Frequently
Asked Tax Questions |
The following are questions that have been asked by visitors
to Maxwell Shmerler & Co.
Maxwell Shmerler & Co., CPAs
93 Years and Counting
TAX
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IRA QUESTIONS
Can I use last year's AGI to determine if I am
eligible for a Roth IRA conversion in the current year?
- The AGI limit is for the tax year that the
conversion takes place. You cannot use a previous year's AGI to
determine eligibility.
If I convert my IRA into a Roth, how do I pay
the tax due?
- You can no longer pay the tax due on conversion over a
four-year period. The entire tax is due no later than April 15 of the
following year. The
taxpayer should attempt to pay the tax due from non-IRA
funds. If the tax is paid from the IRA funds, a 10%
penalty may apply.
If I convert my IRA into a Roth and
then find out later that year that my AGI will be above the limit
of $100,000, can I simply convert the Roth back into a regular
IRA?
- Yes, you are allowed one re-conversion back to a standard
IRA.
Does the $100,000 AGI limit for eligibility to
convert an IRA into a Roth IRA include the Converted Amount?
- The AGI limit does not include the
converted amount. For example, if a taxpayer's 2005 AGI
is $90,000 and the taxpayer converts a $50,000 IRA into a
Roth, the conversion qualifies since the AGI limit does
not include the $50,000 converted amount. Keep in mind
that tax is still due on the conversion.
Do I have to wait at least five years before I
can withdraw my nondeductible contributions to a Roth IRA?
- No, the nondeductible contributions can be
withdrawn at any time. This is not true for funds
converted from a regular IRA.
How are Nondeductible Contributions considered
when Converting an IRA into a Roth?
- If the IRA contains both tax-deferred and
after-tax funds, the converted amount is considered to
have such funds in the same ratio. For example, if a
$10,000 IRA contains $2,000 (20%) in nondeductible
contributions, than if $5,000 is rolled over, tax
nondeductible portion is $1,000. If you have separate
funds for your after-tax and deferred funds, than you can
convert the after-tax funds and pay no tax on the
conversion.
Can I convert my 401(k) into a Roth IRA?
- No, only IRAs can be converted. To
determine if you can convert your 401(k) into an IRA,
contact your plan administrator.
A Roth IRA allows withdrawal of the
nondeductible funds without penalty at any time. Can a taxpayer
convert IRA funds into a Roth, pay the taxes, and then withdraw
the funds, thus circumventing the 10% penalty on premature
withdrawals from an IRA?
- A 10% penalty will be collected unless the
funds are left on deposit for a minimum of five years.
Can I withdraw my 401(k) funds for up to
$10,000 in first time home expenses without penalty?
- No, only Individual Retirement Account
funds can be used for a first time home purchase.
Should I open separate accounts for my Roth
contributions and Roth conversion funds?
- Yes, you should have separate accounts for
each Roth rollover as well as one for contributions. The
law differs as to distribution requirements for rolled
over funds and contributions. If the funds are
commingled, the first withdrawals will be treated as
coming from the latest rollover. This could force the
taxpayer to pay penalties that would not have to be paid
if the funds were kept separate.
What are the Roth IRA AGI limits for married
filing separately?
- The phase-out range is from $0 to $15,000.
What happens if I convert my IRA into a Roth
and then I find out that my income exceeds $100,000?
- You go to jail for life. Seriously, since
you will not pay the tax until you file your return in
early 2006, you will know whether you qualify at that
time. The problem develops if the custodian of your IRA,
after being informed that you are converting or after
receiving your rollover, wants to charge you to cancel
the conversion. Please consult your IRA custodian for
more information.
-
- Does this mean that you should wait until
the end of the year to convert? The longer your funds are in
a Roth IRA, the longer they enjoy tax-free growth. If
your IRA is worth a great deal, this delay may cost you
an appreciable amount. If your IRA is not worth a lot,
the decision to delay may be prudent. Everyone's
situation is different. Consult your tax advisor for
guidance.
Can I file an amended return and claim my IRA
contributions as nondeductible and then roll the funds into a
Roth in the current year? Since my tax bracket is much higher
now, this will allow me to pay tax at the lower rate on these
contributions.
- Yes, the designation may be changed by
amending the tax return prior to expiration of the
statute of limitations on assessments. Of course, since
contributions must be made by April 15 of the year
following the tax year for which the contributions are
made, no additional contributions may be made after that
date.
-
- Designate your prior deductible
contribution as non-deductible (by filing Form 8606 with
the amended return), pay the tax (and interest) on the
amended return, and convert your prior deductible
contribution to a non-deductible contribution.
- EDUCATIONAL QUESTIONS
Are expenses to pay for qualified education deductible?
Since 2002 there has been a tax deduction from gross income that
enables a taxpayer to take a tax deduction of up to $3,000 per family for
the cost of qualified tuition and related expenses paid for yourself, your
spouse or your dependent(s) to a qualified educational institution. The
deduction is allowed even if you do not itemize your deductions on Schedule A of
Form 1040. However, if you elect to use the Tuition and Fees Deduction,
you cannot also claim the Hope and Lifetime Learning Tax Credit
When can an individual first make a withdrawal from an IRA to pay for
qualified higher education expenses without paying the 10 percent early
withdrawal tax?
An individual can make withdrawals from his/her
IRA to pay for qualified higher education expenses without paying the 10 percent early
withdrawal tax. See Notice 97-53, 1997-40 IRB. The 10 percent early withdrawal
tax does not apply to a distribution from an IRA to the extent that the amount
of the distribution does not exceed the qualified higher education expenses for
the taxpayer, the taxpayer's spouse, and the child or grandchild of the taxpayer
or the taxpayer's spouse at an eligible educational institution. For purposes of
this rule, the term "qualified higher education expenses" means
tuition, fees, books, supplies and equipment required for the enrollment or
attendance of the student at an eligible educational institution. Qualified
higher education expenses also include room and board if the student is enrolled
at least half-time. Qualified higher education expenses paid with an
individual's earnings, a loan, a gift, an inheritance given to the student or
the individual claiming the credit, or personal savings (including savings from
a qualified state tuition program) are included in determining the amount of the
IRA withdrawal which is not subject to the 10 percent early withdrawal tax.
Qualified higher education expenses paid with a Pell Grant or other tax-free
scholarship, a tax-free distribution from an Education IRA, or tax-free
employer-provided educational assistance are excluded.
Who may claim the Hope Scholarship Credit?
An individual paying qualified tuition and related expenses at a
postsecondary educational institution may claim the credit, provided the student
whose expenses are being paid and the institution meet certain eligibility
requirements.
Who may claim the Lifetime Learning Credit?
An individual paying qualified tuition and related expenses at a
postsecondary educational institution may claim the credit, provided the
institution is an eligible educational institution. Unlike the Hope Scholarship
Credit, students are not required to be enrolled at least half-time in one of
the first two years of postsecondary education. Nonresident aliens generally are
not eligible to claim the Lifetime Learning Credit.
What is an Education IRA?
An Education IRA is a trust or custodial account that is created or organized
in the United States exclusively for the purpose of paying the qualified higher
education expenses of the designated beneficiary of the account. The account
must be designated as an Education IRA when it is created in order to be treated
as an Education IRA for tax purposes.
May an individual claim a Hope Scholarship Credit for paying qualified
tuition and related expenses for other family members?
Yes. An individual may claim the credit for his/her own qualified tuition and
related expenses and the qualified tuition and related expenses of his/her
spouse and other eligible dependents (including children) for whom the
dependency exemption is claimed. Generally, a parent may claim the dependency
exemption for his/her unmarried child if: (1) the parent supplies more than half
the child's support for the taxable year, and (2) the child is under age 19 or
is a full-time student under age 24.
What are the eligibility requirements for the student?
A student is eligible for the Hope Scholarship Credit if: (1) for at least
one academic period (e.g., semester, trimester, quarter) beginning during the
calendar year, the student is enrolled at least half-time in a program leading
to a degree, certificate, or other recognized educational credential and is
enrolled in one of the first two years of postsecondary education, and (2) the
student is free of any conviction for a Federal or State felony offense
consisting of the possession or distribution of a controlled substance. For
purposes of the Hope Scholarship Credit, a student will be considered to be
enrolled at least half-time if the student is enrolled for at least half the
full-time academic workload for the course of study the student is pursuing as
determined under the standards of the institution where the student is enrolled.
The institution's standard for a full-time workload must equal or exceed the
standards established by the Department of Education under the Higher Education
Act and set forth in 34 C.F.R. § 674.2(b).
What are the eligibility requirements for the institution?
The college, university, vocational school, or other postsecondary
educational institution where the student is enrolled must be an institution
that is described in section 481 of the Higher Education Act of 1965 (20 U.S.C.
1088) and, therefore, eligible to participate in the student aid programs
administered by the Department of Education. This category includes virtually
all accredited public, nonprofit, and proprietary postsecondary institutions.
(The same eligibility requirements for institutions apply for the Lifetime
Learning Credit, described in the next section.)
The Hope Scholarship Credit may be claimed only for amounts spent on
qualified tuition and related expenses. Which expenses are included in qualified
tuition and related expenses?
The term "qualified tuition and related expenses" means the tuition
and fees an individual is required to pay in order to be enrolled at or attend
an eligible institution. Amounts paid for any course or other education
involving sports, games, or hobbies are not eligible for the credit, unless the
course or other education is part of the student's degree program. Charges and
fees associated with room, board, student activities, athletics, insurance,
books, equipment, transportation, and similar personal, living, or family
expenses are not qualified tuition or related expenses. (The same definition of
qualified tuition and related expenses applies for the Lifetime Learning Credit,
described in the next section.)
The Hope Scholarship Credit is available only if a taxpayer's modified
adjusted gross income is below a specified amount. How does a taxpayer know what
his/her modified adjusted gross income is?
For most taxpayers, modified adjusted gross income is the same as adjusted
gross income. Taxpayers compute adjusted gross income as part of completing a
Federal income tax return. For those few taxpayers who earn income abroad or
receive income from certain American territories or possessions, modified
adjusted gross income will be greater than adjusted gross income. In those
cases, the individual's adjusted gross income will be increased by: (1) certain
amounts that the individual earns abroad, (2) amounts effectively connected with
the individual's conduct of a trade or business or derived from sources in Guam,
American Samoa, or the Northern Mariana Islands (if the individual is a resident
of the possession where the source of the income is located), and (3) amounts
derived from sources in Puerto Rico (if the individual is a Puerto Rican
resident). (The same rules apply for the Lifetime Learning Credit, described in
the next section.)
May a nonresident alien claim the Hope Scholarship Credit?
Generally no. There is an exception for certain nonresident aliens who are
married to U.S. citizens or resident aliens. Nonresident aliens should consult a
U.S. tax advisor to determine whether the exception applies to them. (The same
rules apply to the Lifetime Learning Credit, described in the next section.)
Are qualified tuition and related expenses for graduate-level degree work
eligible for the Hope Scholarship Credit?
No. However, the Lifetime Learning Credit is available for these expenses
May an individual claim a Hope Scholarship Credit for more than one family
member?
Yes. Furthermore, the credit is calculated on a per student, rather than a
per family, basis. For example, if an individual whose modified adjusted gross
income is $35,000 pays over $2,000 in qualified tuition and related expenses for
himself and over $2,000 in qualified tuition and related expenses for his
dependent child, and both he and his dependent child meet the eligibility
requirements, the individual may claim a Hope Scholarship Credit of $3,000
(i.e., a credit of $1,500 for his expenses plus a credit of $1,500 for his
child's expenses).
May both the parent and a dependent child claim the Hope Scholarship
Credit for the child's qualified tuition and related expenses in the same year?
No. Either the parent or the child, but not both, may claim the credit for
the child's expenses in a particular year. If an individual claims the child as
a dependent on his/her Federal income tax return for the year, only the
individual may claim the Hope Scholarship Credit for the child's qualified
tuition and related expenses. If no one claims the child as a dependent on a
Federal income tax return for the year, only the child may claim the Hope
Scholarship Credit for the child's expenses. (The same rules relating to
individuals and dependents apply for the Lifetime Learning Credit, described in
the next section.)
If a married taxpayer files a separate return, may the taxpayer claim a
Hope Scholarship Credit on his/her income tax return?
No. Married taxpayers may claim the credit only if the taxpayer and the
taxpayer's spouse file a joint return for the taxable year. (The same rules
apply for the Lifetime Learning Credit, described in the next section.)
May an individual claim a Lifetime Learning Credit for paying qualified
tuition and related expenses for other family members?
Yes. An individual may claim the credit for his/her own qualified tuition and
related expenses and the qualified tuition and related expenses of his/her
spouse and other eligible dependents (including children) for whom the
dependency exemption is allowed. Generally, a parent may claim the dependency
exemption for his/her unmarried child if: (1) the parent supplies more than half
the child's support for the taxable year, and (2) the child is under age 19 or
is a full-time student under age 24.
What are the eligibility requirements for the institution?
They are the same requirements that apply for the Hope Scholarship Credit.
Are qualified tuition and related expenses for graduate-level education
eligible for the Lifetime Learning Credit?
Yes.
May an individual claim a Lifetime Learning Credit for more than one
family member?
Yes. However, unlike the Hope Scholarship Credit, the Lifetime Learning
Credit is calculated on a per family, rather than a per student, basis.
Therefore, the maximum available credit does not vary with the number of
students in the family. For example, if in 2005 a married individual whose
modified adjusted gross income is $35,000 pays $5,000 of qualified tuition and
related expenses to attend an eligible educational institution, the individual
may claim a $1,000 Lifetime Learning Credit. If in the same year the individual
also pays another $2,000 in qualified tuition and related expenses for his
spouse to attend an eligible educational institution, the individual's Lifetime
Learning Credit is still $1,000
How does a parent claim a Lifetime Learning Credit for the qualified
tuition and related expenses of a dependent child?
The parent may claim the credit on his/her Federal income tax return even if
the child files his/her own tax return. When a child is claimed as a dependent
on the parent's return, any qualified tuition and related expenses paid by the
child during the year are treated as if the parent had paid them and, therefore,
are included in calculating the parent's Lifetime Learning Credit. A child may
not claim a Lifetime Learning Credit on his/her tax return for any year if the
child's parent claims the child as a dependent in that same year. Also, a
married taxpayer who does not file a joint return is not eligible to claim the
Lifetime Learning Credit.
What does the term qualified tuition and related expenses mean for
purposes of the Lifetime Learning Credit?
The term "qualified tuition and related expenses" for purposes of
the Lifetime Learning Credit has the same meaning as it does for purposes of the
Hope Scholarship Credit.
For whom may an Education IRA be established?
An Education IRA may be established for the benefit of any child under age
18. Contributions to the Education IRA will not be accepted after the designated
beneficiary reaches his/her 18th birthday.
May a designated beneficiary take a tax-free withdrawal from an Education
IRA to pay qualified higher education expenses if the designated beneficiary is
enrolled less than full-time at an eligible educational institution?
Yes. Whether the designated beneficiary is enrolled full-time, half-time, or
less than half-time, he/she may take a tax-free withdrawal to pay qualified
higher education expenses.
What are "qualified higher education expenses" for an Education
IRA?
"Qualified higher education expenses" mean expenses for tuition,
fees, books, supplies, and equipment required for the enrollment or attendance
of the designated beneficiary at an eligible educational institution. Qualified
higher education expenses also include amounts contributed to a qualified state
tuition program. Qualified higher education expenses also include room and board
(generally the school's posted room and board charge, or $2,500 per year for
students living off-campus and not at home) if the designated beneficiary is at
least a half-time student at an eligible educational institution. The standards
for determining whether a student is enrolled at least half-time are the same as
those used for the Hope Scholarship Credit.
- HOME SALE GAIN
EXCLUSION QUESTIONS
If I do not meet the 2-out-of-5 year residence
requirement, do I qualify for any gain exclusion?
- You may qualify for a partial exclusion.
This partial exclusion is based on the ratio of the
number of days residing in the residence over 730,
multiplied by the maximum exclusion rate ($500,000 for
married filing jointly).
If I sell part of the land that my primary
residence sits on, can I exclude the gain?
- No, only a sale that includes the
residence may be eligible for the gain exclusion.
In order to qualify for the $500,000 exclusion
on home sale gain, do both spouses have to meet the ownership and
use tests?
- Only one spouse has to meet the ownership
test while both spouses have to meet the use test.
To meet the 2-out-of-5 year rules, does the homeowner have to
live and own the home for the same period
- No. The time owned and living in the house does not have
to be the same period.
1040 FILING
QUESTIONS
Should I file Married Filing Separately
or Jointly?
- There is really no way to be able to
answer that question for sure, other than by actually
preparing both "sets" of returns, and see which
ones come out better.
In general, those who MIGHT benefit from filing
separately are couples who:
1. Both work outside of the home,
2. Have sizable medical deductions that apply to only one
of them,
3. Have income from separate investments or property
4. Do NOT live in a community property state (or do, but
most of their holdings are separate property under state
law), OR
5. You are separated or contemplating a separation, and
have doubts about the wisdom of being individually liable
for your joint tax liability.
(Hint: If even only one of the above applies to you, you
might consider trying to file separately, and see if it
would come out to less than filing jointly.)
Note: There are significant restrictions that apply to
Married Filing Separately returns. For example, you BOTH
must itemize or claim the standard deduction, you do not
get the $25,000 exemption from passive treatment for
active-participation rental real estate losses, and half
of ALL of your Social Security benefits are taxed. Be
sure you read the instructions carefully for guidance
with these and other restrictions.
If you live in a community property state, state law may
dictate how you need to report your earned income, as
well as certain other income and deductions. Local
professional guidance is suggested.
-
- How do I determine if someone is a
Dependent?
-
- In order to be able to claim someone as a
dependent, they must not have claimed themselves when
filing a return (if they had to file), and you must
satisfy EACH of FIVE tests:
1. RELATIONSHIP or MEMBER OF HOUSEHOLD test: The
dependent must
be related to you by blood or marriage. This includes
children (including legally adopted), brother, sister,
parents, grandchildren, great-grandchildren, parents-in-
law, daughter/son-in-law, brother/sister-in-law, step
brother/sister, half brother/sister or - if related by
blood - your aunt, uncle, nephew or niece. If you do NOT
meet the relationship test, the dependent can still
qualify if he or she lived in your home the ENTIRE tax
year. This would include a foster child (any child who
lived in your home as a family member for the year).
2. UNMARRIED test: The dependent must be unmarried at the
end of the year OR, if he or she is married, cannot be
filing a joint return with his or her spouse.
3. CITIZEN OR RESIDENT test: The dependent must be a
citizen of the United States, a resident alien, a
resident of Canada or Mexico, or your adopted child who
is none of the above BUT who lived with you all year in a
foreign country.
4. INCOME test: In general, the dependent cannot have had
gross income subject to tax of $2,700 or more.
EXCEPTIONS: The income limitation does not apply if the
dependent is your child AND either - is under age 19 at
the end of the year OR - is under age 24 at the end of
the year AND a full-time student for any part of five
months in the tax year.
5. SUPPORT test: Generally, you must be able to establish
that you have provided MORE than half of the dependent's
total support for the tax year. The cost of support
includes food, clothing, education, medical and dental
care as well as the fair rental value of shelter
provided. This must exceed the total of all other
assistance coming from other sources, including other
relatives, government entities, the person's savings and
non-taxable income.
Note: Special rules apply to divorced or separated
parents, or cases where the bulk of the person's support
is provided by two or more people. See Forms 8332 and
2220, respectively.
-
- How do I treat my child's interest
and dividend income?
-
- A return must be filed by (or for) a
dependent child, if the child has income above ANY of the
following limits:
- Wages (when added to self-employment income) over a predetermine
amount (changes yearly)
- Unearned income over $650
- Total income over $650 includes at least $1 of unearned
income
- Self-employment income over $400
- Sale of stock, bonds or mutual funds (whether at a gain
or loss) if the gross proceeds from the sale exceed $650.
If your child has to file a return, and is being claimed
as a dependent on your return, he or she cannot also
claim a personal exemption on his or her personal return.
If your child is under age 14 at the end of the year, and
has investment income, Form 8615 must be attached to the
child's return, to determine what portion (if any) of the
income is to be taxed at the parent's marginal rate.
Under certain circumstances, you can forego filing a
separate return for your child, if you elect to report
his or her income on your return using Form 8814. This
election is available ONLY if ALL of these conditions
apply:
- All income is from interest or dividends only
- Income does not exceed a predetermined amount
- No estimated tax payments have been made in the child's
name
- No taxes were withheld from the income
- If the child is under 14 at year end, you are the
parent referred to in the instructions for Form 8615.
Note: Under most circumstances, we do NOT recommend that
this Form 8814 election be made. It will generally result
in a higher portion of your child's income being subject
to tax, will increase your AGI (which limits some of your
deductions), could increase or cause an underpayment
penalty, and could make an even more dramatic difference
on your state income tax return.
Starting in 1998, the new tax law provides some
relief from the taxation of unearned income under $250,
even if the dependent has earned income over $650. See
the summary of the new tax law, elsewhere in the FAQ
area, for details.
- I received a 1099-OID. How to I
report this income?
-
- Original Issue Discount (OID) is the
difference between the principal (or "face
value", redeemed at maturity) and the (lower) price
at which it was issued. Generally, part of the OID is
assumed to be received each year you hold the bond, and
is taxed in same manner as interest income on that bond.
Each year, the issuer of the bond (or your broker, if you
bought it on the secondary market) will provide you with
a Form 1099-OID, reporting the OID it believes is taxable
to you that year. This is calculated on the assumption
that the discounted price was your acquisition price, and
that you held the bond for every day of the tax year.
If you bought or disposed of the bond during the year, or
paid a premium over the discount amount in buying the
bond, the amount of OID shown on Form 1099-OID will be
more than what you actually have to report. (The same may
be true in cases where you have stripped or coupon bond.)
In such cases, you should report the Form 1099-OID amount
on Schedule B, but then subtract out (as "OID
Adjustment") the difference.
-
- How do I file if I was recently
divorced?
-
- For tax purposes, your marital status is
determined as of December 31st of the tax year.
Therefore, if you are legally married as of that date,
your filing status choices are generally married filing
joint or married filing separately. While filing a joint
return is usually easier, it can have drawbacks if the
other party does not cooperate in assembling the
information necessary, and both spouses will remain
separately liable for the income and deductions of BOTH
parties reported on the joint return.
One exception: If you do not live together, nor mingle
your finances, for the last six months of the tax year,
AND you paid more than half the cost for the year of
keeping up the home in which you and your dependent child
lived, you can generally file as Head of Household.
If you live in a community property state, be aware that
your state law will determine what allocations need to be
made between your separate returns for the period of time
you were married.
For a divorce decree after 1985, the custodial parent is
generally permitted to claim the dependency exemptions
for the children, regardless of who actually provided
most of the support. If the custodial parent agrees that
the other parent should be able to claim the child, he or
she must sign a Form 8332 which gets attached to the
non-custodial parent's return for the year.
-
OTHER QUESTIONS
An LLC can elect to be treated as a
Corporation or Partnership. What happens if the LLC has only one
member?
- If you have a one member LLC owned by an
individual that elected non-corporate treatment, you'd
simply report the income on the appropriate form on Form
1040 (Schedule C for a business, Schedule E page 1 for a
rental, etc.).
Do Mutual Fund Capital Gain Distributions have
to go on Schedule D?
- Yes, and if they are long term capital
gain distributions, the tax rate is less than if added to
ordinary income.
If I buy land on which I will build my primary
residence, can I deduct the interest on the loan to purchase the
land?
- Yes, under specific circumstances. Qualified
residence interest is deductible up to specific
limits. A residence under construction may be treated as
a qualified residence for a period of up to 24
months, but only if it qualifies as of the time it is
ready for occupancy.
ESTATE PLANNING
What is the Unified Credit for 2004 and is it the same
for gifts.
The Unified credit for 2004 remains at $1,000,000 for
gift tax purposes. The Credit increases to $1,500,000 for estate tax purposes. This means that an individual can shelter up to
$1,500,000 of
assets from estate tax.
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Revised: January 11, 2006.