It’s that time of year to prepare and file your annual income tax returns. Most all individuals are calendar year taxpayers. You file your tax returns each year by April 15, reporting income for the previous calendar year. So this year, you are reporting all of your income for 2017. This week, I will discuss a few tax questions that have come up in our office recently during this year’s tax season.
Are my estate planning fees deductible on my income tax?
In most instances when you itemize deductions, at least some, if not most of your estate planning fees are deductible on your income tax return as a miscellaneous itemized deduction. Under Section 212 of the Internal Revenue Code and the regulations thereunder, you may deduct expenses paid or incurred during the taxable year for the production, collection, management, conservation, or maintenance of property held for the production of income which, if and when realized, will be required to be included in income for Federal income tax purposes.
That portion of your estate planning fees related to your health care powers, living will and other personal matters would not be deductible. However, those expenses for the drafting of your financial documents, such as your financial power of attorney, will or trust and the funding of your trust, other than those related to your residence, vehicle and personal assets, are generally deductible because they are associated with income producing assets.
For example, in our office, many of our clients have income producing assets such as investments, rental real estate, IRAs and other retirement accounts. When we prepare a fully-funded trust-based estate plan, the majority of the legal fees incurred by our clients are related to those income producing assets. For most of our clients, between 80%-95% of their estate planning fees are deductible on Schedule A of their US Form 1040 Individual Income Tax Return with their other miscellaneous itemized deductions in excess of 2% of their adjusted gross income.
How can I keep my ample tax refund the same in 2019 when I file my 2018 taxes?
On December 22, 2017, President Trump signed into law the Tax Cuts and Jobs Act of 2017. You have always over-withheld your Federal income taxes from your paycheck and enjoyed a sizeable Federal income tax refund. You want this to continue. Under the Trump tax act, although most of the lower tax brackets were only adjusted slightly from 2017, the rates for each of the brackets were generally reduced by 2%-3%. Although the standard deduction has nearly doubled in 2018 over 2017 for most taxpayers, the personal exemption has been eliminated. You no longer get a personal exemption tax deduction for you, your spouse, or each of your dependents.
So how does this affect you and your tax refund for next year? Discuss the matter with your tax preparer. Have them run a projection for you using your anticipated 2018 taxable income. Based upon that projection, your preparer should be able to tell you how many Federal income tax withholding allowances to claim on your paycheck in order to keep your tax refund in place. Then go to your employer’s payroll department and update those allowances.
Are my lottery ticket purchases tax deductible?
As we discussed above, expenses for the production of income are deductible. Because of this, you may think that the costs of your lottery ticket losers are tax deductible. If you think that, you are partly right. Generally, you can deduct gambling losses, including the cost of lottery tickets, only to the extent of gambling winnings. If you have the gambling expenses, you can reduce your gambling winnings to zero, but cannot deduct any more expenses than that.
Many tax experts have stated that the lottery is a regressive tax since the chances of winning are infinitesimal and those in lower tax brackets are spending a greater percentage of their income on lottery tickets than those in higher tax brackets. Unfortunately, the IRS doesn’t see it that way and does not allow a tax deduction for lottery ticket purchases.
It is interesting to note the huge advertising campaign in which the state of Michigan is currently engaged, and which claims the billions of dollars that the lottery has contributed to education. What the advertising campaign conveniently omits is that the lottery dollars have not increased the overall education funding, they have just reduced the amount going to education from the state general fund. The lottery actually has only freed up general fund dollars for the politicians to spend somewhere else. It is just a political shell game. This is very similar to many school district bond requests. The bond dollars used for the special projects are only freeing up general fund dollars that would have been used for those projects, and now can be used elsewhere.
What is the tax effect of cashing in the life insurance policy on me that my parents gave to me?
Many parents take out infant life insurance policies on their children. These are usually permanent policies which build up cash value. After you are an adult, your parents may have given your policy to you. If you just hold on to it and continue to pay the premiums, if any, then the life insurance proceeds will be income tax-free to your beneficiaries upon your death. If however, you cash-in the policy during your lifetime, you may have taxable income.
If your parents gave you the policy, you generally would take their basis in the policy. When the policy is cashed-in, any amounts over and above the premiums paid and post-tax dividends that are retained in the policy would generally be taxed to you as ordinary income. This would be the case even if you inherited the policy from your parents after their deaths. You do not get an inherited property step-up in basis in the policy upon their deaths because it contains income that has not been taxed to your parents.
This untaxed income is called income in respect to a decedent or IRD. Just like with inherited IRAs, retirement plans and annuities, when you distribute the IRD out of the life insurance policy at time of cash-in, the IRD is taxed to you the recipient at ordinary income tax rates.
What medical expenses are deductible?
If you itemize deductions, you can generally deduct unreimbursed medical and dental expenses that are in excess of 7.5% of your adjusted gross income. This used to be a very challenging threshold to reach. However, with the proliferation of Obamacare triggered high-deductible health insurance plans, it is not so difficult anymore. Medical expenses that are deductible are amounts paid for the diagnosis, cure, mitigation, treatment, or prevention of disease; for the purpose of affecting any structure or function of the body; for transportation for and essential to medical care; and for qualified long-term care services. The expenses must be for the taxpayer, spouse, dependents and other qualifying individuals.
Deductible medical expenses include health insurance premiums, and expenses and co-payments for hospital and doctors’ visits and prescriptions. Eyeglasses, artificial teeth or limbs, hearing aids and similar items are also deductible, as are diagnostic tests aiding in the detection of a medical condition or disease, and mental health therapy service animals. Expenses that are not deductible include expenses that are merely beneficial to your general health, and also expenses for cosmetic surgery, unless the surgery was necessary to ameliorate a deformity from a congenital abnormality, accident, trauma, or disease.
Certain long-term care premiums are deductible, as are long-term care expenses paid to someone other than an unlicensed relative. Because long-term care in a nursing home is costly at $8,000-$10,000 per month, most of our clients who are private-pay in a facility pay little or no income tax as a result of their large medical expense deduction. For more detail on deductible medical and dental expenses, see Publication 502 on the irs.gov website.
What if I have tax questions?
There are many online resources available, such as the irs.gov website or just entering your question in a web browser. If all else fails, hire a professional to prepare your taxes. Even though I am a CPA and used to prepare tax returns for a living, I do not do my own taxes anymore. I have them done by professionals who do hundreds, if not thousands of tax returns each tax season.
By Matthew M. Wallace, CPA, JD
Published edited March 11, 2018 in The Times Herald newspaper Port Huron, Michigan as: It’s the season for income tax questions