INITIAL STEPS TO OPENING YOUR BUSINESS

By: Jeffrey Skolnick, CPA, M.S. Taxation

This blog is meant to start you out on the right path when you open your business. I will cover the basic steps that should be followed.

The steps are shown below:

Write a business plan. This is a blueprint of the way you will run your business. Although not the sexiest of things to do (most new business owners are passionate about their products and services), however writing a business plan will force you to consider many areas in a more structured way which will increase your chances of success. A business plan will include a description of your products/services, the type of entity structure you are operating under (i.e., sole proprietorship, partnership, S or C corporation), market analysis, funding requirements and projections among other things. For more information on business, plans see my podcast on business plans or go to my website www.jeffcpaworld.com and check out my blog.

Determine and entity type. Before you begin your business, you must determine whether you will operate as a sole proprietorship, partnership, LLC, S or C corporation.  There are advantages and disadvantages to each, and you must decide which entity form is most beneficial to your situation. This is an area where you no doubt should work with a tax professional. Some things to consider are your overall tax liability, legal liability, and complexity of each entity type.  For more information on entity structure, see my podcast on choosing an entity structure or go to my website www.jeffcpaworld.com and check out my blog.

Form with the appropriate state or states. Once you’ve determined the entity structure type that you would like for your business you must register with your state.  Most states require you to perform a name search before you open. This is to avoid two businesses with the same name or having names so close that it confuses the public. Upon formation, you will receive some type of Certificate of Formation or Articles of Incorporation.  This is a step that sole proprietorships can typically avoid. I would also include filing a DBA (Doing Business As) or Alternative Name as well. These are used when the entity is formed under one name (possibly the name of the owners), but the business operates under a different name. Once your entity is formed, you will now be recorded with the Secretary of State.  You will form in only one state, but if you do business in multiple state you will most likely have to register in each state.

Register with the Federal government and the appropriate state or states. Once you’ve legally formed your organization, you must obtain an Employer Identification Number (EIN) from the IRS (this step is not a requirement of sole proprietors unless they have payroll). This can be done online and typically only takes under 15 minutes. You must also register for taxes with the state. This is a separate step from forming your organization. Every business should register for tax purposes, including sole proprietorships.  The most common types of taxes you will register for are income, payroll, and sales, and use taxes. There can be other taxes as well, but again these are the most common. I want to mention again that it is possible that you may be required to register with several states aside from your state of organization.

Order a corporate book. You must order a corporate book if you form as a corporation or an LLC. Partnerships and sole proprietors are not required to maintain a corporate book. A corporate book will contain your Articles of Incorporation or Certificate of Formation, by-laws, operating agreement, minutes and certificates issued to shareholders or members.  The reason for a corporate book is that since there is legal protection offered by your entity structure if you are a corporation or an LLC, you must treat your company as a separate entity. In other words, when you spend money from your corporation or LLC you should document that your members or shareholders (even if it’s only you) consent to you spending this money. Corporations are required to have annual shareholder meetings. The corporate book is where you would record the minutes of such meetings. If legally it can be proven that although your company was incorporated or formed as an LLC but you are treating the organization as your own personal piggy bank then if you are sued, the plaintiff my be able to “pierce the corporate veil” meaning you lose the liability protection normally offered by these entity types. The reason sole proprietorships and partnerships are not required to have a corporate book is there is no legal liability protection in these entities, to begin with.

Prepare your by-laws or operating agreement. Whether you’ve formed a corporation and are writing your by-laws or a partnership or LLC writing an operating agreement, this is one of the most important documents you can have. These are the rules by which your organization is to be run. This will explain titles, responsibilities, and requirements for the shareholders, partners, or members. These will cover items such as what happens if additional capital is required, how to deal with the death of a shareholder or member, and how to dissolve the organization.  Very often, lenders may ask for an operating agreement. It is also vital that these agreements are written when the entity is formed. Far too often, I run into individuals that did not want to spend the time on this when they formed their entity, and it is too late to write them once a dispute has arisen.

Establish a bank account. Once you’ve received your EIN, open a bank account in the name of your business. Sole proprietorships that do not obtain an EIN (they are operating under the taxpayer’s social security number) should still have a separate bank account for their business.

Check on other miscellaneous items that affect your business. Don’t be fooled by the fact that I use the term miscellaneous. These can be very important. The areas I am thinking of here are insurance needs and licensing or permit requirements.  I believe you should speak with an insurance professional to determine your needs and be careful to make sure you are aware of all licensing and permit requirements for each jurisdiction in which you operate.

Consider your funding sources. Most start-up businesses will require cash infusions in their early stages while building their organization. Make sure you have considered where this money will come from; savings, home equity line of credit, business line of credit, family or friends, and last resort credit cards.  Please keep in mind if you are going to borrow the money you will be required to show financial statements and will almost certainly have to personally guarantee the loan.

Establish a proper system for accounting. Now you’ve formed your business and performed each of the steps I’ve outlined, the next area you need to address is a bookkeeping system. I always tell my clients to use a system like QuickBooks. It is by far the most widely used small business program; all small business accountants are familiar with it, it’s user-friendly and relatively inexpensive.  I also tell my clients that the main reason for keeping your records on QuickBooks is not to give me information in February or March, but it is to assist you in managing your business. A proper set of books will show you trends of your busy and slow periods and help you analyze items of income and expense in order to make informed decisions. A proper accounting system, in my opinion, should also include a system to file sales invoices, paid bills, bank reconciliations, tax filings, insurance policies, employee personnel files, subcontractor files, and any contracts entered into by the business.

Conclusion.  I will repeat myself here. The steps required to setup a business are not the most exciting part of starting your business. I am very aware of this.  I do believe, however, that taking the time to set your business up correctly will make you say more than once, “I’m glad I took care of that.”

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Why write a business plan?

Article By: Jeffrey Skolnick, CPA, M.S. Taxation

A business plan is going to serve as a blueprint to the way you run your business. By far the biggest mistake I see individuals make when they decide to open their own business is they do it without enough thought. Let’s face it, writing a business plan is not fun, and most people go into business because they have a passion for something and very few people have a passion for anything as tedious as a business plan.

One reason you should do one, even if it is not a long plan is that it will require you to think about some things that are vital to your existence and should help you map out your future strategy.  Another reason may be if you are looking to raise capital, either through investors or borrowing, then you will need to provide information to the potential investors or lenders so that they are comfortable with going forward with you.  Keep in mind most startup businesses do not make it, and while I don’t know the statistical data, I can guarantee you those that plan will vastly increase their chances of success.

Where can I find out more about business plans?

There are some very good resources to choose from that can help you write a business plan. There are software packages that can walk you through the process and guide you to what information you require, and it will also require some research on your part. I believe the initial research is one of the biggest keys to your success, and I will explain a little more as we move along. While there are a lot of software packages, I also recommend searching the U.S. Small Business Administration website www.sba.gov.  This is a great free resource, everything is written in easy to understand language (as opposed to legalese), and there is some great information. I believe by spending just a little time there; you can gain some clarity on what you are trying to accomplish.

What is included in a business plan?

A traditional business plan will contain the following key elements:

Executive summary. This is going to a brief description ofwhat your business is, what need you are going to fulfill, and why you believe you will be successful. This is a summary of the overall plan. The details will be put forth in the remaining sections. Think of this as your elevator pitch or 30-second story. In other words, you want to explain what you do, how you do it, and why you do it very briefly.  

Company description. As the title suggests, this is information about your company. You will explain:

• Your products and services
• Your target market
• Your ownership, both from the type of legal entity you are (i.e., sole proprietor, partnership or corporation) and who you owners are as well as their experience
• Any advantages you may have in the market

This is going to be a detailed explanation of who you are and why you will succeed. I stress that even if you are not currently looking for investors or lenders that you approach this section as if you were seeking one or both of these groups. This will force you to think about your business in a more structured manner.

Market analysis. In my opinion, one of the most important areas you can think about. I am reminded of the old Honeymooners episode where Alice is scolding Ralph on some of his past ventures, and she asks about the time he invested in a parking lot near the new movie theater? He answers with, “How did I know they were building a drive-in theater?” While that is funny, you want to look at the market and see who your competition is. How will you compete and what will you need to do to be successful.

Organization and management. This area will explain the type of entity structure you will have (sole proprietorship, partnership, LLC, S or C corporation) and an organizational chart. This is also the area where you would explain the major players and possibly their qualifications.

Service or product line. Think of this as if you were going to appear on shark tank. You will explain either what your services are or what products you sell. Make sure you are thinking about the benefits to your customers/clients. Nobody spends money to benefit you. People spend money because they see value to themselves.

Marketing and sales. This section, while it will vary greatly depending on several variables such as business type or geographic region to name a couple, lays out how you will attract clients/customers.  Marketing is an area that is a constantly changing trial and error pathway. How many times have you seen or heard companies asking how you heard about them? These companies are spending money on advertising and attempting to determine the effectiveness of such advertising.

Funding requirements. Another key area that I see that causes business owners huge headaches. It is key that you understand how much money your business will require and how you are going to use it. Again, let’s go back to the show shark tank. The panelists will almost always ask, “What will you use the money for?” No lender or investor wants to give his or her hard-earned money to someone who is “winging it.”  If you’re a brick and mortar store, you may require funding for equipment, advertising, personnel, etc. 

You will also look at your business to determine your slow and busy times during the year. In my business, for example, I have much greater cash flow February through May then I have in August and September.  It is important to think of all the money you will need for funding capital expenditures and operations. Very few thing will make you less prepared then asking for money and then six months later asking for more because you didn’t anticipate correctly.

Financial projections. You will want to show projections to potential investors or lenders to give them a reason to give you their money. If your business is established you will use your current financial statements (balance sheet, income statement and cash flows statement). You will also show your projections over the next five years or so. New businesses will obviously only show projected numbers. When making financial projections you can should be more detailed and more accurate with the near term (next year or two).

These are the  basic areas of a business plan.  The SBA also lists an Appendix section for additional materials requested but I’m not going to cover that here.  The SBA also mentions a “lean startup format” which is a much simpler version of what I just discussed. Theses are sometimes referred to as a Business Model Canvas.

Conclusion. Although not typically the first thought on a new owners mind (these individuals are usually focused on their products or services), having a business plan will increase your odds of success greatly. If the venture is worthwhile, then please spend the time to make sure your foundation is solid before you build your house.

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Article by: Jeff Skolnick, CPA, M.S. Taxation

This question is one of the most popular ones that I receive from clients.  Usually when this question is posed it is actually code for “I want to throw some paperwork out and I want you to tell me its okay”.

The most common answer

If you consult the IRS website or speak with tax preparers they tell you to retain most records for 7 years.  

The general rule for an audit is that you may be audited for 3 years after the later of the due date of the return or the date the return is actually filed.  This would mean that if you filed your 2018 tax return before April 15, 2019, then you could be audited until April 15, 2022.

Another part of the statute for audits allows the IRS to go back 6 years if you do not report income that should have been reported and it is more than 25% of the gross income shown on your return.

The answers that you may not like now, but may save you later

I suggest that my clients retain copies of all tax returns indefinitely.  They can be useful even once the most common 3 or 6 year statute of limitations have passed.

If you have not filed your return, then the statute of limitations does not start to run.  If you receive a notice from the IRS about a return from 10 years ago that they claim was never filed, the easiest way to answer them is by providing a copy of the return.  In the age of electronically filed returns this problem has been greatly reduced as the IRS sends confirmation once electronically filed returns are received.  Although the risk has certainly been reduced, I still advise clients to retain all tax returns. If you prefer not to take up the space with actual hard copies (paper) of your return, then I suggest keeping them in electronic format.

In addition, if the IRS suspects fraud, the statute of limitations is indefinite.

The retention time for financial records pertaining to investments is much longer.  For example records of stocks purchased would have to be kept from the day the stock was purchased until 7 years after the security was sold. This is even more important if you have dividend reinvestment plans as each year you are adding to the basis of the security.  Keep in mind that if a security is gifted, then the person receiving the gift generally has the same basis as the person giving the gift and therefore should be given proof of basis along with the gift. In addition, you should retain the closing statement from the purchase of your home as well as records for any improvements you made over the years until your home is sold.

If you have received property through an inheritance, such as real estate or portfolio instruments such as stocks, bonds or mutual funds then you would want to keep the proof of the basis.  The reason for this is the tax code allows for a “step-up” in basis of assets received from a decedent.  In other words let’s say a parent purchased a home for $100,000 and over the years spent another $60,000 in improvements.  I will also say that the home was worth $500,000 at the date of death of the owner.  Although the owner had a basis of $160,000 because it was conveyed to you through an inheritance your basis would be $500,000.  Proof of this basis would come from tax returns or appraisals and would have to be retained for 7 years following your sale of the property.

Certain paperwork such as tax returns (previously mentioned), formation papers, bylaws, minutes and partnership agreements should be kept indefinitely.

Please keep in mind that I have only been discussing the IRS, however your state taxing authority could also audit your return.

Conclusion

I know there are many rules as to which records should be kept and for how long.  The good news is that most people have computers today and records can be scanned to save space.  Once again if you’re not sure, then check with a tax professional before discarding any records. 

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Deducting Automobile Expenses

Article by: Jeff Skolnick, CPA, M.S. Taxation

Who can deduct automobile expenses?

Any business may reimburse individuals who use their automobiles for business purposes and deduct those expenses.  This includes self-employed individuals as well as small or large businesses.  You must keep in mind; however, that commuting mileage does not count as business mileage. Additionally, the automobile should be owned by the business entity and not the individual.

There are special rules if you are an employee.  For many years you were able to deduct your expenses; however, your deduction was reduced by any reimbursements received from your employer.  Your overall deduction was reported on your tax return as a “miscellaneous” deduction on Schedule A. These expenses when added together with other miscellaneous deductions such as other unreimbursed employee expenses, union dues, investment fees and tax preparation fees were deductible to the extent that they exceeded 2% of your adjusted gross income (AGI). 

As of 2018 miscellaneous itemized deductions subject to 2% of your adjusted income were all eliminated.  2017, therefore is the last year these expenses were allowed as a deduction on a personal income tax return. These new rules force employees to request reimbursement from their employer, otherwise the employee will be out the money.

What automobile expenses are deductible?

When deducting automobile expenses, you have a choice of one of two methods.  The first method is to use actual expenses.  Actual expenses would include gasoline, oil, repairs, registration fees, insurance, depreciation and lease payments.

The second method would be to use the standard mileage rate published by the IRS.  Using the standard mileage rate eliminates the need to keep track of all of the above expenses.  You simply track the amount of business mileage driven and multiply those miles by the appropriate rate.  The standard mileage rate for 2019 is 58 cents per mile.   

Parking fees and tolls can be taken as additional expenses whether you elect to use actual expenses or the standard mileage rate.

In this blog I am concentrating on business mileage. Keep in mind the mileage rate for those who itemize and use their vehicle for medical reasons may use a standard mileage rate of 20 cents per mile as a medical expense deduction also 14 cents per mile if the vehicle was used for charitable purposes.  Keep in mind that the medical mileage increases medical expenses, however, medical expenses must exceed 10% of Adjusted Gross Income (AGI) in order to count as an itemized deduction.

Additionally, charitable mileage counts as an itemized deduction but in order to benefit from either medical mileage or charitable mileage you must itemize on your tax return.  Please keep in mind with the new higher standard deductions (ie $24,000 for married individuals filing jointly) far fewer individuals will itemize than used to be the case.

Can I switch from one method to the other in later years?

You are not allowed to switch from the actual expense method to the standard mileage method in a later year.  You are allowed to switch from the standard mileage method to the actual expense method in a later year although there are some special rules concerning depreciation expense.

It is therefore very important to plan your expected benefits under each method before you report the expenses of a vehicle placed in service during the year as your first year of reporting has an impact on all future years.

Special rules for Luxury Automobile Depreciation

Long ago tax law carved out a special deduction for luxury automobiles. This was done to stop the very wealthy from deducting what were determined to be luxury automobiles as an ordinary and necessary business expense.  Think about from a standpoint that the IRS does not want to see a business depreciating a $300,000 Ferrari over five years.  Almost everybody would agree that a write off of that nature is over the top. 

The problem was the IRS for years was using a figure that was far too low.  For 2017 the luxury automobile depreciation limitations were $11,160 in year 1, $5,100 in year 2, $3,050 in year 3 and $1,875 in each subsequent year until the automobile is either fully depreciated or disposed of.  These limitation figures allowed taxpayers a write off of only $23,060 after five years.  It would be difficult to find anyone that would classify an automobile with a price tag of $23,060 a luxury automobile. 

Luckily the new tax law made changes to these figures and beginning in 2018 the new luxury automobile limitations are $10,000 in year 1, $16,000 in year 2, $9,600 in year 3 and $5,760 in each subsequent year.  These new limitations allow for $47,120 of depreciation on a luxury vehicle over the first five years.  I feel this adjustment was long overdue and makes much more sense in today’s world.

Recordkeeping Requirement

In order to deduct automobile expense, you should keep a log in which you record the date, where you traveled, the business purpose, the mileage and any expenses incurred such as gas or tolls.  Nowadays this has become much easier with the use of telephone apps that can track this for you.  Keep in mind if you do not meet the substantiation requirements, then your automobile deduction may be disallowed.

Conclusion

This blog gives only the very basics concerning automobile expense deductions. Once again if you’re not sure of the rules, then check with a tax professional before taking these deductions. 

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Article by: Jeff Skolnick, CPA, M.S. Taxation

There is always a great deal of discussion on capital gains and losses, including special tax rates and short term and long term holding periods.

This article addresses some of the basic questions.

What Transactions Are Considered Capital Transactions?

Gains or losses resulting from the sales of capital assets are capital transactions. The Internal Revenue Code defines a capital asset as any property except:

1. inventory;

2. depreciable or real property used in the taxpayer’s trade or business;

3. specified literary or artistic property;

4. business accounts or notes receivable; or

5. certain U.S. publications.

The most common types of capital assets would include stocks, bonds, mutual funds, and land held for investment.

What Are The Current Tax Rates on Capital Gains?

Short term capital gains are taxed at the same rates as ordinary income (somewhere between 10% and 37% depending on your tax bracket).

Long term capital gains also have different rates. The long term capital gains tax rates are 0%,15% or 20% depending on your taxable income and filing status.

There are also long term capital gains taxed at 25%. These occur in certain sales of depreciable real estate.

There is also a 28% tax rate used for collectibles and certain corporate stock sales.

What Is The Difference Between Long Term And Short Term Capital Gains?

Assets held for one year or less are considered short term while assets held for more than one year are considered long term.

Can Capital Losses Be Used To Offset Capital Gains?

Although short term and long term capital gains are taxed at different rates, losses from one category can offset income in the other. For example, if you have a $10,000 short term capital gain and a $5,000 long term loss, then you would be taxed on $5,000 of gain at ordinary income tax rates.

If the situation was reversed (a $10,000 long term gain and a $5,000 short term loss) then you would be taxed on $5,000 at long term capital gain rates.

Keep in mind that although your losses can exceed your gains, you may only deduct $3,000 of losses in excess of gains in any year. If we change the example above to a $10,000 short term capital gain and a $30,000 long term capital loss, then you would offset all of the $10,000 short term gain plus an additional $3,000 with the long term loss. Since your long term loss was $30,000 and only $13,000 was used, then the remaining $17,000 is carried over to the next year’s tax return.

Although capital losses can be carried forward indefinitely, they may never be carried back against prior year capital gains. This can have a profound impact on your return. 

Let’s say that you have a $1,000,000 capital loss one year and a $1,000,000 capital gain the next year. For this example, ignore the rule about allowing $3,000 of capital losses in excess of capital gains as it is immaterial and makes the example a little easier to understand. In the situation I just outlined clearly the $1,000,000 of unused capital loss can be carried forward to offset the capital gain in the next year resulting in $0 of taxable income.

If I change this scenario around and have the $1,000,000 capital gain occur in year one and the $1,000,000 capital loss in year two the result is the $1,000,000 is taxed as a capital gain (long or short term based on the amount of time the item had been owned) in year one and the $1,000,000 loss in year two cannot be used to offset this gain. It can only be used to offset future capital gains plus an additional $3,000 per year. If in year two the taxpayer had a $20,000 capital gain then $23,000 of the loss would be used (enough to offset all of the gain plus an additional $3,000) and $977,000 would be carried forward.

The reason I point this out is it is a rule that I believe to be unfair. In both scenarios, there was a $1,000,000 gain and a $1,000,000 loss which should net to $0. Unfortunately, because of the way the law is written if you incur a gain before a loss you will pay taxes even though economically you were not any better off than if you incurred the loss initially and then the gain.

Net Investment Tax

There is a net investment income tax of 3.8% which is levied on taxpayers with Modified Adjusted Gross Income over $250,000 for married individuals filing jointly, $125,000 for married individuals filing separately and $200,000 for everyone else. This tax is on the lesser of the investment income or the income in excess of the aforementioned limits. Capital gains and losses are considered to be investment income. This tax is in addition to any income tax levied whether at ordinary rates or more preferential long term rates.

Tax planning

As a general rule, I would like tax consequences to be a factor in your investing strategy, but by no means the only factor. For example, if you are thinking of selling a real estate investment property and you are planning to buy another, then, by all means, see if you can take advantage of the tax-free exchange provision or even move in for a few years to then get the sale of home residence exclusion. I also, like many accountants, advise my clients to search for items in their portfolio that may have losses and you no longer like. If you like a stock and it is just down, I don’t advise selling it to take a loss and buying back later. First, if all if you do this too quickly (within 30 days) this is called a wash sale and the loss is disallowed.

Conclusion

This article discusses capital gains and losses. While I have given a quick overview, this area can be quite complex. I would encourage anyone with significant capital transactions to contact a tax professional.

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Article By: Jeff Skolnick, CPA, M.S. Taxation

There are a number of items available in the tax code to assist taxpayers paying for qualified education expenses. These include tax credits, deductions and even a way to eliminate penalties on IRA distributions before age 59 ½.

I will start with the two different credits available for higher education tuition and fee expenses.  They are the American Opportunity Credit and the Lifetime Learning Credit. You are only able to use one of these credits per student in any tax year.

American Opportunity Credit

The American Opportunity Credit is available for any student within his/her first four years of post secondary education. The maximum credit allowed is $2,500. In addition, 40% of the credit is a refundable credit. This means it would be allowed even if income tax was reduced to zero. An example of this would be where a taxpayer has an income tax liability before any credits of $1,500. If the taxpayer had 1 child eligible for the maximum credit of $2,500, then the first 60% or $1,500 would offset the income tax, bringing it down to zero. The refundable portion of $1,000 would be allowed as a refund. 

The $2,500 limit is calculated as 100% of the first $2,000 of tuition and required fees and 25% of the next $2,000 of such fees. Qualified fees include tuition, required student activity fees, books, supplies and equipment. Room and board do not qualify.

Eligible students must also be enrolled in a program that leads to a degree, must be taking at least 50% of the course load needed to be considered full–time and not have any felony conviction for possessing or distributing a controlled substance.

There are also income phaseouts for this credit. This credit begins to phase out for individuals with income between $80,000 and $90,000 ($160,000 to $180,000 for joint filers). Married taxpayers filing separately do not qualify for the American Opportunity Credit.

Lifetime Learning Credit

This is a nonrefundable credit. The credit is a 20% credit on the first $10,000 of qualified tuition and fees paid for the taxpayer, spouse or dependents.  The maximum credit is therefore $2,000. This credit is per taxpayer, not per student. There is no degree or workload requirement. This credit is also not limited to the first four years of post secondary education.

There are also income phaseouts for the lifetime learning credit. This credit begins to phase out for individuals with income between $57,000 and $67,000 ($114,000 to $134,000 for joint filers). Married taxpayers filing separately do not qualify for the Lifetime Learning Credit.

In addition to the two credits discussed there are a few more programs available to assist taxpayers with the heavy burden of education expenses.

529 Plan

Technically called Qualified Tuition Programs, these plans are better known as 529 plans which refers to the Internal Revenue Code section in which they are defined. These plans allow individuals to prepay or contribute to an account for paying a student’s qualified education expenses. While there are a number of parts to these plans the basics are the following:

• Contributions to these plans are not tax deductible however if used for eligible education expenses none of the income earned will be taxable.
• Eligible education expenses include tuition and fees, books, supplies, equipment and room and board (although there are certain rules to be closely followed in this area).
• Beginning in 2018 it is now possible to use up to $10,000 per year per beneficiary for either elementary or secondary education expenses. Helpful to those with children in private schools.
• Coordinating with the annual gift tax exclusion, taxpayers may contribute up to $15,000 per beneficiary per year. This means parents can contribute $30,000 per year per beneficiary. In addition, the law allows a contribution equivalent to five years of the gift tax exclusion, or $75,000. You are then not eligible to give any gifts for the next four years. Technically, you can give gifts you would just have to file a gift tax return.
• The same expenses may not be used for the American Opportunity or Lifetime Learning Credits and for 529 distributions or Coverdell ESA Distributions (these will be explained next).

Coverdell Educaion Savings Account

For beneficiaries under 18 years of age, $2,000 may be contributed to an Education Savings Account (sometimes referred to as Education IRAs or ESAs). Married taxpayers filing jointly making the contribution will have this $2,000 figure phased out when their Modified adjusted Gross Income (MAGI) is between $190,000 and $220,000, for everyone else (including those married filing separately) the phaseout occurs between $95,000 and $110,000. Like the 529 plan contributions, ESA contributions are not deductible however if used for eligible education expenses none of the income earned will be taxable. Eligible expenses are basically the same as those allowed for 529 plans.

Again keep in mind the same education expenses cannot be used more than once. They can be used for the American Opportunity Credit, Lifetime Learning Credit, 529 plan or Coverdell ESA but only one type in a year. You may be able to utilize more than one benefit type in a year. In other words,  vthe American Opportunity Credit and 529 plan but you could not use the same expenses for both.

Other Benefits Available with regards to Education

Student Loan Interest

Taxpayers can deduct up to $2,500 of interest paid on qualified education loans. This deduction begins to phase out for individuals with income between $65,000 and $80,000 ($130,000 to $160,000 for joint filers). Married taxpayers filing separately do not qualify for the Student Loan Interest deduction. In addition, this deduction is allowed for taxpayers whether they itemize or not.

Exception to 10% Penalty on IRA Withdrawals Before Age 59 ½

Money withdrawn from your IRA (not 401K or other retirement plan, IRA only) and used for qualified education expenses of a taxpayer, spouse, child or grandchild will be exempt from the 10% penalty normally levied on early withdrawals. Eligible expenses are basically the same as those allowed for 529 or Coverdell ESA plans.

Tax Planning Tip

If you are in a position where you are unable to receive any benefit from the education deductions/credits previously discussed, then it may make sense to employ your child (if you are self-employed) and not claim them as a dependent or not claim them if they have other employment. The child would then be able to offset his/her income if they’ve exceeded $12,000.

Conclusion

This article only highlights education credits.  I would encourage taxpayers to contact a tax professional that has complete knowledge of these credits if they feel they may be eligible.

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