Quick links to articles on this page:
Mortgage Interest Deduction
The Scoop on 1099 Reporting
Credit for Increasing Research Activities
Have you Filed you AZ Corporation Commission Annual Report?
Considerations in Determining Whether to Work after Retirement
Mortgage Interest Deduction
The first test to consider is the Qualifying Residence Test. A qualifying residence is a home that is owned by the taxpayer and is either their principal residence or a second home used by the taxpayer.
Situations do arise where the residence is titled in the name of another which is done for financing reasons. If the taxpayer holds the benefits and burdens of ownership and establishes equitable and beneficial ownership, the taxpayer can take the deduction.
A home can be a house, condo, mobile home, house trailer, or boat. The home must include a bathroom, sleeping quarters, and kitchen. This will include many types of home which many may not think of as a home.
There are two loan types which qualify for the deduction. The first is debt used to acquire, construct, or substantially improve the qualified residence and the debt must be secured by the same residence. The loan balances cannot exceed $1 million, and if they do the portion that exceeds is nonqualified acquisition debt.
Taxpayers can also include home equity debt other than qualified acquisition debt but not more than $100,000. This debt can be a separate loan or $100,000 of the first. For example interest on a $1.1 million loan can be deducted if the $1 million acquisition debt is satisfied. Tracing rules are not required for the $100,000 if deducted under the general home mortgage interest rules.
If the debt that was incurred is refinanced without additional loan proceeds, than the character of the loan and the deductibility of the interest expense remains unchanged. If additional funds are borrowed, interest tracing may be required to determine proper deduction.
Points on Purchase or Refinance
Points are additional charges paid to the lender with the benefit of a reduced interest rate. The general rule is that points are deductible at the same rate as the loan is paid off. If points are paid on a 30 year loan than the points are amortized over 360 months. A special rule exists for immediate deduction if the loan is used to buy or improve the taxpayer's principal residence. There are tests that must be satisfied for points to qualify (clearly stated on settlement, computed as a percentage of principal amounts, cannot exceed standards, and must use taxpayer's own funds.
Frequently Asked Questions (FAQs)
I paid off my mortgage three years ago and now I would like to use the equity to invest into my start-up company. Can I deduct that interest?
Since the mortgage was paid off, the qualifying loan attributes are lost. The new loan does not qualify as acquisition debt and is subject to the $100,000 personal debt limitations and deductible under the home equity debt rules. However, the full amount of the interest can be reported as a business expense under the interest tracing rules.
I paid cash for a house and received a loan to reimburse the purchase 20 days after closing. Would this debt qualify?
There is a 30 day rule that says that the acquisition debt will be deemed to be satisfied if the loan is obtained either 30 days before or 30 days after close. This debt would qualify and the interest deductible, subject to general limitations.
I refinanced my home with new debt without taking additional funds; does the refinance change the character of the loan?
If no additional funds are taken the character and deductibility of the interest carryover into the new loan.
I have the ability to take a second mortgage on the property even though there is no equity left in the home, does this interest qualify?
If there is no equity left in the home, than the loan is not home equity indebtedness and is considered a personal loan. The interest is not deductible.
I am building a house using a construction loan which will convert to a traditional 30 year loan on completion. How does this impact the qualifying rules test?
A residence under construction is a qualified residence for a period of 24 months, if the property becomes a qualified residence at that time and is ready for occupancy the loan qualifies.
I am refinancing my home and will take additional funds out for a family vacation, what tax implications must I be aware of?
The first is that the value of the home must be sufficient to cover the loan at the time of refinance. Secondly the $100,000 home equity rules apply.
I have a new loan in which the funds went to multiple uses, am I required to follow interest tracing rules?
If the nonqualified resident portion is less than $100,000 no tracing is required. If the funds are more than $100,000 and are deductible elsewhere on the return, interest tracing is required in order to properly deduct the correct amounts on the correct forms.
How does this change when I have multiple uses of funds on the loan and principal payments are made in future years?
If interest tracing is required, the order of repayment is not prorata as some might suspect. The repayment is deemed to be in the following order:
investment expenditures and passive activity expenditures
active participation real estate expenditures
formers passive activity expenditures
active trade or business expenditures.
This creates a more favorable situation for taxpayers as the active trade or business is deemed to be paid last. The business debt is deemed to be held the longest when multiple uses of the loan proceeds are spent.
I have a loan that was used for business and the business closed, does this change the character of the interest deduction under the interest tracing rules?
The deduction of the interest does not change. For example if funds were used for a business reported on schedule C and the business subsequently closes, the future interest payments will continue to be deductible as a business expense.
I used some of the money to purchase tax-exempt bonds; does the $100,000 limitation still apply?
No, a taxpayer cannot deduct interest which is used for generating tax-exempt income. Interest tracing is required in this situation and the portion attributable to non tax-exempt income and non qualified debt is subject to the $100,000 limitation. This rule prevents taxpayers from reaping double benefits on the deduction of interest without paying tax on the income that the loan proceeds create.
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The Scoop on 1099 Reporting
Many of you have heard about the recent legislation that was amended by the 2010 Health Care Act which included a new requirement for everyone engaged in a trade or business to file a Form 1099 for every payment made to another person totaling more than $600 in a year.
Understandably, this has raised many questions about what all this new law entails.
We have had several inquiries as to what the process is for meeting this requirement.
First the good news: Currently this law is not scheduled to take effect until after December 31, 2011. So you are off the hook for this year.
Secondly, the hopeful news: Efforts are being made to repeal this law partly because it contradicts the IRS paper reduction act. It was not, however repealed during the most recent “Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010” signed into law on December 17, 2010. We are hoping it was a timing issue and there just wasn’t enough time to address the repeal of Code Section 6041(a) to include it in this most recent legislation that was passed.
Worst case scenario: Beginning in January of 2012, you will need to track all payments made by you or your business to determine which Forms 1099 will need to be filed. This will include anyone whom you pay more than a total of $600 in gross proceeds for property or services in a year. You will be required to obtain EINs or Social Security numbers and mailing addresses for each of these persons or businesses in order to complete the Form. Forms 1099 will need to be filed with the IRS as well as a copy sent to each individual or business. Non-compliance will result in penalties.
We will most definitely keep you posted on the status of this law.
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Credit for Increasing Research Activities
We have already contacted our clients whose businesses may qualify for valuable tax credits under Research and Development activities. If you have family, friends or acquaintances that are business owners, do them a favor and ask them if they have looked into applying for this credit. They could be entitled to thousands of dollars in refunds from the IRS by filing amended returns if they have not utilized this credit to which their business may be entitled.
This R&D tax credit can generate many opportunities. Among them:
~ A hidden and immediate source of cash for many small and mid-sized companies.
~ Creates a significant reduction to current and future years federal and state tax liabilities.
~ The R&D tax credit is not a deduction; it is an actual dollar-for-dollar credit against taxes owed or taxes paid. Additionally, the taxpayer may be able to expense all such qualifying R&D costs in the year incurred.
~ More than $7.5 billion in federal R&D tax credit benefits alone are given out annually. More than 80% goes to a few of the nation’s largest companies.
~ A business can take the credit for all open tax years, generally the last three or four years plus the current year.
~ Tax credits may carry forward 20 years.
~ Recent tax laws are taxpayer-friendly and bring additional benefits.
~ In addition to the federal R&D tax credit, many states offer a state R&D tax credit as well.
We have found that many clients regard their own efforts to make new, lighter, stronger, cheaper, more reliable products, or to make more precise, more economical, and more versatile processes as “just doing my job,” when in fact they have been performing R&D qualifying activities all along.
As defined in the tax code, research and development activities must meet four main requirements to be eligible for tax credits:
1. Business component development or improvement
2. Elimination of uncertainty
3. Process of experimentation
4. Technological in nature
Businesses involved in any of the following activities may qualify to file a claim for the R&D tax credit:
Developing an innovative product that is new to the market
Engineering and designing a new product
Research aimed at discovering new knowledge
Searching for ways to apply new research findings
Designing product alternatives
Evaluating product alternatives
Significant modifications to the concept or design of a product
Designing, constructing, and testing preproduction prototypes and models
Engineering activity to advance the product’s design to the point of manufacture
Systems processing modeling
System and functional requirements analysis
Experimenting with new technologies
Experimenting with new material and integrating the material to improve manufactured products
Engineering to evaluate new or improved specification/modifications in terms of performance, reliability, quality, and durability
Developing new production processes during prototyping and preproduction phases
Research aimed to significantly cut a product’s time-to-market
Research aimed to obtain more efficient designs
Developing and modifying research methods/formulations/products
Paying outside consultants/contractors to do any of the above activities
When the pace of business was accelerated and competition fierce, business owners were more likely to overlook this source of cash because they lacked the time, resources or expertise needed to identify and manage R&D tax credit claims. If the slowdown in the economy has affected their business, the time to look for additional cash resources may be now. The funding for the R&D credits has already been allocated by the government; the distribution of these funds is left open for those who qualify to apply. If reading this article causes a particular business to come to your mind, they will thank you for bringing this to their attention. Please give our name and number to the owner and ask him to give us a call. We will be happy to help them determine if they should perform a study to ascertain if they qualify for this credit.
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Have You Filed Your AZ Corporation Commission Annual Report?
The Arizona Corporation Commission no longer gives notice to businesses that the filing of their annual report is due. For those of you who have been in business for many years, you may recall receiving your renewal notice/form in the mail a month before you needed to file. A couple of years ago the AZ Corporation Commission discontinued this practice and have made the forms available on line for electronic filing or to download and print to file by mail. They also will mail a form to you, upon request. The Corporation Commission used to send out a postcard to remind business owners when the filing due date was approaching.
Please be aware that as of October 1, 2009 they no longer do this. It is up to you to remember when to file. There have been clients who have over-looked this filing and the penalty has been costly. In addition to the $45 annual fee a $9 per month penalty is assessed. After 60 days the ACC sends out a delinquency notice. We are aware of circumstances where some of our clients have no knowledge of receiving such a notice. If after 120 days you still have not remembered to file your report there is a dissolution notice sent to your statutory agent. To reinstate a business following an Administrative Dissolution, you must pay a $100 filing fee plus your $45 annual fee, the $9 per month penalty, and an additional expediting fee of $35 (recommended).
A larger cost for this oversight is that you may lose your business name. During the time you are “Administratively Dissolved” because of your failure to file, the name of your company is up for grabs to anyone who files a request for it. It makes no difference how many years you have owned that company name. As this is something easily over-looked and each business has their own due date (unlike April 15th) we would like to suggest you mark this important date on your new 2011 calendar now!
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Considerations in Determining Whether to Work After “Retirement.”
Since an individual's excess earnings may affect his own benefits as well as those that are payable to his dependents, while the earnings of a dependent or survivor reduce only the social security check of that dependent or survivor, before considering any type of work, an individual should determine the expenses of working. One would have to pay social security or self-employment taxes on those earnings—even though he is receiving social security benefits. He also may be required to pay federal income taxes on that income, depending on his total income. An individual should remember that, above a certain level of income, a portion of any social security benefits is taxed. Also important are direct expenses, such as the cost of transportation, meals, clothing, etc.
An individual also should also take into consideration that if he earns more than $14,160 in 2011 and is between age 62 and full social security retirement age, he must forfeit $1 in benefits for each $2 of excess earnings—a 50 percent reduction in earnings over $14,160 (or $1,180 per month). Individuals who reach full social security retirement age in 2011 forfeit $1 in benefits for each $3 in excess benefits for each month before reaching full social security retirement age; the income level for these individuals is $37,680 or $3,140 per month (both unchanged from 2010).
Individuals need to face these facts head-on; however, the offset of earnings against early retirement benefits is merely a factor to consider in determining whether to continue to do at least some paid work after electing to receive early retirement benefits. The offset should not prevent an individual from working who needs or chooses to do so.
If an individual is collecting benefits and knows that his earnings will exceed the annual limit, he should notify his local Social Security Administration (SSA) office. By doing so, benefits can be withheld currently instead of the individual having to repay them later. As soon as his earnings drop, the benefit payments can start in full again. He must file a report of his calendar year earnings by April 15 of the following year. The report form is available at any SSA office and is filed with SSA, not IRS.
An additional point to remember about continuing to work: More earnings may help raise an individual's social security retirement benefit. If an individual has worked all of his life in social-security covered employment, higher current earnings may substitute for earlier lower earnings years. If close to the minimum years of coverage, additional years of work raise the amount of benefits payable even more directly.
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Armando Roman, who has been a partner with Johnson, Harris & Goff during the past three years served a dual role as principal of his own wealth management firm. He has decided to focus his efforts exclusively in the wealth management practice, and has left our firm. We wish Armando success with AXIOM Financial Advisory Group, LLC. which is just downstairs from us!
As we begin a new year, we would like to take this opportunity to thank you again for your business. Being able to preserve relationships with you, our clients, is of upmost value to us. We hope that 2011 brings success and stability for your business and health and happiness for your lives.
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