Dependents and Deductions: Writing off the Cost of Supporting Adult Children and Elderly Parents

Providing support for an adult child or elderly parent is an addition to your financial burden—but it can also be a deduction from your taxes. The IRS permits taxpayers to claim adult relatives (and non-relatives who live with the taxpayer) as dependents on their tax return for a write-off of up to $3,700.

These days, that’s a useful tax tip for many Americans (Credit’s due to The Wall Street Journal, which recently brought the deduction to greater attention for tax season). With unemployment high, many kids graduating from high school or college can’t find jobs, so they’re staying reliant on Mom and Dad. Meanwhile, many members of the huge Baby Boomer generation are aging and becoming dependent on their grown children. Census Bureau statistics show that 59 percent of men ages 18 to 24 and 50 percent of women in the same range live with or are supported by their parents (Those figures were 53 percent and 46 percent in 2005). The statistics also show that 43.5 million Americans care for somebody older than 50 (28 percent more than in 2004).

Does your family make up part of those stats? You might qualify for this tax deduction.

To claim the deduction for an adult child (including a stepchild or eligible foster child):

• You must have provided more than half the child’s financial support in the tax year
• The child must have lived with you for at least six months of the year (temporary absences like attending college may be disregarded)
• The child must have been under age 19 on Dec. 31, or ages 19 to 24 but a full-time student
• The amount of the deduction may comprise the costs of the child’s college, food, clothing, haircuts, recreation, weddings and medical and dental care, as well as the child’s prorated share of the mortgage, utilities and other household expenses

To claim the deduction for an adult dependent such as an elderly parent:

• You must have provided more than half the dependent’s financial support in the tax year
• The dependent’s gross income, minus Social Security benefits and tax-exempt income, must have been less than $3,700
• The dependent must be a U.S. citizen or a legal resident of the United States, Canada or Mexico
• The dependent must not have filed a joint return or claimed him or herself on a tax return

Office Sweet Office

Do you work from home? Have a room in your house that serves as your office away from the office? Frequently do some work before bed at your nightstand-desk? Many taxpayers are aware that a deduction for maintaining a home office is available, but few know what qualifies as a home office for tax purposes.

Your nightstand-desk, unfortunately, probably doesn’t cut it. To qualify for the deduction, a home office must be a part of your home you use exclusively and regularly for business. Moreover, the office must be utilized more than occasionally; how much isn’t precisely defined, but legal precedent suggests 10 hours a week is the minimum.

If you want to claim the home-office deduction, you have to document your use of the office. You can do this with:

• Phone bills showing long-distance calls you made from the office
• E-mails you sent from the office
• A signed guest log showing client meetings you held at the office.

For more information about the home-office deduction, visit the IRS’ website or contact your tax professional.

501(c)-ing the Distinction Between Tax-Exempt Organizations

Whether you’re setting up a nonprofit or just trying to figure out if you can write off a donation to one, it’s essential that you know the difference between a 501(c)(3) and 501(c)(4) organization.

Both types of nonprofits are exempt from paying federal income tax, and both may engage in some form of civic activity—but the similarities end there.

501(c)(3) organizations are permitted to lobby lawmakers on issue-based legislation, but must tell the IRS they’re doing so by filing form 5768, and aren’t allowed to spend more than a certain percentage of their organizational budget on the activity (The percentage depends on the organization’s size). 501(c)(3) groups also aren’t permitted to engage in election-related activity, including endorsing or opposing candidates and donating money or time to campaigns. Finally, donations to 501(c)(3) organizations are deductible as charitable contributions.

501(c)(4) organizations, in contrast, are nearly unlimited in their ability to lobby, so long as their lobbying is related to their mission. They’re also allowed to engage in election-related activity. However, donations to 501(c)(4) organizations aren’t deductible.

If you’re founding a nonprofit and deciding between a 501(c)(3) and 501(c)(4) status, consider how much lobbying you’re planning for the organization to do. Choose a 501(c)(4) status if you’re expecting to lobby fairly extensively, as to not risk violating a 501(c)(3) status. Better yet, you can form two separate but related organizations—one a (c)(3), the other a (c)(4). Many nonprofits do this, using the former for charitable giving and education and the latter for lobbying.

Employment Post-Deployment: Give a Vet a Job, Get a Break from Uncle Sam

Looking to fill a position at your business or nonprofit? Hiring a veteran could be a win-win situation.

7.7 percent of all vets (and a dismal twelve percent of vets returning from Iraq and Afghanistan) are currently unemployed—nearly 900,000 people. The VOW to Hire Heroes Act of 2011, passed late last year, helps put former servicemembers to work by providing for-profit companies and not-for-profit organizations tax incentives for hiring them.

Under the new legislation, employers who hire veterans who (a) are certified qualified veterans and (b) begin work before January 1, 2013 can claim the Work Opportunity Tax Credit (WOTC) as a credit against its share of social-security tax. This credit may be as high as $9,600 for for-profit employers and $6,240 for qualified tax-exempt employers (depending on how long the vet was unemployed before being hired, how many hours they work and how much they earn in their first year of work).

To claim the WOTC under the VOW act, employers must first get confirmation that the hiree is indeed a qualified veteran, then follow a process (different for for-profit and nonprofit employers) for filing a claim. For more information, visit this IRS webpage or contact your tax professional.

Coming Year Looks Turbulent for High-Net-Wealth Individuals

A political climate heating up over tax policy, combined with an election cycle, means the year ahead looks to be an uncertain time for taxpayers—particularly high-net-worth individuals. The New York Times‘ Paul Sullivan recently surveyed tax advisers on how the wealthy should respond to this lack of certainty, and came away with this advice: Batten down the hatches.

“For high-net-worth individuals, chances are the next year or so is going to be a challenging time,” Sullivan was told by Chris Johnson, head of United States wealth advisory at Barclays Wealth. “There is going to be a lot of attention focused on ways to extract additional tax dollars.”

The changes brewing for 2012 include:

• Expiration of about 70 tax breaks, maybe. Congress used to regularly renew these “patches” for a year or two, drawing little attention. But, under unprecedentedly intense scrutiny on tax measures this year, it’s not clear they’ll do so again. The tax breaks are varied, ranging from a patch that allows teachers to deduct $250 for classroom expenses to one that lets people choose between deducting state income or sales tax from their federal tax.

• Expiration of two big tax breaks, definitely. The first allowed people whose marginal tax bracket is under 15 percent to not pay capital gains tax when they sold securities they had held for over a year. The second is a 2010 Tax Relief Act provision that let 100 percent of an investment in a private company be free of capital gains taxes. Both will lapse this year regardless of what Congress does.

• Expansion of the alternative minimum tax. The AMT was designed to apply to the wealthy, but because it wasn’t keyed to inflation, Congress has had to adjust it every so often to prevent it from affecting middle-income taxpayers. Again, intensified scrutiny this year might lead to Congress not making an adjustment, meaning the tax would expand to include about 20 million more people.

• Enactment of broker reporting requirements. Irrespective of Congress’ actions, brokers this year are required to report the purchase price of mutual funds and exchange-traded funds to the IRS for capital gains purposes.

For more information on how tax changes this year could affect you, and for help preparing for those impacts, contact your tax professional.

A Couple Housekeeping Items…

…before we sally forth into 2012:

2012 standard mileage rates

First, the IRS has announced the 2012 standard mileage rates. Standard mileage rates are used to calculate the deductible costs of operating an automobile for business, charitable, medical or moving purposes (in lieu of calculating the actual costs). The new rates are:

• 55.5 cents per mile driven for business purposes
• 23 cents per mile driven for medical or moving purposes
• 14 cents per mile driven in service of a charitable organization

The IRS bases standard mileage rates on an annual independent study of the costs of operating an automobile. The agency adjusts the rates often, most recently last July. This latest adjustment left the business and and charitable rates unchanged, but reduced the medical and moving rate by .5 cents.

Updated Publication 557

The IRS has released an updated version of Publication 557, which contains the rules and procedures concerning tax-exempt status. For nonprofit organizations, knowing what’s new is a must. Some of the top-line changes:

• If a tax-exempt organization fails to file a Form 990, 990-EZ, 990-PF or 990-N annually for three consecutive years, it will lose its tax-exempt status automatically.
• Form 990 has been redesigned—Schedule H (Hospitals) most drastically, due to the passage of the Patient Protection and Affordable Care Act.
• The advance ruling process for section 501(c)(3) organizations has been eliminated. Now, a new 501(c)(3) will be classified as a publicly supported organization (not a private foundation) if, when it applies for tax-exempt status, it can demonstrate that it can reasonably be expected to be publicly supported. 501(c)(3) organizations also will no longer have to file a Form 8734 after their first five tax years.
• Tax-exempt organizations are now supposed to report significant new program services, significant changes in how it conducts program services and significant changes to its organizational documents on their Form 990, instead of in a letter to the IRS Exempt Organizations Determinations.

For more information about these and other tax-related changes concerning nonprofits, contact your tax professional.

Tags: standard mileage rates

Employee Classification and 1099 Forms

The misclassification of employees as independent contractors is a common small-business tax issue that governments have recently been looking at more closely. Last year, the IRS introduced an initiative called the Voluntary Classification Settlement Program that allowed employers who had misclassified their employees as independent contractors to get those classifications in order and merely pay a discounted employment tax.

Now, the state is getting involved. On January 1, a new California law known as SB 459 went into effect, significantly increasing the penalties for intentional employee misclassification. Under the new law, if an employer is found to have violated SB 459, they must “display prominently” on their website a notice that they have “committed a serious violation of law by engaging in willful misclassification of employees.” Fines (depending on whether there is a pattern of misclassification) can range up to $25,000 per violation.

If you work with independent contractors, you should consult an attorney experienced in employment law about whether your relationship with the contractors is appropriately classified.

If you determine that you have indeed properly classified the independent contractors with whom you work, remember: You are required to file a 1099-MISC form each year to show that you paid the contractors for services rendered.

Any time you make an agreement with a sole proprietor or other self-employed person (i.e., not a corporation) for them to perform a service for your business, you should ask them to fill out a W-9 form, including their Taxpayer Identification Number (either a federal Employer Identification Number or a Social Security Number), before they begin work. If you pay an independent contractor more than $600 in a year, you must send them a 1099-MISC form by January 31 of the following year and send the IRS a copy by February 28.

It’s not uncommon for small businesses to fail to file 1099-MISC forms, but if they continually do so,  the penalties can be steep. While fines for unintentionally late or incorrect forms are no higher than $50, they’re no lower than $100 for “intentional disregard” of IRS 1099 rules. And if the IRS audits you and finds just 10 instances where you should have filed 1099s but intentionally didn’t, the penalties can reach into the thousands.