Home Is Where the Business Is
For some taxpayers, their home office is their only place of business. For others, it may be the “headquarters” for a side business. According to the IRS, there are more than 3 million taxpayers who claimed home office deductions in recent years. There are basically two ways to claim a deduction for business use of a home:
Claim a deduction for certain expenses (electricity, gas, real estate taxes and mortgage) proportionate to the share of the home used as an office. Taxpayers can also claim depreciation for a share of the home, which may affect the capital gains taxes due on an eventual sale. The deduction is limited to the gross income derived from the business, although any excess may be carried over to later years.
A simplified method that limits the deduction to $1,500, but with less paperwork. There is no depreciation on the home. Mortgage interest and real estate taxes are deductible as itemized deductions on the homeowner’s Schedule A and need not be allocated between personal and business use.
Other business expenses for office supplies, insurance, phones and advertising are deductible separately, regardless of which method is used. It’s also a good idea for anyone with a home-based business to determine if insurance coverage on the home includes office equipment (copier, computer, printer, phones) and any injuries to customers who hurt themselves on your property.
What’s Ahead, Tax-Wise, in 2017?
With a new Congress and occupant in the White House, there’s been much discussion about possible tax law reform. Among the proposals mentioned:
- Reducing tax rates from the current seven brackets to three — 12%, 25% and 33%
- Eliminating certain itemized deductions or placing a cap on total deductions
- Boosting the standard deduction
- Repealing the estate tax and possibly the generation-skipping transfer tax
- Lowering tax rates on businesses
- Doing away with the alternative minimum tax
- Introducing a 50% deduction on capital gains, effectively reducing the rates to 6%, 12.5% or 16.5%, depending on the taxpayer’s top tax rate
Given the uncertainty, what’s the best route in planning for income taxes in 2017? It’s best to proceed based on the tax laws as they currently exist. First, it’s unclear what, if any, changes will be made. Second, some tax law changes may be effective retroactively to January 1, 2017, while others may phase in over future years. Estate planning means more than just tax planning, so it’s a good idea early in the year to review your existing will or living trust to see that the provisions still reflect your wishes regarding the disposition of your estate. It’s also a good time to revisit beneficiary designations on life insurance, IRAs, 401(k) plans and other financial accounts to see that they are in accord with your will or trust. Remember, the beneficiary designation generally prevails, even if your will or living trust names a different beneficiary.
While reviewing beneficiary designations, keep in mind that if you name a charity to receive part or all of your IRA or 401(k), the income tax that family members would pay is completely avoided. It’s also possible to provide payments for life to a family member from your gift of an IRA or 401(k).
Helping Parents with Charitable Gift Annuities
Charitable gift annuities are generally arranged by donors who are at or near retirement age. But gift annuities also may be appealing to sons and daughters of retirees who want to help both charity and their parents, as well. Here’s an example:
Dr. S sends a monthly $500 check to her mother, age 85. Dr. S wants to keep helping her mother, but would also like to reduce her income taxes and make an important gift to a favorite charity. She could transfer $75,000 in exchange for a charitable gift annuity that would pay her mother about $500 a month for her life. (A somewhat larger amount would be required to fund a gift annuity that makes survivor payments to Dr. S after her mother’s death.) Dr. S receives a charitable deduction of more than $42,000 and achieves personal goals, as well. Gift taxes can be avoided by including a special clause in the gift annuity agreement.
Note: Charitable deductions can be especially helpful to friends who experience a year of unusually high income, such as when they convert to a Roth IRA. We would be pleased to provide you with complete tax and financial illustrations for charitable gift annuities or any other gift arrangements.
Estate Planning to Minimize Future Family Conflicts
As much as parents try, it’s usually impossible to divide an estate into precisely equal shares for their children — and sometimes that’s not a parent’s goal. There are ways for parents to minimize friction, however: Talk with your children about your intentions, particularly if you are leaving more to one child than the others. This “favoritism” may be due to health problems, financial setbacks or to even out assistance given to others during lifetime. Whatever the reasons, discuss the plans with your children.
A letter of instruction may prevent disputes over who should receive certain assets of sentimental value. Unlike a will or living trust, a letter of instruction is not a legal document, but it will express your wishes regarding items of personal property and can be updated without the requirements of a will. If it’s important for one child to have a particular item, consider giving it to him or her now.
If one child wishes to buy the family home, consider leaving it to him or her in your estate plan and dividing the rest of the estate among the other children. If the home represents a major portion of the estate, allow the child to purchase the other siblings’ shares or place the home in a trust for the benefit of all children. The child living in the home will pay rent that is then distributed to the others; he or she can also buy the home from the trust.
When designating assets for the children, consider valuation issues. Leaving the silver to one and an antique vase to another may seem fair today, but the assets may not appreciate at the same rate over the years. Periodic appraisals will help determine if one child is reaping a windfall and will also assist the executor in appraising the assets for estate tax purposes.
Fluctuations in the stock market make it important to review plans for how your brokerage and retirement accounts will be distributed. Take a look at your will or revocable living trust to see if changes in stock values could result in some of your beneficiaries being shortchanged. Remember that income taxes are payable on some assets, such as retirement accounts and savings bonds. Divide these tax-burdened assets among children evenly, or better yet, leave them to charity, avoiding all income tax.