February 2000
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In This Issue

Q & A: Business Use of Your Home–Part II
Your Business: Can You Claim an R&E Credit?

Federal Tax on Your Child’s Income
Estate Tax Relief This Year
Retirement Tax Tips for the Self-Employed
Tax Calendar

 

Do You Know . . .

What measurements a surveyor uses to measure the borders and dimensions of a tract of land? In the U.S., the customary units are 7.92 inches = 1 link; 100 links = 1 chain; 1 chain = 4 rods = 66 feet; 80 chains = 1 survey mile = 5,280 feet.

Q & A: Business Use of Your Home–Part II

Last month, we discussed how to qualify for the business use of your home deduction. In order to qualify for the deduction, you must meet a two-part test. The first part has three criteria, that is, the use must be exclusive, regular, and for your trade or business. The second part of the test requires you to meet only one of the following criteria: The business part of your home must be: 1) your principal place of business or 2) a place where you meet or deal with patients, clients, or customers in the normal course of your trade or business, or 3) a separate structure (not attached to your home) you use in connection with your trade or business. Once you meet these tests, you are eligible to take the deduction.

Q: I’m eligible for the deduction, but I’d like to know how it is computed?

A: To figure your deduction, you need to know that your deduction is limited by the following:

1) The percentage of your home used for business (business percentage), and

2) The deduction limit.

Q: What is the business percentage?

A: The business percentage is calculated by comparing the size of the part of your home that you use for business with the size of your whole house. The resulting percentage is used to figure the business part of the expenses for operating your entire home. You can use any reasonable method to determine the business percentage. The following are two common methods you can use to figure the percentage.

1) Divide the area (length multiplied by width) used for business by the total area of your home.

2) Divide the number of rooms used for business by the total number of rooms in your home. You can use this method if the rooms in your home are all about the same size.

Example 1: Your office is 240 square feet (12 feet by 20 feet). Your home is 1,200 square feet. Your office is 20% (240/1,200) of the total area of your home, so your business percentage is 20%.

Example 2: You use one room in your home for business. Your home has four rooms, all of about equal size. Your home office is 25% of the total area of your home, so your business percentage is 25%.

Q: I started using my home for my business on July 1 of this year. Can I still take the deduction?

A: Yes, but only for the part of the year you did use your home for business purposes. Since you started using the home for business in July, consider your expenses only from July 1 until the end of the year in figuring your deduction.

Q: What is the deduction limit?

A: If your gross income from the business use of your home equals or exceeds your total business expenses (including depreciation), you can deduct all your business expenses. If your gross income from that use is less than your total business expenses, your deduction for certain expenses for the business use of your home is limited. Your deduction of otherwise nondeductible expenses, such as insurance, utilities, and depreciation allocable to business, is limited to your gross income from the business use of your home, minus the sum of the following:

1) The business part of expenses you can deduct even if you did not use your home for business (such as mortgage interest, real estate taxes, and casualty and theft losses).

2) The business expenses that relate to the business activity in the home (for example, salaries or supplies), but not to the use of the home itself.

If you are self-employed, don’t include in number 2, above, your deduction for half of your self-employment tax.

Q: What happens to any expenses that aren’t allowed? Can I use them another year?

A: If your deductions are greater than the current year’s limit, you can carry over the excess to your next tax year. They are subject to the gross income limit from the business use of your home for the next tax year. The amount carried over will be allowable only up to your gross income in the next tax year from the business in which the deduction arose, whether or not you live in the home during that year.

Q: What types of expenses are deductible?

A: Whether you can deduct an expense depends on two things:

1) Whether the expense is direct, indirect, or unrelated to your business, and

2) The percentage of your home that is used for business.

A direct expense is one that is incurred only for the business part of your home, such as painting the area used for the business. This would be deductible in full. An indirect expense is one that you incur for running your home, such as insurance, utilities, and general repairs. An indirect expense is deductible based on the percentage of your home used for business. Both direct and indirect expenses are subject to the deduction limit. An unrelated expense is one that is incurred only for the parts of your home not used for business, such as lawn care. This type of expense is not deductible. Below are some examples of how to treat certain specific expenses.

Real estate taxes. To figure the business part of your real estate taxes, multiply the real estate taxes paid by the percentage of your home used for business.

Deductible mortgage interest. To figure the business part of your deductible mortgage interest, multiply this interest by the percentage of your home used in business. You can include the interest on a second mortgage in this computation. If your total mortgage debt is more than $1 million or your home equity debt is more than $100,000, your deduction may be limited.

Rent. If you rent rather than own a home, but you meet the requirements for business use of your home, you can deduct part of the rent you pay by multiplying your rent payments by the percentage of your home used for business.

Casualty losses. If you have a casualty loss on your home that you use in business, the casualty loss can be treated as a direct, indirect, or unrelated expense, depending on the property affected. Treat it as a direct expense if the loss is on the portion of the property you use only in your business. Use the entire loss to figure the business use of the home deduction. Treat it as an indirect expense if the loss is on property you use for both business and personal purposes. Use only the business portion to figure the deduction. If the loss is on property not used in your business, it is an unrelated expense, and you don’t use any of the loss to figure your deduction.

Summary

In order to qualify for the deduction for the business use of your home, you must meet a two-part test. The first part has three criteria, that is, the use must be exclusive, regular, and for your trade or business. The second part of the test requires you to meet only one of the following criteria: The business part of your home must be:

1) your principal place of business, or

2) a place where you meet or deal with patients, clients, or customers in the normal course of your trade or business, or

3) a separate structure (not attached to your home) you use in connection with your trade or business.

Once you qualify for the deduction, the amount you can deduct is limited by the following:

1) the percentage of your home used for business (business percentage), and

2) the deduction limit. The business percentage is calculated by comparing the size of the part of your home that you use for business with the size of your whole house. The resulting percentage is used to figure the business part of the expenses for operating your entire home. Your deduction, if your gross income from the business use of your home equals or exceeds your total business expenses (including depreciation), is 100%. You can deduct all your business expenses. If your gross income from that use is less than your total business expenses, your deduction for certain expenses for the business use of your home is limited.

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Your Business: Can You Claim a Research Tax Credit?

Your business may be able to claim a valuable tax credit for research, experimentation, and development by looking carefully at prior year returns. Congress extended the research tax credit through June 30, 1999, and is expected to retroactively extend it again. In addition, treasury regulations have expanded what constitutes research and experimentation (R&E). As a result, it may be worthwhile for your business to amend open-year returns and claim the credit.

Activities that may qualify for the credit don’t necessarily need to happen in a research and development department or cost center. R&E opportunities can occur in other areas, and frequently go unnoticed. For example, R&E can be used to create products more efficiently or with fewer materials, or it can be used to design a special piece of equipment, software, or packaging that is not commercially available and that helps in innovation, efficiency, or product damage prevention.

Speak with others in your company — from engineers to management to information systems staff—to find out what activities may be eligible for the tax credit. Keep in mind that even those activities that were not successful may be eligible.

The research tax credit is generally a 20% credit based on the excess of qualifying research expenses over a base amount. An alternative method is also available, which increases the eligibility for some taxpayers that otherwise would not qualify for the credit because of a high base amount, thus providing additional incentives to look into this credit.

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Federal Tax on Your Child’s Income

For a child under the age of 14, unearned income exceeding $1,400 is taxed at the parents’ top rate rather than at the child’s rate. Compensation income received by a child under age 14 is taxed at the child’s rate.

A child with earned income can claim a standard deduction up to $4,300 and may be eligible for the $2,000 deductible IRA contribution. The child should also consider contributing to a nondeductible Roth IRA.

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Estate Tax Relief This Year

Estate and gift taxes often can take an enormous portion out of the estate. The payment of those taxes often forces the sale of many small businesses and family farms. However, some relief is in sight. Effective January 1, the exclusion from federal estate taxes will increase from $650,000 in 1999 to $675,000 this year. The exclusion eventually will reach $1 million in 2006.

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Retirement Tax Tips for the Self-Employed

If you’re self-employed and don’t have a retirement plan or account, consider a SEP plan, a Simplified Employee Pension plan (SEP). Unlike other retirement plans, a SEP can be established by the due date of your 1999 return, and your contributions to it will be deductible as long as they are made by that due date.

If you established a Keogh plan in 1999 before December 31, you can still make a contribution. The full contribution to the plan need not be made until the due date of your 1999 return, including extensions.

NOTE: In our last issue, in discussing the business use of your home, example 1 on page 2 stated that John Stone the plumber could not deduct his home office. In 1998, this would have been true. However, under new rules effective for 1999, his home office now qualifies for the deduction.

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Tax Calendar

February

February 10

Employers. For nonpayroll taxes, file Form 945 to report income tax withheld for 1999 on all nonpayroll items. This due date applies only if you deposited the tax for the year in full and on time.

For Social Security, Medicare, and withheld income tax, file Form 941 for the fourth quarter of 1999. This due date applies only if you deposited the tax for the quarter in full and on time.

For federal unemployment tax, file Form 940 (or 940-EZ) for 1999. This due date applies only if you deposited the tax for the year in full and on time.

February 15

Individuals. If you claimed exemption from income tax withholding last year on the Form W-4 you gave your employer, you must file a new Form W-4 by this date to continue your exemption for another year.

Employers. For Social Security, Medicare, withheld income tax, and nonpayroll withholding, deposit the tax for payments in January if the monthly deposit rule applies. Begin withholding income tax from the pay of any employee who claimed exemption from withholding in 1999 but did not give you a new Form W-4 to continue the exemption in 2000.

February 28

All businesses. File information returns (Form 1099) for certain payments you made during 1999. Payments that are covered include: 1) compensation for workers who are not considered employees, 2) dividends and other corporate distributions, 3) interest, 4) amounts paid in real estate transactions, 5) rent, 6) royalties, 7) amounts paid in broker and barter exchange transactions, 8) payments to attorneys, 9) profit-sharing distributions, 10) retirement plan distributions, 11) original issue discount, 12) prizes and awards, 13) medical and health care payments, 14) debt cancellation (treated as payment to debtor), and 15) cash payments over $10,000. There are different forms for different types of payments.

February 29

All employers. File Form W-3 ss, Transmittal of Wage and Tax Statements, along with Copy A of all the Forms W-2 you issued for 1999. If you file Forms W-2 electronically (not by magnetic media), your due date for filing them with the Social Security Administration will be extended to March 31. The due date for giving the recipient these forms will still be January 31.

March

March 1

Individuals. If you are a farmer or a fisherman and owe estimated tax, file your 1999 income tax return by this date to avoid an underpayment penalty. However, you have until April 15 to file if you paid your 1998 estimated tax by January 18, 2000.

March 15

Corporations. File a 1998 calendar year income tax return (Form 1120 or 1120-A) and pay any tax due. If you want an automatic six-month extension of time to file the return, file Form 7004 and deposit what you estimate you owe.

S corporations. File a 1999 calendar year income tax return (Form 1120S) and pay any tax due. Provide each shareholder with a copy of Schedule K-1 (Form 1120S), Shareholder’s Share of Income, Credits, Deductions, etc., or a substitute Schedule K-1. If you want an automatic six-month extension of time to file the return, file Form 7004 and deposit what you estimate you owe.

S corporation election. File Form 2553, Election by a Small Business Corporation, to choose to be treated as an S corporation, beginning with calendar year 1999. If Form 2553 is filed late, S treatment will begin with calendar year 2000.

Electing large partnerships. Provide each partner with a copy of Schedule K-1 (Form 1065-B), Partner’s Share of Income (Loss) From an Electing Large Partnership. This due date is effective for the first March 15 following the close of the partnership’s tax year.

Employers. For Social Security, Medicare, withheld income tax, and nonpayroll withholding, deposit the tax for payments in February if the monthly rule applies.

March 31

All businesses. File Forms 1098, 1099, and W-2G with the IRS. This due date applies only if you file electronically (not by magnetic media). Otherwise, see February 28.

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