August, 2005
The Ins and Outs of Interest Deductions
August, 2005
The Ins and Outs of Interest Deductions
You need a loan. So you compare alternatives and choose the loan with the most favorable rate and repayment terms. Do you also consider the tax implications? You should. If the interest you pay on a loan is tax deductible, your real cost of borrowing will be less.
Business loans.
Interest paid on loans taken to finance business expenditures is generally deductible as a trade or business expense. If you use the proceeds of a loan for both business and nonbusiness purposes, an allocation must be made to determine the amount of interest that is deductible as a business expense.
Consumer debt.
You cannot deduct interest on loans taken to buy personal items, such as cars and appliances. (But see the information on "home equity debt" below.)
Home mortgages and home equity loans/credit lines.
In general, you can deduct as an itemized deduction interest paid on up to $1 million of "acquisition debt" - mortgage loans taken to buy or build a primary and/or a second residence. On top of this deduction, the law allows an itemized deduction for interest paid on up to $100,000 of "home equity debt" - a home equity loan or line of credit, for instance - no matter what the loan proceeds are used for.
Investment debt.
If you borrow money to buy or carry taxable investments, the interest you pay on the loan is deductible as an itemized deduction, subject to a limitation based on your net investment income. A margin loan from a brokerage is an example of investment debt.
Student loan interest.
Qualified student loan interest of up to $2,500 a year is deductible "above the line," so the interest would be deductible even if you don't itemize your deductions. Above-the-line deductions reduce your adjusted gross income, potentially allowing you to quality for other deductions and tax breaks that are reduced or unavailable when adjusted gross income exceeds certain caps specified in the tax law. The deduction for student loan interest is subject to an income-based phaseout.
Additional factors, such as alternative minimum tax and the itemized deduction limitations that apply to higher income taxpayers, could affect your interest deductions. We can help you weigh your options.
Do U.S. Series EE savings bonds earn interest at a fixed or variable rate?
For now, you'd be right if you answered either way. The interest rate on bonds issued before May 1, 2005, is variable. But, for bonds issued on or after that date, a fixed rate, set at the time of purchase, will apply for the 30-year life of the bond.
The fixed rates are based on 10-year Treasury note yields, with certain adjustments to account for features unique to savings bonds. The bonds must be held for at least one year, and a three-month interest penalty applies if a bond is not held for at least five years.
Fixed rate EE bonds reach original maturity after 20 years. If a bond does not double in value as the result of applying the fixed rate for 20 years, the Treasury guarantees it will make up the difference.
How's business? It depends on how you look at it. Stan improved receivables substantially last month, but skyrocketing transportation costs caused his cash flow to dip. Serena has a new product on the market that's going gangbusters. But she's using it as a loss leader, so big sales could be a mixed blessing.
A Simple Concept
The formula for calculating break-even point in terms of units sold is:
Fixed costs - costs that don't change regardless of volume - include expenses such as rent and property taxes. Contribution margin is equal to selling price minus variable costs - costs such as raw materials that fluctuate directly with a change in volume.
A Simple Example
Freddie's Fabulous Food (FFF) sells one thing: onion rings. Being an enthusiastic entrepreneur, Freddie keeps a close eye on his break-even point.
A Powerful Tool
Freddie is thinking of adding onion ice cream to his menu next year. He has already used break-even analysis to figure out how much ice cream he'll have to sell before he starts turning a profit. Now he's calculating how raising his selling price or reducing his costs would change the outcome.
Would you like to know more about using break-even analysis as a management tool? We'd be glad to discuss it with you.
Your will is up to date. You've executed both a health-care proxy and a power of attorney. And you have life insurance. What else can you do to make sure your family will be taken care of should something happen to you? Take another look at life . . . insurance.
Do You Have Enough?
One of the most common mistakes people make is underestimating the amount of money their families will need should a breadwinner die unexpectedly. Inflation can take a big bite out of a life insurance payout over time. And families, especially young ones, will need financial help for many years. The lesson: Don't skimp on insurance coverage.
What's Your Policy?
People often confuse term life insurance with permanent life insurance. Term insurance, which expires after a certain number of years (unless the policyholder dies, of course), is attractive because the premiums are lower. And it's a good fit when coverage will be needed for a predictable period of time.
But, if the term expires and the insured still needs coverage, the renewal policy may be much more costly. Permanent insurance is generally a better choice when there is a long-term or indefinite need for coverage. Most permanent life insurance policies build up a cash value, while term policies do not.
An in-depth assessment of your financial situation and your long-term goals will provide a much more detailed picture of your insurance needs. We'd be happy to help.
Number One is well dressed, articulate, and quiet. Number Two appears to be less professional, but is outgoing and personable. Their resumes indicate that both candidates have admirable job histories and solid references. Which one will you hire? More and more employers are turning to pre-hire tests for help.
Skill tests
Having job candidates take skill-based tests confirms that they have the skills they claim to have and shows how well they compare to others in the field (and the employee who's being replaced, if that is the case).
Skill tests
Personality tests
Measuring traits like flexibility and ambition, personality tests provide an indication of candidates' interpersonal skills.
But be careful; there are legal issues to consider. Always treat all candidates for the same position equally. And use objective, trustworthy tests that pertain only to skills relevant to the position you are filling.
Establishing a new business relationship and starting your first project together can be very exciting. You already have systems in place to help you establish a timeline and keep track of the details. But what's your system for billing your new customer or client?
Making Advances
Asking for an advance is a fairly common practice. Amounts generally range from 10% up to as much as 50%. The remaining charges are then billed when a predetermined amount of work has been completed. In some cases, the outstanding charges aren't due until all the work has been completed.
The drawback with this approach is that your new customer probably has high expectations. If you've asked for a sizeable advance, it may be difficult to meet those expectations in the early stages. In some cases, requiring a large advance can be the beginning of a rocky relationship.
Like Clockwork
Another common practice is to divide a project into "equal" intervals and bill accordingly. The first bill would be due when the project is 25% completed, the second bill when you're 50% finished, etc., The trouble with this approach is that your and your new costumer's impression of 25% finished may differ may differ considerably. Spell things out as clearly as you can in advance if you choose this option.
It Can Wait
This one's a breeze. You start a project, you finish it, you send the bill. Of course, this method makes two assumptions: one, that your cash flow is flush, and two, that the customer trustworthy.
Feelin' Groovy
This approach can be comforting to new customers. Send frequent, incremental bills in the early stages so they can see the work their payments cover. At the same time, you recoup your costs as they are incurred. This can help you establish a good rapport and, once you and your client are in the groove, you can bill less frequently.
Jean's nephew wants to expand his business and has asked her to lend him a substantial amount of money. Jean wants to help him out, but she's not sure it would be wise.
Lending money to a family member or friend requires at least as much caution as any other important financial decision. So Jean should be sure to base her decision on facts not emotions.
Will loaning the money compromise Jean's own financial situation? if it will, she should probably decline. She may find it difficult to say no, but if making the loan means scaling back on her own plans - for retirement, for instance - her relationship with her nephew may become permanently strained if she doesn't refuse his request.
If Jean has the means to make the loan, she'll want to make sure that her nephew has a detailed business plan and that he shares it with her, for his protection as well as her own. If she has serious questions about his changes of success (and, thus, her chances of success (and, thus, her chances of being paid back), she'll want to voice her concerns.
Family loans can have complicated income -, gift-, and estate-tax consequences. If Jean decides to go ahead, she should have a formal loan agreement drawn up that spells out the interest rate and repayment terms. Without documentation, the IRS could argue that the transaction we a gift rather than a bona fide loan.
Are you considering lending money to a friend or family member? We can help you weigh all the relevant financial factors and structure the loan so that it will withstand IRS scrutiny.
Flexible spending arrangements (FSAs) allow employees to set aside money on a pretax basis to pay health and dependent care expenses. Under a longstanding tax rule, employees have been required to "use or lose" their FSA money by the end of the plan year. As under the old rule, any amounts not spent by the end of the grace period would be forfeited.
A study conducted earlier this year for the National Council on Economic Education found that most high school students have not mastered basic economic concepts. Students' average score on a 24-question quiz in economics and personal finance was 53, a failing grade. Only 9% of students received an A or B on the quiz.
401(k) plan participation rates rose slightly in 2004, to 70.3% of eligible employees, according to a bench-marking report from Hewitt Associates. The average account balance was $68,630. More than 25% of employees held half or more of their 401(k) balances in their employer's stock, despite the widely publicized losses sustained by Enron plan participants who were heavily invested in Enron stock.
About 3% of the W-2 forms filed each year contain Social Security numbers and names that do not match the Social Security numbers and names that do not match the Social Security Administration's records. Employers that want to avoid mismatches (and the resulting paperwork) can use the Social Security Administration's Employee Verification Service when they hire an employee.
Q. My eight-year-old son went to day camp this summer. Does the cost of day camp quality as an expense for the child care credit.?
A. Yes, if you sent your son to camp so that you (and, if married, your spouse) could work. The credit rate ranges from 20% to 35% (depending on your income) on up to $3,000 of expenses for the year (6,000 for two or more children)
Q. I operate my business through a corporation and a subsidiary. Several of my key people work for both companies and receive separate paychecks from each. Are we paying more Social Security tax for them than necessary?
A. You could be if your shared employees earn more than the Social Security wage base ($90,000 in 2005). Let's say one of your employees earns $120,000, split 50-50 between the companies. Each company pays $4,590 of tax (a total of $9,180, based on a Social Security tax rate of 6.2% and the 1.45% Medicare tax). If, instead, you paid the employee through a "common paymaster" (the parent company), the tax would come to just $7,320, since the maximum amount of earnings subject to the 6.2% Social Security tax is capped at $90,000. (All wages are subject to the Medicare tax).
The general information in Client Line may or may not be appropriate to you. Before applying anything you read to your personal or business situation, you should contact us.