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

Any discussion of the earned income tax credit (EITC) needs to begin with a discussion of why Congress created it in the first place. It has a twofold purpose: first, as an incentive for people to work and get off public assistance, and second, to provide financial assistance for low-income taxpayers and their families based upon their income from working, which the tax code refers to as “earned income.” When originally created back in 1979, it even allowed taxpayers to obtain the credit in advance through their employer’s payroll payments, based on projecting the credit they would be entitled to on their tax return for the year. This was referred to as advanced EITC. However, because of the many problems associated with the advanced payment credit, it was repealed for years after 2010.

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.

Taxable earned income does not include any form of earned income that is excluded from income, such as a clergyperson’s housing allowance, excluded military combat pay (but see the election for combat pay later), tax-deferred retirement contributions, or excludable dependent care benefits.

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.

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• 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.

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
• 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

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.

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

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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Congress Passes Last-Minute Tax Changes

Congress, at almost the last minute, has passed a large number of tax changes, including retirement plan issues that will become effective in 2020, as well as extensions through 2020 of a number of tax provisions that had expired or were about to end. The list of changes is quite large, so we have only included those that are most likely to affect individual tax returns. Here is a run-down on some of the new tax provisions:

Article Highlights:

• Discharge of Qualified Principal Residence Indebtedness
• Mortgage Insurance Premiums
• Above-the-Line Deduction for Qualified Tuition and Related Expenses
• Medical AGI Limits
• Residential Energy (Efficient) Property Credit
• Employer Credit for Paid Family and Medical Leave
• Maximum Age Limit for Traditional IRA Contributions
• Penalty-Free Pension Withdrawals in Case of Childbirth or Adoption
• Increase in Age for Required Minimum Pension Distributions
• Difficulty of Care Payments Qualifying for IRA Contributions
• Expansion of Sec. 529 Plan Uses
• Required Distributions Modified for Inherited IRAs and Retirement Plans
• Increase in Penalty for Failure to File
• Major Change to Kiddie Tax Rules

Congress, at almost the last minute, has passed a large number of tax changes, including retirement plan issues that will become effective in 2020, as well as extensions through 2020 of a number of tax provisions that had expired or were about to end. The list of changes is quite large, so we have only included those that are most likely to affect individual tax returns. Here is a run-down on some of the new tax provisions:

TAX EXTENDERS

The tax changes retroactively revive a number of provisions that had previously expired or were going to at the end of 2019, and extend them through 2020. So, review them carefully to see if any of them provide you with an opportunity to amend your return for a refund.

Discharge of Qualified Principal Residence Indebtedness – When an individual loses his or her principal residence to foreclosure, abandonment, or short sale or has a portion of their loan forgiven under the HAMP mortgage-reduction plan, they will generally end up with cancellation-of-debt (COD) income. COD income is equal to the amount of debt on the home that is forgiven by the lender. To the extent that the mortgage debt becomes COD income, it is taxable income unless the taxpayer can exclude it based on specific provisions in the tax code.

After the housing market crash a few years back, Congress added the qualified principal residence COD exclusion, which allowed taxpayers to exclude up to $2 million ($1 million if married filing separately) of COD income, to the extent it was discharged debt used to acquire the home, termed acquisition debt. Equity debt was not eligible for the exclusion. However, equity debt is deemed to be discharged first, thus limiting the exclusion if both equity and acquisition debt are involved in the transaction.

This COD exclusion was temporarily added in 2007, was extended, and then expired at the end of 2017. Under the current legislation, the exclusion for qualified principal residence indebtedness is retroactively extended through 2020. Thus, if you paid taxes on principal residence COD income in 2018, be sure to call attention to that fact so your return can be amended for a refund.

Mortgage Insurance Premiums – For tax years 2007 through 2017, taxpayers could deduct the cost of premiums for mortgage insurance on a qualified personal residence as an itemized deduction. The premiums were deducted as home mortgage interest on Schedule A. To be deductible:

• The premiums must have been paid in connection with acquisition debt (note: acquisition debt includes refinanced acquisition debt).
• The mortgage insurance contract must have been issued after Dec. 31, 2006.
• It must be for a qualified residence (first and second homes).
• The deductible amount of the premiums phases out ratably by 10% for each $1,000 by which the taxpayer’s adjusted gross income (AGI) exceeds $100,000 (10% for each $500 by which a married separate taxpayer’s AGI exceeds $50,000).

Qualified mortgage insurance means mortgage insurance provided by the:

• Dept. of Veterans Affairs (VA),
• Federal Housing Administration (FHA), or
• Rural Housing Services (RHS), as well as
• Private mortgage insurance.

This deduction was previously allowed through 2017 and has retroactively been extended through 2020.

Above-the-Line Deduction for Qualified Tuition and Related Expenses – An above-the-line deduction for qualified tuition and related expenses for higher education has been available since 2002 and was previously extended through 2017. For purposes of the higher education expense deduction, “qualified tuition and related expenses” has the same definition as for the American Opportunity and Lifetime Learning credits for higher education expenses – that is, with certain exceptions, tuition and fees paid for an eligible student (the taxpayer, the taxpayer’s spouse, or a dependent) at an eligible higher education institution. The deduction – up to $2,000 or $4,000, depending on AGI – is not allowed for joint filers with an AGI of $160,000 or more ($80,000 for other filing statuses), except no deduction is allowed for taxpayers using the married filing separate status. The phase-out amounts are not inflation-adjusted. The same expenses can’t be used for both an education credit and the tuition and fees deduction.

This deduction was previously allowed through 2017 and has retroactively been extended through 2020.

Medical AGI Limits – For 2017 and 2018, individuals could claim an itemized deduction for unreimbursed medical expenses, to the extent that such expenses exceeded 7.5% of their AGI. For post-2018 years, the percent of AGI has been increased to 10%. The provision retroactively extends the lower threshold of 7.5% through 2020.

Residential Energy (Efficient) Property Credit – This non-refundable credit has been available in one form or another since 2006 and through 2017, with credit amounts varying from 10% to 30% and the maximum credit ranging from $500 to $1,500. Most recently, the credit percentage was 10%, with a lifetime credit amount limited to $500. This credit is best described as an energy-saving credit since it applies to improvements to the taxpayer’s existing primary home to make it more energy efficient. Generally, it applies to insulation, storm windows and doors, and certain types of energy-efficient roofing materials, energy-efficient central air-conditioning systems, water heaters, heat pumps, hot water systems, circulating fans, etc.

The recent legislation extends this credit through 2020, with a lifetime credit cap of $500.
Caution: The lifetime credit extends to returns going all the way back to 2006.

Employer Credit for Paid Family and Medical Leave – This credit provides an employer with credit for paid family and medical leave, which permits eligible employers to claim an elective general business credit based on eligible wages paid to qualifying employees with respect to family and medical leave. The maximum amount of family and medical leave that may be taken into account for any qualifying employee is 12 weeks per taxable year. The credit is variable and only applies if the leave wages are at least 50% of the individual’s normal wages. The credit percentage is 12.5% and increases by 0.5%, up to a maximum of 25%, for each percentage point that the payment rate exceeds 50%.

The credit was originally only for 2018 and 2019 but has been extended through 2020.

RETIREMENT PLAN AND IRA CHANGES

Maximum Age Limit for Traditional IRA Contributions – The legislation repeals the maximum age for making traditional IRA contributions, which, prior to this legislation, prohibited traditional IRA contributions after an individual reached the age of 70½. The provision is effective for contributions made for taxable years beginning after December 31, 2019.

Penalty-Free Pension Withdrawals in Case of Childbirth or Adoption – The legislation allows a penalty free but taxable distribution of up to $5,000 from a qualified plan made within one year of birth or in the case of a finalized adoption of an individual aged 18 or younger or an individual who is physically or mentally incapable of self-support. Distributions can later be repaid to avoid the tax on the distribution.

Increase in Age for RMDs – For decades, individuals were required to begin taking distributions from their traditional IRAs and qualified plans once they reached age 70½. These distributions, commonly referred to as a required minimum distribution or RMD, have never been adjusted to account for increases in life expectancy. The legislation changes the required beginning date for mandatory distributions to age 72, effective for distributions required to be made after December 31, 2019, with respect to individuals who attain the age of 72 after this date.

Special Rule – Difficulty of Care Payments – Many home health-care workers do not have a taxable income because their only compensation comes from “difficulty of care” payments that are exempt from taxation under Code Section 131. Because such workers do not have taxable income, they cannot save for retirement in a defined contribution plan or IRA. This provision will allow home health-care workers to contribute to a qualified plan or IRA by amending the tax code so that tax-exempt difficulty of care payments are treated as compensation, for purposes of calculating the contribution limits to defined contribution plans and IRAs. This is effective for plan years after December 31, 2015, and IRA contributions after the act’s date of enactment (December 20, 2019).

Sec. 529 Plan Modifications – Sec. 529 plans (also referred to as qualified state tuition plans) were originally created to allow tax-free accumulation saving accounts for a child’s education but generally limited the funds’ use to post-secondary education tuition and certain college fees. Since then, Congress has continued to expand the use of funds to include supplies, books, equipment, and reasonable room and board expenses for attending college. With the passage of the tax reform at the end of 2017, Congress allowed up to $10,000 a year to be used for elementary and secondary school tuition expenses. This new legislation adds the following to the list of qualified expenses:

• Qualified higher education expenses associated with registered apprenticeship programs certified by the Secretary of Labor under Sec. 1 of the National Apprenticeship Act
  
• Payment of education loans, up to a maximum of $10,000 (reduced by the amount of distributions so treated for all prior taxable years), including those for siblings

These changes are effective for distributions made after December 31, 2018.

RMDs for Designated Beneficiaries – The legislation modifies the required minimum distribution rules with respect to defined contribution plan and IRA balances upon the account owner’s death. Under the legislation, distributions to individuals other than the surviving spouse of the employee (or IRA owner), disabled or chronically ill individuals, individuals who are not more than 10 years younger than the employee (or IRA owner), or a child of the employee (or IRA owner) who has not reached the age of majority must generally be distributed by the end of the tenth calendar year following the year of the employee’s or IRA owner’s death. A special rule for children requires any remaining undistributed funds to be distributed within 10 years after they reach the age of maturity.

This is a major change since beneficiaries previously had options to take certain lifetime payouts. This will require careful planning to minimize the tax on the distributions. The change applies to distributions with respect to employees or IRA owners who die after December 31, 2019.

Penalty for Failure to File – The legislation increased the minimum penalty for failure to file a tax return within 60 days of the return’s due date to $435, up from $330, for returns with a due date (including extensions) after December 31, 2019. Thus, the $435 penalty will apply to 2019 returns and will be inflation adjusted for future years.

Kiddie Tax – The tax reform enacted late in 2017 changed how the income of dependent children is taxed, causing a child’s unearned income to be taxed at fiduciary rates that very quickly reach the maximum tax rate of 37%. That change created an unintentional tax increase for survivors of service members and first responders who died in the line duty. This last-minute change reverts the kiddie tax computation to the pre–tax reform method for years beginning in 2020. It also allows taxpayers to choose whichever method provides the lowest tax for 2018 and 2019. Taxpayers can amend their 2018 return if doing so will provide a better outcome.

The changes are extensive and, in many cases, open the door to amending prior years’ returns. If you have any questions or think any of these changes might benefit you for a prior year, please give this office a call at 336-705-6322, visit our website or visit us on Facebook.

The 1099-MISC Filing Date Is Just Around the Corner – Are You Ready?

If your business engages the services of an individual (independent contractor), other than one who meets the definition of an employee, and you pay him or her $600 or more for the calendar year, then you are required to issue that person a Form 1099-MISC to avoid penalties and the prospect of losing the deduction for his or her labor and expenses in an audit. Payments to independent contractors are referred to as non-employee compensation (NEC).

Article Highlights:

• Independent Contractors
• Non-employee Compensation
• 1099 Filing Requirement
• Due Dates
• Penalties
• Form W-9 and 1099 Worksheet

If your business engages the services of an individual (independent contractor), other than one who meets the definition of an employee, and you pay him or her $600 or more for the calendar year, then you are required to issue that person a Form 1099-MISC to avoid penalties and the prospect of losing the deduction for his or her labor and expenses in an audit. Payments to independent contractors are referred to as non-employee compensation (NEC).

Note: The IRS has cautioned taxpayers who are treating rental activities as a trade or business for purposes of claiming the 20% passthrough deduction that they are required to issue 1099-MISC forms to their services providers who meet the $600 test for those rental activities.

Because so many fraudulent tax returns are filed right after e-filing opens up in January, the IRS requires 1099-MISCs for NEC to be filed by January 31 and will not release refunds for individual income tax returns that include the earned income tax credit until the NEC amounts can be verified.

Thus, the due date for filing 2019 1099-MISC forms for NEC is January 31, 2020. This is also the same due date for mailing the recipient his or her copy of the 1099-MISC.

It is not uncommon for a business or rental property owner to have a repairperson go out early in the year, pay him or her less than $600, use his or her services again later in the year, and have the total paid for the year be $600 or more. As a result, the business or landlord may have overlooked getting the needed information from the individual to file the 1099s for the year. Therefore, if you own a business or are a landlord, it is good practice to always have individuals who are not incorporated complete and sign an IRS Form W-9 the first time you engage them and before you pay them. Having a properly completed and signed Form W-9 for all independent contractors and service providers will eliminate any oversights and protect you against IRS penalties and conflicts. If you have been negligent in the past about having the W-9s completed, then it would be a good idea going forward to establish a procedure for getting each non-corporate independent contractor and service provider to fill out a W-9 and return it to you.

The government provides IRS Form W-9, Request for Taxpayer Identification Number and Certification, as a means for you to obtain the vendor’s data you’ll need to accurately file the 1099s. It also provides you with verification that you complied with the law, in case the vendor gave you incorrect information. We highly recommend that you have potential vendors complete a Form W-9 prior to engaging in business with them. The W-9 is for your use only and is not submitted to the IRS.

The penalty for failure to file a required information return due in 2020, such as the 1099-MISC, is $270 per information return. The penalty is reduced to $50 if a correct but late information return is filed no later than the 30th day after the required filing date of January 31, 2020, and it is reduced to $110 for returns filed after the 30th day but no later than August 1, 2020. If you are required to file 250 or more information returns, you must file them electronically.

In order to avoid a penalty, copies of the 1099-MISCs you’ve issued for 2019 need to be sent to the IRS by January 31, 2020. The forms must be submitted on magnetic media or on optically scannable forms (OCR forms).

Note: Form 1099-MISC is also used to report other types of payments, including rent and royalties. Payments to independent contractors are reported in box 7 of the 1099-MISC, and the dates mentioned in this article apply when box 7 has been used. When the 1099-MISC is used to report income other than that in box 7, the due date to the form’s recipient is January 31, 2020, while the copy to the government is due by February 28, 2020.

If you have any questions, please call. This firm prepares 1099s for submission to the IRS along with recipient copies and file copies for your records. Use the 1099 worksheet to provide this office with the information needed to prepare your 1099s. Contact us on our website and visit us on Facebook.

Forget Something on Your 2018 Return?

If you forgot to include necessary information on your 2018 return, you are not alone. In addition, you may have received a revised 1099 or K-1 since filing your return. The IRS has struggled to deal with the enormity of the changes in the recent tax reform; despite significant pressure to update its regulations, forms, and publications, the IRS could not finish all of its tax-reform updates in a timely manner. Some IRS publications still have not been updated for 2018, and others even include errors. The new tax regulations have been dribbling out, but the IRS still has not provided sufficient guidance for some issues.

Article Highlights:

• Tax Reform Problems 
• Corrected 1099s and K-1s 
• Overlooked Income and Deductions 
• Marital Issues 
• Mitigating Penalties 
• The Need for Prompt Amendments 

As a result of this uncertainty, you may receive a corrected 1099 or K-1. You may also need to update your return because, like most taxpayers, you did not fully comprehend all of the provisions of the new tax law thus failing to include an item of income, deduction, or credit. You also may have simply overlooked an item of income or missed a significant deduction. These mistakes happen, which is why the IRS and state tax agencies allow for amended tax returns.

A failure to report an item of income will generate an IRS inquiry; this typically happens a year or so after the filing of the original return—which is after the interest and penalties have built up. On the other hand, if you forgot a deduction and are owed a refund, you should not let that go by the wayside.

In some cases, marital problems lead taxpayers to file incorrectly—for instance, by incorrectly claiming children or not allocating income correctly. These and myriad other issues can be corrected by amending the returns. As a warning, please note that, if you are married and filed a joint return, you cannot amend to file separate returns. However, a married couple’s separate returns can be amended into a single joint return.

Regardless of the issue, the solution is to file an amended return as soon as possible. This will minimize the penalties and interest in the case of omitted income and will also prevent you from getting those annoying letters from the IRS. Amended returns can also be used to claim an overlooked credit, to correct your filing status or the number of dependents, to report an omitted investment transaction, to submit a delayed K-1, or to include any other information that should have been on the original return.

If overlooked item results in a tax increase, filing the amended return quickly will mitigate the penalties and interest. Procrastination will lead to further complications when the IRS eventually determines that information is missing, so it is always best to take care of the issue right away.

Generally, to claim a refund on an amended return, you must file the amendment within three years of the date when you filed the original return, or within two years of the date when you paid the tax—whichever is later.

If any of these issues apply to you, please give this office a call so that we can prepare the necessary amended returns https://gallowaytax.com/tax-preparation

Top 10 Startup Business Questions Every Entrepreneur Should Answer

Starting a small business can be one of the most exciting and rewarding events in someone’s life. But it can also be extremely stressful. If you’re thinking about becoming an entrepreneur, you might have more questions swirling around in your mind right now than you can count. Don’t despair. This is completely normal. After all, it shows you’re serious about your business venture and care enough to want to do things the right way. Before moving forward with a new business idea, ensuring you know the answers to the following vital questions is crucial.

Starting a small business can be one of the most exciting and rewarding events in someone’s life. But it can also be extremely stressful. If you’re thinking about becoming an entrepreneur, you might have more questions swirling around in your mind right now than you can count. Don’t despair. This is completely normal. After all, it shows you’re serious about your business venture and care enough to want to do things the right way. Before moving forward with a new business idea, ensuring you know the answers to the following vital questions is crucial.

1. Does your startup idea meet a need?
Before starting a small business, you need to know if your product or service will meet a need those in your target market have. It doesn’t matter how special your potential product or service offerings are to you. If you can’t convince others to care about them, your small business won’t be a success.

2. Is your plan feasible?
Learning things on the fly isn’t smart in the business world. Rather than taking a blind leap of faith, determine if your plan is actually feasible before moving forward. For instance, will you be able to afford to put your plan into action? Will your loved ones commit to the ways this venture might affect them? Starting a small business isn’t for the faint of heart. Do you have the ambition and determination to see your vision through?

3. How much financing do you need?
Not adequately estimating financing needs is a common mistake of entrepreneurs. To avoid this pitfall, strive to perform an accurate cost analysis. Approximate both foreseen and unexpected expenses for the first year. Also, determine how long it will take you to become profitable. When creating a cost analysis, be realistic. Don’t count on things going perfectly. Despite your best efforts, they most certainly won’t.

4. Where will your company be located?
The type of small business you want to start will largely determine where it should be located. For example, you wouldn’t attempt to open a ski lodge in sunny, balmy Florida. Generally, you’ll want to find a location with lots of foot traffic. If you’re a new entrepreneur looking to break into an already crowded market, locating your business near your competitors might be a good idea. According to Biz Brain, you’ll already have a built-in market in the location. But if you’re competing in a saturated market with major brand-name competition, locating your business a short distance away from your competitors may be your best bet.

5. Who will comprise your customer base?
If you’re thinking about starting a small business, you likely already have a vague idea about who will comprise your customer base. However, delving into the profiles of potential clients of your company is a smart idea. During this research, you can study characteristics such as age, gender, buying triggers and general preferences. This should help you fine-tune your marketing efforts and target your products or services to the people who would most benefit from them.

6. When can you expect to be profitable?
The old adage is that you should expect to wait at least a year until your startup becomes profitable. But times are changing. Innovations in technology and communication mean entrepreneurs can start companies with little to no overhead nowadays. This rings especially true for service-oriented companies. Therefore, having an astute business plan is essential. A good business plan will help you predict when you may start turning a profit.

7. What setbacks can you anticipate?
The road to small business success can be a bumpy one, so anticipating setbacks is important. One of the most common ones is failing to meet revenue expectations. This can sometimes be blamed on overestimating the amount of business your company will generate in the early days of its existence. A second setback startups can face is losing vital employees. If you plan to start a sole proprietorship, this isn’t an issue. But if you’re launching a business venture with one or more partners, someone might decide to jump ship. To prevent your company from disintegrating into shambles, develop an exit plan that can be utilized if a partner wants to get out.

8. Do you need solid advisors?
Starting a small business can be overwhelming. This is especially the case if you try to do everything yourself. Surprisingly, the CountingWorks What Small Business Owners Value Most in 2019 survey reveals that 60% of small business owners handle their budgeting themselves. Unfortunately, the U.S. Small Business Administration Office of Advocacy’s 2018 Frequently Asked Questions says only about half of small businesses survive past five years. To boost your chances of long-term success, surround yourself with solid advisors. For instance, experienced financial advisors can help you with accurate budgeting. Legal advisors can assist you with contracts and permits.

9. How will you lure the best talent to your company?
Obviously, offering prospective employees a competitive salary can help you lure the best talent to your company. But when you’re just starting a business, this might not be an option. To compensate for this, providing employees with growth bonuses is a good alternative. Offering employees flexible scheduling options and wellness perks such as an onsite gym, a break room stocked with healthy snacks, and standing desks may also attract promising talent to your company.

10. Should you start more than one company at once?
Do you have multiple ideas for new small businesses? Perhaps you’re eager to get more than one startup running at the same time. While this might be tempting, starting out with one company is best. You can put all your energy into getting it profitable and stable. This will prevent you from spreading yourself and your resources too thin. You can always branch out later if your first business takes off.

Starting a business can be quite an undertaking. Therefore, planning correctly and thoroughly is critical. Before you can enjoy small business success, you’ll need to learn the answers to the above questions.

"Business Made Simple"
We help struggling and overwhelmed startup entrepreneurs who want to get their business up and running and existing businesses position themselves so they can build the business of their dreams, feel they’re getting the most value for the money they pay and receive the highest value. Let us know what we can do for you.

Have questions about becoming a business owner or need assistance with getting started or next assistance with building, contact us as soon as you need us at gte@gallowaytax.com or call us at 336-705-6322.

Combatting Retirement Anxiety and the Fear of Running Out of Money

Retirement is the endgame for most people - it's literally why we work so hard our entire lives. But it's also no longer a situation that is as straightforward as it once was, particularly as far as financial planning is concerned. 

According to one recent study, nearly one out of every three people have nothing saved for retirement. More than half that have less than $10,000 set aside in a bank account for this specific purpose. 

Indeed, a recent survey of CPA financial planners confirms that this situation may be a lot more precarious than most people think. 

Your Money, Your Retirement and You 

According to the most recent AICPA PFP Trends Survey, running out of money for retirement is the top concern of 41% of CPA financial planners today. If people aren't worried about not having enough money to retire in the first place, they're worried about not having enough to maintain their current lifestyle — a fear that 29% of respondents shared. The third biggest concern — coming in far behind the other two — had to do with the rising cost of healthcare, which 11% of people said that they were worried about. 

The same study also revealed that once people retire, the biggest fear of 52% of retirees was a sharp decline in the value of their investments. 

The second biggest fear, coming in at 24%, was a serious illness like dementia. To put that into perspective, millions of people are diagnosed with dementia or other cognitive issues every year, and that trend is expected to increase sharply over the next decade. Despite this, people are STILL more worried about their financial situation than they are about anything related to their health and wellbeing. 

So at the very least, if you've come down with a severe case of retirement anxiety and are worried about your financial situation during your twilight years, know that you are not alone. Luckily, there are a few key steps you can take today to help ease some of this anxiety moving forward. 

The Fight Against Retirement Anxiety 

One of the biggest ways to combat retirement anxiety involves knowing what you can cut if needed. Take a look at your current spending patterns and decide which actions are related to "needs" and which are related to "wants." You can't necessarily cut the amount of money you're spending on healthcare, but you CAN get rid of that expensive cable package. Experts agree that running out of money is actually rare for older people who actively track and plan their spending, so keep this in mind moving forward. 

Likewise, you should also at least consider delaying your Social Security checks until you reach the age of 70. Depending on when you retire, this might mean that you go almost a decade without receiving these monthly checks (if the current average retirement age is any consideration). 

However, making this move means that you'll actually get a lot more money every month - something that may make all the difference if this is something you're truly concerned about. 

Finally, the most important thing that you can do involves the acknowledgment that these types of issues are incredibly common - worrying about having enough money to comfortably retire is not something that is exclusive to you. Everyone thinks about these things and they cause everyone to stress every now and again. It's a natural part of getting older. Don't try to avoid it. 

But you also can't let retirement anxiety prevent you from taking the action today that will protect your financial situation tomorrow. Partner with a financial advisor to lay out your goals and work to come up with the right plan that meets your needs together. That in and of itself is one of the best ways to prevent these types of fears from becoming a reality in the first place.