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Income Tax

Is a personal gift or loan taxable?

If your parents sent the money as a gift, it is not taxable. Likewise, if they sent the money as a loan, it also is not taxable. Any interest you paid to your parents on the loan, however, would not be deductible on your taxes as it is considered a personal loan.

Although the gift or loan is not taxable, you may need to report the amount. If the funds advanced are in excess of $100,000, you must file a Form 3520 with your income tax return. You also would need to report any interest you receive on such funds on your income tax return.

Do I have to report foreign funds to the IRS?

You only need to report and pay taxes on income. The treatment of the principal is the same whether you have the account in a foreign or United States bank. Removal of principal is a non-taxable event.

If you have funds in a foreign bank, however, you are supposed to file a Form TD F 90-22-1 with the Treasury Department if your combined overseas balance exceeds $10,000 on an annual basis.

For how many years must I file back taxes?

f you owe no taxes, you probably will have no problems with either the Internal Revenue Service (IRS) or the California Franchise Tax Board (FTB), assuming you reside in California. Be aware, however, that you will not receive refunds more than three years old. So, for example, if you filed all your returns for tax years 2002 through 2011 by April 15, 2013, you will only receive refunds for tax years 2009, 2010 and 2011. (Refunds for a tax year come in the following year. A refund for tax year 2009 would have come in 2010 if you had filed your 2009 taxes on time.)

Even if you believe you are due a refund, it is to your advantage to file your income tax return. If you don't file a return, the IRS may file a substitute return on your behalf based on the information reported to it by your employers, banks and stockbrokers. Such a filing likely will not include all your exemptions, credits and deductions. So the IRS might find that you owe taxes. The FTB also requires you to file if you meet certain income levels.

And if you owe taxes for any of the years you missed, you will be subject to a failure to file penalty, a failure to pay penalty and interest on each of those years. Therefore, you should file as early as possible for all the years you failed to file. Once you file, the IRS has up to 10 years to collect taxes, penalties and interest on the taxes you owe. The FTB has up to 20 years. If you don't file and owe taxes, the IRS and state have no time limit on collecting taxes, penalties and interest for each year you did not file.

If you owe back taxes, consult a qualified tax preparer such as a CPA as well as legal counsel. These professionals can help you find any deductions and credits that will reduce your overall tax bill. They can also negotiate with the IRS and FTB to set up a payment schedule you can reasonably meet. Tax laws change; so the quicker you attend to this matter, the better.

Do I have to file taxes in two states?

Although you were a resident of another state for some years, you will be considered a part-year resident for the year that you moved to California. You will have to file a part-year resident income tax return for each state. Your wages are allocated to the state where the income was earned, so there should not be any double taxation.

Podcast discussing how to handle a notification that you owe back taxes


Sales Tax

When are services subject to California tax?

You may sometimes have to charge sales tax, while at other times you should not.

California law restricts the application of sales or use tax to transfers or consumption of tangible personal property or physical property other than real estate. Unlike many other states, California does not tax services unless they are an integral part of a taxable transfer of property. The law does not specifically name most services as exempt, but such activities are automatically excluded from the tax base because they are outside the definition of tangible personal property.

Two types of service activities still may be swept into the tax base, however. The first is any service that is so tied to the sale of property that it is considered a part of that sale and, thus, inseparable from the measure of the tax. Example: a taxable sale of machinery that the seller must calibrate as a condition of the sale. The calibration fee will be taxable even if the seller separates the charge.

The second taxable service is fabrication. Fabrication (manufacturing) is the labor involved in creating tangible personal property that is different in form or function from its component parts. This type of labor includes something as simple as drilling holes in a metal strap and bending the strap to make a bracket. The charge for drilling and bending would be taxable unless some other exemption applied.

The line between taxable fabrication and nontaxable repair labor can be hard to discern. For example, the alteration of new garments is taxable but the alteration of used clothing is exempt. Thus, if a person buys new clothing and takes it to a tailor to be altered, the tailor must charge sales tax on both the labor and the price of any materials provided. Reason: the alteration is regarded as a step in the creation of a new item, which is taxable fabrication. (See California Sales and Use Tax Regulation 1524(b)(1)(A).)

Conversely, if the same person buys the clothing, wears it, and then brings it to the same tailor for the same alteration, the tailor’s services will be regarded as exempt repair or restoration labor. The tax will only apply to the sale of any accompanying materials and supplies, and then only if either the retail value of the materials and supplies is separately stated on the bill or the value exceeds 10 percent of the tailor’s total charge. (California Sales and Use Tax Regulation 1524(b)(1)(B).)

Sales and use tax law is often assumed to be relatively simple and straightforward.

As you can see, that assumption may be hazardous to your financial health.

Should service technician charge sales tax?

In California, sales tax is applied to the retail sale of tangible personal property when it changes hands. That being the case,  the technician would not charge sales tax for the service s/he provides for the adjustment or repairs for equipment already sold and installed. Were s/he providing repair parts, sales tax would be applied on those items, but not on the labor to install.

Can a sales tax be added to a delivery charge?

California sales tax rules say that if a seller has a fixed fee for the delivery of goods delivered to the ultimate customer, the seller must charge tax on the entire amount unless the seller can document that the fee is exactly the cost to make the delivery. From your question, it looks to me like the pizza storeowner charges a flat fee for every delivery. The fee is probably designed to cover a reimbursement to you for your average fuel and other travel costs and your identified tip of $1.60. It is, therefore, proper for the owner to charge sales tax on the total delivery charge.

The good news is that any tip the consumer voluntarily gives to you is not subject to sales tax. Wouldn’t it be awful if, in addition to reporting that tip for income tax purposes, you had to charge the consumer sales tax, too? It would make the job very complicated.

Do I charge sales tax on cleaning services?

Under California sales tax rules, cleaning or janitorial services are exempt from having to charge sales tax even when certain products (cleaning products and supplies) are used incidentally in connection with the services. If, however, you should sell and separately bill for cleaning supplies or products, you should charge sales tax for that portion of the sale on invoices.

California State Board of Equalization’s Publication 61, “Sales and Use Taxes: Exemptions and Exclusions,” states: “SERVICES—The sale of services where no tangible personal property is transferred or where the transfer of property is incidental, are not subject to sales and use taxes. Persons providing services are consumers of property used in their business activities. However, persons who engage in service operations are retailers of any supplies or other tangible personal property sold to their customers or clients, and tax applies to gross receipts from such sales. Certain services, however, are deemed as sales of tangible personal property. For example, the fabrication of tangible personal property for a consumer is deemed as a 'sale' even when the consumer provides all the tangible personal property used to fabricate the end product.”

California sales tax rules can be confusing and complex. So you might want to seek the advice of a knowledgeable certified public accountant (CPA) to be sure that your services are tax exempt or that you need to charge sales tax.

Podcast discussing when and when not to charge sales tax


1031 Exchanges

How long can I delay renting property involved in a 1031 exchange?

You can take some or all of the proceeds from a 1031 exchange out of the exchange and use it for any purpose you like. There are many calculations that are necessary in order to determine whether this would be considered a taxable event. Generally speaking, however, withdrawal of funds would be a taxable event.

The tax rate on the cash that you withdraw depends on the property that was sold. You may have sold raw land, rental real estate, a business, a vehicle or collectibles. Normally, if there is tax, you recognize the income first that has the highest tax rate. For example, you take $10,000 out of the exchange upon the sale of rental real estate that you held for over one year. You also previously reported $5,000 of straight-line depreciation. Of the $10,000 gain that you will report, you will first have $5,000 of depreciation recapture taxed at 25 percent and the rest taxed at 15 percent. If you are in California, all reportable gain will be taxed at normal rates.

Tax rates for asset sales that are fairly prevalent are as follows:

  • Raw land held over one year—15 percent
  • Collectibles held more than one year—28 percent
  • Real estate straight-line depreciation recapture—25 percent
  • Real estate accelerated depreciation recapture—ordinary.

There are many other types of assets that might be exchanged and each may have one or more of the above tax rates applied.

Like-kind exchanges are complicated. You would be wise to seek legal advice or consult a CPA should you want to transfer your property in a future 1031 exchange. You can find out more about like-kind exchanges by watching or listening to CalCPA’s Financial Empowerment podcast on the subject.

Will proceeds from a 1031 exchange be taxed?

As long as you are holding the property for investment purposes and are not using them primarily for personal use, you can wait to rent either property until you complete improvements. You note that one property is a vacation home. If you plan to occupy the vacation home yourself for at least a portion of the year, however, you must comply with certain rules in order to ensure that it retains its status as a 1031 exchange. Primarily, you should occupy the vacation home no more than 15 days of each of the two (fiscal) years after date of purchase. If you occupy the property personally for a longer time, it will be uncertain whether it will still be considered 1031-eligible.

Like-kind exchanges are complicated. You would be wise to seek legal advice or consult a CPA should you want to transfer your property in a future 1031 exchange.

Podcast discussing 1031 exchange rules


IRAs

Who pays taxes on a Roth IRA?

There are a couple of issues here. Possible taxes are income taxes or gift taxes. You cannot transfer a Roth IRA to another person during your lifetime, so a gift to your wife is not possible. You can, however, name her as the beneficiary of the Roth IRA, and she would have free access to it once you pass away. If you want to make an immediate gift to your wife, you can take money out of your Roth IRA and do so, but you would lose all of the future tax free benefits of a Roth. There is no gift tax imposed on gifts to your spouse if she is a United States citizen.

There is no income tax on amounts withdrawn from a Roth IRA once you have had a Roth IRA for five years. If you have more than one Roth IRA, the five-year period begins when you open the first one and all subsequent Roth IRAs use the same five-year period as that first one. So if you have had your Roth IRA for five years, anything you take out of it is income tax free. If your wife inherits the IRA when you pass away (after you've held it for five years) all of her withdrawals would be income tax free as well.

If you open a Roth IRA in 2013 and pass away in 2016, for example, your wife could withdraw your initial contribution tax free but would be taxed on the growth of the Roth IRA if she took additional amounts out before 2018 (five years later).

There are no required distributions during your lifetime from a Roth IRA and also none are required for a spouse beneficiary. Once both of you are gone, any nonspouse beneficiary must begin required distributions (tax free if the five-year period has passed) beginning in the year after the second death.


Capital Gains

What taxes do I pay if I sell a house below its basis?

When someone dies, the inherited property gets what is known as a step-up in basis. For example, in your situation, it does not matter that hypothetically, your mother paid $200,000 for her home. Your cost basis would be the appraised value on the date of death, or $900,000. Let’s assume that you sell the home for the asking price of $788,000. You would then have closing costs that would increase your loss. Let’s assume that those closing costs would be $48,000, which would increase your capital loss from the $112,000 difference in basis and sales price to $160,000. You are allowed to use this loss to offset capital gain income in the future or concurrently. You are only allowed to deduct $3,000 in capital losses each year against ordinary income. The remainder gets carried forward indefinitely. So instead of paying a tax, this transaction would generate a capital loss that would provide you with some significant tax benefits.

Can I pay taxes before selling a property?

Unfortunately, there is no way to prepay your taxes based on the current tax rate when you have a property with a low basis from a 1031 exchange. The only trigger to incurring the tax would be the sale. Of course, you would be paying taxes at whatever the prevailing rate is in the year of sale.

There are two ways to avoid the tax. One would be doing another 1031 exchange into another property, which would just be another deferral. The other way is if you hold the property until you die. When you die, your heirs would get a step-up in basis to the fair market value on the date of death. Unlike the 1031 exchange, which is a tax deferral, this step-up in basis is an elimination of the tax. Of course I am just talking about income taxes, not estate taxes. The current (2013) estate tax exemption is $5,490,000