Author Archives: Jeramiah Young

YEAR-END TAX PLANNING FOR 2021

November 2021

BUSINESS TAX ISSUES

Prepay Expenses Using the IRS Safe Harbor   You just have to thank the IRS for its tax-deduction safe harbors.  IRS regulations contain a safe-harbor rule that allows cash-basis taxpayers to prepay and deduct qualifying expenses up to 12 months in advance without challenge, adjustment, or change by the IRS, (IRS Reg. 1.263(a)-4(f).  Under this safe harbor, your 2019 prepayments cannot go into 2021.  This makes sense, because you can prepay only 12 months of qualifying expenses under the safe-harbor rule.

For a cash-basis taxpayer, qualifying expenses include, among others, lease payments on business vehicles, rent payments on offices and machinery, and business and malpractice insurance premiums.

Example.  You pay $3,000 a month in rent and would like a $36,000 deduction this year.  So on Tuesday, December 31, 2021, you mail a rent check for $36,000 to cover all of your 2022 rent.  Your landlord does not receive the payment in the mail until Thursday, January 2, 2022. Here are the results:

  1. You deduct $36,000 in 2021 (the year you paid the money).
  2. The landlord reports $36,000 in 2022 (the year he received the money).

The landlord gets what he wants – next year’s entire rent in advance, eliminating any collection problems while keeping the rent taxable in the year he expects it to be taxable.

Don’t surprise your landlord: if he had received the $36,000 of rent paid in advance in 2021, he would have had to pay taxes on the rent money in 2021.

Before sending a big rent check to your landlord, make sure the landlord understands the strategy.  Otherwise, he might not deposit the rent check (thinking your payment was a mistake)  and instead might return the check to you. This could put a crimp in the strategy, because you operate on a cash basis.

Also, think “proof”. Remember, the burden of proof is on you.  How do you prove that you mailed the check by December 31st ?  Think like the IRS auditor or, better yet, a prosecuting attorney.

Answer:  Send the check using one of the postal service’s tracking delivery methods, such as priority mail with tracking and possibly signature required , or one of the old standards, such as certified or registered mail.  With these types of mailings, you have proof of the date that you mailed the rent check.  You also have proof of the day the landlord received the check.

Stop Billing Customers, clients, and Patients  Here is one rock-solid, time-tested, easy strategy to reduce your taxable income for this year:  stop billing your customers, clients, and patients until after December 31, 2021. (We assume here that you or your corporation is on a cash basis and operates on the calendar year.)

Customers, clients, and patients, and insurance companies generally don’t pay until billed.  Not billing customers and patients is a time-tested tax-planning strategy that business owners have used successfully for years.  Example.  Will E. Maket, a dentist, usually bills his patients and the insurance companies at the end of each week; however, in December , he sends no bills.  Instead, he gathers up those bills and mails them the first week in January. Presto! He just postponed paying taxes on his December 2021 income by moving that income to 2022.

Buy Office Equipment  With bonus depreciation now at 100 percent along with increased limits for Section 179 expensing, buy your equipment or machinery and place it in service before December 31, and get a deduction for 100 percent of the cost in 2021.

Qualifying bonus depreciation and Section 179 purchases include, among others; new and used personal property such as machinery, equipment, computers, desk, furniture, and chairs (and certain qualifying vehicles).

PLANNING TIP:  Remember, the equipment need only be placed in service prior to the end of the year, it does not have to be completely paid for.  That’s right,  you could pay a minimum down payment yet get a 100% deduction.

Use Your Credit Cards  If you are a single-member LLC or sole proprietor filing Schedule C for your business, the day you charge a purchase to your business or personal credit card is the day you deduct the expense, (Rev. Rul. 78-38).  Therefore, as a Schedule C taxpayer, you should consider using your credit cards for last minute purchases of office supplies and other business necessities.

If you operate your business as a corporation, and if the corporation has a credit card in the corporate name, the same rule applies:  the date of the charge is the date of the deduction for the corporation.

But if you operate your business as a corporation and you are the personal owner of the card, the corporation must reimburse you if you want the corporation to realize the tax deduction, and that happens on the date of reimbursement.  Thus, submit your expense report and have the corporation on a Cash Method of Accounting make its reimbursement to you before midnight on December 31.

Retirement Plans  Owners of companies should consider putting retirement plans into service before December 31.  They may be funded in 2022 for 2021 if started by year-end.

Some Benefits:

  1. Claim the new, Improved Retirement Plan Start-Up tax credit of up to $15,000. By establishing a new qualified retirement plan (such as a profit-sharing plan, 401 (k) plan, or defined benefit pension plan, a SIMPLE IRA plan, or SEP, you can qualify for a non-deductible tax credit that is the greater of $500 or the lesser of (a) $250 multiplied by the number of your non-highly compensated employees who are eligible to participate in the plan, or (b) $5,000. The credit is based on your “qualified start-up cost,” which means any ordinary and necessary expenses of an eligible employer that are paid or incurred in connection with the establishment or administration of an eligible plan, or the retirement-related education of employees with respect to the plan.
  2. Claim the New Automatic Enrollment $500 Tax Credit for each of three years ($1,500 total) The SECURE Act added a non-refundable credit of $500 per year for up to three years, beginning with the first taxable year (2020 or later) in which you, as an eligible small employer, include an automatic contribution arrangement in a 401 (k) or SIMPLE plan.  This credit can be in addition to the start-up tax credit and can apply to older plans as well new plans just add the automatic enrollment feature.

Dividend VS. Salary Owners of regular corporations should consider taking a dividend as opposed to salary.  If the corporation is in a lower tax bracket than the owner’s personal income tax bracket the owner gets a preferential tax advantage on the dividend and the corporation avoids payroll taxes.  This only works with C -Corporations.

Don’t Assume You Are Taking Too Many Deductions  If your business deductions exceed your business income, you have a tax loss for the year.  With a few modifications to the loss, tax law calls this a “net operating loss,” or NOL, (IRS Section 172(d)2018).

If you are just starting your business, you could very possibly have an NOL.  You could have a loss year even with an ongoing and successful business.

You used to be able to carry back your NOL two years and get immediate tax refunds from prior years; however, the Tax Cuts and Jobs Act eliminated this provision,(IRC Section 172(b)(1)(A) (i) 2018). Now, you can only carry your NOL forward, and it can only offset up to 80 percent of your taxable income in any one future year,(IRC Section 172(a)(2)2018).  NOTE: Special rules applied to an NOL occurring in any tax year beginning after December 31, 2017 and before January 1, 2021, an NOL must be carried back to each of five years preceding the tax year of the loss unless an irrevocable election is made to waive the carryback period. (Rev. Proc 2020-24 and Notice 2020-26) were added to assist individuals and firms affected by the COVID-19 issues.

Deal With Your Qualified Improvement Property (QIP)  In the CARES Act, Congress finally fixed the qualified improvement property (QIP) error that it made when enacting the Tax Cuts and Jobs Act of 2017 (TCJA).

QIP is any improvement made by you to the interior portion of a building you own that is non- residential real property (think office buildings, retail stores, and shopping centers) if you place the improvement in service after the date you place the building in service.

The big deal with QIP is that it’s not considered real property that you depreciate over 39 years. QIP is 15 year property, eligible for immediate deduction using either 100 percent bonus depreciation or Section 179 expensing.  To get the QIP deduction in 2021, you need to place the QIP in service on or before December 31, 2021.

PLANNING TIP:  If you have QIP property on an already filed 2018 or 2019 return, it’s on that return as 39-year property, then you should consider amending those returns to adjust to the new ruling and reap additional cash because of this fix.

 

Small Business New Rule  IRC Section 199A was added to the Code for years after 2017. Taxpayers other than C-corporations may be entitled to a deduction of up to 20% of their qualified business income.  If taxable income does not exceed $329,800 for a married couple filing jointly, $164,900 for all other taxpayers, the deduction may be limited based on whether the taxpayer is engaged in a service-type trade or business (such as law; accounting, health, actuarial science, consulting services, performing arts, athletics, financial services, investment management, trading services, dealing in securities, partnership interests, commodities, or any business where principal asset is the reputation or skill of one or of its employees), the amount of W-2 wages paid by the trade or business, and/or the unadjusted basis of qualified property (such as machinery and equipment) held by the trade or business.

 PLANNING TIP:  Taxpayers may be able to achieve significant savings by deferring income or accelerating deductions so as to come under the dollar thresholds (or be subject to a smaller phase out of the deduction) for 2021.  Depending on their business model, taxpayers also may be able to increase the new deduction by increasing W-2 wages before year-end. Other ways to reduce taxable income for which Section 199A deduction is based is to:

  1. Harvest Capital Losses Capital gains adds to your taxable income.
  2. Make Charitable Contributions Again the intent is to reduce taxable income.
  3. Buy Business Assets Remember bonus depreciation and expensing 179 reduce  taxable income.
  4. If you have Excess Capital Losses they are Limited to $3,000 Sell stocks to purge capital losses, you can immediately repurchase the stock after you sell it as there is no “wash-sale gain” rule. You can sell other assets as well, rental property, other real property, etc., however, this needs to be a completed transaction prior to December 31.
  5. Gifting If you are considering gifts to parents or children (children not subject to kiddie tax), consider transferring highly appreciated stock in leu of cash as opposed to you selling it and thereby increase your taxable income.  This works well with charitable deductions of highly appreciated stock too, as you get to deduct the fair market value of the stock given as a charitable contribution (reducing taxable income) and you don’t pay tax on the gain in value of the stock.

Cash Method Of Accounting   More “Small Business” are able to use the cash method of accounting in 2018 and later years than were allowed to do so in the past.  To qualify as a “Small Business” a taxpayer must, among other things, satisfy a gross receipts test.  Effective for tax years beginning after December 31, 2017, the gross receipts test is satisfied if, during a three year test period, average annual gross-receipts don’t exceed $25 million (the dollar amount use be $5 million).  Cash method taxpayer may find it a lot easier to shift income, for example, by holding off billing till next year or by accelerating expenses, paying bills early or by making certain prepayments.

Bonus Depreciation  Finally a deduction for business that makes sense.  Business can claim a 100% bonus first-year depreciation for machinery and equipment – bought and placed in service, new or used (with some exceptions) after September 17, 2017 and before January 1, 2023.  That means 100% of cost whether paid off or not placed in service this year is fully deductible. As a result, the 100% bonus first-year write off is available even if the qualifying asset is in service even one day in the year. The bonus reduces to 80% in 2023, 60% in 2024, 40% in 2025, 20% in 2026 and no bonus after 2026.

Expensing 179  Businesses should consider making expenditures that qualify for the liberalized business property expensing option.  For tax years beginning in 2018, the expensing limit is $1,050,000 and the investment ceiling is $2,620,000.  Expensing is generally available for most depreciable property (other than buildings), and off-the-shelf computer software.  Expensing is also available for qualified improvement property (generally, any interior improvement to a building’s interior, but not enlargement of a building, elevators or escalators, or the internal structural framework), for roofs, and HVAC, fire protection, alarm, and security systems.  Expensing deduction is available (provided you are otherwise eligible to take it)  regardless of how long the property is held during the year.  This can be a powerful planning tool, thus property placed in service even the last day of 2021 gets the deduction if elected. The election is made when filing your 2021 tax return in 2022 by the due date of your return including extension.

De Minimis Safe Harbor Election Businesses may be able to take advantage of the de minimis safe harbor election (also known as the book-tax conformity election) to expense the cost of lower-cost assets, materials and supplies, assuming the cost does not have to be capitalized under Code Sec. 263A uniform capitalization (UNICAP) rules.  To qualify for the election, the cost of a unit of property can’t exceed $5,000 when taxpayer has applicable financial statement (AFS; e.g., a certified audited financial statement along with an independent CPA’s report).  If there’s no AFS, the cost of a unit of property can’t exceed $2,500.  Where the UNICAP rules aren’t an issue, consider purchasing such qualified items before the end of 2021.

PLANNING TIP:  The purpose of this election is to reduce the depreciation of small asset acquisitions used in your trade or business.  This is another form  of expensing, and there is no recapture of depreciation when the  asset is disposed of later.

Employee Meals and Business Meals:  IRC Sec 274(n)(2)(D); IRS Notice 2021-25. Employee meal deduction and business meal deductions under IRC Sec 274(a); 274(d).

The following are 100% deductible for 2021:

  1. Restaurant meals with clients and prospects
  2. Employee meals for required business meetings, purchased from a restaurant
  3. Meal consumed in a fancy restaurant while overnight business travel status
  4. Year-end party for employees and spouses
  5. Golf outing for employees and spouses
  6. Meals made on premises for general public at marketing presentation
  7. Team building recreational event for all employees
  8. Meals with a prospective customer at the country club following your nondeductible round of golf

The following are 50% deductible for 2021:

  1. Employee meals for convenience of employer, served by in-house cafeteria
  2. Meals cooked by you in your hotel room kitchen while traveling away from home overnight

 Entertainment Expense:  IRC Sec 274(a); 274(e) Entertainment directly related to a trade or business was 50 percent deductible. Now, entertainment is no longer deductible.

Small Business Medical Plan  All business owners with 49 or fewer employees should have a medical plan for their business.  Is it required? No, 49 or fewer employees does not require you to have a plan, however, let consider some benefits:

  1. Make sure to claim the federal tax credit equal to 100 percent of required (2020) and voluntary (2021) emergency sick leave and emergency family leave payments. It’s likely that you made payments that qualify for the credits.
  2. If you have a Section 105 plan in place you have not been reimbursing expenses monthly, do a reimbursement now to get 2021 deductions, and then put yourself on a monthly reimbursement schedule in 2022.
  3. If you want to implement a Qualified Small Employer Health Reimbursement Arrangement (QSEHRA), but have not yet done so, make sure to get that done properly now. You are late, so you could suffer that $50-peremployee penalty should your lateness be found out.
  4. But if you are thinking of the QSEHRA and want to help your employees with more money and flexibility, be sure to consider the Individual Coverage Health Reimbursement Arrangement (ICHRA). It’s got more advantages.
  5. If you operate your business as an S corporation and you want an above-the-line tax deduction for the cost of your health insurance, you need the S corporation to (a) pay for or reimbursed you for the health insurance, and (b) put it on your W-2. Make sure that the reimbursement happens before December 31 and that you have the reimbursement set up to show on the W-2.
  6. Claim the tax credit for the group health insurance you give your employees. If you provide your employees group health insurance, see whether your pay structure and number of employees put you in a position to claim a 50 percent tax credit for some or all the monies you paid for health insurance in 2021 and possibly in prior years.

 

Sole-Proprietorship and Single Member LLCs

  1. Consider hiring your children as employees, provided they can perform a legitimate business function, and pay them a fair market wage.  They are exempt from FICA, and Medicare if under age 18 and FUTA if under age 21 and in many states unemployment compensation tax  if under age 21.   The benefit here is that it reduces your taxable income saving both income tax and possible self-employment tax. The child could fund a custodial ROTH IRA and save for their future and or college up to $6,000 per year.
  2. Hire your spouse and incorporate a Section 105 Plan You do not have to pay your spouse a lot of wage for this to work. Under the Section 105 Plan all of your family medical expenses become a Schedule C tax deduction.  Medical expenses include health insurance cost and out of pocket medical expenses, as a business deduction you save income tax and self-employment tax and remember most taxpayers do not get to have a medical deduction  as medical expenses are an itemized deduction subject to limits of their AGI.

 

Other Employer Programs 

  1. Paycheck Protection Program
  2. Paid sick leave and Paid family leave credit
  3. Employee Retention Credit
  4. COBRA premium Assistance
  5. HRA Final Regulations (Health Reimbursement Arrangements)

Questions about the above issues have been covered in prior letters.  For information contact me at al@whalengroup.com.

 

INDIVIDUAL TAX ISSUES

Individuals Who Are 70 ½ Years Of Age Or Older  In this calendar year you must take a Required Minimum Distribution (RMD) from their IRA by December 31st .  There is a 50% penalty tax for forgetting this provision.  Due to the SECURE Act if your 70th birthday is July 1, 2019 or later you do not have to take RMDs until you are age 72.  The only exception to this rule is the year you first turn 72 you may wait until April 15th of the following year, however, you must make two distributions in that next year if you use this delay of distribution.

PLANNING TIP:  Take advantage of a charitable break for IRA owner’s that’s now perinate in the law.  Individual’s 70 ½ and older can transfer as much as $100,00 annually from their IRAs directly to a qualifying charity.  If married, you and your spouse can give up to $100,000 each from your separate IRAs.  The benefits here are: 1) This distribution also qualifies toward your RMD requirements, 2) This distribution in not taxable to you, 3) This amount of IRA is forever removed from future income and estate tax, and 4) The charity of your choice benefits from your generosity.  This planning is a WIN, WIN, WIN, WIN, when used properly, remember the distribution must go from the IRA directly to the charity, you cannot receive the funds and then write a check to the charity for this to work.  All IRA account custodians will have the necessary forms.  NOTE:  This provision is just for IRAs, therefore, if you have 401Ks, 403Bs, 457 plans, pension, profiting sharing or qualified plans you must transfer the funds to an IRA rollover account first then directly transfer to the charity.

Higher-Income Earners remember the top marginal tax bracket is now 37%, however, the Tax Cuts and Jobs Act (TCJA) did not eliminate the surtax of 3.8% on certain unearned income. The surtax is the lesser of: 1) net investment income (NII), or 2) the excess of modified adjusted gross income (MAGI) over a threshold amount ($250,000 for joint filers or surviving spouses, $125,000 for married filing separate, and $200,000 in any other case).  The IRS does not index these ACA thresholds for inflation. NII included capital gains and Section 475 ordinary income.

PLANNING TIP:  Long-term Capital Gains are most likely the issue to get the surtax. Many taxpayers that normally have adjusted gross income under $250,000 do not experience the surtax until they have a large long-term capital gain tax.  One way to either reduce or eliminate the surtax is to consider an installment sale.  Example:  You sell a piece of real estate for $110,000 with a basis of $10,000, therefore, you have a gain of $100,000, you could spread the gain over two years by receiving half this year and half next year, this is especially good towards the end of the year.  Now let’s further assume your adjusted gross income is $200,000. By spreading the $100,000 gain over two years you would not experience the surtax of 3.8% at all.

Estimated Tax And RMDs Individuals who must pay estimated tax and need to take RMD’s from retirement accounts or IRA distributions can elect to have up to 100% of the distribution go to income tax withholding. This possibility eliminates the need to pay estimated tax installments using Form 1040-ES. This is especially effective is you take the distribution near year end as the IRS considers the withholding as if it had been timely withheld throughout the year.

Take Advantage Of Capital Gains Rules Long-term capital gain from sale of asset held over one year and qualifying dividend is taxed at 0%, 15%, or 20%, depending on the taxpayer’s taxable income. The 2021 long-term capital gains rate are 0% for taxable income under $40,000 single, and $80,000 married filing jointly. The 15% capital gains rate applies to taxable income up to  $441,450 for filing single and $496,000 married filing jointly.  The top bracket rate of 20% applies to gains above those amounts.

PLANNING TIP: Zero-percentage-rate gains and dividends produce increased adjusted gross income (modified adjusted gross income) which can cause more of your social security to be subject to income tax.

ROTH IRA Conversion:  Convert a traditional IRA into a ROTH IRA before year-end to accelerate income.  The conversion income is taxable in 2021, but the 10% excise tax on early withdrawals before age 59 ½ is avoided provided, you pay the conversion taxes from outside the ROTH plan.  One concern is that TCJA repealed the recharacterization option; you can no longer reverse it if the plan assets decline after conversion.  There isn’t an income limit for making ROTH IRA conversions.

PLANNING TIP: When to use this type of planning:

  1. When income declines in the current year, due to reduction of income from salary.
  2. When retirement income in less than your prior working income.
  3. When your business (non-C Corporation) income produces a net-operating loss (NOL) for the year. Convert enough IRA income to reduce your taxable income to zero after considering the standard deduction.
  4. When the IRA investment suffers a large decline in value.

Use Of FSA and HSA Plans: Consider increasing the amount you set aside for next year in your employer’s health flexible spending account (FSA), if you set aside too little for this year.  If you become eligible in December of 2021 to make health savings account (HSA) contributions, you can make a full year’s worth of deductible HSA  contributions for 2021. The HSA 2021 limits are; $3,600 for self-only coverage and $7,200 for family coverage. People age 55 or older get $1,000 more.

Review Your Investment Portfolio For Possible Tax Savings Adjustments:  If you are considering taking profits in your portfolio, then make sure that you balance gains and losses to reduce the tax.  Now is the time to reduce underperforming investments as an offset against the winners.  Remember losses offset gains dollar for dollar. Any excess losses are deductible up to $3,000 and the balance must be carried forward until used up or your death whichever comes first.

PLANNING TIPS:  If you hold under performing stock positions and have an unrealized loss, you could sell the stock experiencing a capital loss and then repurchase the same stock after 31 days and avoid the WASH LOSS rules.  If repurchased prior to 31 days, then your stock price gets adjusted and no loss is recognized.

Gifting To Avoid Gift Tax:  Consider making gifts sheltered by the annual gift tax exclusion before the end of the year if doing so may save gift or estate taxes.  The exclusion applies to gifts up to $15,000 made in 2021 to each of an unlimited number of individuals.  There is an unlimited transfer directly to educational institutions for tuition (not considered a gift), or unlimited transfer to medical care providers (not considered a gift).  You cannot carryover unused exclusions from one year to the next.  Such transfers may save family income taxes where income earning property is given to family members in lower income tax brackets who are not subject to the kiddie tax.

PLANNING TIP:  Many may prefer CASH, however, consider appreciated stocks, mutual funds or other appreciated assets.  Remember the transfer of these assets are transferred at FMV so keep the FMV at $15,000 or under.  The basis of the asset transfers as well. Example; you own a stock position that has a market value of $15,000 with a cost basis of $5,000 for a gain of $10,000, and you transfer to an individual that is in a ZERO capital gains bracket then the $10,000 gain would not be taxable.  Remember there are three capital gains brackets; 0%, 15%, and 20% depending upon your adjusted gross income.

Divorce Under The Tax Cuts and Jobs Act (TCJA):  Tax reform changes the alimony game.  TCJA eliminates tax deductions for alimony payments that are required under post 2018 divorce agreements.  More specifically, the TVJA new denial of alimony tax deductions applies to payments required by divorce or separation agreements; 1,) Executed after December 31, 2018, or 2.) Modified after that date, if the modification specifically states that the new TCJA treatment of alimony payments now applies.  When alimony payments are not deductible by the person paying them, they are not  taxable to the one receiving the payments.

Education Planning Changes:  There are two ways to help your kids or grandkids with their education.

  1. Contributing to a 529 plan is one option, you can shelter from gift tax as much as $75,000 in a single year per beneficiary ($150,000 if your spouse joins in). If you contribute the maximum, you will be treated as gifting $15,000 (or $30,000) per beneficiary in 2021 and in each of the next four years. Payments are excluded from your estate as long as you live through the fifth year. PLANNING TIP:  Now the 529 Plans are not just for college. Tax free distributions of up to $10,000 can now be taken each year to help pay for private parochial K-12 tuition.  The $10,000 cap does not apply to 529 plan withdrawals to pay for college.
  2. Paying a person’s tuition directly to the school is tax-favored, too. The payment is not treated as gift for purposes of the gift tax rules.

Remember The Sunset Rules for Gift and Estate Taxes:  Continuing the planning conversation about gifting, the current increased estate, gift, and generation-skipping transfer tax exclusions under TCJA are scheduled to sunset effective January 1, 2026 or potentially sooner, if President Biden proposed tax changes take effect.  If this law is not extended then it defaults to the rules in place in 2010 adjusted for inflation.  Why is this important? Because currently the estate and gift tax exclusion is $11,700,000  and that drops back to $5,000,000 adjusted for inflation, therefore, gifting large amounts now may be very important for large estates.

Charitable Contribution Limits Changed: Prior to 2018 cash contributions were limited to 50% of your adjusted gross income (AGI), any excess got carried over for up to the next 5 years then lost if unused.  The 50 % limit is now 60% for years after 2017, however a special concession was made for 2021 only,  100% of AGI. Special note; for 2021 you can deduct up to $600 above the line deduction for charitable contributions made to qualifying charities on a joint return or $300 on single or head of household return without itemized deduction.

Home Mortgage Interest:  IRC Sec 163(h) prior to ACJA you could deduct interest payments on up to $1 million in acquisition indebtedness and up to $100,000 of home equity interest. Now, for tax years 2018 through 2025:

  1. You can deduct interest payments on up to $750,000 in acquisition indebtedness for homes purchased after December 14, 2017.
  2. You can deduct up to $100,000 of home equity interest, but only if funds are used to buy, build, or substantially improve the home.

Hobby Deductions:  IRC Sec 183 Hobby expenses could be deducted as miscellaneous itemized deductions subject to the 2 percent-of-AGI threshold.  Now, hobby expenses that don’t qualify as cost of sales are not deductible.

Educator Expenses: There is a limit of $250 per year as above the line deduction, without itemizing for educator expenses, (classroom supplies, equipment used in presentations, etc.)

Dependent Care Expenses   Effective for 2021 tax year only, the American Rescue Plan Act of 2021 makes the Child and Dependent Care Expense Credit under IRC section 21 a refundable credit.  This means it is not limited to taxes owed. There is an increased dollar limit  effective for 2021 only, the $3,000 dollar limitation on expenses for one child is increased to $8,000 and the $6,000 dollar limitation on expenses paid for two or more qualifying persons is increased to $16,000.

Child Tax Credit  Effective for the 2021 tax year only, The American Rescue Plan Act increased the $2,000 per child credit to $3,000 per child between age 6 and age 18 (under age 19 by December 31). A child under age 6 gets a $3,600 credit and the credits are refundable (not limited to tax owed).  The credit start phasing out when AGI exceeds $75,000 single filer and $150,000 for joint filers.  Remember, unless you opt-out, you have been receiving advanced credits monthly, remember to keep a record of the amounts received.

OTHER TAX ISSUES

 Who Pays What Of Our Federal Income Tax:  The IRS released the 2017 “share of income and share of Federal Income Taxes Paid” report in late 2019:

Top 1% income earners  with AGI of $515,371 or greater paid 38.47% of tax

Top 5% income earners with AGI of $208,053 or greater paid 59.14% of tax

Top 10% income earners with AGI of $145,135 or greater paid 70.08% of tax

Top 25% income earners with AGI of $83,682 or greater paid 86.1% of tax

Top 50% income earners with AGI of $41,740 or greater paid 96.89% of tax

Bottom 50% income earners with AGI of less than $41,740 paid 3.11% of tax

 NOTE:  In the 2016 report to be in the top 1% of income earners your AGI was $480,804 or above and to be in the bottom 50% your AGI had to be below $40,078.

 The question is always in our “progressive system” of taxation, how much should someone that makes more than me be paying  for the benefits that we all have?  What is really fair? The percentage is relative, if the country needs more money to operate, then collect it from someone other than me, is how many feel.

If you wish to know where you fit into this system, just go to your 2017 income tax return and look at your Adjust Gross Income (AGI) then you will know.

Corporate Tax Revenue  The IRS recently released the total revenue collected from corporations Form 1120, and surprise to some,  since the corporate tax rate went from 35% under

President Obama to 21% under President Trump. The amount collected from corporations have increased each year.

Social Security COLA Increase: Given that Social Security is our country’s most successful social program, and that 62% of retired workers are netting at least half of their income from their Social Security benefit, all eyes were on Oct. 10. That’s because Oct. 10 is the release date for the U.S. Bureau of Labor Statistics’ (BLS) September inflation data, which contains the last puzzle piece needed to calculate Social Security’s cost-of-living adjustment (COLA) for 2022.  The BLS reported September’s inflation data, allowing for the concrete announcement that Social Security’s COLA in 2021 will be rising by 5.9%. Now just pray that the increase in Medicare cost are less than this increase.

This letter will be posted on the Web Site: www.whalengroup.com.  Please share with friends, that’s the greatest compliment I can receive.

I wish all my clients, friends and family a Very Happy Thanksgiving.  We have so much to be thankful.

 

Respectfully,

 

Al Whalen, EA, ATA, CFP®

 

 

Sources:

The Tax Cuts and Jobs Act of 2017

Wolters Kluwer CCH CPE Link

CPECredit.com

Globalcredit.com

The Tax Foundation

Internal Revenue Code and Regulation

IRS, Statistics of Income, Individual Income Rates and Tax Shares (2019)

The Bradford Tax Institute

National Taxpayers Union Foundation

The Tax Book

 

 

Benefit Big from the Work Opportunity Tax Credit

The Work Opportunity Tax Credit rewards your good deeds. And now, because of new legislation, the rules are in place for longer than usual. If you need to hire workers in your business, this dollar-for-dollar reducer of your taxes is one to know about.

Suppose your business hires a member of a targeted group. In that case, you can claim the potentially lucrative federal Work Opportunity Tax Credit (WOTC) for some of the wages paid to the individual.

Overview of the Credit

The credit generally equals 40 percent of qualified first-year wages paid to an eligible employee, up to a maximum wage amount of $6,000. That translates into a maximum credit of $2,400 (40 percent x $6,000).

Of course, some employees don’t work out. The tax code recognizes that and reduces the credit rate to 25 percent of qualified first-year wages for an employee who completes at least 120 but fewer than 400 hours of service. That translates into a maximum credit of $1,500 (25 percent x $6,000).

Eligible Employees

To be an eligible employee, your new hire must be certified as a member of a targeted group by the applicable State Workforce Agency (SWA). You, as the employer, can either

  • obtain the certification by the day the employee begins work, or
  • complete a pre-screening notice, using IRS Form 8850 (Pre-Screening Notice and Certification Request for the Work Opportunity Credit), by the day you offer a job to a prospective employee. Then submit Form 8850 to the SWA (not to the IRS) within 28 days after the employee begins work.

Click here for links to the names, addresses, phone and fax numbers, and email addresses of the WOTC coordinators for each of the SWAs.

A simplified certification process is available for qualified unemployed veterans.

You can claim the WOTC only if you hire a member of a targeted group. Targeted groups include the following:

  • Qualified IV-A recipients
  • Qualified veterans
  • Qualified ex-felons
  • Designated community residents
  • Vocational rehabilitation referrals
  • Qualified summer youth employees
  • Qualified supplemental nutrition assistance benefits recipients
  • Qualified SSI recipients (anyone who is certified by the designated local agency as receiving Supplemental Security Income benefits under Title XVI of the Social Security Act for any month ending within the 60-day period ending on the hiring date)
  • Long-term family assistance recipients
  • Qualified long-term unemployment recipients

Exceptions to the General Rule on Credits

There’s a higher limit of $12,000 for first-year wages paid to a qualified veteran who is entitled to compensation for a service-connected disability and was discharged or released from the military within the past year. That translates into a maximum credit of $4,800 (40 percent x $12,000).

There’s an even higher limit of $14,000 for first-year wages paid to a qualified veteran who was unemployed for at least six months in the prior year. That translates into a maximum credit of $5,600 (40 percent x $14,000).

If a qualified veteran both has a service-connected disability and was unemployed for at least six months in the prior year, the limit for first-year wages is $24,000. That translates into a maximum credit of $9,600 (40 percent x $24,000). Wow!

The WOTC for a long-term family assistance recipient equals 40 percent of qualified first-year wages, up to a maximum wage amount of $10,000. That translates into a maximum credit of $4,000 (40 percent x $10,000).

In addition, for long-term family assistance recipients, the WOTC can be claimed for 50 percent of qualified second-year wages, up to a maximum wage amount of $10,000. That translates into a maximum second-year credit of $5,000 (50 percent x $10,000) and a maximum combined credit for the two years of $9,000 ($4,000 + $5,000). Another wow!

The WOTC for a qualified summer youth employee (a 16-year-old or 17-year-old who lives in an empowerment zone) equals 40 percent of first-year wages paid during any 90-day period between May 1 and September 15, up to a maximum wage amount of $3,000. That translates into a maximum credit of $1,200 (40 percent x $3,000).

Tax Planning for the New $142,800 Base for Self-Employment Taxes

What happens when lawmakers enact a new tax? It starts small. It looks easy.

In 1935, the self-employment tax topped out at $60. Those 1935 lawmakers must be twirling in their graves with the new rules for 2021, which levy the following taxes:

  • A self-employment tax of up to $21,848, which comes from the 15.3 percent rate that applies to self-employment income of up to $142,800.
  • A 2.9 percent tax that applies to all self-employment income in excess of the base amount.

Beware

Look at what has happened to self-employment taxes since they first came into being in 1935, assuming you earn at the base amount:

  • $60 in 1935
  • $60 in 1949
  • $3,175 in 1980
  • $7,849 in 1990
  • $14,413 in 2006
  • $21,848 in 2021

To put the rates in perspective, say you are single and earn $150,000. On the last dollar you earned—dollar number 150,000—how much federal tax did you pay? The answer in round numbers—39 cents (14 cents in self-employment and 24 cents in federal income taxes).

Wow! That’s a lot. Then, if you live in a state with an income tax, add the state income tax on top of that.

Tax Planning

Two things to know about tax planning:

  1. Your new deductions give you benefits starting at your highest tax rates.
  2. In most cases, the return on your planning is not a one-time event. Once your plan is in place, you reap the benefits year after year. Thus, good tax planning is like an annuity.

Checklist

Here is a short checklist of some tax-planning ideas. Review these ideas so you can identify new business deductions for your tax return. You want business deductions because business deductions reduce both your income and your self-employment taxes.

  • Eliminate the word “friend” from your vocabulary. From now on, these people are sources of business, so start talking business and asking for referrals over meals and beverages.
  • Hire your children. This creates tax deductions for you, and it creates non-taxable or very low taxed income for the children. Also, wages paid by parents to children are exempt from payroll taxes.
  • Learn how to combine business and personal trips so that the personal side of your trip becomes part of your business deduction under the travel rules (for example, traveling by cruise ship to a convention on St. Thomas).
  • Properly classify business expansion expenses as immediate tax deductions rather than depreciable, amortizable, or (ouch!) non-deductible capital costs.
  • Properly identify deductible start-up expenses ($5,000 up front and the balance amortized) rather than letting them fall by the wayside (a common oversight).
  • Correctly classify business meals that qualify for the 100 percent deduction rather than the 50 percent deduction.
  • Know the entertainment facility rules so your vacation home can become a tax deduction.
  • Identify the vehicle deduction method that gives you the best deductions (choosing between the IRS mileage method and the actual expense method).
  • Correctly identify your maximum business miles, so you deduct the largest possible percentage of your vehicles.
  • Qualify your office in your home as an administrative office.
  • Use allocation methods that make your home-office deductions larger.
  • If you are married with no employees, hire your spouse and install a Section 105 medical plan to move your medical deductions to Schedule C for maximum benefits.
  • Operate as a one-person S corporation to save self-employment taxes.
  • If you are single with no employees, operate as a C corporation and install a Section 105 medical plan so you can deduct all your medical expenses.

 

IRS Focuses on Cryptocurrency

Cryptocurrencies have gone mainstream.

For example, you can use bitcoin to buy far more than you would think. To see, try googling “What can I buy with bitcoin?” You will get more than 350,000 hits. But using cryptocurrencies has federal income tax implications that may surprise you.

With the price of bitcoin having gone through the roof (before its recent decline), and with increasing acceptance of bitcoin and other cryptocurrencies as forms of payment, the tax implications of using cryptocurrencies are a hot-button issue for the IRS.

The 2020 version of IRS Form 1040 (the form you recently filed or will file soon) asks whether you received, sold, sent, exchanged, or otherwise acquired—at any time during the year—any financial interest in any virtual currency. If you did, you are supposed to check the “Yes” box.

The fact that this question appears on page 1 of Form 1040, right below the lines for supplying taxpayer information such as your name and address, indicates that the IRS is getting serious about enforcing compliance with the applicable tax rules. Fair warning!

The 2020 Form 1040 instructions clarify that virtual currency transactions for which you should check the “Yes” box include but are not limited to

  1. the receipt or transfer of virtual currency for free (i.e., without having to pay),
  2. the exchange of virtual currency for goods or services,
  3. the sale of virtual currency,
  4. the exchange of virtual currency for other property, and
  5. the disposition of a financial interest in virtual currency.

To arrive at the federal income tax results of a cryptocurrency transaction, the first step is to calculate the fair market value (FMV), measured in U.S. dollars, of the cryptocurrency on the date you receive it and on the date you use it to pay for something.

When you exchange cryptocurrency for other property, including U.S. dollars, a different cryptocurrency, services, or whatever, you must recognize taxable gain or loss just as you do when you make a stock sale in your taxable brokerage account.

  • You’ll have a taxable gain if the FMV of what you receive exceeds your basis in the cryptocurrency that you exchanged.
  • You’ll have a taxable loss if the FMV of what you receive is less than your basis in the cryptocurrency.

It is hard to imagine that a cryptocurrency holding will be classified for federal income tax purposes as anything other than a capital asset—even if you use it to conduct business or personal transactions, as opposed to holding it for investment. Therefore, the taxable gain or loss from exchanging a cryptocurrency will be a short-term capital gain or loss or a long-term capital gain or loss, depending on how long you held the cryptocurrency before using it in a transaction.

Example. You use one bitcoin to buy tax-deductible supplies for your booming sole proprietorship business. On the date of the purchase, bitcoins are worth $55,000 each. So, you have a business deduction of $55,000.

But there’s another piece to this transaction: the tax gain or loss from holding the bitcoin and then spending it.

Say you bought the bitcoin in January of this year for only $31,000. You have a $24,000 taxable gain from appreciation in the value of the bitcoin ($55,000 – $31,000). The $24,000 gain is a short-term capital gain because you did not hold the bitcoin for more than one year.

Detailed records are essential for compliance. Your records should include

  • the date when you received the cryptocurrency,
  • its FMV on the date of receipt,
  • the FMV on the date you exchanged it (for U.S. dollars or whatever),
  • the cryptocurrency trading exchange that you used to determine FMV, and
  • your purpose for holding the currency (business, investment, or personal use).

 

Congress Closes the PayPal 1099-K Reporting Loophole

The PayPal loophole is going away in a little over six months from now.

You used to be able to avoid giving 1099s to contractors and vendors when you use PayPal or a similar service as your payment platform. This pushed the reporting requirements to PayPal. Current federal law requires that PayPal file Form 1099-K with the IRS and send it to you when

  • your gross earnings are more than $20,000, and
  • you have more than 200 transactions.

Example. You work as a consultant. Your clients pay you $30,000 via PayPal. PayPal does not give you a 1099-K because this fails the more than 200 transactions in a calendar year test.

According to lawmakers, this created a situation where those people who use PayPal have an easy ability to cheat (i.e., not report the income on their tax returns).

Starting January 1, 2022, the American Rescue Plan Act kills the two-step “more than $20,000 and more than 200 transactions” threshold for third-party settlement organization (TPSO) filing of 1099-K and replaces it with the single “$600 or more” reporting threshold.

The Joint Committee on Taxation estimates that this change in the 1099 rules will gain more than $8 billion in new taxes over the next 10 years.

Several states have already closed this reporting loophole on the state level:

  • Maryland, Massachusetts, Mississippi, Vermont, and Virginia require a 1099-K to be filed with the state tax agency if a TPSO pays a state resident $600 or more during the year.
  • Illinois and New Jersey have a $1,000 1099-K threshold (plus, for Illinois, a requirement of at least four transactions).
  • Arkansas has a $2,500 threshold.
  • Missouri has a $1,200 threshold.

Still Waiting For Your Refund  The Internal Revenue Service was still facing a backlog of more than 35 million unprocessed tax returns as of the end of the 2021 filing season in May — a pileup more than four times bigger than the end of the 2019 filing season, according to a government watchdog.

 The National Taxpayer Advocate stressed that the IRS is underfunded by Congress, which allocated enough funding for fiscal years 2020 and 2021 to reach “a 60 percent level of service” AP service.

The agency received more than 85.1 million calls to its critical 1040 customer support phone line for individual tax returns in the 2021 season, the watchdog said. That’s up a staggering 978 percent from 2018 levels, it added.

Of the millions who called the agency over the past year, just 3 percent were able to connect with a human being, the NTA found.

The watchdog noted that the IRS has faced a surge in demand for its services as the federal government rolled out economic relief efforts that relied on the agency’s support.

The agency has processed 136 million individual income tax returns and issued 96 million refunds totaling $270 billion during the 2021 filing season, the NTA said.

“The IRS and its employees deserve tremendous credit for what they have
accomplished under very difficult circumstances, but there is always room for improvement,” it added.

 

Respectfully,

Al Whalen, EA, ATA, CFP®

al@whalengroup.com

al@whalenfinancial.com

Phone: 702-878-3900

FAX:  702-878-7200