What Is Depreciation?

When operating any business, it always takes money to make money. This money that is being spent is your expenses and can actually be deducted on a taxpayer’s tax return.

There are many different expenses that can be deducted such as cost of goods, sales commission expenses, rent, salaries, or advertising expense. These are all expenditures that do not have a useful life beyond one year, which are generally deductible in the year incurred.

Today we are going to discuss how a business can expense larger items or fixed assets such as buildings or vehicles used in the course of business. This is where depreciation comes in.

Depreciation is an accounting method that allows a company to write off an assets value over a period of time, commonly the assets useful life. I will explain what types of business property can be depreciated and their recovery periods. There are also four different methods of depreciation that I will describe for you.

What types of property can be depreciated?

There are many different types of property that can be depreciated. For a property to be depreciated it must meet the following requirements:

  • The taxpayer must own the property
  • The taxpayer uses the property in business or income producing activity (e.g., rental property)
  • The property has a determinable useful life
  • The taxpayer expects the property to last more than one year

Land, Property placed in service and disposed of the same year and equipment used to build capital improvements all cannot be depreciated. Also, a taxpayer cannot depreciate personal use property. The depreciation deduction is allowed only on the part of the property used for a business or income producing activity.

There are many different properties that are depreciable, and they can all be categorized by their recovery period. The recovery period of each asset or property is the amount of time the IRS requires you to depreciate it. These periods theoretically track the actual useful life of an asset.

Depreciable properties generally fall into one of the following categories.

  • 5-year Property – Computers and peripheral equipment, office machinery (typewriters, calculators, copiers, etc.) automobiles, light trucks, appliances, carpeting, furniture used in residential rental real estate activity.
  • 7-year Property – Office furniture and fixtures (desks, file cabinets, etc.) This class also includes any property that does not have a class life and that has not been designated by law as being in any other class.
  • 15-year Property – Roads, fences and shrubbery.
  • 20-year Property – Includes improvements such as utilities and sewers.
  • Residential rental property (27.5 year property) – Real property that is a rental building or structure (including mobile homes) for which 80% or more of the gross rental income for the tax year is from dwelling units. It does not include a unit in a hotel, motel, inn, or other establishments where more than half of the units are used on a transient basis.
  • Nonresidential real property (39-year Property) – Commercial buildings and structures. Includes section 1250 property.

How Does Depreciation Work?

Tax payers must use the Modified Accelerated Cost Recovery System (MACRS) to depreciate residential rental property placed in service after 1986. MACRS consists of two systems that determine how property may be depreciated.

  • General Depreciation System (GDS)- Generally, taxpayers must use GDS for property used in most rental activities. Recovery periods generally are shorter than under ADS.
  • Alternative Depreciation System (ADS)- ADS uses the straight-line method of depreciation. A taxpayer electing to use ADS may not change the election, which applies to all property in the same class that is placed in service during the year of the election. However, the election applies on a property-by-property basis for residential rental property ad nonresidential real property.

Taxpayers must continue to use the same depreciation method unless the IRS grants approval to change the accounting methods. The methods under MACRS for depreciating property are as follows:

  • Straight-line-depreciation– Deduct equal amounts throughout the recovery period.
  1. A taxpayer must use the straight-line method and a mid-month convention for residential rental property. In the first year of claiming depreciation for residential rental property, take depreciation only for the number of months the property is in use.
  • 200% or 150% declining balance– Allows for greater depreciation percentages in early years. Us the straight-line method in place of accelerated depreciation in the first tax year it provides and equal or larger deduction than either the 200% or 150% declining balance method.

Depreciation begins when the taxpayer places the property in service for the production of income.

taking money out of a wallet

Depreciation ends when either the taxpayer fully recovers the cost, or the property is retired from service, whichever happens first. Property is placed in service in a rental activity when it is ready and available for a specific use in that activity. Even if unused, it is in service when it is ready and available for specific use.

A convention is a method established under MACRS to set the beginning and end of the recovery period. The convention used determines the number of months that the taxpayer may claim as depreciation in the year the property was placed in service and in the year disposed.

Use the mid-month convention for residential rental property and nonresidential real property. For all other property, use the half-year or mid quarter convention, as appropriate.

  • Mid-month convention– Use a mid-month convention for all residential rental property and nonresidential real property. Treat all property place in service or disposed of during the month as placed in service or disposed of at the midpoint of that month.
  • Mid-quarter convention– Use a mid-quarter convention if the mid-month convention does not apply and the total depreciable basis of MACRS property placed in service in the last three months of a tax year is more 40% of the total basis of such property placed in service during the year.

For this convention the MACRS property excludes nonresidential real property and property placed in service and disposed of in the same year, under this convention, treat all property place in service, or disposed of during any quarter of a tax year as placed in service or disposed of at the midpoint of the quarter.

  • Half-year convention– Use the half-year convention if neither the mid-quarter convention nor the mid-month convention applies. Under this convention, treat all property placed into service, or disposed of during a tax year as being placed in service, or disposed of, at the midpoint of that tax year.

If this convention applies, the taxpayer may deduct a half year of depreciation for the first year and the last year that the taxpayer depreciates the property. The taxpayer may deduct a full year of depreciation for any other year during the recovery period.

Depreciation is meant to simulate your property losing its value over time. You are basically getting the IRS to reduce your taxes by telling them that your property is losing value.

If the property does not lose value and you end up selling the property for more than the depreciated value this money has to be paid back. This is called depreciation recapture.

Depreciation recapture is the gain realized by the sale of depreciable property that must be reported as income for taxed purposes.

Depreciation recapture is assessed when the sale price of an asset exceeds the tax basis or adjusted cost basis. The difference between these figures is thus “recaptured” by reporting it as ordinary income and is taxed at a 25% recapture tax rate.

A business taxpayer may take an additional 100% special depreciation allowance often referred to as “bonus depreciation” on certain qualified property. The special depreciation allowance only for the first year the property is in service. Bonus depreciation is taken before the taxpayer figures regular depreciation under MACRS. Qualified property includes tangible property depreciated in 20 years or less.

For the 100% special depreciation allowance, the qualified property must be acquired and placed in service after September 27, 2017, and before January 2, 2023. A taxpayer may elect out of this additional first year depreciation deduction with respect to any class of property that is qualified property placed in service during the taxable year.

There are many reasons why it is a huge mistake to not claim depreciation. The IRS will expect a taxpayer to pay this recapture tax even if they have not taken the depreciation on the property. So, it would be a huge mistake for a taxpayer not to use a depreciation method as part of their business.

Also, by claiming depreciation you get money today that you can use to invest, even if you have to pay taxes in the future. Since you are going to pay the bill in the future you may as well get the benefits today.

How to Get the Child Tax Credit Early

parents with their two children

There have been many different programs made available by the government to help people get through these tough times. With the Covid-19 pandemic, there has been a record number of people on unemployment, and many small businesses and self-employed people had a serious loss of income. 

The government has provided benefits in the form of stimulus payments, adding an additional federal amount to people state unemployment and they have given many tax breaks as well.

This article will discuss the major changes to the Child Tax Credit through the American Rescue Plan. These changes may not only give taxpayers with qualified dependents a much larger amount, but it will also give them a portion of the money earlier. The American Rescue increased the amount received per qualified child from $2000 to $3000 or $3600 per child under the age of 6. It also makes this credit fully refundable. 

I discussed this increase in the amount possibly credited to taxpayers in a previous article.  Please refer to our June 2nd article on the Child Tax Credit for more information. The reason I am coming back to this topic today is to further discuss the efforts that the IRS is taking as we speak to disburse a portion of this early over the next six months to taxpayers in need.

Starting July 15, 2021, about 36 million American families will start receiving checks from the IRS. Taxpayers who are eligible for this credit will receive up to $1800 broken up equally over the next six months. They will be receiving half of the credit that they qualify for and then they can claim the other half when they file their tax return for 2021. This is a temporary change just for the 2021 tax year.

To qualify for advance Child Tax Credit payments, you, and your spouse if you filed a joint return must have:

  • Filed a 2019 or 2020 tax return and claimed the Child Tax Credit on the return: or
  • Given us your information in 2020 to receive the Economic Impact Payment using the Non-Filers: Enter Payment Info Here tool; and
  • A main home in the United States for more than half the year (the 50 states and the District of Columbia) or file a joint return with a spouse who has a main home in the United States for more than half the year; and
  • A qualifying child who is under age 18 at the end of 2021 and who has a valid Social Security number; and
  • Made less than certain income limits.

The IRS will use information that taxpayers have already provided to determine who qualifies and will automatically enroll you for advance payments. There is nothing the taxpayer must do to get these advance payments.

 

What Are the Income Limits For the Child Tax Credit?

Not all taxpayers with qualified children will receive the higher child tax credit. The taxpayers who will receive the maximum amount will be taxpayers who make $75,000 a year or less if filing single, $112,500 or less if filing head of household, and $150,000 or less if filing a joint return or are qualified widows or widowers. Taxpayers who make more than these amounts will receive a phased-out amount. They will receive $50 less for every $1000 of income over the thresholds until the payments are phased out for people who earn roughly $20,000 more than the salary thresholds. 

The IRS has set up a tool on their website where a taxpayer can see if they qualify. For parents that qualify payments can be up to $300 for children under six and $250 per month for each child between 6 & 17.

If you do not qualify because you earn more than the maximum income allowed for the credit then you still may qualify for the original Child Tax Credit. This Child Tax Credit of $2000 is available to single parents who earn up to $200,000 or married couples who earn up to $400,000. If you earn higher than these amounts, then you will not qualify for any Child Tax Credit.

Since the IRS is relying on previous years’ filings, they may not have information for some people that qualify. Low-income households that are not required to file tax returns may fall through the cracks. If you were not required to file in 2020 or 2019 and qualify for this credit the IRS has set up a Child Tax Credit non-filers tool. 

Non-filers will need to provide personal information such as their date of birth, as well as their social security numbers for themselves and the qualified child. 

 

What Is a Qualifying Child for the Child Tax Credit?

A qualifying child is a child who meets the four IRS requirements to be a dependent for tax purposes. These six requirements are the relationship, age, residence, support, joint return, and citizenship.

Relationship: The child must be a son, daughter, stepchild, foster child, brother, sister, half-brother, half-sister, stepbrother, stepsister, or a descendent of any of them.

Age: To meet this test a child must be younger than the taxpayer (or spouse if filing jointly) and meet the following conditions.

  • Younger than the age of 19 at the end of the year
  • Younger than age 24 at the end of the year and a full-time student
  • Any age if permanently and totally disabled (does not need to be younger than the taxpayer)

Residence: The child must live with the taxpayer more than half of the year. A child who is born or dies during the year qualifies if the home was the child’s home the entire time the child was alive. A child is considered to live with a taxpayer when at a hospital following birth, or temporary absences due to special circumstances such as illness, education, business, vacation, or military service.

Support: The child cannot provide more than half of their own support.

 

How Do You Opt-Out of Receiving the Advance Payments?

While this seems like how stimulus payments were distributed there is one major difference. With stimulus checks, if you received more than you were entitled to you did not have to pay the money back. With the Child Care Tax Credit that is not the case. If you are not eligible when you file your 2021 tax return, then you will have to repay the amounts advanced to you. This could happen if you had an increase in income from last year where you are now over the income threshold or if your qualified child is now older than the age limits. Also, a lot of marital situations changed during this rough year.

The IRS is doing all their qualifications from old information. They are using the information provided on 2020 tax filings. If that year has not been filed or processed, then they are using 2019. If you are a taxpayer that no longer qualifies it is important that you opt-out of these payments or you could have a hefty tax bill, come filing time.

The IRS has set up a tool on their website where taxpayers can opt out of receiving these payments. This tool will allow people who either do not want or no longer qualify for the credit to unenroll before the first payment is made on July 15th.  This tool can be used by families if they have internet access and a smartphone or computer. 

The IRS is planning on updating this portal to allow people to see payment history and change banking information or mailing addresses. They are also working on updating the tool to allow taxpayers who have had children in 2021 or if the child has aged out of qualification to update that information so they can begin receiving the advance or to correct the amount received.

If a taxpayer chooses to opt out they must notify the IRS before set deadlines for each payment. You must opt out by June 28th to skip the 1st payment. If they miss this opt-out before the 1st payment, then they can still opt-out prior to the next payments.

In conclusion, this is another step taken by the government to aid struggling families and to influx money back into our economy sooner than later. Vice President Harris was quoted as saying, “The proudest moment that I have experienced in this position was when President Joe Biden signed the American Rescue Plan into law. Because through tax credits and food assistance and housing assistance and health care coverage and direct checks the American Rescue Plan will lift half of America’s children out of poverty.” 

As much good as this will seem to do, I do have one reminder to point out where people need to be careful: If you no longer qualify for the tax credit, then it is especially important that you opt out. If you do not, then you can see yourself with a tax bill you may not be able to afford come tax time. If you can afford to pay it that is always best but if you can not you do need to remember that you have a lot of rights when it comes to owing delinquent taxes.  

If you find yourself in this tax situation reach out to a true tax professional for assistance to make sure your rights are enforced. In situations like this Enrolled Agents and CPAs have the educational background and licensing to best represent you.

 

Which Education Expenses Are Tax Deductible?

woman taking online courses

For many Americans, their years spent in college are a time when every little extra dollar counts. Fortunately, the government sees this, but they also value higher education so much that there are many different exclusions of income, tax deductions, and tax credits that can be utilized that are associated with different aspects of cost spent on education. 

This article will cover some of the savings programs that parents can utilize that have tax benefits. Then we will go through some of the exclusions and deductions from college expenses that can be utilized on the return to reduce taxable income as well as the different credits that can reduce the actual tax debt owed or maybe even get you a bigger refund. We all know that any sort of tax refund especially when things are tight helps.

 

Saving For Your Child’s College Expenses

There are many different programs and types of savings accounts that have specific tax benefits if the distributions from that account are for higher learning.

Education Savings Bond Program

A taxpayer may exclude all or part of the interest received on the redemption of qualified US savings bonds during the year if the taxpayer uses that interest to pay for qualified higher educational expenses during the same year.

Coverdell Education Savings Account

A Coverdell ESA is a trust or custodial account created or organized in the United State only for paying the qualified education expenses of the designated beneficiary of the account. While there is no tax deduction for contributions, earnings are tax-deferred. You can exclude distributions from a Coverdell ESA from income up to the number of qualified education expenses for the year, adjusted for other benefits received.

Qualified Tuition Programs

A qualified tuition program is a program set up to allow the taxpayer to either prepay or contribute to an account established for paying a student’s qualified expenses at an eligible educational institution. A state, a state agency, an instrumentality of a state, or an eligible educational institution can establish and maintain a QTP.

All these savings mechanisms can help you set aside a nice nest egg for your child’s college education while avoiding taxation. One major qualifier of each one is that the distributions must be spent on qualified education expenses.  

The qualified educational expense for these programs is the amounts paid for tuition, fees, books, supplies, and equipment required for enrollment or attendance to an eligible educational institution. They also include the reasonable costs of room and board for a designated beneficiary who is at least a half-time student. These are the qualified expenses for this type of savings program but remember different tax breaks have different criteria for what is considered a qualifying expense.

Another big way to save money while paying for college is by receiving scholarships and fellowships. These scholarships can provide a path to higher education that may not be feasible by other means. The government values this opportunity of higher education, so they provide a tax break on the income of a scholarship used for qualified educational expenses. 

When it comes to scholarships, qualified educational expenses included are tuition and fees to enroll at or attend an educational institution and any fees, books, supplies, and equipment required for courses at the educational institution. Amounts for room and board do not qualify for this exclusion. 

Another way some parents help their children pay for school is by doing early withdrawals from their IRAs. Typically, when you do an early withdrawal before the age of 59 ½ you must pay a 10% additional tax.  However, if you withdraw the funds to pay for qualified college expenses you can avoid the additional 10% tax. 

The educational expenses must be for yourself, your spouse, you or your spouse’s child, foster child or adopted child, or you or your spouse’s grandchild. Qualified educational expenses in this case include tuition, fees, books, supplies, and equipment required for enrollment or attendance at an eligible educational institution.

 

What Educational Credits Can I Claim on my Taxes?

Outside of some income being used for paying for educational expenses being excluded many credits can be applied to your filing. A tax credit is designed to reduce taxable income. The amount of the credit that you qualify for comes right off the total payable tax. Sometimes these credits can turn your tax bill into a refund. 

There are two major education tax credits that students can utilize to reduce their tax bill: the American Opportunity Tax Credit & The Lifetime Learning Credit. A student or the parent of the student can only claim one of these credits for that student on a tax filing. If you have more than one child, you can claim either of the credits for each child but not both.

The American Opportunity Tax Credit

This credit could reduce your tax bill by up to $2500 if you paid that much in qualified education expenses. You can claim 100% of the first $2000 that you spent on qualified educational expenses. After that, you can add 25% of the next $2000 spent for a total of $2500. 

To qualify for this, you must make under $180, 000 if filing Married Filing Jointly and $90,000 if filing Single, Head of Household or Qualified Widower. This is a partially refundable credit. It can be refundable up to 40% so up to $1000.

The Lifetime Learning Credit

This credit could reduce your tax bill up to $2000 if you paid for students enrolled in eligible educational institutions. The Lifetime Learning Credit is computed on a family-wide basis. The amount of the Lifetime Learning credit is up to 20% of the first $10,000 of qualified education expenses paid for all eligible students. 

To qualify you must make under $138,000 if Married Filing Jointly and $69.000 if filing Single, Head of Household or Qualified Widower. This is a non-refundable credit.

Qualified living expenses for these two credits must be required for enrollment or attendance at an eligible educational institution and include tuition and required enrollment fees. Expenses include amounts paid to the institution for course-related books, supplies, and equipment. Room and board, insurance, medical expenses, transportation, and other similar personal expenses do not qualify.

 

Can I Use Educational Expenses as a Deduction?

The American Tax Credit and the Lifetime Learning Credit will give you the biggest tax break available but if you do not qualify there are other possibilities to save some money. You still may be able to claim a tax deduction for college tuition and fees for yourself, your spouse, or your dependents. This education deduction can be worth up to $4000. 

You can get the full amount of your income is under $65,000 on a single return or under $130,000 if you file jointly. The write-off for singles drops to $200 if your income is more than $65,000 and it disappears when your income passes $80,000. For married couples, the max is $2000 when income passes $130,000 and it is wiped out when income exceeds $160,000.  

Qualified expenses that can be used for this deduction are tuition, student fees, and required expenses for course-related books, supplies, and equipment. Room and board, insurance, medical expenses, transportation, and similar personal living expenses do not qualify. 

If you are self-employed generally can deduct the cost of work-related educational expenses. This will reduce the amount of income subject to both the federal income tax and self-employment tax. The education must be required to keep your present salary, status, or job or to maintain or improve skills needed in your present work. 

Expenses cannot be used in the education is needed to meet the minimum educational requirements of your present trade or business or if the expenses are for a program that will qualify you for a new trade or business. The qualified expenses that can be written off by self-employed individuals are tuition, books, supplies, lab fees, certain transportation, and travel costs.

With all these exclusions, credits, and deductions you cannot double-dip. You cannot deduct tuition and fees if:

  • You also deduct those expenses for another reason (e.g., as a business expense);
  • You or anyone else claims an American Opportunity or Lifetime Learning Credit for the same student in the same year.
  • The expenses are used to figure the tax-free portion of the 529 plan or Coverdell ESA distribution.
  • The expenses are paid with tax-free interest on U.S. savings bonds; or
  • The expenses are paid with tax-free educational assistance, such as a scholarship, grant, or assistance provided by an employer.

In conclusion, as you can see there are a lot of opportunities to save from some of your expenses derived from education. As you can see there are very definitive qualifications and distinct benefits to all these different credits, deductions, and exclusions. 

That is why it is important to reach out to a true tax professional for assistance, so you do not miss out on an opportunity to use them or filing them incorrectly. An IRS Enrolled Agent or CPA has the educational background and licensing to properly advise you and legally save you the most money possible.

 

Earned Income Tax Credit: What It Is and How to Claim It

father and young son

In tough times the hardest hit is always the low-income earners in our society.  This past year has been one of the toughest times this nation has ever seen. It is important at this time to know all the tax credits available when filing your return to either reduce your tax debt or strengthen your refund. A tax credit is a dollar-for-dollar reduction of the income tax you owe. 

In previous articles, we have covered a few of these credits. I have mentioned this credit in previous articles, but today we will go into further detail about the Earned Income Tax Credit. If you make under $56,844 you may qualify for this and be able to save substantial money.

 

What Is the Earned Income Tax Credit?

The Earned Income Tax Credit (EIC) is a refundable tax credit for low- and moderate-income workers. This credit was first enacted in 1975 to provide financial assistance to working families with children. It was originally conceived as a “work bonus plan” to supplement the wages of low-income workers, help offset the effect of social security taxes, and to encourage workers to steer people off welfare programs. It continues to be viewed as an anti-poverty tax. 

The credit has evolved over the years and now helps taxpayers with or without children.  Since the credit is considered refundable, if your tax credit exceeds your tax liability, you may be eligible for a refund.

 

How Do You Qualify?

The main qualifier for this tax credit is you must be earning income. Earned income includes wages, tips. and net self-employment income. A taxpayer who only has income from unemployment, alimony, child support, or interest is not considered earned income for qualification for the EITC. There are 7 rules the IRS requires taxpayers to meet to qualify for the credit.

  1. You must meet the minimum income requirements. Your 2020 AGI must be below $56,844 if you have three or more qualifying children. $53,330 if you have two or more qualifying children. $47, 646 if you have one qualifying child and $21,710 if you do not have children.
  2. You must have a valid social security number.
  3. Your filing status must be single, married filing jointly, head of household, or qualifying widower. Taxpayers who file married filing separately can not qualify for the earned income credit.
  4. You must be a US Citizen or resident alien.
  5. If you earned foreign income and are required to file form 2555 you will not qualify.
  6. Your investment income must be $3650 or less. Investment income includes interest income, dividends, rents, or royalties.
  7.  You must have earned income to qualify.

What Is the Income Limit?

As mentioned earlier there is an income limit for the earned income credit. The income limit is based on the number of qualifying children that you have. The first important part of that would be to determine what a qualified child is.

Qualifying Child

A qualifying child is a child that meets the IRS requirements to be your dependent for tax purposes. Though it does not have to be your child, the qualifying child must be related to you. There are four tests a person must satisfy to qualify as a qualified child. 

Relationship

The taxpayer’s child or stepchild (whether by blood or adoption), foster child, sibling, stepsibling, or a descendant of one of these.

Residence

Has the same principal residence as the taxpayer for more than half the tax year. Exceptions apply in certain cases, for children of divorced or separated parents, kidnapped children, temporary absences, and children who were born or died during the year.

Age

Must be under the age of 19 at the end of the tax year, or under the age of 24 if is a full-time student for at least five months of the year.

Support

Did not provide more than one-half of his/her own support for the year.

The income limits to qualify for and how much you qualify for adjustments based on how many qualified dependents that you can claim. The EITC ranges from $1502 to $6728 depending on tax filing status, income, and the number of children. Below as seen on Nerd Wallet are the maximum earned income tax credit amounts, plus the max you can earn before losing the benefit all together.

 

2020 Earned Income Tax Credit

(for taxes due in April 2021)

Number of childrenMaximum earned income tax creditMax earnings, single or head of household filersMax earnings, joint filers
0$538$15,820$21,710
1$3,584$41,756$47,646
2$5,920$47,440$53,330
3 or more$6,660$50,954$56,844

 

Taxpayers who are married filing separately can not qualify for the earned income credit. The rules are also different for military members and clergy or ministers. If you or your spouse get nontaxable pay as a member of the Armed Forces, you do not have to include it as earned income on your federal taxes. If you and your spouse do choose to include your nontaxable pay as earned income for the EIC, you may owe less tax and get a larger refund. 

A person who includes their nontaxable income as earned income must include all of it. If you are a clergy member or minister you must include the rental value of the home you live in, or the housing allowance if that was provided to you by the church. You must also include all income provided to you working as a minister if you are an employee.

 

Earned Income Tax Credit Fraud

With substantial amounts of money flowing through the EIC program, it has become a fertile ground for tax fraud. The IRS estimates that between 21-26% of EIC claims are fraudulent. Some of the errors are unintentionally caused by the complexity of the law but some of the claims are intentional disregard of the law. The fraud is so rampant that the IRS has added a clause that if found erroneously claiming the credit you are prohibited from claiming the credit for two years. 

There are many ways that people have defrauded this program. One common scam is that people with no earned income will report cash income right at the level to receive the greatest allowance from the program. 

Another common tactic used is if one person has children but does not have income, they will allow someone else who did not help support those children to use their children for the credit. In a lot of these circumstances, the parent of the children and the person filing with the children will split the money. 

And another common practice is when married couples split their qualifying children and both file as head of household to reap the benefits of the EITC. 

With these known practices of fraud, the IRS has tightened up on their review of returns filing for the EITC. The IRS uses both internal information and information from external sources such as other government agencies. The information of the return is matched with information already on file with the IRS and other government agencies. If the review shows questionable or incomplete information, the IRS holds the EIC portion of the taxpayer’s refund ad contacts the taxpayer to verify the information. 

The IRS also uses a screening process based on historical information to select returns for examination. The IRS can conduct these exams both pre and post the refund. Unfortunately, currently, the IRS does not have the resources to examine all questionable EIC returns. 

In this age of computers, a lot of offenders are caught. At this point not only will you have to pay back the refund and credits received but you will also be assessed interest, penalties, late payment penalties, and possibly under-reported fines. If you don’t pay this amount back they can garnish your wages or freeze your bank accounts.

 

How to Claim the Earned Income Tax Credit

To claim the EIC, you must complete your Form 1040 with a complete EIC schedule attached. The EIC schedule requires you to provide your qualifying child’s name, social security number, date of birth, age, relationship, and residency information. This information is especially important to have correct on the forms because this is verifying your rights to the credit. 

There are many tax software programs and apps available that can assist you with this. When trying to take advantage of all the different credits available to a taxpayer it would usually financially benefit somebody to hire a true tax professional such as an Enrolled Agent or CPA.

In conclusion, if you qualify for the EIC then definitely take advantage of it. It has been found to be an effective program in fighting poverty. If you do not qualify, I would highly recommend not trying to defraud the system that helps so many. Not only is it wrong and takes away from the ones who need it but if you are one of the ones that get caught the consequences are costly.

 

How Solar Tax Credit Works

installation of residential solar panels

With the science showing indications that there is a necessity to change the way energy is provided, many people are making the change towards renewable energy. 

Renewable energy is useful energy that is collected from renewable resources, which are naturally replenished on a human timescale, including carbon-neutral sources like sunlight, wind, rain, tides, waves, and geothermal. These forms of renewable energy generate energy without producing any greenhouse gas emissions from fossil fuels and reduce some types of air pollution. Also, they can help pull our country away from dependence on imported fuels. 

With all this necessary benefit the government has put forth tax credits to incentivize people to utilize renewable energy and make investments into their properties to make their residences more energy efficient.  These incentives are coming in the form of tax credits. 

One of the most popular and the ones we will discuss further today is the Solar Tax Credit. I will start off by explaining exactly what the solar tax credit is and the benefits it provides. I will also give a little bit of the history of this credit.

 

What Is a Tax Credit?

A tax credit is a sum that can be subtracted from the total payable tax and offsets the overall liability. If an individual is charged more tax, then the excess tax is given as a tax credit which can be adjusted against future liabilities. So, if you owe $1000 in taxes and you qualify for a $1000 tax credit your net liability would be zero. It is an actual dollar to dollar reduction.

 

What is the Solar Tax Credit?

The Solar Tax Credit is also known as the investment tax credit and allows you to deduct 26% of the cost of installing a solar energy system from your federal taxes. The Solar Tax Credit was first introduced in 2005 as a 30% reimbursement credit. The credit was a part of the Energy Policy Act of 2005 during the Bush Administration. It has been extended annually since then up to 2015. 

In 2015 it got a long-term extension with a dropdown. The plan dropped the credit down to 26% in 2020, 22% in 2021, and down to zero after 2021. Fortunately, new legislation signed last year would keep the credit at 26% for 2021 and 2022 then drop it to 22% in 2023. This means that you are reimbursed 26% of the actual cost of the full cost of purchasing and installing the solar power system. 

Since this credit was introduced the U.S. solar industry has grown by more than 10,000% not only helping our environment but it has also helped create hundreds of thousands of jobs and investing billions in the economy in the process.

 

Do I Qualify for the Solar Tax Credit?

The major form of solar energy that can be installed and qualify for reimbursement through credit is solar panels. Solar energy property is recognizable for the solar array on its roof or on its grounds. They are typically black panels that are filled with solar PV &photovoltaic) cells. These cells convert sunshine into useable electricity. 

The tax credit is not only good for personal taxes and residential property it can also be used on a business filing with a commercial property. If you are trying to utilize the credit on a personal tax return the property must be one that you own not one that you rent. It must be a property that you live in for at least part of the year, so vacation homes are eligible. These residences can include a house, a houseboat, condominium, cooperative, mobile home, and prefabricated homes. 

Also, the solar equipment must be owned not leased. If a new homebuyer buys a newly built home with solar and owns the system outright, the homeowner would be eligible for the credit the year they move into the house.

Solar panels are not the only equipment that qualifies for the tax credit. Geothermal heat pumps, small wind turbines, fuel cell property, energy-efficient heating and air conditioning systems, water heaters, and biomass stoves also qualify. If this equipment or solar panels are used to heat a swimming pool or hot tub they do not qualify. 

Rental properties that are not lived in throughout the year by a taxpayer also do not qualify. But if you live in the house part of the year and rent it while you are not there it will qualify. If you live in the house part-time you will have to reduce the credit for a vacation home or rental to reflect the time when you are not there. If you live there for 3 months of the year, then you can claim 25% of the credit.

Unfortunately, the solar tax credit is a nonrefundable credit. This means if the credit is more than the taxes owed the remainder will not be sent out as a refund as some other credits do. The credit can be carried back 1 year and forward 20 years. This means if you had a tax liability last year, but you do not have one this year you can still claim the credit.

 

How Do I File For The Solar Tax Credit?

To claim the solar tax credit, you must complete an IRS Form 5695 and include the result on your IRS schedule 3 on the 1040 form.  This form calculates tax credits for a variety of qualified residential improvements. These steps as seen on energysage.com break down how to fill out this form.  

  • First, you will need to know the qualified solar electric property costs. That is the total gross cost of your solar energy system after any cash rebates. Add that to line 1.
  • Insert the total cost of any additional energy improvements, if any, on lines 2 through 4, and add them up on line 5.

filing for a Solar Tax Credit step 1

  • On line 6, multiply line 5 by 26%. This is the amount of the solar tax credit.

filing for a Solar Tax Credit step 2

Note: this is from the 2019 form when the ITC was still 30%.

  • Assuming you are not also receiving a tax credit for fuel cells installed on your property, and you aren’t carrying forward any credits from last year, put the value from line 6 on line 13.

Now you need to calculate if you will have enough tax liability to get the full 26% credit in one year.

  • Complete the worksheet on page 4 of the instructions for Form 5695 to calculate the limit on tax credits you can claim. If you are claiming tax credits for adoption expenses, interest on a mortgage, or buying a plug-in hybrid or electric vehicle, you will need that information here. (For this example, the total federal tax liability is $7,000.)

screenshot of the Solar Tax Credit worksheet

  • Enter the result on line 14 of Form 5695. Review line 13 and line 14, and put the smaller of the two values on line 15.
  • If your tax liability is smaller than your tax credits, subtract line 15 from line 13, and enter it on line 16. That’s the amount you can claim on next year’s taxes.

filing for a Solar Tax Credit step 3

Add the credit to Schedule 3/Form 1040.

The value on line 15 is the amount that will be credited to your taxes this year. Enter that value into Schedule 3 (Form 1040 or 1040-SR), line 5, or Form 1040NR, line 50.

filing for a Solar Tax Credit step 4

The steps above outline all you need to do to have 26% of the cost of your solar panel system credited back to you! If you did energy efficiency improvements to your home in the same year, you may also need to complete page 2 of Form 5695. Either way, be sure to include Form 5695 when you submit your taxes to the IRS.

In conclusion, if you are ever thinking about installing any of this equipment to make your home more energy-efficient now is the time. It seems that this credit keeps on getting extended, but it has been reduced so you never know what the future will bring. At this point, it expires in 2024. 

Obviously, for some people it is just not affordable but if it is the 26% credit and the savings over time in reduced energy bills seem to make it a great investment. Currently, estimates show the average national cost to purchase and install panels on a residence is $16,860. This would result in a tax credit of $4618. 

This is still an excessively big investment so the next thing to consider is the savings on energy cost. Studies show that solar panels will pay for themselves after three years. Also, some states and counties offer additional credits as well. In some areas, if your equipment produces excess electricity that you do not use it can be sold to your electric company. 

Of course, one of the most important reasons to go solar is so that you can do your part for our environment. With the present administration and their push for more green energy, the credit could get better but acting now you know you will get huge savings.

 

A Guide to Tax Credit for First-Time Homebuyers

man holding a key to his new home

During President Joe Biden’s campaign, he had made promises about bringing back incentives and credits to help first-time homebuyers. At a time when interest rates are at an all-time low, there may be some help coming through Congress for those wanting to buy their first home. 

Rep Earl Blumenauer and Rep Jimmy Pancetta announced sponsorship of two bills.  If passed they could result in as much as $25,000 in down payment assistance and a new first-time home buyer’s credit up to $15,000. Rep. Blumenauer stated that this legislation would help those who have been historically shut out of the housing market If passed these huge incentives this will open a chance to buy for so many people that have been waiting on the sidelines with hopes of buying a home.

 

Who Qualifies for the First-Time Homebuyer Tax Credit?

The first big question is who qualifies as a first-time home buyer and has eligibility for this tax credit.  Eligibility will come down to income level, home price, and other factors. Qualification would be reserved for first-time homebuyers. They are considering people for the first-time home buyers’ tax credit anyone who has not owned a home in the last 3 years, a single parent or displaced homemaker who has only shared ownership with a spouse while married, or anyone who has owned a home that not permanently connected to a foundation. Also, someone who owned a home but lost it due to financial distress including foreclosure can qualify.

With the 1st Bill which is “The Down Payment Toward Equity Act of 2021” up to $20,000 can be provided to a homebuyer as assistance. $25,000 can be provided to eligible homebuyers if the buyer qualifies as socially or economically disadvantaged. For the average home buyer, this would take the average homebuyer 14 years to save this amount. So, this can provide substantial help. 

To be eligible for this grant a homebuyer cannot make more than 120% of their median local income. The amount required to be paid back to the government will be dependent on how long you live in the home. If you are not living in the home within the 1st year, then you would have to pay back the debt in full. Each year after that the amount you would have to pay back would decrease by 20%. So, if you lived in the home for 5 years you would not have to pay back the amount at all.

 

How the Tax Credit Works

The 2nd bill is the “1st Time Home Buyers Act “this would provide a tax credit of up to 10% as a home’s purchase price or as much as $15,000 to first-time home buyers. To be eligible for this you cannot make more than 160% of your area’s median income. A tax credit directly reduces your actual tax bill. A lot of people confuse it with a deduction, which reduces taxable income. 

Also, this credit will be considered refundable which means that if you owe less in taxes than the amount received you would receive the difference added to your annual refund. This would be like the first-time homebuyer credits approved by Congress during the great recession. A big difference from those tax credits is that this credit could be advanceable to be used at the time of purchase which would help homebuyers unable to save up much-needed down payments.

Studies show that the advanceable 15% tax credit could cover a standard 3.5% down payment for a 30-year mortgage with a low rate of 3% which is readily available from the banks would set up 9.3 million renters so they could purchase a home and have a monthly payment at 1/3rd of there income. A standard 3.5% down payment on a typical home sold was less than $15,000 in 40 out of the largest 50 US Metros. This is based on the median home value in their area in 2020. Alexandra Lee a Zillow economic analyst said, “Legislation that reduces barriers to homeownership could allow millions of renter households to finally enjoy the stability and wealth-building owning a home can provide.”

There have been initiatives in the past like this that have helped a collapsed housing market. In 2008 during the financial crisis, many home buyers who had bought their homes just before or during the housing market collapse found themselves upside down on their mortgages. This means that they owed more on the mortgage than the home was worth.  Sometimes this difference was significant. This 2008 tax credit covered homes purchased between 2008 & July 2009 and allowed homebuyers to claim a credit up to 10% of the purchase price up to $7500. Approximately 1.5 million homeowners took advantage of this tax credit before it expiring in 2010.

At this point, there are already many other tax benefits to owning a home. This deduction can be taken if you decide to itemize on a Schedule A. Remember from earlier since the 2017 Tax Act almost doubling the standard deduction it may not be beneficial to itemize. But if you choose to itemize this deduction can apply to any mortgage insurance paid. This is a deduction, not a credit so this would be a reduction in the taxable income.  This would obviously reduce the overall tax but unlike the credit, it is not a direct reduction of the tax debt. 

This tax deduction applies to any mortgage insurance you paid from a conventional loan or one backed by a government agency like an FHA loan. You can also deduct the funding fee from a mortgage-backed from the Department of Veteran Affairs. You can also deduct mortgage interest on your federal tax return. If filing married filing jointly you can claim interest paid up to $1 million if the loan was originated before 2017. If originated after 2017, you can deduct the mortgage interest up to $750,000 for MFJ and $375,000 if filing single or separately. 

 

Tax Credits Related to Energy Efficiency

Property tax and any state income tax are also deductible. You may deduct up to $10,000 of state and local taxes from your federal taxable income. There are also renewable energy tax credits. If you have made upgrades to your home that have improved their energy efficiency you may claim credit for 10% of the cost of the qualified energy efficiency improvement. As detailed on the IRS website, qualified energy efficiency improvements include the following products:

  •       Energy-efficient exterior windows, doors, and skylights
  •       Roofs (metal or asphalt) and roof products
  •       Insulation

Residential energy property expenditures include the following qualifying products:

  •       Energy efficient heating and air conditioning systems
  •       Water heaters (natural gas, propane, or oil)
  •       Biomass stoves

Other Programs That Could Benefit First-Time Homebuyers

Each state has its own versions of the first-time buyer programs as well. Many of these programs were created in the 1980s to encourage homeownership. New Jersey for example provides down payment assistance to first-time buyers. This program provides $10,000 towards a down payment and closing costs. New Hampshire offers a Mortgage tax credit which helps reduce taxable income. This can save you thousands yearly on federal taxes owed.

If the bill is passed this new credit could be available as early as next year. It still has a hard road to go to become law but if passed the legislation would make 10% of the nation’s renters about 4.37 million people eligible for down payment assistance. As quoted on Yahoo Finance Sunny Shaw, the president of the National Association of Housing and Redevelopment says, “The refundable tax credit proposed in the bill would increase homeownership among low- and moderate-income Americans, especially those from marginalized communities with historically low homeownership rates.”

The hope is that this assistance could help stimulate minority homeownership. There are still other hurdles that must be passed to enter homeownership and benefit from the tax credit. The two major qualifiers to obtain a mortgage to pay for the property after a down payment are income and credit. A lot of renters may not be positioned to qualify for the mortgage even if a down payment is provided. 

Also, people can only benefit from the credit if there is affordable housing in their area. Currently, there is such competition and tight inventory that homes are selling at a historically quick pace and extremely high prices. If you can’t qualify for a mortgage or there aren’t homes available for sale in your price range, then these programs unfortunately are of no benefit to you. This may be the case for many aspiring homeowners.

In conclusion, this new tax credit if passed will provide many the ability to purchase a property and take advantage of the low-interest rates and the stability of homeownership. If you are one of these people who have always wanted to buy but found it impossible to set money aside for the expected down payment on a property, then definitely follow this through the law-making process. If approved make sure you reach out to a certified tax professional, either an enrolled agent or CPA to make sure to get all the benefits from these programs.

 

Child Tax Credit: How It’s Beneficial and Who Benefits from It

a Hispanic mother and her young son

With the current economic situation, there have been many different programs added and changes made to existing benefits to help provide for families. One major change was to the Child Tax Credit. With the most recent $1.9 million American Rescue Plan presented by President Joe Biden, this credit has been temporarily increased for the 2021 tax year. 

This article will explain the Child Tax Credit, how it works, and how it has changed over time up until the point of these new major changes. Once the history of the credit is understood we can further explore the changes that have been made with the American Rescue plan and how they may benefit you and our economy.

The Origin of the Child Tax Credit

The credit itself is not something completely new. This is a credit that has been around since 1998. It was originally introduced by 1997 legislation and was first available to taxpayers to be used in 1998. It started as a $500-per child non-refundable credit to taxpayers but has steadily increased over the past 20 years. In the beginning, this was a nonrefundable credit generally available to the middle and upper class. The changes over the years have not only increased the amount of the credit but it has also made it available to lower-income families.

The biggest increase before The American Rescue Plan was back in 2001. When Congress enacted the Economic Growth & Tax Act of 2001 it doubled the child tax credit to $1000 per child and made it partially refundable. The change from nonrefundable to refundable means that that if the amount of the credit exceeds income tax liability it would be added to the taxpayer’s refund. In prior years, the credit would be lost if it exceeded the income tax liability. 

Recent Changes

This year, the refundable Child Tax Credit (CTC) earnings threshold was set at $10,000 so families could now receive a subsidy for earnings above that amount. In 2017 tax law increased the maximum value of the Child Tax Credit from $1000 to $2000 per child.

There have also been changes over the years regarding who qualifies for this credit. Over the years key parameters of the credit have been changed, expanding the availability to more low-income families. With the 2017 increase, they also increased the income threshold at which the credit begins to phase out. In addition, the 2017 act also requires taxpayers to provide an SSN associated with each child. 

Failure to provide the child’s current social security number could result in the taxpayer being denied the credit. This helped cut down on the fraud that unfortunately was taking place regarding this credit, but it also ended the CTC being available for more than 1 million children lacking a social security number in low-income families.

The most recent changes within the American Rescue Plan have drastically changed the amount of the credit. It has been made more available to low-income families. It has become fully refundable, meaning families can receive the full excess amount as a refund. At his point, these changes are just temporary for the tax year of 2021. The Act increased the amount tax filers can claim up to $3600 for children under the age of 6 and up to $3000 per child ages 6 to 17. 

The Act also expanded the availability of the tax credit to millions of families who did not qualify before. In the past households had to earn $2500 in income and could only receive $1400 if the tax credit exceeds taxes owed. With the changes from the Act, families will qualify for the maximum credit regardless of how much they earned. This expansion of the credit makes it available to millions of families who did not qualify before.

As seen on NBC, Kris Cox the deputy director of federal tax policy at the Center on Budget and Policy Priorities said that some 27 million children, including half of Black and Latino children because their families did not earn enough. She said the poorest children have been getting the least from this credit she added that “this bill is completely historic because it would shift that and make sure that low-income children receive the full credit. The expansion would lift millions of children above the poverty line.

Who Qualify for the Child Tax Credit?

Not all families with children will qualify for the higher child tax credit. The enhanced tax break begins to phase out at adjusted gross incomes of $75,000 on single returns, $112,500 on the head of household returns, and $150,000 on joint returns. The amount of credit is reduced by $50 for each $1000 of the adjusted gross income over the applicable threshold amount.

Another major difference will be the distribution of the credit. Typically, the child tax credit would be applied to income tax owed, or if it exceeds the amount owed portions of it would be disbursed through a tax refund. With the American Rescue Plan half of the amount that you qualify for will be distributed by the IRS as monthly payments between July and December. You will receive the second half when you file your 2021 tax return next spring.  This means up to $300 a month per eligible child under 6 and up to $250 per month for each eligible child between 6 & 17 years old. 

The IRS has said it will begin sending payments on July 15th. These payments will be based on a taxpayer’s 2020 return or the 2019 return if 2020 has not been filed yet.

With all these changes made and such extra benefit being provided it is important to know who qualifies for the Child Care Tax Credit. At this point anybody with a qualified child dependent below $75,000 income for individuals and married couples below $150,000 income. The big question is what qualifies a child as a qualifying child dependent. 

A qualifying child dependent is a child who meets the IRS requirements to be your dependent for tax purposes. They do not have to be your child, but the qualifying child must be related to you.

A qualifying child is a child whose relationship to you meets five qualifying tests for relationship type, age, residency, support, and joint return.

  • To pass the relationship test the child must be a son, daughter, stepchild, foster child, brother, sister, half-sister, half-brother, stepbrother, stepsister, or a descendant of any of them.  
  • To pass the age test the child must be younger than the taxpayer (or spouse if filing jointly) They must be younger than 19 at the end of the year if not in school and younger than 24 at the end of the year if they are a full-time student. They can be any age if permanently and completely disabled and if this is the situation, they do not have to be younger than the taxpayer.
  • To pass the residency test the child must live with the taxpayer more than half of the year. A child who is born or dies during the year qualifies if the home was the child’s home the entire time the child was alive. A child is considered to live with a taxpayer when at the hospital following birth, or temporary absences due to special circumstances such as illness, education, business, vacation, or military service.
  • To pass the support test the taxpayer must provide more than half of their support.

So, if the child meets these requirements in relation to the taxpayer, they will qualify to add them as a qualified child dependent on the tax return and get the benefits of the increased Child Tax Credit for the 2021 tax year.  

One of the major questions of taxpayers and other politicians is how these credits and additional increases in spending going to be paid for.  There is a major proposal in play to make a significant spending increase in the IRS collections process. They feel this investment will produce 10 times the revenue than the initial needed investment. Please check out my next article about how IRS enforcement will soon get a major boost.

Other Tax Credits That You Might Qualify For

In conclusion, with these major changes to the Child Tax Credit, there is a major benefit of filing correctly. If you do not qualify for the Child Tax Credit, then there many more credits that can be utilized on a tax return. The Earned Income Credit or the qualifying relative credit are good examples of these.  

The American Rescue Plan also added some more credits other than this one that did not exist in tax law in previous years. A good example of this would be the 2020 Recovery Rebate Credit. This will help people claim credit for missed stimulus check payments. 

They are also pushing to extend the new benefits of the Child Tax Credit into future years as well. With this said with all the different credits and deductions being added and changing every year it is so important to get the right tax professional to assist you in your filings. 

Always look for somebody reputable who holds a licensing that backs up their education. CPAs and IRS Enrolled Agents are the ones that have the level of education to maximize and use everything within tax law to save you money.