Ask a CPA

I recently had to cash in a 401k to help defray some living expenses because of hardship. I lost my job. What should I be looking at concerning tax penalties? I want to get a feel on approximately how much I should be looking to pay. Also, What can I do to reduce my tax burden because of my actions?

401k distribution information In general, early distributions taken from a 401k plan incur a 10% tax Federal penalty AND the amount distributed is added to a person's taxable income for the year the distribution occurs. (Depending upon where you live, there may also be a STATE penalty for distribution and also state income tax. ) There are some exceptions to the penalty for immediate and heavy financial need.

The information about how the Internal Revenue Service classifies "heavy financial need" and additional information is available on the IRS site at http://www.irs.gov/retirement/participant/article/0,,id=151787,00.html .

The rules are complex, and we recommend that individuals receive advice from a tax professional.

The steps you can take to reduce the tax liability from the distribution are the same ones which you should normally take to pay the least legal amount of taxes. There are no special procedures to follow.

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My husband and I had already mailed our taxes off and received our refund in the mail when our daughter reminded us that she and I had sold $1102 worth of books and such on eBay. After we paid shipping fees, PayPal fees, and eBay fees we cleared $856.07. That isn't half of what these materials cost us new. We were wondering do we have to pay tax on this income?
You asked a great question, especially since eBay and online auctions are so popular.

The government taxes personal gains, but not personal losses. If you sell items for more than you paid for them, tax is owed. If you sell personal property for less than you paid for it, you incur a non-deductible personal loss. There is no income tax due on what a seller receives when it is a loss.

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My parents sold their house in 2004 and will end up paying a little over $20,000 in capital gains tax which we computed. If they did not increase their estimated tax payments to cover this gain, will they incur an underpayment penalty? They are both retired.
In general, you are expected to submit estimated tax payments to the Federal government that are:
- equal to 90% of the current year's (2004's) estimated taxes,
  Or
- equal to 100% or 110% of the previous year's (2003's) taxes. Your parents' adjusted gross income level determines whether the percentage is 100 or 110.
The IRS discusses estimated taxes more fully on their website.

Your parents or their tax preparer will need to look at the estimated tax payments made during 2004 to determine whether or not they are subject to an underpayment penalty. Links from the IRS page referenced above also let you calculate the amount of the underpayment penalty, if any.

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I am a sole-proprietorship small business owner. Unfortunately, I have had to claim a net loss on Schedule C for 2002, 2003 and now 2004 will also be a loss. I am actively marketing/advertising the business trying to bring in a profit but have not been able to do so. I would like to give it one more year.
Am I allowed to claim a Schedule C net loss 3 years in a row and if not, what are my options?

In general, a person in a circumstance similar to yours may be allowed claim a Schedule C net loss three years in a row.

The question the IRS looks at is whether or not the activity is truly engaged with a profit-making motive and not a way to write off a hobby. So, as long as the individual is actually engaging in this activity to make a profit, it is a business and the individual can claim the loss. Net income is just one factor in determining that an activity is engaged in for profit. Other factors are :

(1) manner in which taxpayer conducts the activity
(2) expertise of taxpayer or his advisers
(3) time and effort taxpayer spends on the activity
(4) expectation that assets used in activity may appreciate in value
(5) taxpayer's success in similar or dissimilar activities
(6) taxpayer's history of income or losses with respect to the activity
(7) the amount of profits
(8) taxpayer's finances and
(9) elements of personal pleasure or recreation

The general presumption is that you need to make a profit 3 out of 5 years in order to show profit motive. However, this is just one of the elements and can be easily rebutted by the other 8 elements.

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Are property management expenses like finding a tenant, advertising, repairs, a new Washer/Dryer and fridge deductible? I also upgraded my laptop to keep track of my bookkeeping.

In general, business expenses can be deducted to offset income in order to determine net profit or loss of a business. The most common form that business income and expenses are recorded on is a Schedule C, although Schedule E is used to track rental property transactions. In this case, to know where your expenses should be recorded, there would have to be a determination of whether your property management activity is a business or simply part of managing your own personal rental properties.
Some items -- such as expenses for items which typically have a useful life of more than one year -- are capital expenses and part of their cost is deducted over several years. Any expenses on your list that fall into this category may not be fully deducted in their first year of use. Instead you would depreciate the item and deduct part of the item's cost for several years. The number of years over which you depreciate an item varies according to the IRS rules for the type of item.

You might want to read the IRS instructions on depreciation. That page itself points to several other pages that cover depreciation details. There is a specific IRS publication on Residential Rental Property which you may also find helpful.

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I have an office in my home. Can I deduct a portion of our rent and utilities on my taxes this year?

The home office deduction is a great example of the complexity of our laws. In general, the IRS requires that a home office space be dedicated for business in order for it to qualify as a deductible expense. If you have such an area, then you may be able to deduct a percentage of your rent and other expenses. The percentage you deduct would be the same as the size of the office area to the overall house. These costs would be recorded as business expenses and used to offset income from your business. The IRS has more information available on calculating the deductions at http://www.irs.gov/instructions/i8829/ch01.html and other pages of their site.
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I have heard somewhere about deducting Christmas gifts? Is that possible?

Personal gifts for Christmas, birthdays, or other occasions are not deductible.
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Can I deduct sales taxes?

The 2004 revisions to the Federal tax law allows you to deduct either the state income tax or sales tax you paid. The IRS provides tables which tells you by state and income level the amount of assumed sales tax you may deduct. A booklet is available from the IRS at http://www.irs.gov/pub/irs-pdf/p600.pdf . The rules also allow you to declare your actual sales tax paid, if it is above the assumed level and if you are able to document this higher amount.

You or your tax preparer should calculate your tax bill using both the state income tax deduction and state sales tax deduction. Then choose the option which results in the lower tax for you.
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I was wondering if it is possible to write off my car registration. My tax person asks for it every year, but I've heard from the California DMV that you can only write off licensing fees? Is that true?

There are several fees included in the vehicle registration amount that you pay. Most are not deductible.

When you look at the statement that the DMV sends you, there is a box on the right side of the form which lists all the fees .

The line that says "vehicle license fee" is the amount which is deductible from Federal taxes. In California no DMV fees are deductible from state taxes. The other fees (registration fee, county fees, special plate fees) are not deductible from either return.

Generally, for 2004, the California nondeductible fees amount to $48. So, CPAs will often ask their clients for the DMV fee and subtract the amount of the nondeductible fees in preparing the return.
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My husband was sent to Iraq in Feb 2004. I bought a used laptop computer to keep track of his military pay and communicate with his unit and him. Can I deduct the cost of the computer since it was purchased for military purposes?

We appreciate the service of your husband and the sacrifice of your entire family.
All three of our partners tried to find something in the tax code which would support deducting the computer from the amount of taxes you owe. Based on the information in your email, they could not locate anything in the law which would clearly make the computer a deductible expense.

If there are other factors, such as an order from your husband's commander to buy a computer to retain his position, then a tax professional might be able to advise you to take a deduction.

Even then, the computer would be an un-reimbursed employee business expense.
That would mean that only that amount which exceeds 2% of your adjusted gross income could be deducted. And then, it could be deducted only if you are able to itemize.

Thank you for sending in your question. I wish we could provide the answer you were looking for.

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I am selling my personal residence. Do I have to purchase a new house to avoid paying tax?

No. If you have lived in your personal residence two out of the preceding five years, you may exclude up to $250,000 of gain from your taxable income ($500,000 for a married couple filing jointly). You do not need to purchase a new home to do this.
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My wife and I bought and lived in our condo in South Florida for just over a year prior to my retirement from my job. Then we sold it realizing $6728 and moved to Central Florida to be near our family. We have not claimed any other residence sale since 1999. Can we exclude this gain from our income even though we owned and lived in it less than 2 years? I believe a change in employment would satisfy the requirement. Would retirement also satisfy the rules?

The rules for excluding the gain from the sale of a residence allow for a reduced gain exclusion under certain circumstances, even if the residence was sold before it was occupied for two years. Details on this rule are on the IRS site.
There are a number of conditions which, if met, would allow you to exclude the gain. These are (from the IRS site):
- A change in place of employment
- Health
- Unforeseen circumstances (as defined later on the IRS web page).
Unhappily, none of the reasons listed by the IRS obviously fit your situation.

You should read the sections on Unforeseen Circumstances, Changes in Employment, and Health to see if any of those exclusions apply. Alternatively, you may want to engage a local tax professional to research your specific situation.
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Less than two years ago I sold my condo which was my personal residence. I had a $125,000 gain from the sale. I then bought a new condo which has appreciated about $100,000, and I now want to sell it. If I sell the property, will I be taxed on the gain?
You are only allowed the capital gain exclusion ($250,000 single/$500,000 married filing jointly) from the sale of your personal residence on one sale every two years. If you sell before the two years you will have to pay full capital gain. However, there are rules with regard to a reduced exclusion amount if the two-year test is not met. The overall rules apply to job relocation, health, or unforeseen circumstances.

The two-year time test starts on the day you purchased the second property. And, the capital gain exclusion requires that you have lived in the new condo as your primary residence the entire two years.
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My husband and I sold our house last year. We were forced to move due to constant harassment to our daughter from girls that lived across the street from us. She was followed home from the bus everyday and jumped at school, and our house was vandalized. After the fight, the harassment continued on a daily basis and my daughter was afraid to even walk to the bus stop or even go to school. I finally was forced to remove her from the school for her own safety because the girls were threatening to jump her again. Our daughter couldn't even go outside because the girls would be waiting for her — sometimes in our driveway — trying to get her to come out. Anyway, we really had no choice but to sell our home to end this. We were about 1 1/2 months shy from being there for the two years but we just had to go. Do you think that this would qualify as unforeseen circumstances.
From your inquiry, it sounds like that you're aware that the IRS rules for excluding the gain from the sale of a residence allow for a reduced gain exclusion under certain circumstances, even if the residence was sold before it was occupied for two years.

As you mention, one event which allows for excluding the gain is unforeseen circumstances. The IRS offers this explanation: "The sale of your main home is because of an unforeseen circumstance if your primary reason for the sale is the occurrence of an event that you could not reasonably have anticipated before buying and occupying your main home."

The IRS web page goes on to list five situations which are safe harbors. A problem with neighbors is not listed there.

If one of our clients had a similar reason for a home sale, we would tell them that the IRS would likely be skeptical of an unforeseen circumstances claim. The IRS would have to be convinced that harassment by underage girls required mature adults to sell their home.

We would want our client to have documentation available regarding complaints made to the police, complaints made to the school, discussions with the harassers' parents, and other steps taken to resolve the problem. Other helpful records would include a disclosure statement to the new buyers of the house notifying them of an known problem with the neighborhood that could affect their enjoyment of the property.

Even if our client had persuasive evidence to show an IRS auditor, we still could not guarantee what the IRS would do. However, with strong documentation we believe a reasonable person could overcome an IRS auditor's initial skepticism.

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We have been living in our principal residence for less than 2 years and have about $150K built up in equity. We are looking for ways to extract the equity without being taxed on it. Is it possible for us to get a Home Equity Line of Credit or a second mortgage taking us up to 90%-100% of the home's value and then sell the house to escape paying income tax on the property when we sell it. We are looking to sell it before the 2-year mark.

The size of the mortgage on the residence will not affect the amount of taxes you will have to pay.
To identify the gain that might be taxable on your personal residence, we would want an estimate of how much the selling price of your home would be. We would also need to know what the purchase price of your home was plus any improvements that you may have made to the home. The difference between these two amounts would be the gain that might be taxable when you sell the home. The amount owed in home equity loans and mortgages is not part of the gain calculation.

Married couples can exclude up to $500,000 (for single taxpayers, the amount is $250,000) in gain arising from the sale of their principal residence provided that they owned and used the home as their principal residence for at least two years out of the five years before the sale. A reduced exclusion is available if the sale occurred because of a change in place of employment, health, or other unforeseen circumstances where the taxpayer fails to meet the two-year ownership and use requirements.

We recommend that you sit down with a CPA to discuss the specifics of your situation and how you might be able to plan the tax impact of selling your home.
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I have a rental home that I want to sell. It was previously my primary residence up to about 7 years ago. It has been a rental property for the past seven years. How much taxes do I have to pay If I do not invest the profits into another rental property?

The Federal tax law allows you to exclude from income the gain of the sale of your home. However, you must have used the residence as your main home for at least two of the prior five years. If you have not lived in the home for seven years, it does not appear that you would qualify for this exclusion.
For rental property, in general, people owe taxes on the gain they make from the sale of the property. Calculating the gain involves a number of factors including the original purchase price, cost of improvements made over the years, and the amount of depreciation claimed for the rental property.

The percentage of tax paid on any gain varies according to a number of factors including the person's overall income and other factors. For 2004, the maximum capital gains rates are 5 percent, 15 percent, 25 percent or 28 percent.

The IRS discusses the sale of rental property and other assets on its web site.

If you have questions after reviewing that the IRS says, I would recommend that you contact a local accountant or tax preparer to assist you in calculating the taxes owed on this transition. My recommendation is especially strong if you have not sold rental property before and do not have a previous sale to help you with the different items to consider.

It sounds from your email that you are still considering selling your property. If possible, talk with a tax preparer BEFORE you sell so that you are aware of the selling documents that will help you prepare your taxes next January.

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Back in the mid 90s, my wife and I purchased a few lots in Florida. At that time, we thought we would probably build on them, during our retirement years. Well, as luck would have it, our heaths will probably prevent us from fulfilling our dreams. Because of this circumstance, we are now considering selling these lots in the near future. These lots have went up in value, over the years, so we believe we will be in a capital gains tax situation. If we sold these unimproved investment lots, what kind of tax liability can we expect? Would they be treated like long-term stock investments and be taxed at 5% for those of us in the 15% income tax bracket?
Generally, appreciated unimproved real estate is considered investment property and would quality for the long-term capital gain rate that corresponds to your tax situation (5% for individuals whose regular tax rate is in the 10% or 15% brackets).

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I am single and participate in a 401(k) at work. Can I still contribute to an IRA?

It depends.... If your Adjusted Gross Income is less than $45,000 you are able to take full advantage of an IRA deduction.

If, on the other hand, your income exceeds $45,000 then your deductible contribution is reduced. Once your Adjusted Gross Income is $55,000, you are not entitled to a deduction at all.

Talk to your accountant about how the deductible "phase-out" is handled when your Adjusted Gross Income is between $45,000 and $55,000.
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I've recently started working as a consultant and will be performing work for several different clients. How will my tax situation change from the days when I received a paycheck?

There are many significant changes that you can anticipate as a result of this change. The first one that comes to mind is that your earnings are not subject to withholding. Instead, you will need to make quarterly estimated payments. These payments will be due April 15, June 15, September 15 and then by January 15 of next year. We can work with you, to minimize the amount of these payments while still avoiding underpayment penalties.
Another significant change in your situation is that your net earnings will be subject to the self-employment tax. For 2004, the rate of this tax is 15.3% of your net earnings up to $87,900 and then 2.9% on the excess.

Your income and expenses will be reported on your form 1040 on Schedule C. You will need to maintain complete records of your income and expenses. In particular, you should pay attention to recording your expenses in order to be able to take the full amount of the deductions to which you are entitled. Certain types of expenses, such as automobile, travel, entertainment, meals, and home office expenses, are subject to special recordkeeping requirements or limitations on their deductibility and require special attention. We'd be happy to discuss these items with you in greater detail when you are ready.
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Can I take a charitable contribution for out of pocket expenses I incur on behalf of a not-for-profit organization? And if so how much and how?

Yes, un-reimbursed monies spent on behalf of a qualified not-for-profit organization registered under Sec. 501(c)(3) is deductible. These monies are deductible as if you contributed CASH to the organization. But, you must receive a letter of acknowledgement from the organization supporting the "out-of-pocket" expense.
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I have a vacation home in Florida. Can I donate a week to a charity and take a deduction for the value of the rental income which I gave up?

No, you cannot take a deduction for the use of property.
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I have a quick question based on your newsletter. What would happen if the company would not send the 1099 or if it would be sent late?

Generally, the IRS may assess a penalty ranging from $15 to $50 per 1099 that is not filed with the IRS by the due date. Additionally, if a 1099 is not furnished to the recipient by the due date, the IRS can assess a $50 or $100 penalty. Generally, the penalties are higher the later the 1099 is filed or furnished to the recipient or if the IRS determines that the 1099's were not prepared due to an intentional disregard of the requirements.
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I live in California. Dad was a Teamster and left me $9,500 from his pension fund when he died. His pension will be paid to me in a single check. I am a school teacher and plan on investing it. How much tax do I have to pay on this money?

Unfortunately, there is not an across-the-board consistent taxable amount for a $9500 pension pay out. The tax depends on a combination of your income and your overall tax situation. Inheritance of a pension falls into a category called Income in Respect of a Decedent (IRD). Sorry that there's not a simple answer for you!
In order to determine how much tax will be owed because of the pension money, a tax preparer would need to do a tax projection on your total income and they would need to look at the pension plan documents in order to apply, where applicable, the IRD rules.

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I provide classroom training around the country. Attendees sign-up for it online. Do I need to collect sales tax?
Your question raises an excellent issue. However, is no general-case answer we can give you. The determination is whether or not the state has jurisdiction over what you "sell" in that state, and that is dependent upon how what you do is advertised, sold, and delivered.

If you were our client, we'd advise you to check with each locality that you visit. Each state has different rules as to what they collect sales tax on and how the state has jurisdiction over the "product." For example, professional services are not subject to sales tax in California, but they
are in Florida.

Equally important for your tax situation, some states and local governments may want to you pay income taxes on what you earn while you teach there. Non-resident income taxes are common, and we would advise a client of ours to look into each jurisdiction in which he or she worked to see what
payments are required.

Many -- but not all -- states have adopted the Uniform Division of Income for Tax Purposes Act (UDIPTA) which can simplify somewhat the payment of the appropriate taxes. But, there are still details which need attention.

Since your situation is complex and involves several different work locations, we recommend that you contact a Certified Public Accountant near your home to help you comply with the differing requirements.