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Personal Deduction Planning

Personal Deduction Planning

Taxes, like death, are inevitable. But why pay more than you have to? The trick to minimizing your federal income tax liability is to understand the rules and make the most of your tax planning opportunities. Personal deduction planning is one aspect of tax planning. Here, your goals are to use your deductions in the most efficient manner and take all deductions to which you’re entitled.

Deductions lower your taxable income

Your first step is to understand how deductions work. You subtract certain deductions from your total income to arrive at your adjusted gross income (AGI); these deductions are commonly referred to as adjustments to income or as “above-the-line” deductions. Then, you subtract other deductions and exemptions from your AGI to determine your taxable income; these deductions are sometimes referred to as “below-the- line” deductions. Your tax liability is calculated based on your taxable income. Generally speaking, therefore, the higher your deduction level, the lower your tax liability.

You can either take a standard deduction or itemize

After you’ve computed your AGI, you’ll generally want to subtract the greater of either the standard deduction or the total of your itemized deductions. The standard deduction is a fixed dollar amount, indexed for inflation yearly, that is determined according to your filing status (e.g., married filing jointly, single) and certain circumstances. Itemized deductions are various deductions that are reported on Schedule A of your federal tax return (Form 1040). They involve certain personal expenses, such as medical expenses, mortgage interest, state taxes, charitable contributions, theft losses, and miscellaneous itemized deductions. If you have enough of these types of expenses, your itemized deductions may exceed your standard deduction. In that case, it would generally be to your advantage to itemize.

When filling out your tax return, how do you know whether to take the standard deduction or itemize? You should calculate your taxes (including any alternative minimum tax) using both methods, and go with the one that lowers your tax liability the most. Be aware that there are some limitations regarding who can use the standard deduction and who can itemize. Also, certain itemized deductions are available to you only if your expenses exceed a particular percentage of your AGI. For example, many miscellaneous itemized deductions are allowed only to the extent that they (when totaled) exceed 2 percent of your AGI. So, if your AGI is $100,000, your first $2,000 of miscellaneous itemized deductions won’t count toward your total itemized deductions. Your medical expense deduction may also be limited by your AGI. Additionally, for 2013 an overall limitation on itemized deductions generally applies to individuals with high AGIs (this limitation did not apply for 2012).

Caution: There may be circumstances where it is better to itemize deductions even if the standard deduction is greater than itemized deductions. For example, if you are subject to alternative minimum tax, even a small amount of some itemized deductions may be preferable to the standard deduction, which is reduced to zero for alternative minimum tax purposes.

The medical and dental expenses deduction: what it is, and how it involves your income level

The medical and dental expenses deduction is an itemized deduction that you may take (within certain limits) for unreimbursed medical and dental expenses you paid during the year for yourself, your spouse, and your dependents. You may be surprised to learn which medical and dental expenses are deductible and which are not; the line is sometimes blurry. For example, you can’t deduct your expenses for nicotine gum, but you can deduct your fee for a smoking cessation program. Many expenses qualify for this deduction, including acupuncture treatments, crutches, eyeglasses, and prescription drugs. You should obtain IRS Publication 502, Medical and Dental Expenses, for an authoritative list of eligible and nondeductible expenses. If you don’t review this list, you may miss out on some important tax-saving opportunities.

For 2013, you can take this deduction only to the extent that your unreimbursed medical expenses exceed 10 percent of your AGI (7.5 percent if you or your spouse are age 65 or older). That might sound complicated, but here’s how it works. First, add up your eligible medical expenses. You can deduct only part of that total on Schedule A of your federal income tax return. The schedule will actually lead you through this calculation. On that form, you’ll multiply your AGI by 10 percent (.10). The figure you come up with will represent the amount of your medical expenses that you cannot deduct. Subtract this figure from your total eligible medical expenses. The remaining amount is your medical deduction.

Note: Prior to 2013, the threshold to deduct medical expenses was 7.5 percent of adjusted gross income. For those age 65 or older, the AGI threshold remains 7.5 percent, and will not increase to 10 percent until 2017.

Proper timing of your deductions will minimize your taxes

For most people, income is reported in the year that it’s received, while deductions are generally taken for the year in which expenses are paid. In many cases, you can control whether you incur an expense this year or next. That means that you can control the timing of your itemized deductions to some extent. If you’re in a higher income tax bracket this year than you expect to be in next year, you may want to accelerate your deductions into the current year to minimize your tax liability. You can do this by paying deductible expenses before year-end and making charitable contributions before year-end. For example, if you have major dental work scheduled for January of next year, you can reschedule for December to take advantage of the deduction this year. Here are some tips:

  • If you pay a deductible expense by check, make sure it’s dated and mailed before year-end. It needn’t clear the bank by year-end, however.
  • If you pay by credit card, the expense is deductible in the year the charge is incurred, not when the credit card bill is paid.
  • A mere pledge or promise to make a charitable contribution is not deductible.
  • Along with your cash contributions to a charity, remember to deduct noncash contributions like clothes. You can also deduct mileage if you use your car for charitable purposes.

Disclosure:The content provided in this publication is for informational purposes only. Nothing stated is to be construed as financial or legal advice. Sterling Group United recommends that you seek the advice of a qualified financial, tax, legal, or other professional if you have questions.

Tax Planning Tips: Disability Insurance

Tax Planning Tips: Disability Insurance

The income you receive from disability income insurance may or may not be taxable. The taxability of disability income insurance benefits depends on what type of benefits you receive, whether the premiums were paid with pretax or after-tax dollars, and who paid the premiums (you or your employer).

Individual disability income insurance

The rules surrounding taxation of individual disability income insurance benefits are generally simple. Because you pay the premiums with after-tax dollars, the benefits you receive are tax free. However, unlike health insurance premiums, you can’t deduct premiums paid for individual disability income insurance as a medical expense.

Sometimes, your employer pays for an individual disability insurance policy on you. This may be the case if you are considered to be a key employee of the business. If so, different rules may apply. If the employer gets the benefit, then the premium is not deductible to the company, and the benefit is not taxable when received by the company.

Employer-sponsored group disability insurance

If you are enrolled in a group disability insurance plan sponsored by your employer, the taxability of your benefits depends on who pays the premium. If you pay the total premium using after-tax income, then your benefits will be tax free. On the other hand, if your employer pays the total premium and does not include the cost of coverage in your gross income, then your benefits will be taxable.

If your employer pays part of the insurance premium and you pay the rest, then your tax liability will be split as well. The part of the benefit you receive that is related to the employer-paid share of the premium is taxable; any part of the benefit related to your share of the premium is tax free.

If you pay part of the premium for employer-sponsored disability coverage, the type of dollars you use to pay the premium determines whether your benefit will be taxable. If you pay your part of the premium with pretax dollars, through a cafeteria or medical reimbursement plan, you’ll owe income tax on any disability benefit you receive that is related to that part of the premium. On the other hand, if you pay your part of the premium with after-tax dollars, you won’t owe income tax on any disability benefit you receive that is related to that part of the premium.

Benefits under a cafeteria plan

An employer-sponsored cafeteria plan allows you to select among certain employee benefits, including health, life, and disability insurance. You normally pay for these benefits on a pretax basis. Sometimes, however, your employer pays the premium for the benefits you choose, and if you choose additional benefits, you pay for extra coverage using either pretax or after-tax dollars.

If you pay your share of the premium with after-tax dollars, that portion of your disability benefits will be considered tax-free income; you’ll be taxed only on the portion of the benefit related to your employer’s contribution. However, if you pay your share with pretax dollars, that portion of your disability benefits will be considered taxable income, and you’ll have to pay income tax on all of your benefit.

If you are totally and permanently disabled, and you receive fully or partially taxable disability benefits from an employer-sponsored disability insurance plan, you may be eligible to claim a tax credit when you file your annual income tax return.

Group association disability insurance

Disability policies purchased through an association are called group policies because members of the association are offered special terms, conditions, and rates based on the characteristics of that group. Association policies function much like individual policies and have similar tax consequences. If you pay the premiums for an association policy, the benefits you receive are tax free, but you cannot deduct the cost of the premiums.

Government disability insurance

All, part, or none of the disability benefits you receive through government disability insurance programs may be taxable. How much of the benefit is taxable, depends on the type of government disability benefit you are receiving.

Social Security benefits

If the only income you had during the year was Social Security disability income, your benefit usually isn’t taxable. However, if your total income exceeds a certain base amount and you earned other income during the year (or had substantial investment income), then you might have to pay tax on part of your benefit. More specifically, your Social Security benefit is taxable if your modified adjusted gross income plus one-half of your Social Security benefit exceeds the base amount for your filing status.

Medicare benefits:

When you are disabled, you may be eligible to enroll in Medicare. If you pay premiums for the medical insurance portion of Medicare, you may deduct these premiums as a medical expense (provided, of course, that your medical expenses exceed 7.5 percent of your adjusted gross income). In addition, Medicare benefits you receive are not taxable.

Workers’ compensation:

Generally, if you receive a disability benefit from workers’ compensation, that benefit won’t be taxable. Any benefits paid to your survivors would also be tax exempt. However, in certain cases, you may be able to return to work and continue to receive payments. If this is the case, then your workers’ compensation benefit would be taxable. Note, though, that if part of your workers’ compensation benefit offsets (reduces) your Social Security benefit, then that part is considered to be a Social Security benefit. It may then be taxable according to the rules governing Social Security.

Veterans benefits

Disability benefits you receive from the Department of Veterans Affairs, formerly known as the Veterans Administration, are not taxable, except for certain payments for rehabilitative services.

Military benefits

Most military disability pensions are taxable. However, if you were disabled due to injury or illness resulting from active service in the armed forces of any country, your disability benefits may be tax free under certain conditions.

Federal employees retirement system (FERS) benefits

If you retire on disability, the payments under FERS that you receive from a pension or annuity are taxable as wages until you reach minimum retirement age. Beginning on the day after you reach minimum retirement age, payments you receive are taxable as a pension.

Is it wiser to buy disability coverage with pretax or after-tax dollars?

If you pay for disability income insurance with pretax dollars, you are reducing your taxable income. This means that you won’t have income taxes withheld on the portion of your income you used to pay your disability income insurance premium. However, you also have to consider how your benefit would be taxed if you ever begin receiving disability benefits. If you use pretax dollars to pay your insurance premium, then your benefit would be fully taxable. However, if you use after-tax dollars, your benefit won’t be taxable.

It comes down to this: If you never use your disability benefits, you’ll save money by paying your premiums with pretax dollars. But if you do use your disability benefits, using after-tax dollars to pay your premiums places you in a better position. Consult your tax professional for advice.

Disclosure:The content provided in this publication is for informational purposes only. Nothing stated is to be construed as financial or legal advice. Sterling Group United recommends that you seek the advice of a qualified financial, tax, legal, or other professional if you have questions.

Income Tax Planning and 529 Plans

Income Tax Planning and 529 Plans

The income tax benefits offered by 529 plans make these plans attractive to parents (and others) interested in saving for college. Qualified withdrawals from a 529 plan are tax free at the federal level, and some states also offer tax breaks to their residents. It’s important to evaluate the federal and state tax consequences of plan withdrawals and contributions before you invest in a 529 plan.

Federal income tax treatment of qualified withdrawals

There are two types of 529 plans–college savings plans and prepaid tuition plans. The federal income tax treatment of these plans is identical. Your contributions to college savings plans and prepaid tuition plans are tax deferred. This means that you don’t pay income taxes on the plan’s earnings each year.

Then, if you take out money and use it to pay for qualified education expenses, the earnings portion of your withdrawal is free from federal income tax. This presents a significant opportunity to help you accumulate funds for college.

Qualified education expenses include tuition, fees, and books for college and graduate school. Room-and-board expenses are also considered qualified if the beneficiary is attending college or graduate school on at least a half-time basis.

State income tax treatment of qualified withdrawals

States differ in the 529 plan tax benefits they offer to their residents. For example, some states may offer no tax benefits, while others may exempt earnings on qualified withdrawals from state income tax and/or offer a deduction for contributions. However, keep in mind that states may limit their tax benefits to individuals who participate in the in-state 529 plan.

You should look to your own state’s laws to determine the income tax treatment of withdrawals (and deductions). In general, you won’t be required to pay income taxes to another state simply because you opened a 529 account in that state. But you’ll probably be taxed in your state of residency on the earnings distributed by your 529 plan (whatever state sponsored it) unless your state grants a specific exemption. Also, make sure you understand your state’s definition of “qualified education expenses,” since it may differ from the federal definition.

Income tax treatment of nonqualified withdrawals (federal and state)

If you make a nonqualified withdrawal (i.e., one not used for qualified education expenses), the earnings portion of the distribution will usually be taxable on your federal (and probably state) income tax return in the year of the distribution. The earnings are usually taxed at the rate of the person who receives the distribution (known as the distributee). In most cases, the account owner will be the distributee. Some plans specify who the distributee is, while others may allow you (as the account owner) to determine the recipient of a nonqualified withdrawal.

You’ll also pay a federal 10 percent penalty on the taxable amount of the nonqualified withdrawal (usually, that means on the earnings). There are a couple of exceptions, though. The penalty is usually not charged if you terminate the 529 account. This is because the beneficiary has died or become disabled. Or, if you withdraw funds not needed for college because the beneficiary has received a scholarship. A state penalty may also apply.

Deducting your contributions to a 529 plan

Unfortunately, you can’t claim a federal income tax deduction for your contributions to a 529 plan. Depending on where you live, though, you may qualify for a deduction on your state income tax return. A number of states now allow a state income tax deduction for contributions to a 529 plan, and several other states are considering such a measure. Again, keep in mind that most states let you claim an income tax deduction on your state tax return only if you contribute to your own state’s 529 plan.

Most of the states that provide a deduction for contributions impose a deduction cap, or limitation, on the amount of the deduction. For example, if you contribute $10,000 to your son’s 529 plan this year, your state might allow you to deduct only $4,000 on your state income tax return. Check the details of your 529 plan and the tax laws of your state to learn whether your state imposes a deduction cap.

Also, if you’re planning to claim a state income tax deduction for your contributions, you should learn whether your state applies income recapture rules to 529 plans. Income recapture means that deductions allowed in one year may be required to be reported as taxable income if you make a nonqualified withdrawal from the 529 plan in a later year. Again, check the laws of your state for details.

Coordination with the Coverdell education savings account and education tax credits

You can fund a Coverdell education savings account and a 529 account in the same year for the same beneficiary without triggering a penalty.

You can also claim an education tax credit in the same year you withdraw funds from a 529 plan to pay for qualified education expenses. But your 529 plan withdrawal will not be completely tax free on your federal income tax return if it’s used for the same higher education expenses for which you’re claiming a credit. (When calculating the amount of your qualified higher education expenses for purposes of your Section 529 withdrawal, you’ll have to reduce your qualified expenses figure by any expenses used to compute the education tax credit.)

Disclosure:The content provided in this publication is for informational purposes only. Nothing stated is to be construed as financial or legal advice. Sterling Group United recommends that you seek the advice of a qualified financial, tax, legal, or other professional if you have questions.

Tax Tips: Health Insurance

Tax Tips: Health Insurance

Your health insurance coverage probably came in handy several times over the past year. It all seemed so simple at the time. You paid a deductible, and your insurance usually kicked in the rest. But what do you do at tax time? Just what are you taxed on, and what can you deduct on your federal income tax return?

Your income taxes may be affected by two aspects of your health insurance plan–the premiums and the benefits. Here’s what you need to know.

You don’t include employer-paid premiums in your income

For tax purposes, you can generally exclude from your income any health insurance premiums paid by your employer. The premiums can be for insurance covering you, your spouse, and any dependents. It doesn’t matter whether the premiums paid for an employer-sponsored group policy or an individual policy. You can even exclude premiums that your employer pays when you are laid off from your job.

What if your employer reimburses you for your premiums?

If you pay the premiums on your health insurance policy and receive a reimbursement from your employer for those premiums, the amount of the reimbursement is not taxable income. However, if your employer simply pays you a lump sum that may be used to pay health insurance premiums but is not required to be used for this purpose, that amount is taxable.

In most cases, you won’t be able to deduct the premiums you pay

The deductibility of health insurance premiums follows the rules for deducting medical expenses. Usually, the premiums you pay on an individual health insurance policy won’t be deductible. However, if you itemize deductions on Schedule A, and your unreimbursed medical expenses exceed 7.5 percent of your adjusted gross income (AGI) in any tax year, you may be able to take a deduction. You can deduct the amount by which your unreimbursed medical expenses exceed this 7.5 percent threshold.

For example, if your AGI is $100,000, then 7.5 percent of your AGI is $7,500. If your unreimbursed medical expenses amount to $8,000 and you itemize deductions, you’ll be able to deduct $500 worth of your expenses.

Unreimbursed medical expenses include premiums paid for major medical, hospital, surgical, and physician’s expense insurance, and amounts paid out of your pocket for treatment not covered by your health insurance.

If you’re self-employed, special deduction rules may apply

In addition to the general rule of deducting premiums as medical expenses, self-employed individuals can deduct a percentage of their health insurance premiums as business expenses. These deductions aren’t limited to amounts over 7.5 percent of AGI, as are medical expense deductions. They are limited, though, to amounts less than an individual’s earned income. The definition of self-employed individuals includes sole proprietors, partners, and 2 percent S corporation shareholders.

If you qualify, you can deduct 100 percent of the cost of health insurance that you provide for yourself, your spouse, and your dependents. This deduction is taken on the front of your federal Form 1040; the portion of your health insurance premiums that is not deductible there can be added to your total medical expenses itemized in Schedule A.

Your health insurance benefits typically aren’t taxable

Whether we’re talking about an employer-sponsored group plan or a health insurance policy you bought on your own, you generally aren’t taxed on the health insurance benefits you receive.

What about reimbursements for medical care? You can generally exclude from income reimbursements for hospital, surgical, or medical expenses that you receive from your employer’s health insurance plan. These reimbursements can be for your own expenses or for those of your spouse or dependents. The exclusion applies regardless of whether your employer provides group or individual insurance, or serves as a self-insurer. The reimbursements can be for actual medical care or for insurance premiums on your own health insurance.

Note that there is no dollar limit on the amount of tax-free medical reimbursements you can receive in a year. However, if your total reimbursements for the year exceed your actual expenses, and your employer pays for all or part of your health insurance premiums, you may have to include some of the excess in your income.

Disclosure:The content provided in this publication is for informational purposes only. Nothing stated is to be construed as financial or legal advice. Sterling Group United recommends that you seek the advice of a qualified financial, tax, legal, or other professional if you have questions.

Tax Benefits of Home Ownership

Tax Benefits of Home Ownership

In tax lingo, your principal residence is the place where you legally reside. It’s typically the place where you spend most of your time, but several other factors are also relevant in determining your principal residence. Many of the tax benefits associated with home ownership apply mainly to your principal residence–different rules apply to second homes and investment properties. Here’s what you need to know to make owning a home really pay off at tax time.

Deducting mortgage interest

One of the most important tax benefits that comes with owning a home is the fact that you may be able to deduct any mortgage interest that you pay. If you itemize deductions on Schedule A of your federal income tax return, you can generally deduct the interest that you pay on debt resulting from a loan used to buy, build, or improve your home, provided that the loan is secured by your home. In tax terms, this is referred to as “home acquisition debt.” You’re able to deduct home acquisition debt on a second home as well as your main home. However, that when it comes to second homes, special rules apply if you rent the home out for part of the year.

Up to $1 million of home acquisition debt ($500,000 if you’re married and file separately) qualifies for the interest deduction. (Different rules apply if you incurred the debt before October 14, 1987.) If your mortgage loan exceeds $1 million, some of the interest that you pay on the loan may not be deductible.

You’re also generally able to deduct interest you pay on certain home equity loans or lines of credit secured by your home, but the rules are different. Home equity debt typically involves a loan secured by your main or second home, not used to buy, build, or improve your home. Deductible home equity debt is limited to the lesser of:

  • The fair market value of the home minus the total home acquisition debt on that home, or
  • $100,000 (or $50,000 if your filing status is married filing separately) for main and second homes combined

The interest that you pay on a qualifying home equity loan or line of credit is generally deductible regardless of how you use the loan proceeds. For more information, see IRS Publication 936.

Mortgage insurance

Qualified mortgage insurance is mortgage insurance provided by the Department of Veterans Affairs, the Federal Housing Administration, the Rural Housing Service, and qualified private mortgage insurance (PMI) providers. The deduction is phased out, though, if your adjusted gross income is more than $100,000 ($50,000 if you’re married and file separately).

Deducting real estate property taxes

If you itemize deductions on Schedule A, you can also generally deduct real estate taxes that you’ve paid on your property in the year that they’re paid to the taxing authority. If you pay your real estate taxes through an escrow account, you can only deduct the real estate taxes actually paid by your lender from the escrow account during the year. Only the legal property owner can deduct real estate taxes. You cannot deduct homeowner association assessments, since they are not imposed by a state or local government.

AMT considerations

If you’re subject to the alternative minimum tax (AMT) in a given year, your ability to deduct mortgage interest and real estate taxes may be limited. That’s because, under the AMT calculation, no deduction is allowed for state and local taxes, including real estate tax. And, under the AMT rules, only interest on mortgage and home equity debt used to buy, build, or improve your home is deductible. So, if you use a home equity loan to purchase a car, the interest on the loan may be deductible for regular income tax purposes, but not for AMT.

Deducting points and closing costs

Buying a home is confusing enough without wondering how to handle the settlement charges at tax time. When you take out a loan to buy a home, or when you refinance an existing loan on your home, you’ll probably be charged closing costs. These may include points, as well as attorney’s fees, recording fees, title search fees, appraisal fees, and loan or document preparation and processing fees. You’ll need to know whether you can deduct these fees (in part or in full) on your federal income tax return, or whether they’re simply added to the cost basis of your home.

Before we get to that, let’s define one term. Points are certain charges paid when you obtain a home mortgage. They are sometimes called loan origination fees. One point typically equals one percent of the loan amount borrowed. When you buy your main home, you may be able to deduct points in full in the year that you pay them if you itemize deductions and meet certain requirements. You may even be able to deduct points that the seller pays for you.

Refinanced loans are treated differently. Generally, points that you pay on a refinanced loan are not deductible in full in the year that you pay them. Instead, they’re deducted ratably over the life of the loan. In other words, you can deduct a certain portion of the points each year. If the loan is used to make improvements to your principal residence, however, you may be able to deduct the points in full in the year paid.

What about other settlement fees and closing costs? Generally, you cannot deduct these costs on your tax return. Instead, you must adjust your tax basis (the cost, plus or minus certain factors) in your home. For example, you’d increase your basis to reflect certain closing costs, including:

  • Abstract fees
  • Charges for installing utility services
  • Legal fees
  • Recording fees
  • Surveys
  • Transfer or stamp taxes
  • Owner’s title insurance

For more information, see IRS Publication 530.

Tax treatment of home improvements and repairs

Home improvements and repairs are generally nondeductible. Improvements, though, can increase the tax basis of your home (which in turn can lower your tax bite when you sell your home). Improvements add value to your home, prolong its life, or adapt it to a new use. For example, the installation of a deck, a built-in swimming pool, or a second bathroom would be considered an improvement. In contrast, a repair simply keeps your home in good operating condition. Regular repairs and maintenance (e.g., repainting your house and fixing your gutters) are not considered improvements and are not included in the tax basis of your home. However, if repairs are performed as part of an extensive remodeling of your home, the entire job may be considered an improvement.

Energy tax credit

You might be entitled to a tax credit if you make certain energy-efficient improvements to your home. The credit is generally equal to 10% of the amount paid for qualified improvements including roofs, windows, exterior doors, skylights, and insulation materials. The credit is also available for the costs of certain energy efficient property, including up to $150 for qualified furnaces and hot water boilers, and up to $300 for qualified electric heat pump water heaters and central air conditioning units.

There is a $500 lifetime limit for the credit (and a $200 lifetime cap on the credit for windows)–meaning you won’t be able to claim the credit if you claimed the maximum credit in one or more prior tax years. A separate credit is also available for qualified solar, wind, geothermal heat pump, and fuel cell property costs.

Exclusion of capital gain when your house is sold

If you sell your principal residence at a loss, you generally can’t deduct the loss on your tax return. If you sell your principal residence at a gain you may be able to exclude some or all of the gain from federal income tax.

Generally speaking, capital gain (or loss) on the sale of your principal residence equals the sale price of your home less your adjusted basis in the property. Your adjusted basis is the cost of the property (i.e., what you paid for it initially), plus amounts paid for capital improvements, less any depreciation and casualty losses claimed for tax purposes.

If you meet all requirements, you can exclude from federal income tax up to $250,000 ($500,000 if you’re married and file a joint return) of any capital gain that results from the sale of your principal residence. Anything over those limits is generally subject to tax. In general this exclusion can be used only once every two years. To qualify for the exclusion, you must have owned and used the home as your principal residence for a total of two out of the five years before the sale.

For example, you and your spouse bought your home in 1981 for $200,000. You’ve lived in it ever since and file joint federal income tax returns. You sold the house yesterday for $350,000. Your entire $150,000 gain ($350,000 – $200,000) is excludable. That means that you don’t have to report your home sale on your federal income tax return.

What if you fail to meet the two-out-of-five-year rule? Or what if you used the capital gain exclusion within the past two years with respect to a different principal residence? You may still be able to exclude part of your gain if your home sale was due to a change in place of employment, health reasons, or certain other unforeseen circumstances. In such a case, exclusion of the gain may be prorated.

Additionally, special rules may apply in the following cases:

  • If your principal residence contained a home office or was otherwise used partially for business purposes
  • If you sell vacant land adjacent to your principal residence
  • If your principal residence is owned by a trust
  • If you rented part of your principal residence to tenants, or used it as a vacation or second home
  • If you owned your principal residence jointly with an unmarried individual

Note: Members of the uniformed services, foreign services, and intelligence community, as well as certain Peace Corps volunteers and employees may elect to suspend the running of the two-out-of-five-year requirement during any period of qualified official extended duty up to a maximum of ten years.

Disclosure:The content provided in this publication is for informational purposes only. Nothing stated is to be construed as financial or legal advice. Sterling Group United recommends that you seek the advice of a qualified financial, tax, legal, or other professional if you have questions.ails.

Tax Tips: Health Insurance

Tax Tips: Health Insurance

Your health insurance coverage probably came in handy several times over the past year. It all seemed so simple at the time. You paid a deductible, and your insurance usually kicked in the rest. But what do you do at tax time? Just what are you taxed on, and what can you deduct on your federal income tax return?

Your income taxes may be affected by two aspects of your health insurance plan–the premiums and the benefits. Here’s what you need to know.

You don’t include employer-paid premiums in your income

For tax purposes, you can generally exclude from your income any health insurance premiums (including Medicare) paid by your employer. The premiums can be for insurance covering you, your spouse, and any dependents. It doesn’t matter whether the premiums paid for an employer-sponsored group policy or an individual policy. You can even exclude premiums that your employer pays when you are laid off from your job.

What if your employer reimburses you for your premiums?

If you pay the premiums on your health insurance policy and receive a reimbursement from your employer for those premiums, the amount of the reimbursement is not taxable income. However, if your employer simply pays you a lump sum that may be used to pay health insurance premiums but is not required to be used for this purpose, that amount is taxable.

In most cases, you won’t be able to deduct the premiums you pay

The deductibility of health insurance premiums follows the rules for deducting medical expenses. Usually, the premiums you pay on an individual health insurance policy won’t be deductible. However, if you itemize deductions on Schedule A, and your unreimbursed medical expenses exceed 7.5 percent of your adjusted gross income (AGI) in any tax year, you may be able to take a deduction. You can deduct the amount by which your unreimbursed medical expenses exceed this 7.5 percent threshold.

For example, if your AGI is $100,000, then 7.5 percent of your AGI is $7,500. If your unreimbursed medical expenses amount to $8,000 and you itemize deductions, you’ll be able to deduct $500 worth of your expenses.

Unreimbursed medical expenses include premiums paid for major medical, hospital, surgical, and physician’s expense insurance, and amounts paid out of your pocket for treatment not covered by your health insurance.

If you’re self-employed, special deduction rules may apply

In addition to the general rule of deducting premiums as medical expenses, self-employed individuals can deduct a percentage of their health insurance premiums as business expenses. These deductions aren’t limited to amounts over 7.5 percent of AGI, as are medical expense deductions. They are limited, though, to amounts less than an individual’s earned income. The definition of self-employed individuals includes sole proprietors, partners, and 2 percent S corporation shareholders.

If you qualify, you can deduct 100 percent of the cost of health insurance that you provide for yourself, your spouse, and your dependents. This deduction is taken on the front of your federal Form 1040; the portion of your health insurance premiums that is not deductible there can be added to your total medical expenses itemized in Schedule A.

Your health insurance benefits typically aren’t taxable

Whether we’re talking about an employer-sponsored group plan or a health insurance policy you bought on your own, you generally aren’t taxed on the health insurance benefits you receive.

What about reimbursements for medical care? You can generally exclude from income reimbursements for hospital, surgical, or medical expenses that you receive from your employer’s health insurance plan. These reimbursements can be for your own expenses or for those of your spouse or dependents. The exclusion applies regardless of whether your employer provides group or individual insurance, or serves as a self-insurer. The reimbursements can be for actual medical care or for insurance premiums on your own health insurance.

Note that there is no dollar limit on the amount of tax-free medical reimbursements you can receive in a year. However, if your total reimbursements for the year exceed your actual expenses, and your employer pays for all or part of your health insurance premiums, you may have to include some of the excess in your income.

Disclosure:The content provided in this publication is for informational purposes only. Nothing stated is to be construed as financial or legal advice. Sterling Group United recommends that you seek the advice of a qualified financial, tax, legal, or other professional if you have questions.