Education Tax Credits

Education Tax Credits Help Pay Higher Education Costs

Two federal tax credits may help you offset the costs of higher education for yourself or your dependents. These are the American Opportunity Credit and the Lifetime Learning Credit.

To qualify for either credit, you must pay postsecondary tuition and fees for yourself, your spouse or your dependent. The credit may be claimed by either the parent or the student, but not both. If the student was claimed as a dependent, the student cannot file for the credit.

For each student, you may claim only one of the credits in a single tax year. You cannot claim the American Opportunity Credit to pay for part of your daughter's tuition charges and then claim the Lifetime Learning Credit for $2,000 more of her school costs.

However, if you pay college expenses for two or more students in the same year, you can choose to take credits on a per-student, per-year basis. You can claim the American Opportunity Credit for your sophomore daughter and the Lifetime Learning Credit for your spouse's graduate school tuition.

Here are some key facts the IRS wants you to know about these valuable education credits:

1. The American Opportunity Credit

• The credit can be up to $2,500 per eligible student.
• It is available for the first four years of postsecondary education.
• Forty percent of the credit is refundable, which means that you may be able to receive up to $1,000, even if you owe no taxes.
• The student must be pursuing an undergraduate degree or other recognized educational credential.
• The student must be enrolled at least half time for at least one academic period.
• Qualified expenses include tuition and fees, coursed related books supplies and equipment.
• The full credit is generally available to eligible taxpayers whose modified adjusted gross income is less than $80,000 or $160,000 for married couples filing a joint return.

2. Lifetime Learning Credit

• The credit can be up to $2,000 per eligible student.
• It is available for all years of postsecondary education and for courses to acquire or improve job skills.
• The maximum credited is limited to the amount of tax you must pay on your return.
• The student does not need to be pursuing a degree or other recognized education credential.
• Qualified expenses include tuition and fees, course related books, supplies and equipment.
• The full credit is generally available to eligible taxpayers whose modified adjusted gross income is less than $60,000 or $120,000 for married couples filing a joint return.

If you don't qualify for these education credits, you may qualify for the tuition and fees deduction, which can reduce the amount of your income subject to tax by up to $4,000. However, you cannot claim the tuition and fees tax deduction in the same year that you claim the American Opportunity Tax Credit or the Lifetime Learning Credit. You must choose to either take the credit or the deduction and should consider which is more beneficial for you.

For more information about these tax benefits, see IRS Publication 970, Tax Benefits for Education available at www.irs.gov or by calling the IRS forms and publications order line at 800-TAX-FORM (800-829-3676).

Links:

• The American Recovery and Reinvestment Act of 2009: Information Center
• American Opportunity Credit
• Form 8863, Education Credits

Mortgage Debt Forgiveness

Mortgage Debt Forgiveness: 10 Key Points

Canceled debt is normally taxable to you, but there are exceptions. One of those exceptions is available to homeowners whose mortgage debt is partly or entirely forgiven during tax years 2007 through 2012.

The IRS would like you to know these 10 facts about Mortgage Debt Forgiveness:

1. Normally, debt forgiveness results in taxable income. However, under the Mortgage Forgiveness Debt Relief Act of 2007, you may be able to exclude up to $2 million of debt forgiven on your principal residence.

2. The limit is $1 million for a married person filing a separate return.

3. You may exclude debt reduced through mortgage restructuring, as well as mortgage debt forgiven in a foreclosure.

4. To qualify, the debt must have been used to buy, build or substantially improve your principal residence and be secured by that residence.

5. Refinanced debt proceeds used for the purpose of substantially improving your principal residence also qualify for the exclusion.

6. Proceeds of refinanced debt used for other purposes – for example, to pay off credit card debt – do not qualify for the exclusion.

7. If you qualify, claim the special exclusion by filling out Form 982, Reduction of Tax Attributes Due to Discharge of Indebtedness, and attach it to your federal income tax return for the tax year in which the qualified debt was forgiven.

8. Debt forgiven on second homes, rental property, business property, credit cards or car loans does not qualify for the tax relief provision. In some cases, however, other tax relief provisions – such as insolvency – may be applicable. IRS Form 982 provides more details about these provisions.

9. If your debt is reduced or eliminated you normally will receive a year-end statement, Form 1099-C, Cancellation of Debt, from your lender. By law, this form must show the amount of debt forgiven and the fair market value of any property foreclosed.

10. Examine the Form 1099-C carefully. Notify the lender immediately if any of the information shown is incorrect. You should pay particular attention to the amount of debt forgiven in Box 2 as well as the value listed for your home in Box 7.

For more information about the Mortgage Forgiveness Debt Relief Act of 2007, visit www.irs.gov. IRS Publication 4681, Canceled Debts, Foreclosures, Repossessions and Abandonments, is also an excellent resource.

You can also use the Interactive Tax Assistant available on the IRS website to determine if your cancelled debt is taxable. The ITA takes you through a series of questions and provides you with responses to tax law questions.

Finally, you may obtain copies of IRS publications and forms either by downloading them from www.irs.gov or by calling 800-TAX-FORM (800-829-3676).

Links:

• Form 982
• Form 1099-C
• Publication 4681

Videos:

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Tax Issues in Year of Marriage or Divorce

W

hen a couple ties the knot or gets divorced, taxes are probably not the first thing on their minds. But many decisions that couples make do affect their tax returns -- and the amount they ultimately owe the federal government.

Here are some answers to some frequently asked questions about marital status and taxes.

Q. What if I get married (or divorced) during the year?

A. You're considered married for the whole year if, on the last day of the year, you and your spouse meet any one of the following tests:

• You are married and living together as husband and wife.

• Sometimes Being Smart Isn't an Advantage when it Comes to Dealing with the IRS In one case, a wife who signed a joint return tried to claim innocent spouse treatment. The court sided with the IRS in finding that even though she didn't read the return, she had constructive knowledge of the data in the return. The understatements on the tax return were substantial and court noted that the wife was not only well-educated, she had her own business and should have known there was a problem. Finally, the court found the wife had a responsibility to review the return.

  You are living together in a common law marriage that is recognized in the state where you now live or in the state where the common law marriage began.
• You are married and living apart, but not legally separated under a decree of divorce or separate maintenance.
• You are separated under an interlocutory (not final) decree of divorce.

Q. What if my spouse died last year? How is it handled on my tax return?

A. If your spouse died during the year, you are considered married for the whole year for filing status purposes. If you did not remarry before the end of the year, you can file a joint return for yourself and your deceased spouse.

If you have at least one dependent child you may be eligible to use qualifying widow(er) with dependent child as your filing status for two years following the death of your spouse. This filing status entitles you to use joint return tax rates and the highest standard deduction amount (if you don't itemize). However, the status does not entitle you to file a joint return.

Q. If I am married, does it pay to use "married filing separately" status?

A. Many married taxpayers seem to think it would be advantageous to file their returns as married, filing separately, rather than as joint. However, only rarely does this filing method save taxes. You report only your own income, exemptions, credits, and deductions on your individual return. But the, your spouse must also itemize.

For example, in most instances you can't take the credit for child and dependent care expenses, you cannot take the education credits, your capital loss deduction is limited to $1,500 (not $3,000), etc. On the other hand, there are some combinations of spousal income and deductions where married filing separately will save taxes. Best advice? Ask your tax adviser if filing separately would be beneficial.

Q. Can I deduct legal and accounting fees incurred in my divorce?

A. It depends. Certain fees may be deductible.

For example, tax planning advice related to the divorce and legal fees incurred in securing alimony may be deductible. But you've got to be prepared to show the relationship and the amount of the fees. That means any bills from your attorney, accountant, etc. should show a breakdown of the time and charges with details of the services rendered. Taxpayers are often denied deductions for attorney and accountant fees when invoices do not break out fees related to tax planning or taxable income.

Q. For tax purposes, is there anything I should do if I change my name due to a recent marriage or divorce?

A. If you changed your name after a recent marriage or divorce, take the necessary steps to ensure the name on your tax return matches the name registered with the Social Security Administration (SSA).

Here are five tips from the IRS for recently married or divorced taxpayers who have a name change.

• If you took your spouse's last name -- or if you hyphenated your last names, notify the SSA. When newlyweds file a tax return using their new last names, IRS computers can't match the new name with their Social Security number. A mismatch between the name shown on your tax return and the SSA records can cause problems in the processing of your tax return and may even delay your refund.
• If you recently divorced and changed back to your previous last name, you also need to notify the SSA of this name change.
• To inform the SSA of a name change, simply file a Form SS-5, Application for a Social Security Card, at your local SSA office or by mail and provide a recently issued document as proof of your legal name change.
• Form SS-5 is available on SSA's Web site at http://www.socialsecurity.gov/, by calling 800-772-1213 or at local offices. A new card will have the same number as your previous card, but will show your new name.
• If you adopted your spouse's children after getting married and their names changed, you'll need to update their names with SSA too. For adopted children without SSNs, the parents can apply for an Adoption Taxpayer Identification Number - or ATIN - by filing Form W-7A,Application for Taxpayer Identification Number for Pending U.S. Adoptions with the IRS. The ATIN is a temporary number used in place of an SSN on the tax return.

Q. What is the difference between an injured spouse and an innocent spouse?

A. When a married couple files a joint tax return, they are both "jointly and severally" liable for the tax -- and any tax additions, interest, and penalties that arise -- even if they later divorce. They are also both responsible even if one spouse earned all of the income or claimed improper deductions or credits. This means the IRS can go after either spouse for the entire amount owed.

As you can imagine, this creates problems because one high-earning spouse could disappear and the IRS could pursue the spouse who is easier to find -- but did not earn the money or cause the issues on the tax return. For these people, there may be "innocent spouse" relief. Under the rules, a spouse must prove he or she was unaware of the activities that caused the caused the tax and did not benefit financially. If a spouse or former spouse qualifies, he or she will be relieved of the tax, interest, and penalties on a joint tax return.

There are separate rules for "injured spouses." You are an injured spouse if your share of a tax refund shown on your joint return is applied (or offset) against your spouse's legally enforceable past-due federal taxes, state income taxes, state unemployment compensation debts, child or spousal support payments, or federal non-tax debt, such as a student loan. If you are an injured spouse, you may be entitled to receive your share of the refund.

Fun or Profit ? It Matters for Hobby Loss Rules

Beware of the Hobby Loss Rules

If an individual, partnership, estate, trust, or an S corporation engages in an activity that is not conducted as a for-profit business, deductions are limited to the amount of income from the activity. If an activity is considered a for-profit business, deductions can exceed income, allowing the resulting loss to offset other income. Regulations contain a list of factors to be considered in determining whether an activity is engaged in for profit.

The factors include:

1) The manner in which the taxpayer carries on the activity,

2) The expertise of the taxpayer or his advisers,

3) The time and effort expended by the taxpayer in carrying on the activity,

4) The expectation that assets used in the activity may appreciate in value,

5) The success of the taxpayer in carrying on other similar or dissimilar activities,

6) The taxpayer’s history of income or losses with respect to the activity,

7) The amount of occasional profits, if any, which are earned,

8) The financial status of the taxpayer, and

9) Whether elements of personal pleasure or recreation are involved.

No single factor is determinative.

Court Case: The taxpayers became interested in Welsh ponies and cobs in 1995 when their daughter began riding lessons on a Welsh pony. They purchased a second horse in 1998. By 2003, they owned 10 horses. Their business plan was to acquire, breed, and train high-quality Welsh ponies and cobs and sell them.They began reporting their horse activity as a Schedule C business in 1998. After sustaining substantial losses in the activity over the next several years, the IRS disallowed the losses, claiming the activity was a hobby rather than a for-profit business.The court looked to the nine factors listed in IRS regulations to determine whether the taxpayers were engaged in a hobby or a for-profit business. For the following reasons, the court determined the manner in which the taxpayers carried on their activity, and their history of losses indicated it was not for profit.

At first, the taxpayers paid to board their horses with third-party providers. In 1999, the taxpayers concluded the horse activity could be profitable only if they purchased land and facilities where they could board their horses and generate income by providing boarding and training services to others. However, they did not begin this search until 2001, and did not actually purchase the land until 2005, on which they did not begin construction until 2006.The taxpayers continued to acquire horses in the years after 1999, increasing their stock from two horses to 10 even though they had not yet acquired land for a facility.

The court concluded that an actual and honest profit motive would have halted the purchase of new horses until after obtaining the new facility to board the horses.

Capital Gains and Losses

Ten Things to Know About Capital Gains and Losses

Did you know that almost everything you own and use for personal or investment purposes is a capital asset? Capital assets include a home, household furnishings and stocks and bonds held in a personal account. When you sell a capital asset, the difference between the amount you paid for the asset and its sales price is a capital gain or capital loss.

Here are 10 facts about how gains and losses can affect your federal income tax return.

1. Almost everything you own and use for personal purposes, pleasure or investment is a capital asset.

2. When you sell a capital asset, the difference between the amount you sell it for and your basis – which is usually what you paid for it – is a capital gain or a capital loss.

3. You must report all capital gains.

4. You may only deduct capital losses on investment property, not on personal-use property.

5. Capital gains and losses are classified as long-term or short-term. If you hold the property more than one year, your capital gain or loss is long-term. If you hold it one year or less, the gain or loss is short-term.

6. If you have long-term gains in excess of your long-term losses, the difference is normally a net capital gain. Subtract any short-term losses from the net capital gain to calculate the net capital gain you must report.

7. The tax rates that apply to net capital gain are generally lower than the tax rates that apply to other income. For 2011, the maximum capital gains rate for most people is 15 percent. For lower-income individuals, the rate may be 0 percent on some or all of the net capital gain. Rates of 25 or 28 percent may apply to special types of net capital gain.

8. If your capital losses exceed your capital gains, you can deduct the excess on your tax return to reduce other income, such as wages, up to an annual limit of $3,000, or $1,500 if you are married filing separately.

9. If your total net capital loss is more than the yearly limit on capital loss deductions, you can carry over the unused part to the next year and treat it as if you incurred it in that next year.

10. This year, a new form, Form 8949, Sales and Other Dispositions of Capital Assets, will be used to calculate capital gains and losses. Use Form 8949 to list all capital gain and loss transactions. The subtotals from this form will then be carried over to Schedule D (Form 1040), where gain or loss will be calculated.

For more information about reporting capital gains and losses, see the Schedule D instructions, Publication 550, Investment Income and Expenses or Publication 17, Your Federal Income Tax. All forms and publications are available at www.irs.gov or by calling 800-TAX-FORM (800-829-3676).

Links:

• Publication 17, Your Federal Income Tax (PDF 2015.9K)
• Publication 550, Investment Income and Expenses (PDF 516K)

Medical and Dental Expenses

Eight Things to Know about Medical and Dental Expenses and Your Taxes

If you, your spouse or dependents had significant medical or dental costs in 2011, you may be able to deduct those expenses when you file your tax return. Here are eight things the IRS wants you to know about medical and dental expenses and other benefits.

1. You must itemize You deduct qualifying medical and dental expenses if you itemize on Form 1040, Schedule A.

2. Deduction is limited You can deduct total medical care expenses that exceed 7.5 percent of your adjusted gross income for the year. You figure this on Form 1040, Schedule A.

3. Expenses must have been paid in 2011 You can include the medical and dental expenses you paid during the year, regardless of when the services were provided. You’ll need to have good receipts or records to substantiate your expenses.

4. You can’t deduct reimbursed expenses Your total medical expenses for the year must be reduced by any reimbursement. Normally, it makes no difference if you receive the reimbursement or if it is paid directly to the doctor or hospital.

5. Whose expenses qualify You may include qualified medical expenses you pay for yourself, your spouse and your dependents. Some exceptions and special rules apply to divorced or separated parents, taxpayers with a multiple support agreement or those with a qualifying relative who is not your child.

6. Types of expenses that qualify You can deduct expenses primarily paid for the diagnosis, cure, mitigation, treatment or prevention of disease, or treatment affecting any structure or function of the body. For drugs, you can only deduct prescription medication and insulin. You can also include premiums for medical, dental and some long-term care insurance in your expenses. Starting in 2011, you can also include lactation supplies.

7. Transportation costs may qualify You may deduct transportation costs primarily for and essential to medical care that qualify as medical expenses. You can deduct the actual fare for a taxi, bus, train, plane or ambulance as well as tolls and parking fees. If you use your car for medical transportation, you can deduct actual out-of-pocket expenses such as gas and oil, or you can deduct the standard mileage rate for medical expenses, which is 19 cents per mile for 2011.

8. Tax-favored saving for medical expenses Distributions from Health Savings Accounts and withdrawals from Flexible Spending Arrangements may be tax free if used to pay qualified medical expenses including prescription medication and insulin.

For additional information, see Publication 502, Medical and Dental Expenses or Publication 969, Health Savings Accounts and Other Tax-Favored Health Plans, available at www.irs.gov or by calling 800-TAX-FORM (800-829-3676).

How Much Tax Help Do You Need?

Ask yourself the following 10 questions to determine whether it’s in your best interest to do your taxes yourself or whether you should seek the help of a professional.

Are you a salaried employee who takes the standard deduction?

If so, your return is likely to be simple, and you may be able to do the work on your own or by using tax preparation software.

Are you technology savvy?

If you’re comfortable using computer software programs, tax preparation software might be right for you. Most tax programs use a question-and-answer interview format that prompts you through the filing process, determines your eligibility for deductions and credits, and helps you enter information on the forms. Beware, though, that you must enter the correct information to ensure that your taxes will be calculated correctly.

Have you kept abreast of changing tax laws?

Tax law is constantly changing and getting more complex. If you plan on doing your own taxes, it’s important that you keep up to date on the latest changes and how they affect your situation.

Are you itemizing your deductions on Schedule A?

Owning a home is often the factor that enables taxpayers to itemize their deductions. If you own a home, your mortgage interest and real estate taxes are deductible on Schedule A. Most taxpayers can complete Schedule A on their own.

Have you had a major life change such as marriage or divorce?

Lifestyle changes often call for specialized help, both in terms of taxes and financial planning opportunities.

Have you exercised incentive stock options or actively traded stocks?

Complex returns have more gray areas where judgment calls and expert advice can make a significant difference.

Do you own a vacation home or rental property?

Owning a second home, particularly one that you rent out, can complicate your tax situation. We can explain the impact of ownership and rental income on your tax liability so you pay the correct amount of tax.

Are you self-employed or own a small business?

Self-employed individuals and small business owners are frequently the targets of IRS audits. Working with us can help your business minimize audit risk.

Do you have high income?

Watch out! You may be subject to the Alternative Minimum Tax or AMT. The AMT, which eliminates many itemized deductions, was created to ensure that the wealthy pay their

share of taxes. But because the thresholds have not been adjusted regularly for inflation, more filers are finding themselves subject to this tax. If you think you might be affected, consult with us.

Are you seeking tax planning help for 2011?

If you’re interested in taking steps now to lower your tax bill in 2011, consulting us is a good first step. We can explain the tax law changes to you and help you understand how these changes will affect your tax situation.