If your child is fortunate enough to be awarded a scholarship, you may wonder about the tax implications. Fortunately, scholarships (and fellowships) are generally tax free for students at elementary, middle and high schools, as well as those attending college, graduate school or accredited vocational schools. It doesn’t matter if the scholarship makes a direct payment to the individual or reduces tuition.

Requirements for tax-free treatment

However, scholarships are not always tax free. Certain conditions must be satisfied. A scholarship is tax free only to the extent it’s used to pay for:

• Tuition and fees required to attend the school and
• Fees, books, supplies and equipment required of all students in a particular course.

For example, expenses that don’t qualify include the cost of room and board, travel, research and clerical help.

To the extent a scholarship award isn’t used for qualifying items, it’s taxable. The recipient is responsible for establishing how much of an award is used to pay for tuition and eligible expenses. Maintain records (such as copies of bills, receipts and cancelled checks) that reflect the use of the scholarship money.

Payment for services doesn’t qualify

Subject to limited exceptions, a scholarship isn’t tax free if the payments are linked to services that your child performs as a condition for receiving the award, even if the services are required of all degree candidates. Therefore, a stipend your child receives for required teaching, research or other services is taxable, even if the child uses the money for tuition or related expenses.

What if you, or a family member, are an employee of an education institution that provides reduced or free tuition? A reduction in tuition provided to you, your spouse or your dependents by the school at which you work isn’t included in your income and isn’t subject to tax.

What is reported on a tax return?

If a scholarship is tax free and your child has no other income, the award doesn’t have to be reported on a tax return. However, any portion of an award that’s taxable as payment for services is treated as wages. Estimated tax payments may have to be made if the payor doesn’t withhold enough tax. Your child should receive a Form W-2 showing the amount of these “wages” and the amount of tax withheld, and any portion of the award that’s taxable must be reported, even if no Form W-2 is received.

These are just the basic rules. Other rules and limitations may apply. For example, if your child’s scholarship is taxable, it may limit other higher education tax benefits to which you or your child are entitled. As we approach the new academic year, best wishes for your child’s success in school. Contact us if you’d like to discuss these or other tax matters further.

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If you have a parent entering a nursing home, you may not be thinking about taxes. But there are a number of possible tax implications. Here are five.

1. Long-term medical care

The costs of qualified long-term care, including nursing home care, are deductible as medical expenses to the extent they, along with other medical expenses, exceed 7.5% of adjusted gross income (AGI).

Qualified long-term care services are necessary diagnostic, preventive, therapeutic, curing, treating, mitigating and rehabilitative services, and maintenance or personal-care services required by a chronically ill individual that is provided under care administered by a licensed healthcare practitioner.

To qualify as chronically ill, a physician or other licensed healthcare practitioner must certify an individual as unable to perform at least two activities of daily living (eating, toileting, transferring, bathing, dressing, and continence) for at least 90 days due to a loss of functional capacity or severe cognitive impairment.

2. Long-term care insurance

Premiums paid for a qualified long-term care insurance contract are deductible as medical expenses (subject to limitations explained below) to the extent they, along with other medical expenses, exceed the percentage-of-AGI threshold. A qualified long-term care insurance contract covers only qualified long-term care services, doesn’t pay costs covered by Medicare, is guaranteed renewable and doesn’t have a cash surrender value.

Qualified long-term care premiums are includible as medical expenses up to certain amounts. For individuals over 60 but not over 70 years old, the 2021 limit on deductible long-term care insurance premiums is $4,520, and for those over 70, the 2021 limit is $5,640.

3. Nursing home payments

Amounts paid to a nursing home are deductible as a medical expense if a person is staying at the facility principally for medical, rather than custodial care. If a person isn’t in the nursing home principally to receive medical care, only the portion of the fee that’s allocable to actual medical care qualifies as a deductible expense. But if the individual is chronically ill, all qualified long-term care services, including maintenance or personal care services, are deductible.

If your parent qualifies as your dependent, you can include any medical expenses you incur for your parent along with your own when determining your medical deduction.

4. Head-of-household filing status 

If you aren’t married and you meet certain dependency tests for your parent, you may qualify for head-of-household filing status, which has a higher standard deduction and lower tax rates than single filing status. You may be eligible to file as head of household even if the parent for whom you claim an exemption doesn’t live with you.

5. The sale of your parent’s home. 

If your parent sells his or her home, up to $250,000 of the gain from the sale may be tax-free. In order to qualify for the $250,000 exclusion, the seller must generally have owned the home for at least two years out of the five years before the sale, and used the home as a principal residence for at least two years out of the five years before the sale. However, there’s an exception to the two-out-of-five-year use test if the seller becomes physically or mentally unable to care for him or herself during the five-year period.

These are only some of the tax issues you may deal with when your parent moves into a nursing home. Contact us if you need more information or assistance.

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More than 43 million student borrowers are in debt with an average of $39,351 each, according to the research group EducationData.org. If you have student loan debt, you may wonder if you can deduct the interest you pay. The answer is yes, subject to certain limits. However, the deduction is phased out if your adjusted gross income exceeds certain levels — and they aren’t as high as the income levels for many other deductions.

Basics of the deduction

The maximum amount of student loan interest you can deduct each year is $2,500. The interest must be for a “qualified education loan,” which means a debt incurred to pay tuition, room and board, and related expenses to attend a post-high school educational institution, including certain vocational schools. Post-graduate programs may also qualify. For example, an internship or residency program leading to a degree or certificate awarded by an institution of higher education, hospital, or health care facility offering post-graduate training can qualify.

It doesn’t matter when the loan was taken out or whether interest payments made in earlier years on the loan were deductible or not.

For 2021, the deduction is phased out for single taxpayers with AGI between $70,000 and $85,000 ($140,000 and $170,000 for married couples filing jointly). The deduction is unavailable for single taxpayers with AGI of more than $85,000 ($170,000 or married couples filing jointly).

Married taxpayers must file jointly to claim this deduction.

The deduction is taken “above the line.” In other words, it’s subtracted from gross income to determine AGI. Thus, it’s available even to taxpayers who don’t itemize deductions.

Not eligible

No deduction is allowed to a taxpayer who can be claimed as a dependent on another tax return. For example, let’s say a parent is paying for the college education of a child whom the parent is claiming as a dependent. In this case, the interest deduction is only available for interest the parent pays on a qualifying loan, not for any of the interest the child may pay on a loan the student may have taken out. The child will be able to deduct interest that is paid in later years when he or she is no longer a dependent.

Other requirements 

The interest must be on funds borrowed to cover qualified education costs of the taxpayer or his spouse or dependent. The student must be a degree candidate carrying at least half the normal full-time workload. Also, the education expenses must be paid or incurred within a reasonable time before or after the loan is taken out.

Taxpayers must keep records to verify qualifying expenditures. Documenting a tuition expense isn’t likely to pose a problem. However, care should be taken to document other qualifying education-related expenses including books, equipment, fees, and transportation.

Documenting room and board expenses should be straightforward for students living and dining on campus. Student who live off campus should maintain records of room and board expenses, especially when there are complicating factors such as roommates.

Contact us if you’d like help in determining whether you qualify for this deduction or if you have questions about it.

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If you’re planning your estate, or you’ve recently inherited assets, you may be unsure of the “cost” (or “basis”) for tax purposes.

The current rules

Under the current fair market value basis rules (also known as the “step-up and step-down” rules), an heir receives a basis in inherited property equal to its date-of-death value. So, for example, if your grandmother bought stock in 1935 for $500 and it’s worth $1 million at her death, the basis is stepped up to $1 million in the hands of your grandmother’s heirs — and all of that gain escapes federal income tax.

The fair market value basis rules apply to inherited property that’s includible in the deceased’s gross estate, and those rules also apply to property inherited from foreign persons who aren’t subject to U.S. estate tax. It doesn’t matter if a federal estate tax return is filed. The rules apply to the inherited portion of property owned by the inheriting taxpayer jointly with the deceased, but not the portion of jointly held property that the inheriting taxpayer owned before his or her inheritance. The fair market value basis rules also don’t apply to reinvestments of estate assets by fiduciaries.

Gifting before death

It’s crucial to understand the current fair market value basis rules so that you don’t pay more tax than you’re legally required to.

For example, in the above example, if your grandmother decides to make a gift of the stock during her lifetime (rather than passing it on when she dies), the “step-up” in basis (from $500 to $1 million) would be lost. Property that has gone up in value acquired by gift is subject to the “carryover” basis rules. That means the person receiving the gift takes the same basis the donor had in it ($500 in this example), plus a portion of any gift tax the donor pays on the gift.

A “step-down” occurs if someone dies owning property that has declined in value. In that case, the basis is lowered to the date-of-death value. Proper planning calls for seeking to avoid this loss of basis. Giving the property away before death won’t preserve the basis. That’s because when property that has gone down in value is the subject of a gift, the person receiving the gift must take the date of gift value as his basis (for purposes of determining his or her loss on a later sale). Therefore, a good strategy for property that has declined in value is for the owner to sell it before death so he or she can enjoy the tax benefits of the loss.

Change on the horizon?

Be aware that President Biden has proposed ending the ability to step-up the basis for gains in excess of $1 million. There would be exemptions for family-owned businesses and farms. Of course, any proposal must be approved by Congress in order to be enacted.

These are the basic rules. Other rules and limits may apply. For example, in some cases, a deceased person’s executor may be able to make an alternate valuation election. Contact us for tax assistance when estate planning or after receiving an inheritance. We’ll keep you up to date on any tax law changes.

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Do you have significant investment-related expenses, including the cost of subscriptions to financial services, home office expenses and clerical costs? Under current tax law, these expenses aren’t deductible through 2025 if they’re considered investment expenses for the production of income. But they’re deductible if they’re considered trade or business expenses.

For years before 2018, production-of-income expenses were deductible, but they were included in miscellaneous itemized deductions, which were subject to a 2%-of-adjusted-gross-income floor. (These rules are scheduled to return after 2025.) If you do a significant amount of trading, you should know which category your investment expenses fall into, because qualifying for trade or business expense treatment is more advantageous now.

In order to deduct your investment-related expenses as business expenses, you must be engaged in a trade or business. The U.S. Supreme Court held many years ago that an individual taxpayer isn’t engaged in a trade or business merely because the individual manages his or her own securities investments — regardless of the amount or the extent of the work required.

A trader vs. an investor

However, if you can show that your investment activities rise to the level of carrying on a trade or business, you may be considered a trader, who is engaged in a trade or business, rather than an investor, who isn’t. As a trader, you’re entitled to deduct your investment-related expenses as business expenses. A trader is also entitled to deduct home office expenses if the home office is used exclusively on a regular basis as the trader’s principal place of business. An investor, on the other hand, isn’t entitled to home office deductions since the investment activities aren’t a trade or business.

Since the Supreme Court decision, there has been extensive litigation on the issue of whether a taxpayer is a trader or investor. The U.S. Tax Court has developed a two-part test that must be satisfied in order for a taxpayer to be a trader. Under this test, a taxpayer’s investment activities are considered a trade or business only where both of the following are true:

1. The taxpayer’s trading is substantial (in other words, sporadic trading isn’t considered a trade or business), and
2. The taxpayer seeks to profit from short-term market swings, rather than from long-term holding of investments.

Profit in the short term

So, the fact that a taxpayer’s investment activities are regular, extensive and continuous isn’t in itself sufficient for determining that a taxpayer is a trader. In order to be considered a trader, you must show that you buy and sell securities with reasonable frequency in an effort to profit on a short-term basis. In one case, a taxpayer who made more than 1,000 trades a year with trading activities averaging about $16 million annually was held to be an investor rather than a trader because the holding periods for stocks sold averaged about one year.

Contact us if you have questions or would like to figure out whether you’re an investor or a trader for tax purposes.

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The IRS just released its audit statistics for the 2020 fiscal year and fewer taxpayers had their returns examined as compared with prior years. But even though a small percentage of returns are being chosen for audit these days, that will be little consolation if yours is one of them.

Latest statistics

Overall, just 0.5% of individual tax returns were audited in 2020. However, as in the past, those with higher incomes were audited at higher rates. For example, in 2020, 2.2% of taxpayers with adjusted gross incomes (AGIs) of between $1 million and $5 million were audited. Among the richest taxpayers, those with AGIs of $10 million and more, 7% of returns were audited in 2020.

These are among the lowest percentages of audits conducted in recent years. However, the Biden administration has announced it would like to raise revenue by increasing tax compliance and enforcement. In other words, audits may be on the rise in coming years.

Prepare in advance 

Even though fewer audits were performed in 2020, the IRS will still examine thousands of returns this year. With proper planning, you may fare well even if you’re one of the unlucky ones.

The easiest way to survive an IRS examination is to prepare in advance. On a regular basis, you should systematically maintain documentation — invoices, bills, canceled checks, receipts, or other proof — for all items reported on your tax returns.

It’s possible you didn’t do anything wrong. Just because a return is selected for audit doesn’t mean that an error was made. Some returns are randomly selected based on statistical formulas. For example, IRS computers compare income and deductions on returns with what other taxpayers report. If an individual deducts a charitable contribution that’s significantly higher than what others with similar incomes report, the IRS may want to know why.

Returns can also be selected if they involve issues or transactions with other taxpayers who were previously selected for audit, such as business partners or investors.

The government generally has three years within which to conduct an audit, and often the exam won’t begin until a year or more after you file your return.

Complex vs. simple returns

The scope of an audit depends on the tax return’s complexity. A return reflecting business or real estate income and expenses will obviously take longer to examine than a return with only salary income.

An audit may be conducted by mail or through an in-person interview and review of records. The interview may be conducted at an IRS office or may be a “field audit” at the taxpayer’s home, business, or accountant’s office.

Important: Even if your chosen for audit, an IRS examination may be nothing to lose sleep over. In many cases, the IRS asks for proof of certain items and routinely “closes” the audit after the documentation is presented.

Don’t go it alone

It’s advisable to have a tax professional represent you at an audit. A tax pro knows the issues that the IRS is likely to scrutinize and can prepare accordingly. In addition, a professional knows that in many instances IRS auditors will take a position (for example, to disallow certain deductions) even though courts and other guidance have expressed contrary opinions on the issues. Because pros can point to the proper authority, the IRS may be forced to concede on certain issues.

If you receive an IRS audit letter or simply want to improve your recordkeeping, we’re here to help. Contact us to discuss this or any other aspect of your taxes.

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