2021 Education Tax Breaks

The Consolidated Appropriations Act of 2021 officially put an end to the tuition and fees deduction after tax year 2020. This deduction was previously an adjustment (“above the line”) for adjusted gross income (AGI) worth up to $4,000. However, below we will discuss the remaining education related-tax deductions, credits and saving incentives that are still offered.

Tax Deductions

Student loan interest - An “above the line” deduction for up to $2,500 is available for student loan interest used to pay qualified education expenses. Tuition and fees, required course materials, room and board and other necessary costs of education are all qualified expenses for purposes of the deduction. For 2021, the deduction phases out for modified AGI from $70,000 to $80,000 (unmarried) and $140,000 to $170,000 (married filing jointly).

Tax Credits

To mitigate the loss of the tuition and fees deduction, the Consolidated Appropriations Act increased the impact of the Lifetime Learning Credit. For expenses that qualify for both the AOTC and the LLC, taxpayers may only claim one of the credits. Information for claiming the education credits is provided to taxpayers on Form 1098-T.

American Opportunity Tax Credit - Provides a maximum annual amount of $2,500 per student, calculated as 100 percent of the first $2,000 in qualifying expenses and 25 percent of the next $2,000 in qualifying expenses for the first four years of undergraduate education. If the credit reduces a taxpayer’s liability to zero, then up to $1,000 (40%) may be refunded. The credit is subject to income limits: to claim the full credit, income must be below $80,000 for single taxpayers ($160,000 married filing jointly). Taxpayers cannot claim the credit if income exceeds $90,000 ($180,000 married filing jointly). Eligible expenses for the credit include tuition and fees, books, and required course materials. Students must be enrolled at least half time. Room and board are not eligible expenses for the credit.

Lifetime Learning Credit - Provides a maximum annual amount up to $2,000 per tax return, calculated as 20 percent of the first $10,000 of qualified expenses, and it is nonrefundable. Undergraduate, graduate, and job skills courses qualify. Also note that room and board are not eligible expenses. Instead of phasing out at income levels starting at $59,000 for single filers and $118,000 for joint filers, the phaseout will begin at $80,000 for single filers and $160,000 for joint filers. Higher phaseout limits will help hold the vast majority of taxpayers harmless from the elimination of the temporary tuition and fees deduction. There is no limit on the number of years a taxpayer may claim the credit (compared to the American Opportunity Tax Credit which can only be claimed for the first four years).

Tax Exclusions

Scholarship income - Amounts received from scholarships and used to pay for tuition, fees, and required course related materials can be excluded from income by college students. The scholarship must not represent payment for services. Undergraduate and graduate scholarships are eligible, and there are no income phase outs for the exclusion. However, be aware that the tax exemption for scholarships is lost if the money is used for other purposes like room-and-board or supplies. Finally, the scholarship amount can’t exceed the tuition cost.

Forgiven student loan debt - Taxpayers, regardless of solvency, are allowed to exclude from income any student loan debt forgiven from 2021 to 2025. The student loan proceeds must have been used to pay for tuition and fees, required course related materials, room and board, and any other necessary educational expenses (including transportation).

Saving Incentives

Coverdell Education Savings Account - A $2,000 contribution per beneficiary per year is allowed under the Coverdell Education Savings Account. Earnings on investments are not taxed if used for K-12 or higher education eligible expenses. Allowed contributions are phased out for taxpayers with AGI of $95,000 to $110,000 (unmarried) and $190,000 to $220,000 (married).

Qualified Tuition Programs (529 Plans) - Earnings on investments in 529 plans may be excluded from income if used to pay for qualifying education expenses. Eligible expenses include tuition and fees, required course materials, and room and board (if student is enrolled at least half time) for undergraduate and graduate education. In addition, up to $10,000 per beneficiary per year may be used to pay K-12 tuition expenses. A lifetime limit of $10,000 per borrower may be used to repay student loan principal and interest. Annual contribution limits are set by individual states. There are no AGI limitations.

Don't hesitate to call our tax advisors if you have any questions about this topic and others. Also, make sure to follow us on social media for more tax and accounting tips!

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The Kiddie Tax - Children with Investment Income

In 1986, a law was passed that prevented parents from shielding money from taxes by transferring investments to their children's names. Before then, the children's investments were taxed at the child's low rate, and some wealthy parents would move investments to their children specifically to reduce their own tax liability. The "kiddie tax" law changed the rules.

The "kiddie tax" is tax on a child's unearned income (investment income). Investment income generally includes interest, dividends, and capital gains. It also includes other unearned income, such as passive income from a trust and K-1 investments.

If your child is under age 18 (and in certain situation if the child is older) use form 8615 to figure your child’s total tax on unearned income over $2,200. Note that the child tax rate will be based on the tax rate of their filing parent. If you are required to file form 8615, you may be subject to the Net Investment Income Tax (use form 8960 to figure out this tax).

Parents may be able to elect to report child's investment income on your return if the investment income was more than $1,100 but less than $11,000 for the year. If you make this election, your child won't have to file a tax return. To make this election, attach form 8814 Parents’ Election to Report Child’s Interest And Dividends, to your tax return. Form 8814 applies a child’s tax rate to the first $2,200 of their investment income, and the parent’s tax rate to the remainder.

TAX PLANNING OPPORTUNITY

If your family paid the kiddie tax in 2018 or 2019, you could be eligible for a refund.

The Tax Cuts and Jobs Act of 2017 effectively raised the kiddie tax by basing it on the tax rates used for estates and trusts, instead of the rates used for parents. That change has since been repealed, so if you calculated your child’s liability using estate and trust tax rates in 2018 or 2019, you have the option to file an amended return using your tax rate for your child’s unearned income instead. Just be sure the potential refund is worth the additional paperwork and any associated preparation costs.

Don't hesitate to call if you have any questions about this topic and others. Also, make sure to follow our accounting firm on social media for more tax and accounting tips!

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Maximizing Tax Deductions for the Business Use of Your Car

The business use of your car can be one of the largest tax deduction you can take to reduce your business income. There are two methods of calculating the business use of your car. You’ll want to calculate your vehicle expenses each way and then choose the method that yields the largest deduction for you.

Actual Expenses - To use the actual expense method, you need to figure out the actual costs of operating the car for business use. You are allowed to deduct the business-related portion of costs related to gas, oil, repairs, tires, insurance, registration fees, licenses, and depreciation (or lease payments). To find the percentage of your car’s use for business, divide your total business miles by the total number of miles you drove for the year (business + personal).

Standard Mileage Rate - To use the standard mileage deduction, multiply 56 cents (in 2021) by the number of business miles traveled during the year.  You should still track both your personal and business miles but you will only use the business portion to calculate your deduction.

Deduct car expenses such as parking fees and tolls attributable to business use separately no matter which method you choose.

Which Method Is Better?

 For some taxpayers, using the standard mileage rate produces a larger deduction. Others fare better tax-wise by deducting actual expenses. You may use either of these methods whether you own or lease your car.

To use the standard mileage rate for a car you own, you must choose to use it in the first year the car is available for use in your business. In subsequent years, you can choose to use the standard mileage rate or actual expenses. If you choose the standard mileage rate and lease a car for business use, you must use the standard mileage rate method for the entire lease period - including renewals.

Opting for the standard mileage rate method allows you to bypass certain limits and restrictions and is simpler; however, it's often less advantageous in dollar terms. Generally, the standard mileage method benefits taxpayers who have less expensive cars or travel many business miles. However, taxpayers with heavy vehicles (as discussed below) will typically opt for the actual method.

Heavy Vehicles

Heavy SUVs, pickups, and vans are treated for tax purposes as transportation equipment. They qualify for 100% first-year bonus depreciation and Sec. 179 expensing if used more than 50% for business. This can provide a huge tax break for buying new and used heavy vehicles. However, if a heavy vehicle is used 50% or less for business purposes, you must depreciate the business-use percentage of the vehicle’s cost over a six-year period.

To illustrate the potential savings from these first-year tax breaks, suppose you buy a new $65,000 heavy SUV and use it 100% for your business in 2021. You can deduct the entire $65,000 in 2021 thanks to the 100% first-year bonus depreciation privilege. If you use the vehicle only 60% for business, your first-year deduction would be $39,000 (60% x $65,000).

To qualify as a “heavy” vehicle, an SUV, pickup or van must have a manufacturer’s gross vehicle weight rating (GVWR) above 6,000 pounds.

Annual income inclusion amount

When the value of the leased vehicle is above a certain amount, you must also subtract an "income inclusion" amount from the deductible amount of your lease. This income inclusion rule is an attempt to equalize the tax benefits from leasing and owning business vehicles.

• For vehicles first leased in 2020, the threshold is $50,000.

• Income inclusion amounts vary depending on the lease amount and the number of tax years during which the leased vehicle was in use for business.

• The income inclusion amount increases each tax year for five years.

• The IRS releases income inclusion amounts each year for vehicles leased and put into use in that year.

Documentation

Tax law requires that you keep travel expense records and that you show business versus personal use on your tax return. Furthermore, if you don't keep track of the number of miles driven and the total amount you spent on the car, your tax advisor won't be able to determine which of the two options is more advantageous for you at tax time. It is essential to keep careful records of your travel expenses (if you use the actual expenses method, you must keep receipts) and record your mileage.

You can use a mileage logbook or, if you're tech-savvy, an app on your phone or tablet. Several phone applications (apps) are available to help you track your business expenses, including mileage and billable time. These apps also allow you to create formatted reports that are easy to share with your CPA.

Don't hesitate to call and find out which deduction method is best for your particular tax situation. Also, make sure to follow us on social media for more tax and accounting tips!

Tax Relief in Disaster Situations

Prior to 2018, the Casualty Loss Deduction allowed taxpayers to deduct a wide range of uninsured casualty losses on their federal tax return, including damages resulting from earthquakes, fires, floods, vandalism, theft, terrorism and other similar disasters. Passage of TCJA brought with it significant changes to the deduction, putting tighter limits on which theft and casualty losses qualify as potential tax breaks for disaster victims through the 2025 tax year.

Now, and through 2025, you may only claim casualty losses incurred due to a federally declared disaster (officially declared by the U.S. President). Of course, you must also itemize your return to access the casualty loss deduction, making the standard deduction unavailable.

Theft and Casualty Losses

Personal casualty losses are deductible on your tax return as long as the property is located in a Presidentially-declared disaster area as long as:

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

2. The damages were not covered by insurance.
You can only claim a deduction for casualty losses not covered or reimbursed by your insurance company. The catch here is that if you submit a claim to your insurance company late in the year, your claim could still be pending come tax time. If that happens, you can file an extension on your taxes.

3. Your losses were sufficient to overcome any reductions required by the IRS.
The IRS requires several "reductions" to claim casualty losses on your tax forms. The first is that you must subtract $100 from the total loss amount for each casualty event. This is referred to as the $100 loss limit.

Second, you must reduce the amount by 10 percent of your adjusted gross income (AGI) or adjusted gross income from the total casualty losses for the year. For example, Say you experienced $20,000 of uninsured damage to your home in 2020. This damage was the result of a flood in a federally declared disaster area. Because you made $60,000 in Adjusted Gross Income for the year, you may only deduct the amount of damage exceeding $6,000 ($60,000 x 10% = $6,000).

To determine your deductible losses in this scenario, calculate your total loss ($20,000 - $100 = $19,900) and subtract the 10% AGI threshold ($6,000) from that total. In this case, you could likely claim a total of $13,900 ($19,900 - $6,000) on this year’s return.

Claiming Disaster-related Casualty Losses

 Affected taxpayers in a Presidential Disaster Area have the option of claiming disaster-related casualty losses on their federal income tax return for either this year or last year on form 4684. Claiming the loss on an original (2021) or amended return for last year (2020) will get the taxpayer an earlier refund, but waiting to claim the loss on this year's return could result in a greater tax saving, depending on other income factors. If you choose to deduct losses on your 2020 tax return, you have one year from the due date of the tax return to file.

When claiming casualty loss tax breaks, be sure to maintain all records and documents of your losses.

These may include:

• Documents proving ownership of every asset you’re claiming as damaged, destroyed or stolen (receipts, deeds, etc.).

• Receipts or contracts showing each item’s original cost, as well as any subsequent improvements.

• Records clearly listing each property’s fair market value, including appraisals, insurance records, and cost-of-repair receipts.

Check out the IRS publication relating to Casualties, Disasters, and Thefts. IRS Publication Link

If you have any question about whether you qualify for tax relief after a recent natural disaster, please contact our accounting firm for assistance in figuring out the best way to handle casualty losses related to hurricanes and other natural disasters.

Make sure to follow us on social media for more tax and accounting tips!

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Divorce and Alimony Payments Tax Rules

Tax rules regarding divorce and separation can and do change so it is important to stay on top of current tax law. The most recent change took effect in 2019 on a federal level. It is important to note that each state has its own state income tax laws. How divorce related payments and income are treated differs from state to state. Refer to your state's taxation authority to see how your state's tax laws will impact you. Below are the major federal taxation areas related to divorce.

Who is Impacted

The new rules relate to alimony or separate maintenance payments under a divorce or separation agreement and includes all taxpayers with:

• Divorce decrees.

• Separate maintenance decrees.

• Written separation agreements.

Timing of Agreements

Agreements executed beginning January 1, 2019 or later -  Alimony or separate maintenance payments are not deductible from the income of the payor spouse, nor are they includable in the income of the receiving spouse if made under a divorce or separation agreement executed after December 31, 2018.

Agreements executed on or before December 31, 2018 and then modified - The new law applies if the modification does these two things:

• Changes the terms of the alimony or separate maintenance payments.

• Specifically states that alimony or separate maintenance payments are not deductible by the payer spouse or includable in the income of the receiving spouse.

Agreements executed on or before December 31, 2018 - Before tax reform, a taxpayer who made payments to a spouse or former spouse could deduct it on their tax return. The taxpayer who receives the payments is required to include it in their income. If an agreement was modified after that date, the agreement still follows the previous law as long as the modifications do not:

• Change the terms of the alimony or separate maintenance payments.

• Specifically state that alimony or separate maintenance payments are not deductible by the payer spouse or includable in the income of the receiving spouse.

How the IRS defines alimony payments

To qualify as alimony or separate maintenance, the payments you make to your former spouse must meet all six of these criteria:

1. You don't file a joint tax return with your former spouse.

2. You make payments in cash, by check, or by money order.

3. You make payments to or for a spouse or former spouse under an applicable divorce or legal separation agreement.

4. Legally separated spouses cannot be part of the same household when making payments.

5. Liability for the payment doesn't extend beyond the death of the spouse who receives payments.

6. The payment is not child support or a property settlement.

When the IRS defines alimony, it also specifically exclude certain payments as not qualifying for alimony or separate maintenance treatment. These include:

• Child support

• Non-cash property settlements

• Payments to keep up the property of the alimony payer

• Payments for the use of the alimony payer's property

• Voluntary payments not required under a divorce decree or separation agreement

If a person paying alimony must also pay child support, but they do not fully complete the payment for both, payments would go toward child support first for tax purposes.

Alimony Tax Reporting

If you have a divorce agreement finalized before January 1, 2019, reporting alimony paid and received on your tax return is easy. You simply input alimony paid or received on Form 1040, Schedule 1.

• If you're the person receiving alimony payments: You will enter the amount on line 2a. On line 2b, you must input the date of the original divorce or separation agreement. You're also required to give your Social Security number to the alimony payer, or you may face a $50 penalty.

• If you're the person making alimony payments: You'll enter the amount paid on line 18a. Alimony payers are also required to input the recipient's Social Security number on line 18b, and the date of the original divorce or separation agreement on line 18c. If you do not include the recipient's Social Security number, you may be subject to a $50 penalty.

People with divorce agreements dated January 1, 2019, or after do not have to include information about alimony payments on their federal income tax returns.

If you're required to report alimony income on your tax return and you forget to include this information, you'll be subject to the usual penalties and interest payments for underreporting your income.

Tax reform made an already complicated situation even more so. Don't hesitate to call if you have any questions about the tax rules surrounding divorce and separation.

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