Understanding the Complexities of Capital Gains Tax in India

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Understanding the Complexities of Capital Gains Tax in India

Dec 28, 2016 Posted by Sanjiv 1 Comment

A few years ago, Aarav inherited a parcel of land from his parents.  Since he lives in the city and has no plans of going back to his hometown, he decides to sell the land. He then uses the money to buy an apartment right in the heart of the city.  It took almost three years for Aarav to buy the apartment after selling his inherited property. He falsely assumes that there is no tax liability in his reinvestment. After some time, he finds out from a tax consultant or worse, from the tax authorities, that he will have to pay tax on the capital gained from the sale of his inherited property.

It may have occurred to Aarav that the property he received is not subject to tax. This is true. In India, any asset that is received as an inheritance is fully exempt from gift tax. So he’s not obligated to pay any tax upon receipt of the parcel of land from his folks.

But the sale of the asset is not exempted from tax. This is taxable under capital gains.

In India, it is not uncommon for taxpaying individuals like Aarav to inherit properties such as land or house from their families.  And just like what Aarav did, these individuals would sell the property and invest in another property at some point in time.

However, it is also common for many people in India to be unaware of tax laws regarding inherited properties like land and house, as well as the tax stemming from the sale of those properties. They would only know of the tax liabilities they have when notified by the tax authorities, or as in the case of Aarav, when informed by his tax consultant or a chartered accountant.

It is thus very important for individual taxpayers in India to know of these laws especially if they are to inherit a property from their families.

What is Capital Gains?

In the case of Aarav, he failed to realize that he had to pay the capital gains tax from the sale of the parcel of land that he disposed of.  By definition, capital gains is the profit that Aarav got when he sold the capital asset (in his case, the parcel of land) for a price higher that the purchase price.

Capital assets are property held in any kind by the taxpayer. It may be a parcel of land, a building, a house, or a vehicle. Leasehold rights, trademarks, patents and even jewellery may be considered as capital assets as well.  In certain cases, capital assets may include rights of management to any Indian company.

Thus, capital gains tax not only applies to the sale of an inherited house or parcel of land. It can also apply to the sale of a vehicle, patent, and jewellery.

Capital assets are classified into two – short-term capital asset and long term capital asset.

In Aarav’s case, the sale of the inherited land took him 35 months after the date of the transfer into his name. As such, it is considered short-term capital asset.

If he had disposed the property a month or so longer, it would have been treated as long-term capital asset.

Under the Indian tax laws, the following aren’t considered capital assets:

  • Stock in trade
  • Consumable stores or raw materials
  • Personal effects
  • 5 percent gold bonds
  • Gold deposit bonds
  • Special Bearer Bonds 1991
  • Agricultural land in a rural area. As of AY 2014-15, rural area is defined as any area outside the jurisdiction of a municipality having a population of 10,000 or more.

Calculating Capital Gains

Short-term capital gains and long-term capital gains are computed differently.

Long term capital gain is computed as the full value of consideration fewer expenditures incurred wholly in connection with the transfer of the capital asset. This includes brokerage, commission, and advertisement expenses, among others.  Indexed cost of acquisition and indexed cost of the improvement, if any, may also be deducted.

Full value consideration pertains to the amount that the seller agrees to get in exchange for his or her capital assets. It should be noted that capital gains is chargeable to tax in the year of the transfer.

t of acquisition pertains to the amount for which the capital asset was acquired by the seller. Cost of improvement, on the other hand, pertains to the expenses incurred to make improvements to the capital asset. However, all, improvements made before April 1, 1981 won’t be taken into consideration.

 

On the other hand,  short term capital gains is computed as the sales value of the asset less expenses incurred related to the transfer of the capital asset.  Cost of acquisition, or the purchase price of the capital asset, as well as cost of improvement, may also be deducted from the sales value of the asset.

 

Cost of acquisition pertains to the amount that any of the previous owners has paid to acquire for the property. Going back to Aarav’s case, let’s say that his grandfather was the original owner of the parcel of land. He had purchased it for Rs 20,000. This will be the cost of acquisition that Aarav can deduct to arrive at the short-term capital gains tax.

 

It can be said that calculation of long term and short term capital gains is basically the same. The only difference is that in calculating long-term capital gains, the cost of acquisition and improvement is indexed, or adjusted for inflation.

Short term capital gains on the sale of a property are taxable per slabs rates as applicable to the individual taxpayer. This means that the capital gains tax is payable at the same rate as the income tax of the tax payer.   In Aarav’s case, the capital gains would have been taxed at a rate of 25 per cent if he falls under the 25 per cent bracket.

On the other hand, long-term capital gains are taxable at a uniform rate of 20% plus surcharge and education cess.

Exemptions Under Income Tax Act

However there are exemptions on capital gains that can be applied as specified under certain sections of the Income Tax Act of 1961.

Going back to Aarav’s case, if he had used the proceeds arising from the sale of his inherited property, then he could have been exempt from paying capital gains tax.

Section 54, for instance, exempts sale of house property on the purchase of another house property. In this case, the capital gains arising from the sale of a house property is used in buying another house property.

The new property should have been purchased a year before the sale of the inherited property or two years after the sale of the property.

Going back to Aarav’s case, if he had bought the property he now has in the city within two years after he sold his inherited land, then he would have been able to apply for this exemption. Or, if he had bought the house a year before he was able to dispose of the parcel of land he inherited from his family.

Also, he could have been exempt from capital gains if he used the gains in the construction of the property that was completed within three years from the date of the sale of the inherited property.

It should be noted that under this section, only one house property can be bought or constructed using the capital gains to claim the exemption. The exemption can be nullified if the new property is sold within three years of its purchase or construction.

Investing in Bonds

Under Section 54EC, exemption is available when the capital gains from the sale of the first property are reinvested into specific bonds. These bonds are issued by the Rural Electrification Corporation and the National Highway Authority of India. Investment in these bonds should be up to Rs.50 lakhs.

The money that Aarav invested in bonds should be redeemed after three years. However it cannot be sold before the lapse of three years from the date of sale. Aarav should have invested the money he gained from the sale of his inherited land within six months after the sale of the property to have been able to claim this exemption.

The tax exemption is equal to the capital gain or to the investment, whichever is lower.  Transferring the bonds or taking a loan against them within three years is forbidden, though. It can result to the capital gain becoming taxable.

Investing in these bonds would yield a return of 5.5 per cent interest in a year.

Capital Gains Account

Aarav could have also invested the money that he had gained from the sale of his inherited property in a Capital Gains Account. This is specified under the Capital Gains Account Scheme. Aarav could have deposited the money in any public sector bank. The deposit can then be claimed by Aarav as exempted from capital gains. Moreover, he won’t have to pay any tax on it.

However, Aarav should have done this before the deadline for filing tax returns which usually is on July 1. The money deposited in the account should only be used in buying or constructing a residential house within the prescribed period.

There are two kinds of capital gains deposits in the market. One is a savings type account while the other is terms deposit. Any individual taxpayer can transfer money from one account to another by paying fixed penalties or charges in a bid to exempt his or her capital gains against tax.

In the savings deposit type of capital gains deposit, the money can be withdrawn as long as there is a declaration that the money will be for the construction or purchase of a house. The money will have to be used for the declared purposes within 60 days. Any unutilized amount will have to be re-deposited into the capital gains account as well.

As far as interest rates are concerned, capital gains deposit will have the same rates as those on regular savings and term deposits. There’s also tax for the interest earned. Proof of deposit has to be attached with the taxpayer’s income tax return.

In the event that the deposited amount is not fully used to buy and construct a new house at the end of the three-year period from the sale of the asset, the money in the account will be treated as capital gains.

Opting to open a capital gains account should be considered only as a stop-gap measure.  The individual taxpayer will eventually have to use the money to buy or build a house within a specified period.

Other Exemptions

There’s also an exemption specified under Section 54B of the 1961 Act. This specifies that short term or long term capital gains are tax exempt when the proceeds are used to purchase new agricultural land. The purchase should have been consummated within two years after the sale of the inherited property. Also, the agricultural land should not be sold within 3 years from the date of its acquisition.

Under Section 54G, exemption is also allowed if the gain is reinvested in acquiring a building or machinery in a rural area. There’s also exemption allowed if the gain is used in acquiring land, building, or machine in a Special Economic Zone as specified under Section 54GA.

Conclusion

The truth is that computing capital gains tax on the sale of a property, whether it is inherited or not, can be very tricky.  It is thus highly recommended that tax payers who acquire a property and then sell it later on consult a tax expert or chartered accountant.

As shown in the case of Aarav, he would not have been caught surprised and unaware of his tax obligations had he consulted a tax expert or accountant before he sold his property and bought a new house. This only underscores the need to get professional advice especially when dealing with real estate.

tax audits

Dealing with IRS and other Tax Audits

Sep 7, 2016 Posted by Sanjiv No Comments

It’s one of those fears that bog the minds of rich people and even ordinary taxpayers—getting audited by the IRS. But what are the chances that you’ll be audited by the government for your tax returns?

The chances of a tax audit are very low these days. Taxpayers with moderate income levels have a 1 percent chance; while those earning $1 million and up were audited at a 7.5 percent clip.

For companies, the rates are also low. Firms with total assets of less than $10 have a 1 percent chance. Those with assets between $1 and $5 million have a 1.2 percent rate, while firms with asset size of between $5 and $10 million have a 1.9 percent chance of being audited. Even the middle-sized firms or those with assets between $10 and $50 million had a low 6.2 percent chance of being audited.

Sure, the chances of getting a visit from the IRS have shrunk to all-time lows. But that should not be enough reason for you to be complacent. It still pays to know what to do just in case someone from the IRS knocks at your door or you get a letter from the said agency.

Individual Tax Audit

You may not be a millionaire but there are conditions that can increase your risks of being visited by the IRS:

• Being self-employed. There are lots of write-offs that self-employed taxpayers can claim, unlike most employees. These range from a home office to the use of a car, and the IRS may have queries about these claims.
• You have itemized deductions that are a lot higher than those of taxpayers with comparable incomes. The tax department will likely flag your return when it notices that there’s a big difference between your write-offs and averages.

Should you get a notification that you are to be audited, don’t panic. Keep in mind that the audit will be done in a professional manner. And if you can give the IRS people the right paperwork then you will be off the hook, so to speak.

You must not also think of ignoring the IRS. Your problem won’t go away. Worse, your interest and penalties will continue to accrue. So the earlier you deal with it, the better.

Have you signed up for our upcoming webinar on Sep 24th @ 10 am PST – Its FREE

 

Types of Audit

There are three types of audit. The more common is correspondence audit, which is handled by a way. According to the Transactional Records Access Clearinghouse, 76 percent of individual audits were of this kind.

These computer-generated correspondences may tell you that there was a mathematical error on your return, or that your return wasn’t the same as the 1099 statements that the IRS received from your bank or broker. In these cases, you simply send the money that you owe.

The letter may also dispute a tax break that you claimed. If you can’t prove that you were correct, then you will have to pay additional taxes.

But what if you’re right? You’ll have to collate the right paperwork then send it back to the IRS through certified days within 30 days of receipt of the letter. You’ll also have to prepare a letter that includes a copy of the correspondence audit plus your reference number.

In some cases, you imply have to go back and get receipts. But there are cases when you can’t do that. Instead, you may have to get a written acknowledgment from the charity that you gave to in order to claim a charitable contribution.

This is a task that you can handle yourself, especially if the issue is simple enough to reply to. You may ask a tax pro to help you out, but you’ll obviously have to pay him or her for the service

If you feel you are deserving of the tax break but you want a stronger case or reply to the IRS, a tax professional can be of significant help. He or he can prepare your return respond to the agency, and give you a better shot at defending your case.

The second type is field audit, which is conducted in person at your home or at IRS offices. However, the chances of an IRS guy dropping by your home are very low these days. The agency is no longer conducting a lot of field audits because these often mean additional expenses.

This type of audit is conducted when the IRS has lots of questions about your return. The agency may also resort to this type of audit when there is a certain write-off that is difficult to handle by mail.

The field audit in an IRS office shouldn’t last more than four hours. However there will likely be a follow-up visit, or the agency would require you to pass additional paperwork.

The last type is the ‘random’ audit. Among the three types of audit, this is the least likely that the IRS will conduct. You have a very slim chance of being selected for this audit.

But then again, it pays to be prepared.

The random audit is perhaps the most detail-oriented and intrusive of the three types of audit. IRS agents may even ask for your birth certificate and marriage license just to check your filing status.

This is also the type of audit where a professional expert can help you. There’s a good chance that something will happen at the audit that can cause the agency to demand you to pay more. With the help of a pro, you’ll be ready just in case the proverbial can of worms is opened.

Attitude During the Audit

Whether you are going to the IRS office or accompanied by a tax pro, you need to behave professionally during the audit. Don’t become argumentative, and treat the agents with respect.

Be honest and truthful with your answers. But you should also answer straight to the point. Avoid talking too much because the more you talk, the more questions that the agency will have.

You should also come to the office prepared and organized. You don’t want to upset the agent with your messy folder and jumbled receipts.

If you are unable to provide the document the agent is looking for, politely ask if there’s any other documentation that you may provide in lieu of the document. For example, you claimed the business use of a vehicle but couldn’t show receipts for gas. Maybe a calendar of your business meetings may be accepted as a substitute.

You can go through the appeals process if you disagree with the contention of the agent. This is where a tax pro can help you as he or she would be able to handle this step.

So what happens if you have to pay the IRS more money but you don’t have cash? You have three choices—one is to pay with a credit card, although you will have to pay a convenience fee of around 2.35 percent. You can also for an installment agreement or request for a compromise.

Business IRS Audits

Again, the chances of a business getting audited by the IRS have gone down in the past few years. But this still should not give your company a false sense of security.

What are the possible issues that the IRS will look into your company’s tax returns? Here are some of the red flags that should make the IRS agents knock on your door:

1. Net loss in more than two of the past five years.
2. Excessive deductions for travel, business meals, and entertainment
3. High salaries paid to shareholders
4. Shifting income to tax-exempt organizations in a bid to avoid payment of taxes
5. Claiming 100 percent business use of a vehicle

Like in individual tax audits, it is important for a business to be prepared if it has been picked for an audit. There’s a silver lining to being audited, as if the agency’s findings show that there is no change to the tax liability then the business won’t be audited on the same issue for the next year.

Hiring a tax professional is the first step that you need to undertake if your business has been pinpointed by the IRS for auditing. Don’t be anxious in thinking that this will indicate that your business is guilty, after all, the IRS is very much used to this practice. A tax professional can help you through the audit.

You can even sign a power-of-attorney agreement to give your tax professional the legal authority to deal with the IRS directly. This is ideal if you are unsure of what to say and what not to say during the audit. This basically takes you out of the loop and puts your tax professional in.

But there are three things that you, as the business owner, should remember when your business is faced with the prospect of being audited by the IRS:

1. Review the audit letter carefully.

An IRS agent won’t just barge into your door and announce an audit. The agency will send an audit letter to your office informing you that your firm has been picked for the audit.

Be cautious with scammers who will masquerade as the IRS by sending you email messages or leaving phone messages. Those guys will attempt to hack your personal data. The real IRS doesn’t communicate through email or phone.

Once you receive the letter, open it promptly. Read and understand what the IRS needs from you.

If your company doesn’t have a financial adviser, you can hire an accountant or tax professional to help you review the review letter. He or she will also identify the issues that the agency has flagged.

Don’t ignore the letter because the IRS will not go away. Worse, the auditor may become more suspicious and even antagonistic.

2. Organize your records.

The next step is to organize your records. Gather and organize all your business records from the previous tax year even before you meet with the tax professional and IRS auditor.

These records range from receipts and invoices from income and expenses, accounting books and ledgers, bank statements, leases or titles for properties and hard copies of tax-prep data. You should also make sure that you have the specific documents requested by the IRS for review.

3. Answer the questions honestly.

During the audit, the IRS agent will ask you a lot of questions about the information reported on your business tax return. Simply answer the questions of the auditor—no more, no less. Giving any information that you are not required to give may put you in more hot water.

Similar to dealing with individual tax audits, providing unasked-for information may give the auditor more questions to ask. The last thing that you want to happen is for the auditor to uncover more issues about your tax returns. IRS auditors won’t forgive tax debt or mistakes, so any admission that you may have will be used against you.

Be straightforward in replying to the questions. However, don’t manufacture excuses. IRS agents would know if you’re making any.

Also, don’t be antagonistic with the auditor. It would only make things worse for you and your business.

In order to avoid future audits, you should track bank transfers and other financial records aside from receipts. Anything that you cannot explain on the standard IRS form must be explained on paper. Of course, double-check all your calculations before filing your returns.

Aside from keeping proper documentation, you can avoid getting picked for an audit by deducting ordinary and necessary business expenses as allowed by the IRS. So even if your company is chosen for an audit, you have nothing to be afraid of.

Indeed, getting a letter from the IRS informing that you are to be audited can be very worrisome. But if you know how to deal with tax audits, then you don’t have anything to be afraid of. It also helps to have a tax professional guiding you to be assured that you can respond to whatever audit findings the IRS guys have with you or your business.

Tax Deduction Strategies for Small Businesses

Apr 12, 2015 Posted by Sanjiv No Comments

As a small business owner, you can utilize a proactive approach and seize all opportunities available for conducting tax deductions as provided for under the law. Overlooking certain crucial write-offs leads to a bloated tax bill. Changes to the recent tax law have altered how Section 179 on deduction on bonus depreciation works. You can maximize write-offs for your home office and get deductions for business travel and automobiles, along with tax shelters for real estate property.

  1. Tapping into Major Tax Savings as per Section 179 Depreciation

A small business can benefit through huge increment in First-Year depreciation allowance as covered by Section 179. Following this law, you can deduct full cost of most used and new business personal property. The maximum amount provided for here got gradually boosted for 2009 from $25,000 to $250,000. Later on, the 2012 American Taxpayer Relief Act (ATRA) preserved the $500,000 maximum deduction adopted by the 2010 Small Business Jobs Act for two years. This provision was backdated to 1st of January 2012 and remained effective through 31st December 2013.

  1. Claiming Bonus Depreciation for All Qualified Assets

A business can lay claim to “bonus depreciation” for assets which are qualified and placed in service during the whole year. This business tax credit applies to the following:

  • Property with 20 years or below of cost recovery period
  • Qualified leasehold improvements
  • Depreciable software which is not amortized for over 15 years
  • Water utility property

 

  1. Triggering Quicker Write-Offs as per Section 179 Depreciation

It is possible to maximize Section 179 expensing deduction by undertaking some shrewd planning of your taxes through the ways below:

  • You can claim the allowance accrued through compensation payments if your company zeroes out its taxable income. The tax law limits annual deduction to amount of income taxable.
  • Boost the limit of your business income, which should include that accrued from your active businesses.
  • Maximize business percentage if claiming allowance for assets partially utilized for non-business reasons.

 

  1. Larger Deductions for ‘Heavy’ SUVs according to Section 179

If you opt to deduct annual expenditure as opposed to using standard mileage allowance, take note of an appreciably large tax advantage if owning heavy-duty vans, pickups and SUVs. These vehicles have gross vehicle weight rating or GVWR of over 6,000 pounds from the manufacturer and are viewed as “trucks” for purposes of taxation.

Such heavy-duty vehicles depreciate more rapidly than regular passenger vehicles, when used intensively for business purposes.

  1. Deductions of Fuel Tax for Business Vehicles

You may deduct automotive expenses via a standard mileage rate, set each year by the IRS. Doing this sets you free from having to account for actual expenditure incurred. For instance, business drivers got 56.5 cents for each mile in 2013.

  1. Tax-Free Family Vehicles as part of Business Deductions

Operation and maintenance costs are deductible for cars utilized in doing business, which includes depreciation. Your auto repair firm may provide cars for the whole family in this case. The business you own can deduct the entire amount of operating costs if your family members are employed by the enterprise. Car expenses which are deductable include:

  • Cost of gasoline
  • Repairs,
  • Insurance
  • Interest on car loans
  • Depreciation
  • Licenses
  • Taxes
  • Garage rents
  • Parking tolls and fees

 

  1. Writing off Home Furniture and Computer as part of Self-Employed Tax Deductions

Under Section 179, many taxpayers who are self-employed may deduct purchases for equipment, as opposed to capitalizing them. This section applies to the vast number of business assets, including furniture and computers meant for domestic use.

  1. Owning Your Business Premises

Once profits of your company start growing and business stabilizes, consider owning as opposed to renting your quarters. When evaluating the comparative costs, think of a reasonable time-period, such as of 10 years and factor into your calculations purchase price of your desired building at a prime location.

  1. Sheltering Real Estate Property of up to $25,000

Prices of real estate have recently gone down in many places, presenting great opportunities for investment. As well, business owners can enjoy tax shelters for investing in property. One has to own a 10 percent minimum portion of such investment property without involving limited partnership interests, apart from actively managing it. Business tax credit of 10 percent is available too for fixing old buildings, which changes to 20 percent if the building has historic significance.

  1. Turning Home into Rental Property

Many home owners have been adversely affected by recent devaluation in real estate property. This even gets worse due to inability of deducting loss from selling your principal residence.

Turning your home into rental property is a brilliant strategy in such situations. You only require holding it out for rent while relocating, before deducting losses once the place is sold. This is a shrewd tax move which capitalizes on an important distinction that applies to business or investment property.

Understanding Depreciation For Taxes

Mar 30, 2015 Posted by Sanjiv No Comments

Depreciation is a market term used to signify the fall in value of a commodity or a market in a bigger context. Generally, depreciation is observed over a period of time; and in commercial aspect, it is used to represent the fall in price of an asset over a fiscal year.

Depreciation is a method which allows income tax deduction for the taxpayer in order to claim the cost based on specific property. This acts as an annual allowance for devaluation, wear and tear or uselessness of a property.

The properties that can be categorized as tangible property, furniture, buildings, machinery, vehicles and other equipment other than land, all these properties are depreciable. Similarly, patents, computer software programmes and copyrights are also depreciable.

The Internal Revenue Service specifies properties that can be depreciated and how they can be depreciated. There are certain depreciation schedules for various types of assets as per IRS. Referring these schedules, you can know about the percentage of an asset’s value that you can deduct every year and for how many years. These depreciation deductions determine the asset’s recomputed basis when you sell the asset

You are required to use Form 4562, Depreciation and Amortization for reporting depreciation when filing a tax return. Form 4562 has six sections and you can get information on filling out each section by contacting your tax professional or searching online.

 Section 167

In US law book, the section 167 deals with depreciation tax deduction of commodities. If you are purchasing a property that you are going to use in some form of business activity or to make money from it, it is possible that you fail to subtract the complete business expense in the same year of acquiring the property. You need to spread the cost over a fiscal year and then deduct part of the cost every year. This fall in the cost of a business property is called depreciation.

 Repairs are immune to depreciation

Investments made on property to increase its life time are immune to depreciation. If you are spending some more money on repairs and adding new things to the property to increase its usefulness, then you can slow down the rate of depreciation.

The procedure of depreciation

In order to depreciate, the investment property and other business matters should be placed for Modified Accelerated Cost recovery System (MARCS). This method allows deduction for a larger amount during initial years and during later years, lower amount of deductions are done and both are compared through straight line methods.

Conditions required for allowing depreciation tax deduction for any property

  • The legal taxpayer must be the owner of property. Taxpayers also have the right to deduct tax regarding capital improvements for any property that he/she has taken on lease.
  • The property must be used by the taxpayer for business or any other activity that can produce income. In case of using any property for business and personal use, the taxpayer may reduce the depreciation depending upon use of the property only for business purpose.
  • The property for which depreciation and tax deduction is applied, must be useful for at least more than a year or two.

Under the following circumstances a taxpayer cannot depreciate his or her property, in case of property being disposed within the same year.  When equipments are used for building capital advancements, a taxpayer is only allowed to do so for equipments used during construction depending on the improvements. And certain terms and interests are also an issue.

Depreciation initiates only when the taxpayer provides the property for a trade or for business, after using it for the production or as a source of income. When the taxpayer fully recovers the cost of property, then the property becomes invalid for depreciation. Even if the taxpayer takes voluntary retirement from service, the above mentioned scenario is applicable!

 Things to know for proper depreciation tax deduction

  • Knowing the absolute method for depreciating your property.
  • Knowing your asset details well.
  • If the property falls under the listed property category.
  • If the taxpayer is electing for the expense for any part regarding the assets.
  • How depreciation is possible, based on the property.

179 deductions for deprecation

As per this section, one can deduct a cost for the limited account for a certain amount of depreciable property, only if you have placed it for service.  This kind of deduction is called section 179.  In 2013, the maximum amount that could be deducted was $500,000. However, higher limits are also applicable but it depends upon the asset.

The limitation is reduced depending upon the amount, and the cost of property offered for the service during tax year goes above $2 million. Publication 946 clearly states about regulations and details about properties which are applicable for deduction, its limitation, and how one can place the deduction at the right time.

Traditionally, the capital assets and their deduction is based upon casual fact that vehicles, buildings, roads and similar improvements have a life for more than one year. But relying on the theory and facts, they get paid out of the savings brought together for several years.

Taxpayer should keep in mind that the land property does not fall under the category of depreciation, simply because it never wears out! The bookkeeping method is mainly used for reflecting the operations, which are an on-going procedure for the current year.  Specifically for this obvious reason, inflows about capital investments and depreciation are not reflected, same for income as well.

Should you take depreciation ?

With the proper guidance and knowledge about depreciation tax deductions, one can save a good deal of money from tax. Several methods are available for calculating depreciation tax deductions based on the property. But it should be kept in mind that there are also some limitations in it.For example, when you sell an asset to earn profit and have made depreciation deductions on it, depreciation recapture is applied to impose tax on the profit or gain from its sale. Since you have already benefitted  from  depreciation deduction from ordinary income, any gain you get, up to the depreciation sum, is required to be entered as ordinary income to make up for the previously made deduction.

Tax Amortization Deduction Benefits

Mar 23, 2015 Posted by Sanjiv No Comments

What is Amortization and how it works ?

Amortization is a system of deducting certain capital expenses over certain duration. In other words is a way of recovering the cost of intangible assets. It is like the straight line system of devaluation.

How to reduce amortization from taxes?

To reduce the amortization amount incurred during the current tax year, fill out Part VI of Form 4562 and submit it along with your income tax return.

For reporting amortization from previous years, apart from amortization that begins in the current year, make an entry on Form 4562 and record each item separately. For example, in 2013, you began amortizing a lease. In 2014, you began to amortize a second lease. The new lease being amortized will be reported on line 42 of your 2014 Form 4562 while the previous lease being amortized from 2013 will be reported on line 43 of your 2014 Form 4562.

If there are no current expenses of amortization in the year for which you are going to file tax return, there is no need to fill Form 4562 (unless you are asserting devaluation). Report the current year’s written off expenses for amortization that started in the earlier year directly under the “Other deduction” or “Other expense line” of your return.

How amortization deductions can help?

Sole Proprietorships

Guaranteeing government tax as a sole proprietor implies that your organization works under your heading without the profit of joining or aid from a board or standard staff. Sole proprietors make use of Schedule C with Form 1040 or C-EZ in order to record the federal income taxes. This expense assertion permits amortized derivations as a component of your regular tax recording. Schedule C allows a deduction for devalued supplies with a valuable operational life of more than one year. The favorable circumstances of utilizing amortization reductions under a sole proprietorship incorporate the capacity to recoup the expense of your “standard and vital” devices through a progression of yearly assessment derivations.

Business Expansion

The Internal Revenue Service permits amortizing property rents, the expenses of beginning an organization and any unmistakable resources that are bought to direct business. Actually when amortized over various expense years, these conclusions offer the organization the chance to grow operations by buying top quality devices and modernizing the hardware expected to work. For example the Laundry or the dry cleaners can buy pressing apparatus to supplant hand irons and recuperate the cost over the helpful life of the mechanical presser.

Manufacturing Expansion

Producing operations can utilize the amortization deductions for general equipment utilized as a part of operations and also to buy supplies to grow assembling techniques. Entrepreneurs ought to counsel an assessment expert in order to understand the perceived legitimate lifetime of equipment since the administration terms sporadically change under the government law. Bookkeepers with assembling knowledge have the learning of late rules characterizing the life of equipment and capital ventures. Producers utilize the amortized gimmick, in order to grow a solitary mechanical production system to different lines to build generation. Amortization deductions permit organizations with the opportunity to completely waive off amounts over the life of supplies.

Monetary Expansion

The capacity to deduct capital expenses as amortized expense derivations helps fuel the monetary extension for organizations and makers supplying products to organizations. The government amortization tax deductions procurements help to grow the organization deals for items utilized as a part of assembling and products utilized by both little and vast organizations. Business commercials reiterating it for clients to remember the accessibility of expense derivations for qualified things help offer items, since the utilization of the yearly amortization in the end brings reimbursement of the expense of item. The constrained lifetime of a few items debilitates the buy without added focal point to amortize the thing as an amortized business charge deduction.

 How is amortization deduction different from depreciation deduction?

A lot of people consider amortization and depreciation to be the same thing. However, there is a thin line of difference between the two. The explanations given below give clarity regarding this.

The idea of depreciation/amortization is an assessment system that is intended to spread out the expense of a business resource, what the IRS calls “cost recuperation.” In the event that you purchase copy paper for your business, you expect the valuable life to be months and not years. So copy paper can be included as a cost for the year it is bought in.

However, on the off chance that you purchase office furniture or some supplies, you hope to utilize it for quite a while, so the IRS says you must “recuperate” the expense by taking it as a cost for a while, considered as the “functional life” of that asset. Along these lines, in the event that you purchase a work space for your office, the IRS has set a particular time for which you can spread out that cost, not including any rescue (remaining) quality.

What is Depreciation?

In terms of accounting, depreciation point towards the value of an asset that has been utilized. Regarding tax needs, one can deduct the expenditure incurred in purchasing tangible assets by labeling them as business expenses. Nevertheless, businesses are required to depreciate these assets as per the IRS norms as to how and when the deduction must be made in accordance with the type of asset and its life. For instance the work area as mentioned above depreciates, as is an organization vehicle, a bit of assembling gear, racking, and so on. Anything that you can see and touch and that endures longer than a year is viewed as a depreciable resource (except a few special cases).

What is Amortization?

Amortization is the same process as depreciation but applies to intangible resources i.e. those things that have value and you can’t touch. For instance, a patent or trademark has value, so does goodwill. To add to this, the amortization additionally has an importance in paying off an obligation, in the same way as a home loan.

The IRS has assigned certain intangible resources as qualified for amortization in excess of 15 years, as indicated by Section 197 of the Internal Revenue Code.

Thus, the fundamental general guideline is that you devalue assets that are tangible and amortize assets that are intangible. For both categories, there are possible deductions in tax payable, and so you need to clearly understand this topic in order to use it to the best.

Understanding Depreciation For Tax Filings

Feb 9, 2015 Posted by Sanjiv No Comments

The field of commerce is vast and people tend to analyse every single monetary attribute by using the definition used in this field. Depreciation is a market term used to signify the fall in value of a commodity or a market in a bigger context. Generally, depreciation is observed of a period of time and in commercial aspect we use it to represent the fall in price of an asset over a fiscal. It also signifies the fall in a company’s revenue or in other things related to the business of the company. There are various reasons which foster this kind of a situation in the market and false inflation is one among them. Various market commodities like real estate, oil and precious metals can face a steep fall in their market price during recession.

Factors behind value depreciation in the market:

A recession is an economic scenario where a local or global market suffers from fall in the value of different commodities, and there are multiple situations that can trigger this. In US law book, the section 167 deals with depreciation for commodities. If you are purchasing a property that you are going to use in some form of business activity or to make money from it, it is possible that you fail to subtract the complete business expense in the same year of acquiring the property. You need to spread the cost over a fiscal and then deduct part of the cost every year. According to the countries law book, this fall in the cost of a business property is called Depreciation.

Repairs are immune to depreciation.

Investments made on the property to increase its life time are immune to depreciation. If you are spending some more money on repairs and adding new things to the property to increase its usefulness, then you can slow down the rate of depreciation.

The procedure for Depreciation

In order to depreciate, the investment property and other business matters should be placed for Modified Accelerated Cost recovery System (MARCS). This method allows deduction for a larger amount during initial years and during later years, lower amount of deductions are done and both are compared through straight line methods.

 Brief description about Depreciation

Depreciation is a method which allows income tax deduction for the taxpayer in order to claim  the cost based on specific property. This acts as an annual allowance for devaluation, wear and tear or uselessness of a property.

The properties that can be categorized as tangible property, furniture, buildings, machinery, vehicles and other equipments other than land, all these properties are depreciable. Similarly, patents, computer software programmes and copyrights are also depreciable.

Conditions required for allowing deduction and depreciation for any property

  • The legal taxpayer must be the owner of property. Taxpayers also have the right to deduct tax regarding capital improvements for any property that he/she has taken on lease.
  • The property must be used by the taxpayer for business or any other activity that can produce income. In case of using any property for business and personal use,  the taxpayer may reduce the depreciation depending upon use of the property only for business purpose.
  • The property for which depreciation and tax deduction is applied, must be useful for at least more than a year or two.

Under the following circumstances a taxpayer cannot depreciate his or her property, in case of property being disposed within the same year.  When equipments are used for building capital advancements, a taxpayer is only allowed to do so for equipments used during construction depending on the improvements. And certain terms and interests are also an issue.

Depreciation initiates only when the taxpayer provides the property for a trade or for business, after using it for the production or as a source of income. When the taxpayer fully recovers the cost of property, then the property becomes invalid for depreciation. Even if the taxpayer takes voluntary retirement from service, the above mentioned scenario is applicable!

 Identifying proper items for apt depreciation

  • Knowing the absolute method for depreciating your property.
  • Knowing your asset details well.
  • If the property falls under the listed property category.
  • If the taxpayer is electing for the expense for any part regarding the assets.
  • How depreciation is possible, based on the property.

179 deductions for deprecation

As per this section, one can deduct a cost for the limited account for a certain amount of depreciable property, only if you have placed it for service.  This kind of deduction is called section 179.  In 2013, the most amounts that could be deducted were $500,000. But higher limits can also be applicable but it depends upon the asset.

The limitation is reduced depending upon the amount, and the cost of property offered for the service during tax year goes above $2 million. Publication 946 clearly states about regulations and details about properties which are applicable for deduction, its limitation, and how one can place the deduction at the right time.

Traditionally, the capital assets and their deduction is based upon casual fact that vehicles, buildings, roads and similar improvements which have a life for more than one year. But relying on the theory and facts, they are getting paid out of the savings brought together for several years. Taxpayer should keep in mind that the land property does not fall under the category of depreciation, simply because it never wears out! The bookkeeping method is mainly used for reflecting the operations, which are an on-going procedure and for the current year.  Specifically for this obvious reason, inflows about capital investments and depreciation are not reflected, same for income as well.

 With the proper guidance and knowledge about depreciation, one can save a good deal of money from tax. But it should be kept in mind that, there are also some limitations in it and it comes under the Internal Revenue Service, which specifies about properties and how they can be depreciated. Several methods are available for calculating depreciation based on the property.

Saving For College: A Parent’s Guide To Federal Tax Incentives

Jul 19, 2014 Posted by deepak No Comments

When your child receives the college acceptance letter in the mail from their dream school, the only thing that could make you happier is knowing that they will have the financial resources to pay for the college of choice.

The cost of college for your child(ren) might be the largest expenditure you ever have. Millions of other parents face this same challenge. The good news is there are more options to save for future college expenses than ever before. The traditional investment options – taxable investment accounts, savings accounts, United States Savings Bonds and annuities – are joined with new education savings vehicles including Coverdell education savings accounts and Section 529 college savings programs.

While these new investment education programs bring new opportunities, they can also make a parent’s decisions much more difficult. Understanding all of the available options is the best way to maximize the return on each dollar you save for your child’s future. It is important to remember that even though saving for your child’s education may seem overwhelming now, with savings and proper planning, college costs can be within your reach.

One of the best ways make your child’s education more affordable is to take advantage of some of the federal tax breaks geared toward savings and reducing the cost of college including:

529 Plans (Qualified Tuition Programs): Tax deferred earnings. When distributions are taken for qualified post-secondary education costs, they are tax-free.

Coverdell Education Savings Accounts: Tax deferred earnings. When distributions are taken for qualified post-secondary education costs, they are tax-free. Withdrawals from education savings accounts are also tax-free when they are taken for primary and secondary school expenses.

United States Savings Bonds: I and EE savings bonds that were purchased after 1989, by someone 24 years or older, may be redeemed tax-free for college tuition and fees for the bond owner, dependents or their spouse. The tax exclusion, in 2014, is phased out for those with incomes from $76,000 to $91,000 (for married filing jointly the incomes are phased out from $113,950 to $143,950). Each year, the income levels increase.

Individual Retirement Accounts: With traditional IRAs and Roth IRAs, the penalties for early withdrawals are waived when the funds are used to pay qualified post-secondary education costs for the account holder, dependants, their spouse or grandchildren. However, taxes for the withdrawal may still be due.

American Opportunity Tax Credit: Available through 2017. Parents can claim a tax credit for their dependant children’s college tuition and fees equaling 100% of the first $2,000 and 25% of the following $2,000 ($2,500 maximum per child). If the student is not claimed by someone else as a dependant, they can claim the American Opportunity Credit themselves. The tax credit is phased out with incomes from $80,000 to $90,000 (for married filing jointly it is phased out from $160,000 to $180,000). The tax credit is only available when students attend a college degree program half-time or more and if they have not completed 4 years before the beginning of the tax year. The American Opportunity Credit cannot be taken more than 4 tax years.

 Lifetime Learning Credit: This is a tax credit for 20% of up to $10,000 in tuition and fees for the taxpayer, dependent children or their spouse. This tax credit is phased out in 2014 for incomes from $54,000 to $64,000 (for married filing jointly it is phased out for incomes from $108,000 to $128,000). When a taxpayer claims the Lifetime Learning Credit, they cannot claim the American Opportunity Credit during that tax year. With the Lifetime Learning Credit, there are no enrollment time or degree program requirements. Also, this credit has no limit on the amount of years it can be claimed.

Student Loan Interest Deduction: An above-the-line deduction may be taken for student loan interest up to $2,500 if the student loan was used to pay the taxpayer, dependent children or their spouse’s college costs. The student must be attending a college degree program at least half-time. In 2014, the deduction is phased out for taxpayers with incomes from $65,000 and $80,000 (for married filing jointly the deduction is phased out for income from $130,000 and $160,000). This deduction cannot be claimed by the student if he/she is a dependant on someone else’s tax return.

Tax Free Education Grants: If the recipient does not provide a service in exchange for the grant, the majority of grants are tax-free.

Tax Free Education Scholarships: If the recipient does not provide a service in exchange for the scholarship, the majority of scholarships are tax-free.

Tax Free Employer Educational Assistance: When an employer provides tuition assistance to an employee, the benefit is tax-free. It can only be used to pay the employees education, not the spouse or dependent children. The education doesn’t have to be related to the job. Also, under a Section 127 educational assistance plan, employers are able to deduct up to $5,250 in tuition and fees for college or graduate school for each employee.

Your goal is to afford the college of your child’s choice. You should not look at college costs as another expense, like your rent or electric bill. Think of it as an investment in your child’s future. According to the Census Bureau, college graduates earn 85% or more than those who only have a GED certificate or high school degree. The additional income earnings for people with a college education could exceed $1 million over their lifetime.

The best way to make sure that your child has higher education options later is to save now. That way your child can base their college selection on a school that offers the best education, not the school that offers the best financial aid. Knowing that affording their college education will not be dependent on outside sources, like scholarships and loans will put your mind at ease.

To maximize your college education savings, there are many vehicles available for you to choose from. It is critical that you select a suitable strategy and combine the best investment vehicles. Take time to carefully evaluate all of your options. It may be helpful to seek professional financial and tax planning advice to develop the best strategy to save for your child’s college education.

 

 

 

 

 

There Is Still Time To Cut Your Taxes!

Mar 17, 2014 Posted by Sanjiv No Comments

Even though the tax year is over, you still have opportunities to reduce your 2013 taxes.  Many strategies for tax planning need to be done by December 31st; however, there are others that you can still take advantage of before you file your taxes. The best thing you can do is do not leave any viable deductions on the table.

Maximize Contributions To Your IRA

Self-employed individuals and small business owners have until April 15th to contribute to their SEP IRA for the prior year. The limits are the lesser of 25% or $51,000 in 2013. If you get an extension, you will have until October 15th to fund your SEP IRA for the 2013 tax year.  The SEP IRA is much more flexible than a Roth IRA or a regular IRA because it gives you an opportunity to make a contribution when you receive higher profits later in the year.

The New Deduction For A Home Office

If you did not keep good records of your home office expenses in 2013, you do not have to scramble around looking for them with the new simple home office deduction. This deduction lets you take a $5.00 deduction per sq. ft. for the place in your home that you use for work. Many people do not claim any deductions for their home office because they feel it will trigger an audit. With the new standard home office deduction, anyone who uses a home office should claim it this year.

Look For Miscellaneous Tax Credits

Take time to go through your receipts to see if you have anything that qualifies for tax credits. Tax credits reduce your tax liability dollar for dollar. See if you bought anything that qualifies for the energy efficient tax credit. You will find a list on the IRS website of all eligible Energy Star appliances and electric and hybrid vehicles that qualify for a credit up to $7,500.

If you have children in college or are in college yourself, you could offset some of the expenses using the LLC (Lifetime Learning Credit) or the AOTC (American Opportunity Tax Credit).

Get Organized

Before you start preparing your tax return, make sure you organize all of your documents and receipts. This will help you identify any deductions you might not have thought of and will make sure your tax return is accurate.

Organizing your tax records and financial documents now will make the process of filing your taxes easier. Take a little time each day to go over your bank statements, credit card bills and charitable contributions you made in 2013 to make sure that nothing is overlooked.

Keep all of the 1099s and W-2s you receive in one secure location so they do not get misplaced forcing you to file a late tax return or an incomplete tax return

There is a lot you can still do between now and when taxes are due on April 15th to lower your tax liability. You can cut your taxes considerably by claiming all of the tax credits you are eligible for and making all prior year contributions.

Tax Provisions That Expire In 2013

Dec 25, 2013 Posted by Sanjiv No Comments

There are many tax provisions that are scheduled to expire at the end of 2013. You should consider taking advantage of these provisions while they exist.

Tax Breaks For Individuals

Exclusion for Mortgage Debt Cancellation on Primary Residences

In general, debts that have been cancelled or forgiven are considered to be taxable income. There has been an exception for mortgage debt cancelled between 2007 and 2013 if the debt was canceled because of a short sale, mortgage restructuring or foreclosure.

Distributions From Retirement Plans Are Tax Free If It Is For Charitable Purposes

Individuals that are at least 70.5 years old can distribute funds from a retirement account directly to the charity of their choosing up to $100,000 per year as a qualified charitable distribution. These qualified charitable distributions are tax free and may satisfy the minimum plan distribution rules.

Qualified Small Business Stock Exclusion

Investors are able to sell qualified small business stock. 100% of the gains from the sale of the stock will be excluded from income. After 2013, only 50% of the small business stock gains will be able to be excluded.

 Tax Breaks For Employee Benefits

 Mass Transit Benefit

 During 2013, the tax free exclusion for the mass transit fringe benefits was $245 each month. The amount is reduced to $130 per month beginning in 2014.

 Above The Line Deductions

Deduction For Classroom Expenses

K through 12 educators, principals and teachers are able to deduct job related expenses up to $250 as an above the line deduction. In 2014, they will only be able to deduct these expenses as part of the itemized deduction for employee business expense.

Deduction for Tuition and Fees

This above the line deduction expires in 2013. In 2014, the American Opportunity Credit and Lifetime Learning Credit will be available.

Itemized Deductions

Mortgage Insurance Premium Deduction

Homeowners are able to deduct mortgage insurance premiums, only through 2013, as part of the mortgage interest deduction.

Local and State Sales Tax Deduction

State sales tax can be deducted in place of state income taxes. This is very valuable for taxpayers that live in any state that does not have state income tax.

 Real Property Charitable Contributions Made For The Purpose of Conservation

Taxpayers that donate conversation easements to a charity can deduct the value of the easement limited to 50% of AGI minus deductions for all additional charitable contributions. The 50% special limitation expires in 2013.

 Tax Credits

Non Business Energy Property Credit

The tax credit is for 10% of the cost of the qualified energy efficient products that are installed at the main residence of the taxpayer.

2 Or 3 Wheeled Plug In Electric Vehicles

This tax credit is for $2,500 for a vehicle that draws energy from a battery that has a minimum of five kilowatt capacity hours. There is an additional $417 credit for each additional kilowatt capacity hours in excess of the minimum five. The total of this credit has a limit of $7,500.

 Credit For Health Coverage

 The health coverage credit is equal to 72.5% qualified health insurance premiums and the taxpayer’s family.

Credit For Work Opportunity Tax Credit

This tax credit is an incentive for businesses to hire specific employees including public assistance recipients or veterans. For example, employers can receive a tax credit of $4,800 for each disabled veteran that is hired.

 Depreciation

Bonus

 Businesses are able to deduct up to 50% of new equipment costs through a bonus depreciation deduction in 2013. All of the rest of the cost of the equipment will be depreciated over the equipment’s useful life. This bonus will not be available in 2014. The only exception in 2014 will be in the case of noncommercial aircrafts and long production period property.

Section 179

Under section 179, businesses are able to expense the total cost of equipment in the year it is purchased instead of using depreciation and spreading the cost over many years. In 2013, businesses are able to expense up to $500,000. In 2014, they will only be able to expense up to $25,000.

 

 

 

Avoiding IRS Tax Audit This Year

Jan 15, 2013 Posted by Sanjiv No Comments

There are many things that seem to raise the red flag every time a tax return goes to the IRS. This article is going to point out some of the reasons behind an IRS audit. These points tend to increase the probability that you are going to get an audit from the IRS at one point in your life.

The first thing that should always put you on the look out is if you make a lot of money. Generally, people who earn a lot of money tend to underpay their taxes. The problem is that while people make money, they tend to spend it on many different things and forget that they are required to declare all sources of income and pay the taxes that arise from such incomes. This means that there is always the risk that such a person is underpaying his taxes or not paying some of them at all. This is a matter of concern for IRS.

There is also the risk that such a person fails to report all of the taxable income from 1099’s or W-2’s reported to the IRS. This failure may be intentional or just out of ignorance.

Another factor to look into is the charitable deductions that you make or receive. Giving back to charity and accepting charitable donations is one of the ways in which many people keep off paying taxes. However, there are some deductions that are tax exempt while others are taxable. There are many other types of deductions that you should also look out for the home office deductions that are claimable the rental losses that you make, business meals and travels as well as entertainment expenses.

One of the common mistakes that many people make is to write off the losses that have been acquired from a hobby activity among the business losses. In some cases, business persons who use their vehicles for business activities tend to claim 100% of the use of the vehicle on the business. Some of these things almost always tend to raise red flags all over the IRS servers.

Other things that may raise the IRS red flags include running a cash only business, failure to report the foreign bank accounts that individual holds and trade in currencies. Even then, whatever the reasons that you may have, it is important to avoid IRS audits. Overstating deductions and profits in most cases also attracts the IRS to your doorstep.

This is why it is important to use professionals in this field to cover the loopholes that you may have had. Professionals will also help you better organize your financial returns and reduce the possibility of raising the red flag at the IRS.