Article Highlights:

Interest Categories
Category Deductibility
Interest Tracing Rules

If you borrow money will the interest you pay be deductible for income tax purposes? The answer to that question can be complicated, and unfortunately, not all the interest an individual pays is tax-deductible. The rules for deducting interest vary, and essentially depend on what the loan proceeds are used for: personal items, investment, home mortgage, business activities or higher-education. Interest expense can fall into any of the following categories:

Personal interest – is not deductible. Typically, this includes interest paid on personal credit card debt, personal car loans, home appliance purchases, etc.
Investment interest – this is typically paid on debt incurred to purchase investments such as land, stocks, mutual funds, and the like. However, interest on debt to acquire or carry investments that produce tax-free income is not deductible at all. The annual investment interest deduction is limited to ‘net investment income,’ which is the total taxable investment income reduced by tax-deductible investment expenses. Prior to the tax reform enacted in 2017, these expenses often included investment advisory fees that were part of miscellaneous itemized deductions. However, for years 2018 through 2025, the deduction of these types of expenses is suspended. Currently, the IRS’s instructions to Form 4952, Investment Interest Expense Deduction, list only depreciation and depletion as examples of eligible expenses, and most individuals typically won’t have these expenses. So, for most taxpayers, their investment interest deduction will be limited to the amount of their investment income. However, the investment interest deduction is only allowed to taxpayers who itemize their deductions on Schedule A.
Home mortgage interest – includes the interest on a taxpayer’s primary home and a single second home. However, the debt on which the interest is deductible is generally limited to $750,000 ($1 million for debt incurred before December 16, 2017) of home acquisition debt (debt used to purchase or substantially improve the home(s)). The acquisition debt must be secured by the home(s) to be deductible as home mortgage interest. In addition, home mortgage interest is only deductible by those who itemize their deductions. Interest paid on equity debt – such as debt that may result when acquisition debt is refinanced – is not deductible as home mortgage interest with a couple of exceptions.
o If the loan proceeds are used to make substantial improvements to the home, the debt is treated as acquisition debt and the interest on that debt would be deductible. o If the amount of the new loan merely replaces the balance of the old acquisition debt, as may be the case when the original loan is refinanced only to take advantage of a lower interest rate and no cash (equity) is taken out, then the interest would continue to be deductible as home mortgage interest so long as the $750,000 or $1 million debt cap isn’t exceeded.
But to the extent the new loan is greater than the balance of the old acquisition loan and isn’t used for substantial home improvements or traceable to another deductible use, the interest on the excess debt isn’t deductible. Note: the rules stated here are for federal tax purposes; state rules may be different.
Passive activity interest – includes interest on debt that’s for business or income-producing activities in which the taxpayer doesn’t ‘materially participate’ and is generally deductible only if income from passive activities exceeds expenses from those activities. The most common passive activities are probably real estate rentals. For rental real estate activities, there is a special passive loss allowance of up to $25,000 for taxpayers who are active, but not necessarily material, participants in the rental. The $25,000 phases out for taxpayers with adjusted gross income between $100,000 and $150,000.
Trade or business interest – includes interest on debts that are for activities in which a taxpayer materially participates. This type of interest can generally be deducted in full as a business expense, although the deduction is limited for taxpayers with average annual gross income for the prior three years exceeding $27 million. The details of this limitation are not covered in this article.
Educational loans – Interest paid on a qualified student loan may be claimed as an above-the-line deduction (i.e., itemizing isn’t required). The maximum deduction per year is $2,500. This is a per return limit, not a per student limit. Mixed-use loans don’t qualify. A ‘qualified student loan’ is generally one used to pay higher education expenses, such as tuition, room and board, and related expenses, for attending post-secondary educational institutions, including certain vocational schools, and certain institutions offering postgraduate training, on behalf of the taxpayer, spouse, or any dependent of the taxpayer (at the time the loan is incurred). For 2022, the deduction is phased out when modified AGI is between $145,000 and $175,000 for joint filers and $70,000 to $85,000 for others, except the deduction is not allowed when filing using the married separate status or if the taxpayer is a dependent of someone else. Once the AGI reaches the upper amount, no deduction is allowed for that year.

Because of the variety of limits imposed on interest deductions, the IRS provides special rules to allocate interest expense among the categories. These ‘tracing rules,’ as they are called, are generally based on the use of the loan proceeds. Thus, interest expense on a debt is allocated in the same manner as the allocation of the debt to which the interest expense relates. Debt is allocated by tracing disbursements of the debt proceeds to specific expenditures, i.e., by ‘following the money.’ These tracing rules, combined with the restrictions associated with the various categories of interest, can create some unexpected results. Here are some examples:
Example 1: A taxpayer takes out a loan secured by his rental property and uses the proceeds to refinance the rental loan and buy a car for personal use. The taxpayer must allocate interest expense on the loan between rental interest and personal interest for the purchase of the car, and even though the loan is secured by the business property, the personal loan interest portion is not deductible. Example 2: A taxpayer takes out a loan secured by his rental property and uses the proceeds to finance a European vacation. The use of the funds was to pay for a vacation and thus the interest on the loan is nondeductible personal interest expense. Example 3: The taxpayer owns a rental property free and clear and wants to purchase a home that he’ll use as his personal residence. He obtains a loan on the rental to purchase the home. Under the tracing rules, the taxpayer must trace the use of the funds to their use, and as the debt was not used to acquire the rental, the interest on the loan cannot be deducted as rental interest. The funds can be traced to the purchase of the taxpayer’s home. However, for interest to be deductible as home mortgage interest, the debt must be secured by the home, which it is not. Result: the interest is not deductible anywhere. Example 4: The taxpayer uses her bank credit card to pay her son’s college tuition and related expenses as well as for purchasing clothing, food, household items, vacations, etc. None of the interest she pays on the credit card balance can be allocated to education interest since interest paid on mixed-use debt isn’t allowed for the student loan interest deduction. On the other hand, if she had one credit card that she used only for her son’s eligible education expenses, then the interest would be deductible as student loan interest if she didn’t exceed the modified AGI phaseout limit.
As you can see, it is very important to plan your financing moves carefully, especially when equity in one asset is being used to acquire another. Please call this office for assistance in applying the various interest limitations and tracing rules to ensure you don’t inadvertently get some unexpected results.

Article Highlights:

Medical Deduction
Tuition To Treat Learning Disabilities is Deductible
Special Teaching Techniques
Private Letter Rulings

A component of itemized deductions is the cost of medical care. The total of eligible medical expenses paid during the tax year is reduced by 7.5% of the taxpayer’s adjusted gross income (AGI). While you are undoubtedly familiar with most of the medical expenses eligible for the deduction, such as payments for doctor/dentist care, surgeries, prescription drugs and other commonly encountered medical costs, one type of eligible medical expense that you may not be aware of is the cost of a child attending a special school. This type of school is designed to compensate for or overcome a physical or mental handicap, in order to qualify the individual for future normal education or for normal living. This includes a school for the teaching of Braille or lip reading. The principal reason for attending must be the special resources available at the school for alleviating the handicap. Treating a child at such a school can be financially burdensome to the child’s parents, especially if the care isn’t covered by health insurance. Provided the parents have total itemized deductions greater than their standard deduction, they can get help from the tax law, which allows as eligible medical costs:

The tuition for ordinary education that is incidental to the special services provided at the school, and
The cost of meals and lodging supplied by the school The distinguishing characteristic of a special school is the substantive content of its curriculum, which may include some ordinary education, but only if the ordinary education is incidental to the school’s primary purpose of enabling students to compensate for or overcome a handicap.

In a private letter ruling, the IRS said that for a child diagnosed with multiple learning disabilities, tuition paid to attend a school designed to assist students in overcoming their disabilities and developing appropriate social and educational skills was a deductible medical expense. IRS ruled that where the school uses special teaching techniques to assist its students in overcoming their condition and that these techniques along with the care of other staff professionals are the principal reasons for the child’s enrollment at the school, then the school is a “special school.” Thus, the child’s tuition expenses at the school in those years he is diagnosed as having a medical condition that handicaps his ability to learn are deductible.
Side Note: Private letter rulings by the IRS are written responses to a taxpayer’s request for guidance on a particular issue or complex situation. A private ruling is applicable only to the specific tax situation, can’t be cited as precedence by other taxpayers and doesn’t commit the IRS to taking a similar position with regard to other taxpayers. However, a ruling does provide a look into the IRS’ position on the matter in question and can sometimes lead to a broader revenue ruling that would apply to all taxpayers. There is a fee, often several thousand dollars, that the taxpayer is required to pay when submitting their request for a private ruling.
The Tax Court has also held and IRS has privately ruled in other situations that, where a school attended by a student with a medical problem doesn’t qualify as a special school because the ordinary education isn’t incidental to the special services provided, the costs of the special program or special treatment (but not the entire tuition) may still be a deductible medical expense. If you have questions related to this or other medical deductions, please give this office a call.

December 15th, 2021 marked the last deposit date for the child tax credit payment expanded under the American Rescue Plan (ARP). Though many had hoped the program would be continued, political leaders are struggling to find a way forward that makes the majority of Congress happy, and as a result, many families have been left waiting and wondering what will come next. Though a child tax credit has existed since 1997, it was significantly revised in the face of the global pandemic to offer parents financial relief. Where it had previously been provided to eligible families as a single, partially refundable amount at tax time, the ARP allowed checks to be sent out on a monthly basis and made the credit fully refundable. It also substantially expanded the credit from $2,000 to $3,000 annually per child, with a $600 bonus for children under the age of 6. The impact of the revision was undeniable. According to a report issued by the Center on Poverty and Social Policy at Columbia University in late October, the payments of up to $300 per child being deposited in bank accounts (along with other COVID-19-related government support) contributed to a 4.6 percentage point (26 percent reduction) in child poverty in September of 2021 alone. Previous reports documented similar results, with an August report on its impact on material hardship reporting that the “more generous and inclusive monthly payment marks a historic, albeit temporary shift in the American welfare state’s treatment of low-income families.” With the addition of the word “temporary” in the report’s main takeaway, the center shines a light on the question of what happens next, now that the payments will stop being sent. Both Democrats and Republicans had backed the credit through the Tax Cuts and Jobs Act under the Trump administration, and there is bipartisan support for some type of continuation, but the devil is in the details and consensus has been hard to find. Much of the disagreement about how to move forward has revolved around whether the tax credit should be tied to a work requirement, and there are other issues surrounding what agency should be responsible for its administration and to whom and how it should be distributed. Where Senator Mitt Romney has proposed that monthly cash should be sent to all families regardless of income, with those above eligible income thresholds reconciling the difference on their income tax return, others object that it doesn’t limit the benefit to working families and those paying into the tax system. Still, others insist that there must be oversight from social service agencies to ensure that children are getting the benefit of the payments – Senator Joe Manchin called attention to the many grandparents who have assumed responsibility for raising their grandchildren and insists that a mechanism be put in place to ensure that the money follows the child rather than their parent. To that last point, the Census Bureau conducted a survey of American households to see how they spent their child tax credit checks. The majority used the cash for household expenses including rent or mortgage payments, groceries, and utilities, with four in ten using the first few payments to pay down their debt and many using it to pay for child-care and school supplies. Others used it to provide extras that they might otherwise not have been able to afford, including music lessons, entertainment, or occasional take-out food during the pandemic. While Congress works its way through the challenges of finding a replacement, many families for whom the extra money made a real difference are dreading the coming months, particularly with inflation rising. There are also some who received the money and believe they may owe some of it back when tax filing season arises. However, the monthly payments were “advance” credit payments and any credit amount you are entitled to and didn’t receive in advance will be credited to your 2021 tax return. So you did not lose out on anything, you just did not get it in advance. The IRS will be sending Letter 6419 which will show the total amount you received in advance payments; you will need to reconcile the advance payments with the amount you are entitled to. Don’t discard that letter and keep it with your other tax records and documents. If your family received advance child tax credit funds, you are not alone in wondering what will come next from Congress for 2022. You also may need help with your upcoming tax return. If so, don’t hesitate to contact us for assistance.

February 10 – Certain Small Employers File Form 944 to report Social Security and Medicare taxes and withheld income tax for 2021. This due date applies only if you deposited the tax for the year in full and on time. February 10 – Farm Employers File Form 943 to report Social Security and Medicare taxes and withheld income tax for 2021. This due date applies only if you deposited the tax for the year timely, properly, and in full. February 10 – Federal Unemployment Tax File Form 940 for 2021. This due date applies only if you deposited the tax for the year in full and on time. February 15 – All Businesses The following information statements are due to recipients to whom certain payments were made during 2021: Form 1099-B (Proceeds from Broker and Barter Exchange Transactions), Form 1099-S (Proceeds from Real Estate Transactions) and Form 1099-MISC (Miscellaneous Income) if substitute payments are reported in Box 8 or gross proceeds paid to an attorney are reported in Box 10. With consent of the recipient, the 1099 can be issued electronically. February 15 – Social Security, Medicare, and Withheld Income Tax If the monthly deposit rule applies, deposit the tax for payments in January. February 15 – Non-Payroll Withholding If the monthly deposit rule applies, deposit the tax for payments in January. February 16 – Payroll Withholding Employers begin withholding for employees who claimed exemption from withholding in 2021 but have not provided a W-4 (or W-4(SP)) to continue the exemption for 2022. February 28 – Information Returns Filing Due File government copies of information returns (Form 1099) and transmittal Forms 1096 for certain payments you made during 2021, other than the 1099-NECs that were due January 31. There are different 1099 forms for different types of payments. February 28 – Payers of Gambling Winnings File Form 1096, Annual Summary and Transmittal of U.S. Information Returns, along with Copy A of all the Forms W-2G you issued for 2021. If you file Forms W-2G electronically, your due date for filing them with the IRS will be extended to March 31. The due date for giving the recipient these forms was January 31. February 28 – Applicable Large Employers (ALE) – Form 1095-C If you’re an Applicable Large Employer, file 1094-C, Transmittal of Employer-Provided Health Insurance Offer and Coverage Information Returns, and 1095-C with the IRS. For all other providers of minimum essential coverage, file paper Forms 1094-B, Transmittal of Health Coverage Information Returns, and 1095-B with the IRS. If you’re filing any of these forms with the IRS electronically, your due date for filing them will be extended to March 31. See the Instructions for Forms 1094-B and 1095-B and the Instructions for Forms 1094-C and 1095-C for more information about the information reporting requirements. February 28 – Large Food and Beverage Establishment Employers File Form 8027, Employer’s Annual Information Return of Tip Income and Allocated Tips. Use Form 8027-T, Transmittal of Employer’s Annual Information Return of Tip Income and Allocated Tips, to summarize and transmit Forms 8027 if you have more than one establishment. If you file Forms 8027 electronically, your due date for filing them with the IRS will be extended to March 31.

February 4 – Tax Appointment
If you don’t already have an appointment scheduled with this office, you should call to make an appointment that is convenient for you.
February 10 – Report Tips to Employer
If you are an employee who works for tips and received more than $20 in tips during January, you are required to report them to your employer on IRS Form 4070 no later than February 10. Your employer is required to withhold FICA taxes and income tax withholding for these tips from your regular wages. If your regular wages are insufficient to cover the FICA and tax withholding, the employer will report the amount of the uncollected withholding in box 12 of your W-2 for the year. You will be required to pay the uncollected withholding when your return for the year is filed.
February 15 – Last Date to Claim Exemption from Withholding
If you are an employee who claimed an exemption from income tax withholding last year on the Form W-4 you gave your employer, you must file a new Form W-4 by this date to continue your exemption for another year.

Article Highlights

Aging Population
Home Improvements for Medical Care or Treatment
Improvements That Increase the Home’s Value
Improvements That Do Not Increase the Home’s Value
Medical AGI Limitations

According to the Social Security Administration, 10,000 baby boomers a day are reaching the age of 65, as of 2018 16% of Americans were age 65 or older, and by 2030 all boomers will be at least 65. Boomers aren’t the only reason the nation’s overall population is aging – people are living longer due partly to better health care (even though deaths from COVID-19 have lowered life expectancy projections). The CDC has stated that falls are the leading cause of injuries among people age 65 and older, and nearly 30% of older adults reported falling at least once in the preceding 12 months. To help minimize falls, and to accommodate age-related infirmities, many people are adding grab bars in showers, modifying stairways, widening hallways to accommodate a wheelchair, and other projects to make the home safer and more accessible for older occupants. If you are planning to make such home improvements, you may be eligible to include the costs as a medical expense for income tax purposes. Generally, the costs of home improvements are not deductible except to offset home gain when the home is sold. But a medical expense deduction may be claimed when the primary purpose of the home modification is for a medical reason. The tax law says that deductible medical expenses are those paid for the ‘diagnosis, cure, mitigation, treatment, or prevention of disease, and the costs for treatments affecting any part or function of the body.’ So, if you are making the modification because you, your spouse, or a dependent has a medical need for doing so, then the modification expense may be deductible as a medical expense, but only to the extent that it exceeds any resulting increase in the property’s value.
Example: A doctor recommends that his patient with severe arthritis have daily hydrotherapy, and so the individual has a hot tub installed at a cost of $21,000. The individual then hires a certified home appraiser to determine how much the hot tub addition increased the home’s value. The appraiser concludes the increase is $20,000. The individual’s medical deduction for the year the hot tub is installed will be limited to $1,000 ($21,000 – $20,000). The other $20,000 of expenses will increase the home’s basis, meaning that it will add to the home’s cost and will offset the sales price when the home is sold.
Even though a prescription from a doctor for most medically related home modifications isn’t required, the taxpayer, if questioned by the IRS, needs to be able to demonstrate how the expenditure relates to his or her medical care or that of a spouse or dependent. And having a letter from the individual’s doctor that explains the type of modifications that would be medically beneficial would help to prove a medical need. Not all improvements result in an increased home value. In fact, some, such as lowering cabinets for an occupant confined to a wheelchair, could actually decrease the home’s resale value. The IRS has identified certain improvements that don’t usually increase a home’s value but for which the full cost can be included as a medical expense. These improvements include, but are not limited to, the following items:

Constructing entrance or exit ramps for the home;
Widening doorways at entrances or exits to the home;
Widening or otherwise modifying hallways and interior doorways;
Installing railings, support bars, or other modifications;
Lowering or modifying kitchen cabinets and equipment;
Moving or modifying electrical outlets and fixtures;
Installing porch lifts and other forms of lifts (but generally not elevators);
Modifying fire alarms, smoke detectors, and other warning systems;
Modifying stairways;
Adding handrails or grab bars anywhere (whether or not in bathrooms);
Modifying hardware on doors;
Modifying areas in front of entrance and exit doorways; and
Grading the ground to provide access to the residence.

Only reasonable costs to accommodate a home to a disabled condition or to an elderly individual are considered medical care costs. Additional costs for personal preferences, such as for architectural or aesthetic reasons, are not medical expenses (but could be additions to the home’s tax basis). Unfortunately, the total of all medical expenses can be deducted only to the extent that they exceed 7.5% of the taxpayer’s adjusted gross income (AGI) and only if the taxpayer itemizes deductions. With the current high value of the standard deductions, fewer than 15% of taxpayers are expected to itemize their deductions in the years through 2025, down from 30% prior to 2018 when the standard deduction amounts were last changed. So even if a medically needed home improvement is made and qualifies to be deducted, only a small percentage of taxpayers will end up with a tax benefit as a result of the expenditure. All is not lost, though. To the extent that the taxpayer doesn’t claim the expense as an itemized deduction, the improvement costs, including those that might not meet the medically necessary standard, can be added to the home’s purchase cost to determine the home’s tax basis. Thus, when the home is sold, the capital gain from the sale will be lower. Either to substantiate the currently deductible improvements or with a future home sale in mind, taxpayers should be sure to keep records of the home improvements they make, including the receipts for the costs. If you have questions related to this deduction and whether you will benefit, tax-wise, from any medically related home modifications, please call this office.

Article Highlights:

Withholding
Other Prepayments
Tax Credits
Earned Income Tax Credit
Child Tax Credit
American Opportunity Tax Credit
Recovery Rebate Credit

These days the tax return is used for more than just collecting taxes. It has also become a tool for the government to provide social benefits. This article discusses the various reasons and resulting benefits available to you when you file, even if you are not required to, as you may be eligible for a refund of withholding or estimated payments or a refund as a result of a refundable tax credit or even a stimulus payment that you didn’t previously receive. Here are some of the possibilities. Refund of Withholding – You may have worked or had other income that included income tax withholding, but the total of all your income was less than the requirement to file a return. You are required to file a 2021 return if your income is equal to or more than the amount shown in the following table based on the filing status you would use if you did file:

2021 GENERAL TAXPAYER FILING REQUIREMENTS

Taxpayer Filing Status
Gross Income

Single
$12,550

Head of Household
$18,800

Surviving Spouse
$25,100

Married Filing Separate
$5

Married Filing Jointly
25,100

Add to the Above Amounts for Taxpayers Aged 65 and Older or Meet the Blind Qualifications

Married Filing Joint or Surviving Spouse
$1,350

All Others
$1,700

Caution: Self-employed taxpayers generally must file in all circumstances
So, if you are not required to file and decide not to bother, you would be forfeiting any income tax withholding on wages you earned. Other Pre-payments – You may have made 2021 tax payments but have forgotten about them, such as estimated tax payments or a 2020 overpayment you applied to your 2021 return. Surely you don’t want to forfeit those amounts. Tax Credits – Even though you may not be required to file a return and the withholding was negligible enough not to worry about it, you may be entitled to more than just a withholding refund. Normally tax credits can only be used to offset income tax. However, there are some credits that are refundable and may provide you with a significant refund. Here are the details of those credits:

Earned Income Tax Credit (EITC) – The EITC provides a fully refundable credit for lower income taxpayers who have earned income (income from working) and can range from $519 to $6,728 for 2021. The amount you receive depends on your income, filing status, and how many children you have. Even eligible individuals without children may qualify for the EITC.
Child Tax Credit – For the 2021 tax year return only (unless Congress extends it) the tax credit is $3,000 per child under the age of 18 ($3,600 under the age of 6). (The credit is reduced for upper-income taxpayers.) The credit is fully refundable for those who are not required to file.
American Opportunity Tax Credit – This is a credit to help pay for college costs. To qualify, the taxpayer, spouse or dependent child must have been a student enrolled at least half time for one academic period during the year to qualify. The maximum credit is 100% of the first $2,000 of eligible expenses and 25% of the next $2,000 but only $1,000 is refundable.
Recovery Rebate Credit – Individuals who didn’t qualify for a third Economic Impact Payment or got less than the full amount, may be eligible to claim the 2021 recovery rebate credit based on their 2021 tax year information. If they’re eligible.

If you were considering skipping filing your 2021 return, maybe you should reconsider. You will need to file a 2021 tax return even if you don’t usually file a tax return to benefit from any of these tax benefits. If you are an existing client and have questions, please give this office a call. If you have been trying to do your own tax return and would like professional preparation, we are here to assist you.