It is that time, crunch time, for us accountants. Monday is the tax deadline for Corporate and Personal Income Tax Returns. To help you be ready and avoid any issues, here is a quick 5 best practices you should know.

1. The requirement to file your tax return and the requirement to pay your taxes are two separate requirements resulting in 2 separate penalties for failing to meet them. Therefore, even if you cannot pay your tax bill on time, you should file your tax return on time. You can easily arrange a payment plan with the IRS. This will avoid late filing penalties.
2. You should not avoid claiming a credit or deduction that you deserve for fear of an audit. That being said, if your tax return has audit flags, you should make sure you have documented proof of your claims. Here are some of the most common audit triggers: Earned Income Credit claims, especially EIC with a Schedule C business on the same tax return. Home office deduction and auto expenses for a business on a Schedule C business return is another common one. Any Schedule C business operating at a loss, especially for multiple years.
3. Don’t underestimate the value of using a tax professional. A good tax professional will help guide you on making good decisions about claims, records and even proactive strategies.
4. E-filing your tax return reduces errors and improves processing time. If you are getting a refund, make sure to e-file your return so you get your refund in a couple of weeks instead of a few of months.
5. If you get a large refund with your tax return, instead of using it to splurge on the next car or vacation, consider contributing it to your ROTH IRA so you can turn those saved dollars into more money.

I hope you enjoyed reading my articles over the last 4 months. If you need a last-minute tax matter addressed or want to discuss your future tax needs, do not hesitate to email or call our office. (845) 504-0910 or [email protected]

It’s very odd that the Inflation Reduction Act introduced a tax credit aimed at encouraging Americans to purchase electric vehicles that are more expensive than their combustion engine counterparts. Government often uses tax credits to drive behavioral change and getting people to adopt using electric vehicles is high on the agenda. This credit provides up to $7,500 as a tax credit for the purchase of an EV, significantly reducing the purchase price for many buyers.

Unfortunately, I have had a number of clients come to me at tax time looking to claim the credit only to find out that they were not eligible or did not have a tax liability great enough to take advantage of this non-refundable tax credit. There is a back-door method to getting around these challenges, so read this article to understand your situation before rushing out to get yourself behind the wheel of a brand new Tesla.

The new credit has a number of guidelines that I will outline. Some of these are date dependent. For the sake of keeping this article short, I am only providing the details for a purchase made today, please consult your tax professional for vehicles already placed in service in 2023.

1. MAGI Limit – The credit is limited to people with a MAGI below $300,000, $225,000 or $150,000 for married filing jointly, head of household or single/married filing separately, respectively. (A C-Corp buying the vehicle has no income limitation.)
2. MSRP Cap – The manufacturer sticker price must be within the MSRP Cap of $80,000 for vans, SUVs and Pickups or $55,000 for all other vehicles. A dealer discount does not help to get you within the MSRP Cap.
3. Domestic Assembly and Components Rule – The vehicle must have its’ final assembly take place in the US as well as have the battery or minerals sourced in the US. If only one of these is true for a given vehicle, the credit is reduced to $3,750. Only 23 vehicles meet both requirements as of the date this article was written.
4. Dealer Submission – Clean Vehicle Tax Credits must be initiated and approved at the time of sale. Buyers are advised to obtain a copy of the IRS’s confirmation that a “time-of-sale” report was submitted successfully by the dealer. (IRS Publication 5900)

What if you earn too much or too little? If your income exceeds the MAGI cap or your tax liability is less than $7,500, you can still receive the tax credit using a back-door lease. A commercial leasing company can claim the credit for buying an EV and then leasing it to you. The commercial credit available to a leasing company does not have the same MSRP Cap or US Sourcing rules and can also be used to bypass these requirements. The leasing company can pass the credit on to you via a lower lease payment. Of course, leases can easily hide this, so be a knowledgeable buyer and use a leasing company that you know is doing right by you.

There is also a credit available for purchasing a used EV. There are a number of rules surrounding the used vehicle credit that I will not expound on here. Please check eligibility before making a purchase.

Finally, as mentioned in the back-door lease above, a business claim for credit is not subject to the battery and mineral sourcing requirements, does not have the MSRP Cap and may avoid the income limitations.

As you can see, making a vehicle buying decision has gotten significantly more complicated as many EV purchasers will not be able to claim the credit. If you want a reputable tax preparer that has your back, please contact my office and we can discuss how we provide personalized and reputable assistance with your unique tax situation. See our full-page ad in this week’s magazine.

Nothing bothers the IRS more than paying someone a refund they didn’t deserve especially when they never paid taxes into the system in the first place. This is why the Earned Income Tax Credit (I will refer to this as EITC for the rest of this article) is one of the most highly audited tax returns.

It is very easy to get unnerved by the prospect of opening yourself up to an IRS tax audit. However, I firmly believe that if you have a right to claim a credit or apply a deduction, you should not avoid doing so just to avoid the prospect of a tax audit. That being said, you should be aware of what is and is not allowed so you do not open yourself up to pain in the future (by owing back taxes, penalties and interest).

To understand this credit requires a fundamental understanding of the difference between a refundable and non-refundable credit. 

Most tax credits are non-refundable, which means that the credit can only reduce your tax liability to $0 and not beyond that. If it reduces your tax liability to $0 and you paid taxes during the year, you will receive a refund of the taxes you paid in.

A refundable credit is a tax credit that will be applied even if your tax liability has reached $0. To illustrate this, a single parent of 3 children ages 5, 7 and 10 that earned $20,000, would have no income tax liability because the standard deduction for a head of household filer is $20,800 reducing their taxable income to $0. They would be refunded any income tax withheld from payroll. In addition to that, they would also receive $7,430 for the maximum refundable EITC AND they would also receive $4,800 for the refundable portion of the child tax credit ($1,600) for each of their 3 children.

This taxpayer would have paid $0 in income taxes but yet received $12,230 in tax credit refunds due to refundable tax credits.

Now we can debate the merit of these credits another day but the reason these credits are designed this way is to encourage workforce participation and to provide some assistance to hopefully keep children fed with a roof over their heads.

The EITC being a refundable credit makes it target for bad actors to make unscrupulous decisions. The EITC is unique in that it increases as you earn more money and then it peaks and phases out the more money you earn above the maximum credit amount. So, the taxpayer in the example above would receive $2,261 on $5,000 of income, $7,430 on income ranging from $16,500 – 21,600 and only $3,541 on income of $40,000. This design creates a unique incentive to encourage a taxpayer within the EITC range to try to reduce their income to achieve the maximum tax credit benefit. It also creates a situation encouraging someone with no income to report fictitious income to unlock this refundable credit.

The best way to control income that is unreported is to report business income. Any taxpayer can file a Schedule C and either report income that did not happen or reduce contractor (1099) income by reporting expenses and essentially controlling the “net income” or profit.

Imagine in our scenario if the single mom of three had no job. She could report business income of $20,000 that never happened. This would create a Self-Employment Tax liability of $2,831 and an EITC credit of $7,430 for a net gain of $4,599. 

Believe it or not, there are unscrupulous tax prep businesses catering to people in this situation who do not know any better and fall victim to making false EITC claims on their tax return. Paying a high preparation fee and receiving money from the IRS as a result.

This is why a tax return with a Schedule C business and EITC combination is the highest target for tax return audits by the IRS.

It is very possible that someone legitimately operating a business in their first years of operation or even further along (can have a difficult year) can fall into the EITC bracket. Someone like this should absolutely claim the credit that was designed to help them. However, more than any other business owner, they need to make sure their records are meticulous as the chances of an audit are very high. 

If you want a reputable tax preparer that has your back, please contact my office and we can discuss how we provide personalized and reputable assistance with your unique tax situation.

You may not be aware of this, but, filing your taxes is your responsibility. In today’s day and age with accountants taking care of e-filing your tax return for you, most people don’t realize they actually need to confirm that their accountant indeed filed their tax return.

As a matter of fact, a recent case in the tax courts has reminded us of this very fact.

Meet Dr. Wayne Lee a Florida surgeon who was earning more than $1 million per year. Lee hired a CPA to prepare his 2014, 2015 and 2016 tax returns. He carefully reviewed the returns and signed Form 8879 authorizing his CPA to e-file his tax returns. 

On December 5, 2018 Dr. Lee had a surprise visit from an IRS agent at his office when he found out that his tax returns for 2014, 2015 and 2016 had never been filed. Dr. Lee had moved to a new office and asked his CPA to update the IRS with his new address and this was never done, so he never got any of the mail the IRS sent.

Dr. Lee had 2 significant and costly issues due to his CPA not filing his tax returns. First, he always overpaid his estimated taxes. However, in 2018, it was already past the statute of limitations for his 2014 tax return and therefore he forfeited the $288,409 overpayment for that tax year!

Dr. Lee wanted to get his refund and correct the issue of the unfiled returns, so he promptly filed his 2014, 2015 and 2016 tax returns which then triggered $70,000 in failure to file and failure to pay penalties. He paid these penalties and then sued the IRS in Tax Court for a refund of the penalties. He claimed that the late filing was due to reasonable cause and not due to willful neglect.

The tax court established in 1985 that a failure to file as a result of reliance on your CPA is not an excuse and even made this a “bright line” rule, meaning there are no exceptions.

Dr. Lee argued that today, with e-filing, since a taxpayer cannot e-file their return on their own, relying on his accountant was the only choice he had and therefore it is different than it was in 1985.

The tax court did not buy this argument and held fast that it is the taxpayer’s duty to confirm that the return has indeed been filed.

The National Taxpayer Advocate in her 2024 report to Congress, urged Congress to change this rule and allow for a penalty waiver if the return as late filed as a result of CPA failure to file. We do not know if this rule will change.

So what should you do?

You can confirm on the irs.gov website that your tax return was indeed filed. It takes about 3 months after the e-filed return is submitted for the website to have your tax return transcript. Also, if you are expecting a refund or a payment to automatically occur in your bank account, seeing that payment or refund hit the bank account is probably a good indicator that your return has been filed.

You also have the option of choosing to paper-file your tax return. You must instruct your tax preparer in writing that you would like to paper-file your tax return and the tax prepare needs to attach Form 8948 to your tax return. If you are expecting a refund, this will significantly delay the processing time for that refund.

If you want a reputable tax preparer that has your back, please contact my office and we can discuss how we provide personalized and reputable assistance with your unique tax situation.

Taxes are a tremendous portion of the economy. If you think about it, New Yorkers pay between 1/5 and 1/3 of their income on average in taxes. Thought of another way, we work between 2.4 and 4 months of the year just to pay taxes. 

It is no wonder then that unscrupulous individuals would see tax dollars as an easy target to try to and steal someone else’s hard-earned money. The IRS is highly aware of the many different scams that are out there and does a lot of work to try to warn and educate the public about them. 

Every year, the IRS identifies the top 12 and releases a list dubbed the IRS Dirty Dozen. In last week’s article I listed the first 6 and below are the next 6, to help you be more aware of them.

Remember, the IRS will never call, text or email asking you to verify or enter information. The IRS always initiates communication via mail.

1. Fraudulent Form Filing and Bad Advice on Social Media – the IRS warns that inaccurate advice around the well known Form W2 and more obscure Form 8944 is used to encourage people to give up their information in hopes of getting a larger refund.
2. Spearphishing and Cybersecurity  for Tax Pros – We covered phishing attempts last week, which is where a bad actor gets a victim to share their personal information by impersonating the IRS or its website. Spearphishing is when phishing attempts target a specific entity type, in this case Accounting Professionals. The bad actor tries to steal the Tax Pros’ client data to file fraudulent returns on their behalf. Although this one is on the Tax Pro to be aware of, you can ask your tax pro what means they have in place to protect your data.
3. Offer in Compromise Mills – Like the name puppy mill, these are shops that are trying to push through as many OICs as they can. They often are advising taxpayers on their eligibility when they really do not meet the requirements which ends up costing the taxpayer thousands of dollars. 
4. High Income Filer Scheme – Two schemes aimed at high income filers are charitable remainder annuity trusts (CRAT) and monetized installment sales. A CRAT lets individuals donate assets to charity using an irrevocable trust and then draw annual income from them for a period of time. The promoters sometimes misuse these trusts to eliminate income and taxable gains. The monetized installment sale is where promoters try to spread the income from the sale of an asset over a period of time. They generally charge a fee for this.
5. Bogus Tax Avoidance Strategies – Two major bogus strategies are listed by the IRS. The first is micro-captive insurance arrangements, where the insurance company’s owners elect to be taxed on the captive’s investment income only. Abusive micro-captive’s usually lack many of the attributes of legitimate insurance. The second is syndicated conservation easements where for a fee the conservation easement will be grossly inflated to try to increase the charitable deduction you will be taking.
6. Schemes with International Elements – The IRS points to 3 major schemes here. The first is a very public and real problem for enforcement actions today and that is the practice of using offshore accounts and virtual currency to conceal income. The second is using Maltese IRA accounts and then improperly reporting them as a deduction for pension plan earnings using the Maltese treaty with the US. The 3^rd one mentioned is Puerto Rican  and foreign captive insurance. Similar to item 11 above, these insurance companies lack many of the attributes of a legitimate insurance company. 

Even smart and educated people can fall victim to these scams. What is scary, is that many of these sound like really smart advice, the desire to reduce your tax liability will potentially blind you to the due diligence you should be doing. The more informed you are, the less likely you become a victim. 

If you want a reputable tax preparer that has your back, please contact my office and we can discuss how we provide personalized and reputable assistance with your unique tax situation. See our full-page ad in this week’s magazine.

Taxes are a tremendous portion of the economy. If you think about it, New Yorkers pay between 1/5 and 1/3 of their income on average in taxes. Thought of another way, we work between 2.4 and 4 months of the year just to pay taxes. 

It is no wonder then that unscrupulous individuals would see tax dollars as an easy target to try to and steal someone else’s hard-earned money. The IRS is highly aware of the many different scams that are out there and does a lot of work to try to warn and educate the public about them. 

Every year, the IRS identifies the top 12 and releases a list dubbed the IRS Dirty Dozen. In this and next week’s article I will list a summary of each of these scams, to help you be more aware of them.

Remember, the IRS will never call, text or email asking you to verify or enter information. The IRS always initiates communication via mail.

1. Employee Retention Credit Claims – Congress enacted the Employee Retention Tax Credit (ERTC) as a COVID-19 relief for business owners. The credit has complex rules and is worth potentially a lot of money for business owners. Businesses have opened just promoting this credit and they are making incorrect claims for business owners. Use a reputable accountant to figure your ERTC, don’t fall prey to the telemarketers on this one.
2. Phishing and Smishing – Phishing is unsolicited emails and smishing is unsolicited text messages that look real and send you to a fake site asking you to enter personal information. Imagine you receive a text message that says “We were unable to process your tax refund due to an error in your bank information, click the link below to update your account information.” If you had recently filed your return and had not received the refund yet, you might fall prey to this one.
3. Online Account Help – scammers offer to assist you in setting up your online irs.gov account and in the process, steal your personal information.
4. False Fuel Tax Credit Claims – most taxpayers are not eligible for these credits, yet there are unscrupulous preparers claiming them on people’s returns. This credit is really intended for off-highway business and farming use.
5. Fake Charities – scammers setup a fake charity and then when you donate they ask for personal identifying information so they can issue you a tax receipt.
6. Unscrupulous Tax Return Preparers – The IRS requires tax return preparers to provide their PTIN number and sign tax returns that they prepare. When unscrupulous preparers prepare a tax return they will leave the preparer section blank, making it look like the return was self-prepared. An unscrupulous preparer can do many things including steal your personal information, direct your tax refund to the wrong account, charge you a fee based on the refund (which is not allowed), and more. 

Even smart and educated people can fall victim to these scams. The more informed you are, the less likely you become a victim. If you want a reputable tax preparer that has your back, please contact my office and we can discuss how we provide personalized and reputable assistance with your unique tax situation.

You may not know this interesting fact about me, I am a Paramedic in Rockland County, NY. Many of my first responder clients owe a decent amount of taxes at tax time and often get hit with an underpayment penalty. One of the most frequently asked questions when that happens is: How can I avoid paying this penalty next year?

2024 will carry the highest underpayment penalty in over 16 years. While this penalty is one of the smaller penalties in the IRS arsenal, it is also one of the easiest to avoid and keep more of your hard-earned dollars in your own pocket.

To understand the underpayment penalty, we must first understand how our tax system works. We are a pay-as-you-go tax system. What that means is that technically every time you earn $1 you must pay the tax on that $1. However, that would simply be impossible to control and too burdensome on the taxpayer to implement. So, the IRS established two parallel payment systems to collect money as it is earned. 

For taxpayers in a employed position receiving a paycheck and a W2 at year-end, employers are tasked with collecting the taxes as the employee is paid. This is why you will see all kinds of withholdings from your paycheck that reduces how much you actually receive. FICA (Social Security and Medicare), Federal Income and State Income Taxes are the bulk of these withholdings. The employer calculates your probable tax liability by having you fill out a W4 where you share information such as your filing status (Married, Single, Head of Household), your dependents and other credits as well as whether this is your only income. The employer then uses tax tables to calculate your taxes to withhold. We will discuss more about the pitfalls of this in a moment.

There are a few other payments that you may be given the option to have taxes withheld from and they include cashing in a bond and withdrawals from a retirement account among other large payments or withdrawals from various account types.

The second parallel payment method is the Quarterly Estimated Tax Payment. This method is primarily intended for individuals who are self-employed but is a great method for anybody who expects a lot of income from sources that do not withhold income taxes. With this method, you estimate your tax liability 4 times each year and you make an estimated tax payment. As long as this payment is made before the due date for the quarter, it will be considered a timely tax payment for the income from the entire quarter. This method also contains its’ challenges which we will discuss shortly.

Let’s get back to my first responder friends. Why, if all their income was earned on a W2, do they notoriously owe money at tax time and also incur penalties for under-withholding? The answer is that many of them hold multiple jobs, sometimes 3 or more jobs. The way the tax tables work, your employer assumes your annual income to be the amount you earn at that job. So if you earn $60k at job 1 and $20k at job 2 and $15k at job 3, job 1 will withhold the taxes on $60k of income and jobs 2 and 3 will not withhold any income taxes because you wouldn’t owe income taxes on that amount of income even though you really earned $95k and the other 2 jobs should have had an even higher withholding rate than job 1. 

So we now know who needs to proactively take steps to avoid the underpayment penalty. Any household where there are more than 2 employment paychecks coming in, any self-employed individual and any individual expecting significant income from a source that will not withhold taxes.

If you fall into any of these then there are 2 different problems to solve. First, how do you avoid paying unnecessary underpayment penalties? Second, how do you avoid having a large, unexpected tax bill when you file your tax return?

I am going to share 5 methods you can use to avoid the underpayment penalty. Only some of these methods will actually solve the second challenge of getting most of your tax bill paid before your file your tax return.

Method 1: Pay at least 100% of the previous year’s tax liability (110% if your adjusted gross income is over $150,000). This method is the easiest method to implement because your previous years’ tax liability is a known amount and you can make 4 equal payments to ensure this amount is covered. This method is not going to help you estimate the current year’s tax bill and therefore, you may need to save some money for tax time if it is a good year from an income perspective.

Method 2: Pay at least 90% of the current year’s tax liability. This and the next 2 methods are all going to address ways to be able to make this calculation. For this method, you need to calculate your income at the end of each quarter and project the same income for the remaining quarters. You then need to assume the appropriate FICA (not assessed on unearned income) and income tax liability. You will likely need to involve your tax professional to make this projection.

Method 3: Pay at least 90% of the current year’s tax liability using payroll withholdings. If you hold multiple jobs and your income stays similar year-to-year, you can ask your primary job to withhold an extra amount each payroll. For example, if you are consistently $5,000 short on tax withholding and you get paid bi-weekly (26 payments each year), you request an additional withholding of $192 on each paycheck. This request is made on the Form W4 in Step 4(c).

Method 4: Pay at least 90% of the current year’s tax liability through your own company’s payroll. This method is only relevant to self-employed individuals who’s business is a Corporation and therefore they are on payroll as an employee of the business. With this method, you pay yourself only one payroll at year-end. Since the year is essentially over, the income for the year is now known and you can accurately assess your tax liability. By having all of those taxes withheld from that payroll you avoid needing to time your payments 4 times per year as it is considered paid timely when withheld from payroll. There is a caveat to this method. If your reasonable compensation amount will not cover your payroll tax liability then you may still need to use Method 2 above. 

Method 5: Use the IRS tax withholding estimator tool. The IRS has a great tool on their website to estimate your taxes. I really dislike this tool because it requires a lot of information to be input and a lot of assumptions to be made. It is useful for my multiple paycheck friends but not so helpful for my business clientele.

In summary, you should never be paying the underpayment penalty as it is fairly easy to avoid. If the methods above feel daunting to you, please contact my office and we can discuss how we provide personalized assistance with your unique tax situation.

Last week, I wrote an article on The Secret to Raising Financially Successful Children where I highlighted the power of children working and starting their ROTH IRA early.

This week, I wanted to provide insight to my business owner readers on how you can shield income 100% from taxes by hiring your child. If you couple this strategy with last week’s ROTH IRA strategy, you will essentially create permanently tax free business income.

As an employer, when you hire an employee their pay is a business expense. So if you generate $10,000 in revenue from clients and pay an employee $10,000, you have no income.

Additionally, as an employer, there are taxes that need to be paid, specifically 7.65% of your employee’s income for half of their Social Security and Medicare tax, otherwise known as FICA tax. These taxes increase the cost of having the employee on your payroll but are also a business expense.

A self-employed individual, pays self-employment tax of 15.3% which is the same as the employer and employee portion of the FICA tax. This makes it extremely valuable to shield income from this tax. One of the best tax strategies is finding things you pay for already that are really business expenses because every dollar spent through the business will save you 15.3% (plus income taxes of 0 – 41%).

An even better strategy is to employ your child in the business. The first $13,850 of income in 2023 is income tax free due to the standard deduction. So any pay up to that amount becomes non-taxable to you as a business expense and income tax free to them as the standard deduction. Furthermore, a sole-proprietor is exempt from collecting FICA taxes on pay to their children, saving the 15.3% and making this truly tax free income.

One item to note is that if you operate your business as a partnership or corporation, including a subchapter S corporation, you will need to pay FICA taxes. Although this strategy is still very good as it avoids income tax on this money.

To use this strategy, you should note a few things. First, your child needs to actually perform the work including tracking their time in a documented place (i.e., a timesheet). Second, your child needs to be paid a reasonable wage for the work performed. You cannot pay a child $150 per hour to shred paper, but if a clerical office worker gets paid $40 per hour, then you can pay the same to your child for clerical work performed.

Lastly, you cannot employ a child who is too young. Tax law has no minimum age, however, it would be hard to prove that a 2 year old worked productively in your office. The youngest case law we have to rely on is the Eller case. Mr. and Mrs. Eller owned and operated mobile home parks. They hired their 3 children ages 7, 11 and 12. The court ruled that Mr. and Mrs. Eller were able to employ their children even at these young ages. The IRS in its acquiescence (where they agree to apply the findings to any similar case) to the court noted that compensation to children is only deductible if reasonable in amount, actually paid and based on services actually rendered. 

So from age 7 and older, you have this previous case to rely on.

If you want personalized, assistance with your unique tax situation, my team can help you get the results you want.

I have fond memories of many things from my childhood. Some of the best ones are from helping my father in his business endeavors. Working for him taught me a variety of skills but more importantly it taught me work ethic. I entered the workforce with a drive and desire to succeed which facilitated a level of success that many young adults these days miss out on.

The great news for you as a parent is that there is an amazing tax protected vehicle you can use to help your child begin creating a foundation of savings from their job and create a whole new level of financial sophistication education as well.

This vehicle is the ROTH IRA.

Using the ROTH IRA, your child can put up to $6,500 (cannot exceed their earned income amount) into their account each year. Technically, they can use a traditional IRA as well, however, in most situations, your child’s income will be tax free, losing the benefit of the traditional IRA. The first $13,850 of income in 2023 is income tax free due to the standard deduction. Money that grows inside of the ROTH IRA is also tax free. Which means that your child can save $6,500 every year that never had a penny of tax paid on it!

To put this in perspective, let’s look at the growth of ROTH IRA savings for 2 scenarios. Child A saves $3,000 every year beginning at age 12, and continues to do so throughout their working career. Child B saves $6,500 every year beginning at age 8 and stops saving at age 30. Assume all savings are invested in the broad market with annualized returns of 10%.

At age 20, Child A will have $43,200 and Child B will have $170,750 in their ROTH IRA accounts respectively. At age 60, Child A will have $3,900,878 and Child B will have $11,363,735 in their ROTH IRA accounts respectively.

These are difficult numbers to wrap our heads around because the power of compound interest year over year is massive when given enough time, something our children have a lot more of than we do.

In a future article, I will explain how compound interest works and why in the above scenario, the child who saved twice as much for half of the time ended up with more than 3 times the savings of the other child.

If you are self-employed and you employ your child and pay them, you also have an opportunity to forgo the Social Security and Medicare taxes on that income. I will cover this strategy in a future article as well. 

You may be thinking a few things at this point. 

“I do not want my child to save 100% of what they earn, I want to encourage them to spend some of their earnings to feel the rewards of their labor.”

“What if my child needs to access their savings? Wouldn’t the IRA keep that money inaccessible without stiff penalties?”

Your child can contribute the maximum allowed each year up to the maximum amount of their earned income. There is nothing stopping you from funding some of that. What I did with my children was to match their savings contributions dollar for dollar up to half of their income. So, if they earned $5,000, they only had to put in $2,500 and with my match, their contribution was the full $5,000 of their earnings.

Of all the tax-deferred investment options, the ROTH IRA is the most flexible to access when needed. Contributions can be withdrawn with no penalty. $10,000 can be withdrawn for education and for a primary residence purchase also penalty free. Finally, the account being inaccessible without penalty is also a deterrent to human behavior that can disrupt the savings cycle by raiding the account. In other words, making sure the money stays there so it can continue to grow, is a good thing!

If you want personalized, assistance with your unique tax situation, my team can help you get the results you want.

Government has social agendas. Some change is done through rules and laws while others are encouraged through financial incentives. For example, EVs or electric vehicles, which are supposedly better for our environment but do not make financial sense to own. They are more costly to produce and therefore purchase and the electricity is not necessarily cheaper than gasoline. Yet the US government wants us to be driving in EVs, so a tax credit of $7,500 was introduced, essentially making it $7,500 cheaper to purchase an EV, significantly closing the gap on the cost differential with a gasoline engine vehicle.

A tax credit is when you receive a discount dollar for dollar on the taxes you owe. To fully understand the concept of tax credits, it is important to understand the difference between a deduction and a credit as well as the difference between a refundable credit and a non-refundable credit. Misunderstanding these can be costly if you make a decision to buy something, pay for something, etc. assuming it would be subsidized by some tax savings and those savings don’t materialize.

A deduction is when you are allowed to reduce your income by an amount of dollars. This saves you the taxes you would have had to pay on this income. For example, there is a deduction allowed for student loan interest. A taxpayer in the 22% tax bracket with $2,500 in student loan interest, would save $550 in income tax ($2,500 x 22%).

In contrast, a credit is a reduction in the taxes owed. If the student loan deduction were a tax credit (it is not) then the $2,500 in interest would save $2,500 in income tax.

Which is better, a deduction or a credit? Yes, you are correct! A tax credit is far better than a tax deduction, for most of us it is about 4-5 times better.

What happens if you are eligible for a $2,500 tax credit but you only have a tax liability of $2,000? What happened to the extra $500 of credit?

This would depend on whether the credit is a refundable credit or a non-refundable credit. A refundable credit is a credit that you receive regardless of your tax liability, it is as if you paid that money as taxes and you would receive the last unused $500 credit as a tax refund. 

With a non-refundable tax credit, the last $500 of unused credit would be lost. A non-refundable credit can only get your tax liability to $0 and then it is lost.

Some examples of refundable credits are some of the child tax credit, the earned income credit and the American Opportunity credit. Some examples of non-refundable tax credits include the EV credit, Child and Dependent Care credit and Lifetime Learning credit.

It is important to note that many deductions can be carried over to the next year if unused whereas credits do not carry over. An unused non-refundable credit is lost forever.

Why is it important to know this?

Let’s look at our first example, an EV. The salesman will likely tell you that the tax credit will make the car affordable for you. If you did not know any better, you might buy the car when you really are unable to afford it. If you only have $3,000 in taxes, then the remaining $4,500 of the tax credit would be lost.

This has implications on whether you should buy the car or not but also on whether you should delay or accelerate the purchase to a better tax year.

As you can see, tax deductions and credits are complex. It is best to have someone who understands it, be in your corner. So, reach out today and book a consultation with our team.