One change to the tax laws for 2011 that can be quite important, but is often overlooked, is the change to the way self-employed taxpayers can deduct the cost of health insurance for themselves, their spouses, and any dependents. For self-employed people, especially those supporting families, the cost of health insurance can be significant, and this means that the deduction related to this cost can also be of significant value.
First, the headline news:
Previous to the recent tax law change, self-employed health could be deducted as an "adjustment to income."
Now, the deduction is still listed as an "adjustment to income"--BUT the deduction also cannow be used to reduce the self-employment tax.
The key to understanding why this is an important change is to realize that self-employed people, unlike those who work for employers "on payroll," do not have Social Security and Medicare taxes withheld from their paychecks; instead, self-employed people must pay these taxes at the end of the year, in additon to regular income tax. Also worth noting is that with employees, the employer pays half the cost of those taxes, the employee pays the other half, while self-employed people pay the whole cost themselves.
The self-employment tax rate is 15.3 percent, based on the "net profit" of the business.
So for example, let's say that a single, self-employed taxpayer has a profit from a business of $40,000. Let's further say that this taxpayer has a federal income tax rate of 15 percent and a California state income tax rate of 5 percent.
This self-employed taxpayer will also owe, in addition to the 15 and 5 income tax rates, a 15.3 percent self-employment tax.
So then let's add this up:
-- 15 percent federal tax comes to $6,000
-- Plus 5 percent state comes to $2,000
-- Plus self-employment tax comes to $6,000
For a total tax liability of $14,000, on that $40,000 of business profit.
Is it any wonder that self-employed people hate tax season?
But now, with the ability to deduct health insurance to reduce the self-employment tax, the self-employed tax burden should get at least a little bit lighter.
For example let's say that this single taxpayer paid $2,400 in health insurance, $200 per month. Previous to the law change, this taxpayer could use that deduction to reduce federal and state income tax, allowing a tax savings of $480 (20 percent of $2,400).
But now, that $2,400 can also reduce income tax, allowing an additional $368 (15.3 percent of $2,400) of tax savings.
Self-employed taxpayers (and the tax preparers who serve them) need to know how to handle the self-employed health insurance deduction under the new law. This is one "little thing" that can help self-employed taxpayers save money on their taxes. And what self-employed taxpayer wouldn't love that?
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As you may have heard a few thousand times in the past few years, the housing market in the U.S. has been in difficult times. often due to unemployment of the homeowner who can then obviously not make a large mortgage payment, let alone the property taxes, maintenance, and all the other costs of owning a home.
Many homeowners, unable to pay their mortages, have experienced foreclosure, short sale, or loan modification. And this trend is expected to continue with some predictions that 2011 will be a record year for foreclosures.
Not being able to pay your mortgage and being in danger of losing your home to the bank is stressful enough, but think about the homeowners who were able to modify their mortgages and then you end up receiving a 1099-C form stating that you have to pay income tax on the value of the "forgiven" debt.
Let's say for example that you had a mortgage of $400,00, your property value is now at $250,000, and you negotiated with your mortgage holder to reduce your outstanding mortgage balance to $350,000.
There is $50,000 of "forgiven" debt there that would, in normal circumstances, be considered taxable income. For example, if you negotiate your credit card debt, the credit card company will send you a 1099-C and you will have to pay income tax on the amount of the canceled debt.
HOWEVER, for tax years 2007-2012, there is a special exception to this rule contained in IRS Code Section 121 which may enable you to avoid being taxed on canceled debt pertaining to your PERSONAL home. To claim this exception, you (or your tax preparer) must file Form 982 with your federal tax return.
It's worth noting, though, that this exception does not necessarily apply to rental property or other property held for investment.
It's also worth noting that the State of California income tax authority, the Franchise Tax Board, has not fully and formally "conformed" to this IRS/Federal regulation. This, too, can be a bit worrisome if California decides at some point to pursue income tax due on canceled debt relating to foreclosures, short sales, and loan modifications.
Stay tuned! Questions about avoiding tax on canceled debt, how and when it's possible?
Call Pronto and consult with a senior preparer who can discuss your options with you.
Well you can definitely say that the start of tax season is a stressful time for tax preparation companies. This year has been especially crazy as we've set up our brand new West Los Angeles / Culver City area Pronto Income Tax and what a lot of work it was to get everything together.
We are happy say though that everything is in place to start cranking out those tax returns. All we need are some new clients to walk in the door!
We are offering free consultations right now, free check your refund, and free refund estimates to get people in the door. As the new kids on the block we know it's a challenge to win over new clients but we are up to the challenge and we know we have a strong value proposition thanks to our culture of client service, affordable prices, and year-round client support.
If you know anyone on the west side of L.A. who needs a good tax preparer, send him or her our way. We are eager to start forming long-term relationships with new clients and we look forward to serving you!