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Recent articles by Jeff Schnepper: • Hiring a maid? Hire an accountant, too, 7/20/2004 • How the tax code makes singles suffer, 6/22/2004 • To avoid a tax burn, know your (stock) options, 10/9/2003 More... |
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Related Articles Hiring a maid? Hire an accountant, too Hire your kids, cut your taxes 5 big myths about the estate tax Turn your basement into a rental Save up to $35,000 on a new SUV Related Resources Decision Center: Estate planning for everyone Related Sites IRS FAQ on employer identification numbers IRS Form 1040X IRS Form 709 |
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| The Basics | |||||||||||||||
| Hey, Jeff, can I deduct my truck? | |||||||||||||||
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It takes more than a magnetic sign to turn a car into a write-off, our tax expert tells readers. Plus, what's the best way to give your house to your kid?
By Jeff Schnepper Hey, Jeff: I just started a lawn business, and I needed to buy a truck to tow my tractor and other equipment. Ill probably use the truck about 50% for personal business. If I place advertising on my vehicle (such as graphics listing the company name and phone number), would I be able to deduct 100% of the costs of owning the truck? Just driving the truck around is advertising for my business, right? Answer: Sorry, this one just wont fly with the Internal Revenue Service. Youll get to deduct the cost of putting the graphics on the truck, but the advertising wont convert personal miles into business miles. To the extent you use the vehicle for business, you can recover your original cost and deduct current expenses. You can take mileage, at 37.5 cents per business mile, plus tolls and parking. Or you can take the business percent of your actual costs, including depreciation, plus the full amount of business parking and tolls. In either case, youll need to keep track of business and total miles used. Should my kid be an independent contractor? Hey, Jeff: We run a home-based business (its a sole proprietorship) and hire our 10-year-old boy to do some cleaning and computer input work. We pay him about $2,000 a year and even issue him a W-2 form as an employee. We know this income is free from self-employment tax and free from federal income tax since he has no other income. But can we treat him as independent contractor? He does have freedom to finish the work whenever he likes. If hes an independent contractor, we won't need to file so many quarterly returns for the IRS or our states revenue department. I admit Im just being a bit lazy and looking for a simpler way. Answer: Youre right on the payroll taxes. If you hire your child, under age 18, theres no liability for Social Security or Medicare taxes. He wont have any federal income-tax liability in 2004, even if you pay him as much as $4,850. Thats true even if you claim him as a dependent. There might be a tax if he did have other income. But theres a problem if he qualifies as an independent contractor. Hed still escape income tax, but, his net income would be subject to Social Security/Medicare tax at a 15.3% rate. Technically, it would be .9235 of his net that would be subject to tax. In this case, thats .9235 times $2,000, or $1,847 at 15.3%, which works out to $282.59.
Half of that would be an above-the-line deduction. But, since theres no income tax payable, theres no tax benefit for that deduction. The good news is that hes really not an independent contractor. If you control what work gets done and how, hes your employee. Its a question of control. If you have control, hes your employee. (Read more about household employees in "Hiring a maid? Hire an accountant, too.") While no one really has control over a 10-year-old, theres no question the IRS is going to consider him an employee rather than an independent contractor. Sorry, if you want the deduction, youre going to have to file the W-2. But, at least youve saved the $289.59. And youve gotten your own deduction for the $2,000 paid. That will reduce your income and Medicare tax. And your Social Security if you havent hit the $87,900 maximum. From my point of view, thats not a bad deal. By the way, you also need an Employer Identification Number (EIN). You get that from the IRS. (For information, click here or call 1-800-829-4933.) Can I get a better tax deal on my duplex? Hey, Jeff: I have a two-family house where I rent out one unit for income. When I did my taxes, I deducted 100% of the mortgage interest on the property as an itemized deduction. But friends tell me I should take half the interest as an itemized deduction. The rest should be an operating expense for the rental unit and reduce any income from the property. That might actually cut my taxes. Is this right? How do I amend this years tax return? Answer: It sure is correct. You should take 50% of your mortgage interest and property taxes on Schedule E and the balance on Schedule A. You get a double benefit here:
Note that taking half the taxes on Schedule E rather than Schedule A also reduces your exposure to the Alternative Minimum Tax (AMT). Use Form 1040X to amend your prior years returns. How do I give my house to my child? Hey, Jeff: Which method offers the best (if any) tax advantage of transferring ownership of a home to a child? How should it be reported? Answer: By far the best method is to have the child inherit the home. Theres a full step-up in basis, so the child can sell immediately with no capital gain. But -- and this is a big but -- for the child to inherit the property, youd have to die. That will take a real serious commitment to tax planning. If you make a lifetime gift, the child assumes your tax basis to figure any gain. Thats normally your original cost, not the current fair market value. Capital gains may be due if he sells without living in and owning the home for at least two years out of the five years prior to sale. Youd have to report the gift on Form 709. Theres a big downside to this strategy. It will erode your lifetime credit for both gift and estate taxes. Thatll increase the chance that youll eventually have to pay estate or gift tax. For gift-tax purposes, the IRS looks at fair market value. Currently, you have an annual $11,000 gift-tax exclusion, plus a lifetime gift-tax exclusion of $1 million. That is, you can give away $11,000 (in cash or other assets) to any one person and a total of $1 million over your lifetime. The current estate-tax exclusion amount is $1.5 million. You dont have to report the gift on your income-tax return, Form 1040, nor does your child until he sells the property. Alternatively, if youve lived in the house for two of the last five years and use it as your principal residence, you can sell it to him and exclude as much as $500,000 in gains. One way to do this would be for you to act as the bank in the deal and take back a note for the full purchase price. That would give your child the full step-up in basis to fair market value. Between you and your wife, youd be able to gift $44,000 each year to your child and his spouse to pay off the note. (Thats $11,000 from you to your son and his spouse, and $11,000 from your spouse to your son and his spouse.) Consider this if your estate is below, and is expected to stay below, the exclusion amount. Down the line, to foil the IRS from making a step-transaction argument, gift the full amount to your child to pay off the debt. Your exclusions would take the hit. But thered be no real damage if youre not paying tax anyway. And, the child would still get the step-up in basis. | |||||||||||||||
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