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Taxation of Credit Card Benefits

A few weeks ago I got a booklet in the mail from my credit card company. The booklet was sent as a reminder that I have a “credit defense” benefit on my credit card.

I pay a premium $0.39 per $100 of ending balance in my account. For that payment, I get to use a variety of benefits provided by the credit card company.

For example, if my wife or I were to get laid off or become disabled, the credit card company would make our minimum monthly payment each month for a certain period of time. Other benefits include reimbursements for medical expenses, car repair, taking the pets to the vet, and moving expenses.

I’ve never actually used any of these benefits, but I don’t mind paying the premium because I’m paranoid about sudden loss of jobs or becoming disabled.

At any rate, what are the tax consequences of these types of benefits?

I did quite a bit of research for this post, but turned up little when it comes to reimbursement of auto expenses, pet expenses and moving expenses. There is, however, guidance on the unemployment benefit part.

Let’s break this into two pieces.

One: Unemployment or Disability Payments

If you become unemployed or disabled and the credit card company makes your monthly payments for you, those payments are taxable if the payments exceed the amount of premiums you paid during the year.

This part is clear (see page 94 of IRS Publication 17).

Two: Reimbursements

What’s less clear is what happens if the credit card company reimburses you for things such as car repairs.

For example, under my credit card’s benefit program, they will pay up to $250 of car repairs once a year. The way it works is, I pay for the car repair using the credit card, and then the credit card company will issue me a credit on my account for up to $250. Same concept for medical expenses, pet expenses, etc.

I couldn’t find anything definitive about this, but I think this type of benefit is not taxable. Unlike with the unemployment/disability payments, these benefits are a reimbursement for expenses actually incurred.

The credit to the account does reduce the amount of credit card debt owed, but unlike in typical debt cancellation, this is not really an acquisition of wealth because it’s a reimbursement of an expense.

The only tax implication I can think of is if you’re reimbursed for a deductible expense. In that case, you would reduce your deduction by the amount paid by the credit card company.

Deducting Losses in Retirement Accounts

The general tax rule is that market losses in retirement accounts are never deductible. That statement is true, but as with everything relating to the taxes, there’s a “but.”

In rare circumstances, you might be able to deduct losses from these accounts.

Basic Requirements for All Types of Accounts

  1. All accounts of the same type must be fully paid out. For example, if you have 3 IRAs, all 3 accounts must be fully paid out.
  2. You must have after-tax basis. This means amounts put into the account with after-tax dollars. With Roth IRAs, your basis is whatever you have paid into the account. In traditional IRAs and 401(k) plans, your basis would be any non-deductible contributions you have made. Most 401(k) plans will never have non-deductible contributions in them.

The Mechanics of Figuring the Deduction
Assuming you meet the above two requirements, you then have to calculate your loss. To do this, you take the amount of cash you receive and compare it to your basis. If the cash received is less than your basis, you are eligible for a deduction.

Example: You close out a Roth IRA account. It is the only Roth IRA you have. Through the years, you paid in $5,000 into the account. You received $4,000 when you closed out the account. The amount of loss eligible for a deduction is $1,000 ($4,000 received minus $5,000 basis).

Hurdles to Clear
In the example above, you are still not in the clear for taking a $1,000 deduction. Tax law puts three hurdles in place that make it hard to actually take the deduction.

  • Hurdle #1: losses on retirement accounts are not considered capital losses. Instead, they are considered miscellaneous itemized deductions. This means: you only get the deduction if you itemize deductions.
  • Hurdle #2: because it’s a miscellaneous itemized deduction, the amount of the loss has to exceed 2% of your income in order to be deductible.
  • Hurdle #3: Only the portion of the loss that exceeds 2% of your income can be taken as a deduction.

Example: continuing with the above example of a $1,000 loss – if your income is $40,000, you take $40,000 x 2%, which equals $800. You subtract $800 from the $1,000 loss, which equals $200. You can put $200 as an miscellaneous itemized deduction on your tax return.

I Can’t Do Much to Help You Once the Transaction Is Completed

A professional in my network of contacts recently asked if I could help one of his clients. His client had sold some property for a large gain and was facing a tax bill of tens of thousands of dollars. According the professional, the client’s current CPA “had no suggestions” on how to make the tax hit go away, so he was hoping I could help.

It turns out, as it so often does with things like this, that the current accountant wasn’t an idiot, and I couldn’t do much to help either.

Why? Because this was in early May 2014, and the property in question had been sold in 2013.

Contrary to popular belief, there’s no magic that any accountant or tax preparer can work after something has been done, especially if the year has ended.

In this person’s case, he may have qualified for a 1031 exchange, but in order for a valid exchange to happen, the replacement property must be identified within 45 days of the sale of the old property. Since the sale happened in 2013 and it was now May 2014, that wasn’t an option.

And since the year had ended, things like selling other properties at a loss weren’t an option either.

Your accountant is not a magician. If you do something without asking for advice beforehand, and you end up with a big tax bill, and your accountant says there’s nothing that can be done … your accountant is saying that BECAUSE IT’S TRUE, NOT BECAUSE HE’S AN IDIOT.

The point is: the time to ask for tax advice about something that will generate a massive tax bill is beforehand, not afterwards.

 

Bedside Manner is Important for Tax Pros, Too

Late last December, I was having awful stomach pains. So bad that it hurt for my shirt to touch my stomach. I thought I had gallstones … or worse.

So I went to the local walk-in clinic and they did a battery of tests. They drew bloodwork and took x-rays.

All the tests came back fine. The doctor hurried in and said I just had “inflamed muscles” and I was quickly sent on my way with a prescription for heartburn medicine and an admonition to take it easy.

(Earlier this month, the pain came back and I went to a different doctor who diagnosed a hernia within literally the first 10 seconds of examining me.)

Anyway ….

When the nurse was drawing my blood, she went on and on and on about how she hoped it wasn’t anything to do with my pancreas, because that’s just really bad and she knows someone blah blah blah blah blah.

Yeah, lady. I know people who have had pancreatic cancer too. It’s scary. You’re diagnosed one day and oftentimes gone in months, if not weeks. That was certainly on my mind.

And this nurse didn’t help by blathering on about it.

And then the doctor, who was obviously in a hurry to move me along as quickly as possible, gave a lame “the x-ray showed inflamed muscles” diagnosis and sent me away with heartburn medicine. Six months later, I finally got a proper diagnosis from a doctor who took time to look for the right things. (The doctor also informed me that it’s not possible to see inflamed muscles from an x-ray. More proof the other guy was just trying to move me along.)

People talk about whether healthcare providers have good bedside manner. But it’s important for accountants and tax pros too.

Especially when delivering bad news.

My rules for delivering bad news:

  1. Do it by phone or in person
  2. Come to the point quickly – I will sometimes say that I have “bad news,” but I find it’s best to avoid the descriptors and just come out with it
  3. Understand that the client may not be happy
  4. If you can work in an explanation before the client says anything, do so. Otherwise, let the client respond and have their say before you proceed with an explanation
  5. Don’t try to break the tension with jokes. Even if the amount of money is relatively small, even a $200 tax bill is a big deal to most average folks, especially if they’ve never owed at tax time before.
  6. Don’t make flippant comments about the IRS or the government, even if you know that the client’s politics lean toward the Tea Party side of things. That sort of talk won’t change the client’s current situation.
  7. Explain the client’s options for paying the amount they owe
  8. Follow up with an e-mail so there’s written documentation

Each year, I have to make calls like this every now and then, and these are the rules I follow.

 

Baseball’s Replay System: Almost Perfect

Major League Baseball is using expanded instant replay for the first time this season. The new system allows managers to ask for a replay. The wikipedia entry on MLB instant replay explains it well:

(M)anagers will be allotted one challenge per game (two if the first challenge results in an overturned call) while the umpiring crew chief will be empowered to initiate a review in innings 7 and later. The umpires will also be allowed to review a home run call at any time, even during innings #1-6. Once a call is challenged an umpire requests a video review, fellow umpires in New York’s Replay Command Center will watch video of the play in question using the “indisputable video evidence” standard when deciding whether to overturn a call.

As with anything MLB does, the system has critics, but I like the replay system. It’s almost perfect.

The only thing I would change is the manager challenge part. That just seems hokey.

If the objective is to get the call right, then either team or any umpire should be able to ask for a replay on any play at any time, regardless of what inning it is or if a manager has “challenges” left. (I feel the same way about the use of replay in football, too.)

Prior-Year Adoption Credits and Same-Sex Marriage

Scenario: Angie and Alice are in a same-sex marriage. In 2012, Alice went through the adoption process to become the parent of Angie’s child. Because of the Defense of Marriage Act, Alice properly filed her 2012 tax return as a single person … and claimed the adoption credit for adopting Angie’s child.

Questions:

  1. After the repeal of DOMA, Angie and Alice’s marriage is recognized by the federal government back to the beginning of their marriage. So Alice’s adoption was a “second-parent” adoption. Second-parent adoptions are not eligible for the adoption credit. Will the IRS come after Angie and Alice on this?
  2. Alice’s 2012 tax return was such that she had an adoption credit carryforward. Can this carryforward be used on her 2013 joint return with Angie, considering that the adoption is now a second-parent adoption?
  3. What if Alice finds something that she needs to amend on her 2012 tax return? Will she need to change her 2012 filing status to “married” and pay back the adoption credit on that amended return, even if she’s amending for some other reason?

ONE: We know that the IRS will honor the filing status used on tax returns filed prior to September 61, 2013. See Revenue Ruling 2013-17. Angie properly filed her 2012 tax return as a single person, so there is no danger of the IRS challenging the adoption credit claim.

Additionally, let’s look at the wording of the Internal Revenue Code regarding the adoption credit. According to IRC Section 36C(d)(1)(C), qualified adoption expenses are expenses:

(W)hich are not expenses in connection with the adoption by an individual of a child who is the child of such individual’s spouse

The Defense of Marriage Act specifically said that the term “spouse” could only refer to couples in opposite-sex relationships. Angie properly filed her 2012 tax return based on the law of the land at the time. Angie and Alice were considered legal strangers at the time, so the adoption was not a second-parent adoption.

Which answers question two: I believe the carryforward can be used on Angie and Alice’s joint 2013 tax return.

Number three is worthy of a blog post of its own, which I’ll have on Wednesday.

A Heretic Speaks Out Against Value Billing

Value billing, as I understand it, is the concept that service providers should bill clients based on the client’s perceived value of the work completed. Across

Image courtesy of Stuart Miles / FreeDigitalPhotos.net

Image courtesy of Stuart Miles / FreeDigitalPhotos.net

the web, one will find plenty of articles about the wonders of value billing, sometimes even in the AICPA’s “Journal of Accountancy.”

Search “value billing” on Google and you’ll see nary a negative word about value billing. (Except in the archives of this law blog.) The few times a contrary word is written, defenders of value billing will rush in to strike down the heretic.

I’ve never been afraid of voicing my opinion on this blog, even if it’s contrary to what everyone else thinks. So here’s my opinion of value billing:

True value billing, where you bill a client based purely on the client’s “perceived value,” is BS.

Yep, I’m a value billing heretic in a world of true believers.

Areas of Agreement

I agree with proponents of value billing when they say that hourly billing is not the way to go (though I do bill by the hour sometimes).

I also agree with them that it’s important to be able to quote a firm price to the client up-front — something that’s hard to do when billing by the hour.

In my own practice, I use a “kinda-sorta” form of value billing, I guess. For tax work, I use a price menu where each form or attachment has a certain fixed price. For ongoing accounting work, I use flat-fee billing where the client pays a pre-determined, set amount each month for the services provided (but the flat fee is determined by an estimate of the ongoing time commitment.)

Determining prices is the hardest thing I do. It may be THE thing that I struggle with the most as a solo operator.

But I’m firm in my heretical conviction that true “value billing” is all wrong.

Example of Why I Think Value Billing is a Bunch of Hocus-Pocus

Let’s say I’ve got two tax clients, the Smiths and the Joneses. Both are married couples with kids. They both itemize deductions and have some daycare expenses. They come to me for tax preparation.

Value billing says I should bill each client based on how much the client “values” the work I’m doing. Meaning, the Smiths might pay $200 but the Joneses might pay $350 if I perceive that I’m providing that much more value to the Joneses.

Where does the extra $150 of value come from? How does one determine that? How did I decide it was $150 more instead of $100 more, or $50 more, or $10,000 more?

Image courtesy of iosphere / FreeDigitalPhotos.net

Image courtesy of iosphere / FreeDigitalPhotos.net

An article in the Journal of Accountancy says firms should appoint a “Chief Value Officer” and a “Pricing Council.”

The author opines that the “Pricing Council” should determine 3 price points: “Reservation” (where you turn a “normal profit”), “Hope For” (where you generate a “supernormal” profit”) and “Fist Pump” (where you “generate a windfall profit”).

Sure sounds to me like the service provider’s goal in “value billing” should be to jack up fees as much as possible, and hope that the client falls for the “Fist Pump” price.

Which leads me to this harsh conclusion — in order to value bill, a service provider should ask two questions:

  1. Is the client rich?
  2. Is the client naive about typical fees for the services they seek?

If the answer to these two questions is yes, then you’ve hit a home run and can jack up the fee while telling yourself that it’s okay because of the client’s “perceived value” — which is seemingly grabbed out of the sky.

So there you have it from this heretic on value pricing. I welcome commentary from any of the True Believers out there who want to save me from damnation for my failure to see the light of value billing.

From the Archives: Filing Separately on Your Iowa Return? Don’t Forget to Allocate Deductions

It’s a holiday week, so I’m hauling out popular posts from the past. This post from March 2012 reminds Iowans who are married and filing separate Iowa returns that they must allocate itemized deductions on the Iowa return based on income.

New blog posts will resume next Tuesday.

—–

(Originally published March 7, 2012)

Married couples in Iowa who both have income will usually find that one of the “separate” filing statuses is the best to use on their Iowa taxes, rather than filing a joint 22691ziyqftheb8Iowa return. The reason is, Iowa has just one tax bracket regardless of filing status, so two people filing a joint return will be taxed on their combined incomes at a high point in Iowa’s highly progressive tax bracket. Filing separate returns allows each spouse to be taxed at a lower point in the tax bracket.

Iowa offers two “separate” filing statuses — married filing separately on a combined return, and married filing separately on separate returns. A more thorough discussion of the differences between the two statuses is for another blog post on another day. The main point I want to make today is: under either of the separate filing statuses, you must allocate itemized deductions based on income.

Allocating Deductions

When a married couple files separately on their Iowa returns — either on a combined return or on a completely separate return — the couple MUST share itemized deductions based on income. This is true even if one spouse made 100% of the payments from their own separate funds.

Example

John and Jane are married in Iowa and file their Iowa taxes as married filing separately. John’s income is $50,000. Jane’s income is $25,000. On the Iowa return, John must claim 2/3 of the itemized deductions ($50,000 income/$75,000 total income of the couple) and Jane must claim 1/3 of the itemized deductions, regardless of who actually made the payments or whether the payments relate to separately held property.

This is a different concept from the married filing separately filing status on federal taxes. On a “separate” federal 1040, the itemized deductions generally go to whoever actually made the payment.

Image: renjith krishnan / FreeDigitalPhotos.net

Glossary of Tax Terms: Community Property

The term community property refers to property laws that apply to married couples in certain states. Those states are: Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington and Wisconsin.

Married couples in those states who choose to file separate federal tax returns must apply community property laws to their tax returns, which means splitting many items of income 50/50 with their spouse.

Example

John and Mary are married and live in a community property state. John earns wages of $40,000 and Mary earns wages of $30,000. They decide to file separate tax returns. Both John and Mary will report $35,000 of wage income (50% of their own income and 50% of their spouse’s income).

The specific rules of income splitting differ from state-to-state. For example, income from interest and dividends is not always treated as community property.

Taxpayer Identity Theft — Part 19

IMAG0318The National Association of Tax Professionals picked up on Wendy Boka’s identity theft saga through my blog and asked me to condense my blog series into an article for their Spring 2014 Tax Pro Journal. The finished product is the cover story of the Journal, which is hitting tax pro mailboxes soon (mine arrived Thursday).

If you’re not a tax pro (or not a member of NATP) you can read my blog series — click here to find Part 1, and from there you should be able to find links to take you through the entire series.

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