From the general business tax credit to the new markets credit, there are endless tax credit opportunities for your small business to save money on your taxes.
At their core, tax credits are a very particular type of benefit designed to offset the actual tax liability associated with SMBs around the country. This isn't the same thing as a tax deduction, which lowers that business's actual income. Tax credits are typically offered to incentivize everything from hiring more workers in order to stimulate the economy to making meaningful contributions to specific industries.
While certain tax credits are obvious, others are decidedly less so. This is why proper tax planning is essential as a small business owner — you need to be proactive about getting every last penny that is owed to you. There are a number of essential small business tax credits in particular that you'll definitely want to take advantage of when tax season rolls around.
The General Business Tax Credit
As the name suggests, this is something of a "kitchen sink" tax credit made up of a number of smaller, individual credits. Collectively, they are designed to act as a way to motivate savvy business owners such as yourself to participate in certain activities. If you purchased a qualified electric vehicle for your business, branched out into a new market, or retained a certain number of employees, you may very well be qualified.
Paid Family and Medical Leave
This particular tax credit is relatively new, having only just been authorized in 2017. Again, it's intended to act as motivation — this time, so that small business owners will provide paid leave to all employees who themselves are covered by the Family and Medical Leave Act. Employees that qualify are entitled to up to 12 weeks of totally unpaid, job-projected leave — all while still retaining access to their group health benefits as well. Note that this is something that happens every year.
The credit itself is equal to a percentage of the wages that an employer pays to those qualified employees while they're on leave for things like unexpected medical emergencies or even giving birth.
Credits for Qualified Research Expenses
Depending on the specific type of small business you're running, you may have to engage in a significant amount of research and development in order to better serve your own customers. The United States government would like to encourage you to do as much of that as possible, which is how the qualified research expenses credit (otherwise known as the "Increasing Research Activities Credit") came into being.
In order to qualify for this credit, you need to engage in domestic research and development for the purposes of things like certification testing, environmental testing, developing or applying for patents, prototype and model development, and more. Research associated with the development of new or even improved products, processes, and formulas would also qualify.
This credit can cover up to 20% of all of your related expenses that fall under this umbrella.
The New Markets Credit
Last but not least, we have the New Markets Credit — one designed to encourage investment in Community Development Enterprises and Community Development Financial Institutions, otherwise known as CDEs and CDFIs, respectively. These are the types of organizations that assist lower income communities around the country and, obviously, they need all the help they can get.
The vast majority of all qualified projects involve either purchasing, renovating or constructing real estate in areas that have a 20% poverty rate or with median family incomes that don't exceed 80% of that of the larger area. This means building or renovating hospitals, for example, or industrial buildings that go on to create jobs.
Note that while all of these small business tax credits are critical, they represent just a small fraction of those that may be available to you. For the complete list, be sure to review the IRS' official website devoted to that very topic. As always, you should also enlist the help of a qualified tax professional to prepare your business taxes as well. Not only can we help ensure you're taking full advantage of these and other critical credits, but we can also help you avoid the types of costly mistakes that small business owners and the self-employed often make when they attempt to do everything themselves. Contact our office for more information today.
Taxation news blog
Friday, January 31, 2020
Thursday, January 30, 2020
Child Daycare and Taxes
When discussing daycare for children so their parents can work, there are two primary areas of discussion: one from the viewpoint of the individual providing the daycare services and another from the parents using a daycare provider’s services. Tax law provides special benefits for both.
Article Highlights:
DAYCARE PROVIDERS
Daycare providers are generally self-employed individuals who provide care in their home, and like other self-employed individuals conducting a business, they are allowed to deduct business expenses, including the following:
Self-Employment Tax – Like all self-employed taxpayers, daycare providers must pay self-employment tax, which is made up of the Social Security tax of 12.4% on the first $132,900 (2019) of profit from the business and a 2.9% Medicare tax on all of the profits. In addition, there is an additional 0.9% Medicare tax on the extent to which the profits exceed $200,000 for single taxpayers, $250,000 for married taxpayers filing jointly, and $125,000 for married taxpayers filing separately. In addition, half of the self-employment tax can be deducted from gross income.
Retirement Plan Contributions – Profits from a daycare business qualify for IRA contributions and self-employed retirement plans, allowing daycare providers to put away substantial amounts for their future retirement.
Medical Insurance Above-the-Line Deduction – While most taxpayers must itemize their deductions in order to deduct the cost of their medical insurance, self-employed taxpayers – including daycare providers, to the extent of the profits from their business – can deduct the premiums from their adjusted gross income and avoid the 10% medical expense haircut when itemizing deductions.
Employer Identification Number – Most daycare clients can claim a tax credit for the cost of daycare. However, to do so, they must include either the daycare provider’s Social Security number (SSN) or an employer identification number (EIN) on their tax returns. It is a best practice in this age of ID theft not to use the SSN and instead obtain an EIN.
DAYCARE USER
Individuals who use the services of daycare providers may qualify for a tax credit if the expense is an “employment-related” expense, i.e., it must enable a taxpayer or spouse, if married, to work, and it must be for the care of a child, stepchild, foster child, brother, sister, or stepsibling (or a descendant of any of these) who is under 13, lives in the taxpayer’s home for more than half the year, and does not provide more than half of his or her own support for the year. Married couples must file jointly, and both spouses must work (or one spouse must be a full-time student or disabled) to claim the credit.
The qualifying expenses are limited to the income from working and, in the case of a married couple, are limited to the lower of the taxpayer’s or the spouse’s income from working. However, under certain conditions, when one spouse has no actual income from working and that spouse is a full-time student or disabled, that spouse is considered to have a monthly income of $250 (if the couple has one qualifying child) or $500 (for two or more qualifying children). This means the income limitation is essentially removed for a spouse who is a student or disabled all year.
The qualifying expenses can’t exceed $3,000 per year for those who have only one qualifying child, while the limit increases to $6,000 per year for those with two or more qualifying persons.
If there are two children, the care expenses need not be divided equally. For example, if the taxpayer paid $2,500 in qualified expenses for the care of one child and $3,500 for the care of another child, the $6,000 can be used to determine the credit. The credit is computed as a percentage of qualifying expenses – in most cases, 20%. See the table below for the credit percentages based on the taxpayer’s adjusted gross income.
The credit reduces a taxpayer’s tax bill dollar for dollar. Thus, in the above example, Al and Janice would pay $600 less in taxes by virtue of the credit. However, the credit can only offset income tax and alternative minimum tax liability, and any excess is not refundable. The credit cannot be used to reduce self-employment tax, if a taxpayer is self-employed, or the taxes imposed by the Affordable Care Act.
Employer Dependent Care Benefits – Some employers provide dependent care assistance programs to help their employees with the cost of daycare. Payments under these plans used by employees to pay dependent care expenses are excludable from employees’ income, up to the lower of:
Other Credit Criteria:
Article Highlights:
- Daycare Providers
- Simplified Food Deduction
- Special Rules for Business Use of the Provider’s Home
- Home Sale Consequences
- Other Expenses
- Other Daycare Provider Issues
- Daycare User Credit
- Employer Dependent Care Benefits
- Other Credit Criteria
DAYCARE PROVIDERS
Daycare providers are generally self-employed individuals who provide care in their home, and like other self-employed individuals conducting a business, they are allowed to deduct business expenses, including the following:
- Business Use of a Vehicle – Examples of business-related use of a personal vehicle by a daycare provider include taking the kids to the park, on field trips, or the movies. Also eligible are miles used to purchase supplies and other business-related travel. What’s deductible is the standard mileage rate of 58 cents per business mile (2019) or the prorated business portion of the actual operating expenses for the vehicle. In either case, a contemporaneously prepared log detailing the business trips should be maintained.
- Food – Daycare providers can deduct the cost of meals provided to the children (not including meals for their own children). The simplest method, which does not require documenting food purchases, is to use the simplified meal deduction. This does not preclude a care provider from using the actual expenses if the actual cost is higher and the provider is willing to document the expenses without including food purchased for his or her own family’s use. The simplified meal deduction amounts for 2019 are illustrated in the table below.
Year States Breakfast Lunch Dinner Snack 2019 Contiguous States
Alaska
Hawaii$1.31
$2.09
$1.53$2.46
$3.99
$2.88$2.46
$3.99
$2.88$0.73
$1.19
$0.86
The rates do not include the cost of nonfood supplies (e.g., utensils), which may be deducted separately. The number of meals per day per child is limited to of the amounts below. (The table uses the amounts based upon the rates for contiguous states and will be higher for Alaska and Hawaii.)Meal Rate 2019 Allowance One Breakfast $1.31 $1.31 One Lunch $2.46 $2.46 One Dinner $2.46 $2.46 Three Snacks $0.73 $2.19 2019 Daily Maximum Per Child $8.42
If the provider receives some form of reimbursement or subsidy, then the provider may deduct only the part of the simplified rate that exceeds the reimbursed amount. - Business Use of the Home – Self-employed individuals may take a business deduction for the business use of a portion of their home if that portion is used exclusively for business. Daycare facilities are not subject to the exclusive use requirement that applies to other home offices. However, that special rule only applies to providers who:
1. Are licensed, certified, registered or approved as a daycare care provider under state law;
2. Have a pending application for licensing, certification, registration, or approval under state law as a daycare provider that has not been denied; or
3. Is exempt from licensing, certification, registration, or approval under state law.
Any daycare provider not meeting one of these three requirements is still subject to the exclusive use rules, which will generally preclude them from the deduction unless they use some portion of the home exclusively for daycare purposes, such as a bedroom or a storage area. The daycare facility exception does not apply if the services performed are primarily educational or instructional in nature (e.g., musical instruction). However, the exception does apply if the services are primarily custodial and if the educational, development, or enrichment activities are only incidental to the custodial services. The services must be provided for individuals age 65 or older, children, or individuals who are physically or mentally incapable of caring for themselves.
When calculating the percentage of business use of the home, both the space used to operate the daycare business and the amount of time that the space is used to provide day care, including preparation and cleaning time, are factors.Example – Edna uses her living room, kitchen, and bathroom ten hours a day, five days a week to provide licensed daycare services. The home is 2,400 square feet, and the living room, kitchen and bathroom are a combined 1,400 square feet. The exclusive use requirement doesn’t apply. Edna’s percentage use of her home for business is determined as follows:
Once the percentage is determined, all of the home expenses, including interest, taxes, home insurance, maintenance, utilities, and depreciation, are summed up and multiplied by the percentage to determine the deduction for the business use of the home. If the home is rented, the rent expense replaces the interest, taxes, and depreciation. After determining the deduction, it is further limited to the gross income from the daycare, and if limited by the gross income, there is a specific order in which the home expenses can be used (not discussed in this article).
Claiming the business use of the home deduction will also impact any future sale of the home. For taxpayers who own and use their home for two years out of the five years prior to the sale, they can generally exclude up to $250,000 ($500,000 if married filing jointly) of any resulting gain. However, any depreciation claimed or that could have been claimed after May 15, 1997, cannot be excluded and, as a result, will be taxable to the extent of any gain from the sale.Example: A care provider is entitled to claim $1,000 per year of home depreciation, and she operates that business for ten years, claiming a total of $10,000 in depreciation. Whenever she ultimately sells her home, the $10,000 cannot be included in the excluded gain and will always be treated as a taxable capital gain, to the extent of any home sale gain. - Other Expenses – Other expenses include just about any expense that has to do with operating the daycare facility, including, for example:
o Advertising
o Business banking account fees
o Daycare licensing
o Daycare organization membership expenses
o Seminars and education related to operating a daycare center
o Business insurance
o Games and toys
o Supplies, diapers, wipes, and cleaning supplies
o Phone service
o Prorated Internet service
o Field trip expenses
o Payroll for employees
Self-Employment Tax – Like all self-employed taxpayers, daycare providers must pay self-employment tax, which is made up of the Social Security tax of 12.4% on the first $132,900 (2019) of profit from the business and a 2.9% Medicare tax on all of the profits. In addition, there is an additional 0.9% Medicare tax on the extent to which the profits exceed $200,000 for single taxpayers, $250,000 for married taxpayers filing jointly, and $125,000 for married taxpayers filing separately. In addition, half of the self-employment tax can be deducted from gross income.
Retirement Plan Contributions – Profits from a daycare business qualify for IRA contributions and self-employed retirement plans, allowing daycare providers to put away substantial amounts for their future retirement.
Medical Insurance Above-the-Line Deduction – While most taxpayers must itemize their deductions in order to deduct the cost of their medical insurance, self-employed taxpayers – including daycare providers, to the extent of the profits from their business – can deduct the premiums from their adjusted gross income and avoid the 10% medical expense haircut when itemizing deductions.
Employer Identification Number – Most daycare clients can claim a tax credit for the cost of daycare. However, to do so, they must include either the daycare provider’s Social Security number (SSN) or an employer identification number (EIN) on their tax returns. It is a best practice in this age of ID theft not to use the SSN and instead obtain an EIN.
DAYCARE USER
Individuals who use the services of daycare providers may qualify for a tax credit if the expense is an “employment-related” expense, i.e., it must enable a taxpayer or spouse, if married, to work, and it must be for the care of a child, stepchild, foster child, brother, sister, or stepsibling (or a descendant of any of these) who is under 13, lives in the taxpayer’s home for more than half the year, and does not provide more than half of his or her own support for the year. Married couples must file jointly, and both spouses must work (or one spouse must be a full-time student or disabled) to claim the credit.
The qualifying expenses are limited to the income from working and, in the case of a married couple, are limited to the lower of the taxpayer’s or the spouse’s income from working. However, under certain conditions, when one spouse has no actual income from working and that spouse is a full-time student or disabled, that spouse is considered to have a monthly income of $250 (if the couple has one qualifying child) or $500 (for two or more qualifying children). This means the income limitation is essentially removed for a spouse who is a student or disabled all year.
The qualifying expenses can’t exceed $3,000 per year for those who have only one qualifying child, while the limit increases to $6,000 per year for those with two or more qualifying persons.
If there are two children, the care expenses need not be divided equally. For example, if the taxpayer paid $2,500 in qualified expenses for the care of one child and $3,500 for the care of another child, the $6,000 can be used to determine the credit. The credit is computed as a percentage of qualifying expenses – in most cases, 20%. See the table below for the credit percentages based on the taxpayer’s adjusted gross income.
AGI Adjusted Applicable Percentage
| AGI Over | But Not Over | Applicable Percent | AGI Over | But Not Over | Applicable Percent |
| 0 | 15,000 | 35 | 29,000 | 31,000 | 27 |
| 15,000 | 17,000 | 34 | 31,000 | 33,000 | 26 |
| 17,000 | 19,000 | 33 | 33,000 | 35,000 | 25 |
| 19,000 | 21,000 | 32 | 35,000 | 37,000 | 24 |
| 21,000 | 23,000 | 31 | 37,000 | 39,000 | 23 |
| 23,000 | 25,000 | 30 | 39,000 | 41,000 | 22 |
| 25,000 | 27,000 | 29 | 41,000 | 43,000 | 21 |
| 27,000 | 29,000 | 28 | 43,000 | No Limit | 20 |
Example: Al and Janice both work, with combined earned income in excess of $50,000 for the year. Janice has a part-time job, from which she earns $10,000 for the year. Her work hours coincide with the school hours of their 11-year-old daughter, Susan, so while school is in session, Al and Janice incur no childcare expenses for Susan. However, during the summer vacation period, they place Susan in a day camp program that costs $4,000. Since the expense limitation for one child is $3,000, their childcare credit would be $600 (20% of $3,000).
The credit reduces a taxpayer’s tax bill dollar for dollar. Thus, in the above example, Al and Janice would pay $600 less in taxes by virtue of the credit. However, the credit can only offset income tax and alternative minimum tax liability, and any excess is not refundable. The credit cannot be used to reduce self-employment tax, if a taxpayer is self-employed, or the taxes imposed by the Affordable Care Act.
Employer Dependent Care Benefits – Some employers provide dependent care assistance programs to help their employees with the cost of daycare. Payments under these plans used by employees to pay dependent care expenses are excludable from employees’ income, up to the lower of:
- The employee’s earned income (for married employees, this is the earned income of the lower-paid spouse) or
- $5,000 ($2,500 for married filing separate).
Other Credit Criteria:
- Age of the Child – If the qualifying child turned 13 during the year, count only the care expenses paid for the child for the part of the year when he or she was under age 13.
- Day Camps – Many working parents must arrange for care for their children under 13 years of age (or any age if disabled) during school vacation periods. A popular solution - with a tax benefit - is a day camp program. The cost of day camp can count as an expense toward the child and dependent care credit. But be careful: expenses for overnight camps do not qualify. Also, not eligible are expenses paid for summer school or tutoring programs.
- Both Parents Working in an Unincorporated Business – When both spouses of a married couple are jointly involved in an unincorporated business, it is fairly common, but incorrect, for all of that business’s income to be reported as just one spouse’s income. As a result, they lose the benefits of the childcare credit, which requires both spouses to have income from working.
- School Expenses – Only school expenses for a child below the kindergarten level are considered qualifying expenses for this credit.
- In-Home Care Providers – If the daycare is provided in a taxpayer’s home, the daycare provider is considered a household employee.
Wednesday, January 29, 2020
Is It Better to Have a Tax Credit or a Deduction?
People often say that an expense is “a tax write-off”; most everyone interprets this to mean that the expense will have a tax benefit. Generally, such a benefit takes the form of either a deduction or a credit; these benefits’ effects are quite different, however, and each type has various categories. As a result, the tax implications may not be as expected. This is especially true when the write-off claim comes from a salesperson who is touting the tax benefits of a product or service, as such individuals often leave out key details. In general, a deduction reduces taxable income, whereas a credit reduces the tax itself.
Article Highlights:
Tax Deductions – In one way or another, tax deductions reduce the taxable portion of an individual’s income, which thus reduces the tax on that income.
Itemized Deductions – When taxpayers think of deductions, they typically think of the itemized deductions that are claimed on Schedule A. This is the only way to deduct personal expenses such as medical costs, state and local tax payments, investment and home-mortgage interest, charitable contributions, disaster-casualty losses, and various rarely encountered expenses. In some cases, itemized deductions are limited. For instance, medical expenses are only deductible to the extent they exceed 10% of the taxpayer’s adjusted gross income (AGI). Similarly, state and local tax payments (including those for income, sales, and property taxes) are capped at $10,000. On top of that, itemization only reduces taxable income to the extent that the total of the itemized deductions exceeds the standard deduction. When the sum does not exceed the standard deduction, the itemized deductible expenses provide no tax benefits at all.
Above-the-Line Deductions – Certain deductions actually reduce income. These are commonly called above-the-line deductions because, when applied, they reduce the income figure that is used to calculate AGI. Thus, their benefits apply regardless of whether the taxpayer uses itemized deductions. Above-the-line deductions include educators’ expenses; contributions to health savings accounts, traditional IRAs, and certain qualified retirement plans; deductible alimony payments; and student-loan interest. Most of these deductions have annual maximums.
Business Deductions – Taxpayers who operate noncorporate businesses can deduct from their business income any expenses that they incur when operating their businesses. These deductions (which cover advertising fees, employee wages, office-supply costs, etc.) are used to reduce profits, which in turn reduces taxable income and, ultimately, income tax. In addition, most self-employed taxpayers pay Social Security and Medicare taxes on their net business income, so any reduction in their business profits also reduces their Medicare taxes and possibly their Social Security taxes.
Asset-Sale Deductions – An individual who sells an asset is allowed to deduct that asset’s cost from the sale price to determine the taxable profit. Good recordkeeping is helpful here because the original expense may have been incurred years prior, even though it is only deductible when the asset is sold. For example, any improvements that an individual makes to a home over years of ownership are not deductible until the home is sold. At that point, the individual can reduce the taxable gain from the sale by counting the improvements as part of the home’s cost.
Tax Credits – Tax credits come in several varieties, and the amount of benefit can vary:
If you have questions related to how you might benefit from tax credits or deductions, please call this office or visit our website.
Article Highlights:
- Itemized Deductions
- Above-the-Line Deductions
- Business Deductions
- Asset-Sale Deductions
- Refundable Credits
- Nonrefundable Credits
- Carryover Credits
- Business Tax Credits
Tax Deductions – In one way or another, tax deductions reduce the taxable portion of an individual’s income, which thus reduces the tax on that income.
Itemized Deductions – When taxpayers think of deductions, they typically think of the itemized deductions that are claimed on Schedule A. This is the only way to deduct personal expenses such as medical costs, state and local tax payments, investment and home-mortgage interest, charitable contributions, disaster-casualty losses, and various rarely encountered expenses. In some cases, itemized deductions are limited. For instance, medical expenses are only deductible to the extent they exceed 10% of the taxpayer’s adjusted gross income (AGI). Similarly, state and local tax payments (including those for income, sales, and property taxes) are capped at $10,000. On top of that, itemization only reduces taxable income to the extent that the total of the itemized deductions exceeds the standard deduction. When the sum does not exceed the standard deduction, the itemized deductible expenses provide no tax benefits at all.
Above-the-Line Deductions – Certain deductions actually reduce income. These are commonly called above-the-line deductions because, when applied, they reduce the income figure that is used to calculate AGI. Thus, their benefits apply regardless of whether the taxpayer uses itemized deductions. Above-the-line deductions include educators’ expenses; contributions to health savings accounts, traditional IRAs, and certain qualified retirement plans; deductible alimony payments; and student-loan interest. Most of these deductions have annual maximums.
Business Deductions – Taxpayers who operate noncorporate businesses can deduct from their business income any expenses that they incur when operating their businesses. These deductions (which cover advertising fees, employee wages, office-supply costs, etc.) are used to reduce profits, which in turn reduces taxable income and, ultimately, income tax. In addition, most self-employed taxpayers pay Social Security and Medicare taxes on their net business income, so any reduction in their business profits also reduces their Medicare taxes and possibly their Social Security taxes.
Asset-Sale Deductions – An individual who sells an asset is allowed to deduct that asset’s cost from the sale price to determine the taxable profit. Good recordkeeping is helpful here because the original expense may have been incurred years prior, even though it is only deductible when the asset is sold. For example, any improvements that an individual makes to a home over years of ownership are not deductible until the home is sold. At that point, the individual can reduce the taxable gain from the sale by counting the improvements as part of the home’s cost.
Tax Credits – Tax credits come in several varieties, and the amount of benefit can vary:
Refundable Credits – A refundable credit offsets current tax liability; it is so called because any amount of unused credit is refunded to the taxpayer. Refundable credits include the Earned Income Tax Credit, the Additional Child Tax Credit, and the Premium Tax Credit (net of any advances received), as well as the American Opportunity Tax Credit (an education credit that is 40% refundable). As a matter of general interest, these credits are subject to significant filing fraud because of their refundability. The IRS also considers prepayments such as income-tax withholding and estimated tax payments to be refundable credits.
Nonrefundable Credits – A nonrefundable credit only offsets tax liability; any unused amount is lost (unless it can be carried over to another year; see below). Over time, Congress has become more generous with credits; most credits that are not refundable now carry over for a given period. Nonrefundable credits include the Saver’s Credit, the Lifetime Learning Credit, and the personal portion of the Electric Vehicle Credit.
Carryover Credits – For some nonrefundable credits, any unused current-year credit can be carried over to the next tax year (or for a longer period) until the carryover amount is used up. These credits include the Adoption Credit (which can carry over for up to five years) and the Home-Solar Credit (which carries over through at least 2021; tax law is unclear on whether it will expire then).
Business-Tax Credits – Numerous business-tax credits are available; however, they are grouped into the General Business-Tax Credit, which is nonrefundable but which carries forward for twenty years and back for one year. (This allows a business owner to amend the prior year’s return so as to claim the credit.) This category includes the business portion of the Electric Vehicle Credit.
Nonrefundable Credits – A nonrefundable credit only offsets tax liability; any unused amount is lost (unless it can be carried over to another year; see below). Over time, Congress has become more generous with credits; most credits that are not refundable now carry over for a given period. Nonrefundable credits include the Saver’s Credit, the Lifetime Learning Credit, and the personal portion of the Electric Vehicle Credit.
Carryover Credits – For some nonrefundable credits, any unused current-year credit can be carried over to the next tax year (or for a longer period) until the carryover amount is used up. These credits include the Adoption Credit (which can carry over for up to five years) and the Home-Solar Credit (which carries over through at least 2021; tax law is unclear on whether it will expire then).
Business-Tax Credits – Numerous business-tax credits are available; however, they are grouped into the General Business-Tax Credit, which is nonrefundable but which carries forward for twenty years and back for one year. (This allows a business owner to amend the prior year’s return so as to claim the credit.) This category includes the business portion of the Electric Vehicle Credit.
If you have questions related to how you might benefit from tax credits or deductions, please call this office or visit our website.
Tuesday, January 28, 2020
3 Common Personal Income Tax Problems & How to Respond
Running into issues with the IRS is a year-round concern. Let’s discuss three of the most common tax problems for personal income & their potential solutions.
Tax problems aren't just a worry that hang over people's heads from January through April every year. Many of them go far beyond the numbers that you report, and they can require additional evidence that your bank statements and paychecks can't provide. Additionally, the IRS isn't the only source of those problems: state tax authorities are hungry for revenue, and if you divide your time among different states, you may find it difficult to establish nexus and may even have to file taxes in multiple states.
Below are some of the most common personal income tax issues people are likely to face.
1. You didn't make (or underpaid) estimated tax payments.
Self-employment is the most common cause of this. When you're used to having taxes withheld from your paychecks at work, it can be a shock to have to pay taxes yourself. You can end up owing not just a large amount of self-employment and income taxes, but also penalties for not making tax payments on time. Estimates must be deposited quarterly, or you will face an underpayment penalty.
If your total tax due when you go to file is under $1,000, you won't have to worry about getting smacked with an underpayment penalty. However, it's a good idea to set aside at least 25%-30% of your income for estimated tax payments and commit to paying this amount every month if quarterly taxes are too complicated to figure out.
Other situations like freelancing on the side or rental income while you're still employed can also cause you to fall short at tax time, so make sure to have extra taxes withheld from your paycheck if you don't want to make estimated payments. State tax payments also shouldn't be neglected.
2. You didn't correctly file state tax returns after moving.
Moving to a state with little or no income taxes like Nevada or Florida can be appealing if your bank account feels squeezed in high-tax states like New York or California. Many people divide their time between multiple states for work or personal reasons, and if it's not just a two- or three-week creative retreat or corporate assignment, it can make nexus difficult to determine in some cases.
With the prospect of a lower tax burden becoming even more appealing, it seems logical to just move to the tax-haven state you've been eyeing. But even after you file for a change of address with the postal service, change your voter registration, and get recognized as a resident by your new state, the high-tax state that you left is likely to also still treat you as one.
Typically, you must spend at least 183 days of the year in the other state and maintain a primary residence there. Simply having property in another state won't do if the rest of your family doesn't also live and wait there for you after your work or travel. Where you spend time outside of work also matters because where you sleep every night is ultimately what counts.
If your move is indeed permanent and your residency is valid, you may have to file a part-year resident tax return for the final months you stayed in the old state. You won't need to worry about it for following years, but keep track of how many days were spent in each state before and after moving day.
3. You neglected to file state income tax returns as a nonresident.
If you have business or rental income in another state, you may be required to file state tax returns as a nonresident. If this income is significant, it can end up producing a large tax bill if you're unprepared.
If you have an out-of-state job, chances are that your payroll provider may also be incorrectly withholding taxes for the appropriate state and/or city. In concentrated regions like the tri-state area, especially for New York City and Philadelphia residents, ensure that city taxes are being correctly withheld if you are a resident, and that withholding curtails if that is no the longer the case. There are usually reciprocity agreements among states and municipalities in areas where state lines cross, but you should carefully check to make sure you don't owe nonresident taxes in addition to what you owe your home state.
Failure to make tax payments on time, and to the right agency, are income tax problems that are often overlooked and can quickly spiral out of control. To avoid these issues and many more, contact our office so we can consult you on your state and local taxation, as well as rules for establishing nexus.
Tax problems aren't just a worry that hang over people's heads from January through April every year. Many of them go far beyond the numbers that you report, and they can require additional evidence that your bank statements and paychecks can't provide. Additionally, the IRS isn't the only source of those problems: state tax authorities are hungry for revenue, and if you divide your time among different states, you may find it difficult to establish nexus and may even have to file taxes in multiple states.
Below are some of the most common personal income tax issues people are likely to face.
1. You didn't make (or underpaid) estimated tax payments.
Self-employment is the most common cause of this. When you're used to having taxes withheld from your paychecks at work, it can be a shock to have to pay taxes yourself. You can end up owing not just a large amount of self-employment and income taxes, but also penalties for not making tax payments on time. Estimates must be deposited quarterly, or you will face an underpayment penalty.
If your total tax due when you go to file is under $1,000, you won't have to worry about getting smacked with an underpayment penalty. However, it's a good idea to set aside at least 25%-30% of your income for estimated tax payments and commit to paying this amount every month if quarterly taxes are too complicated to figure out.
Other situations like freelancing on the side or rental income while you're still employed can also cause you to fall short at tax time, so make sure to have extra taxes withheld from your paycheck if you don't want to make estimated payments. State tax payments also shouldn't be neglected.
2. You didn't correctly file state tax returns after moving.
Moving to a state with little or no income taxes like Nevada or Florida can be appealing if your bank account feels squeezed in high-tax states like New York or California. Many people divide their time between multiple states for work or personal reasons, and if it's not just a two- or three-week creative retreat or corporate assignment, it can make nexus difficult to determine in some cases.
With the prospect of a lower tax burden becoming even more appealing, it seems logical to just move to the tax-haven state you've been eyeing. But even after you file for a change of address with the postal service, change your voter registration, and get recognized as a resident by your new state, the high-tax state that you left is likely to also still treat you as one.
Typically, you must spend at least 183 days of the year in the other state and maintain a primary residence there. Simply having property in another state won't do if the rest of your family doesn't also live and wait there for you after your work or travel. Where you spend time outside of work also matters because where you sleep every night is ultimately what counts.
If your move is indeed permanent and your residency is valid, you may have to file a part-year resident tax return for the final months you stayed in the old state. You won't need to worry about it for following years, but keep track of how many days were spent in each state before and after moving day.
3. You neglected to file state income tax returns as a nonresident.
If you have business or rental income in another state, you may be required to file state tax returns as a nonresident. If this income is significant, it can end up producing a large tax bill if you're unprepared.
If you have an out-of-state job, chances are that your payroll provider may also be incorrectly withholding taxes for the appropriate state and/or city. In concentrated regions like the tri-state area, especially for New York City and Philadelphia residents, ensure that city taxes are being correctly withheld if you are a resident, and that withholding curtails if that is no the longer the case. There are usually reciprocity agreements among states and municipalities in areas where state lines cross, but you should carefully check to make sure you don't owe nonresident taxes in addition to what you owe your home state.
Failure to make tax payments on time, and to the right agency, are income tax problems that are often overlooked and can quickly spiral out of control. To avoid these issues and many more, contact our office so we can consult you on your state and local taxation, as well as rules for establishing nexus.
Monday, January 27, 2020
Employer-Offered Benefits That Can Save You Money and Taxes
Tax law includes a number of tax- and financially favored benefits that employers can offer or provide to their employees. This article is intended to make you aware of these perks, with the caveat that all employers, especially small businesses, may not provide all, or perhaps any, of these covered perks. But whichever of these benefits your employer offers, you should seriously consider taking advantage of them, if you haven’t already.
Article Highlights:
Health Insurance – For a company that has 50 or more employees, the Affordable Care Act (aka Obamacare) requires the business to offer at least 95% of its full-time employees and their dependents (but not spouse) with affordable minimum essential health care coverage or be subject to a penalty. If you work for one of these larger employers and the company picks up the entire health insurance premium cost, consider yourself lucky, as the costs of health insurance coverage have risen dramatically over the last few years. More likely, you may have to pay part of the premium costs, and the plan may have a high deductible and/or co-pays. Even so, the tax-free benefit of what the employer covers is valuable. While not required to, businesses with fewer than 50 employees may offer health care coverage, often for competitive purposes in retaining employees. The health insurance premiums paid on your behalf by your employer are tax-free to you. If you aren’t aware of the value of this nontaxable employee benefit, you can look at your Form W-2, box 12a, code DD, which shows your share of the cost of employer-sponsored health coverage. You can claim the part of the coverage that you pay for with post-tax dollars as a medical expense, if you itemize your deductions.
If you have questions on how job-related benefits might apply to you or if you are an employer interested in providing any of these benefits to your employees, please give this office a call or visit our website.
Article Highlights:
- Health Insurance
- Retirement Plans
- Qualified Transportation Fringe Benefits
- Flexible Spending Accounts (FSAs)
- Group Term Life Insurance
- Qualified Employee Discounts
- Employer-Provided Education Assistance
- Adoption Expenses
- Child and Dependent Care Benefits
- Health Savings Accounts
Health Insurance – For a company that has 50 or more employees, the Affordable Care Act (aka Obamacare) requires the business to offer at least 95% of its full-time employees and their dependents (but not spouse) with affordable minimum essential health care coverage or be subject to a penalty. If you work for one of these larger employers and the company picks up the entire health insurance premium cost, consider yourself lucky, as the costs of health insurance coverage have risen dramatically over the last few years. More likely, you may have to pay part of the premium costs, and the plan may have a high deductible and/or co-pays. Even so, the tax-free benefit of what the employer covers is valuable. While not required to, businesses with fewer than 50 employees may offer health care coverage, often for competitive purposes in retaining employees. The health insurance premiums paid on your behalf by your employer are tax-free to you. If you aren’t aware of the value of this nontaxable employee benefit, you can look at your Form W-2, box 12a, code DD, which shows your share of the cost of employer-sponsored health coverage. You can claim the part of the coverage that you pay for with post-tax dollars as a medical expense, if you itemize your deductions.
Retirement Plans – Although some larger employers may provide a company-funded retirement plan that will pay you a monthly benefit when you retire, most generally offer 401(k) plans with which an employee can save for retirement by making pre-tax contributions up to $19,000 for 2019. and if the employee is age 50 or over, they can qualify to make a catch-up contribution of up to $6,000, bringing the total to $25,000. Some employers also match their employees’ contributions up to a certain amount, which means an employee should endeavor to contribute at least the amount that the employer will match.
Qualified Transportation Fringe Benefits – Certain transportation-related fringe benefits that an employer may provide to employees are tax free to the employee. Prior to the passage of the tax reform in late 2017, employers were able to provide employees with tax-free reimbursement for parking, transit passes, commuter transportation, and bicycle commuting, subject to certain limits, and the employer could deduct the cost. The tax reform had a significant impact on these benefits. It eliminated the $20-per-month bicycle benefit and no longer allows the employer to deduct reimbursements made to employees for other transportation benefits, making some employers less likely to offer any transportation fringe benefits. However, they remain tax-free to the employee; for 2019, the limit on tax-free employer reimbursements is $265 per month each for qualified parking, transit passes, and commuter transportation.
Flexible Spending Account (FSA) – This is a special account established by an employer that allows employees to contribute to the account through salary-reduction contributions. The benefit is that the contributions are pre-tax, meaning the employee doesn’t pay taxes on the money contributed to the account. This allows employees to pay for certain out-of-pocket health care costs with pre-tax dollars. The health care expenses can be used for health plan deductibles, co-payments, and even some over-the-counter-medications. The annual limit on contributions is inflation adjusted and is $2,700 for 2019. However, if you don’t use the money in your FSA, you’ll lose it.
Group Term Life Insurance – The cost for the first $50,000 of group term life insurance (GTLI) coverage provided by an employer is excluded from the employee’s taxable income. However, the employer-paid cost of group term coverage in excess of $50,000 is taxable income to the employee, even if he or she never receives it (i.e., it is “phantom income”). So, while the tax-free coverage of the first $50,000 is a good perk, an employee shouldn’t automatically sign up for more than $50,000 of GTLI coverage without considering whether they truly need the coverage and what the extra cost will be. In some cases, an employee who wants more than $50,000 in coverage may be able to privately acquire a policy that will cost less than the tax on the imputed income for the extra coverage through the employer’s plan.
Qualified Employee Discounts – A certain amount of an employee discount on purchases from an employer or on services provided by an employer is excludable from the employee’s income. The exclusion is limited to the employer's gross profit percentage for property, or 20% of the price at which the employer sells services to non-employee customers, for services.
Employer-Provided Education Assistance – An employee doesn’t have to include, in his or her income, amounts paid by the employer for educational assistance under a qualified education-assistance program. The maximum amount of educational assistance that an employee can exclude is $5,250 for any calendar year. Excludable assistance under a qualified plan includes, among others, tuition, fees, books, supplies, and equipment. The education is any training that improves an individual’s capabilities, whether or not it is job-related or part of a degree program.
Qualified Transportation Fringe Benefits – Certain transportation-related fringe benefits that an employer may provide to employees are tax free to the employee. Prior to the passage of the tax reform in late 2017, employers were able to provide employees with tax-free reimbursement for parking, transit passes, commuter transportation, and bicycle commuting, subject to certain limits, and the employer could deduct the cost. The tax reform had a significant impact on these benefits. It eliminated the $20-per-month bicycle benefit and no longer allows the employer to deduct reimbursements made to employees for other transportation benefits, making some employers less likely to offer any transportation fringe benefits. However, they remain tax-free to the employee; for 2019, the limit on tax-free employer reimbursements is $265 per month each for qualified parking, transit passes, and commuter transportation.
Flexible Spending Account (FSA) – This is a special account established by an employer that allows employees to contribute to the account through salary-reduction contributions. The benefit is that the contributions are pre-tax, meaning the employee doesn’t pay taxes on the money contributed to the account. This allows employees to pay for certain out-of-pocket health care costs with pre-tax dollars. The health care expenses can be used for health plan deductibles, co-payments, and even some over-the-counter-medications. The annual limit on contributions is inflation adjusted and is $2,700 for 2019. However, if you don’t use the money in your FSA, you’ll lose it.
Group Term Life Insurance – The cost for the first $50,000 of group term life insurance (GTLI) coverage provided by an employer is excluded from the employee’s taxable income. However, the employer-paid cost of group term coverage in excess of $50,000 is taxable income to the employee, even if he or she never receives it (i.e., it is “phantom income”). So, while the tax-free coverage of the first $50,000 is a good perk, an employee shouldn’t automatically sign up for more than $50,000 of GTLI coverage without considering whether they truly need the coverage and what the extra cost will be. In some cases, an employee who wants more than $50,000 in coverage may be able to privately acquire a policy that will cost less than the tax on the imputed income for the extra coverage through the employer’s plan.
Qualified Employee Discounts – A certain amount of an employee discount on purchases from an employer or on services provided by an employer is excludable from the employee’s income. The exclusion is limited to the employer's gross profit percentage for property, or 20% of the price at which the employer sells services to non-employee customers, for services.
Employer-Provided Education Assistance – An employee doesn’t have to include, in his or her income, amounts paid by the employer for educational assistance under a qualified education-assistance program. The maximum amount of educational assistance that an employee can exclude is $5,250 for any calendar year. Excludable assistance under a qualified plan includes, among others, tuition, fees, books, supplies, and equipment. The education is any training that improves an individual’s capabilities, whether or not it is job-related or part of a degree program.
Adoption Expenses – An employee may exclude amounts paid or expenses incurred by the employer for qualified adoption expenses connected to the employee’s adoption of a child, if the amounts are furnished under an adoption-assistance program in existence before the expenses are incurred. If the adopted child is a special needs child, the exclusion applies regardless of whether the employee actually has adoption expenses. The maximum exclusion amount is inflation adjusted annually and is $14,080 for 2019 per child, for both non-special needs and special needs adoptions. The exclusion is phased out when the employee’s modified adjusted gross income is between $211,160 and $251,160 for 2019. Taxpayers can claim a tax credit for qualified adoption expenses, subject to the same phaseout range as for the exclusion, but any excludable employer-paid expenses can’t be used for the credit.
Child and Dependent Care Benefits – Qualified payments made or reimbursed by an employer on behalf of an employee for child and dependent care assistance are excluded from the employee’s gross income. The amount of the exclusion is limited to the lesser of $5,000 ($2,500 for married individuals filing separately), the employee’s earned income, or the income of the employee’s spouse. A child and dependent care tax credit is available to taxpayers, but no credit is allowed to an employee for any amount excluded from income under his or her employer’s dependent care assistance program.
Child and Dependent Care Benefits – Qualified payments made or reimbursed by an employer on behalf of an employee for child and dependent care assistance are excluded from the employee’s gross income. The amount of the exclusion is limited to the lesser of $5,000 ($2,500 for married individuals filing separately), the employee’s earned income, or the income of the employee’s spouse. A child and dependent care tax credit is available to taxpayers, but no credit is allowed to an employee for any amount excluded from income under his or her employer’s dependent care assistance program.
Health Savings Accounts – Employees who have a high-deductible health plan through their employer can open a health savings account (HSA) and make annually inflation-adjusted pre-tax contributions, which, for 2019, can be up to $7,000 for families and $3,500 for a single individual. When distributions are made for medical expenses, the money comes out tax-free. However, distributions not used to pay qualified medical expenses are taxable, and if the plan’s owner is under the age of 65, nonqualified distributions are subject to a 20% penalty. Some individuals let the account grow and treat it as a supplemental retirement plan, waiting until after age 65 to begin taking taxable but penalty-free distributions.
If you have questions on how job-related benefits might apply to you or if you are an employer interested in providing any of these benefits to your employees, please give this office a call or visit our website.
Friday, January 24, 2020
Who Claims the Children You or Your Ex-Spouse?
If you are a divorced or separated parent with children, a commonly encountered but often misunderstood issue is who claims the child or children for tax purposes. This is sometimes a hotly disputed issue between parents; however, tax law includes some very specific but complicated rules about who profits from the child-related tax benefits. At issue are a number of benefits, including the children’s dependency, child tax credit, child care credit, higher-education tuition credit, earned income tax credit, and, in some cases, even filing status.
Article Highlights:
This is actually one of the most complicated areas of tax law, and inexperienced tax preparers or taxpayers preparing their own returns can make serious mistakes, especially if the parents are not communicating well. If parents will cooperate with each other, they often can work out the best tax result overall, even though it may not be the best for them individually, and compensate for it in other ways.
Physical Custody (Custodial Parent) – If a family court awards physical custody of a child to one parent, tax law is very specific in awarding that child’s dependency to the parent with physical custody, regardless of the amount of child support provided by the other parent. However, the custodial parent may release that dependency to the non-custodial parent for tax purposes by completing the appropriate IRS form. The release can be granted on a yearly basis or for multiple years at one time. But once made, it is binding for the specified period.
Joint Custody – On the other hand, if the family court awards joint physical custody, only one of the parents may claim the child as a dependent for tax purposes. If the parents cannot agree between themselves as to who will claim the child and the child is actually claimed by both, the IRS tiebreaker rules will apply. Per the tiebreaker rules, the child is treated as a dependent of the parent with whom the child resided for the greater number of nights during the tax year; or if the child resides with both parents for the same amount of time during the tax year, the parent with the higher adjusted gross income will claim the child as a dependent. Parents in the process of divorcing should be aware that for tax purposes, the IRS’s rules as to who can claim a child’s dependency takes precedence over what a divorce decree says or what a judge may have ruled. So, for example, if the family court awards full custody of a child to Parent A but says that Parent B can claim the child as a tax dependent, the IRS’s position is that the child is a tax dependent of Parent A unless Parent A releases the dependency to Parent B, as explained above.
Child’s Exemption Allowance –While there is no longer (through 2025) a monetary tax deduction (also referred to as an exemption allowance) for a dependent child, it still matters who claims the child as a dependent because certain tax credits are only available to the taxpayer claiming the child as a dependent.
Head of Household Filing Status – An unmarried parent can claim the more favorable head of household, rather than single, filing status if he or she is the custodial parent and pays more than half of the costs of maintaining, as his or her home, a household that is the child’s principal place of abode for more than half the year. This is true even when the child’s dependency is released to the non-custodial parent.
Tuition Credit – If the child qualifies for either the American Opportunity or the Lifetime Learning higher-education tax credit, the credit goes to whoever claims the child as a dependent. Credits are significant tax benefits because they reduce the tax amount dollar-for-dollar, while deductions reduce income to arrive at taxable income, which is then taxed according to the individual’s tax bracket. For instance, the American Opportunity Tax Credit (AOTC) provides a tax credit of up to $2,500, of which 40% is refundable. However, both education credits phase out for higher-income taxpayers. For instance, the AOTC phases out between $80,000 and $90,000 for unmarried taxpayers and $160,000 and $180,000 for married taxpayers.
Child Care Credit – A nonrefundable tax credit is available to the custodial parent for child care while the parent is gainfully employed or seeking employment. To qualify for this credit, the child must be under the age of 13 and be a dependent of the parent. However, a special rule for divorced or separated parents provides that if the custodial parent releases the child’s exemption to the non-custodial parent, the custodial parent can still qualify to claim the child care credit, and it cannot be claimed by the noncustodial parent.
Child Tax Credit – A $2,000 credit is allowed for a child under the age of 17. That credit goes to the parent claiming the child as a dependent. However, this credit phases out for higher-income parents, beginning at $200,000 for unmarried parents and $400,000 for married parents filing jointly.
Earned Income Tax Credit (EITC) – Lower-income parents with earned income (wages or self-employment income) may qualify for the EITC. This credit is based on the number of children (under age 19 or a full-time student under age 24) the custodial parent has, up to a maximum of three children. Releasing the dependency of a child or of children to the noncustodial parent will not disqualify the custodial parent from using the children to qualify for the EITC. In fact, the noncustodial parent is prohibited from claiming the EITC based on the child or children whose dependency has been released by the custodial parent.
As you can see, some complex rules apply to the tax benefits provided by the children of divorced parents. It is highly recommended that you consult this office to prepare your return. If you are the custodial parent, you should also consult with this office before deciding whether to release a child as a tax dependent.
Article Highlights:
- Custodial Parent
- Dependency Release
- Joint Custody
- Tiebreaker Rules
- Child’s Exemption
- Head of Household Filing Status
- Tuition Credit
- Child Care Credit
- Child Tax Credit
- Earned Income Tax Credit
This is actually one of the most complicated areas of tax law, and inexperienced tax preparers or taxpayers preparing their own returns can make serious mistakes, especially if the parents are not communicating well. If parents will cooperate with each other, they often can work out the best tax result overall, even though it may not be the best for them individually, and compensate for it in other ways.
Physical Custody (Custodial Parent) – If a family court awards physical custody of a child to one parent, tax law is very specific in awarding that child’s dependency to the parent with physical custody, regardless of the amount of child support provided by the other parent. However, the custodial parent may release that dependency to the non-custodial parent for tax purposes by completing the appropriate IRS form. The release can be granted on a yearly basis or for multiple years at one time. But once made, it is binding for the specified period.
CAUTION – The decision to relinquish dependency should not be taken lightly, as it impacts a number of tax benefits.
Joint Custody – On the other hand, if the family court awards joint physical custody, only one of the parents may claim the child as a dependent for tax purposes. If the parents cannot agree between themselves as to who will claim the child and the child is actually claimed by both, the IRS tiebreaker rules will apply. Per the tiebreaker rules, the child is treated as a dependent of the parent with whom the child resided for the greater number of nights during the tax year; or if the child resides with both parents for the same amount of time during the tax year, the parent with the higher adjusted gross income will claim the child as a dependent. Parents in the process of divorcing should be aware that for tax purposes, the IRS’s rules as to who can claim a child’s dependency takes precedence over what a divorce decree says or what a judge may have ruled. So, for example, if the family court awards full custody of a child to Parent A but says that Parent B can claim the child as a tax dependent, the IRS’s position is that the child is a tax dependent of Parent A unless Parent A releases the dependency to Parent B, as explained above.
Child’s Exemption Allowance –While there is no longer (through 2025) a monetary tax deduction (also referred to as an exemption allowance) for a dependent child, it still matters who claims the child as a dependent because certain tax credits are only available to the taxpayer claiming the child as a dependent.
Head of Household Filing Status – An unmarried parent can claim the more favorable head of household, rather than single, filing status if he or she is the custodial parent and pays more than half of the costs of maintaining, as his or her home, a household that is the child’s principal place of abode for more than half the year. This is true even when the child’s dependency is released to the non-custodial parent.
Tuition Credit – If the child qualifies for either the American Opportunity or the Lifetime Learning higher-education tax credit, the credit goes to whoever claims the child as a dependent. Credits are significant tax benefits because they reduce the tax amount dollar-for-dollar, while deductions reduce income to arrive at taxable income, which is then taxed according to the individual’s tax bracket. For instance, the American Opportunity Tax Credit (AOTC) provides a tax credit of up to $2,500, of which 40% is refundable. However, both education credits phase out for higher-income taxpayers. For instance, the AOTC phases out between $80,000 and $90,000 for unmarried taxpayers and $160,000 and $180,000 for married taxpayers.
Child Care Credit – A nonrefundable tax credit is available to the custodial parent for child care while the parent is gainfully employed or seeking employment. To qualify for this credit, the child must be under the age of 13 and be a dependent of the parent. However, a special rule for divorced or separated parents provides that if the custodial parent releases the child’s exemption to the non-custodial parent, the custodial parent can still qualify to claim the child care credit, and it cannot be claimed by the noncustodial parent.
Child Tax Credit – A $2,000 credit is allowed for a child under the age of 17. That credit goes to the parent claiming the child as a dependent. However, this credit phases out for higher-income parents, beginning at $200,000 for unmarried parents and $400,000 for married parents filing jointly.
Earned Income Tax Credit (EITC) – Lower-income parents with earned income (wages or self-employment income) may qualify for the EITC. This credit is based on the number of children (under age 19 or a full-time student under age 24) the custodial parent has, up to a maximum of three children. Releasing the dependency of a child or of children to the noncustodial parent will not disqualify the custodial parent from using the children to qualify for the EITC. In fact, the noncustodial parent is prohibited from claiming the EITC based on the child or children whose dependency has been released by the custodial parent.
As you can see, some complex rules apply to the tax benefits provided by the children of divorced parents. It is highly recommended that you consult this office to prepare your return. If you are the custodial parent, you should also consult with this office before deciding whether to release a child as a tax dependent.
Thursday, January 23, 2020
Tax Issues Related to Hobbies
Generally, when individuals have a hobby, they have it because they enjoy it and are not involved in their hobby with the goal of making money. In fact, most hobbies never make money or don’t even create any income, for that matter. Tax law generally does not allow deductions for personal expenses except those allowed as itemized deductions on the 1040 Schedule A, and this also applies to hobby expenses.
Article Highlights:
Some hobbyists try to get a tax deduction for their hobby expenses by treating their hobby as a trade or a business. By disguising hobbies as a trade or business, and if the hobby expenses exceed the hobby income, they think they can report the difference between hobby income and expenses as a deductible business loss. Not in this case! To curtail hobbies being treated as businesses, the tax code includes rules that do not permit losses for not-for-profit activities such as hobbies. The not-for-profit rules are often referred to as the hobby loss rules.
The distinction between a hobby and a trade or business sometimes becomes blurred, and the determination depends upon a series of factors, with no single factor being decisive. All of these factors have to be considered when making the determination:
Making the proper determination is important because of the differences in tax treatment for hobbies versus trades or businesses. If an activity is determined to be a trade or business in which the owner materially participates, then the owner can deduct a loss on his or her tax return, and it is not uncommon for a business to show a loss in the startup years.
However, hobbies (not-for-profit activities) have special, unfavorable rules for reporting the income and expenses, which have been exacerbated by the 2017 passage of the Tax Cuts and Jobs Act (tax reform). These rules are:
If you have questions related to how the not-for-profit rules may apply to your activity, please give this office a call or visit our website.
Article Highlights:
- Hobby Losses
- Not-for-Profit Rules
- Determining Factors
- Trade or Business Presumption
- Hobby Tax Reporting
- Self-Employment Tax
Some hobbyists try to get a tax deduction for their hobby expenses by treating their hobby as a trade or a business. By disguising hobbies as a trade or business, and if the hobby expenses exceed the hobby income, they think they can report the difference between hobby income and expenses as a deductible business loss. Not in this case! To curtail hobbies being treated as businesses, the tax code includes rules that do not permit losses for not-for-profit activities such as hobbies. The not-for-profit rules are often referred to as the hobby loss rules.
The distinction between a hobby and a trade or business sometimes becomes blurred, and the determination depends upon a series of factors, with no single factor being decisive. All of these factors have to be considered when making the determination:
- Is the activity carried out in a businesslike manner?
- How much time and effort does the taxpayer spend on the activity?
- Does the taxpayer depend on the activity as a source of income?
- Are losses from the activity the result of sources beyond the taxpayer’s control?
- Has the taxpayer changed business methods in attempts to improve profitability?
- What is the taxpayer’s expertise in the field?
- What success has the taxpayer had in similar operations?
- What is the possibility of profit?
- Is profit from asset appreciation possible?
Making the proper determination is important because of the differences in tax treatment for hobbies versus trades or businesses. If an activity is determined to be a trade or business in which the owner materially participates, then the owner can deduct a loss on his or her tax return, and it is not uncommon for a business to show a loss in the startup years.
However, hobbies (not-for-profit activities) have special, unfavorable rules for reporting the income and expenses, which have been exacerbated by the 2017 passage of the Tax Cuts and Jobs Act (tax reform). These rules are:
- The income is reported directly on the hobbyist’s 1040;
- The expenses, not exceeding the income, are deducted as a miscellaneous itemized deduction. Thus, the expenses are only allowed if a taxpayer is itemizing deductions, rather than taking the standard deduction; and
- Due to tax reform, for tax years 2018 through 2025, miscellaneous itemized deductions that must be reduced by 2% of the taxpayer’s adjusted gross income – which is the category into which the hobby expenses fall – have been suspended (are not deductible). Thus, for those years, there is no deduction at all for hobby expenses, and any hobby income will be fully taxable.
Example: Marcia has income of $750 from her hobby (a not-for-profit activity) of coin collecting and expenses of $500. So, Marcia must include the $750 on her 1040. But because miscellaneous itemized deductions are currently suspended, she will not be able to deduct her $500 in expenses, leaving the full $750 as taxable income.
If you have questions related to how the not-for-profit rules may apply to your activity, please give this office a call or visit our website.
Wednesday, January 22, 2020
What Is the Statute of Limitations on Unpaid Taxes?
Did you know there is a little-known statute of limitations for tax debt collections? Learn more about when this rule kicks in & what conditions must be satisfied.
If you have unpaid taxes that you haven't yet been making payments toward, it might make you fearful that the IRS will come a-knocking one day to collect on what you owe. Tax debt can quickly snowball from interest, penalties, late fees, and the amount of the taxes due.
However, a lot of the scaremongering surrounding the IRS is largely sensationalized in media and daily conversation. Agents won't come bursting through your door just because you have tax debt. Instead, they must follow due process in accordance with the Internal Revenue Service Restructuring and Reform Act of 1998 (RRA). This means that you will always receive written notice concerning your balance due as well as collection actions and any requests for payment plans or settling your account.
However, if you haven't received further notification concerning what you owe, you may be able to ride out the little-known statute of limitations on tax debt collections, which is 10 years.
What the 10-Year Statute of Limitations Entails
Your tax debt can actually be canceled in 10 years if the IRS makes no efforts to collect on your account - and if you also don't contact the IRS. However, it's not as simple as just waiting a decade without ever paying the taxes you owe. There are conditions that must be satisfied. The first is that this 10-year time frame doesn't begin when you filed that tax return with a balance due or when you realized you owed taxes you couldn't pay.
The official statute of limitations date begins once you receive written notice from the IRS concerning what you owe. You may receive a notice of deficiency with an actual tax bill or a substitute tax return if you didn't file by the due date. So, if you filed your tax return on June 15, 2019, and got a notice in the mail dated September 1, your statutory period would begin September 1, not June 15. This date is called the CSED (Collection Statute Expiration Date), and if you make it to September 1, 2029, without further collection actions, then you can actually get your entire tax bill from this period canceled. (Note: Future tax bills, such as next year's taxes you also can't afford to pay on the due date, do not count toward this.)
However, the IRS will not notify you of this. While the date of assessment is also generally when that notice is received, the IRS has argued over when the assessment date actually was. Some situations can also delay the CSED by halting the clock on the 10-year time frame, such as:
State Tax Debt
Unlike the IRS, state tax departments do not have reciprocity with the RRA or the Taxpayer Bill of Rights. Taxpayers who are subject to state income tax need to find out what options, if any, are offered by their state tax department. State tax departments may actually take harsher collection actions since they don't have to have oversight committees and the option for taxpayers to settle back taxes or make payment plans, and they do not have a statute of limitations on collections. The IRS tends to get a bad rap in movies and on TV, but it's actually the state tax departments that are more likely to show up unannounced or issue liens a lot sooner.
It's very rare than anyone rides out the statute of limitations, and it's usually due to extenuating circumstances like disability or a debilitating business closure. If enough time has passed that you think you might be able to go the whole 10 years without payments or responses to collection actions, you must keep fastidious records of all correspondence with the IRS. If the IRS sent you little or no mail in the time period after the time you think the CSED kicked off, you may qualify for the statute of limitations but should not intentionally try to ride it out without the guidance of a tax professional specializing in tax relief and resolution issues.
If you have unpaid taxes that you haven't yet been making payments toward, it might make you fearful that the IRS will come a-knocking one day to collect on what you owe. Tax debt can quickly snowball from interest, penalties, late fees, and the amount of the taxes due.
However, a lot of the scaremongering surrounding the IRS is largely sensationalized in media and daily conversation. Agents won't come bursting through your door just because you have tax debt. Instead, they must follow due process in accordance with the Internal Revenue Service Restructuring and Reform Act of 1998 (RRA). This means that you will always receive written notice concerning your balance due as well as collection actions and any requests for payment plans or settling your account.
However, if you haven't received further notification concerning what you owe, you may be able to ride out the little-known statute of limitations on tax debt collections, which is 10 years.
What the 10-Year Statute of Limitations Entails
Your tax debt can actually be canceled in 10 years if the IRS makes no efforts to collect on your account - and if you also don't contact the IRS. However, it's not as simple as just waiting a decade without ever paying the taxes you owe. There are conditions that must be satisfied. The first is that this 10-year time frame doesn't begin when you filed that tax return with a balance due or when you realized you owed taxes you couldn't pay.
The official statute of limitations date begins once you receive written notice from the IRS concerning what you owe. You may receive a notice of deficiency with an actual tax bill or a substitute tax return if you didn't file by the due date. So, if you filed your tax return on June 15, 2019, and got a notice in the mail dated September 1, your statutory period would begin September 1, not June 15. This date is called the CSED (Collection Statute Expiration Date), and if you make it to September 1, 2029, without further collection actions, then you can actually get your entire tax bill from this period canceled. (Note: Future tax bills, such as next year's taxes you also can't afford to pay on the due date, do not count toward this.)
However, the IRS will not notify you of this. While the date of assessment is also generally when that notice is received, the IRS has argued over when the assessment date actually was. Some situations can also delay the CSED by halting the clock on the 10-year time frame, such as:
- Filing for bankruptcy
- Being outside the U.S. for at least six months
- Military deferment
- Submitting an offer in compromise to settle back taxes
- Filing a lawsuit against the IRS
- Having your assets held in court custody due to divorce, judgments against you, etc.
State Tax Debt
Unlike the IRS, state tax departments do not have reciprocity with the RRA or the Taxpayer Bill of Rights. Taxpayers who are subject to state income tax need to find out what options, if any, are offered by their state tax department. State tax departments may actually take harsher collection actions since they don't have to have oversight committees and the option for taxpayers to settle back taxes or make payment plans, and they do not have a statute of limitations on collections. The IRS tends to get a bad rap in movies and on TV, but it's actually the state tax departments that are more likely to show up unannounced or issue liens a lot sooner.
It's very rare than anyone rides out the statute of limitations, and it's usually due to extenuating circumstances like disability or a debilitating business closure. If enough time has passed that you think you might be able to go the whole 10 years without payments or responses to collection actions, you must keep fastidious records of all correspondence with the IRS. If the IRS sent you little or no mail in the time period after the time you think the CSED kicked off, you may qualify for the statute of limitations but should not intentionally try to ride it out without the guidance of a tax professional specializing in tax relief and resolution issues.
Tuesday, January 21, 2020
Earned Income Tax Credit: Used, Abused and Altered
Article Highlights:
- Purpose of the Earned Income Tax Credit
- Qualifications
- Earned Income
- Qualified Child
- Credit Phaseout
- Computing the Credit
- Investment Income Limit
- Combat Pay Election
- Fraud
- Safeguards
The EITC is a refundable credit, meaning if any unused credit remains after offsetting all of a taxpayer’s tax liability, that remainder is refunded to the taxpayer. This refundable feature has made the EITC a giant target for fraud, which is discussed later in this article. In addition to the other requirements discussed below, the EITC is not allowed to married couples filing separately, nor can the taxpayer claiming the credit be a dependent of another taxpayer. In addition, the taxpayer must have been a U.S. citizen or resident alien all year and have a Social Security Number (SSN). Any children used to qualify the taxpayer for the credit are also required to have an SSN. Furthermore, because this credit is meant for lower-income individuals, if a taxpayer is working overseas and is able to exclude foreign earned income, he or she is barred from claiming the EITC. Taxable Earned Income – As previously mentioned, the EITC is based, in part, on the amount of a taxpayer’s (or in the case of a married couple, both a filer’s and a spouse’s) taxable earned income. For example, taxable earned income includes:
- Wages, salaries, and tips;
- Union strike benefits;
- Long-term disability benefits prior to minimum retirement age; and
- Earnings from self-employment.
Qualified Children – The EITC is also based upon the number of the taxpayer’s qualified children who lived with the taxpayer in the United States for more than half of the year for which the credit is being claimed. Generally, for EITC purposes, a qualified child must be younger than the taxpayer and be under the age of 19 or a full-time student under the age of 24 who had the same principal place of abode as the taxpayer for more than half of the tax year and is not married and filing a joint return (exceptions may apply).
For the EITC, “child” is defined as the taxpayers:
- Son, daughter, adopted child, stepchild, eligible foster child, or a descendant of any of them (for example, a grandchild); or brother, sister, half-brother, half-sister, stepbrother, stepsister, or a descendant of any of them (for example, a niece or nephew).
Exceptions to the residency requirement include temporary absences from the home, such as for school, vacations, illness, and military service.
Computing the Credit and Phaseout – The amount of the EITC increases as the earned income increases until it reaches the maximum credit amount, and then it phases out as the taxpayer’s modified adjusted gross income (MAGI) increases above the phaseout threshold. The following table illustrates how the credit is determined and the maximum amount of the credit for 2019.
| Number of Qualifying Children | Credit Percentage | Earned Income | Maximum Credit |
| None | 7.65 | $6,920 | $529 |
| One | 34.00 | $10,370 | $3,526 |
| Two | 40.00 | $14,570 | $5,828 |
| Three or more | 45.00 | $14,570 | $6,557 |
If a taxpayer has no qualifying children, the taxpayer must be age 25 or older but under the age of 65 before the end of the year. This is to prevent children and retired individuals from claiming the credit. As can be seen from the table above, the credit for a taxpayer who doesn’t have a qualifying child is significantly less than for someone with one or more children.
Example #1: Ted and Jane have two qualifying children, and their only income is Ted’s wages (earned income) of $31,738. From the table above, based on two children, we determine their EITC before the phase-out as being the lesser of $12,695 (40% of $31,738) or $5,828 (the maximum for taxpayers with two qualifying children). Thus, in this case, the EITC before phaseout is $5,828.
Phaseout – The tax law limits the EITC to lower-income taxpayers by phasing out (reducing) the credit as a taxpayer’s MAGI increases above a threshold, with the credit fully phased out when the MAGI reaches the complete phaseout amount shown in the table below.
| Number of Qualifying Children | Phaseout Percentage | Phaseout Threshold | Complete Phaseout |
| None | 7.65 | Joint Filers: $14,450 Others: $8,650 | $21,370 $15,570 |
| One | 15.98 | Joint Filers: $24,820 Others: $19,030 | $46,884 $41,094 |
| Two | 21.06 | Joint Filers: $24,820 Others: $19,030 | $52,493 $46,703 |
| Three or more | 21.06 | JointFilers:$24,820 Others: $19,030 | $55,952 $50,162 |
Example #2: Using Ted and Jane from example #1, who have two qualifying children, we had determined that their EITC before phaseout was $5,828. The next step is to determine their credit after phaseout. We do that using the chart above, and for a married couple with two qualified children, the phaseout threshold begins at $24,820 and the phaseout percentage is 21.06%. Ted and Jane’s only income was Ted’s wages, so their MAGI is also $31,738. Their MAGI exceeds the phaseout threshold by $6,918 ($31,738 – $24,820). Multiplying that amount by the 21.06 phaseout percentage equals $1,457, which is the amount of the EITC that will be phased out. Thus, Ted and Jane’s EITC for 2019 will be $4,371 ($5,828 − $1,457).
Each year, the IRS develops credit look-up tables that take into account the taxpayer’s filing status, the number of qualifying children, earned income, MAGI, and phaseout, so that the math we did in the above example is not needed.
Investment Income Limit – Congress further limited the credit so that taxpayers with substantial financial assets will not qualify for the credit. A taxpayer’s income from investments is used as a gauge for financial assets, and for 2019, taxpayers with investment income of $3,600 or more are disqualified from the credit.
Special Election for Combat Pay – Military members can elect to include their nontaxable combat pay as earned income for the credit. If that election is made, then the military member must include in his or her earned income all nontaxable combat pay received. If spouses are filing a joint return and both spouses received nontaxable combat pay, then each one can make a separate election.
Fraud – As mentioned earlier, the EITC is also a target of major fraud by unscrupulous tax preparers and ID thieves. In fact, the fraud has been so prevalent that the IRS has developed procedures, and Congress has passed tax laws, to combat the abuse.
One of the major areas of fraud was scammers filing returns with stolen IDs and phony income as soon as the IRS began accepting e-filed returns around the end of January. Filing early prevented the IRS from verifying the reported income because employers were not required to file W-2s and 1099s until the end of February. That also minimized the chances that the individuals whose IDs the fraudsters were using would file before them and cause the IRS to reject the return. In fact, many scammers would file married joint returns using the names and SSNs of two unrelated individuals, taking advantage of the IRS’s privacy policies; thus, if one of the victims contacted the IRS, the IRS would be unable to communicate with the individual because the victim would not know the name or SSN of the other filer on the bogus joint tax return. Of course, the income reported on the fraudulent returns was an amount meant to maximize the EITC and minimize the phaseout. The scammers also took advantage of the automatic refund deposit feature and had the refunds deposited into bank accounts that they opened in the names of the individuals whose IDs they were using on the fraudulent returns. Once the refunds were deposited into the accounts, the accounts were quickly cleaned out, leaving absolutely no trace of the scammers who were rarely caught. However, in a notable case in Florida, the scammer got away with millions of dollars in bogus credits and would not have ever been caught had she not bragged about her exploits online.
The IRS has since altered its return-processing procedures and plugged that hole, by not issuing refunds that include the EITC until after mid-February. The filing due dates for W-2s and 1099s have been moved up to January 31, giving the IRS adequate time to verify the earned income before issuing the refunds.
The IRS has also established the Identity Protection Specialized Unit to assist taxpayers who have been victims of ID theft. These taxpayers can file their returns by using an Identity Protection PIN provided annually by the IRS. Taxpayers who are or suspect they are victims of ID theft can call the IRS at 877-438-4338 for assistance.
Safeguards – Congress has also included consequences for taxpayers who have been found to abuse the EITC rules and has included mandatory taxpayer identification procedures for tax preparers.
- Taxpayers – For taxpayers who recklessly or intentionally disregard the EITC rules, the IRS can make them ineligible for the credit in the two subsequent years, and if fraud is involved, the suspension period can be for ten years.
- Tax Preparers – Tax preparers are required to follow mandated EITC due diligence procedures that require them to complete an EITC due diligence check sheet and verify the identity of anyone claiming the EITC before a return can be filed. Failure to adhere to these safeguards can result in a $530 tax-preparer penalty for each failure to comply with the due diligence requirements.
Many taxpayers who legitimately qualify for this credit are failing to claim it because they don’t fully understand the credit. For instance, the IRS estimates that 1.5 million taxpayers don’t realize that taxable long-term retirement benefits received before reaching minimum retirement age qualify as earned income, making them eligible for the EITC. The IRS also estimates that between 20 and 25 percent of the individuals who qualify for the EITC don’t claim it.
If you have questions about your qualifications for this credit or need help amending or filing a prior year’s return to claim the credit, please give this office a call or visit our website.
Monday, January 20, 2020
Tax Changes For 2019
As the end of the year approaches, now is a good time to review the various changes that impact 2019 tax returns. Some of the changes are likely to apply to your tax situation. In addition, be aware that various tax-related bills currently in Congress may or may not pass this year. If any of them do pass, we will quickly get the details to you.
Article Highlights:
Medical Threshold – Medical expenses are deductible as itemized deductions only if the total medical expenses for the tax year exceed a specified percentage of a taxpayer’s income. After dropping to 7.5% for 2017 and 2018, this threshold reverts to 10% for 2019. As a result, any medical expenses from 2019 are deductible only to the extent that they exceed 10% of a taxpayer’s adjusted gross income for the year.
Electric Vehicle Credit Phaseout – As an incentive to get taxpayers to move away from conventional-fuel (gasoline or diesel) vehicles, Congress has provided tax credits of up to $7,500 for the purchase of plug-in electric vehicles. However, Congress’s rules limit the full credit to the first 200,000 vehicles sold by a given manufacturer. Once a company sells 200,000 qualifying vehicles, the credit begins to phase out for that company. Tesla, Chevrolet, and Cadillac have all reached the phaseout point. The table below shows the credits available depending upon the quarter when the vehicle is purchased.
If a qualifying vehicle is used partiality for business, the credit is proportionally allocated between personal and business tax credits. The personal portion can only offset the individual’s current-year tax liability; any excess is lost. The business portion can be carried back for one year and then forward up to 20 years until it is used up; any credit remaining after the 20th year is lost. As a tip, please note that the credit limit is per vehicle, not per taxpayer, so individuals who make multiple purchases can receive multiple credits.
Alimony – One delayed effect of the 2017 tax reform is that, the treatment of alimony changes for some individuals starting in 2019.
For divorces or separations entered into before 2019, alimony payments continue to be deductible for the payer and taxable for the recipient; such payments also still qualify as earned income for purposes of the recipient’s qualification for an IRA deduction. For divorces or separations executed after December 31, 2018, alimony payments are no longer deductible for the payer. In addition, for the recipient, they are no longer taxable income and do not count as earned income for the purposes of IRA deduction.
Divorces or separations entered into before 2019 continue to follow the pre-2019 rules unless they have been modified after December 31, 2018; in that case, the alimony payments are subject to the post-2018 rules if the modification expressly provides for this.
Finalization of State- and Local-Tax Deduction Limitation – The 2017 tax reform limited the itemized deduction for state and local taxes (SALT) to $10,000 (or $5,000 for married individuals filing separately). This has adversely impacted taxpayers in high-tax states such as California, Connecticut, New Jersey, and New York. Elected officials in several states have attempted to work around this restriction by establishing (or proposing to establish) state charities. The idea is that taxpayers would make deductible contributions that, in return, would give them tax credits against their SALT equal to most of the value of the charitable contributions. Unfortunately, these officials have overlooked the 1986 U.S. Supreme Court ruling that, if a taxpayer receives something in return for a contribution (i.e., a quid pro quo), the contribution is not deductible.
The final regulations generally reduce the charitable-contribution deduction by the amount of any SALT credit received. However, as an exception, if the credit does not exceed 15% of the contribution, the entire contribution is deductible.
Penalty for Not Being Insured – The Tax Cuts and Jobs Act (tax-reform) that was enacted at the end of 2017 eliminated the Obamacare shared-responsibility payment, effective starting in 2019. Congress didn’t actually repeal this penalty; instead, it effectively repealed it by tweaking by setting zero values for both the percentage of household income used in the calculation and the flat dollar amount of the penalty. As a result, the amount of the penalty is always zero. However, keep in mind that the penalty could be restored in the future if the direction that the political winds are blowing changes. In addition, beginning in 2020, some states may pick up where the federal government left off and charge a penalty to residents without qualified health insurance coverage.
Qualified Opportunity Funds – Taxpayers who receive capital gains on the sale or exchange of property (if the other party is unrelated) may elect to defer – and, potentially, partially exclude – those gains from their gross income if they are reinvested in a qualified opportunity fund (QOF) within 180 days of the sale or exchange. The amount of the gain (not the amount of the proceeds, as in Sec. 1031 deferrals) needs to be reinvested in order to defer the gain. The deferral period ends when the QOF investment ends or on December 31, 2026 – whichever is sooner. At that time, taxes must be paid on the deferred gain.
However, 10% of the deferred gains are forgiven QOF investments have been held for at least 5 years, and 15% of the gains are forgiven when those investments have been held for at least 7 years. Note that, with the deferral end date of December 31, 2026, qualifying for the 15% forgiveness requires a QOF investment on or before December 31, 2019.
Seniors Get a Special Tax Form – Lawmakers have long sought to provide taxpayers who are age 65 and older with a simplified tax form in place of the Form 1040. In the 2018 budget bill, Congress finally included a requirement that the IRS create such a form. As a result, the IRS will introduce Form 1040-SR, which will look a lot like the old form looked before the 2018 tax reform instituted its (politically motivated) division of the Form 1040 into multiple postcard-size schedules. It is unclear how much simpler the Form 1040-SR will be, but it will be available for 2019 returns. Form 1040-SR will be optional.
Family and Medical Leave Credit – The employer credit for family and medical leave, which was created in the 2017 tax reform, ends after 2019. This two-year program provides employers with a tax credit equal to 12.5% of the wages they paid to qualifying employees during any period when those employees were on family and medical leave, provided that the rate of the leave payments are at least 50% of the employees’ normal wages. The credit can be claimed for a maximum of 12 weeks of leave for any employee during the tax year. For each percentage point for which the leave payments exceed 50% of normal wages, this credit increases by 0.25 percentage points (up to a maximum of 25%). Participation in this credit program is optional.
Inflation Adjustments – Just about every tax-related value is adjusted for inflation. Some values are adjusted for any level of change, but others are adjusted only if the change reaches at least a specific dollar amount (so these values may not change every year). The table below includes the actual 2019 inflation adjustments and the projected 2020 adjustments for some of the most frequently encountered values.
Form W-4 Revision – During the previous tax season, many people received a smaller federal tax refund than normal or actually owed taxes despite usually getting a refund. In most cases, this was due to the last-minute passage of the tax-reform law at the end of 2017, which did not give the IRS not sufficient time to adjust the W-4 form and related computation tables for the 2018 tax year so as to account for all of the new law’s changes. The planned major revision to the W-4 for the 2019 tax year has since been delayed until 2020, so all taxpayers should make sure that their 2019 withholding is adequate.
If you are conversant with tax terminology, you can use the IRS’s newly updated withholding estimator. This tool helps taxpayers to determine whether their employers are withholding the right amount of tax from their paychecks. However, please note that the results are only as good as the information that is put into the estimator. Users need to properly estimate their other income for the year from various sources.
If you have questions related to any of the subjects discussed in this article, be sure to give this office a call.
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Article Highlights:
- Medical Threshold
- Electric Vehicle Credit Phaseout
- Alimony
- Finalization of State- and Local-Tax Deduction Limitation
- Penalty for Not Being Insured
- Qualified Opportunity Funds
- Seniors’ Special Tax Form
- Family and Medical Leave Credit
- Inflation Adjustments
- Form W-4 Revision
Medical Threshold – Medical expenses are deductible as itemized deductions only if the total medical expenses for the tax year exceed a specified percentage of a taxpayer’s income. After dropping to 7.5% for 2017 and 2018, this threshold reverts to 10% for 2019. As a result, any medical expenses from 2019 are deductible only to the extent that they exceed 10% of a taxpayer’s adjusted gross income for the year.
Electric Vehicle Credit Phaseout – As an incentive to get taxpayers to move away from conventional-fuel (gasoline or diesel) vehicles, Congress has provided tax credits of up to $7,500 for the purchase of plug-in electric vehicles. However, Congress’s rules limit the full credit to the first 200,000 vehicles sold by a given manufacturer. Once a company sells 200,000 qualifying vehicles, the credit begins to phase out for that company. Tesla, Chevrolet, and Cadillac have all reached the phaseout point. The table below shows the credits available depending upon the quarter when the vehicle is purchased.
Vehicles Beginning Phaseout out 2019
| |||||||
Date Acquired
>>> Vehicle |
Before 2019
|
Jan - Mar 2019
|
Apr - June 2019
|
July - Sept 2019
|
Oct - Dec 2019
|
Jan - Mar 2020
|
After Mar 2020
|
Tesla*
| $7,500 | $3,750 | $3,750 | $1,875 | $1,875 | $0 | $0 |
Chevrolet*
| $7,500 | $7,500 | $3,750 | $3,750 | $1,875 | $1,875 | $0 |
Cadillac*
| $7,500 | $7,500 | $3,750 | $3,750 | $1,875 | $1,875 | $0 |
*All qualifying models
If a qualifying vehicle is used partiality for business, the credit is proportionally allocated between personal and business tax credits. The personal portion can only offset the individual’s current-year tax liability; any excess is lost. The business portion can be carried back for one year and then forward up to 20 years until it is used up; any credit remaining after the 20th year is lost. As a tip, please note that the credit limit is per vehicle, not per taxpayer, so individuals who make multiple purchases can receive multiple credits.
Alimony – One delayed effect of the 2017 tax reform is that, the treatment of alimony changes for some individuals starting in 2019.
For divorces or separations entered into before 2019, alimony payments continue to be deductible for the payer and taxable for the recipient; such payments also still qualify as earned income for purposes of the recipient’s qualification for an IRA deduction. For divorces or separations executed after December 31, 2018, alimony payments are no longer deductible for the payer. In addition, for the recipient, they are no longer taxable income and do not count as earned income for the purposes of IRA deduction.
Divorces or separations entered into before 2019 continue to follow the pre-2019 rules unless they have been modified after December 31, 2018; in that case, the alimony payments are subject to the post-2018 rules if the modification expressly provides for this.
Finalization of State- and Local-Tax Deduction Limitation – The 2017 tax reform limited the itemized deduction for state and local taxes (SALT) to $10,000 (or $5,000 for married individuals filing separately). This has adversely impacted taxpayers in high-tax states such as California, Connecticut, New Jersey, and New York. Elected officials in several states have attempted to work around this restriction by establishing (or proposing to establish) state charities. The idea is that taxpayers would make deductible contributions that, in return, would give them tax credits against their SALT equal to most of the value of the charitable contributions. Unfortunately, these officials have overlooked the 1986 U.S. Supreme Court ruling that, if a taxpayer receives something in return for a contribution (i.e., a quid pro quo), the contribution is not deductible.
The final regulations generally reduce the charitable-contribution deduction by the amount of any SALT credit received. However, as an exception, if the credit does not exceed 15% of the contribution, the entire contribution is deductible.
Penalty for Not Being Insured – The Tax Cuts and Jobs Act (tax-reform) that was enacted at the end of 2017 eliminated the Obamacare shared-responsibility payment, effective starting in 2019. Congress didn’t actually repeal this penalty; instead, it effectively repealed it by tweaking by setting zero values for both the percentage of household income used in the calculation and the flat dollar amount of the penalty. As a result, the amount of the penalty is always zero. However, keep in mind that the penalty could be restored in the future if the direction that the political winds are blowing changes. In addition, beginning in 2020, some states may pick up where the federal government left off and charge a penalty to residents without qualified health insurance coverage.
Qualified Opportunity Funds – Taxpayers who receive capital gains on the sale or exchange of property (if the other party is unrelated) may elect to defer – and, potentially, partially exclude – those gains from their gross income if they are reinvested in a qualified opportunity fund (QOF) within 180 days of the sale or exchange. The amount of the gain (not the amount of the proceeds, as in Sec. 1031 deferrals) needs to be reinvested in order to defer the gain. The deferral period ends when the QOF investment ends or on December 31, 2026 – whichever is sooner. At that time, taxes must be paid on the deferred gain.
However, 10% of the deferred gains are forgiven QOF investments have been held for at least 5 years, and 15% of the gains are forgiven when those investments have been held for at least 7 years. Note that, with the deferral end date of December 31, 2026, qualifying for the 15% forgiveness requires a QOF investment on or before December 31, 2019.
Seniors Get a Special Tax Form – Lawmakers have long sought to provide taxpayers who are age 65 and older with a simplified tax form in place of the Form 1040. In the 2018 budget bill, Congress finally included a requirement that the IRS create such a form. As a result, the IRS will introduce Form 1040-SR, which will look a lot like the old form looked before the 2018 tax reform instituted its (politically motivated) division of the Form 1040 into multiple postcard-size schedules. It is unclear how much simpler the Form 1040-SR will be, but it will be available for 2019 returns. Form 1040-SR will be optional.
Family and Medical Leave Credit – The employer credit for family and medical leave, which was created in the 2017 tax reform, ends after 2019. This two-year program provides employers with a tax credit equal to 12.5% of the wages they paid to qualifying employees during any period when those employees were on family and medical leave, provided that the rate of the leave payments are at least 50% of the employees’ normal wages. The credit can be claimed for a maximum of 12 weeks of leave for any employee during the tax year. For each percentage point for which the leave payments exceed 50% of normal wages, this credit increases by 0.25 percentage points (up to a maximum of 25%). Participation in this credit program is optional.
Inflation Adjustments – Just about every tax-related value is adjusted for inflation. Some values are adjusted for any level of change, but others are adjusted only if the change reaches at least a specific dollar amount (so these values may not change every year). The table below includes the actual 2019 inflation adjustments and the projected 2020 adjustments for some of the most frequently encountered values.
| Year | 2018 | 2019 | 2020 |
| Standard Deduction | |||
| Single or Married Filing Separately | 12,000 | 12,200 | 12,400 |
| Head of Household | 18,000 | 18,350 | 18,650 |
| Married Filing Jointly | 24,000 | 24,400 | 24,800 |
| Additional Standard Deduction (Age 65+ or Blind) | |||
| Unmarried | 1,600 | 1,650 | 1,650 |
| Married | 1,300 | 1,300 | 1,300 |
| Other Values | |||
| Annual Gift-Tax Exclusion | 15,000 | 15,000 | 15,000 |
| Foreign Earned-Income Exclusion | 103,900 | 105,900 | 107,600 |
| IRA Contribution Limit | 5,500 | 6,000 | 6,000 |
| IRA Contribution Limit (Age 50+) | 6,500 | 7,000 | 7,000 |
| 401(k) Contribution Limit | 18,500 | 19,000 | * |
| 401(k) Contribution Limit (Age 50+) | 24,500 | 25,000 | * |
All values are in U.S. dollars.
* Value not available as of publication
* Value not available as of publication
Form W-4 Revision – During the previous tax season, many people received a smaller federal tax refund than normal or actually owed taxes despite usually getting a refund. In most cases, this was due to the last-minute passage of the tax-reform law at the end of 2017, which did not give the IRS not sufficient time to adjust the W-4 form and related computation tables for the 2018 tax year so as to account for all of the new law’s changes. The planned major revision to the W-4 for the 2019 tax year has since been delayed until 2020, so all taxpayers should make sure that their 2019 withholding is adequate.
If you are conversant with tax terminology, you can use the IRS’s newly updated withholding estimator. This tool helps taxpayers to determine whether their employers are withholding the right amount of tax from their paychecks. However, please note that the results are only as good as the information that is put into the estimator. Users need to properly estimate their other income for the year from various sources.
If you have questions related to any of the subjects discussed in this article, be sure to give this office a call.
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