Tax 101: What to Watch Out For While Filing Taxes

It is tax season! There are reasons to love tax season. The first being, we have no option because the only thing that is certain in life is death and taxes, except if you somehow have figured out how to decode both. It is widely known that there are experiments underway that are tackling the concept of death through life extension with billionaire backers such as Larry Ellison being very keen on the results. In fact, we are already experiencing an increase in life expectancy. We have already gained significant ground on the Grim Reaper. An American born in 1950 could expect to live anywhere between 20 to 25 years longer than one born 50 years earlier, and every five year interval since then has gifted another one to two years of life to US citizens. Now, can we live forever? Well, my friend that is indeed a difficult question to answer at this point in time.

As for the other inevitable brother, taxes, it is something that almost everyone except a considerable few cannot avoid. A not so popular fact among the masses is that the rich (top 1%) paid 37.3% of the total federal income tax, however, the reasons to love tax season are numerous. Not only do we get to enjoy a nice refund (for those who get one), we also discover new opportunities that can be used to our advantage. As they say: the more you know, the better. I will highlight some tax concepts that you might be over-looking in this blog post.
Taxes can be simply broken into 2 categories – Income and then Expense/Deductions/Credits. After 6 years of filing my taxes myself, I always seem to find out something new that can be used to my advantage or something new that I need to be aware of. The IRS maintains a great database with lots of information for every specific case and can be referenced while working on taxes. In fact, the IRS maintains a page with links to where you can even file your taxes for free on their website.
To start off with a slight negative but something to be aware of – Rental activities are considered “passive” activities, and a “loss” on a passive activity is not deductible against non-passive income, such as wages and investments such as stocks. What is considered a “loss” here is after deductions such as property tax, mortgage interest, and depreciation. It is not simply the “earnings” as defined by rental income – operating expense. The positive to a rental “loss” is that the loss can be applied to another rental assuming the individual owns multiple rental properties. There are ways and guidelines given by the IRS to calculate depreciation for each property type. There are exemptions to this rule and it can be found directly on the IRS website with the key to the exemption being the modified adjusted gross income phaseout rule. Below is the phaseout rule from the website of the IRS. “The maximum special allowance of $25,000 ($12,500 for married individuals filing separate returns and living apart at all times during the year) is reduced by 50% of the amount of your modified adjusted gross income that’s more than $100,000 ($50,000 if you’re married filing separately). If your modified adjusted gross income is $150,000 or more ($75,000 or more if you’re married filing separately), you generally can’t use the special allowance. This is because the special allowance is reduced to $0 since the modified adjusted gross income is over the $100,000 amount.”
Another thing to be aware of for those who have Qualified Business Income (QBI) is the section 199A deduction. This deduction may be available to owners of sole proprietorships, partnerships and S-corporations. The deduction was created by the 2017 Tax Cuts and Jobs Act, and allows non-corporate taxpayers to deduct up to 20 percent of their QBI, plus 20% of qualified real estate investment trust (REIT) dividends and qualified publicly traded partnership (PTP) income. There are also income phaseout rules and you can find more information on that here.
Schedule K-1: MLPs and LLCs are often able to pass more income on to investors because they don’t pay corporate income taxes, but that comes at the cost of more complexity and potential tax implications. In other words, because these entities don’t pay corporate taxes, the distributions paid to investors may be treated differently than dividends paid by corporations. A typical corporation’s regular dividend is taxed as long-term capital gains, while much of the income paid and shown on a Schedule K-1 can be classified as regular income. That means it’s taxed at your effective income-tax rate, which is often much higher than the 15% or 20% long-term capital gains rate for regular dividends. If you’re receiving them due to investments in LLCs, partnerships, or a “C” corp, you should look at the bigger picture. Those entities are often able to pay out more of their cash flows because of their legal structures, but you’ll probably pay more tax on your end. In some cases, you’ll also get a share of the losses, deductions, and credits, as well. In other words, there are numerous potential benefits to these kinds of structures. 
Ways to Decrease Tax Liabilities:
There are simple ways to lower your tax liabilities. I will go ahead and list some of those out below.

1. Contribute as much as you can to your retirement account – You can contribute up to $19,000 to a 401(k) and up to $6,000 to an IRA in 2019. You can also make additional catch-up contributions of $6,000 to a 401(k) and $1,000 to an IRA if you’re over 50. For those who are business owners, the SEP IRA contribution limit is $56,000. Yes that is right $56,000 but the actual contributions are limited to 25% of your net earnings from self-employment.

2. Take advantage of tax loss harvesting – You can harvest your losses to offset taxes on investment gains or to reduce your taxable income up to $3,000 each year. 

3. Invest in an HSA – When you put money into an HSA, you invest the funds with pre-tax dollars. This means you could reduce your taxable income by $3,500 if you max out your contributions. You can then take out this money tax-free to cover healthcare costs, so you get a huge tax benefit since both deposits and withdrawals are tax free. And, if you don’t use the funds for healthcare, you also have the option to withdraw money after age 65 and be taxed on the distributions as ordinary income without paying any penalties.

4. Save for college for the kids in your life – If you have a kid, saving for college in a 529 is a no-brainer. But, even if you do not have your own child, you can open a 529 plan for other kids in your life, including grandchildren, nieces and nephews, and even friends. You could even open a 529 to save for your own college tuition if you’re planning to return to college.Contributions to 529 accounts aren’t tax-deductible on the federal level, although invested funds grow tax free. But, depending where you live, you may be able to deduct 529 contributions from your state taxes. In fact, more than 30 states as well as Washington DC allow either deductions or credits for 529 contributions.

5. Bundle your deductible expenditures – Lots of tax deductions such as the deduction for medical expenses, charitable contributions, and mortgage interest are available to you only if you itemize. The standard deduction is large in 2019. Unless your itemized deductions exceed $12,200 for singles; $24,400 for married filing jointly; $18,350 for head of household; or $12,200 for married filing separately, itemizing would not make sense. But, there may be a way to preserve these itemized deductions by bundling them. Basically, this would involve making two years worth of deductible payments or contributions in one taxable year. If you donate $10,000 annually to charity, for example, try donating $10,000 for 2019 throughout the year — and make your full 2020 $10,000 donation in December of 2019. This would mean you now have $20,000 in deductions for one year, so it could suddenly make sense to itemize when it didn’t before.

6. Deduct every business expense you’re entitled to – Business owners have a lot of different deductions they can claim, but many people are reluctant to take advantage of some of them for fear of being audited. In particular, people are afraid to take the home office deduction. If you’re legitimately entitled to a deduction, you should never be afraid to claim it. Just make sure you know the IRS rules and can prove you’re in compliance.

7. Have a baby – Alright, this one might be stretching it a bit but kids come with a whole bunch of tax breaks! While this is definitely not reason enough to add another child to your family, you should be aware of all of the federal tax benefits you get for your bundle of joy. These include the child tax credit, which tax reform doubled to $2,000 per qualified child under aged 17 ($1,400 of which is refundable). Having a child could also make you eligible for an earned income tax deduction at a higher income than if you’re single, and could entitle you to claim head-of-household filing status instead of single status (provided you meet specific requirements related to supporting your child).

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