Tax

Business Tax

Is Canceled Debt Taxable?

Generally, debt that is forgiven or canceled by a lender is considered taxable income by the IRS and must be included as income on your tax return. Examples include a debt for which you are personally liable such as mortgage debt, credit card debt, and in some instances, student loan debt.

When that debt is forgiven, negotiated down (when you pay less than you owe), or canceled you will receive Form 1099-C, Cancellation of Debt, from your financial institution or credit union. Form 1099-C shows the amount of canceled or forgiven debt that was reported to the IRS. If you and another person were jointly and severally liable for a canceled debt, each of you may get a Form 1099-C showing the entire amount of the canceled debt. Give the office a call if you have any questions regarding joint liability of canceled debt.

Creditors who forgive $600 or more of debt are required to issue this form. If you receive a Form 1099-C and the information is incorrect, contact the lender to make corrections.

If you receive a Form 1099-C, don’t ignore it. You may not have to report that entire amount shown on Form 1099-C as income. The amount, if any, you must report depends on all the facts and circumstances. Generally, however, unless you meet one of the exceptions or exclusions discussed below, you must report any taxable canceled debt reported on Form 1099-C as ordinary income on:

  • Form 1040 or Form 1040NR, if the debt is a nonbusiness debt;
  • Schedule C or Schedule C-EZ (Form 1040), if the debt is related to a nonfarm sole proprietorship;
  • Schedule E (Form 1040), if the debt is related to non-farm rental of real property;
  • Form 4835, if the debt is related to a farm rental activity for which you use Form 4835 to report farm rental income based on crops or livestock produced by a tenant; or
  • Schedule F (Form 1040), if the debt is farm debt and you are a farmer.

Exceptions and Exclusions

If you had debt forgiven or canceled last year and receive a Form 1099-C, you might qualify for an exception or exclusion. If your canceled debt meets the requirements for an exception or exclusion, then you don’t need to report your canceled debt on your tax return. Under the federal tax code, there are five exceptions and four exclusions. Here are the five most commonly used:

Note: The Mortgage Debt Relief Act of 2007, which applied to debt forgiven in calendar years 2007 through 2014, allowed taxpayers to exclude income from the discharge of debt on their principal residence. The PATH (Protecting Americans from Tax Hikes) Act extended this relief through the end of 2016.

Up to $2 million of forgiven debt was eligible for this exclusion ($1 million if married filing separately) and debt reduced through mortgage restructuring, as well as mortgage debt forgiven in connection with a foreclosure, also qualified for the relief.

1. Amounts specifically excluded from income by law such as gifts, bequests, devises or inheritances

In most cases, you do not have income from canceled debt if the debt is canceled as a gift, bequest, devise, or inheritance. For example, if an acquaintance or family member loaned you money (and for whom you signed a promissory note) died and relieved you of the obligation to pay back the loan in his or her will, this exception would apply.

2. Cancellation of certain qualified student loans

Certain student loans provide that all or part of the debt incurred to attend a qualified educational institution will be canceled if the person who received the loan works for a certain period of time in certain professions for any of a broad class of employers. If your student loan is canceled as the result of this type of provision, the cancellation of this debt is not included in your gross income.

3. Canceled debt, that if it were paid by a cash basis taxpayer, would be deductible

If you use the cash method of accounting, then you do not realize income from the cancellation of debt if the payment of the debt would have been a deductible expense.

For example, in 2015, you obtain accounting services for your farm using credit. In 2016, due to financial troubles you were not able to pay off your farm debts and your accountant forgives a portion of the amount you owe for her services. If you use the cash method of accounting you do not include the canceled debt as income on your tax return because payment of the debt would have been deductible as a business expense.

4. Debt canceled in a Title 11 bankruptcy case

Debt canceled in a Title 11 bankruptcy case is not included in your income.

5. Debt canceled during insolvency

Do not include a canceled debt as income if you were insolvent immediately before the cancellation. In the eyes of the IRS, you would be considered insolvent if the total of all of your liabilities was more than the FMV of all of your assets immediately before the cancellation.

For purposes of determining insolvency, assets include the value of everything you own (including assets that serve as collateral for debt and exempt assets which are beyond the reach of your creditors under the law, such as your interest in a pension plan and the value of your retirement account).

Here’s an example. Let’s say you owe $25,000 in credit card debt, which you are able to negotiate down to $5,000. You have no other debts and your assets are worth $15,000. Your canceled debt is $20,000. Your insolvency amount is $10,000. Because you are insolvent at the time of the cancellation, you are only required to report the $10,000 on your tax return.

If you exclude canceled debt from income under one of the exclusions listed above, you must reduce certain tax attributes (certain credits, losses, basis of assets, etc.), within limits, by the amount excluded. If this is the case, then you must file Form 982, Reduction of Tax Attributes Due to Discharge of Indebtedness (and Section 1082 Basis Adjustment), to report the amount qualifying for exclusion and any corresponding reduction of those tax attributes.

Exceptions do not require you to reduce your tax attributes.

Questions?

Don’t hesitate to call if you have any questions about whether you qualify for debt cancellation relief.

Business Financial Planning Tax

Ensuring Financial Success for Your Business

Can you point your company in the direction of financial success, step on the gas, and then sit back and wait to arrive at your destination?

Not quite. You can’t let your business run on autopilot and expect good results. Any business owner knows you need to make numerous adjustments along the way – decisions about pricing, hiring, investments, and so on.

So, how do you handle the array of questions facing you?

One way is through cost accounting.

Cost Accounting Helps You Make Informed Decisions

Cost accounting reports and determines the various costs associated with running your business. With cost accounting, you track the cost of all your business functions – raw materials, labor, inventory, and overhead, among others.

Note: Cost accounting differs from financial accounting because it’s only used internally, for decision making. Because financial accounting is employed to produce financial statements for external stakeholders, such as stockholders and the media, it must comply with generally accepted accounting principles (GAAP). Cost accounting does not.

Cost accounting allows you to understand the following:

  1. Cost behavior. For example, will the costs increase or stay the same if production of your product goes up?
  2. Appropriate prices for your goods or services. Once you understand cost behavior, you can tweak your pricing based on the current market.
  3. Budgeting. You can’t create an effective budget if you don’t know the real costs of the line items.

Is It Hard?

To monitor your company’s costs with this method, you need to pay attention to the two types of costs in any business: fixed and variable.

Fixed costs don’t fluctuate with changes in production or sales. They include:

  • rent
  • insurance
  • dues and subscriptions
  • equipment leases
  • payments on loans
  • management salaries
  • advertising

Variable costs DO change with variations in production and sales. Variable costs include:

  • raw materials
  • hourly wages and commissions
  • utilities
  • inventory
  • office supplies
  • packaging, mailing, and shipping costs

Tip: Cost accounting is easier for smaller, less complicated businesses. The more complex your business model, the harder it becomes to assign proper values to all the facets of your company’s functioning.

If you’d like to understand the ins and outs of your business better and create sound guidance for internal decision making, consider setting up a cost accounting system.

Need Help?

Please call if you need assistance setting up cost accounting and inventory systems, preparing budgets, cash flow management or any other matter related to ensuring the financial success of your business.

Tax

Paying Taxes on Household Help

If you employ someone to work for you around your house, it is important to consider the tax implications of this arrangement. While many people disregard the need to pay taxes on household employees, they do so at the risk of paying stiff tax penalties down the road.

As you will see, the rules for hiring household help are quite complex, even for a relatively minor employee, and a mistake can bring on a tax headache that most of us would prefer to avoid.

Commonly referred to as the “nanny tax”, these rules apply to you only if (1) you pay someone for household work and (2) that worker is your employee.

  1. Household work is work that is performed in or around your home by baby-sitters, nannies, health aides, private nurses, maids, caretakers, yard workers, and similar domestic workers.

    A household worker is your employee if you control not only what work is done, but how it is done.

Who Is a Household Employee?

If a worker is your employee, it does not matter whether the work is full-time or part-time or that you hired the worker through an agency or from a list provided by an agency or association. It also does not matter whether you pay the worker on an hourly, daily or weekly basis or by the job.

If the worker controls how the work is done, the worker is not your employee but is self-employed. A self-employed worker usually provides his or her own tools and offers services to the general public in an independent business.

Also, if an agency provides the worker and controls what work is done and how it is done, the worker is not your employee.

Example: You pay Bethany to babysit your child and do light housework four days a week in your home. Bethany follows your specific instructions about household and childcare duties. You provide the household equipment and supplies that Bethany needs to do her work. Bethany is your household employee.

Example: You pay John to care for your lawn. John also offers lawn care services to other homeowners in your neighborhood. He provides his own tools and supplies, and he hires and pays any helpers he needs. Neither John nor his helpers are your household employees.

Can Your Employee Legally Work in the United States?

When you hire a household employee to work for you on a regular basis, he or she must complete USCIS Form I-9 Employment Eligibility Verification. It is your responsibility to verify that the employee is either a U.S. citizen or an alien who can legally work and then complete the employer part of the form. It is unlawful for you to knowingly hire or continue to employ a person who cannot legally work in the United States.

Keep the completed form for your records. Do not return the form to the U.S. Citizenship and Immigration Services (USCIS).

Tip: Two copies of Form I-9 are contained in the UCIS Employer Handbook. Visit the USCIS website or call 800-375-5283 to order the handbook, additional copies of the form, or to get more information, or give us a call.

Do You Need to Pay Employment Taxes?

If you have a household employee, you may need to withhold and pay Social Security and Medicare taxes, or you may need to pay federal unemployment tax or both. Refer to this table for details:

If you…

Then you need to…
Will pay cash wages of $2,000 or more in 2017 to any one household employee.Do not count wages you pay to:

  • your spouse,
  • your child under age 21,
  • your parent, or
  • any employee under age 18 during 2017.
 Withhold and pay Social Security and Medicare taxes.

  • The combined taxes are generally 15.3% of cash wages.
  • Your employee’s share is 7.65%.

(You can choose to pay the employee’s share yourself and not withhold it.)

  • Your share is 7.65%.
Have paid or will pay total cash wages of $1,000 or more in any calendar quarter of 2017 or 2016 to household employees.Do not count wages you pay to:

  • your spouse,
  • your child under age 21, or
  • your parent.
 Pay federal unemployment tax.

  • The tax is 6.0% of cash wages.
  • Wages over $7,000 a year per employee are not taxed.
  • You also may owe state unemployment tax.

If neither of these two contingencies applies, you do not need to pay any federal unemployment taxes. But you may still need to pay state unemployment taxes (see below).

You do not need to withhold federal income tax from your household employee’s wages. But if your employee asks you to withhold it, you can choose to do so.

Tip: If your household employee cares for your dependent that is under the age of 13 or your spouse or dependent that is not capable of self-care, so that you can work, you may be able to take an income tax credit of up to 35 percent (or $1,050) of your expenses for each qualifying dependent. If you can take the credit, then you can include your share of the federal and state employment taxes you pay, as well as the employee’s wages, in your qualifying expenses.

State Unemployment Taxes

Please contact us if you’re not sure whether you need to pay state unemployment tax for your household employee. We’ll also help you figure out whether you need to pay or collect other state employment taxes or carry workers’ compensation insurance.

Note: If you do not need to pay Social Security, Medicare, or federal unemployment tax and do not choose to withhold federal income tax, the rest of this article does not apply to you.

Social Security and Medicare Taxes

Social Security taxes pays for old-age, survivor, and disability benefits for workers and their families. The Medicare tax pays for hospital insurance.

Both you and your household employee may owe Social Security and Medicare taxes. Your share is 7.65 percent (6.2 percent for Social Security tax and 1.45 percent for Medicare tax) of the employee’s Social Security and Medicare wages. Your employee’s share is 6.2 percent for Social Security tax and 1.45 percent for Medicare tax.

You are responsible for payment of your employee’s share of the taxes as well as your own. You can either withhold your employee’s share from the employee’s wages or pay it from your own funds. Note the limits in the table above.

Note: As of January 1, 2013, employers are responsible for withholding the 0.9% Additional Medicare Tax on an individual’s wages paid in excess of $200,000 in a calendar year. An employer is required to begin withholding Additional Medicare Tax in the pay period in which it pays wages in excess of $200,000 to an employee. There is no employer match for Additional Medicare Tax.

Wages Not Counted

Do not count wages you pay to any of the following individuals as Social Security and Medicare wages:

    1. Your spouse.
    2. Your child who is under age 21.
    3. Your parent.

Note: However, you should count wages to your parent if they are caring for your child and both of the following apply: (a) your child lives with you and is either under age 18 or has a physical or mental condition that requires the personal care of an adult for at least four continuous weeks in a calendar quarter, and (b) you are divorced and have not remarried, or you are a widow or widower, or you are married to and living with a person whose physical or mental condition prevents him or her from caring for your child for at least four continuous weeks in a calendar quarter.

    1. An employee who is under age 18 at any time during the year.

Note: However, you should count these wages to an employee under 18 if providing household services is the employee’s principal occupation. If the employee is a student, providing household services is not considered to be his or her principal occupation.

Also, if your employee’s Social Security and Medicare wages reach $127,200 in 2017 ($118,500 in 2016), then do not count any wages you pay that employee during the rest of the year as Social Security wages to figure Social Security tax. You should, however, continue to count the employee’s cash wages as Medicare wages to figure Medicare tax. You figure federal income tax withholding on both cash and non-cash wages (based on their value), but do not count as wages any of the following items:

  • Meals provided at your home for your convenience.
  • Lodging provided at your home for your convenience and as a condition of employment.
  • Up to $255 a month in 2017 for transit passes that you give your employee or, in some cases, for cash reimbursement you make for the amount your employee pays to commute to your home by public transit. A transit pass includes any pass, token, fare card, voucher, or similar item entitling a person to ride on mass transit, such as a bus or train.
  • Up to $255 a month in 2017 to reimburse your employee for the cost of parking at or near your home or at or near a location from which your employee commutes to your home.

As you can see, tax considerations for household employees are complex; therefore, professional tax guidance is highly recommended. This is definitely an area where it’s better to be safe than sorry. If you have any questions at all, please call.

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