We recently received an interesting question from a client that might apply to you or your child as well:
“My daughter-in-law is doing a PhD and has an NSF Fellowship from the government.? Interestingly, the government does not take out taxes nor provide a W2 or 1099 form.? I presume that the income is taxable but the government site says “it?may?be taxable income”.? Are there any situations when this income would not be taxable?”
It’s our understanding that this income is subject to federal and state income taxes, but is not subject to Social Security or Medicare taxes.? A lot of people receiving these grants don’t think the income is taxable since no tax form is provided.? However, grants and scholarships are taxable to the extent that the money received exceeds tuition paid.
Here are the rules from the IRS:?
Scholarships and Fellowships?
A scholarship is generally an amount paid or allowed to, or for the benefit of, a student at an educational institution to aid in the pursuit of studies. The student may be either an undergraduate or a graduate. A fellowship is generally an amount paid for the benefit of an individual to aid in the pursuit of study or research. Generally, whether the amount is tax free or taxable depends on the expense paid with the amount and whether you are a degree candidate.?
A scholarship or fellowship is tax free only if you meet the following conditions:
- You are a candidate for a degree at an eligible educational institution.
- You use the scholarship or fellowship to pay qualified education expenses.
Qualified Education Expenses?
For purposes of tax-free scholarships and fellowships, these are expenses for:
- Tuition and fees required to enroll at or attend an eligible educational institution.
- Course-related expenses, such as fees, books, supplies, and equipment that are required for the courses at the eligible educational institution. These items must be required of all students in your course of instruction.
However, in order for these to be qualified education expenses, the terms of the scholarship or fellowship cannot require that it be used for other purposes, such as room and board, or specify that it cannot be used for tuition or course-related expenses.?
Expenses that Don’t Qualify?
Qualified education expenses do not include the cost of:
- Room and board
- Clerical help
- Equipment and other expenses that are not required for enrollment in or attendance at an eligible educational institution
This is true even if the fee must be paid to the institution as a condition of enrollment or attendance. Scholarship or fellowship amounts used to pay these costs are taxable.
Earlier this summer, the IRS released a draft of the 2018 Schedule A, Itemized Deductions form.? Let’s review the rules for itemizing your deductions for 2018:
For 2018, and only for 2018, medical expenses are deductible to the extent they exceed 7.5% of your Adjusted Gross income (AGI). Staring 1/1/19, the threshold reverts to 10% of AGI.
Planning Opportunity:? Check out IRS Publication 502, Medical and Dental Expenses.? If your allowable medical expenses will exceed 7.5% of your AGI this year, then paying your outstanding medical and dental bills prior to 12/31/18 will increase the allowable deduction.? Same goes for pre-paying for medical expenses even if the services won’t be provided until next year.
Home Mortgage Interest
Big changes with the deductibility of home mortgage interest:
Interest on a total of up to $1 million of pre-12/14/17 outstanding debt on your primary residence and a second home is fully deductible.
New mortgages debt (excluding refinancing of pre-12/14/17 mortgages) taken after 12/14/17 limited to $750k for this deduction.
Interest on home equity debt used to improve the residence securing the debt is still deductible subject to the $1 million and $750k limits above.
All other home equity loans no longer qualify for the mortgage interest deduction.
Planning Opportunity:? Read the IRS’ explanation of the new rules for deducting mortgage interest and home equity loan interest and consider refinancing outstanding debt accordingly, but only if the current interest rates permit. You might also consider claiming the home office deduction to write off a portion of your mortgage interest and real estate taxes that are now non-deductible under the new rules.
The new rules increased the amount of charitable donations you can make and deduct each year to 60% of your AGI, up from 50% based on the pre-1/1/18 rules.
Planning Opportunity:? Consider donating appreciated securities to a charity since you don’t pay taxes on the appreciation but can still write off the full value of the securities donated.? You might also consider setting up and funding a Donor Advised Fund to frontload the tax deduction on your donations while still allowing you to disburse the contributions to the charities over a number of years.
Miscellaneous Itemized Deductions
Investment management fees, tax prep fees, and unreimbursed employee business expenses are no longer deductible effective 1/1/18.
Planning Opportunity:? Consider claiming these expenses if possible against your business income reported on your Schedule C, rental income on the Schedule E, page 1, or partnership income on Schedule E, page 2.
Non-business casualty losses are now only deductible if the loss occurs in a Presidentially declared disaster area. Personal casualty losses and theft losses are no longer deducible as of 1/1/18.
Tougher To Itemize in 2018
With a $24k standard deduction and state and local taxes (SALT), including real estate taxes, limited to just $10k annually, married couples without a large mortgage might find themselves struggling to itemize their deductions under the new tax rules. Unmarried individuals can also deduct $10k in SALT taxes but have a standard deduction of just $12k, so will have a much easier time to itemize just by owning a home, having significant medical expenses, or donating a few thousand dollars to charity each year.
Planning Opportunity:? Married couples might save some taxes by bunching their deductions every other year.?
Phase-out of the Phase-out
Here is one last bit of good news. The new tax rules eliminate the phase-out of itemized deductions starting 1/1/18.? Previously, high income taxpayers saw that their itemized deductions began to be phased-out once their income exceeded $313,800 if married or $287,650 if single.
FROM IRS NEWS – https://www.irs.gov/newsroom/irs2goapp
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Are you a practice owner with employees? You may qualify for a new business tax credit.
Eligible employers who provide paid family and medical leave to their employees during tax years 2018 and 2019 might qualify for a new business tax credit. This new employer credit for family and medical leave is part of tax reform legislation passed in December 2017. Here are some facts about the credit to help employers find out if they might be able to claim it.
To be eligible, an employer must:
- Have a written policy that meets several requirements, as detailed in Notice 2018-71.
- At least two weeks of paid family and medical leave to full-time employees.
- A prorated amount of paid leave for part-time employees.
- Provide pay for leave that is at least 50 percent of the wages normally paid to that employee.
The credit applies to these dates:
- It is available for wages paid in taxable years beginning after Dec. 31, 2017, and before Jan. 1, 2020.
The amount of the credit:
- The credit is generally equal to 12.5 to 25 percent of paid family and medical leave for qualifying employees.
Here?s what kind of leave qualifies:
- The leave can be for any or all of the reasons specified in the Family and Medical Leave Act:
- Birth of an employee?s child.
- Care for the child.
- Placement of a child with the employee for adoption or foster care.
- To care for the employee?s spouse, child, or parent who has a serious health condition.
- A serious health condition that makes the employee unable to perform the functions of his or her position.
- Any qualifying exigency due to an employee?s spouse, child, or parent being on covered active duty ? or having been notified of an impending call or order to covered active duty ? in the Armed Forces.
- To care for a service member who is the employee?s spouse, child, parent, or next of kin.
- However, leave paid by a state or local government, or that is required to be provided by state or local law, does not count toward the 50 percent.
Some employers are eligible to claim the credit retroactively to the beginning of their taxable year:
- Normally employers can only claim the credit based on eligible leave taken after their new or amended policy goes into effect.
- Read Notice 2018-71 for a description of special rules for when an employer can claim the credit retroactively.
To claim the credit, employers will:
- Attach Form 8994 to their return. The IRS expects to have this new form available later in 2018.
The Notice sets out special rules and limitations that apply:
- For example, only paid family and medical leave provided to employees whose prior-year compensation was at or below a certain amount qualify for the credit.
- Generally, for tax-year 2018, the employee?s 2017 compensation from the employer must be $72,000 or less.
Tax Reform Provisions that Affect Businesses
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