Tax

I wanted to take this opportunity to touch base regarding the federal income tax rules on the “kiddie tax” and its potential impact on your financial strategy for your child(ren).

In brief, the kiddie tax was enacted by Congress to prevent parents from passing investment income to their children, who typically have a lower tax rate. Under the kiddie tax rules, a portion of a child’s net unearned income may be taxed at the parent’s marginal federal income tax rate. The kiddie tax applies to children up to age 24, assuming they meet certain criteria.

The kiddie tax can result in higher taxes on an affected child’s net unearned income than otherwise would apply. For example, if a child’s net unearned income exceeds the annual threshold of $2,500 for 2023 (increased from $2,300 in 2022), the portion of the income exceeding the threshold is subject to the kiddie tax.

The kiddie tax does not apply if the child’s net unearned income for the year does not exceed the threshold for that year.

There are four primary criteria for the application of the kiddie tax, including the child not filing a joint return for the year, at least one parent being alive at year’s end, the child’s net unearned income for the year exceeding the threshold for that year, and the child falling under specific age rules.

Despite these rules, there are several strategies to limit the kiddie tax’s impact on your child’s unearned income:

Exploit the unearned income threshold. Manage your child’s unearned income to ensure it remains below the annual threshold.

Pick the right investments. You can reduce unearned income by selecting investments with minimal or no dividends, such as growth stocks or tax-efficient mutual funds.

Invest in Series EE U.S. Savings Bonds. The accumulated interest income from these bonds is tax-deferred until cashed in, meaning no kiddie tax applies if cashed in when the child is kiddie-tax-exempt.

Use a Section 529 College Savings Plan. Withdrawals from a Section 529 plan account are federal-income-tax-free, provided they’re used for qualifying education expenses.

Invest in life insurance products. Investment accounts included in life insurance products such as universal life policies allow tax-deferred accumulations and can be borrowed against for college costs.

Generate earned income. The kiddie tax does not apply to children aged 18-23 if their earned income exceeds 50 percent of their support for the year.

The applicability of these strategies depends on your unique circumstances, and I would be delighted to discuss them in more detail to help you optimize your child’s financial situation. If this sounds good to you, please call me on my direct line at 408-778-9651.

• By Leon Clinton
• August 1, 2023

I am writing today to bring to your attention a crucial aspect of business tax deductions: mileage logs.

In most court cases, taxpayers lose vehicle expense deductions because they cannot present a credible business mileage log. The IRS code forbids deductions for vehicle expenses when taxpayers cannot prove the mileage and provide an adequate record.

Failing to maintain such records could lead to deductions far less than the actual business mileage, potentially resulting in no vehicle deductions at all. In essence, having a mileage log is critical for both proprietors and corporate owner-employees.

Take the case of Jim and Martha Flake. During their IRS audit, they submitted reconstructed calendars, odometer readings, fuel receipts, credit card statements, and other documents. But they created the mileage after the fact, and it contained math errors, thus failing to establish the mileage, time, and purpose of each vehicle use.

The court looked at the Flakes’ work and denied their vehicle deductions entirely. It allowed only what the IRS allowed.

The key takeaways from this case are:

• Maintain a mileage log to substantiate your business mileage.
• Stay updated on the basic principles of tax law.
• Operate your business with proper books, checks, records, and receipts to verify income and expenses.

If you need guidance on how to keep a comprehensive mileage log or require assistance with any other tax-related matters, please do not hesitate to contact me on my direct line at 408-778-9651.

• By Leon Clinton
• July 28, 2023

Have you established a 105-HRA, Qualified Small Employer Health Reimbursement Arrangement (QSEHRA), or Individual Coverage Health Reimbursement Arrangement (ICHRA) to reimburse your employees for medical expenses?

If so, congratulations! These HRAs are a great way to pay your employees’ medical expenses and obtain a tax deduction.

But all three types of HRAs come with a pesky IRS filing requirement: each year, you must pay a Patient-Centered Outcomes Research Institute (PCORI) fee that is used to help support the Institute.

The fee is small—currently, $3.00 times the “average number of lives covered” by your HRA during the previous plan year. There are various ways to calculate the number of lives covered.

You must pay the fee by filing Form 720 with the IRS by July 31 of the calendar year following the end of your plan year.

Paying the PCORI fee is a bit of a nuisance. But on the plus side, the fee is tax-deductible.

If you need my assistance or would simply like to discuss HRAs, please call me on my direct line at 408-778-9651.

• By Leon Clinton
• July 24, 2023