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Freetax 5. Freetax Exemptions, Deductions, and Credits Table of Contents Topics - This chapter discusses: Useful Items - You may want to see: Items Related to Excluded Income Exemptions Contributions to Foreign Charitable Organizations Moving ExpensesAllocation of Moving Expenses Forms To File Contributions to Individual Retirement Arrangements Taxes of Foreign Countries and U. Freetax S. Freetax PossessionsCredit for Foreign Income Taxes Deduction for Foreign Income Taxes Deduction for Other Foreign Taxes How To Report Deductions Topics - This chapter discusses: The rules concerning items related to excluded income, Exemptions, Contributions to foreign charitable organizations, Moving expenses, Contributions to individual retirement arrangements (IRAs), Taxes of foreign countries and U. Freetax S. Freetax possessions, and How to report deductions. Freetax Useful Items - You may want to see: Publication 501 Exemptions, Standard Deduction, and Filing Information 514 Foreign Tax Credit for Individuals 521 Moving Expenses 523 Selling Your Home 590 Individual Retirement Arrangements (IRAs) 597 Information on the United States—Canada Income Tax Treaty Form (and Instructions) 1116 Foreign Tax Credit 2106 Employee Business Expenses 2555 Foreign Earned Income 2555-EZ Foreign Earned Income Exclusion 3903 Moving Expenses Schedule A (Form 1040) Itemized Deductions Schedule C (Form 1040) Profit or Loss From Business SS-5 Application for a Social Security Card W-7 Application for IRS Individual Taxpayer Identification Number See chapter 7 for information about getting these publications and forms. Freetax Items Related to Excluded Income U. Freetax S. Freetax citizens and resident aliens living outside the United States generally are allowed the same deductions as citizens and residents living in the United States. Freetax If you choose to exclude foreign earned income or housing amounts, you cannot deduct, exclude, or claim a credit for any item that can be allocated to or charged against the excluded amounts. Freetax This includes any expenses, losses, and other normally deductible items that are allocable to the excluded income. Freetax You can deduct only those expenses connected with earning includible income. Freetax These rules apply only to items definitely related to the excluded earned income and they do not apply to other items that are not definitely related to any particular type of gross income. Freetax These rules do not apply to items such as: Personal exemptions, Qualified retirement contributions, Alimony payments, Charitable contributions, Medical expenses, Mortgage interest, or Real estate taxes on your personal residence. Freetax For purposes of these rules, your housing deduction is not treated as allocable to your excluded income, but the deduction for self- employment tax is. Freetax If you receive foreign earned income in a tax year after the year in which you earned it, you may have to file an amended return for the earlier year to properly adjust the amounts of deductions, credits, or exclusions allocable to your foreign earned income and housing exclusions. Freetax Example. Freetax In 2012, you had $90,400 of foreign earned income and $9,500 of deductions allocable to your foreign earned income. Freetax You did not have a housing exclusion. Freetax Because you excluded all of your foreign earned income, you would not have been able to claim any of the deductions on your 2012 return. Freetax In 2013, you received a $12,000 bonus for work you did abroad in 2012. Freetax You can exclude $4,700 of the bonus because the limit on the foreign earned income exclusion for 2012 was $95,100 and you have already excluded $90,400. Freetax Since you must include $7,300 of the bonus ($12,000 − $4,700) for work you did in 2012 in income, you can file an amended return for 2012 to claim $677 of the deductions. Freetax This is the deductions allocable to the foreign earned income ($9,500) multiplied by the includible portion of the foreign earned income ($7,300) and divided by the total foreign earned income for 2012 ($102,400). Freetax Exemptions You can claim an exemption for your nonresident alien spouse on your separate return, provided your spouse has no gross income for U. Freetax S. Freetax tax purposes and is not the dependent of another U. Freetax S. Freetax taxpayer. Freetax You also can claim exemptions for individuals who qualify as your dependents. Freetax To be your dependent, the individual must be a U. Freetax S. Freetax citizen, U. Freetax S. Freetax national, U. Freetax S. Freetax resident alien, or a resident of Canada or Mexico for some part of the calendar year in which your tax year begins. Freetax Children. Freetax Children usually are citizens or residents of the same country as their parents. Freetax If you were a U. Freetax S. Freetax citizen when your child was born, your child generally is a U. Freetax S. Freetax citizen. Freetax This is true even if the child's other parent is a nonresident alien, the child was born in a foreign country, and the child lives abroad with the other parent. Freetax If you have a legally adopted child who is not a U. Freetax S. Freetax citizen, U. Freetax S. Freetax resident, or U. Freetax S. Freetax national, the child meets the citizen requirement if you are a U. Freetax S. Freetax citizen or U. Freetax S. Freetax national and the child lived with you as a member of your household all year. Freetax Social security number. Freetax You must include on your return the social security number (SSN) of each dependent for whom you claim an exemption. Freetax To get a social security number for a dependent, apply at a Social Security office or U. Freetax S. Freetax consulate. Freetax You must provide original or certified copies of documents to verify the dependent's age, identity, and citizenship, and complete Form SS-5. Freetax If you do not have an SSN for a child who was born in 2013 and died in 2013, attach a copy of the child's birth certificate to your tax return. Freetax Print “Died” in column (2) of line 6c of your Form 1040 or Form 1040A. Freetax If your dependent is a nonresident alien who is not eligible to get a social security number, you must list the dependent's individual taxpayer identification number (ITIN) instead of an SSN. Freetax To apply for an ITIN, file Form W-7 with the IRS. Freetax It usually takes 6 to 10 weeks to get an ITIN. Freetax Enter your dependent's ITIN wherever an SSN is requested on your tax return. Freetax More information. Freetax For more information about exemptions, see Publication 501. Freetax Contributions to Foreign Charitable Organizations If you make contributions directly to a foreign church or other foreign charitable organization, you generally cannot deduct them. Freetax Exceptions are explained under Canadian, Mexican, and Israeli charities, later. Freetax You can deduct contributions to a U. Freetax S. Freetax organization that transfers funds to a charitable foreign organization if the U. Freetax S. Freetax organization controls the use of the funds by the foreign organization or if the foreign organization is just an administrative arm of the U. Freetax S. Freetax organization. Freetax Canadian, Mexican, and Israeli charities. Freetax Under the income tax treaties with Canada, Mexico and Israel, you may be able to deduct contributions to certain Canadian, Mexican, and Israeli charitable organizations. Freetax Generally, you must have income from sources in Canada, Mexico, or Israel, and the organization must meet certain requirements. Freetax See Publication 597, Information on the United States-Canada Income Tax Treaty, and Publication 526, Charitable Contributions, for more information. Freetax Moving Expenses If you moved to a new home in 2013 because of your job or business, you may be able to deduct the expenses of your move. Freetax Generally, to be deductible, the moving expenses must have been paid or incurred in connection with starting work at a new job location. Freetax See Publication 521 for a complete discussion of the deduction for moving expenses and information about moves within the United States. Freetax Foreign moves. Freetax A foreign move is a move in connection with the start of work at a new job location outside the United States and its possessions. Freetax A foreign move does not include a move back to the United States or its possessions. Freetax Allocation of Moving Expenses When your new place of work is in a foreign country, your moving expenses are directly connected with the income earned in that foreign country. Freetax If you exclude all or part of the income that you earn at the new location under the foreign earned income exclusion or the foreign housing exclusion, you cannot deduct the part of your moving expense that is allocable to the excluded income. Freetax Also, you cannot deduct the part of the moving expense related to the excluded income for a move from a foreign country to the United States if you receive a reimbursement that you are able to treat as compensation for services performed in the foreign country. Freetax Year to which expense is connected. Freetax The moving expense is connected with earning the income (including reimbursements, as discussed in chapter 4 under Reimbursement of moving expenses ) either entirely in the year of the move or in 2 years. Freetax It is connected with earning the income entirely in the year of the move if you qualify for the foreign earned income exclusion under the bona fide residence test or physical presence test for at least 120 days during that tax year. Freetax If you do not qualify under either the bona fide residence test or the physical presence test for at least 120 days during the year of the move, the expense is connected with earning the income in 2 years. Freetax The moving expense is connected with the year of the move and the following year if the move is from the United States to a foreign country. Freetax The moving expense is connected with the year of the move and the preceding year if the move is from a foreign country to the United States. Freetax Amount allocable to excluded income. Freetax To figure the amount of your moving expense that is allocable to your excluded foreign earned income (and not deductible), you must multiply your total moving expense deduction by a fraction. Freetax The numerator (top number) of the fraction is the total of your excluded foreign earned income and housing amounts for both years and the denominator (bottom number) of the fraction is your total foreign earned income for both years. Freetax Example. Freetax On November 1, 2012, you transfer to Monaco. Freetax Your tax home is in Monaco, and you are a bona fide resident of Monaco for the entire tax year 2013. Freetax In 2012, you paid $6,000 for allowable moving expenses for your move from the United States to Monaco. Freetax You were fully reimbursed (under a nonaccountable plan) for these expenses in the same year. Freetax The reimbursement is included in your income. Freetax Your only other income consists of $16,000 wages earned in 2012 after the date of your move, and $100,100 wages earned in Monaco for 2013. Freetax Because you did not meet the bona fide residence test for at least 120 days during 2012, the year of the move, the moving expenses are for services you performed in both 2012 and the following year, 2013. Freetax Your total foreign earned income for both years is $122,100, consisting of $16,000 wages for 2012, $100,100 wages for 2013, and $6,000 moving expense reimbursement for both years. Freetax You have no housing exclusion. Freetax The total amount you can exclude is $113,190, consisting of the $97,600 full-year exclusion for 2013 and a $15,590 part-year exclusion for 2012 ($95,100 times the fraction of 60 qualifying bona fide residence days over 366 total days in the year). Freetax To find the part of your moving expenses that is not deductible, multiply your $6,000 total expenses by the fraction $113,190 over $122,100. Freetax The result, $5,562, is your nondeductible amount. Freetax You must report the full amount of the moving expense reimbursement in the year in which you received the reimbursement. Freetax In the preceding example, this year was 2012. Freetax You attribute the reimbursement to both 2012 and 2013 only to figure the amount of foreign earned income eligible for exclusion for each year. Freetax Move between foreign countries. Freetax If you move between foreign countries, your moving expense is allocable to income earned in the year of the move if you qualified under either the bona fide residence test or the physical presence test for a period that includes at least 120 days in the year of the move. Freetax New place of work in U. Freetax S. Freetax If your new place of work is in the United States, the deductible moving expenses are directly connected with the income earned in the United States. Freetax If you treat a reimbursement from your employer as foreign earned income (see the discussion in chapter 4), you must allocate deductible moving expenses to foreign earned income. Freetax Storage expenses. Freetax These expenses are attributable to work you do during the year in which you incur the storage expenses. Freetax You cannot deduct the amount allocable to excluded income. Freetax Moving Expense Attributable to Foreign Earnings in 2 Years If your moving expense deduction is attributable to your foreign earnings in 2 years (the year of the move and the following year), you should request an extension of time to file your return for the year of the move until after the end of the second year. Freetax By then, you should have all the information needed to properly figure the moving expense deduction. Freetax See Extensions under When To File and Pay in chapter 1. Freetax If you do not request an extension, you should figure the part of the moving expense that you cannot deduct because it is allocable to the foreign earned income you are excluding. Freetax You do this by multiplying the moving expense by a fraction, the numerator (top number) of which is your excluded foreign earned income for the year of the move, and the denominator (bottom number) of which is your total foreign earned income for the year of the move. Freetax Once you know your foreign earnings and exclusion for the following year, you must either: Adjust the moving expense deduction by filing an amended return for the year of the move, or Recapture any additional unallowable amount as income on your return for the following year. Freetax If, after you make the final computation, you have an additional amount of allowable moving expense deduction, you can claim this only on an amended return for the year of the move. Freetax You cannot claim it on the return for the second year. Freetax Forms To File Report your moving expenses on Form 3903. Freetax Report your moving expense deduction on line 26 of Form 1040. Freetax If you must reduce your moving expenses by the amount allocable to excluded income (as explained later under How To Report Deductions ), attach a statement to your return showing how you figured this amount. Freetax For more information about figuring moving expenses, see Publication 521. Freetax Contributions to Individual Retirement Arrangements Contributions to your individual retirement arrangements (IRAs) that are traditional IRAs or Roth IRAs are generally limited to the lesser of $5,500 ($6,500 if 50 or older) or your compensation that is includible in your gross income for the tax year. Freetax In determining compensation for this purpose, do not take into account amounts you exclude under either the foreign earned income exclusion or the foreign housing exclusion. Freetax Do not reduce your compensation by the foreign housing deduction. Freetax If you are covered by an employer retirement plan at work, your deduction for your contributions to your traditional IRAs is generally limited based on your modified adjusted gross income. Freetax This is your adjusted gross income figured without taking into account the foreign earned income exclusion, the foreign housing exclusion, or the foreign housing deduction. Freetax Other modifications are also required. Freetax For more information on IRAs, see Publication 590. Freetax Taxes of Foreign Countries and U. Freetax S. Freetax Possessions You can take either a credit or a deduction for income taxes paid to a foreign country or a U. Freetax S. Freetax possession. Freetax Taken as a deduction, foreign income taxes reduce your taxable income. Freetax Taken as a credit, foreign income taxes reduce your tax liability. Freetax You must treat all foreign income taxes the same way. Freetax If you take a credit for any foreign income taxes, you cannot deduct any foreign income taxes. Freetax However, you may be able to deduct other foreign taxes. Freetax See Deduction for Other Foreign Taxes, later. Freetax There is no rule to determine whether it is to your advantage to take a deduction or a credit for foreign income taxes. Freetax In most cases, it is to your advantage to take foreign income taxes as a tax credit, which you subtract directly from your U. Freetax S. Freetax tax liability, rather than as a deduction in figuring taxable income. Freetax However, if foreign income taxes were imposed at a high rate and the proportion of foreign income to U. Freetax S. Freetax income is small, a lower final tax may result from deducting the foreign income taxes. Freetax In any event, you should figure your tax liability both ways and then use the one that is better for you. Freetax You can make or change your choice within 10 years from the due date for filing the tax return on which you are entitled to take either the deduction or the credit. Freetax Foreign income taxes. Freetax These are generally income taxes you pay to any foreign country or possession of the United States. Freetax Foreign income taxes on U. Freetax S. Freetax return. Freetax Foreign income taxes can only be taken as a credit on Form 1040, line 47, or as an itemized deduction on Schedule A. Freetax These amounts cannot be included as withheld income taxes on Form 1040, line 62. Freetax Foreign taxes paid on excluded income. Freetax You cannot take a credit or deduction for foreign income taxes paid on earnings you exclude from tax under any of the following. Freetax Foreign earned income exclusion. Freetax Foreign housing exclusion. Freetax Possession exclusion. Freetax If your wages are completely excluded, you cannot deduct or take a credit for any of the foreign taxes paid on your wages. Freetax If only part of your wages is excluded, you cannot deduct or take a credit for the foreign income taxes allocable to the excluded part. Freetax You find the taxes allocable to your excluded wages by applying a fraction to the foreign taxes paid on foreign earned income received during the tax year. Freetax The numerator (top number) of the fraction is your excluded foreign earned income received during the tax year minus deductible expenses allocable to that income (not including the foreign housing deduction). Freetax The denominator (bottom number) of the fraction is your total foreign earned income received during the tax year minus all deductible expenses allocable to that income (including the foreign housing deduction). Freetax If foreign law taxes both earned income and some other type of income and the taxes on the other type cannot be separated, the denominator of the fraction is the total amount of income subject to foreign tax minus deductible expenses allocable to that income. Freetax If you take a foreign tax credit for tax on income you could have excluded under your choice to exclude foreign earned income or your choice to exclude foreign housing costs, one or both of the choices may be considered revoked. Freetax Credit for Foreign Income Taxes If you take the foreign tax credit, you may have to file Form 1116 with Form 1040. Freetax Form 1116 is used to figure the amount of foreign tax paid or accrued that can be claimed as a foreign tax credit. Freetax Do not include the amount of foreign tax paid or accrued as withheld federal income taxes on Form 1040, line 62. Freetax The foreign income tax for which you can claim a credit is the amount of legal and actual tax liability you pay or accrue during the year. Freetax The amount for which you can claim a credit is not necessarily the amount withheld by the foreign country. Freetax You cannot take a foreign tax credit for income tax you paid to a foreign country that would be refunded by the foreign country if you made a claim for refund. Freetax Subsidies. Freetax If a foreign country returns your foreign tax payments to you in the form of a subsidy, you cannot claim a foreign tax credit based on these payments. Freetax This rule applies to a subsidy provided by any means that is determined, directly or indirectly, by reference to the amount of tax, or to the base used to figure the tax. Freetax Some ways of providing a subsidy are refunds, credits, deductions, payments, or discharges of obligations. Freetax A credit is also not allowed if the subsidy is given to a person related to you, or persons who participated in a transaction or a related transaction with you. Freetax Limit The foreign tax credit is limited to the part of your total U. Freetax S. Freetax tax that is in proportion to your taxable income from sources outside the United States compared to your total taxable income. Freetax The allowable foreign tax credit cannot be more than your actual foreign tax liability. Freetax Exemption from limit. Freetax You will not be subject to this limit and will not have to file Form 1116 if you meet all three of the following requirements. Freetax Your only foreign source income for the year is passive income (dividends, interest, royalties, etc. Freetax ) that is reported to you on a payee statement (such as a Form 1099-DIV or 1099-INT). Freetax Your foreign taxes for the year that qualify for the credit are not more than $300 ($600 if you are filing a joint return) and are reported on a payee statement. Freetax You elect this procedure. Freetax If you make this election, you cannot carry back or carry over any unused foreign tax to or from this year. Freetax Separate limit. Freetax You must figure the limit on a separate basis with regard to “passive category income” and “general category income” (see the instructions for Form 1116). Freetax Figuring the limit. Freetax In figuring taxable income in each category, you take into account only the amount that you must include in income on your federal tax return. Freetax Do not take any excluded amount into account. Freetax To determine your taxable income in each category, deduct expenses and losses that are definitely related to that income. Freetax Other expenses (such as itemized deductions or the standard deduction) not definitely related to specific items of income must be apportioned to the foreign income in each category by multiplying them by a fraction. Freetax The numerator (top number) of the fraction is your gross foreign income in the separate limit category. Freetax The denominator (bottom number) of the fraction is your gross income from all sources. Freetax For this purpose, gross income includes income that is excluded under the foreign earned income provisions but does not include any other exempt income. Freetax You must use special rules for deducting interest expenses. Freetax For more information on allocating and apportioning your deductions, see Publication 514. Freetax Exemptions. Freetax Do not take the deduction for exemptions for yourself, your spouse, or your dependents in figuring taxable income for purposes of the limit. Freetax Recapture of foreign losses. Freetax If you have an overall foreign loss and the loss reduces your U. Freetax S. Freetax source income (resulting in a reduction of your U. Freetax S. Freetax tax liability), you must recapture the loss in later years when you have taxable income from foreign sources. Freetax This is done by treating a part of your taxable income from foreign sources in later years as U. Freetax S. Freetax source income. Freetax This reduces the numerator of the limiting fraction and the resulting foreign tax credit limit. Freetax Recapture of domestic losses. Freetax If you have an overall domestic loss (resulting in no U. Freetax S. Freetax tax liability), you cannot claim a foreign tax credit for taxes paid during that year. Freetax You must recapture the loss in later years when you have U. Freetax S. Freetax source taxable income. Freetax This is done by treating a part of your taxable income from U. Freetax S. Freetax sources in later years as foreign source income. Freetax This increases the numerator of the limiting fraction and the resulting foreign tax credit limit. Freetax Foreign tax credit carryback and carryover. Freetax The amount of foreign income tax not allowed as a credit because of the limit can be carried back 1 year and carried forward 10 years. Freetax More information on figuring the foreign tax credit can be found in Publication 514. Freetax Deduction for Foreign Income Taxes Instead of taking the foreign tax credit, you can deduct foreign income taxes as an itemized deduction on Schedule A (Form 1040). Freetax You can deduct only foreign income taxes paid on income that is subject to U. Freetax S. Freetax tax. Freetax You cannot deduct foreign taxes paid on earnings you exclude from tax under any of the following. Freetax Foreign earned income exclusion. Freetax Foreign housing exclusion. Freetax Possession exclusion. Freetax Example. Freetax You are a U. Freetax S. Freetax citizen and qualify to exclude your foreign earned income. Freetax Your excluded wages in Country X are $70,000 on which you paid income tax of $10,000. Freetax You received dividends from Country X of $2,000 on which you paid income tax of $600. Freetax You can deduct the $600 tax payment because the dividends relating to it are subject to U. Freetax S. Freetax tax. Freetax Because you exclude your wages, you cannot deduct the income tax of $10,000. Freetax If you exclude only a part of your wages, see the earlier discussion under Foreign taxes paid on excluded income. Freetax Deduction for Other Foreign Taxes You can deduct real property taxes you pay that are imposed on you by a foreign country. Freetax You take this deduction on Schedule A (Form 1040). Freetax You cannot deduct other foreign taxes, such as personal property taxes, unless you incurred the expenses in a trade or business or in the production of income. Freetax On the other hand, you generally can deduct personal property taxes when you pay them to U. Freetax S. Freetax possessions. Freetax But if you claim the possession exclusion, see Publication 570. Freetax The deduction for foreign taxes other than foreign income taxes is not related to the foreign tax credit. Freetax You can take deductions for these miscellaneous foreign taxes and also claim the foreign tax credit for income taxes imposed by a foreign country. Freetax How To Report Deductions If you exclude foreign earned income or housing amounts, how you show your deductions on your tax return and how you figure the amount allocable to your excluded income depends on whether the expenses are used in figuring adjusted gross income (Form 1040, line 38) or are itemized deductions. Freetax If you have deductions used in figuring adjusted gross income, enter the total amount for each of these items on the appropriate lines and schedules of Form 1040. Freetax Generally, you figure the amount of a deduction related to the excluded income by multiplying the deduction by a fraction, the numerator of which is your foreign earned income exclusion and the denominator of which is your foreign earned income. Freetax Enter the amount of the deduction(s) related to excluded income on line 44 of Form 2555. Freetax If you have itemized deductions related to excluded income, enter on Schedule A (Form 1040) only the part not related to excluded income. Freetax You figure that amount by subtracting from the total deduction the amount related to excluded income. Freetax Generally, you figure the amount that is related to the excluded income by multiplying the total deduction by a fraction, the numerator of which is your foreign earned income exclusion and the denominator of which is your foreign earned income. Freetax Attach a statement to your return showing how you figured the deductible amount. Freetax Example 1. Freetax You are a U. Freetax S. Freetax citizen employed as an accountant. Freetax Your tax home is in Germany for the entire tax year. Freetax You meet the physical presence test. Freetax Your foreign earned income for the year was $122,000 and your investment income was $10,380. Freetax After excluding $97,600, your AGI is $34,780. Freetax You had unreimbursed business expenses of $2,500 for travel and entertainment in earning your foreign income, of which $500 was for meals and entertainment. Freetax These expenses are deductible only as miscellaneous deductions on Schedule A (Form 1040). Freetax You also have $500 of miscellaneous expenses that are not related to your foreign income that you enter on line 23 of Schedule A. Freetax You must fill out Form 2106. Freetax On that form, reduce your deductible meal and entertainment expenses by 50% ($250). Freetax You must reduce the remaining $2,250 of travel and entertainment expenses by 80% ($1,800) because you excluded 80% ($97,600/$122,000) of your foreign earned income. Freetax You carry the remaining total of $450 to line 21 of Schedule A. Freetax Add the $450 to the $500 that you have on line 23 and enter the total ($950) on line 24. Freetax On line 26 of Schedule A, enter $696, which is 2% of your adjusted gross income of $34,780 (line 38, Form 1040) and subtract it from the amount on line 24. Freetax Enter $254 on line 27 of Schedule A. Freetax Example 2. Freetax You are a U. Freetax S. Freetax citizen, have a tax home in Spain, and meet the physical presence test. Freetax You are self-employed and personal services produce the business income. Freetax Your gross income was $116,931, business expenses $66,895, and net income (profit) $50,036. Freetax You choose the foreign earned income exclusion and exclude $97,600 of your gross income. Freetax Since your excluded income is 83. Freetax 47% of your total income, 83. Freetax 47% of your business expenses are not deductible. Freetax Report your total income and expenses on Schedule C (Form 1040). Freetax On Form 2555 you will show the following: Line 20a, $116,931, gross income, Lines 42 and 43, $97,600, foreign earned income exclusion, and Line 44, $55,837 (83. Freetax 47% × $66,895) business expenses attributable to the exclusion. Freetax In this situation (Example 2), you cannot use Form 2555-EZ since you had self-employment income and business expenses. Freetax Example 3. Freetax Assume in Example 2 that both capital and personal services combine to produce the business income. Freetax No more than 30% of your net income, or $15,011, assuming that this amount is a reasonable allowance for your services, is considered earned and can be excluded. Freetax Your exclusion of $15,011 is 12. Freetax 84% of your gross income ($15,011 ÷ $116,931). Freetax Because you excluded 12. Freetax 84% of your total income, $8,589 (. Freetax 1284 x $66,895) of your business expenses is attributable to the excluded income and is not deductible. Freetax Example 4. Freetax You are a U. Freetax S. Freetax citizen, have a tax home in Brazil, and meet the physical presence test. Freetax You are self-employed and both capital and personal services combine to produce business income. Freetax Your gross income was $146,000, business expenses were $172,000, and your net loss was $26,000. Freetax A reasonable allowance for the services you performed for the business is $77,000. Freetax Because you incurred a net loss, the earned income limit of 30% of your net profit does not apply. Freetax The $77,000 is foreign earned income. Freetax If you choose to exclude the $77,000, you exclude 52. Freetax 74% of your gross income ($77,000 ÷ $146,000), and 52. Freetax 74% of your business expenses ($90,713) is attributable to that income and is not deductible. Freetax Show your total income and expenses on Schedule C (Form 1040). Freetax On Form 2555, exclude $77,000 and show $90,713 on line 44. Freetax Subtract line 44 from line 43, and enter the difference as a negative (in parentheses) on line 45. Freetax Because this amount is negative, enter it as a positive (no parentheses) on line 21, Form 1040, and combine it with your other income to arrive at total income on line 22 of Form 1040. Freetax In this situation (Example 4), you would probably not want to choose the foreign earned income exclusion if this was the first year you were eligible. Freetax If you had chosen the exclusion in an earlier year, you might want to revoke the choice for this year. Freetax To do so would mean that you could not claim the exclusion again for the next 5 tax years without IRS approval. Freetax See Choosing the Exclusion in chapter 4. Freetax Example 5. Freetax You are a U. Freetax S. Freetax citizen, have a tax home in Panama, and meet the bona fide residence test. Freetax You have been performing services for clients as a partner in a firm that provides services exclusively in Panama. Freetax Capital investment is not material in producing the partnership's income. Freetax Under the terms of the partnership agreement, you are to receive 50% of the net profits. Freetax The partnership received gross income of $244,000 and incurred operating expenses of $98,250. Freetax Of the net profits of $145,750, you received $72,875 as your distributive share. Freetax You choose to exclude $97,600 of your share of the gross income. Freetax Because you exclude 80% ($97,600 ÷ $122,000) of your share of the gross income, you cannot deduct $39,300, 80% of your share of the operating expenses (. Freetax 80 × $49,125). Freetax Report $72,875, your distributive share of the partnership net profit, on Schedule E (Form 1040), Supplemental Income and Loss. Freetax On Form 2555, show $97,600 on line 42 and show $39,300 on line 44. Freetax Your exclusion on Form 2555 is $58,300. Freetax In this situation (Example 5), you cannot use Form 2555-EZ since you had earned income other than salaries and wages and you had business expenses. Freetax Prev Up Next Home More Online Publications
IRS Releases the Dirty Dozen Tax Scams for 2013
IRS YouTube Video
Dirty Dozen: English | Spanish | ASL
IR-2013-33, March 26, 2013
WASHINGTON — The Internal Revenue Service today issued its annual “Dirty Dozen” list of tax scams, reminding taxpayers to use caution during tax season to protect themselves against a wide range of schemes ranging from identity theft to return preparer fraud.
The Dirty Dozen listing, compiled by the IRS each year, lists a variety of common scams taxpayers can encounter at any point during the year. But many of these schemes peak during filing season as people prepare their tax returns.
"This tax season, the IRS has stepped up its efforts to protect taxpayers from a wide range of schemes, including moving aggressively to combat identity theft and refund fraud," said IRS Acting Commissioner Steven T. Miller. "The Dirty Dozen list shows that scams come in many forms during filing season. Don't let a scam artist steal from you or talk you into doing something you will regret later."
Illegal scams can lead to significant penalties and interest and possible criminal prosecution. IRS Criminal Investigation works closely with the Department of Justice (DOJ) to shutdown scams and prosecute the criminals behind them.
The following are the Dirty Dozen tax scams for 2013:
Tax fraud through the use of identity theft tops this year’s Dirty Dozen list. Identity theft occurs when someone uses your personal information such as your name, Social Security number (SSN) or other identifying information, without your permission, to commit fraud or other crimes. In many cases, an identity thief uses a legitimate taxpayer’s identity to fraudulently file a tax return and claim a refund.
Combating identity theft and refund fraud is a top priority for the IRS, and we are taking special steps to assist victims. For the 2013 tax season, the IRS has put in place a number of additional steps to prevent identity theft and detect refund fraud before it occurs. We have dramatically enhanced our systems, and we are committed to continuing to improve our prevention, detection and assistance efforts.
The IRS has a comprehensive and aggressive identity theft strategy employing a three-pronged effort focusing on fraud prevention, early detection and victim assistance. We are continually reviewing our processes and policies to ensure that we are doing everything possible to minimize identity theft incidents, to help those victimized by it and to investigate those who are committing the crimes.
The IRS continues to increase its efforts against refund fraud, which includes identity theft. During 2012, the IRS prevented the issuance of $20 billion of fraudulent refunds, including those related to identity theft, compared with $14 billion in 2011.
This January, the IRS also conducted a coordinated and highly successful identity theft enforcement sweep. The coast-to-coast effort against identity theft suspects led to 734 enforcement actions in January, including 298 indictments, informations, complaints and arrests. The effort comes on top of a growing identity theft effort that led to 2,400 other enforcement actions against identity thieves during fiscal year 2012. The Criminal Investigation unit has devoted more than 500,000 staff-hours to fighting this issue.
We know identity theft is a frustrating and complex process for victims. The IRS has 3,000 people working on identity theft related cases — more than double the number in late 2011. And we have trained 35,000 employees who work with taxpayers to help with identity theft situations.
The IRS has a special section on IRS.gov dedicated to identity theft issues, including YouTube videos, tips for taxpayers and an assistance guide. For victims, the information includes how to contact the IRS Identity Protection Specialized Unit. For other taxpayers, there are tips on how taxpayers can protect themselves against identity theft.
Taxpayers who believe they are at risk of identity theft due to lost or stolen personal information should contact the IRS immediately so the agency can take action to secure their tax account. Taxpayers can call the IRS Identity Protection Specialized Unit at 800-908-4490. More information can be found on the special identity protection page.
Phishing is a scam typically carried out with the help of unsolicited email or a fake website that poses as a legitimate site to lure in potential victims and prompt them to provide valuable personal and financial information. Armed with this information, a criminal can commit identity theft or financial theft.
If you receive an unsolicited email that appears to be from either the IRS or an organization closely linked to the IRS, such as the Electronic Federal Tax Payment System (EFTPS), report it by sending it to firstname.lastname@example.org.
It is important to keep in mind the IRS does not initiate contact with taxpayers by email to request personal or financial information. This includes any type of electronic communication, such as text messages and social media channels. The IRS has information that can help you protect yourself from email scams.
Return Preparer Fraud
About 60 percent of taxpayers will use tax professionals this year to prepare their tax returns. Most return preparers provide honest service to their clients. But some unscrupulous preparers prey on unsuspecting taxpayers, and the result can be refund fraud or identity theft.
It is important to choose carefully when hiring an individual or firm to prepare your return. This year, the IRS wants to remind all taxpayers that they should use only preparers who sign the returns they prepare and enter their IRS Preparer Tax Identification Numbers (PTINs).
The IRS also has created a new web page to assist taxpayers. For tips about choosing a preparer, red flags, details on preparer qualifications and information on how and when to make a complaint, visit www.irs.gov/chooseataxpro.
Remember: Taxpayers are legally responsible for what’s on their tax return even if it is prepared by someone else. Make sure the preparer you hire is up to the task.
IRS.gov has general information on reporting tax fraud. More specifically, report abusive tax preparers to the IRS on Form 14157, Complaint: Tax Return Preparer. Download Form 14157 and fill it out or order by mail at 800-TAX FORM (800-829-3676). The form includes a return address.
Hiding Income Offshore
Over the years, numerous individuals have been identified as evading U.S. taxes by hiding income in offshore banks, brokerage accounts or nominee entities, using debit cards, credit cards or wire transfers to access the funds. Others have employed foreign trusts, employee-leasing schemes, private annuities or insurance plans for the same purpose.
The IRS uses information gained from its investigations to pursue taxpayers with undeclared accounts, as well as the banks and bankers suspected of helping clients hide their assets overseas. The IRS works closely with the Department of Justice (DOJ) to prosecute tax evasion cases.
While there are legitimate reasons for maintaining financial accounts abroad, there are reporting requirements that need to be fulfilled. U.S. taxpayers who maintain such accounts and who do not comply with reporting and disclosure requirements are breaking the law and risk significant penalties and fines, as well as the possibility of criminal prosecution.
Since 2009, 38,000 individuals have come forward voluntarily to disclose their foreign financial accounts, taking advantage of special opportunities to comply with the U.S. tax system and resolve their tax obligations. And, with new foreign account reporting requirements being phased in over the next few years, hiding income offshore will become increasingly more difficult.
At the beginning of 2012, the IRS reopened the Offshore Voluntary Disclosure Program (OVDP) following continued strong interest from taxpayers and tax practitioners after the closure of the 2011 and 2009 programs. The IRS continues working on a wide range of international tax issues and follows ongoing efforts with DOJ to pursue criminal prosecution of international tax evasion. This program will be open for an indefinite period until otherwise announced.
The IRS has collected $5.5 billion so far from people who participated in offshore voluntary disclosure programs since 2009.
“Free Money” from the IRS & Tax Scams Involving Social Security
Flyers and advertisements for free money from the IRS, suggesting that the taxpayer can file a tax return with little or no documentation, have been appearing in community churches around the country. These schemes promise refunds to people who have little or no income and normally don’t have a tax filing requirement – and are also often spread by word of mouth as unsuspecting and well-intentioned people tell their friends and relatives.
Scammers prey on low income individuals and the elderly and members of church congregations with bogus promises of free money. They build false hopes and charge people good money for bad advice including encouraging taxpayers to make fictitious claims for refunds or rebates based on false statements of entitlement to tax credits. For example, some promoters claim they can obtain for their victims, often senior citizens, a tax refund or nonexistent stimulus payment based on the American Opportunity Tax Credit, even if the victim was not enrolled in or paying for college. Con artists also falsely claim that refunds are available even if the victim went to school decades ago. In the end, the victims discover their claims are rejected. Meanwhile, the promoters are long gone. The IRS warns all taxpayers to remain vigilant.
There are also a number of tax scams involving Social Security. For example, scammers have been known to lure the unsuspecting with promises of non-existent Social Security refunds or rebates. In another situation, a taxpayer may really be due a credit or refund but uses inflated information to complete the return.
Beware: Intentional mistakes of this kind can result in a $5,000 penalty.
Impersonation of Charitable Organizations
Another long-standing type of abuse or fraud is scams that occur in the wake of significant natural disasters.
Following major disasters, it’s common for scam artists to impersonate charities to get money or private information from well-intentioned taxpayers. Scam artists can use a variety of tactics. Some scammers operating bogus charities may contact people by telephone or email to solicit money or financial information. They may even directly contact disaster victims and claim to be working for or on behalf of the IRS to help the victims file casualty loss claims and get tax refunds.
They may attempt to get personal financial information or Social Security numbers that can be used to steal the victims’ identities or financial resources. Bogus websites may solicit funds for disaster victims. As in the case of a recent disaster, Hurricane Sandy, the IRS cautions both victims of natural disasters and people wishing to make charitable donations to avoid scam artists by following these tips:
- To help disaster victims, donate to recognized charities.
- Be wary of charities with names that are similar to familiar or nationally known organizations. Some phony charities use names or websites that sound or look like those of respected, legitimate organizations. IRS.gov has a search feature, Exempt Organizations Select Check, which allows people to find legitimate, qualified charities to which donations may be tax-deductible.
- Don’t give out personal financial information, such as Social Security numbers or credit card and bank account numbers and passwords, to anyone who solicits a contribution from you. Scam artists may use this information to steal your identity and money.
- Don’t give or send cash. For security and tax record purposes, contribute by check or credit card or another way that provides documentation of the gift.
Call the IRS toll-free disaster assistance telephone number (1-866-562-5227) if you are a disaster victim with specific questions about tax relief or disaster related tax issues.
False/Inflated Income and Expenses
Including income that was never earned, either as wages or as self-employment income in order to maximize refundable credits, is another popular scam. Claiming income you did not earn or expenses you did not pay in order to secure larger refundable credits such as the Earned Income Tax Credit could have serious repercussions. This could result in repaying the erroneous refunds, including interest and penalties, and in some cases, even prosecution.
Additionally, some taxpayers are filing excessive claims for the fuel tax credit. Farmers and other taxpayers who use fuel for off-highway business purposes may be eligible for the fuel tax credit. But other individuals have claimed the tax credit although they were not eligible. Fraud involving the fuel tax credit is considered a frivolous tax claim and can result in a penalty of $5,000.
False Form 1099 Refund Claims
In some cases, individuals have made refund claims based on the bogus theory that the federal government maintains secret accounts for U.S. citizens and that taxpayers can gain access to the accounts by issuing 1099-OID forms to the IRS. In this ongoing scam, the perpetrator files a fake information return, such as a Form 1099 Original Issue Discount (OID), to justify a false refund claim on a corresponding tax return.
Don’t fall prey to people who encourage you to claim deductions or credits to which you are not entitled or willingly allow others to use your information to file false returns. If you are a party to such schemes, you could be liable for financial penalties or even face criminal prosecution.
Promoters of frivolous schemes encourage taxpayers to make unreasonable and outlandish claims to avoid paying the taxes they owe. The IRS has a list of frivolous tax arguments that taxpayers should avoid. These arguments are false and have been thrown out of court. While taxpayers have the right to contest their tax liabilities in court, no one has the right to disobey the law.
Falsely Claiming Zero Wages
Filing a phony information return is an illegal way to lower the amount of taxes an individual owes. Typically, a Form 4852 (Substitute Form W-2) or a “corrected” Form 1099 is used as a way to improperly reduce taxable income to zero. The taxpayer may also submit a statement rebutting wages and taxes reported by a payer to the IRS.
Sometimes, fraudsters even include an explanation on their Form 4852 that cites statutory language on the definition of wages or may include some reference to a paying company that refuses to issue a corrected Form W-2 for fear of IRS retaliation. Taxpayers should resist any temptation to participate in any variations of this scheme. Filing this type of return may result in a $5,000 penalty.
Disguised Corporate Ownership
Third parties are improperly used to request employer identification numbers and form corporations that obscure the true ownership of the business.
These entities can be used to underreport income, claim fictitious deductions, avoid filing tax returns, participate in listed transactions and facilitate money laundering and financial crimes. The IRS is working with state authorities to identify these entities and bring the owners into compliance with the law.
Misuse of Trusts
For years, unscrupulous promoters have urged taxpayers to transfer assets into trusts. While there are legitimate uses of trusts in tax and estate planning, some highly questionable transactions promise reduction of income subject to tax, deductions for personal expenses and reduced estate or gift taxes. Such trusts rarely deliver the tax benefits promised and are used primarily as a means of avoiding income tax liability and hiding assets from creditors, including the IRS.
IRS personnel have seen an increase in the improper use of private annuity trusts and foreign trusts to shift income and deduct personal expenses. As with other arrangements, taxpayers should seek the advice of a trusted professional before entering a trust arrangement.
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Page Last Reviewed or Updated: 07-Mar-2014
Freetax 5. Freetax Taxes Table of Contents What's New Introduction Topics - This chapter discusses: Useful Items - You may want to see: When To Deduct Taxes Real Estate TaxesSeparate elections. Freetax Making the election. Freetax Form 3115. Freetax Income TaxesAccrual of contested income taxes. Freetax Employment Taxes Other TaxesAdditional Medicare Tax. Freetax What's New Additional Medicare Tax. Freetax Beginning in 2013, you must withhold a 0. Freetax 9% Additional Medicare Tax from wages you pay to an employee in excess of $200,000 in a calendar year. Freetax Also, self-employed individuals may be required to pay Additional Medicare Tax on self-employment income. Freetax See Employment Taxes , and Self-employment tax , later. Freetax Introduction You can deduct various federal, state, local, and foreign taxes directly attributable to your trade or business as business expenses. Freetax You cannot deduct federal income taxes, estate and gift taxes, or state inheritance, legacy, and succession taxes. Freetax Topics - This chapter discusses: When to deduct taxes Real estate taxes Income taxes Employment taxes Other taxes Useful Items - You may want to see: Publication 15 (Circular E), Employer's Tax Guide 334 Tax Guide for Small Business 510 Excise Taxes 538 Accounting Periods and Methods 551 Basis of Assets Form (and Instructions) Sch A (Form 1040) Itemized Deductions Sch SE (Form 1040) Self-Employment Tax 3115 Application for Change in Accounting Method 8959 Additional Medicare Tax See chapter 12 for information about getting publications and forms. Freetax When To Deduct Taxes Generally, you can only deduct taxes in the year you pay them. Freetax This applies whether you use the cash method or an accrual method of accounting. Freetax Under an accrual method, you can deduct a tax before you pay it if you meet the exception for recurring items discussed under Economic Performance in Publication 538. Freetax You can also elect to ratably accrue real estate taxes as discussed later under Real Estate Taxes . Freetax Limit on accrual of taxes. Freetax A taxing jurisdiction can require the use of a date for accruing taxes that is earlier than the date it originally required. Freetax However, if you use an accrual method, and can deduct the tax before you pay it, use the original accrual date for the year of change and all future years to determine when you can deduct the tax. Freetax Example. Freetax Your state imposes a tax on personal property used in a trade or business conducted in the state. Freetax This tax is assessed and becomes a lien as of July 1 (accrual date). Freetax In 2013, the state changed the assessment and lien dates from July 1, 2014, to December 31, 2013, for property tax year 2014. Freetax Use the original accrual date (July 1, 2014) to determine when you can deduct the tax. Freetax You must also use the July 1 accrual date for all future years to determine when you can deduct the tax. Freetax Uniform capitalization rules. Freetax Uniform capitalization rules apply to certain taxpayers who produce real property or tangible personal property for use in a trade or business or for sale to customers. Freetax They also apply to certain taxpayers who acquire property for resale. Freetax Under these rules, you either include certain costs in inventory or capitalize certain expenses related to the property, such as taxes. Freetax For more information, see chapter 1. Freetax Carrying charges. Freetax Carrying charges include taxes you pay to carry or develop real estate or to carry, transport, or install personal property. Freetax You can elect to capitalize carrying charges not subject to the uniform capitalization rules if they are otherwise deductible. Freetax For more information, see chapter 7. Freetax Refunds of taxes. Freetax If you receive a refund for any taxes you deducted in an earlier year, include the refund in income to the extent the deduction reduced your federal income tax in the earlier year. Freetax For more information, see Recovery of amount deducted (tax benefit rule) in chapter 1. Freetax You must include in income any interest you receive on tax refunds. Freetax Real Estate Taxes Deductible real estate taxes are any state, local, or foreign taxes on real estate levied for the general public welfare. Freetax The taxing authority must base the taxes on the assessed value of the real estate and charge them uniformly against all property under its jurisdiction. Freetax Deductible real estate taxes generally do not include taxes charged for local benefits and improvements that increase the value of the property. Freetax See Taxes for local benefits , later. Freetax If you use an accrual method, you generally cannot accrue real estate taxes until you pay them to the government authority. Freetax However, you can elect to ratably accrue the taxes during the year. Freetax See Electing to ratably accrue , later. Freetax Taxes for local benefits. Freetax Generally, you cannot deduct taxes charged for local benefits and improvements that tend to increase the value of your property. Freetax These include assessments for streets, sidewalks, water mains, sewer lines, and public parking facilities. Freetax You should increase the basis of your property by the amount of the assessment. Freetax You can deduct taxes for these local benefits only if the taxes are for maintenance, repairs, or interest charges related to those benefits. Freetax If part of the tax is for maintenance, repairs, or interest, you must be able to show how much of the tax is for these expenses to claim a deduction for that part of the tax. Freetax Example. Freetax To improve downtown commercial business, Waterfront City converted a downtown business area street into an enclosed pedestrian mall. Freetax The city assessed the full cost of construction, financed with 10-year bonds, against the affected properties. Freetax The city is paying the principal and interest with the annual payments made by the property owners. Freetax The assessments for construction costs are not deductible as taxes or as business expenses, but are depreciable capital expenses. Freetax The part of the payments used to pay the interest charges on the bonds is deductible as taxes. Freetax Charges for services. Freetax Water bills, sewerage, and other service charges assessed against your business property are not real estate taxes, but are deductible as business expenses. Freetax Purchase or sale of real estate. Freetax If real estate is sold, the real estate taxes must be allocated between the buyer and the seller. Freetax The buyer and seller must allocate the real estate taxes according to the number of days in the real property tax year (the period to which the tax imposed relates) that each owned the property. Freetax Treat the seller as paying the taxes up to but not including the date of sale. Freetax Treat the buyer as paying the taxes beginning with the date of sale. Freetax You can usually find this information on the settlement statement you received at closing. Freetax If you (the seller) use an accrual method and have not elected to ratably accrue real estate taxes, you are considered to have accrued your part of the tax on the date you sell the property. Freetax Example. Freetax Alberto Verde, a calendar year accrual method taxpayer, owns real estate in Olmo County. Freetax He has not elected to ratably accrue property taxes. Freetax November 30 of each year is the assessment and lien date for the current real property tax year, which is the calendar year. Freetax He sold the property on June 30, 2013. Freetax Under his accounting method he would not be able to claim a deduction for the taxes because the sale occurred before November 30. Freetax He is treated as having accrued his part of the tax, 181/366 (January 1–June 29), on June 30, and he can deduct it for 2013. Freetax Electing to ratably accrue. Freetax If you use an accrual method, you can elect to accrue real estate tax related to a definite period ratably over that period. Freetax Example. Freetax Juan Sanchez is a calendar year taxpayer who uses an accrual method. Freetax His real estate taxes for the real property tax year, July 1, 2013, to June 30, 2014, are $1,200. Freetax July 1 is the assessment and lien date. Freetax If Juan elects to ratably accrue the taxes, $600 will accrue in 2013 ($1,200 × 6/12, July 1–December 31) and the balance will accrue in 2014. Freetax Separate elections. Freetax You can elect to ratably accrue the taxes for each separate trade or business and for nonbusiness activities if you account for them separately. Freetax Once you elect to ratably accrue real estate taxes, you must use that method unless you get permission from the IRS to change. Freetax See Form 3115 , later. Freetax Making the election. Freetax If you elect to ratably accrue the taxes for the first year in which you incur real estate taxes, attach a statement to your income tax return for that year. Freetax The statement should show all the following items. Freetax The trades or businesses to which the election applies and the accounting method or methods used. Freetax The period to which the taxes relate. Freetax The computation of the real estate tax deduction for that first year. Freetax Generally, you must file your return by the due date (including extensions). Freetax However, if you timely filed your return for the year without electing to ratably accrue, you can still make the election by filing an amended return within 6 months after the due date of the return (excluding extensions). Freetax Attach the statement to the amended return and write “Filed pursuant to section 301. Freetax 9100-2” on the statement. Freetax File the amended return at the same address where you filed the original return. Freetax Form 3115. Freetax If you elect to ratably accrue real estate taxes for a year after the first year in which you incur real estate taxes, or if you want to revoke your election to ratably accrue real estate taxes, file Form 3115. Freetax For more information, including applicable time frames for filing, see the Instructions for Form 3115. Freetax Note. Freetax If you are filing an application for a change in accounting method filed after January 9, 2011, for a year of change ending after April 29, 2010, see Revenue Procedure 2011-14, 2011-4 I. Freetax R. Freetax B. Freetax 330, as modified and clarified by Revenue Procedure 2012-19, 2012-14 I. Freetax R. Freetax B. Freetax 689, and Revenue Procedure 2012-20, 2012-14 I. Freetax R. Freetax B. Freetax 700, or any successor. Freetax Revenue Procedure 2011-14 is available at www. Freetax irs. Freetax gov/irb/2011-04IRB/ar08. Freetax html. Freetax Income Taxes This section discusses federal, state, local, and foreign income taxes. Freetax Federal income taxes. Freetax You cannot deduct federal income taxes. Freetax State and local income taxes. Freetax A corporation or partnership can deduct state and local income taxes imposed on the corporation or partnership as business expenses. Freetax An individual can deduct state and local income taxes only as an itemized deduction on Schedule A (Form 1040). Freetax However, an individual can deduct a state tax on gross income (as distinguished from net income) directly attributable to a trade or business as a business expense. Freetax Accrual of contested income taxes. Freetax If you use an accrual method, and you contest a state or local income tax liability, you must accrue and deduct any contested amount in the tax year in which the liability is finally determined. Freetax If additional state or local income taxes for a prior year are assessed in a later year, you can deduct the taxes in the year in which they were originally imposed (the prior year) if the tax liability is not contested. Freetax You cannot deduct them in the year in which the liability is finally determined. Freetax The filing of an income tax return is not considered a contest and, in the absence of an overt act of protest, you can deduct the tax in the prior year. Freetax Also, you can deduct any additional taxes in the prior year if you do not show some affirmative evidence of denial of the liability. Freetax However, if you consistently deduct additional assessments in the year they are paid or finally determined (including those for which there was no contest), you must continue to do so. Freetax You cannot take a deduction in the earlier year unless you receive permission to change your method of accounting. Freetax For more information on accounting methods, see When Can I Deduct an Expense in chapter 1. Freetax Foreign income taxes. Freetax Generally, you can take either a deduction or a credit for income taxes imposed on you by a foreign country or a U. Freetax S. Freetax possession. Freetax However, an individual cannot take a deduction or credit for foreign income taxes paid on income that is exempt from U. Freetax S. Freetax tax under the foreign earned income exclusion or the foreign housing exclusion. Freetax For information on these exclusions, see Publication 54, Tax Guide for U. Freetax S. Freetax Citizens and Resident Aliens Abroad. Freetax For information on the foreign tax credit, see Publication 514, Foreign Tax Credit for Individuals. Freetax Employment Taxes If you have employees, you must withhold various taxes from your employees' pay. Freetax Most employers must withhold their employees' share of social security, Medicare taxes, and Additional Medicare Tax (if applicable) along with state and federal income taxes. Freetax You may also need to pay certain employment taxes from your own funds. Freetax These include your share of social security and Medicare taxes as an employer, along with unemployment taxes. Freetax Note. Freetax Additional Medicare Tax is only imposed on the employee. Freetax There is no employer share of Additional Medicare Tax. Freetax Your deduction for wages paid is not reduced by the social security and Medicare taxes, Additional Medicare Tax, and income taxes you withhold from your employees. Freetax You can deduct the employment taxes you must pay from your own funds as taxes. Freetax Example. Freetax You pay your employee $18,000 a year. Freetax However, after you withhold various taxes, your employee receives $14,500. Freetax You also pay an additional $1,500 in employment taxes. Freetax You should deduct the full $18,000 as wages. Freetax You can deduct the $1,500 you pay from your own funds as taxes. Freetax For more information on employment taxes, see Publication 15 (Circular E). Freetax Unemployment fund taxes. Freetax As an employer, you may have to make payments to a state unemployment compensation fund or to a state disability benefit fund. Freetax Deduct these payments as taxes. Freetax Other Taxes The following are other taxes you can deduct if you incur them in the ordinary course of your trade or business. Freetax Excise taxes. Freetax Generally, you can deduct as a business expense all excise taxes that are ordinary and necessary expenses of carrying on your trade or business. Freetax However, see Fuel taxes , later. Freetax For more information on excise taxes, see Publication 510. Freetax Franchise taxes. Freetax You can deduct corporate franchise taxes as a business expense. Freetax Fuel taxes. Freetax Generally, taxes on gasoline, diesel fuel, and other motor fuels that you use in your business are included as part of the cost of the fuel. Freetax Do not deduct these taxes as a separate item. Freetax You may be entitled to a credit or refund for federal excise tax you paid on fuels used for certain purposes. Freetax For more information, see Publication 510. Freetax Occupational taxes. Freetax You can deduct as a business expense an occupational tax charged at a flat rate by a locality for the privilege of working or conducting a business in the locality. Freetax Personal property tax. Freetax You can deduct any tax imposed by a state or local government on personal property used in your trade or business. Freetax Sales tax. Freetax Treat any sales tax you pay on a service or on the purchase or use of property as part of the cost of the service or property. Freetax If the service or the cost or use of the property is a deductible business expense, you can deduct the tax as part of that service or cost. Freetax If the property is merchandise bought for resale, the sales tax is part of the cost of the merchandise. Freetax If the property is depreciable, add the sales tax to the basis for depreciation. Freetax For more information on basis, see Publication 551. Freetax Do not deduct state and local sales taxes imposed on the buyer that you must collect and pay over to the state or local government. Freetax Also, do not include these taxes in gross receipts or sales. Freetax Self-employment tax. Freetax You can deduct part of your self-employment tax as a business expense in figuring your adjusted gross income. Freetax This deduction only affects your income tax. Freetax It does not affect your net earnings from self-employment or your self-employment tax. Freetax To deduct the tax, enter on Form 1040, line 27, the amount shown on the Deduction for one-half of self-employment tax line of Schedule SE (Form 1040). Freetax For more information on self-employment tax, see Publication 334. Freetax Additional Medicare Tax. Freetax Beginning in 2013, you may be required to pay Additional Medicare Tax on self-employment income. Freetax See Form 8959 and the Instructions for Form 8959 for more information on the Additional Medicare Tax. 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