Charged Up! podcast: Maximizing your tax savings

Episode 67 with accountant Barbara Weltman

Charged Up! with Jenny Hoff

 



When it comes to preparing taxes, good advice can save you thousands of dollars. In this episode we talk with well-known accountant Barbara Weltman on the must-dos of taxes, how to calculate credit card rewards, and what to do if you own your own small business or side hustle. So, before you tackle those taxes yourself, give yourself the gift of free tax advice and see if there's money you could be saving!

So, let's get Charged Up! about mastering taxes!

Transcript:

Jenny Hoff: Barbara, thank you so much for joining me today.

Barbara Weltman: It's a pleasure.

Hoff: So it's tax time, and for some that means a refund that they can use to pay down debt or save or a purchase something nice. For others it means coughing up a bunch of money that they hopefully had the wherewithal to set aside.

I want to start with some best practices. If someone is using a tax preparer what are some questions they need to be asking and may not think of?

Weltman: When using a preparer you want to make sure that he or she is legitimate. You want to steer clear of anybody who's kind of shady, and you may know this by what they say or don't say. For example if they say they're going to guarantee you money or they're charging you a percentage of your refund or they won't show you their preparer tax identification number, they're PTIN, or they refuse to sign your return run away as fast as you can, those are kind of shady practices that is a tip off.

And the reason why you want to steer clear of such a preparer is because when the IRS catches these types of preparers then they go look at all the clients that they dealt with, and then you are basically inviting IRS scrutiny, which is something you obviously don't want to do.

Hoff: Right, absolutely. And what about like as far as maximizing their deductions as taxes? What are some things people just don't really think of that actually are maybe deductible or they think are deductible and they're actually not?

Weltman: I think the good news when it comes to this is that if you're using a paid preparer or if you are using software to prepare your return you're not likely to overlook deductions, because you're going to be asked or prompted about various expenses. And then you're going to know whether or not they're deductible.

I think one of the things that people may think is deductible that is not is commuting. And no matter how far you commute or how costly it is to do so you usually can't deduct your commuting costs, and there's a couple of minor exceptions but for the vast majority commuting costs are not deductible.

I think one of the things that some people may think is a problem and they may be reluctant to claim a deduction even though they're entitled to is the home office deduction. Because there's been a lot of buzz about that being an audit red flag and people don't want that to happen, but I think that if you are entitled to it, because you work from home, the Small Business Association says 52 percent of all businesses in the U.S. are home-based, so a lot of people legitimately work from home and would be entitled to the deduction.

The thing is just make sure you're entitled to it, follow the rules, and then just don't worry about it. And another reason why I think it's a legitimate write-off is the fact that the IRS has gone so far as to create what amounts to a standard deduction for a home office. So you don't even have to figure out all your particular expenses related to this space that you use in your home that you can just use the IRS allowance.

Hoff: Now if you have an actual office at your job that you could be using but you've asked to work remotely and you do work from home then you could not write that off as a home office, correct?

Weltman: That's exactly correct because you have to work at home for the convenience of your employer not for your own preference. And for the convenience of your employer usually means that there's no office space for you. It doesn't mean that you're allowed to just work a couple of days from home because it's better for your personal situation.

Hoff: How does the office need to be set up? Does it have to be in a room with a door so you have an exact amount of square feet? Or let's say you use the dining room, instead of using it as a dining room you use as your office and set it up as an office, could you then deduct that whole square footage? Does it have to be an actual room or could it be just a space that you've designated as your office?

Weltman: That's a great question. You have to use the home office space regularly and exclusively for business, which means that your dining room table which your family eats on later on in the day is not going to qualify because it's not exclusively used for business. But you don't have to use an entire room as a home office, whatever space you have; you don't even need a formal partition or anything like that. As long as the space that you allocate for business use is used only for business.

Hoff: OK, so good to know. That's just for people because it is so common that people work from home now and a lot of offices are virtual, I think it's important to kind of know what qualifies and what doesn't so that they make sure that they deduct that because that can be a big deduction.

Speaking of itemizing and deductions, when is it worth it? And then what is the best way to go about it if you do know that you're going to be deducting and itemizing at the end of the year?

Weltman: Well, if you have maintained records for your itemized expenses, meaning you have proof of your charitable contributions including written acknowledgments for donations of $250 or more, it may pay to itemize. The good news is that if you're using software or pay preparer it will help you determine whether it makes sense to itemize or to claim the standard deduction, whichever saves you more money. If you don't have the records then you may just want to use the standard deduction.

I think the difficulty comes for people who are kind of on the cusp. For people who know they don't have a home mortgage, they don't have state and local income taxes, we're talking about 2017 returns and those kinds of things, they're deductible, they know to take the standard deduction. But going forward in 2018 it's going to be more complicated.

Hoff: Yeah, and we're definitely going to get into that a little bit because I think if somebody is preparing now for next year what are things that they can be doing and thinking of right now so they're not at the end of the year trying to scramble to find everything that they did and get all those papers together since there are changes. But first what would you say the most common mistakes people make during tax time?

Weltman: Well, I think one of the most common mistakes is that people fail to report all income that's been reported to them or they don't report it correctly. Meaning that if you get a W2, a 1099, a schedule K1 you have to report what's been reported to you because the IRS computers are going to cross-check this with what's been reported to the IRS versus what's reported on your return.

So for example if you received a distribution from an individual retirement account or 401(k) and you received a form 1099R, be sure to report what you received correctly on your return. In other words you may have to report the amounts, even if part of it may not be taxable to you and that you have to follow the reporting rules. But be sure to report what's reported so the IRS computers won't single you out.

Hoff: OK, so that means look at all of your investments, look at whatever stocks even if you're not taking anything out of your let's say E-Trade account so you don't feel like it's cash that you've earned, if they paid out a dividend and all that stuff you need to be reporting all of it.

Weltman: Exactly, and you will be getting information returns as I said like the 1099 DIV if you got dividends, or the 1099 INT if you got interest from a bank account. Or if you're an independent contractor you're going to get a 1099 MISC to report the income that was payable to you. So if you fail to report the income on your return, the IRS is going to know about it.

Hoff: And I'll quickly want to get into side gigs because I think a lot of people are kind of picking up extra jobs on the side as they either want to make more money or they want to test the waters before launching their own business, what are the different types of side gigs that people need to be actually making sure they're documenting and reporting so they don't get in trouble? Let's say you are baby-sitting on the side and they just pay you cash or you're driving for Uber, what different ones that you need to be making sure that you report and what amount does it need to be when you know that you could get in big trouble if you don't?

Weltman: As a technical matter you have to report all of your income from wherever you get it, from whatever source. There's no dollar amount that you have to earn from Uber before you have to start to report it. But there are filing thresholds, so if for example the local neighborhood baby sitter earns a few hundred dollars a year that person may not have to file a tax return and report that income. But for a person who's working a day job and then driving Uber at night they're going to have to be filing a return and they're going to have to be reporting their income from the gig.

Hoff: Can you report it if you're just getting paid cash or does it need to be now an official thing, let's say if you're baby-sitting or doing something and you get an official form from the person who's hiring you?

Weltman: The method of payment technically doesn't dictate whether or not you have to report it. You're supposed to report your income. I will say though that for independent contractors there's more reporting going on than ever, for example if anybody pays you $600 or more in a year you're going to get a 1099 MISC reporting that income. If you accept credit cards or PayPal or other electronic payments and you do a certain number of transactions or have a certain amount of revenue from those transactions in a gross amount you're going to be receiving a 1099K from the bank or the credit card processor. And so the IRS uses this information to see that you're reporting your income.

Hoff: All right, good to know. So what about credit card rewards? We've had people ask that they have to declare the credit card rewards that our experts say no. Is there ever a circumstance where you would have to mention credit card rewards on a tax form?

Weltman: That's a really good question. So the IRS thus far has not tried to tax credit card rewards. So if you get cash back on a credit card it is in taxable. The IRS looks at the cash backs as effectively an adjustment to the purchase price of the items you pay, so they're not trying to tax this. But I want to point out that frequent flyer miles awarded as a promotion like say by a bank for opening a bank account that would be taxable. And this particular situation came up in the IRS and the tax court said, "Yeah, that's taxable." In this case a particular bank issued a 1099 valuing the frequent flyer miles and that the taxpayer receiving it who cashed in the voucher for a ticket was taxed on it.

Hoff: Interesting, so it's only if you're issued essentially a 1099. So if you sign up for an American Express card and you get a hundred thousand points as your sign up bonus after you spend the minimum spend they don't send you a 1099 that's not something that you need to be taxed on, but if they do, you do.

Weltman: Yeah, you're right. And really I think it's usually when it's a separate promotion, not a promotion for the card itself but rather in this case it was a bank offering this is a reward.

Hoff: Right, because I think it is interesting if you do get gifts of a certain amount or you give gifts of a certain amount. So can we briefly talk about that? I think this is something that is confusing to a lot of people. Let's say you give your parents $20,000, do they need to declare that on their taxes or your parent gives you $20,000, puts it in your bank account to help you out a house purchase or anything like that, is that something that you needed to declare?

Weltman: When you get a gift of any amount, $20,000, $20 million, if you get that gift it's tax-free to you. You don't have to do anything as the recipient. The person who makes the gift has to handle it, but it's not an income tax issue, it's a gift tax issue. So if you give more than an annual exclusion amount which happened to have been $14,000 in 2017, it's going to be $15,000 in 2018 per person then you just have to report it. And you may not necessarily have to pay any gift tax on it because you have a lifetime exclusion amount in the millions. So it's just a question of reporting it, but it has nothing to do with income tax, and just to repeat as the recipient there's no burden on you, it's tax-free and you don't have to report it.

Hoff: OK, good to know. Also about kind of one of those surprise taxes that might crop up as people who had their debt forgiven, so they've been able to negotiate down their debt, they used a service to do that, they negotiated down their debt and yet then they get something in the mail that says, "Hey, you actually owe taxes on the money that was forgiven," almost treating it as income. Can you go into that a little bit? When would somebody have to pay that and when would they not have to pay that?

Weltman: Well, it's really unfortunate that you think that you're settling up debt because you have a financial issue and you're not really flush enough to pay off the debt that you owe, and then turn around and the government says the cancellation of debt income is taxable. And so as a general rule you do have to report all of the debt that you're relieved of, the amount that you didn't have to pay that you would otherwise have had to pay.

There are some exceptions in having to report this. So if you filed for bankruptcy or you were insolvent at the time the debt was canceled then you're not taxed on it. But other than that unfortunately it's good to have the credit card burden off your back but you may have to divvy up in taxes.

Hoff: Wow, and is it taxed at the regular rate of your income?

Weltman: Exactly, it's just another kind of ordinary income just like wages or bank interest.

Hoff: Wow, OK. So it is important. So only if you were really insolvent at the time of the debt being forgiven or bankruptcy was an issue then you would to be able to not have to pay that. But if you're making an income and you're OK and you just couldn't afford those bills then you will have to pay the taxes on that.

Weltman: That is correct.

Hoff: And do you declare that or will you get something from the IRS or from the credit card companies that forgave your debt?

Weltman: There's a 1099 for that. There's a special 1099 reporting cancellation of debt that you will receive from the bank or the credit card company. And again this will be reported to the IRS. And there's even been a case recently where a taxpayer got this 1099 but just really didn't understand that he had to report the debt, and the court said, "Well, sorry, the fact that you didn't understand it doesn't mean that it's tax-free. You still have to report it."

Hoff: Right, ignorance is not an excuse when it comes to the law unfortunately. How about charitable giving? So let's say during Hurricane Harvey and other major events, we know basically when you give something to Goodwill or to the Red Cross, you make a cash offer that you will get a form and then you can then deduct that. But what if you instead give your frequent flyer miles or something like that, is that a case where you can then deduct that later? And how should you go about making sure that you could?

Weltman: Well, it's really a generous thing to donate your frequent flyer miles to charity. And Make A Wish Foundation uses 2.8 billion miles each year and they're always soliciting for donations. But the bad news I guess from a tax perspective is that you can't take a chargeable deduction for this. And the reason is the miles are viewed as property, and a deduction is limited to your basis and property. Well, because you aren't taxed on your frequent flyer miles you have no basis so you have nothing to deduct. So it's a great thing to donate the miles especially if you won't be able to use them and somebody else can, but you can't get the deduction for it.

Hoff: And then speaking about that for businesses if you use frequent flyer miles too, if you own your own business and you are using frequent flyer miles once in a while to take a trip, what happens when it comes to then deducting your travel expenses down the road?

Weltman: Well, let's say you use your frequent flyer miles for business, you can't double dip. So because you are in tax on the frequent flyer miles the IRS said back in 2002 you wouldn't be taxed on them but you can't deduct them either. If you get a free ticket for business trip you can't deduct the cost of the ticket.

Hoff: So it'd be smarter to then just use it for personal travel and then go ahead if you know that you're going to have to use it anyway.

Weltman: And pay for the ticket.

Hoff: And pay for the ticket, because that's what you'll be deducting.

Weltman: Exactly. You pay for the business travel, use your frequent flyer miles for the personal travel.

Hoff: I don't know if you know this specifically, but what if you have a card that you use for business let's say and you earn miles and then use it for personal travel, that's not a problem because you're personally liable I guess for your business cards too, right?

Weltman: Yeah, that's not a problem. I mean, let's face it most of the mileage is accumulated on business travel. And you use it for your personal travel and that's fine. And even if let's say a company charges the tickets to a company card but lets you use the personal travel, that's fine too.

Hoff: OK, fantastic. So, we talked about the new tax laws coming into place and we talked about how 2018 tax year will be very different from this tax year, let's go into the biggest changes the average person is going to see. How can they best prepare now to minimize their tax burden and be organized with the information that will be required next tax season?

Weltman: If you're working for a company you've already seen what the new law means to you, it means lower taxes and more take-home pay because that's already been implemented. But one of the biggest changes is the dramatic increase in the standard deduction which means that fewer people will be itemizing.

So if you won't be itemizing because of the new higher standard deduction and the elimination of certain itemized deductions as well, the elimination or the curtailment, then you won't need to keep records throughout this year. But again for anyone who may be uncertain it's still advisable to keep records so that you could decide later on whether itemizing will still make sense for you for 2018.

Hoff: And what if you have that home office and you have a mortgage that you're paying, are those again you think there'll be enough to be able to itemize I guess depending on the size of the mortgage and the interest that you're paying on that? Or is the deduction going to be so big that you probably won't even be able to deduct your home office anymore?

Weltman: Well, if you are an employee you are not going to be able to deduct your home office anymore regardless of anything, because the deduction for unreimbursed employee business expenses is eliminated for 2018 through 2025. So if you pay for your travel or any other business expenses that your employer doesn't cover, you're going to just be out of luck, you won't be able to itemize with that.

I think that really the good thing may be that employers will consider more reimbursement arrangements so that you will be able to be covered for your out-of-pocket costs that you incur on behalf of the business. And if it's done in the correct way, in other words, if the company sets up an accountable plan for reimbursements then you will not have any income and the company would like to do this because of a couple of reasons - they won't have any employment taxes, they get to deduct the amounts, they'll have no employment tax cost, and in this ever-tightening job market this will be a way to attract and retain good employees.

Hoff: All right, so anything else that you think we need to know about that we may not have realized about the new tax plan and how it's going to affect us?

Weltman: Well, another thing that we talked earlier about people who are working in the gig economy, and there is a new deduction, a 20 percent deduction of qualified business income and it's meant for owners of pass-through entities including independent contractors. And this is going to be a great kind of reduction. It reduces taxable income much like the standard deduction.

The new deduction is very complicated with many limitations and we're waiting for IRS guidance on various rules related to the deduction. We may not have them anytime soon, but come next year at tax time I think many people will see that their taxes are lowered because of this new deduction.

Hoff: And speaking of that, so if people have side gigs or they're self-employed and they're just using even their Social Security number to give to the employers, the people that are hiring them for different jobs and stuff to deduct their taxes, what should they be considering in order to get that big tax break? Do they need to form an S Corp, a C Corp? What do they need to do to make sure they get that 20 percent tax break and they're part of that?

Weltman: Well, that's a good question. First of all the break only applies to pass-through, to owners of pass-through entities. So it wouldn't include anyone who owns a C corporation, because a C corporation is a separate taxpayer. But your choice of entity for a business is a very complicated matter, and it goes beyond federal taxes. So you have to consider state taxes as well as non tax issues. For example if you think you're going to want to do equity crowd funding for your business you need to be a  C corporation, you can't be an S corporation because of the limitation on shareholders.

So whether you should set up a particular type of entity or make a change at this time from the way you're operating now to another type of entity that requires a full discussion with your legal and tax advisers.

Hoff: What about people with side gigs? So it might be just they do it a limited amount of time but they're making money, they're an independent business so to speak, will they get that tax break that small businesses are getting?

Weltman: If they're working as independent contractors or they've set up an LLC or an S corporation they're going to have the opportunity to qualify for the 20 percent deduction. There are limitations on the deductions that may curtail or prevent you from any of it but they will have access to it, that's the important thing.

Hoff: OK, so that's one thing that they need to be asking when they start getting their taxes ready for next year. What about refund anticipation loans, receiving the anticipated amount of your refund before you get it, do you recommend people stay away from these, why or why not?

Weltman: Well, I'm not a fan of refund anticipation loans which are really short-term loans with high interest. So I say just wait for the refund. And the IRS says most refunds are issued within 21 days, so if you note your bank account on you your tax return the IRS will deposit it directly cutting the receipt time even further.

Refunds related to the earned income tax credit or the additional child tax credit were not allowed to be issued before mid-February, that's just the law. But the IRS expects the earliest refunds related to these credits should be available in taxpayer bank accounts or debit cards starting Feb. 28, 2018, assuming these taxpayers chose direct deposit and there are no other issues with their tax return. So, again the bottom line here is just opt for direct deposit and file electronically and you'll get your refund pretty quickly in most cases.

Hoff: All right, because otherwise you're just being a really high interest loan on something that's your money any way that you would be getting pretty quickly anyway. Finally Barbara, a lot of amazing information, what gets you charged up about mastering the tax game?

Weltman: Well, I've been involved with taxes for more than 40 years, it's hard to believe. And I have to say never a dull moment. Things are always changing. But I get charged up about helping people learn how they can save money and stay out of trouble with the IRS. I see the same mistakes being made that cost people money that they could take tax breaks that they're legitimately entitled to but they make the mistakes and fail to do that. And I want to help them avoid these mistakes and know how to take advantage of opportunities.

Hoff: Perfect. Thank you so much, really great information. As we head into tax season I think it's important that people pay attention to what they're deducting and knowing what they can deduct and take advantage of that while they still can. Barbara, thank you so much for joining me today.

Weltman: My pleasure.

See related: Pros, cons of paying taxes with a credit cardWhat records to keep and how long to keep them, Charged Up! podcast: How to write a financial plan


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Updated: 08-18-2018