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Q&A on Medicare Health Insurance Premiums and Taxes

Medicare health insurance premiums can add up to significant dollars—especially if you’re upper-income, you’re married, and both you and your spouse are paying for Medicare.

 

What Is Medicare Part B Coverage?

 

Medicare Part B coverage is commonly called Medicare medical insurance or Original Medicare. Part B mainly covers doctors and outpatient services.

 

Medicare-eligible individuals must pay monthly premiums for this benefit.

 

How Are Part B Premiums Determined and Paid?

 

The monthly premium for the current year depends on your modified adjusted gross income (MAGI), as reported on your Form 1040 two years earlier. For Medicare, MAGI means the adjusted gross income (AGI) number shown on your Form 1040 plus any tax-exempt interest income.

 

Your 2022 Part B premiums will depend on your 2020 MAGI, as reported on your 2020 Form 1040.

 

Your 2023 premiums will depend on your 2021 MAGI, as reported on your yet-to-be-filed 2021 Form 1040. That means that things you do or don’t do on that 2021 return can impact your 2023 premiums. This is especially true if you’re self-employed with a Coeur d’Alene Idaho Business or an owner of a pass-through business entity (LLC, partnership, or S corporation).

 

Part B premiums are withheld from your Social Security benefit payments and are shown on the annual Form SSA-1099 sent to you by the Social Security Administration (SSA).

 

What Were 2021 Part B Premiums?

 

Although this is history, it’s still good to know. For 2021, most individuals paid the base Part B premium of $148.50 per covered person ($1,782 for a full year).

 

Part B Premium Surcharges

 

Higher-income individuals must pay a surcharge on top of the base premium for Part B coverage. In gov-speak, the surcharge is called an Income-Related Monthly Adjustment Amount (IRMAA), but let’s just call it a surcharge, because that’s what it is.

 

2021 Premiums Including Surcharges

 

For 2021, surcharges applied if you (1) filed as a single taxpayer for 2019 and reported MAGI for that year in excess of $88,000, or (2) filed jointly for 2019 and reported MAGI for that year in excess of $176,000. For 2021, Part B monthly premiums, including surcharges if applicable, for each covered individual were as follows:

 

Monthly Amounts You Paid in 2021 for Medicare Part B

2019 MAGI (single)

2019 MAGI (joint)

Per person, you paid

$88,000 or less $176,000 or less

$148.50

above $88,000 and up to $111,000 above $176,000 and up to $222,000

$207.90

above $111,000 and up to $138,000 above $222,000 and up to $276,000

$297.00

above $138,000 and up to $165,000 above $276,000 and up to $330,000

$386.10

above $165,000 and less than $500,000 above $330,000 and less than $750,000

$475.20

$500,000 or above $750,000 or above

$504.90

 

Key point. As you can see, the premiums quickly became quite expensive as you climbed the income ladder, especially for single filers.

 

Example. If you are single and had 2019 MAGI of $170,000, you paid $475.20 a month for Medicare Part B ($5,702.40 for the year). Had your 2019 MAGI been $85,000, you would have paid $1,782 total in 2021 Medicare premiums.

 

What Will 2022 Part B Premiums Be?

 

For 2022, most individuals will pay the base Part B premium of $170.10 per covered person ($2,041.20 if you pay premiums for the full year). As stated earlier, higher-income individuals must pay a surcharge on top of the base premium for Part B coverage, as shown in the table below:

 

Monthly Amounts You Pay in 2022 for Medicare Part B

2020 MAGI (single)

2020 MAGI (joint)

Per person, you pay

$91,000 or less $182,000 or less

$170.10

above $91,000 and up to $114,000 above $182,000 and up to $228,000

$238.10

above $114,000 and up to $142,000 above $228,000 and up to $284,000

$340.20

above $142,000 and up to $170,000 above $284,000 and up to $340,000

$442.30

above $170,000 and less than $500,000 above $340,000 and less than $750,000

$544.30

$500,000 or above $750,000 or above

$578.30

 

Key point. As you can see, the 2022 premiums are significantly higher than the 2021 amounts. We don’t yet know the numbers for 2023, but they will probably be considerably higher than the 2022 amounts. Ugh!

 

What Is Medicare Advantage (Medicare Part C)?

 

You can get your Medicare Part B benefits through the government, for the monthly premium costs listed above, or you can get your benefits through a so-called Medicare Advantage plan offered by a private insurance company that contracts with Medicare to provide benefits under rules established by Medicare.

 

Medicare Advantage plans are also sometimes called Medicare Part C.

 

Medicare Advantage Basics

 

When you sign up for a Medicare Advantage plan, you still must pay the standard Part B premium, including any applicable surcharge for higher-income folks, and you still get the standard Part B coverage.

 

The advantage is that the Medicare Advantage plan will deliver benefits beyond what the government gives you under Part B, such as prescription drug coverage, dental care, and vision care. You may be charged an additional monthly premium for the Medicare Advantage plan, but depending on where you live, some plans don’t charge anything extra.

 

The additional premium, if any, depends on the plan you select and where you live. With a Medicare Advantage plan, you are usually limited to a defined provider network, which you may view as a disadvantage.

 

Medicare Advantage Payments

 

When you have a Medicare Advantage plan, the standard Part B premiums, including any surcharge for higher-income folks, will still be withheld from your Social Security benefit payments and will still be shown on the annual Form SSA-1099 sent to you by the SSA.

 

If you pay an extra premium for your Medicare Advantage coverage, you can pay it like any other bill or arrange to have it withheld from your Social Security benefit payments.

 

What Is Medicare Part D, and What Are the Premiums?

 

Medicare Part D premiums are for private prescription drug coverage. Base premiums vary depending on the plan. Higher-income individuals must pay a surcharge on top of the base premium. Once again, the feds call it an IRMAA, but we will call it a surcharge.

 

2021 Part D Surcharges

 

For 2021, surcharges applied to individuals who (1) filed as singles for 2019 and reported MAGI for that year in excess of $88,000, or (2) filed joint returns for 2019 and reported MAGI in excess of $176,000. The 2021 monthly Part D surcharges for each covered person were as follows:

 

Monthly Amounts You Paid in 2021 for Medicare Part D

2019 MAGI (single)

2019 MAGI (joint)

Per person, you paid

$88,000 or less $176,000 or less

$0.00

above $88,000 and up to $111,000 above $176,000 and up to $222,000

$12.30

above $111,000 and up to $138,000 above $222,000 and up to $276,000

$31.80

above $138,000 and up to $165,000 above $276,000 and up to $330,000

$51.20

above $165,000 and less than $500,000 above $330,000 and less than $750,000

$70.70

$500,000 or above $750,000 or above

$77.10

 

2022 Part D Surcharges

 

For 2022, surcharges will apply to individuals who (1) filed as singles for 2020 and reported MAGI for that year in excess of $91,000, or (2) filed joint returns for 2020 and reported MAGI in excess of $182,000. The 2022 monthly Part D surcharges for each covered person are as follows:

 

Monthly Amounts You Will Pay in 2022 for Medicare Part D

2020 MAGI (single)

2020 MAGI (joint)

Per person, you will pay

$91,000 or less $182,000 or less

$0.00

above $91,000 and up to $114,000 above $182,000 and up to $228,000

$12.40

above $114,000 and up to $142,000 above $228,000 and up to $284,000

$32.10

above $142,000 and up to $170,000 above $284,000 and up to $340,000

$51.70

above $170,000 and less than $500,000 above $340,000 and less than $750,000

$71.30

$500,000 or above $750,000 or above

$77.90

 

Key point. As you can see, the 2022 surcharges are barely above the 2021 amounts. Good! We don’t yet know the numbers for 2023, but we can hope for more good news. Fingers crossed!

 

Payments for Part D Coverage

 

You pay the base Part D premium, which depends on the private insurance company plan that you select, to the insurance company. Any surcharge will be withheld from your Social Security benefit payments and reflected on the annual Form SSA-1099 sent to you by the SSA.

 

Planning for Next Year (2023): What Can You Do Now Before Filing Your 2021 Form 1040?

 

Taxable income has consequences.

 

Your 2021 Form 1040 can reflect decisions that affect your 2021 MAGI and, in turn, your 2023 Medicare health insurance premiums. If you’re self-employed or an owner of a pass-through business entity, you have more ways to reduce your MAGI. For instance:

 

·

Until the due date for your 2021 Form 1040 (October 17, 2022, if you get an extension), you as a self-employed individual can make a bigger or smaller deductible contribution to your self-employed retirement account for your 2021 tax year. Your choice will impact your 2021 MAGI and, in turn, your 2023 Medicare health insurance premiums.

·

You as an owner of a pass-through business entity (along with the other owners, if applicable) can make other choices that will impact your 2021 MAGI, such as choosing to maximize or minimize depreciation deductions for the entity. Those choices will impact each owner’s 2021 MAGI and, in turn, his or her 2023 Medicare health insurance premiums.

 

Key point. Sure, 2021 is over. But because your tax return has not yet been filed, you can choose from the possibilities listed above for reducing your taxable income, which also reduces your Medicare MAGI.

 

What About Delayed Premium Surcharges?

 

For years, the IRS has had big-time data processing problems, and nothing has changed yet for 2022 and likely beyond. For that reason, it can take a long time for Medicare health insurance premium surcharges for the year in question to catch up with the MAGI number reported on your Form 1040 for two years earlier—and eventually reported by the IRS to the SSA.

 

When the SSA finally gets your MAGI number for two years earlier, it will refigure your Part B and Part D surcharges, if necessary. If prior withholding from your Social Security benefits did not cover the refigured surcharges, you will be charged the difference via additional withholdings.

 

For example, if you extended your 2019 Form 1040 return and filed at the extended deadline, you may just now be finding out how much your actual Part B and Part D surcharges were for 2021. Any shortfall between what was actually withheld from your Social Security benefits in 2021 and what should have been withheld for that year after the SSA’s refiguring will be withheld from your 2022 benefits.

 

If you paid too much, SSA will credit your account.

 

Can I Deduct Medicare Health Insurance Premiums?

 

You can combine premiums for Medicare health insurance coverages with other qualifying health care expenses for purposes of claiming the itemized federal income tax deduction for medical expenses on Form 1040. Under current law, you can claim an itemized medical expense deduction to the extent your total qualifying expenses exceed 7.5 percent of AGI.

 

If you’re self-employed or an S corporation shareholder-employee, you can potentially claim an above-the-line deduction for health insurance premiums, including Medicare health insurance premiums. If you qualify, you don’t need to itemize to collect the tax savings from your Medicare premium payments.5

 

Can I Take Tax-Free HSA Distributions to Cover Medicare Health Insurance Premiums?

 

Yes! You can take federal-income-tax-free health savings account (HSA) distributions to reimburse yourself for Medicare health insurance premium costs if you’re age 65 or older. That’s one of the key benefits of the HSA.

 

If you take distributions during the year, fill out IRS Form 8899, Health Savings Accounts (HSAs), and include it with your Form 1040 for that year.

 

Takeaways

 

Medicare health insurance premiums can add up to major bucks, and premiums for Part B coverage will probably increase significantly again in 2023. So, this is not a trivial issue.

 

Medicare health insurance premiums and the related tax implications have lots of moving parts, and what you do with your 2021 Form 1040 can impact your 2023 premiums.

 

While 2023 seems far in the future right now, it will be here before you know it (11 months from now). So, keep the Medicare health insurance premium factor in mind when making decisions for your 2021 Form 1040.

 

And of course, think ahead. Use the strategies you find on this website to keep your 2022 taxable income low and to reduce both your income taxes and Medicare costs.

 

Don’t Rob Yourself of the Home Internet Deduction CDA Idaho

Given the connected nature of remote work these days, you likely use your home internet to do a little or a lot of work.

In this article, you will learn how to deduct the cost of your home internet. The rules that apply to the home internet also apply to all the other expenses incurred while working at home, regardless of whether you claim the home-office deduction.

Let’s get started.

 

Deduction on Schedule C

 

If you operate your business as a sole proprietorship or as a single-member LLC, you file a Schedule C to report your business income and expenses. As a Schedule C taxpayer, you may deduct ordinary and necessary expenses, which include business-related internet subscription fees.

 

You can deduct your use of your home internet whether or not you claim the home-office deduction, as follows:

  • If you claim the home-office deduction on your Form 1040, the internet expense goes on line 21 (utilities) of IRS Form 8829 as either a direct or an indirect expense.
  • If you do not claim the home-office deduction, enter the business portion of your internet expenses as utilities expenses on line 25 of your Schedule C.

 

Deduction When You Operate as Corporation

 

When you operate your business as a corporation, you are an employee of that corporation. Because of the Tax Cuts and Jobs Act (TCJA), the only way for you to reap the benefits of the home internet deduction (or a home office) is to have your corporation reimburse you for the deduction.

In the case of a reimbursed employee expense

  • The corporation deducts the expense as a utility expense, and
  • you receive the reimbursement as a tax-free reimbursed employee Idaho business expense.

 

Why is the reimbursement method the only way for the corporate owner to get the deduction? The TCJA eliminated the 2018-2025 deduction for miscellaneous itemized expenses. These include unreimbursed employee expenses, such as internet connection fees.

 

Deduction When You Operate as a Partnership

 

If you have deductible home internet expenses and/or a home office and operate as a partner in a partnership, you have two ways to get a tax benefit:

 

1. Deduct the costs as unreimbursed partner expenses (UPE) on your personal return.
2. Or get reimbursed from your partnership via an accountable plan (think “expense report”).

 

Substantiating Your Home Internet Expense Deduction

 

Where business owners can run into trouble with the IRS is in substantiating their internet expense deduction.

 

Unless you have a home internet connection you use solely for business and also have another one for personal use, you can’t reasonably deduct your entire home internet connection expense.

 

The IRS won’t believe you make no personal use of your sole home internet connection. We would not believe you either.

 

You should have no problem showing the total cost for your home internet connection—just total your monthly bills. The problem is in establishing what percentage of the total cost was for business, because only that percentage is deductible.

 

Ideally, you should keep track of how much time you use your home internet connection for business and how much time for personal use. A simple log or notation on your business calendar or appointment book—indicating approximately how many hours you were online for business each day while working at home—should be sufficient.

 

Google it and you can find software and apps that will track your internet use.

 

Instead of tracking your home internet use every day throughout the year, you could use a sampling method such as that permitted for tracking business use of vehicles and other listed property.8 There is no logical reason the IRS shouldn’t accept such a sampling for internet use.

 

Making an Estimate and Relying on the Cohan Rule

 

Since home internet connection costs are relatively small—usually no more than $1,000-$2,000 per year—even minimal recordkeeping is too much trouble for many taxpayers. Instead, they estimate the percentage of the time they use their home internet for their Coeur d’Alene business.

 

Estimating your internet expenses can work.

 

Under the Cohan rule, in some cases, courts may accept a reasonable estimate of a business expense where the taxpayer does not have adequate records.

 

The Cohan rule may not be used for travel, vehicle and other listed property, meal, lodging, and gift expenses, for which strict substantiation is required. But since internet expenses are characterized as utility expenses, the Cohan rule can be used to estimate them.

 

The Cohan rule may be applied not only by the Tax Court, but also by IRS auditors and agents as well. If you are undergoing an IRS correspondence examination, you may have to go through the appeals process or even file a petition in Tax Court to get any consideration under the Cohan rule.

 

Be aware that application of the Cohan rule is discretionary. Neither the courts nor the IRS is required to employ the rule to grant you a deduction for which you don’t have adequate records. And even when they do apply the Cohan rule, courts and the IRS auditors tend to lowball the amount of the deductible expense because your inexactitude is of your own making.

 

Two Requirements

For the Cohan rule to apply, you must satisfy two requirements:

 

1.You must convince the court or the IRS that you actually incurred the expense.
2.There must be a reasonable basis for making an estimate of the expense.

 

You should have no problem proving requirement number 1: your internet bill is proof you actually incurred the expense involved.

 

Requirement number 2 is where you can trip up. You must give the court or the IRS some reasonable basis to estimate what percentage of your total home internet bill was for business. You can’t just make a wild ballpark guess.

 

Credible Testimony

 

Credible testimony is a common way to convince the IRS or the Tax Court to accept your estimate.

 

For example, Robert G. Franklin, a loan officer, maintained a home office, which he used primarily in the mornings and evenings. The Tax Court found that he presented credible testimony that his home internet service was primarily for business and that any personal use was incidental.

 

Such testimony included the fact that he emailed a daily marketing update to several hundred real estate agents, past customers, and borrowers. The court applied the Cohan rule and held that Franklin could deduct $377 of his $499 annual home internet bill.

 

On the other hand, in one example, husband and wife college professors were not allowed to deduct any portion of their $2,757 annual home internet expense. The couple testified credibly that they used their home internet service to conduct academic research.

 

But they provided no evidence, by testimony or otherwise, as to what percentage of internet use was for business purposes. The court refused to make its own estimate under the Cohan rule, because it would be “wholly arbitrary.”

 

Reasonable Basis

 

The moral of the story, as shown in these cases, is that you need to give an IRS auditor or the court some reasonable basis to estimate how much you use your home internet for business. This could include testimony about the type of work you do at home; copies of emails you send and receive; videoconferencing records; appointment books or calendars showing the work you do at home; or any other evidence that you use your home internet for business, not pleasure.

 

Gather this information and use it to make your own estimate of your deductible home internet expenses when you prepare your tax return. This will go a long way to helping the IRS or the court use the Cohan rule.

 

Takeaways

 

The entity you choose for your business operation determines the strategy you need to use to deduct your home internet expenses. For example, if you operate as a Schedule C taxpayer, you can deduct your use of your home internet whether or not you claim the home-office deduction, as follows:

  • If you claim the home-office deduction on your Form 1040, the internet expense goes on line 21 (utilities) of IRS Form 8829 as either a direct or an indirect expense.
  • If you do not claim the home-office deduction, enter your internet expenses as utilities expenses on line 25 of your Schedule C.

 

When you operate your business as a corporation, you are an employee of that corporation. Because of the TCJA, the only way for you to reap the benefits of the home-office or home-internet deduction is to have your corporation reimburse you for the deduction. For reimbursed employee expenses,

  • the corporation deducts the expenses, and
  • you receive the reimbursements as tax-free reimbursed employee business expenses.

 

If you have deductible home internet expenses and operate as a partner in a partnership, you have two ways to get a tax benefit from the home office:

 

1. Deduct the cost as a UPE.
2. Or get reimbursement from your partnership via an accountable plan, such as an expense report.

 

If you claim the home-office deduction, you can deduct your home-internet costs based on either

 

  • the home-office percentage use of your home, or
  • a direct or individual cost allocation.

 

Ideally, you should keep track of how much time you use your home internet connection for business versus personal use. You can use a sampling method to reduce this record-keeping burden. Also, you can lighten the load with an internet-use tracking app.

 

If you lack adequate records of your home internet use, the IRS and the Tax Court may accept a reasonable estimate under the Cohan rule. But there must be some reasonable basis for the estimate, such as records showing the type of work you do at home. And even with this, both the IRS and the court will lower your deduction because you failed to keep the records.

 

Using a Reverse Mortgage in Coeur d’Alene as a Tax Planning Tool

If you’re an “experienced” homeowner, age 62 or older, you may need to tap into your home equity because you are “house-rich but cash-poor.”

 

If so, you are not the only one.

 

But what are your options? You can solve this cash shortfall problem and reap big tax-saving bonuses if you follow the reverse mortgage strategy explained in this article.

 

Here’s what you need to know about reverse mortgages and the tax angles.

 

Reverse Mortgage Basics

 

With a reverse mortgage, you as the borrower don’t make payments to the lender to pay down the mortgage principal over time. Instead, the reverse happens: the lender makes payments to you, and the mortgage principal gets bigger over time.

 

Interest on the reverse mortgage accrues, and it’s added to the loan balance. You don’t have to make any interest or principal payments until required to do so under the terms of the loan. Typically, no payment is due until you pass away or permanently move out of the home.

 

You can receive reverse mortgage proceeds as a lump sum, in installments over a period of months or years, or as line-of-credit withdrawals. After you pass away or permanently move out, you or your heirs sell the property and use the net proceeds to pay off the reverse mortgage balance, including accrued interest.

 

So, with a reverse mortgage, you can keep control of your home while converting some of the equity into much-needed cash. In contrast, if you sell your residence to raise cash, it could involve an unwanted relocation and a big income tax hit if the place has appreciated substantially in value.

 

While taking out a conventional home equity loan is an option for many homeowners, seniors often cannot qualify for an equity loan due to low income. But often they can qualify for reverse mortgages.

 

HECMs

 

These days, most reverse mortgages are so-called home equity conversion mortgages, or HECMs, which are insured by the federal government. You must be at least 62 years old to be eligible.

 

For 2022, the maximum amount you can borrow under an HECM is a whopping $970,800.

 

That limit is up a ton from just a couple of years ago, reflecting surging home prices. But the maximum amount that you can actually borrow is limited to a percentage of the appraised value of the home that secures the mortgage.

 

More specifically, the exact lending limit depends on

 

  • the value of your home,
  • your age, and
  • the amount of any other mortgage debt against the property.

 

The percentage of your home’s value (net of any existing mortgage debt) that you can borrow goes up with your age.

 

Reverse mortgage interest rates are fixed or variable, depending on the deal you sign up for. Fixed rates are available if you take your loan proceeds as a lump sum. Interest rates are higher than for regular home loans, but not a ton higher.

 

Key point. As with any major borrowing transaction, it’s important to find an acceptable interest rate and acceptable up-front charges. Up-front charges for a reverse mortgage can be higher than costs for a conventional mortgage, as explained later in this article.

 

Problem: House-Rich but Cash-Poor and Exposed to Inflation to Boot

 

Some seniors own hugely appreciated homes but are short of cash. You may be among them. Inflation only makes things worse.

 

An unwelcome side effect of owning a hugely appreciated home is the fact that selling your property to raise cash can trigger a taxable gain far in excess of the federal home sale gain exclusion break—up to $500,000 for joint-filing couples and up to $250,000 for unmarried individuals.

 

The combined federal and state income tax hit from selling could easily reach into the hundreds of thousands of dollars.

 

For instance, the current maximum federal income tax rate on the taxable portion of a big home sale gain is 23.8 percent—20 percent for the “regular” maximum federal capital gains rate plus another 3.8 percent for the net investment income tax (NIIT).

 

In California, the maximum state income tax rate on the taxable portion of a big home sale gain is 12.3 percent. So, the combined federal and state rate could be as high as 36.1 percent.

 

In New York City, the maximum combined state and city income tax rate on the taxable portion of a big home sale gain is 14.8 percent. So, the combined federal, state, and city rate could be as high as 38.6 percent Yikes! If you sell, all that money you pay in taxes will be gone forever. Not good!

 

Potential Solution: Reverse Mortgage and Basis Step-Up to the Rescue

 

Thankfully, there’s a potential solution that involves taking out a reverse mortgage on your property instead of selling. That way, you can raise needed cash and also take advantage of the tax-saving basis step-up rule explained below.

 

How the Basis Step-Up Rule Works with a Home

 

The federal income tax basis of an appreciated capital gain asset owned by a deceased individual, including a personal residence, is stepped up to fair market value (FMV) as of the date of the owner’s death or (if the estate executor chooses) the alternate valuation date six months later.

 

When the value of an asset eligible for this favorable treatment stays about the same between the date of death and the date of sale by your heirs, there will be little or no taxable gain to report to the IRS—because the sale proceeds are fully offset (or nearly so) by the stepped-up basis. Good!

 

Here’s how the basis step-up rule can play out in the context of a greatly appreciated principal residence.

 

If you’re married and your spouse predeceases you, the basis of the portion of the home owned by your dearly departed mate, typically 50 percent, gets stepped up to FMV. This usually removes half of the appreciation that has occurred over the years from the federal income tax rolls. So far, so good.

 

If you then continue to own the home until you pass away, the basis of the part you own at that point, usually 100 percent, gets stepped up to FMV as of the date of your departure (or the alternate valuation date, if applicable). So, your heirs can sell the property and owe little or nothing to Uncle Sam. Good!

 

If you’re unmarried and you own the home by yourself, the tax results are easier to understand. The basis of the entire property gets stepped up to FMV when you pass on, and your heirs can then sell the residence and owe little or nothing to the feds. Also good!

 

Key point. The Biden tax plan included a proposal to greatly cut back the basis step-up break, but that idea has been abandoned for now—and hopefully forever.

 

Extra-Good Step-Up Rule in Community Property States

 

If you and your spouse own your home as 50/50 community property in one of the nine community property states (Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin), the federal income tax basis of the entire residence is stepped up to FMV when the first spouse dies (not just the 50 percent portion that was owned by the now-deceased spouse).

 

This weird-but-true rule means the surviving spouse can sell the home shortly after the other spouse’s departure and owe little or nothing in federal taxes.

 

In other words, if you turn out to be the surviving spouse in a community property state, you need not hang on to the property until your drop-dead date to reap the full tax-saving advantage of the basis step-up rule.

 

And if you want to hang on to the property until the bitter end, there’s no tax disadvantage to doing so.

 

The Tax-Saving Reverse Mortgage Strategy

 

As you can see, holding on to a hugely appreciated residence until death can save a ton of taxes thanks to the basis step-up rule. But if you need cash right now to make ends meet, we have not yet solved that part of the equation. Enter the reverse mortgage strategy.

 

As stated earlier, a reverse mortgage does not require any payments to the lender until you move permanently out of your home or pass away. At that time, the property can be sold, and the reverse mortgage balance paid off out of the sales proceeds. Any remaining proceeds go to you or, if you’ve died, to your estate.

 

Alternatively, after your death, your heirs can pay off the reverse mortgage and keep the property along with the basis step-up.

 

Reverse Mortgage Fees

 

Fees to take out and maintain a reverse mortgage are usually considerably higher than for a regular “forward” home equity loan or home equity line of credit.

 

With an HECM, you’ll usually be charged an origination fee equal to 2 percent of the first $200,000 of your home’s value plus 1 percent of any value above $200,000. But the origination fee cannot exceed $6,000.

 

With an HECM, you’ll also be charged a mortgage insurance premium (MIP). The MIP consists of a one-time upfront charge that’s due at closing, plus an annual charge. The upfront charge equals 2 percent of your home’s appraised value or 2 percent of the HECM lending limit ($970,800 for 2022), whichever is less. The annual charge equals 0.5 percent of the outstanding loan balance.5

 

In addition, the lender can charge a monthly servicing fee.

 

Typically, you’ll also have to pay the standard third-party home mortgage closing costs for things such as title insurance, an appraisal, settlement services, and so forth.

 

Key point. Any one-time upfront fees are usually deducted from the initial reverse mortgage loan amount. For instance, say the total upfront fees for a $450,000 reverse mortgage amount to $20,000. The actual proceeds will be $430,000 ($450,000 – $20,000).

 

Can You Deduct Interest on a Reverse Mortgage?

 

You may not deduct reverse mortgage interest under the current federal income tax rules. Per the Tax Cuts and Jobs Act (TCJA), the interest on home equity loans is non-deductible for 2018-2025 unless you use the proceeds to acquire or improve a first or second home.

 

A reverse mortgage taken out to raise cash is classified as a home equity loan for tax purposes, but since the proceeds are not used to acquire or improve a first or second residence, the interest is non-deductible for 2018-2025.

 

Key point. Even under the pre-TCJA rules, interest on a reverse mortgage balance of up to $100,000 would not be deductible until the interest is actually paid in cash, which usually would not be until the homeowner passes away or moves permanently out of the home. That could be long after the reverse mortgage was taken out.6

 

Takeaways

 

You might object to the notion of borrowing against your home to solve a cash shortage. Fair enough, but the cash you need has to come from somewhere.

 

If it comes from selling your hugely appreciated and beloved home, the cost of getting your hands on the money will be

 

  • a big income tax bill, and
  • a detriment to your date of death (or six-months-later date) basis step-up to fair market value.

 

In contrast, if you can raise the cash you need by taking out a reverse mortgage, the only cost will be the fees and interest charges.

 

If those fees and interest charges are a small fraction of the income taxes that you could permanently avoid by continuing to own your home and thereby also benefit from the basis step-up rule, the reverse mortgage strategy can make perfect sense.

 

Paying for College Tax Saving Strategy

In Paying for College for those living in the greater CDA Idaho area, you can pay your college student, for example, $23,255 for a one-time job that was not subject to self-employment taxes.

With this strategy, you deducted the $23,255 and your child paid $1,028 in 2021 taxes.

This is terrific, but you might ask:

1. Do I need to give my student a 1099? Which one—the NEC or the MISC? What box do I check on the 1099?
2. Since the $23,255 is not subject to the self-employment tax, how do I help my college student (if he is still my dependent) avoid the kiddie tax?
3. Would this one-time income enable an IRA—Roth and/or traditional?

 

The 1099

 

The 1099 reporting is somewhat of a surprise. You report most payments to individuals for services performed on IRS Form 1099-NEC. But that’s not where you report the $23,255 one-time payment to your child.

 

In the instructions for IRS Form 1099-NEC, you find that you report in box 1 of Form 1099-NEC amounts that are subject to the self-employment tax.

 

For payments to individuals that are not subject to the self-employment tax, you report them in box 3 of Form 1099-MISC.

 

As you know from the article linked above, you paid your college student for a one-time job that was not subject to the self-employment tax; therefore, you report the payment in box 3 of Form 1099-MISC.

 

Kiddie Tax

 

The kiddie tax does not apply to this one-time payment to your college student. Why? Because the student received earned income for his personal services.

 

The kiddie tax applies to unearned income such as investment income. The kiddie tax does not apply to earned income.

 

The kiddie tax rules use IRC Section 911(d)(2) to define earned income as “wages, salaries, or professional fees, and other amounts received as compensation for personal services actually rendered.” The key words for the college student are “personal services actually rendered.”

 

Some tax professionals have trouble getting their software to stop applying the kiddie tax to this one-time payment. This may require an override, but first make sure that you have this one-time payment on Form 1040, Schedule 1, line 8z. Per the IRS instructions, this is where you put income from a sporadic activity that’s not subject to the self-employment tax.

 

And then there’s a question: Is this student a dependent in the year he received the $23,255? If the student provides more than one-half of his own support for the year, he is not a dependent for the year.

 

As a dependent, the student pays tax of $2,495, whereas if the student is not a dependent, the tax is $1,028. And, of course, you have to consider the effect (or lack thereof) of the dependent on the parent’s taxes.

 

Contribute to an IRA

 

The tax code limits the IRA deduction to the lesser of (a) the deductible amount or (b) the compensation included in the taxpayer’s income.

 

The first question: Is this one-time payment to the college student “compensation” in the eyes of the tax code?

 

Section 219(f) states that the term “compensation” includes earned income as defined in Section 401(c)(2). That definition is not as expansive as we need, so let’s look to the IRS for more info.

 

The IRS in its regulations interprets compensation to mean wages, salaries, professional fees, and other amounts derived from or received for personal services actually rendered. In this proposed regulation, the IRS goes on to state that compensation includes earned income as defined in IRC Section 401(c)(2).

 

Here, although it is different from the path for the kiddie tax, we focus on “other amounts derived from or received for personal services actually rendered.” Without question, our college student earned the $23,255 from his personal services.

 

As you may remember from above, the student’s IRA deduction is limited to the lesser of the deductible amount or his taxable compensation. The deductible amount is $6,000 for tax years 2021 and 2022, so our student’s contribution to a traditional or Roth IRA is limited to $6,000.

 

Again, as with avoiding the kiddie tax, your tax preparer is likely going to have to use an override to get his or her tax preparation software to allow either (a) the $6,000 traditional IRA tax deduction or (b) the $6,000 contribution to the Roth.

 

Takeaways

 

The one-time payment your business makes to your college student for work on a project triggers little-known rules that have a big impact on the tax benefits.

 

For IRS Form 1099, you should put the one-time payment in box 3 of Form 1099-MISC, even though that may not be where you would’ve expected to put that payment.

 

Regarding the kiddie tax, it’s important to recognize that most tax preparation software treats the box 3 income as non-earned income, which triggers the kiddie tax—and which is incorrect for this payment to your collect student. To fix this problem, your tax preparer has to override the tax preparation software entry.

 

And when you get to the tax deduction for the traditional IRA, your college student has earnings that qualify, but your tax preparer has software that requires an override to get this tax deduction in place.

 

 

Big Tax Break: Qualified Improvement Property Coeur d’Alene Idaho

Do you own or lease non-residential (think commercial) real property for your business or rent non-residential real property to others?

 

If so, interior improvements you make to the property may be fully deductible in a single year instead of over multiple years.

 

But to be deducted instantly, the improvements must fit into the category that the tax code calls “qualified improvement property” (QIP).

 

What Is QIP?

 

Ordinarily, non-residential real property is depreciated over 39 years. And so are improvements to such real property after it is placed in service. Note that we’re talking about real property improvements—changes to the building structure and building systems such as plumbing, electrical, and HVAC.

 

You depreciate personal property in a building, such as furniture, carpeting, and removable partitions, over seven years.

 

But Congress wants to encourage Coeur d’Alene business owners to improve their properties. So, starting in 2018, the Tax Cuts and Jobs Act (TCJA) established a new category of depreciable real property: QIP, which has a much shorter recovery period than regular commercial property—15 years. But even better, for tax years 2021 and 2022, QIP can qualify for that immediate 100 percent bonus depreciation deduction.

 

QIP consists of improvements, other than personal property, made by the taxpayer to the interior of non-residential real property after the date the building was first placed in service. For example, QIP includes interior improvements or renovations to any of the following:

 

  • Office building (or single offices)
  • Restaurant or bar
  • Store
  • Strip mall
  • Motel or hotel
  • Warehouse
  • Factory

 

Since QIP applies only to non-residential property, improvements to residential rental property such as an apartment building are not QIP.

 

Mixed-Use Property

 

But mixed-use property—for example, an apartment building with ground-floor retail space—qualifies as non-residential property and can receive QIP treatment if less than 80 percent of the building’s gross rental income is from dwelling units.

 

Transient Property

 

Airbnb and similar short-term residential rentals also qualify as non-residential property if they are rented on a transient basis—that is, over half of the rental use is by a series of tenants who occupy the unit for less than 30 days per rental.

 

QIP Examples

 

Examples of interior improvements that can receive QIP treatment include the following:

 

  • Drywall
  • Ceilings
  • Interior doors
  • Modifications to tenant spaces (if the interior walls are not load-bearing)
  • Fire protection
  • Mechanical
  • Electrical
  • Plumbing
  • Heating and air interior equipment and ductwork
  • Security equipment

 

QIP does not include improvements related to the enlargement of a building, an elevator or escalator, or the internal structural framework of a building. Structural framework includes “all load-bearing internal walls and any other internal structural supports.”

 

QIP for Section 179

 

You can use Section 179 expensing on QIP.

 

In addition, you may use Section 179 to deduct the following improvements to a non-residential building after the building is placed in service:

 

  • Roofs
  • Heating, ventilation, and air-conditioning (HVAC) property
  • Fire-protection and alarm systems
  • Security systems

 

Key point. These can be exterior building improvements. Technically, such improvements are not QIP, but by law, they are “qualified real property” for purposes of Section 179.

 

Placed in Service

 

QIP consists only of improvements made after the building was placed in service. But for these purposes, “placed in service” means the first time the building is placed in service by any person. By reason of this rule, you can purchase an existing property that was placed in service by an owner anytime in the past, renovate it before you place it in service, and still get QIP treatment.

 

But you have to make the improvements. You can’t acquire a building and treat improvements made by a previous owner as QIP.

 

Example—Arthur in Coeur d’Alene Idaho

 

Arthur owns a house in Coeur d’Alene that he uses as a full-time Airbnb rental. Because the vast majority of his guests occupy the home on a transient basis (less than 30 days), he classifies the house as non-residential property to be depreciated over 39 years.

 

In 2022, he remodels the house by taking out several of the interior (non-structural) walls to create a large open space, and adds new windows. The improvements are QIP. He uses 100 percent bonus depreciation to fully deduct the $50,000 cost in 2022.

 

Key point. Say the $50,000 deduction creates a tax loss. To fully deduct the loss, Arthur does not have to qualify as a tax-code-defined real estate professional because the transient-occupied property escapes those rules. But to deduct the $50,000, Arthur needs to materially participate in the CDA Idaho Airbnb rental.

 

Section 179

 

In contrast to bonus depreciation, Section 179 expensing is subject to an annual dollar limit, which the IRS adjusts each year for inflation. For 2021, the limit is $1,050,000; for 2022, it’s $1,080,000.

 

Additionally, because lawmakers intend Section 179 to help smaller businesses, they created a deduction limit based on the dollar amount of Section 179 property purchased during a year. The limit works like this: You must reduce your Section 179 deduction by one dollar for every dollar your annual purchases exceed the applicable limit. The limit is $2,620,000 for 2021 and $2,700,000 for 2022.

 

Bonus Depreciation Can Cause an NOL

 

Using bonus depreciation to fully deduct the cost of QIP in one year can provide a substantial deduction resulting in a net operating loss (NOL) for the year, depending on your other income and expenses.

 

Unfortunately, NOLs for 2021 and later cannot be carried back to prior years so that you can claim a tax refund.

 

Instead, you must carry NOLs forward to any number of future years. (NOLs for 2018 through 2020 could be carried back five years.)

 

No NOL for Section 179

 

Section 179 expensing cannot result in an NOL because it cannot exceed your taxable business income for the year. If you have a net loss for the year and no other qualifying income, you get no Section 179 deduction for that year; but you can claim bonus depreciation.

 

Beware of the Automatic Bonus Depreciation Application

 

Bonus depreciation applies automatically. If you don’t want it, you must elect not to use it.

 

With no election out of bonus depreciation, your QIP depreciates 100 percent. If you elect out of the bonus depreciation, you have two remaining choices:

 

  • You can elect Section 179 expensing for some or all of the QIP, or
  • You can use straight-line depreciation on the QIP over 15 years.

 

Alert: QIP Placed in Service 2018-2019

 

When Congress wrote the TCJA, it intended to permit QIP to be fully deducted in one year using 100 percent bonus depreciation or depreciated over 15 years.

 

But due to a drafting error, the 15-year recovery period for QIP was left out of the TCJA. As a result, during 2018 and 2019, QIP had to be depreciated over 39 years and did not qualify for bonus depreciation. Taxpayers were still able to deduct such improvements using Section 179.

 

Congress corrected its error when it enacted the Coronavirus Aid, Relief, and Economic Security Act (CARES Act) in 2020. In the CARES Act, Congress fixed the QIP 100 percent bonus depreciation and 15-year depreciation—retroactive to December 22, 2017.

Takeaways

 

Improvements to non-residential commercial real property in Coeur d’Alene Idaho such as an office building are ordinarily depreciated over 39 years and don’t qualify for bonus depreciation. But a special class of improvements called “qualified improvement property” may be depreciated over 15 years instead of 39 years.

 

Better yet: for tax years 2021 and 2022, QIP qualifies for 100 percent bonus depreciation.

 

QIP includes only interior improvements to non-residential commercial property. It does not include

 

  • exterior improvements (such as a roof) or improvements related to the enlargement of a building,
  • an elevator or escalator, or
  • improvement of the internal structural framework of a building.

 

You may also use Section 179 expensing to deduct QIP in one year, subject to an annual limit ($1,050,000 in 2021, $1,080,000 in 2022). If you elect not to use bonus depreciation or Section 179 expensing, you deduct QIP over 15 years.

 

The special deductions for QIP were supposed to take effect in 2018, but due to a drafting error in the TCJA, this did not happen. The CARES Act of 2020 cured this defect retroactively to 2018. If you placed QIP in service during 2018-2019 and did not use Section 179 expensing on it, you must redo your depreciation deductions for the QIP by either

 

  • filing an amended return, or
  • filing IRS Form 3115, Application for Change in Accounting Method, with your current-year tax return.