Simplifying the tax code - step 1 of many

There's no doubt our tax code needs some simplification. Despite running a risk of eliminating my livelihood, I have decided to commit my personal suggestions about how to simplify the tax code to writing.  And I am putting it out on this blog for the whole world (or a dozen of you, anyway) to read.

The general concept of my ideas is to apply a cost-benefit analysis to various tax provisions.  Provisions that affect a small number of people are the first to go.  Provisions that have a small dollar impact to individuals should also go. Provisions that are extremely complex to understand, because of exceptions as to who might qualify or how a deduction is calculated may also have to go.

First up is the above-the-line teacher classroom deduction.  This is a maximum $250 deduction for teachers who spend their own money on items for their classroom. Now, I don't have anything against teachers. I have many close friends and relatives, including my sister, who are teachers. They are great people and have a very important job.  But to add an entire line to the front of the 1040 for a $250 deduction is ridiculous. Teachers can deduct their unreimbursed job expenses just like everyone else, on Schedule A, as a miscellaneous deduction.

There is an implied importance of a deduction or a credit having it's own line on the 1040. Other items in this section include IRAs and items that allow for thousands of dollars of adjustment. Reserving a line for a $250 deduction is like playing Monopoly with the one dollar bills. It's insignificant. Teachers will disagree, I'm sure. The effect on a teacher's refund is around $38 to $63 (depending on their tax bracket) and no one wants to give that up. But in the grand scope of things, getting rid of this line is a great start to simplifying the tax code.

Home office deduction simplified for 2013

The IRS has recently announced a simpler way for taxpayers to take the home office deduction.  One way to think of it as a "standard deduction" for the home office. This is a step in the right direction to simplifying tax preparation for many people.

The new optional deduction allows a flat $5 per square foot of home office as the deduction.  There is a cap at $1500 (or a space of 300 square feet). The basic rules for what is a home office remain the same; that is, a space regularly and exclusively used for business.

Current law for 2012 tax returns require the taxpayer to calculate the percentage of the home used for business, and also track ALL home expenses to determine the amount of the deduction. This is a lot of record keeping. Tracking utility bills, home repairs, maintenance, improvements, insurance, mortgage and taxes can be time-consuming.  In addition, there is a depreciation component based on the cost of the home. Preparing the tax return requires an allocation of mortgage interest and property taxes between the home office and the Schedule A (itemized deductions).  The flat rate eliminates the need for this.

Of course, it wouldn't be a true American tax law without a few exceptions.  Being optional, taxpayers may find the old way is more beneficial for them.  People who use a large percentage of their home for business may find that the $1500 cap unfavorable.  Also, the $5 amount might not be favorable; your actual cost might be more.

If you're someone who already takes a home office deduction, pay close attention to your 2012 tax return. See if the $5/sq foot rate would be better or worse than your actual expenses.  This will be a clue to what you will probably want to do in 2013.

I think the biggest users of this rule change will be folks with very small spaces used for business, such as the corner of a spare room.  Also it will be good for people who have trouble tracking all of their expense or don't keep good records. Under the old law the time and cost of taking the deduction might not have been worth the tax savings. But with this flat rate, it will be very easy. In addition, the mortgage and property tax are still fully deductible on the Schedule A.

Keep in mind this starts next filing season (tax year 2013).

Special Provision in new tax law makes me chuckle

After Congress passed the new tax legislation January 1, 2013 I was preparing a training session for our staff on January 5.  I couldn't find any in-depth summaries of the legislation so quickly after it's passing, so I was forced to read the legislation myself.

The document is very difficult to read and understand.  A mish-mash of references to prior tax laws, it only includes the new dates and provisions sprinkled throughout. As I sifted through attempting to make sense of things, one of the provisions made me chuckle.  I thought I'd share it.

Background:  There is a tax law that allows a taxpayer to take a distribution from an IRA and have it go directly to a charity.  Of course, this is not a huge deal because if you took the distribution, then donated the money to charity, you could deduct it on Schedule A and not pay federal tax on it. However, if the standard deduction is better for you than your itemized deductions, you are better off excluding the full amount directly.  Also, if the distribution goes directly to the charity, it does not get included in your Adjusted Gross Income. Lower AGI means possibly less of your social security is taxable, you avoid AMT, or avoid other phaseouts based on AGI.  Also, for Ohio residents, excluding the donation from AGI means you are not paying Ohio income tax on the distribution.

This provision expired December 31, 2011, meaning all throughout 2012 you could not have your IRA distribution go directly to a charity.

Provision:  As I'm reading the new legislation passed January 1, 2013, I see where this provision is extended through 2013. I stop and ponder "why"?  Now that 2012 is over, no one can possibly do anything about their 2012 IRA distibutions.  It's a nice extension for 2013, but too bad for 2012, right?

Then behold!  Congress did not forget that 2012 was over.  Several paragraphs are included as "special provisions".  This just made me chuckle.

To paraphrase the law, you can take a distribution from your IRA and donate it directly to charity in January 2013 and it will be considered a 2012 distribution. (I imagine the IRA companies love this one; I don't think they can backdate a distribution.  And when will you get that 1099R?)

The second part of the special provision allows you to donate to charity in January 2013 the exact amount of the IRA distribution you took December 2012 and exclude it from 2012 income.  My only guess for this one is they think taxpayers were waiting to take their IRA required minimum distribution (RMD) until this provision was extended.  By December, they couldn't wait any longer and took the RMD. Since the law was extended, taxpayers can now donate to the charity as they might have done if the law were in place in 2012.

The whole thing makes me chuckle. These are a couple examples of some of the most convoluted tax law, all because people can't agree in a timely manner. We wonder why our tax code is so complex.

Big tax changes passed Jan 1, 2013, or not?

Congress pushed the limits of tax legislation this time.  Recent tax legislation was passed January 1, 2013 to avoid the "fiscal cliff".  The tax law includes significant laws effecting 2013. But it even includes tax laws effecting 2012; even though the year had already ended. I'd say "why bother", but there are actually some good things in there.

As far as tax changes; not so much. The American Tax Relief Act of 2012 (ATRA) primarily extends many of the deductions, credits and tax rates we are already used to. If you're looking for some great, new tax breaks, you won't find them. But you won't lose them either.  What you will get is a continuation of most of the great credits and deductions we've had.  The most popular of these are the child tax credit, American Opportunity Credit, and the expansion of the earned income credit to include a third child.  These credits have been extended through 2017.

Other items included in the new law are retroactive extensions of deductions that expired at the end of 2011.  Did you even miss them? You would have very soon. Had the law not been passed, you would have lost these deductions on the tax return you'll be filing in a few weeks.  These are extended through 2013 and include:

• mortgage insurance premium deductions
• teacher’s above-the-line deduction
• state and local general sales taxes
• tuition and related expenses deduction

You may have heard of the higher tax rates for "wealthy" Americans.  This is the most significant change, but it doesn't really effect most of us.  Tax brackets for income tax and rates for capital gains were scheduled to revert to higher levels on December 31, 2012.  The new tax law keeps the lower rates for everyone with income levels under:

MFJ  $450,000
MFS $225,000
Single $400,000
HOH  $425,000

Most significantly, the Alternative Minimum Tax (AMT) patch, was also reinstated for 2012.  Not only that, it has been made permanent!  Hooray!  Woo hoo! What, you're not cheering?  Long story, but suffice to say many taxpayers would be hit with this tax without the patch. The AMT is now permanently indexed to inflation.

Next time, a blog on my favorite "special provision" in the new tax law.

Last minute filing tips

In a couple days, tax returns for individuals, partnerships, trusts and estates are due.  This year it's April 17. Usually taxes are always due on April 15, but this year it falls on a Sunday.  So one would think they are due on Monday, the 16th.  However, that is Emancipation Day in the Washington, D.C., so the whole country gets to skip right on over to April 17 for tax day. So much for simplifying the tax code.

If you haven't filed your taxes yet, you are not alone.  Procrastination, vacations, family emergencies, hectic schedules all get in the way. The dog ate your W2? Call your employer and get a replacement. If you can't get to it in time, it may be the year to file an extension.

I haven't filed my tax returns yet.  By the time I get all my tax documents, so has everyone else. I get so overloaded with other tax returns I can't possibly get to it. So I do a rough estimate in January to see if I'm going to owe or not. My husband is self-employed, so we have quarterly estimates to pay as well.  I file an extension and include what I think I owe plus extra to cover the first quarter estimate.  When I file the taxes in May, I'll have the extra applied to 2012 and that (hopefully) will take care of the first quarterly payment.

If you haven't filed yet, here are my recommended priorities:
1) File your taxes
2) File an extension
3) Pay what you think you owe
4) If you can't pay the full amount, pay what you can and file and Installment Agreement Request


An extension is super-easy to file and it does not raise any kind of red flag whatsoever.  Form 4868 is available at  http://www.irs.gov/pub/irs-pdf/f4868.pdf.  This form extends your due date to October 15. Keep in mind, the extension does not extend the due date of your balance due.  If you expect to owe, make sure you send a payment with your extension.  The Federal extension covers Ohio as well.  Most Ohio cities accept a copy of the extension when you eventually file that return.  However, if you live in Eastlake, know that they require a copy filed with them before April 17th.


If you know you are going to owe and you can't pay, DON'T IGNORE THE 17th.  That is the worst thing you can do.  The IRS has a hierarchy of penalties, and the most severe are the failure to file, then failure to pay. At least file an extension.

Similarly, if you have filed and you can't pay the whole amount, DON'T IGNORE THE 17th.  Pay something and fill out and Installment Agreement Request (Form 9465 http://www.irs.gov/pub/irs-pdf/f9465.pdf).  With that you can choose how much you want to pay with the return, how much you can pay each month, the date each month you would like it to be due. The IRS charges $52 to set it up if you agree to have your payment automatically deducted from your bank account ($104 if you write a check each month). Interest and penalties will continue to accrue; however this is the lowest level of penalty.

PS. If you have a refund, there is no penalty for missing the April 17th filing deadline.  As a professional, I always recommend filing an extension even if you expect a refund - just in case.  It could turn out you owe on the Federal or Ohio unexpectedly. Think of it as a free insurance policy against those failure to file penalties.  

Health Savings Accounts or HSAs

In my last blog, I explained how and when medical expenses are deductible.  I didn't get to the Health Savings Account, or HSA.  HSAs are special accounts that get favorable tax treatment for these funds set aside for medical expenses.  My advice:  if you have an HSA, USE IT.  Fund it as much as you can, and take advantage of this great tax deduction.

In my experience, HSAs underused.  I think a lot of people don't really understand what they are and how much they can really benefit from them.

Why use an HSA?  All of the hurdles and pitfalls of deducting medical expenses are avoided if you have this account.  Basically, you get an above-the-line deduction for funding your HSA. You don't have to itemize. You don't have to meet any 7.5% floor.  You don't even have to be sick or have medical expenses. You get the deduction when you put the money into the account, not when you spend it. The only catch is that if you take a distribution NOT for medical expenses, that part of the distribution is subject to a 20% penalty. Keep good records in case the IRS questions you.

How do I get an HSA?  First, you must have a medical plan that allows an HSA. These must be high-deductible plans, with a minimum deductible of $1200 for single coverage and $2400 for family coverage. Check with your benefits provider to be sure your plan qualifies.  Then you can open your HSA at most banks; some plans may prefer a specific account holder.

How do I fund my HSA?  Just make a deposit!  Most of the HSA holders I see only have it because their employer set it up and contributes to it.  Employers can save so much on the premiums, they will contribute a small amount to the employee's HSA. These employees are perhaps not fully taking advantate of the HSA.  Even if your employer contributes, you can also contribute up to the limit ($6250 in 2012 for family coverage).  It's not a "use it or lose it" plan.  Any unused portion stays in the account earning interest, until you need it for medical expenses. This is a key difference from the old Flexible Spending Accounts many employers offer (which are very good plans if you can't have an HSA).

How do I get the money out of the HSA?  Your account is generally just a checking account.  Some plans/accounts will provide debit card to use for purchases. Any time you have a medical expense, use that account to pay.  But what happens if you don't have that checkbook with you?  Or if you have mixed purchases at a store; I may buy Clif Bars with my prescription at Target. Or I may want to use my credit card to pay the Cleveland Clinic so I can earn reward points. That's okay. What I do is keep track of all my expenses and periodically reimburse myself for the medical expenses I paid outside my HSA. I have all the receipts to justify every payment from the HSA.

How do I report the HSA on my tax return? Form 8889 is needed (http://www.irs.gov/pub/irs-pdf/f8889.pdf and instructions at http://www.irs.gov/pub/irs-pdf/i8889.pdf)  At tax time, you will receive a two statements; a 1099SA reporting your distributions from the HSA, and a 5498-SA, reporting how much went in to the HSA. Report the contributions in Part I and distributions in Part II.

Note:
See http://www.irs.gov/publications/p502/ar02.html#en_US_publink1000178851
for a list of qualified medical expenses.  You can use HSA funds for things not covered by your plan; co-pays, co-insurance, eye glasses, orthodontia, excess chiropractor visits, etc.

Medical expenses - what's deductible?

Medical expenses can be a confusing deduction for many taxpayers.  What exactly is deductible?  And why don't all my medical expenses help reduce my taxes?

Medical expenses only help if they exceed 7.5% of your Adjusted Gross Income (AGI). To give you a ballpark of how much that is, if your income is $50,000, you will need over $3,750 in medical expenses before they might reduce your taxes.  That is the first hurdle.

The second hurdle is the standard deduction.  Even though you may have over 7.5% in medical expenses, your other itemized deductions (mortgage interest, property taxes, charitable donations, etc) , may be less than the standard deduction.  For your 2011 taxes, the standard deduction for a single person is $5,800, and for married couple filing jointly it's $11,600.  For those over 65 it's even higher.  So if you don't normally itemize, the excess medical expenses might not help you on your Federal retun.

There is one thing to keep in mind even if you don't itemize.  The excess medical expenses (i.e., those over 7.5%) are one of the few deductions that you can use on your Ohio return.  This will reduce your Ohio tax even if you don't itemize on the Federal.

What medical expenses can be included?  Co-pays and co-insurance for doctors, dentists, hospitals, labs, prescriptions, as well as contacts and eye glasses. Even mileage to medical appointments can help, though at a lower rate than business miles.

Your health insurance premiums are deductible ONLY if they are not already a pre-tax deduction through your payroll.  Check your pay stub or your payroll department to find out for sure.  Medicare B and COBRA premiums are examples of premiums that are not already pre-tax.  Long term care insurance can be included as a medical expense.  If you are self-employed, your health insurance premiums are a medical expense, but they get a more favorable treatment as an adjustment to your income.

What isn't deductible?  Over-the-counter medications, like cold medicine and tylenol, and first-aid items like band-aids and neosporin.  Plastic surgery is not allowed as a deduction.  Vitamins and nutritional supplements are pretty much never deductible (unless prescribed by a physician).  Your health club membership?  Nice try, but not a medical expense - even if your doctor tells you to exercise more!

More next time on Health Savings Accounts.