What Is the Property Tax Deduction and How do I Claim It?

When you own property, such as a car, a house, or land, you have to pay annual property taxes to your state or local government, depending on the value of your property. However, you may be able to claim a property tax deduction from your federal income tax bill. 

This article will bring you an overview of the property tax deduction and how to claim it. 

What is the property tax deduction?

Property taxes are paid on property owned by an individual or other legal entity (such as an LLC or a corporation) to the state and local tax authority of the property’s jurisdiction. These taxes are generally used to fund public services such as schools, roadways, libraries, and first responders.

Property taxes are virtually always levied on several types of property, and each state, county, and municipality sets the taxable value for each item.

Common examples of property taxes are mortgage interest, state and municipal taxes on property investments such as homes, land, or apartments, and taxes collected on personal property such as boats or vehicles.

What is deductible

The IRS accepts the following items as property tax deductions: 

  • Your primary house
  • Houses for vacationing
  • Apartment in a cooperative (see IRS Publication 530 for special rules)
  • Land
  • Cars, boats, RVs, and other types of vehicles

What is non-deductible

Certain items on your real estate property tax bill may look like taxes but are actually miscellaneous charges and are not deductible. These are the following: 

  • Taxes on properties you don’t own
  • Property taxes you haven’t paid yet
  • Transfer taxes when you sell your properties
  • Expenses for public services, such as water or garbage collection.
  • Renovation expenses to your home (even if they add value to your property)
  • Payments on loans for energy-efficient house upgrades. (However, you may be able to deduct the interest component of your payment as home mortgage interest.)
  • Property taxes plus government and county tax payments or state taxes totaling over $10,000 ($5,000 for married filing status).
  • Local benefit taxes for constructing streets, walkways, or sanitary sewer infrastructure in your neighborhood. (However, taxes on the maintenance or repair of these items are deductible)

FYI: You can deduct your maintenance and repair expenses; however, only if the tax authority itemizes these amounts in your bill.

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How to claim your property tax deduction

Store your tax documents properly 

If you pay taxes on your properties, you may be able to deduct this sum from your income tax. However, you need to be extra accurate when estimating your property taxes for the year. A simple practice to achieve your goal of claiming a property tax deduction is to keep a copy of your property documentation. 

For example, though your local taxing authority can give you a copy of your property taxable income, you should also keep the licensing documentation for your car, boat, or other mobile assets. If you have a home mortgage, require a 1098 Form from your mortgage company to state how much property tax you paid. And lastly, if you pay your taxes with a check, make sure you keep the bank statement showing how much you paid.

Use Schedule A to file your property taxes

Schedule A is used by the IRS to file taxes on a federal income tax filing. In this file, you should specifically categorize your deductions for property taxes. This form itself is where taxpayers keep track of their write-offs and any property taxes they want to deduct. Filers can also deduct expenses of monthly mortgage interest they paid throughout the tax year using this form.

Subtract your property taxes in the year you pay them. 

This may sound simple, but don’t let it fool you. Property taxes are normally paid in one of two ways: by writing a check once or twice a year when the bill arrives or by setting away money each month in an escrow account while paying the mortgage. Don’t rely on the second way; you should only deduct the taxes you paid during the year.

The bottom line

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What Are Pass-Through Entities and Sole Proprietorships?

Pass-through entities and sole proprietorships are considered the dominant business structure in the US, but what do these terms really mean? How do they pay taxes to the US government? 

This blog will walk you through the pass-through structure and taxation, from the definition, types, and pros and cons of this business structure. 

What are pass-through entities and sole proprietorships?

A pass-through entity is a corporate structure in which taxation on the business income is immediately passed on to the shareholders to prevent duplicate taxation. Organization owners and shareholders under this model are taxed on the individual income earned by the company and do not have to pay extra company tax for managing the company.

Pass-through entities file more tax returns and report more business income than C corporations. Pass-through entities are not subject to corporate income tax and instead report their income on their owners’ individual tax returns.

Sole proprietorships, partnerships, limited liability companies (LLCs), and S-corporations are the most typical examples of pass-through entities. We’ll go over each of them in more detail below.

Types of pass-through entities

The most excellent part about operating a pass-through organization is that business owners have many alternatives. Here are the four different types of pass-through entities to help you better understand why you should or shouldn’t use each one.

Sole proprietorships

Sole proprietorships are the most popular type of pass-through entity, as they are the default choice for most independent contractors or freelancers. This type of business is typically easy to establish. However, sole proprietors have limited economic and accounting safeguards.

This form of pass-through entity is appropriate if you are a new business owner who is just starting up on your own. You can convert to a different model when hiring people or collaborating with other persons and groups.

Sole proprietors use Schedule C to report their business’s income or loss and determine their taxation. 

Partnerships

This type of pass-through entity is commonly used to incorporate larger micro-businesses than sole proprietorships. Partnerships are controlled by two or more people and require formal incorporation and ownership rights percentages. 

You can consider electing your business as a partnership if your company has numerous owners but isn’t large enough to be a corporation.

Limited Liability Companies (LLCs)

There are two kinds of limited liability companies (LLCs): Single-Member LLCs and Multi-Member LLCs. 

Single-Member LLCs pay their taxes in the same way as sole proprietorships, whereas Multi-Member LLCs pa in the same way as partnerships. Owners of Single-Member LLCs file their income taxes with Schedule C, Schedule E, and Schedule F, whereas associates in Multi-Member LLCs file Schedule K-1, which reflects their share of corporate profits on Form 1065.

S corporations

S corporations file their company taxes on Form 1120-S, but their revenue is immediately passed to the stakeholders and investors, who report them on Schedule E

Owners must pay “appropriate compensation,” taxed under the Federal Insurance Contributions Act but are not obligated to pay SECA tax on their profits (FICA)

Advantages and disadvantages of pass-through entities

It is advisable to investigate the benefits and drawbacks of pass-through entities to understand before electing your business as a pass-through entity.

Advantages of pass-through entities

  • Tax breaks: Pass-through entities help enterprises minimize multiple taxes by classifying net profit as individual income.
  • Simple set-up process: Several pass-through entities (including sole proprietorships and partnerships) have very few service charges and registrations, making them very simple to set up.
  • Equitable tax structure: By categorizing corporate income as personal income, owners in higher tax brackets will shoulder a more significant percentage of the tax burden.
  • Deductible losses: Owners of a pass-through organization can claim losses sustained by their firm to decrease their personal taxable income.

Disadvantages of pass-through entities

  • Stock restrictions: S-corps are the only kind of pass-through corporation that can issue stock. They are restricted to 100 investors and one form of stock, which may make raising funds from investors more challenging.
  • Fringe benefits tax: Fringe benefits (such as health insurance, stock options, and vehicles) are income for C-corps but not employees. Pass-through entities are not eligible for this benefit. However, there are limited exceptions for medical insurance. Therefore fringe benefits may be taxed.
  • Income tax on unreceived income: Even if the money stays in the bank account, shareholders of pass-through organizations must pay tax on business revenue (instead of being distributed to the owners).

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Two Most Common Business Strategies To Avoid Corporate Income Tax Issues

Multinational corporations strategically employ international transfer pricing and tax inversion to place their operations in low tax-rate countries, resulting in lower income taxes. 

1. International transfer pricing

What is international transfer pricing? 

Companies can manage where their profits are reported through international transfer pricing. International transfer pricing is the act of selling products from one division to another within the same corporation, but located in different countries. 

In other words, they strategically place operations in low tax-rate countries. 

What are the benefits of international transfer pricing?

  • Tax benefits 

When a company is able to provide accurate transfer pricing documents, it is eligible for a number of tax breaks that allow it to avoid paying taxes in many countries.

  • Avoid high tariffs 

By sending goods to nations with high tariff rates and employing low transfer charges, transfer pricing helps to reduce duty expenses by lowering the duty base of such transactions.

  • Lower tax rate 

Transfer pricing ensures profits for products and services in many countries with a lower tax rate. 

  • Reduce tax liability 

A transfer pricing document serves as a foundation for calculating the entire cost of association between two organizations, which aids in the avoidance or reduction of tax liability.

  • Reduce duty costs 

In international trade, duty costs are a significant challenge. You will have to deal with such costs on a regular basis if you run a worldwide corporation.

Transfer pricing aids businesses in lowering their duty costs. Furthermore, organizations can ship goods to nations with high tariffs at low transfer costs.

  • Reduce income taxes 

Organizations can also significantly cut their income taxes in nations with high tax rates. This is accomplished by overpricing the items being exported to countries with lower tax rates.

As a result, overall profits are balanced, and enterprises can make more money.

What are the risks involved in international transfer pricing? 

  • There may be disagreements between an organization’s divisions about pricing and transfer procedures.
  • In terms of time and labor, there are significant additional costs associated with implementing transfer prices and maintaining a comprehensive accounting system to support them. Transfer pricing is a time-consuming and sophisticated approach.
  • It’s tough to set pricing for intangible commodities such as services.
  • Buyers and sellers fulfill various jobs and, as a result, take different risks. For example, the seller may decline to provide a product guarantee. However, the buyer’s price would be affected by the discrepancy.

Case study

According to the Corporate Finance Institute, Google can be a good case study of how a big corporation employs the international transfer pricing strategy. 

In Singapore, Google has a regional headquarters and an Australian subsidiary. Users and Australian businesses benefit from the Australian subsidiary’s sales and marketing help. Google uses the Australian subsidiary for research services all around the world. 

Google Australia had a profit of roughly $46 million on revenues of $358 million in 2012-13. After claiming a $4.5 million tax credit, Google Australia had a projected tax payment to be AU$7.1 million.

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2. Tax inversions

What is tax inversion?

Another strategy that corporations can use to decrease the tax rate is to move their legal headquarters to a location with lower tax rates. 

Corporations can do the tax inversion practice because the corporate structure is relatively flexible. On the other hand, if the business’ structure leans more towards a partnership, where the partnership’s tax law is different from country to country, this inversion practice is not possible. 

What are the benefits of tax inversions? 

Corporations invert to take advantage of reduced tax rates, mainly found in tax-haven countries. A company’s global income is no longer taxed in the United States once it has been inverted. It is only responsible for paying taxes on income earned in the United States.

What are the risks involved in tax inversions?

1. There’s a chance you’ll lose your expertise. 

You need to work with tax and legal consultants who have completed inversions in the country where you seek to re-incorporate. Tax inversion isn’t a “do-it-yourself” undertaking.

2. The danger to shareholders. 

It’s also crucial to consider any potential tax implications for your stockholders. You’ll be trading shares in the old firm for shares in the new one when you incorporate. Shareholders may face severe tax repercussions if it is not correctly constituted.

3. The danger of making the front page. 

In addition, tax inversions aren’t widely discussed in the media. Despite being fully legal, opponents contend that the practice is unpatriotic and unfair. While it’s doubtful that Congress will adopt new legislation prohibiting tax inversions anytime soon, the U.S. Treasury Department is considering what steps it may take to discourage them further in light of recent media attention.

Case study 

According to the American For Tax Fairness Organization, Walgreens, which had $72 billion in U.S. sales in 2014, inverts with a Swiss corporation and will likely save $4 billion in U.S. income taxes over the next five years. If Pfizer was successful in its attempt at an inversion with AstraZeneca in the UK, it would have saved $1 billion a year in taxes in the US. 

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National governments on avoiding income taxes

 Do large corporations abuse these tax rules to evade legitimate income taxes? 

This is entirely up to national governments to decide. 

One example of the relationship between the government and corporations regarding the tax inversions is the U.S. government’s policy on reporting income arising from intellectual property. 

In 2008, the U.S. government decided that all U.S.-based corporations must compute how much income is generated from intellectual property. Then the corporations must pay U.S. income tax on that intellectual property-related income no matter where the income is generated in the world. 

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