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Opportunities For Tax Savings



American Opportunity Credit The tax law passed by Congress in December 2015 extended many provisions retroactive to January 1, 2015 and made many of them permanent. Taxpayers who qualify for the deductions and credits but did not take advantage of them on their 2015 return, can file an amended return to use them. They should also be aware of the ones made permanent and use them in preparing future returns.This article discusses the major provisions to help taxpayers save taxes.

HOMEOWNERS PROVISIONS

Mortgage Interest:

This is allowed as a deduction for a primary and second residence owned by the taxpayer for personal use. The limitation on the mortgage interest for the primary and secondary residence is the interest paid on $1 million ($500,000 married separate return) of debt incurred to purchase, build, or improve a personal residence. Debt incurred before October 14, 1987 is called “grandfathered” debt. There is no limit on the amount of grandfathered debt that you can deduct interest on but any amount reduces the $1 million and $500,000 caps and fair market value of the house. Both grandfathered and debt incurred after October 13, 1987 are subject to the $1 million cap. If the debt is not incurred to purchase, build, or improve a personal residence, it is treated as home equity indebtedness. Interest paid on a home equity loan is limited to indebtedness of the lesser of $100,000 ($50,000 for married separate, single, and head of household) or the fair market value.

Points:

A point is one percent of the amount borrowed and is deductible as interest. Points are fully deductible in the year paid if they are incurred to purchase, build, or improve a personal residence. If the points are paid to refinance a mortgage, they must be deducted over the life of the loan.

Mortgage Insurance (PMI):

This is an additional deduction for 2015 and 2016. It is deductible on a primary and second personal residence if the mortgage was acquired in 2007 or later. The deduction phases out as AGI exceeds $100,000 and is zero when AGI reaches $109,000.

Debt Forgiven in Foreclosures:

This is also is applicable to “short sales” (when the sales price of a house is less than the mortgage balance). Normally, the amount of debt forgiven is taxable income if the taxpayer is solvent at the time. But, Congress extended through 2016, a provision that allows a taxpayer to exclude from income up to $2 million in forgiven debt on a personal residence. The provision is extended to 2017 if the discharge agreement was signed in 2016.

Energy Credits:

The 2015 tax law extended these through 2016. The credit is claimed on form 5695. The amount is 10% of qualifying expenditures for energy efficient improvements with maximum of $500. Credits taken in prior years reduce the $500. The credit limits on the type of expenditures are: $150 for water heaters, $200 for windows and skylights, and $300 for biomass fuel stoves. A larger credit of 30% is available for residential solar panels and other alternative energy systems.

SALES TAXES

A taxpayer can deduct the greater of state income tax paid (current year withholding and estimated tax payments and the balance paid on the prior year return and the fourth quarter estimate paid in the current year). The sales tax deduction is beneficial for taxpayers who live in states that do not have an income tax. The IRS provides tables to compute the general sales tax deduction. (go to www. IRS.gov and select “sales tax calculator). Tax return preparation software automatically computes the allowed amount based on AGI using the combined state and local rates. In addition, to the general sales tax, you can deduct amounts paid on major purchases (e.g., autos, trucks, appliances, furniture). Sales tax paid on major home improvements are added to this cost and treated as an addition to the cost of the house.

NON BUSINESS RELATED EDUCATIONAL EXPENSES

A separate article is being written on the details of the credit for qualifying expenditures and persons. Amounts paid (not billed) for tuition, fees, and books for the taxpayer, spouse and dependents are available as either a deduction for AGI or a credit. The taxpayer should use the one which results in the most tax savings. Tax preparation software automatically computes the allowed amount and whether a credit or deduction is more beneficial. The credit is comprised of two amounts­the “American Opportunity” credit and the “Lifetime Learning” credit. Both credits cannot be used for the same person in the same year.

American Opportunity Credit (AOC):

The credit was made permanent by the 2015 tax law. Form 8863 is used to compute the credit. This amount is allowed for four years of undergraduate tuition, fees, and books (reduced by any tax free education assistance). It is 100% of first $2,500 and 25% of the next $2,000 of qualified education expenses for EACH eligible student, but is limited to $2,500. The credit is available if MAGI is less than $160,000 for married filing joint ($80,000 for married filing separate, single, and head of household). It phases out if MAGI reaches $160,000 ($80,000). When MAGI exceeds $180,000 ($90,000) the credit is zero). Any amounts paid in 2016 for 2015 expenses cannot be used in 2015. They are qualified expenses for 2016. A taxpayer should receive form 1098T from the school that shows the amount of tuition and fees billed and paid, but only the amounts paid are eligible for the credit. Make sure the amount of expenses reported match the amounts on form 1098T or the IRS will disallow the credit. If this happens, the taxpayer should file an amended return to compute the allowable credit based on mounts paid shown on form 1098T. Starting in 2016, taxpayers will be required to have a form 1098T to be able to claim the credit. The credit is refundable if it exceeds the tax.

Lifetime Learning Credit:

The credit was made permanent by the 2015 tax law. Form 8863 is used to compute the credit. This credit is for tuition, fees, and books (reduced by any tax free education assistance) for post undergraduate school and continuing education courses. The credit is 20% of the qualified expenses up to $10,000. It is limited to $2,000 regardless of the number of qualifying students. It is available if MAGI is less than $110,000 for married filing joint ($55,000 for married filing separate, single, and head of household). It phases out as MAGI exceeds these amounts and is zero when MAGI reaches $130,000 ($65,000). The lifetime learning credit cannot be claimed if the AOC is claimed for the same qualifying person in the same year. The lifetime learning credit is not refundable if it exceeds the tax.

CREDIT FOR HEALTH CARE INSURANCE PURCHASED ON AN EXCHANGE

The Affordable Care Act (“Obama Care”) provides a credit for eligible persons who purchased health insurance on an exchange. Taxpayers should have received form 1095­A which shows the amount of the subsidy the insured received. Form 1095­A is used to complete form 8962 based on the estimate provided of your 2015 income. If income was overestimated, the credit will increase your refund or reduce the tax owed. If income was underestimated, the credit will reduce your refund or increase the tax owed. For employees who are eligible for a qualified affordable employer covered plan but do not participate in the plan, the credit is not allowed. A special provision provides that retired persons who are otherwise not eligible for Medicare, can forgo the option for retiree coverage under their former employer’s plan and get the credit for coverage purchased on an exchange if they meet certain income limits for 2016: (a) $11,770 to $47,080 for singles, married filing separate and head of household (b) $15,930 to $63,720 for married filing joint.

RECOVERY OF ATTORNEY FEES IN LAWSUITS AGAINST THE IRS

This is available if the taxpayer substantially prevails on the issues in their lawsuit regarding tax matters if they exhausted all administrative remedies within the IRS. They will not be allowed if the government shows that its litigating position was substantially justified. The recovery for 2015 tax cases is limited to $200 per hour. Taxpayers whose net worth, based on the acquisition cost of all assets owned, is more than $2 million are not eligible for any recovery. The assets include money in foreign accounts and uncollected loans [TC Memo, 2016­27]. The IRS has acquiesced.

FOREIGN TAX CREDIT FOR INCOME TAXES PAID TO CUBA

Generally a credit for foreign taxes paid is not available for countries for whom the U.S. has severed diplomatic relations, which included Cuba. But, as a result of the U.S. establishing diplomatic relations with Cuba as of December 22, 2015, these taxes are now allowed for the foreign tax credit [The Kiplinger Tax Letter, March 11, 2016].

CONTRIBUTIONS TO HEALTH SAVINGS ACCOUNTS (HSA)

Taxpayers can make contributions to qualified accounts until the due date of their tax return, including an extension. They are a deduction for AGI. To be a qualified policy, it must have a $2,600 deductible for family coverage. For 2015, you can contribute up to $3,350 for single coverage or $6,600 for family coverage. If you are 55 or older, you can contribute an additional $1,000. If you withdraw money from a HSA, the provider should have given you form 1099­SA which will also be sent to the IRS. Form 8889 is used to reconcile the amounts withdrawn with qualified medical expenses paid. Withdrawals used to pay nonqualified expenses are taxable and taxpayers under 65 are subject to a 20% penalty.

DEDUCTION FOR CONTRIBUTIONS TO AN IRA

Traditional IRA:

Taxpayers who are not enrolled in an employer retirement plan can take a deduction for AGI for after tax contributions made by the due date of the tax return including an extension. The amount allowed in 2015 is limited to $5,500 ($6,500 if you are age 50 or older). If you are making a contribution in the current tax year for the prior year, give a written note to the financial  institution or plan provider that the amount is for the prior tax year. There is no limit on how much income you can have to be eligible for the deduction. If you are covered by a company plan, the deduction is phased out for AGI between $61,000 and $71,000 for single, married filing separate and head of household ($98,000 and $118,000 for married filing joint). For 2015, if your spouse is covered by an employer plan, but you are not, the full deduction is allowed if AGi does not exceed $183,000. If AGI is between $183,000 and $193,000, a partial deduction is allowed.

SEP IRA:

For taxpayers and/or their spouse who are self ­employed, they can contribute  up to 20% of net self- employment income (self employment income less one­half of self- employment tax). The maximum is $53,000. The contribution is deductible for AGI and must be made by the due date of the tax return including an extension.

Harold Goedde

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Dr. Goedde is a former college professor who taught income tax, auditing, personal finance, and financial accounting and has 25 years of experience preparing income tax returns and consulting. He published many accounting and tax articles in professional journals. He is presently retired and does tax return preparation and consulting. He also writes articles on various aspects of taxation. During tax season he works as a volunteer income tax return preparer for seniors and low income persons in the IRS’s VITA program.

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