FAQs

Each year, everyone is entitled to deduct either their standard deduction (a “freebie” amount of deductions that the government allows everyone to have) or their itemized deductions added together. The standard deduction amount increases a little bit each year due to inflation. Itemized deductions mainly consist of out-of-pocket medical expenses, taxes that you pay, mortgage interest, and charitable contributions. You are entitled to take either the standard deduction amount for that year or your itemized deductions – not both. You get one or the other. Of course, you normally want to take whichever one is higher – more deductions usually mean less taxes (although there are exceptions). Until you reach the point where you have more itemized deductions than the standard deduction, additional itemized deductions won’t help. Your tax bill won’t be any lower.

If you are a partner in a partnership or an S-Corporation shareholder, you normally take all of the income and deductions from your business on your own personal income tax return. We call these entities “pass-through” or “flow-through” entities, because the income and deductions from the company “flow-through” to you – the business owner. When this happens, you pick up the tab for the taxes your company generates. You still have to file a separate tax return for your partnership or S-Corporation, but the actual taxes are paid by you personally.

Let’s say that you and your buddy are each 50% partners in a partnership. You divide everything equally between you from the profits you make from clients to the cost of printer toner. If your company makes $100,000, the company does not typically pay any taxes on this amount. Instead, you would show $50,000 on your tax return (50% of the profits). Naturally, this would increase your tax bill since you are showing an additional $50,000 in income on both your federal and state income tax returns. Let’s say that your state charges a 12% income tax – that means that you are paying $5,000 in state income taxes on your share of the income ($50,000 x 12% = $6,000).

Would this additional $6,000 in state income taxes be deductible on your federal income tax return? Well, yes – as long as you haven’t already hit the $10,000 deduction limit. Remember – the most that anyone can deduct is $10,000. No matter what, you can’t deduct more than that for state income taxes, real estate taxes, and personal property taxes on your personal income tax return.

What if you are already at that $10,000 limit before your business taxes? For example, what if you have already paid $10,000 in real estate taxes? If that’s the case, you would normally not be able to take any deduction on your federal income tax return, since you have already maxed out. That’s a pretty bad result! You paid $6,000 in state income taxes because of your business, but your tax deduction is zero on your federal return!

One way to get around the bad tax result is to do something called a pass-through entity (PTE) election. While every state is a little bit different, many states offer you the ability to choose to have your business pay its own state income taxes. The entity takes the deduction for the payment – and you have less income on your personal return to pay taxes on!

Let’s go back to our example from the “I am a business owner; how does that affect my deductions?” question, If you let your partnership pay the state income taxes, then only $44,000 of income would flow-through to you - $50,000 in partnership income minus the $6,000 in state income taxes paid. In other words, by letting the partnership pay the taxes, you now have $6,000 less in income to show on your personal return.

But what about that $10,000 limit on state income taxes? Well, it won’t matter here because the deduction for the $6,000 is taken by the partnership – not you. The partnership can deduct as much in state income taxes as it wants. It is only you that has the $10,000 limit. By letting the partnership pay, you show less income on your personal return. It is almost as if you are taking a higher deduction than what is allowed by the $10,000 limit.

While this can be a really helpful election for a business owner, it is important to remember that the rules around PTE elections vary by state and the planning can get very complex. It is also important to remember that this is only possible in states that actually have an income tax. Before committing to making a PTE election, you should talk to a professional to make sure you know the details. In the right circumstances though, this can save a small business owner significant tax money.

It is never worth it to keep a mortgage only for the tax deduction. Let’s say that you pay $5,000 in mortgage interest in a year – and you are in the 22% federal tax bracket. If that’s the case, you would not save $5,000 on your tax bill. You would only save about $1,100 ($5,000 x 22% tax bracket = $1,100 in tax savings). Why? Because there is a difference between credits and deductions. A tax credit will reduce your tax bill dollar for dollar. A $5,000 credit will reduce your tax bill by $5,000. However, a deduction only reduces the income that you pay taxes on. Mortgage interest is a tax deduction – not a credit.

That’s a pretty bad deal, if you think about it. You are paying $5,000 to the bank in the form of interest on your loan, but you are only receiving $1,100 back in the form of a reduced tax bill. In other words, you are only getting 22 cents in benefit for every dollar you spend. That’s not great – and certainly not a reason to keep yourself in thousands of dollars of debt!

The IRS generally allows you to deduct any business expense that is ordinary, necessary, and reasonable in the circumstances. While there are some expenses that we put some additional requirements around, most things that we spend money on for our business are going to be deductible. The one requirement is to keep it reasonable for the business that you are in. For example, a hammer and screwdriver are probably deductible for a contractor, but not if you are an attorney. Similarly, cattle feed is deductible for a dairy farmer, but that same expenditure would likely not be available as a write-off to a plumber. All business expenses need to be reasonable in the circumstances for the given business.

There are a few things that go against this principle. For example, in nearly all instances, political contributions are not deductible. The same is true for fines and penalties assessed by the IRS against you, since such things would never be considered “ordinary or necessary” for any business. However, most every other normal business expense is deductible.

One important thing that the IRS normally wants to see is substantiation. In other words, for every deduction you take, you need to be able to show that you actually spent the money on something business-related. In most cases, this means keeping receipts, cancelled checks, or credit card transaction records. You should also try to classify the expenses into the type of business expense it is – office supplies, inventory, legal fees, etc. By doing this, it will help you to recognize the business purpose of the expenditure. It will also be what the IRS will generally want to see if you ever get audited.

Whenever you run your own business or have a side gig, it is imperative to keep good accounting records. Regardless of whether your customers paid you by cash, check, credit card, or payment application, you need to declare all of it as revenue. Once you have done this, you should take all of your deductions. As explained above, nearly all amounts paid that are ordinary, necessary, and reasonable are deductible for the business. Your total revenue minus your total deductions is your company’s net income from self-employment. If you are the only owner of a business and you have not elected to be treated like an S-Corporation or a S-Corporation, then you will show the calculation of your net income (revenue minus deductions) on Schedule C on your personal income tax return. Net income shown on Schedule C of your personal income tax return is subject to your regular income tax rate plus self-employment taxes.

If you have ever worked for an employer, take a look at your pay stub. On it, you will normally see two payroll taxes that have been taken out of your check – Social Security and Medicare taxes. Social Security taxes are calculated as 6.2% of your wages, while Medicare taxes are calculated at 1.45% of your wages. Your employer pays a matching amount of payroll taxes on your wages equal to 6.2% of your wages for Social Security and 1.45% for Medicare taxes. When you are self-employed, the IRS assumes that you are both the employer and employee for the company. Therefore, you pay both the employer and employee sides of Social Security and Medicare Taxes. This totals 15.3% (6.2%+6.2%+1.45%+1.45% = 15.3%). This 15.3% tax representing both the employer and employee side of Social Security and Medicare taxes is referred to as self-employment taxes.

Self-employment taxes are paid on the net income of the business. They are paid in addition to your regular tax rate. If you don’t have net income from your business, then no self-employment taxes are owed. Therefore, self-employment taxes tend to sneak up on new business owners, as well as people who just started a side gig. Once they start turning a profit from their venture, they have a bigger tax bill due to those pesky self-employment taxes!

The good news is that you reduce your self-employment taxes by simply making sure that you are taking all of the deductions that you are entitled to. When most people first start a new business or side gig, they don’t do a great job of keeping track of expenses. They forget about expenditures that they had early in the year. Two things that can be helpful are keeping a separate bank account for your business and keeping track of everything (all income and expenses) in an accounting program or Excel file. By doing this, you are making sure that all of your deductions are easy to locate and total.

It should be noted that most businesses are on a cash basis. This means that you are able deduct your ordinary, necessary, and reasonable deductions as soon as you pay for them. Therefore, one way to keep your self-employment income to a minimum is to consider paying for a business expense during the year, rather than waiting until the next year. For example, let’s say that you know that your business will be using more office supplies soon. You may want to consider purchasing more in December of this year (as opposed to waiting until January). By doing this, you are able to take the deductions in the current year, rather than waiting until next year. While there are some limitations around this, in general the tax code allows you to “accelerate” deductions into the current year by paying for them in the current year.

This could not be further from the truth.

The most student loan interest that anyone can deduct on their tax return is $2,500 per year. That means that if I pay $10,000 in student loan interest on an education loan, I can only deduct $2,500. What if I am in a really expensive graduate program? Surely, I can deduct more, right? Nope. You can only deduct $2,500. That amount must go up with inflation each year, right? Nope. It is $2,500 – and it has been $2,500 for a long time. Even though student loan interest rates have generally increased, the $2,500 deduction has held steady.

To make matters worse, many people won’t be able to deduct even that. Student loan interest is subject to a phaseout. In 2024, if you are married, the phaseout is from $165,000 to $195,000. This means that if you and your spouse have modified adjusted gross income (MAGI) of $195,001, you will get no deduction for your student loan interest. The only way that you are able to get the full $2,500 is if you have MAGI of $165,000 or less.

If you do phaseout of the student loan interest deduction, then student loan debt is hardly “good debt.”It is just debt that you will be paying on for 10 years. You can stretch that timeline out longer – but that means paying even more interest. Regardless of the length of time, since student loan interest is not collateralized debt (I am pretty sure the government cannot repossess your brain), it often carries a higher interest rate than that of a mortgage

Not every child is a dependent. Tax incentives are generally given if you have a dependent – not just for merely having a child. At a certain point, normally due to age, a child is no longer your dependent. They will be able to take more of their own deductions – and you won’t be able to take them anymore on your return. In short, kids grow up – and when they do, the tax incentives stop. So, when is your kid considered a dependent? There are two ways to qualify as a dependent. You must either qualify as a qualifying child or a qualifying relative. Let’s look at the rules for both.

To be considered a qualifying child, you must meet all of the following tests:

• Dependent Taxpayer Test - In general, you cannot be someone else’s dependent and also claim a dependent on your own tax return. Said another way, if I am someone else’s kid, I can’t claim my own kid.

• Joint Return Test – A dependent cannot file a joint tax return for him or herself and be claimed as a dependent on someone else’s return. In other words, your kid can’t file a joint tax return and then you still claim him/her.

• Citizen or Resident Test – In order to be claimed, your child has to be a US citizen or a resident of the United States, Canada, or Mexico.

• Relationship Test – You can only claim as a dependent anyone who is:

  • Son, daughter, stepchild, eligible foster child, adopted child, or a descendant (for example, your grandchild) of any of them, or

  • Brother, sister, half-brother, half-sister, stepbrother, stepsister, or a descendant of any of them.

• Age Test – Your dependent needs to be:

  • Under age 19 at the end of the year and younger than you (or your spouse if filing jointly); or

  • A full-time student under age 24 at the end of the year, and younger than you (or your spouse if filing jointly); or

  • Permanently and totally disabled at any time during the year, regardless of age.

• Residency Test – In general, your kid needs to live with you over half of the year. Don’t worry about temporary absences for school, vacation, or military service. Those don’t count.

• Support Test – If your kid is paying for most of their own expenses (over 50%), then you may NOT claim them.

Keep in mind that all of these tests must be met before you can claim your kid on the tax return. If you don’t meet even one of these tests, then your dependent is NOT a qualifying child. They could then only be claimed if they were a qualifying relative.

Families come in many different shapes and sizes. If you are unable to claim someone as a qualifying child, you might be able to claim them as a qualifying relative. Like the qualifying child rules though, you have to meet ALL of the tests in order to claim a qualifying child:

• Dependent Taxpayer Test – This rule is the same one as above. If you can be claimed as a dependent by someone else, you can’t have any dependents yourself.

• Joint Return Test – Same as above. A dependent cannot file a joint tax return for him or herself and be claimed as a dependent on someone else’s return. In other words, your kid can’t file a joint tax return and then you still claim him/her.

• Citizen or Resident Test – Same as above. In order to be claimed, your dependent has to be a US citizen or a resident of the United States, Canada, or Mexico.

• Not a Qualifying Child Test – If your kid is a qualifying child, they cannot also be a qualifying relative. This is a bit redundant, because remember that your kid just needs to qualify as one or the other. If they qualify as a qualifying child or a qualifying relative, then they are a dependent.

• Member of Household/Relationship Test – There are two ways to meet this test. You meet this test if: a) your dependent lives in your household for the entire year, or b) if they are related to you in one of the following ways (even if they don’t live with you):

  • Child or a descendant of a child.

  • Brother, sister, stepbrother, or stepsister.

  • Father or mother, or an ancestor of either.

  • Stepfather or stepmother.

  • Son or daughter of a brother or sister of the taxpayer.

  • Brother or sister of the father or mother of the taxpayer.

  • Son-in-law, daughter-in-law, father-in-law, mother-in-law, brother-in-law, or sister-in-law.

• Gross Income Test – Your dependent cannot have gross income over $5,050 (in 2024) and be claimed as a qualifying relative.

• Support Test – You must have paid for over half of the expenses for someone in order for them to meet this test.

If you pay for your dependent’s medical expenses, you can take an itemized deduction for the amounts you pay. Remember that it is only when you pay for medical expenses for yourself, your spouse, or your dependents that they are deductible. Also, only medical expenses that are paid out of pocket are deductible. In other words, if a medical expense is reimbursed by insurance, you can’t take a deduction for it.

One thing that most parents would agree with is that kids are expensive! From the time they are born until they go off to college, kids will need to go to the doctor, pay for flu shots, and maybe even get braces. If you do end up paying for these things, you might as well take a tax deduction for them!

Many parents are surprised to hear that kids do need to file their own tax return, if they have over a certain amount of income:

• If a dependent child made over $14,600 in earned income (wages or self-employment income) only in 2024, they need to file a tax return. They are over the standard deduction amount, so they may owe tax.

• If they made money only from their investments (dividends, interest, and capital gains), then they need to file a tax return if this amount is over $1,300 in 2024.

• If they made money from both earned income and investments, they will need to file a tax return if they are above the dependent standard deduction. The dependent standard deduction is earned income plus $400 in 2024 (not to exceed $14,600).

As you can see, the actual requirements are complicated. However, even if your child does not need to file a tax return, they should file one. Why? At the very least, they want to get their withholding back.

When it comes to rental property, the rules are very similar to owning your own small business. In addition to depreciation, you can deduct items like small repairs, lawncare maintenance, HOA fees, real estate taxes, mortgage interest, house cleaning, pest control, and other maintenance and upkeep costs. Utilities, internet, phone, and television costs are deductible as well. Big expenditures (like constructing an addition to the house or replacing a roof) cannot be deducted right away. These costs need to be taken over time using depreciation – similar to the cost of the property itself.

In order to alleviate the headaches of trying to find tenants and collect rent, many rental property owners will engage the services of a property manager. The fee that the property managers charge is deductible as well. Most of the normal costs of owning a home are deductible in full. Like our discussion on side gigs, the costs are deductible when you pay for them (cash basis). It is possible then to pay some costs in December (rather than January) to lower your tax bill in the current year.

Wages are hard to move. What that means is that there isn’t much tax planning you can do around wages. You get paid to do your job and you have to declare the income on the tax return. You can make 401(k) contributions and maybe even stick some money in an HSA (we talked about those things earlier), but the fact is that you really have to just take the wages on your tax return. When you are working, you can’t really do much except just declare wages.

When you are retired, you don’t have wages anymore. You are usually reliant on three sources of income: your portfolio, retirement accounts, and income from Social Security. On your portfolio, you won’t have any capital gains until you sell something. You may need to declare interest and dividends, but only if you invest in stocks, bonds, or funds that generate this type of income. Your portfolio does produce taxable income, but you usually have a lot of control over the type, amount, and timing of that income.

When it comes to retirement accounts, you control the timing of the income as well. It is only when you make a distribution from a traditional retirement account that you need to declare income. While the IRS does make you pull a minimal amount out each year (called a Required Minimum Distribution or RMD), anything beyond that is really up to you. You need to pull what you need, but you can normally control how much.

Out of the three, Social Security may be the one that you have the least control over. After all, the government just sends you a check. However, you don’t need to take Social Security right away. In fact, you can wait until you are 70 to take Social Security, if you want. As an added bonus, your check will be considerably higher if you take at age 70 as well! Even once you begin receiving a Social Security check, you may still be able to control some of the income that you have to declare. If you have low enough income, you don’t have to declare any Social Security Income on your federal tax return. Even in the worst-case scenario, only 85% of the income is shown on your tax return. No one gets taxed on 100% of their Social Security benefits on their federal tax return. There are also several states who do not tax Social Security benefits as well.

As you can see, most retirees can control their taxable income better once they are no longer working. Wages are hard to move, but most of the sources of income for retirees are not. They can be deferred (put off until later tax years) or in certain cases even not declared on the tax return at all (excluded)!

Remember that the tax return is merely a reconciliation of the year that just passed. The perfect spot is if you have enough withholding or estimated tax payments to cover your tax liability, but nothing more. A big refund usually means that you gave the government an interest-free loan for the entire year. You gave them too much withholding or estimated tax payments. You don’t want to give them too much. However, you also don’t want to risk an underpayment penalty either. If you pay in too little in withholding and estimated taxes, then you will get penalized by the IRS. Therefore, you want to hit it right on the nose – no refund and no balance due (or as close to this as possible).

The only way that the tax return becomes that predictable though is if you actively engage in bracket management. You need to make specific moves to reduce or lessen taxable income where possible throughout the year. Let’s talk about how to do that for each of the forms of income that most retirees have – portfolio income, income from retirement accounts, and Social Security. Give us a call or let us setup an appointment to do this.

Few expenditures in most people’s lifetimes are bigger than buying a new house. Therefore, it is important to be prepared for it. If you can, you should try to put at least 20% down on the price. While it may be possible to put down a lower downpayment, you will normally have to pay the cost of private mortgage insurance (PMI) in addition to the cost of the mortgage itself. If you can’t quite make the full 20%, try to put as much down as you can. The closer you are to 20%, the less the PMI premiums will be.

When looking for a mortgage, try to look for the lowest interest rate possible. This generally involves shopping around. One option to streamline the process of finding the lowest interest rate is to work with a mortgage loan originator (MLO). An MLO can shop for your mortgage to various lenders in order to find the lowest rate. While they do take a fee for this service, this can be the most efficient way to find the lowest rate.

Owning your own home has various tax advantages as well. You can generally deduct any real estate taxes that you pay (including any that you may be responsible for in the year you buy). You can also deduct any mortgage interest as well within certain limits. Many people combine the cost of their real estate taxes and mortgage into one payment. This does not affect their deductibility. Real estate taxes are still deductible, even if you pay them as a part of your mortgage payment. Both would be itemized deductions on Schedule A.

If you need to sell your existing home, there are some tax incentives that may help. First, you are still allowed to deduct any real estate taxes or mortgage interest that you may have paid for the portion of the year that you owned the home. If you lived and used your home as a primary residence (not a vacation home) for at least 2 years before you sell it, you will be able to exclude the first $250,000 (if you are single) or $500,000 (if you are married) of capital gains from the sale. As a reminder, a capital gain occurs when you sell something for more than you bought it for. If you are single and you sell your home for $350,000 after buying it for $50,000, you would have a capital gain of $300,000 ($350,000 - $50,000 = $300,000). Assuming you met the two-year rule, you would only be taxed on $50,000 of this gain. The first $250,000 would be excluded from your taxable income (due to Sec 121). In other words, you won’t pay taxes on this first $250,000 (or $500,000 if you are married). This makes it so most people can sell their home at a gain – and not pay a dime in taxes!

Our federal tax system (and state income tax systems) are pay as you go. In other words, you don’t pay taxes once per year – you pay them throughout the year. If you work for an employer, you pay taxes through withholding. Every single paycheck has an amount withheld for federal (and state) income taxes. In this way then, the tax return is a reconciliation. You are reconciling what you owe versus how much you have paid in during the year. If you have paid in more than you owe, you are entitled to a tax refund. If you owe more than you paid in so far, you have a balance due. April 15th is a time to square up with the taxing authorities.

In some situations, you may not have withholding taken from your check. The most common example of this is when you are self-employed. Unless you are paying yourself a salary and withholding taxes, most small business owners do not have any withholding. As another example, some retirees who are living primarily off of their investment portfolio may not have any withholding either. In these instances, the IRS has a system that penalizes people for not paying in enough in taxes throughout the year. More specifically, if you don’t pay in enough either through withholding or estimated taxes or both, you need to pay a penalty in addition to the normal taxes you would owe.

On your federal tax return, the amount you need to pay in through withholding and estimated taxes is based on your prior year and current year tax liabilities. If your federal tax liability in the current year is estimated to be less than $1,000, then you do not need to make any estimated tax payments. You can simply square up on your tax return.

Essentially, if your child has too much investment income, it will result in that investment income being taxed at your tax rate (a higher rate) than theirs (normally a lower tax rate). Therefore, if you want to give your child something from your investment portfolio, what can you give?

One option could be to give them investments that typically don’t result in taxable income. For example, you might be able to give them stocks that historically have not paid a dividend or a fund that has a strategy not resulting in income. It should be noted that it is possible for a company or fund manager to break from historical precedence and pay a dividend. This is rare though, because most fund managers and companies tend to follow what they have done in the past. Another option may be to give your child municipal bonds or treasury bonds. Municipal bond interest is not taxable at the federal tax level (and in certain instances may not be taxable at the state level either). Treasury bonds are taxable at the federal level but may not be taxable at the state level. With all of these options, the point is to consider giving a child an investment that won’t generate too much taxable income.

Another option is using a loss harvesting approach with the investment portfolio of a child. Loss harvesting involves selling offsetting gains and losses from the portfolio. The kiddie tax is only assessed on net investment income, so if you can offset some capital gains with capital losses, this could limit exposure to the kiddie tax as well.

It should be noted that not all investment income of a child is subject to the kiddie tax. As we discussed, the first $2,600 of investment income in 2024 of a child is not subject to the parent’s tax rate. Another strategy could be simply trying to limit the amount of investment income, rather than trying to eliminate all of it completely.

Perhaps the most effective strategy of all may be the simplest – just wait. Remember that the kiddie tax only applies while your child is…. well, a kid! Once your child can no longer be claimed on your tax return as a dependent, then the kiddie tax no longer applies either. Investment income is taxed at whatever your child’s tax rate is. Most of the time, when someone first enters the working world, their income is lower. Even if your child is no longer a dependent, there is a strong chance that he/she is still at a lower tax rate than you. If you wait until they are no longer a dependent and then transfer assets, this strategy may work well. As a reminder, you can transfer up to $18,000 to each child in 2024 and not pay any gift taxes on the transfer.