Summer Tax Tips

Ah Summer Time….

The time when the flowers are in full bloom and we all enjoy family activities like dragging the kids to the swimming pool and then off to baseball practice but then they start to whine incessantly about how they’re so bored and that there’s NOTHING to do…

Ah Summer Camp….

A few weeks respite when the kids can be entertained by trained professionals and we can relax and enjoy the season.

One question I get a lot from my clients is whether the cost of summer camp is tax deductible.  Many of them have their children in daycare or after-school programs during the school year and receive the Dependent Care Credit, so isn’t summer camp more of the same?

Well, sort of.

Let’s review the basics of the Dependent Care Credit first.

If you (or both you and your spouse) are working or seeking work, attending school fulltime, or are permanently disabled, you can usually deduct a portion of the costs you pay for child care.  While this person is usually your own dependent child under the age of 13, the credit might also apply to other persons, such as an elderly parent, who lived with you for more than half the year.

To claim the credit, you need to calculate how much you paid for child care and then subtract from that amount any dependent care benefits that you received from your employer.  This is typically a pre-tax deduction that you sign up for every year, but not every employer offers it.

Once you’ve figured the out-of-pocket expenses for day care services, you then check your Adjusted Gross Income (that’s going to be the figure on the last line of Page 1 of your Form 1040). 

Based on your Adjusted Gross Income, your credit will be a percentage of your out-of-pocket costs. This could be anywhere from 35% for very low-income workers to a maximum of 20% for people earning $43,000 or more.  To see the tables, go to http://www.irs.gov/pub/irs-pdf/p503.pdf.

Caveat:  You cannot claim child care expenses paid to your spouse, the child’s parent (if not your spouse), or to anyone who you claim as a dependent on your tax return.

Other Caveat: The person who provides the day care must report this income.  The Form on which you claim the Dependent Care Credit (Form 2441) asks for the Social Security or Tax Identification number of the person (or company) that provides the services.

If you’re paying “under the table” for child care, then you can’t claim the credit.

OK.  So what about summer camp?

The basic rule is this – any summer camp that does NOT provide overnight accommodations is considered daycare the same as any other daycare provider.  So if you have your child enrolled at a number of summer camp programs through the YMCA or other organization, these costs are deductible the same as your regular day care costs.

However, camps where your kids spend the night are NOT considered daycare and don’t qualify for the Dependent Care Credit.  Bummer.

But you really have to look at it from the government’s perspective.  If the cost of overnight camps was tax deductible, you could send your kids to “camp” at Disneyland for two weeks and then claim a tax credit.  And if you think that nobody would be so foolish as to even attempt such a thing, you need to read some of the whoppers that turn up in court on a regular basis.

So have a good summer, and if you have a tax question, drop me a line at jeffrey.ritchie@yahoo.com and I’ll do my best to answer it.

Thanks for reading.

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Disaster Scenario

First of all, I want to send my prayers, condolences and best wishes to those in the Deep South who have been ravaged by an unprecedented series of natural disasters from tornadoes to massive flooding.  Have courage and rely on your faith and each other to get through this.

It’s probably not surprising that as a tax guy, this morning I found myself thinking about the Casualty, Disaster, & Theft Loss tax deduction that is available to taxpayers on Schedule A of the federal Form 1040.  Can it help in this situation?  Sort of.

As I often tell my clients, the Casualty, Disaster &Theft tax deduction is something I hope they will never need.  Qualifying for the deduction isn’t easy because the IRS doesn’t allow the deduction for comparatively minor losses, so qualifying means that you’ve taken a serious and really significant financial hit during the course of the year.

For openers, any loss that you might experience – such as damage from a tornado or a flood – must be an uninsured loss.  You can’t claim the deduction for losses to the extent that you are being compensated by somebody else because, at least in the financial sense of the word, you haven’t really experienced a loss.  So if replacing the hail-damaged roof of your house is going to cost $15,000 and your insurance will pay the whole thing, you don’t have a deductible loss.

On the other hand, if you experienced $20,000 in flood damage and your insurance specifically excludes flooding (and many policies do – check yours today) then you have a $20,000 loss that is potentially deductible. If your insurance only paid a portion of the damages, then the portion not covered by insurance is also a potentially deductible loss.

Potentially.

Potentially.  Because here’s the catch – you’re not going to be able to claim the whole amount.  Let’s say that your car was stolen and subsequently wrecked.  To calculate your deductible loss, you would take the Fair Market Value of your car on the date it was stolen and then subtract from that amount whatever you received from the insurance company in addition to any amount that you received from the salvage company that towed your wrecked car to the junk yard.

After you deduct the amount of any insurance compensation and salvage value, you then deduct $100 from the remaining balance (don’t ask me how or why the IRS settled on this figure) and then you deduct 10% of your Adjusted Gross Income that appears on from Line 37 of your Form 1040.

And that’s what makes qualifying for the Casualty, Disaster, & Theft tax deduction so difficult.  It’s the reduction by 10% of your AGI that will most likely take “routine” losses off the table for the purpose of receiving a tax deduction.  If your Adjusted Gross Income is $75,000, it would take an uninsured loss of more than $7,600 (10% of your AGI plus $100) before you could even start counting your losses against your income. 

All of which is not to say that people don’t sometimes suffer catastrophic losses like what we’ve seen in Mississippi and Alabama this week.  What happens then?  Let’s use this scenario:

Your home and its contents are insured for $150,000.  A tornado basically destroys everything, and the claims adjuster places the total loss at $300,000.  You receive a check for $150,000 from the insurance company and are able to salvage $5,000 worth of property from the wreckage, so you have a total casualty loss of $145,000. 

Your Adjusted Gross Income for the year was $80,000 and so that reduces your deductible loss by $8,000.  Combine that with the $100 IRS-designated reduction, the amount you can claim on your Schedule A for a Casualty, Disaster & Theft loss is $136,900.  

Now with only $80,000 in Adjusted Gross Income and $136,900 in deductible losses (that’s not including the usual itemized deductions for income taxes paid and so forth), clearly you’re not going to owe any taxes this year because your deductions are greater than your income.  What’s more, the IRS will allow you to carry back these losses up to five years.

What does that mean?  Let’s say that your modified Adjusted Gross Income – this is your AGI minus other itemized deductions and exemptions – comes to $60,000 for the year and you have a $136,900 casualty deduction.  Subtract the $60,000 from the $136,900 and you have zero taxable income for the year, along with $76,900 left over.  This is what’s called a Net Operating Loss or NOL.

You can then carry that Net Operating Loss back to the previous year and amend your tax return to claim this as a loss for the previous year.  All things being equal, you’re probably not going to owe any taxes for the previous year and will get back whatever you had originally paid.  If there’s still a remaining Net Operating Loss, you can carry it back to the next preceding year until you’ve used up the entire amount.  

In the scenario I’ve described, you would realize a savings on your taxes of a less than $20,000 when all is said and done – the actual amount will depend on a host of other factors that would effect your final tax liability.  That’s a good thing, of course, and after a disaster you need whatever help you can get.  But it hardly makes up for the loss of your house and all your belongings.

So as I said earlier, I’m glad that the Casualty, Disaster & Theft tax deduction is out here, but I pray that you’ll never need it.

Thanks for reading.