxpayer may deduct the remaining start-up costs ratably over 180 months beginning in the month in which the taxpayer begins the active conduct of the business under Section 195(b)(2). For example assume that a taxpayer's start-up costs were $23,000. The taxpayer may deduct $5,000 immediately. In addition, the taxpayer deducts the remaining $18,000 of start-up costs at the rate of $100 a month [($23,000 - $5,000) / 180].
The ratable deduction of start-up costs over 180 months is called an amortization deduction. A taxpayer claims an amortization deduction on Form 4562 and then carries the total deductions on Form 4562 to the appropriate form.
If the taxpayer sells the business before deducting all of the start-up costs, the taxpayer may deduct the remaining start-up costs as a loss as allowed by Sections 165 and 195(b)(2).
A taxpayer should take advantage of these rules to ensure the highest possible tax deductions. Because the time for making the election is quite limited, a taxpayer should be sure to make the election in a timely manner.
