What Would You Do?

What Would You Do?

You’ll find the answers to the “What Would You Do?” game from the eWeekly below!

Q: The client provides expenses for their Sch C, but tells you that their loan officer said to not report all of them so my income is higher. Should you report the expenses?

A: If you have a business, you have business expenses. In the same way that you need to report all of your business income, you need to report all of your business expenses. Not reporting could be determined to be mortgage fraud or tax fraud.

Q: I am receiving Workers Compensation due to an injury received at work. Will I have to pay Federal Tax on this Workers Compensation?

A: No. Amounts you receive as Workers Compensation for an occupational Sickness of Injury are fully exempt from Federal Tax if they are paid under a Workers Compensation Act of Statute in the nature of a Workers Compensation Act.

Q: Client invested $25,000 in a tech company in 2011 and in 2018 it was determined the company stock was worthless.  What is the loss amount the client can report on their 2018 tax return?

A: Under Section 1244 Stock losses from the sale or worthlessness of small business stock are ordinary losses and up to $50,000 ($100,000 MFJ) per year and are not subject to the capital loss limits.  (Quickfinder – Page 7-7)

Q: My client is a US citizen and is working outside of the United States for many years. Do they need to file a US tax return?

A: Yes, if you are a U.S. citizen or a resident alien living outside the United States, your worldwide income is subject to U.S. income tax, regardless of where you live. However, you may qualify for certain foreign earned income exclusions and/or foreign income tax credits. Please refer to Publication 54, Tax Guide for U.S. Citizens and Resident Aliens Abroad, for additional information.

Q: John Smith and Mary Smith, who are married, are domiciled in two different local jurisdictions.  How do I determine their locality rate?

A: If you and your spouse were domiciled in different taxing jurisdictions, you should file separate Maryland returns even though you filed a joint federal return. (See Instruction 7.) However, if you choose to file a joint Maryland return, use the following instructions. Enter both counties and/ or local jurisdictions in the county, city, town or special taxing area box of your return. If the local tax rates are the same, complete the worksheets as instructed and attach a schedule showing the local tax for each jurisdiction based on the ratio of each spouse’s income to the total income. Also note the words “separate jurisdictions” on line 28 of Form 502. If the local tax rates are different, calculate a ratio of each spouse’s income to total income. Then apply this ratio to the taxable net income and calculate the local tax for each spouse separately using the appropriate local tax rates. Enter the combined local tax on line 28 of Form 502 and write the words “separate jurisdictions” on that line. Attach a schedule showing your calculations.

Q: George and Sarah bought a new principal residence for $650,000.  Unfortunately, it was not as advertised by the seller.  The quick fixes the house flipper used were inadequate and unsafe.  He sued the seller for damages and received a settlement of $100,000.  His attorney fees were $40,000.   Is the settlement taxable?  Can he deduct the attorney fees?

A: As this is a settlement due to injury of capital, the settlement is not taxable and would reduce the basis of the home.  It would only be taxable if the recovery exceeded the taxpayer’s basis. If the recovery was more than the basis the excess would be capital gain. The legal fees are added to the basis of the home.

Q: Can you defer tax on rollover distributions?

A: If you withdraw cash or other assets from a qualified retirement plan in an eligible rollover distribution, you generally can defer tax on the distribution by rolling it over into another qualified retirement plan, a traditional IRA or, after 2 years of participation, in a SIMPLE IRA plan sponsored by your employer, a SIMPLE IRA under that plan.

For this purpose, the following plans are qualified retirement plans.

  • A qualified employee plan.
  • A qualified employee annuity.
  • A tax-sheltered annuity plan (403(b) plan).
  • An eligible state or local government section 457 deferred compensation plan.

Q: Are lump-sum distributions taxable?

A: The taxable part of a lump-sum distribution is the employers contributions and income earned on your account. You may recover your cost in the lump-sum and any net unrealized appreciation (NUA) in employer securities tax free.

Q: Are life insurance proceeds taxable?

A: Life insurance proceeds paid to you because of the death of the insured person aren’t taxable unless the policy was turned over to you for a price. This is true even if the proceeds were paid under an accident or health insurance policy or an endowment contract. However, interest income received as a result of life insurance proceeds may be taxable.

Q: How are royalties taxed?

A: Royalties from copyrights, patents, and oil, gas and mineral properties are taxable as ordinary income.

Q: Do you need to report unemployment compensation on your taxes?

A: Yes. You must include in income all unemployment compensation you receive. You should receive a Form 1099-G showing in box 1 the total unemployment compensation paid to you. In most cases, you enter unemployment compensation on Schedule 1 (Form 1040), line 19.

Q: On September 1, 2016, you loaned another individual $2,000 at 12%, compounded annually. You aren’t in the business of lending money. The note stated that principal and interest would be due on August 31, 2018. In 2018, you received $2,508.80 ($2,000 principal and $508.80 interest). Which method would you use to report the interest income — cash or accrual?

A: You would use the cash method, as most individual taxpayers generally report their interest income in the year in which they actually or constructively receive it.

Q: Taxpayer A owns his mail home and has solar energy equipment installed and plans on claiming the 30% Energy Credit in Year 1.  Taxpayer B wasn’t to add solar energy equipment to her home, but cannot benefit from the credit due to her gross income.  If Taxpayer A were to have his name added to the deed of the main home of Taxpayer B; and he paid for all or part of the installation on B’s main home would A be able to claim the credit on his tax return?

A: No, because based upon the information provided it does not sound like the home (taxpayer B’s home) is or will be used as a residence by Taxpayer A.  He will have ownership interest, but no residential use of the home.  For the Residential Energy Efficient Property credit, qualified expenditures include (IRC Sec. 25D(d)), property which uses solar energy to generate electricity for use in a dwelling unit located in the United States and used as a residence by the taxpayer.

Q: A client has a Sole-Proprietorship. In year one contributed the max to her 401(k) in both elective deferrals and employer contributions. She was still working this business early in year 2 when she began new employment with a large company. The employer sponsors a 401(k) plan for all eligible employees. May the proprietor contribute for year 2 an employer matching payment based upon the net self-employment income? Will she be subject to an overall limit for contributions to both 401(k) plans? She turns 50 in year 2 (2019).

A: Yes, the taxpayer (sole proprietorship) can contribute to the employer matching payment based upon the net self-employment income providing there is no common ownership.

The taxpayer can contribute to two 401(k)s as long as the two businesses she works for have no legal overlap or affiliated relationship. If the taxpayer has more than one active 401(k) account the taxpayer needs to be aware that the IRS’s contribution limit for elective deferrals refers to the combined 401(k) accounts. If the taxpayer has more than one 401(k), the limit applies to the total deferrals.

Example: Jane works for XYZ company, and makes her maximum salary deferral contribution to her 401(k) of $19,000 ($25,000 if she is age 50 or older by using the $6,000 “catch-up” contribution). Her employer kicks in another $31,000, meeting the $56,000 limit in total (for 2019).

Jane also makes $300,000 running a consulting business as a sole proprietor. There is no common ownership between this business and XYZ Corp. If Jane establishes a 401(k), she can contribute up to $56,000 to her account under that plan.  Jane’s total contribution for the year can be up to $112,000 (or $118,000 if over age 50 the “catch-up” provision can only be used once).

Q: A home was owned by husband, son and nephew. Husband put the funds up to purchase the home. Son and nephew have not paid the home bills. Mother lives in the home, but has no ownership interest. Husband passed away so the home is now owned by son and nephew. Home Cost $129,000 in May 1993 and now is assessed at $270,000. There is a mortgage balance of $30,000. Daughter has been paying most of mother’s expenses mortgage, health costs, etc. Daughter wants to pay off the mortgage and son and nephew want to turn the home over to daughter. Is this really two gifts from son and nephew to daughter? What is her basis in the home after the gifts?

A: Yes, each son and nephew have given the daughter a gift of $135,000 (one-half of the home.)  They must each file a gift tax return.  Upon death of the husband, the basis of the home is stepped up 1/3 of amount to FMV at time of death, and the remaining 2/3 are the adjusted basis of the property. Each son and nephew will file a gift tax return for 1/2 of the amount given to the daughter.

Your adjusted basis is generally your cost in acquiring your home plus the cost of any capital improvements you made, less casualty loss amounts and other decreases. For more information on basis and adjusted basis, refer to Publication 523, Selling Your Home. If you financed the purchase of the house by obtaining a mortgage, include the mortgage proceeds in determining your adjusted cost basis in your residence.