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Tax questions answered
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March 3, 2000: 5:40 p.m. ET
Jeff Kelson guides taxpayers through stock gifts and IRA withdrawals
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NEW YORK (CNNfn) - Jeff Kelson, partner at BBDO Seidman answers your questions on separate tax returns for married couples, home office deductions and tax-exempt dividends from mutual funds.
Every Friday afternoon from now until April 15, our network will provide expert advice to viewers who call in with tax questions and CNNfn.com readers who send us their e-mails.
Here is a transcript of Friday's show with Kelson. Some e-mail questions were answered on air while others were addressed after the show. Those answers are at the bottom of this transcript.
PATRICIA SABGA, CNNfn ANCHOR, MARKET COVERAGE: It's tax time. April 15th is just 43 days away, but since it falls on a Saturday, you've got until midnight on Monday, the 17th , to file your federal return. Today, as we do every Friday during tax season, we are taking your questions about all those complex tax issues. Joining us today is Jeff Kelson, a partner at BDO Seidman here in New York City. Thank you very much for joining us.
JEFF KELSON, BDO SEIDMAN: Thank you.
SABGA: Let me first ask you about any major changes in the tax laws this year that everybody should know about.
KELSON: 1999 was a relatively mild year for changes. However, one of the important changes is in the home office deduction. Prior to 1999, the IRS made it very difficult for you to claim a home office deduction. It had to be a primary place of business where you generate your income. So for instance, a doctor who worked at the hospital but kept his books and records in his apartment, could not deduct his home office expenses because that was not where he primarily earned his income.
But in 1999, there was a nice change. They liberalized it, Congress did, and what they have done is they have expanded it to people who do substantial administrative and managerial in their home. So the doctor in my example now will be able to claim his home office as a deduction.
SABGA: Now what? Remember that years ago it used to be something that you had to have a separate entrance, you know, in order to constitute a home office. Does that still exist?
KELSON: Well, that still exists. For instance, what the IRS likes you to do is to do it on a square footage. So if you use 15 percent of home for home office that would be that percentage of all your deductions that you can claim. Now, you know, the IRS would like to have you partition it. It is not necessary; obviously, you can just have a dedicated part of your house be your home office.
SABGA: Now what about the people who are not necessarily independent contractors or freelancers, people who say, "Hey, I bring my work home; I've got an office in my house to do my work while my kids are asleep." Does that count?
KELSON: Well, not really, actually. If you are doing it toward the convenience of the employer, yes, you can claim your home office. But if it's for the convenience of you, for instance, a lot of telecommuters out there, and if they telecommute Monday and Friday but go into the office Tuesday and Wednesday and Thursday and there's an office for them, the IRS would probably not allow you to take that home office because that is for your convenience rather than for the employer's convenience.
SABGA: Sounds like a pretty fuzzy distinction, but --
KELSON: Yes. I mean, you know, these rules are always open to interpretation, and a lot of it is based on facts and circumstances. But you've got to be careful with home office deductions though because basically you can kind of shoot yourself in the foot.
For instance, the deductions sometimes are not always magnificent: depreciations over a long period of time, if you own the home; utilities and insurance you can take.
But you might find when you go to sell the house that -- since there are nice rules now in $500,000 exclusion for married couple on the sale of a home to exclude the gain -- you might find that what you've done now is taken that 10 percent of your house that you are using for a home office, and if you go sell that house, that 10 percent of that gain would be taxable because then it is no longer your personal residence; it's a home office.
SABGA: So always think ahead to the future. Well, we have a question for you.
KELSON: Sure.
SABGA: And our phone lines are open. We have a question from Chad in Georgia. Go ahead, please.
CALLER: Yes, I have got some stock that has been gifted to me. And if I sell that stock, I don't know if my capital gains is on the value when it was gifted, or if it's the original cost basis.
KELSON: That`s a good question. What you do in gifted stock is typically, you take the holding period - excuse me - the basis of the donor. So let's say your father gifted you the stock, it would be your father's basis in the stock, and you would have to go ask him, or try to find that out, what that basis is. However, if you go to sell it at a loss, the IRS has a "heads, you lose; tails, they win." If it's a loss, then you have to take the fair market value of the date of the gift. So you should just check on that to determine what the basis is and see what records you can obtain.
SABGA: Our next question is from Katharine in North Carolina. Go ahead, please.
CALLER: Hi, thank you for taking my call. I had to go out on long-term disability from my company due to blindness, and I am getting SSVI and then a remaining balance from an insurance company for 70 percent of my income. My question is: what portion of those two sources of income are taxable?
KELSON: Typically, SSVI is not taxable. And typically disability benefits are not taxable. Unless the employer paid your disability. You know, a lot of times you have a choice of paying the disability insurance yourself or having the employer pay it. If the employer pays it and you become disabled, that is taxable to you; if you pay it, and you become disabled, it is not taxable since you were the payer. So it helps to check with your employer about what, you know, what you had there.
SABGA: We have another call on the line for you. People full of questions. Let's start with John from Missouri; go ahead with your question for Jeff.
CALLER: They were talking about home office deductions That`s changed a little bit.
KELSON: Yes it has.
CALLER: And they mentioned doctors bringing work home.
KELSON: Correct.
CALLER: Would that qualify with school teachers?
KELSON: School teachers is a little trickier. If they provide an office for you in the school, it might be a little problem. However, if the bulk of your work is done in your home, and they give you a small little office, you might be still able to claim the home office deduction, assuming that the bulk of the administrative and managerial and maybe homework checking, or whatever, is done in the home. These rules, even though they have been liberalized, are not always very clear and they rely a lot on facts and circumstances. But in those situations, I would suggest you consult your tax adviser to make sure in your specific instance that you are qualified.
SABGA: Now I think we have an e-mail regarding the joint returns: "Last year my wife and I filed a joint return. Can we file separately this year?"
KELSON: Yes. That election - and what I mean by "election" is, you just file two separate returns - can be done every year. You can decide which is better for you, but be very careful; while you might hear from your friends at a party that filing separately might be cheaper because of the so-called marriage penalty - that's evil penalty that affects married couples that end up paying more than if they both filed single.
However, when you file marry filing separate, there's a whole host of other rules that come into play that might limit other deductions. So while it might help you in a vacuum, you have do a calculation both with and without, and see what gets you to the better tax.
SABGA: Let's go back to the phone lines; our next question is from Joseph in New York. Go ahead, please.
CALLER: What I'd like to know is where do you report tax-exempt dividends from mutual funds - things that are triple-tax-free in New York? Does that all go on the same line where tax-exempt interest goes, even though it's a dividend?
KELSON: Yeah, well, tax-exempt dividends can go on the tax-exempt interest line; it's not going to show up in page one of your return as an income item. So to be complete, the IRS likes you, or, actually mandates you, to disclose your tax-exempt interest and dividend income, and you do it on the Schedule B, but you do not compute it of course in the taxable income -- and you living in New York, and it's New York state's municipal bonds probably you're talking about when you also avoid the heavy New York state taxes as well.
SABGA: OK, well, a lot of people with a lot of questions. Let's take our next one, Bob in Washington, D.C. Go ahead, please.
CALLER: I withdrew an entire IRA amount last summer and it was about $19,000 in the account. Now am I going to be taxed -- and I was going to buy a house, but I have not bought one yet. Can I buy one in the future, like this spring or summer? And what would I be taxed on: the entire $19,000? It was a regular IRA, not a Roth.
KELSON: With a regular IRA, when you take distribution from it, and assuming you are not 59-1/2 by the end of the year, you will pay tax on the entire amount of $19,000. But on top of that, unfortunately, you would also have to pay a 10 percent penalty tax, and obviously that penalty tax is there to sort of nudge you not to take the money out until retirement. However, as I said earlier, you can take money out of an IRA to buy your first home. What I mean by "first home" is, you haven't bought a home in the previous two years. But there's some time limits, restrictive time limits on having use of the money and putting it in, and I believe in your situation, you might have waited too long. But I would consult with your tax adviser to see if there's anything you can do to fix it.
Q: My company has an Employee Stock Purchase Plan covered under IRC Section 423, and a portion of each paycheck goes towards an account that holds the funds until the stock purchase time. It is now more than one year after the purchase and I still hold those shares.
Question 1: When can I sell these shares and realize long term capital gains on the profits?
Question 2: When I sell these shares, which portion of the gains is treated as income and which is treated at capital gains?
Question 3: Where can I find official IRS documentation on these rules? This has been hard to find.
A: If you have already held the shares for one year after exercising the option, and it has been more than two years since the option to make the purchase was granted, you can get mostly long-term capital gain treatment now. (See question 2). Otherwise, you can get this treatment once it is more than two years after the option to purchase the shares was granted. This assumes you are still an employee, or that your employment terminated less than three months before the shares were purchased under the option.
If the option was granted at the fair market value of the stock on the date of grant, all of your gain will be long-term capital gain (assuming you meet the holding period above). If the option was granted at less than fair market value, the compensation portion of income will equal the smaller of:
The excess of the fair market value of the share at the time the share was sold over the option price; or
The excess of the fair market value of the share at the time the option to purchase the share was granted over the option price.
There is no IRS publication wholly devoted to this point. The best source of information is the Statutory Stock Options portion of IRS Publication 525, Taxable and Nontaxable Income. This discussion is in the executive compensation portion of the publication.
Q: In a simple IRA Retirement Plan for self-employed individuals, my understanding is that the maximum contribution that can be made by the owner for his/her own account is $6,000. Is this contribution also limited to the net-earnings from self-employment?
A: Yes, the contribution is limited to net earnings from self-employment.
Q: I am planning to buy a new house, and was thinking of taking out some money from a 401(k) plan for use in paying closing costs. I was wondering will I be penalized for withdrawing from the 401(k). I do not want to take loan against the 401(k).
My question is: Is there any provision for new home buyers not to get penalized because the money withdrawn from 401K plan is getting used for paying closing costs.
I appreciate your help on this.
A. This depends on your other financial resources. These is no specific provision allowing withdrawals for new home purchases. You may be able to get a withdrawal if you meet the requirements for a "hardship" withdrawal. For a distribution to qualify as a hardship distribution, two tests must be met — the participant must have an immediate and heavy financial need, and the distribution must be necessary to meet the need.
Certain expenses are deemed to constitute immediate and heavy financial needs. These include, among other things, purchase, excluding mortgage payments, of a principal residence for the employee.
A hardship distribution may not be made if the employee has other resources available to meet the financial need even if the need is immediate and heavy. Thus, an employee may have to secure the needed funds elsewhere by liquidating other assets, reimbursement, or borrowing of funds from commercial sources. Specifically, you cannot have a hardship distribution until you have exhausted your capacity to borrow funds from the plan. Thus, you cannot take a 401(k) distribution instead of a loan, if you have the ability to borrow from the plan.
Q: I just changed my name and received a Social Security card with my new name. I have couple mutual funds already send in the year-end statement (1099-DIV) to IRS on my old name. Do I file my tax with my old name or new name?
A: For the sake of thoroughness, I suggest that you file your Form 1040 with your new name, and add a parenthetical with your old name (e.g., Jane Doe (f.k.a. Mary Smith)). It would also be a good idea to attach a copy of a court decree that officially shows your new name.
Q: My daughter is a college student. Last summer she worked for a small engineering company for about one month as office assistant. The boss said she will not be on their payroll but will give her 1099-misc and she is responsible for her own tax.
Where should she report this income? Does she have to pay self-employed tax? I have asked several friends but everyone seems to have a different answer.
A: Income from self-employment, net of allowable direct expenses related to your daughter's self-employment, should be reported on Schedule C (or C-EZ). The net income or loss reported on Schedule C should also be reported on page 1 of Form 1040, which will affect Adjusted Gross Income.
Also, your daughter should file Schedule SE to report her liability for self-employment tax, although she may not be subject to this tax if her Schedule C net income is below a specified amount.
Q: I gave some my stock options to a relative a relative. Say the striking price is 50. I bought it at 80 and gave the shares as gift to a relative. Do I need to pay the 30 tax? Or should the relative pay that?
A: If you received "nonqualified" stock options from your employer (options other than under an employee stock purchase plan or an incentive stock option) and the options had a readily ascertainable fair market value (e.g., the options trade on a public exchange), then you should have reported taxable income in the year you received such options. If the nonqualified options did not trade on a public exchange (or did not otherwise have a readily ascertainable fair market value when you received them), then you only recognize taxable income in the year in which you exercise the option. With nonqualified stock options, you will bear the income and capital gains taxes related to the receipt of the options from your employer, and perhaps gift taxes as well when you transfer the options to your relative.
If your employer issued options known as "ISOs" (Incentive Stock Options), then under the terms of the ISO plan, you won't be allowed to transfer the options to your relative.
For more details, see IRS Publication 525, or consult your tax advisor.
Q: I sold a business back in 1997 and carried back the paper. I thought this was wise from a tax standpoint so that I didn't have to realize the total sale all in that year. The people took over the business and made 3 payments that year then stopped paying. They were in default, however, I did not want to take over the business again so
I kept in contact with them and allowed them to operate without paying me because they were having a rough time making it. In 1999 they sold the business to a corporation and paid me in cash all that was owed me, including interest. I am now forced in the top bracket as a result of this. Is there anything I can do? I realize that the IRS has taken away the income averaging option, which would have been great for me. Your help is greatly appreciated.
A: Stock Sale
If you sold the stock of your corporation back in 1997, then the gain to be recognized in 1999 should be capital gain, which would, in your situation, likely be subject to a tax rate of 20%. The interest on the installment note, however, would be taxed as ordinary income at your marginal tax rate.
Asset Sale
On the other hand, if you sold the assets of your business in 1997, then your gain in 1999 from the final installment payment would be taxed as either capital gains or ordinary income, depending on the nature of the assets sold. For example, to the extent the 1999 installment payment related to intangible assets that you sold, such as patents or trademarks, you would pay tax at the appropriate capital gains rate (i.e., 20%). For assets such as machinery, your 1999 gain may be taxed at your marginal income tax rate (as high as 39.6%).
Q: I bought a $2,400 computer this year for the sake of continued education within the context of my current job. How much of the price of the computer can I deduct? Also, would it be a different deduction if I claim that I use the computer to gain extra income via auction sites on the internet? I will be claiming the extra income. Should I only claim one deduction, either the education or the auction business?
A: Educational expenditures incurred during the year which neither permit you to meet certain minimum educational requirements for your occupation, nor qualify you for a new trade or business, are generally deductible. However, the educational expenses must either be required by your employer (or by law) to maintain your present employment status, or the education must serve to maintain or improve the skills required by your trade or business. The expenditures typically claimed for permissible educational costs are for tuition and course-related books.
The tax law also allows annual depreciation deductions for the cost of many types of business assets acquired and used during the year in a trade or business or held for the production of income. Provided certain requirements are met, a taxpayer may immediately deduct the entire cost of a business asset purchased in 1999 up to a maximum of amount of $19,000. However, property that is used solely for personal use is not depreciable, and part business/part business assets will only be partially depreciable, subject to certain limitations. If the cost of your computer is eligible for depreciation, you attach Form 4562 to your Schedule C, Form 1040.
See IRS Publication 508 for more information, or call your tax advisor.
Q: I am owner of an LLC in Pennsylvania. I take distribution from the net income of the company. Do I have to pay self-employment tax on the distribution I receive? I file 1065 and K-1 schedule for the company and then 1040 for my personal income tax.
A: Net earnings from self-employment are subject to OASDI and Medicare. Net earnings from self-employment includes your entire distributive share of income (not just actual distributions) and also any guaranteed payments from any trade or business carried on by any partnership or LLC to which you provide services and of which you are a partner (but not a limited partner) or a LLC member.
Q: I am a makeup artist that is considering working not in a salon but rather for myself with much anticipation of becoming very busy. I am certified and licensed since 1990 and have been employed by a salon/spa. Since then, I have purchased product, literature (such as magazine subscriptions pertaining to esthetics) and have spent much of my own money on travel, education and training. I am considering purchasing business cards and other sales and marketing tools that I want to write off.
I have always been under the impression that in order for me to write off these expenses I need to have a business license.
How can I do this? Can I do this on my standard W-2 form? Do I need to have a business license? It not, what forms do I need? Is there any other information or resources that you can recommend for me?
A: Generally, you do not need to have a business license in order to deduct business expenses. You may claim a deduction for "ordinary and necessary" expenditures incurred in the conduct of a trade or business or incurred for the production of income. In general, to be considered as already engaged in an active business that will allow you to deduct a business expense, you must be actively engaged in marketing or promoting your product or service with the intent to generate sales.
If local law requires that you have a business license prior to promoting your service, then any expenditure incurred prior to obtaining such license will not be immediately deductible, but rather may qualify as "start up expenditures."
"Start up expenditures" are those amounts incurred prior to actually being in business (that is, expenditures to investigate or create a trade or business) and may be deducted over no less than 5 years, subject to various requirements. Note that you must make an affirmative election in the year you actually commence business operations in order to deduct "start-up expenditures."
Q: Last year my wife and I filed a joint return. Can we file separately this year? The reason I am asking is because we had large medical bills this year. However, the bills were not large enough to exceed the 7.5% of our combined AGI. But if we file separately, then the bills exceed 7.5% of my wife's AGI. What is your advice?
A: It's advisable to consider filing separate returns when the medical expenses of one spouse far outstrip those incurred by the other spouse. However, note that if medical expenses are paid from a joint bank account but are claimed on only one spouse's tax return, the IRS will also consider the effect of community property laws.
You may wish to read IRS Publication 555, Community Property, to determine if you live in a community property or noncommunity property state and to see the tax ramifications of each.
Keep in mind that filing separately versus jointly may have other effects on your ultimate combined tax liability, so you should make sure that the benefit of filing separately in order to claim certain medical expenses isn't outweighed by other tax planning concerns.
Q: I am classified as an independent contractor and paid with 1099s. My question is whether or not an independent contractor is considered as self-employed by the IRS and eligible to use a KEOGH retirement account.
A. Any person who has net earnings from self-employment can establish a Keogh plan. Earned income for this purpose consists of earnings attributable to personal services, whether from a sole proprietorship, partnership, or LLC derived from the trade or business with respect to which the plan is established. As there are many types of Keogh plans, you may wish to consult with a tax advisor or financial planner to determine which plan best suits your situation.
Q. I work in Massachusetts and stay in New Hampshire. Do I have to file for Massachusetts state tax and New Hampshire state tax? As per my knowledge there is no state tax for New Hampshie. What do I have to do?
A: Since you earn income in Massachusetts, you must file an income tax return with this state. Although New Hampshire does not have a personal income tax, the state does subject certain interest and dividends from Vermont and New Hampshire bank accounts to taxation. 
--compiled by Staff Writer Antoinette Coulton
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