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TAX TIP LETTER – PRIMARY HOME SALE

Dear Client:                                                                                                            October 21, 2021

The $250,000 ($500,000, if married) home sale gain exclusion break is one of the great tax-saving opportunities.

Unmarried homeowners can potentially exclude gains up to $250,000, and married homeowners can potentially exclude up to $500,000. You as the seller need not complete any special tax form to take advantage.

To take full advantage of the principal residence gain exclusion break, you must pass two tests: the ownership test and the use test.

  • To pass the ownership test, you must have owned the home for at least two years out of the five-year period ending on the sale date.
  • To pass the use test, you must have used the home as your principal residence for at least two years out of the five-year period ending on the sale date.

Key point. These two tests are completely independent. In other words, periods of ownership and use need not overlap.

If you’re married and you and your spouse file your tax returns separately, you can potentially qualify for two separate $250,000 exclusions.

If you’re married and file jointly, you qualify for the $500,000 joint-filer exclusion if:

  • either you or your spouse pass the ownership test for the property and
  • both you and your spouse pass the use test.

When you file jointly, it’s possible for both you and your spouse to individually pass the ownership and use tests for two separate residences. In that case, you and your spouse would qualify for two separate $250,000 exclusions.

Each spouse’s eligibility for the $250,000 exclusion is determined separately, as if you were unmarried. For this purpose, a spouse is considered to individually own a property for any period the property is actually owned by either spouse.

The other big qualification rule for the home sale gain exclusion privilege goes like this: the exclusion is generally available only when you have not excluded an earlier gain within the two-year period ending on the date of the later sale. In other words, you generally cannot recycle the gain exclusion privilege until two years have passed since you last used it.

You can claim the larger $500,000 joint-filer exclusion only if neither you nor your spouse took advantage of it for an earlier sale within the two-year period. If one spouse claimed the exclusion within the two-year window, but the other spouse did not, the exclusion is limited to $250,000.

As you can see, there’s much to know about the home sale exclusion. If you would like to discuss how the exclusion would work for you, please call me on my direct line at 702-878-3900.

Here’s a look at how to apply the $250,000 ($500,000, if married) principal residence tax break when getting married or divorced, or when converting another property into your home.

In both marriage and divorce situations, a home sale often occurs. Of course, the principal residence gain exclusion break can come in very handy when an appreciated home is put on the block.

Sale during Marriage

Say a couple gets married. They each own separate residences from their single days. After the marriage, the pair files jointly. In this scenario, it is possible for each spouse to individually pass the ownership and use tests for their respective residences. Each spouse can then take advantage of a separate $250,000 exclusion.

Sale before Divorce

Say a soon-to-be-divorced couple sells their principal residence. Assume they still are legally married as of the end of the year of sale because their divorce is not yet final. In this scenario, the divorcing couple can shelter up to $500,000 of home sale profit in two different ways:

  1. Joint return. The couple could file a joint Form 1040 for the year of sale. Assuming they meet the timing requirements, they can claim the $500,000 joint-filer exclusion.
  2. Separate returns. Alternatively, the couple could file separate returns for the year of sale, using married-filing-separately status. Assuming the home is owned jointly or as community property, each spouse can then exclude up to $250,000 of his or her share of the gain.

To qualify for two separate $250,000 exclusions, each spouse must have

  • owned his or her part of the property for at least two years during the five-year period ending on the sale date, and
  • used the home as his or her principal residence for at least two years during that five-year period.

Sale in Year of Divorce or Later

When a couple is divorced as of the end of the year in which their principal residence is sold, they are considered divorced for that entire year. Therefore, they will be unable to file jointly for the year of sale. The same is true, of course, when the sale occurs after the year of divorce.

Key point. Under the preceding rules, both ex-spouses will typically qualify for separate $250,000 gain exclusions when the home is sold soon after the divorce. But when the property remains unsold for some time, the ex-spouse who no longer resides there will eventually fail the two-out-of-five-years use test and become ineligible for the gain exclusion privilege.

Let’s see how we can avoid that unpleasant outcome.

When the Non-Resident Ex Continues to Own the Home for Years after Divorce

Sometimes ex-spouses will continue to co-own the former marital abode for a lengthy period after the divorce. Of course, only one ex-spouse will continue to live in the home. After three years of being out of the house, the non-resident ex will fail the two-out-of-five-years use test. That means when the home is finally sold, the non-resident ex’s share of the gain will be fully taxable. But with some advance planning, you can prevent this undesirable outcome.

If you will be the non-resident ex, your divorce papers should stipulate that as a condition of the divorce agreement, your ex-spouse is allowed to continue to occupy the home for as long as he or she wants, or until the kids reach a certain age, or for a specified number of years, or for whatever time period you and your soon-to-be ex can agree on. At that point, either the home can be put up for sale, with the proceeds split per the divorce agreement, or one ex can buy out the other’s share for current fair market value.

This arrangement allows you, as the non-resident ex, to receive “credit” for your ex’s continued use of the property as a principal residence. So, when the home is finally sold, you should pass the two-out-of-five-years use test and thereby qualify for the $250,000 gain exclusion privilege.

The same strategy works when you wind up with complete ownership of the home after the divorce, but your ex continues to live there. Stipulating as a condition of the divorce that your ex is allowed to continue to live in the home ensures that you, as the non-resident ex, will qualify for the $250,000 gain exclusion when the home is eventually sold.

Little-Known Non-Excludable Gain Rule Can Mean Unexpectedly Higher Taxes on a Property Converted into Your Principal Residence

Once upon a time, you could convert a rental property or vacation home into your principal residence, occupy it for at least two years, sell it, and take full advantage of the home sale gain exclusion privilege of $250,000 for unmarried individuals or $500,000 for married, joint-filing couples. Those were the good old days!

Unfortunately, legislation enacted back in 2008 included an unfavorable provision for personal residence sales that occur after that year. The provision can make a portion of your gain from selling an affected residence ineligible for the gain exclusion privilege.

Let’s call the amount of gain that is made ineligible the non-excludable gain. The non-excludable gain amount is calculated as follows.

Step 1. Take the total gain, and subtract any gain from depreciation deductions claimed against the property for periods after May 6, 1997. Include the gain from depreciation (so-called unrecaptured Section 1250 gain) in your taxable income. Carry the remaining gain to Step 3.

Step 2. Calculate the non-excludable gain fraction.

The numerator of the fraction is the amount of time after 2008 during which the property is not used as your principal residence. These times are called periods of non-qualified use.

But periods of non-qualified use don’t include temporary absences that aggregate two years or less due to changes of employment, health conditions, or other circumstances specified in IRS guidance.

Periods of non-qualified use also don’t include times when the property is not used as your principal residence, if those times are

  • after the last day of use as your principal residence, and
  • within the five-year period ending on the sale date.

The denominator of the fraction is your total ownership period for the property.

Step 3. Calculate the non-excludable gain by multiplying the gain from Step 1 by the non-excludable gain fraction from Step 2.

Step 4. Report on Schedule D of Form 1040 the non-excludable gain calculated in Step 3. Also report any Step 1 unrecaptured Section 1250 gain from depreciation for periods after May 6, 1997. The remaining gain is eligible for the gain exclusion privilege, assuming you meet the timing requirements.

If you are in any of the situations described above and would like to discuss this, please call me my at 702-878-3900.

Sincerely,

AL Whalen, EA, ATA, CFP®

al@whalengroup.com

al@whalenfinancial.com

Client Tax Tip Letter September 2021

Save Your Employee Retention Credit

In what clearly must have been a mistake, the IRS issued Notice 2021-49 to deny the employee retention credit (ERC) on the wages paid to most C and S corporation owners.

According to the IRS:

  • Your corporation can qualify for the ERC on the wages paid to a more than 50 percent owner of an S or C corporation if that owner does not have any living brothers and sisters (whether whole- or half-blood), spouse, ancestors, or lineal descendants.
  • Your corporation cannot qualify for the ERC on the more than 50 percent owner’s wages if one of those relatives (other than the spouse) is alive.

Example 1. Tom owns 100 percent of his S corporation, and he has no living relatives. Under this new IRS notice, Tom’s corporation can qualify for up to $33,000 in ERC on Tom’s wages.

Example 2. John owns 100 percent of his S corporation, but he has one living relative, a two-year-old daughter. John’s corporation does not qualify for the ERC. Under the new IRS notice, the two-year-old daughter owns by attribution 100 percent of the S corporation, and the IRS says that John, now a tainted relative, works for her and does not qualify for the ERC.

Whoa, that’s not logical!

Also, it may be technically incorrect.

And it’s possible that lawmakers will kill this IRS rule.

To Amend or Not to Amend

Let’s start with this premise. You are a more than 50 percent owner of a corporation. You thought that your corporation qualified for the ERC. At various times before August 4, 2021, the day when the IRS issued Notice 2021-49, you filed your claim to the ERC for 2020 and the first two quarters of 2021.

As we mentioned, when you filed, you believed (as a more than 50 percent owner of a C or S corporation) that wages paid to you by the corporation qualified for the ERC. We did too.

But then, on August 4, 2021, the IRS issued Notice 2021-49 and said no—you don’t qualify. What now? Here’s what we think you should do:

  1. Do nothing now. There’s no hurry. You have until April 15, 2024, before you have to do anything about your 2020 ERC.
  2. Don’t claim the ERC for the more than 50 percent corporate owner for calendar year 2021 quarters 3 and 4 until you have clarification that you qualify. Again, there’s no hurry. You can file a Form 941-X anytime within the three-year statute of limitations.

If you are upset by this IRS notice, it’s a good idea to communicate that dissatisfaction to your U.S. senators and congressional representatives. For some ideas on what message to convey, here’s a sample letter for your use.

Vaccinated? Claim Tax Credits for Your Employees and Yourself

As the nation suffers from the ravages of the super-contagious COVID-19 Delta variant, the federal government desperately wants all American workers and their families to get vaccinated.

If you have employees, you probably feel the same way. Indeed, more and more employers are implementing vaccine mandates—a trend that will likely grow after the FDA gives final approval to the COVID-19 vaccines.

COVID-19 vaccine mandates are highly controversial.

One thing that’s not controversial is giving your employees paid time off to get vaccinated and to deal with the possible side effects of vaccination (usually, short-lived flu-like symptoms). The federal government does not require that employers provide such paid time off, but it strongly encourages them to do so. And it’s putting its money where its mouth is, by providing fairly generous tax credits to repay employers for the lost employee work time.

You can also collect these credits if your employees take time off to help family and household members get the vaccination and/or recover from its side effects. There’s only one thing better than having an employee vaccinated: having an employee’s entire family vaccinated.

How big are the credits?

  • Employers who give employees paid time off to get vaccinated against COVID-19 and/or recover from the vaccination can collect a sick leave credit of up to $511 per day for 10 days, plus a family leave credit of up to $200 per day for 60 additional days.
  • Employers who give employees paid time off to help household members get vaccinated and/or recover from the vaccination can get a sick leave credit for 10 days and family leave credit for 60 days, both capped at $200 per day.

What if you are self-employed and have no employees? You haven’t been left out. Similar tax credits are available to self-employed individuals who take time off from work to get vaccinated or who help family or household members do so.

But you must act soon. These sick leave and family leave credits are available only through September 30, 2021.

One more thing: these are refundable tax credits. This means you collect the full amount even if it exceeds your tax liability. Employers can reduce their third-quarter 2021 payroll tax deposits in the amount of their credits. If the credit exceeds these deposits, employers can get paid the difference in advance by filing IRS Form 7200, Advance Payment of Employer Credits Due to COVID-19.

The documentation requirements for these credits are modest, and you’ll have to file a couple of new forms with your 2021 tax return.

IRS Private Letter Rulings: Are They Worth It?

Do you have a question about how to apply the tax law to a potential transaction? Wouldn’t it be great if you could get the IRS to give you an answer in advance of filing your tax return?

You may be able to do so by obtaining a private letter ruling (PLR) from the IRS.

You get a PLR by filing a request with the IRS National Office. The IRS is ordinarily bound by the answer it gives a taxpayer in a PLR. But PLRs may not be relied on by other taxpayers.

This sounds great in theory—but in practice, seeking a PLR is usually not a good idea.

There are many reasons why:

  • PLRs are expensive. The filing fee is $3,000 for the smallest businesses. Larger businesses must pay as much as $38,000. You’ll also need professional help to prepare a detailed PLR request.
  • A PLR may not be necessary. The IRS has automatic or simplified methods for obtaining its consent without a PLR for many common situations, including late S corporation elections, late IRA rollovers, and various changes in accounting method.
  • PLRs are unavailable for many types of tax questions, including those that (a) are under IRS examination, (b) were clearly answered in the past, or (c) are too fact intensive.
  • PLRs can take a long time to obtain—six months or more for complex questions.
  • PLRs can backfire. Even if the IRS issues a favorable PLR, you now will be on the agency’s radar, which may increase your chances of an audit.

Given all these drawbacks, you should seek a PLR only when a cheaper alternative is unavailable—for example, when you need to do a late IRA rollover and don’t qualify for the streamlined IRS procedure.

In some instances, it’s wise to seek advance IRS approval of complex transactions involving substantial money. Obtaining a favorable PLR in such a case would assure you the transaction passes IRS muster. But these instances are rare.

Prorated Principal Residence Gain Exclusion Break

Here’s good news. IRS regulations allow you to claim a prorated (reduced) gain exclusion—a percentage of the $250,000 or $500,000 exclusion in select circumstances.

The prorated gain exclusion equals the full $250,000 or $500,000 figure (whichever would otherwise apply) multiplied by a fraction.

The numerator of this fraction is the shorter of

  • the aggregate period of time you owned and used the property as your principal residence during the five-year period ending on the sale date, or
  • the period between the last sale for which you claimed an exclusion and the sale date for the home currently being sold.

The denominator for this fraction is two years, or the equivalent in months or days.

When you qualify for the prorated exclusion, it might be big enough to shelter the entire gain from the premature sale. But the prorated exclusion loophole is available only when your premature sale is due primarily to

  • a change in place of employment,
  • health reasons, or
  • specified unforeseen circumstances.

Example. You’re a married joint-filer. You’ve owned and used a home as your principal residence for 11 months. Assuming you qualify under one of the conditions listed above, your prorated joint gain exclusion is $229,167 ($500,000 × 11/24). Hopefully that will be enough to avoid any federal income tax hit from the sale.

Premature Sale Due to Employment Change

Per IRS regulations, you’re eligible for the prorated gain exclusion privilege whenever a premature home sale is primarily due to a change in place of employment for any qualified individual.

“Qualified individual” means

  1. the taxpayer (that would be you),
  2. the taxpayer’s spouse,
  3. any co-owner of the home, or
  4. any person whose principal residence is within the taxpayer’s household.

In addition, almost any close relative of a person listed above also counts as a qualified individual. And any descendent of the taxpayer’s grandparent (such as a first cousin) also counts as a qualified individual.

A premature sale is automatically considered to be primarily due to a change in place of employment if any qualified individual passes the following distance test: the distance between the new place of employment/self-employment and the former residence (the property that is being sold) is at least 50 miles more than the distance between the former place of employment/self-employment and the former residence.

Premature Sale Due to Health Reasons

Per IRS regulations, you are also eligible for the prorated gain exclusion privilege whenever a premature sale is primarily due to health reasons. You pass this test if your move is to

  • obtain, provide, or facilitate the diagnosis, cure, mitigation, or treatment of disease, illness, or injury of a qualified individual, or
  • obtain or provide medical or personal care for a qualified individual who suffers from a disease, an illness, or an injury.

A premature sale is automatically considered to be primarily for health reasons whenever a doctor recommends a change of residence for reasons of a qualified individual’s health (meaning to obtain, provide, or facilitate care, as explained above). If you fail the automatic qualification, your facts and circumstances must indicate that the premature sale was primarily for reasons of a qualified individual’s health.

You cannot claim a prorated gain exclusion for a premature sale that is merely beneficial to the general health or well-being of a qualified individual.

Premature Sale Due to Other Unforeseen Circumstances

Per IRS regulations, a premature sale is generally considered to be due to unforeseen circumstances if the primary reason for the sale is the occurrence of an event that you could not have reasonably anticipated before purchasing and occupying the residence.

But a premature sale that is primarily due to a preference for a different residence or an improvement in financial circumstances will not be considered due to unforeseen circumstances, unless the safe-harbor rule applies.

Under the safe-harbor rule, a premature sale is deemed to be due to unforeseen circumstances if any of the following events occur during your ownership and use of the property as your principal residence:

  • Involuntary conversion of the residence
  • A natural or man-made disaster or acts of war or terrorism resulting in a casualty to the residence
  • Death of a qualified individual
  • A qualified individual’s cessation of employment, making him or her eligible for unemployment compensation
  • A qualified individual’s change in employment or self-employment status that results in the taxpayer’s inability to pay housing costs and reasonable basic living expenses for the taxpayer’s household
  • A qualified individual’s divorce or legal separation under a decree of divorce or separate maintenance
  • Multiple births resulting from a single pregnancy of a qualified individual

What prompts Tax Law Changes? The need for more money!

National Debt – President Biden is on target to amass the largest national debt in history.

American Rescue Plan – Signed into law April 22, 2021, is $1.9 Trillion.

Proposed $6 Trillion Budget – May 28, 2021, the White House released President Joe Biden’s proposed budget.

Senate Democrats – Reach $3.5 Trillion budget agreement on July 13, 2021.

Senate Passes – $ 1 Trillion Infrastructure bill August 11, 2021.

The Push is on – To get the infrastructure bill passed first then the $3.5 Trillion budget.

Getting What He Wants – If President Biden gets everything he wants, we could add $6 – $7 Trillion to the national debt in his first 9 months. That is more than any other president added in their entire term be it 4 years or 8 years except for Presidents Obama (8.59 trillion in 8 years and Trump 6.7 trillion in 4 years) .

The White House, Senate and House have been working on various proposals to raise more revenue from our progressive system of taxation in last months new letter I spoke about some of President Biden’s tax proposals. Here are some additional proposals:

  1. House Democrats outline tax increases for wealthy businesses and individuals
    The New York Times
    “Senior House Democrats are coalescing around a draft proposal that could raise as much as $2.9 trillion to pay for most of President Biden’s sweeping expansion of the social safety net by increasing taxes on the wealthiest corporations and individuals. The preliminary proposal, which circulated on and off Capitol Hill on Sunday, would raise the corporate tax rate to 26.5 percent for the richest businesses and impose an additional surtax on individuals who make more than $5 million.”
  2. Crypto tax-reporting changes may lead to IRS crackdown
    Accounting Today
    “The bipartisan infrastructure bill includes requirements for brokers to report their customers’ cryptocurrency gains to the Internal Revenue Service, but exactly what constitutes a broker is stirring controversy. As one of the ways to help pay for an estimated $28 billion of the $1.2 trillion in infrastructure spending, congressional negotiators included a provision requiring information reporting on the names, addresses and gross proceeds of cryptocurrency transactions by brokers.”

A bipartisan House bill would require that catch-up contributions to 401K plans and other retirement plans be subject to Roth provisions. That means the extra $6500 contributed by worker 50 or older would automatically go into a Roth 401K and therefore, not reduce there current taxable income (wage).

  1. One of president Biden’s tax proposal is to limit the gain deferral from like-kind exchanges. He wants to limit the amount of deferral to a cap of $500,000 per year per person or $1 million per couple if a joint return is filed. Everything in excess of these caps would be taxable.
  2. In the August letter I mentioned President Biden’s proposal to change the estate tax system by lowering the exemption amount ($11,700,000 to $3,500,00) but also remove the step-up basis provision on death of a taxpayer (a first in our tax history) and subject any unrealized gains to capital gains tax then estate tax.
  3. President Biden wants to hire 87,000 new IRS auditors at a cost of $80 billion to go after tax dodgers. IRS field audits have a 90% plus rate of collecting more money from the audit and correspondence audits have an 80% plus chance. He also proposes allowing the IRS to serval any American’s bank account that has a $600 balance or more looking for more possible audits, remember this is his desire, however, congress would have to make this law in order to give the Treasury department authority for the IRS to serval.

Taxes should be an investment they are the only thing that always goes up!

Keep Tax Break For Home Upgrades

Due to a change in the Tax Cuts and Jobs Act (TCJA), you can’t deduct mortgage interest paid on home equity loans, at least for the next few years. But there is a way to sidestep this tax crackdown if you plan to upgrade your home.

Prior to TCJA mortgage interest paid on up to $1 million of acquisition debt was fully deductible, Home equity debt any other mortgage debt, such as a home equity loan or line of credit, is treated as home equity debt. The mortgage interest paid on up to$100,000 of home equity debt was deductible regardless of how the proceeds were used.

The TCJA changed the rules for acquisition debt, the amount deductible was lowered from $1 million to $750,000 for 2018 – 2025. Debt acquired prior to TCJA is grandfathered (old rules remain). The deduction for interest on home equity debt was completely suspended for the period 2018 through 2025.

Tax Loophole: If you take out a home equity line of credit or equity loan secured by your home and use the proceeds for home improvements. What is an improvement? Anything the adds to the value of the home and has a life of more than a year, grass seed, fertilizer, trees and shrubs, flooring, wall to wall carpet, roofing, siding, additions, remodels, etc. This interest is fully deductible so long as you stay under the new $750,000 limit.

Social Security Issues

Estimates are social security recipients could see as much as a 6.1% increase in 2022 benefits, it is early for the federal government to make the permanent announcement, however, based upon data to date 6.1% is the estimate.

Did you know that social security excludes the child Tax Credit as income and resources for 12 months when considering a person’s eligibility for Supplemental Security income (SSI) and monthly SSI payment amount.

Social Security does not count Economic Impact Payment and certain disaster assistance against your eligibility for SSI or your SSI amount. Learn more by reading “Does COVID-19 financial assistance affect my Supplemental Security Income (SSI) eligibility or payment”.

Some Important Tax Changes For 2021:

  1. Effective for 2020 up to $300 of qualified charitable contributions are deductible as above the line deductions in calculating AGI without the taxpayer having to itemize deductions. For taxpayers who itemize , the 60% AGI limitation for cash contributions is increased to 100%. For 2021 the same rules apply as above, however, for married filing jointly the limit is $600.
  2. Unemployment Benefit Exclusion, effective for 2020 up to $10,200 of unemployment benefits were excludible for income provided your modified AGI was under $150,000 for 2021 there is NO Exclusion, all unemployment is now subject to tax.
  3. Child Tax Credit Effective for the 2021 tax year only, the Child Tax Credit is increased to $3,000 per qualifying child and $3,600 per qualifying child under age 6 by year end. The credit begins to phase out when AGI exceeds $150,000 for MFJ & QW, $112,500 for HOH, and $75,000 for Single & MFS, this is up for prior law $2,000 per qualifying child.
  4. Required Minimum Distribution No RMD was required for 2020, however, that is the only exception year, therefore for 2021 and beyond RMDs are required. Remember RMDs are required for those age 72 or older.
  5. Business Meals Effective for 2020 and 2021 only, a taxpayer can deduct 100% of the cost of a business meal that is purchased in a restaurant. Business meals purchased at any other venue are still subject to the 50% limitation, unless one of the other 100% provisions apply.
  6. Business Bonus Depreciation For year 2021 equipment purchase for your business new or used gets 100% depreciation if placed in service by December 31, 2021. This means even if you did not fully pay the cost of the equipment (any amount down and finance the balance) you get to deduct the full cost of the asset if place in service by December 31, 2021.
  7. Advanced Child Tax Credits Unless you opted out, advance child tax credits started being paid in June. The credit for 2021 increased from $2000 per child to $3000 and if the child is under age 6 by year end then the credit is $3600. I mention this only to remind everyone that this means your 2021 refund will be less as you are receiving some of the credit already.

 

I realize this is a lot of information and everything will not apply to everyone, it is my intension to keep you informed remembering it doesn’t matter how much you make that is important, it is how much you get to keep. I do not want any client to pay one penny more than they are legally required to. Remember “the difference between tax avoidance and tax evasion is jail time”.

Anyone may arrange his affairs so that his taxes shall be as low as possible; he is not bound to choose that pattern which best pays the treasury. There is not even a patriotic duty to increase one’s taxes. Over and over again the Courts have said that there is nothing sinister in so arranging affairs as to keep taxes as low as possible. Everyone does it, rich and poor alike and all do right, for nobody owes and public duty to pay more than the law demands.” The quote was written by Judge Learned Hand (one of the best names for a judge ever) in a tax case titled Helvering v. Gregory (1934),

I wish each and every one good health. The first wealth is health.”. – Ralph Waldo Emerson

Respectfully,

Al; Whalen, EA, ATA, CFP®

Client Tax Tip Letter August 2021

Don’t Miss Out on the Employee Retention Credit

It’s hard to imagine that a small business does not qualify for some or all of the employee retention credit (ERC).

And remember, this is a tax credit—one of the very best things that tax law has to offer. True, it’s not as valuable as some other tax credits, because you have to reduce your payroll income tax deductions for the credits, but the ERC certainly puts you ahead.

And you can be looking at big bucks. The possible ERC is $5,000 per employee for 2020 and $28,000 per employee for 2021. That’s $33,000 per employee.

For 2020, you have two ways to qualify:

  1. You had a gross receipts drop during a 2020 calendar quarter of more than 50 percent when compared to the same calendar quarter of 2019. The more than 50 percent test is the trigger for the ERC, and you automatically qualify for that quarter and the following 2020 quarter.
  2. You suffered from a federal, state, or local government order that fully or partially suspended your operations (under this rule, you qualify for the ERC on the days you suffered the full or partial suspension, even if you did not lose any money).

For 2021, you have three ways to qualify:

  1. You suffered a federal, state, or local government order that fully or partially suspended your operations (under this rule, you qualify for the ERC on the days you suffered the full or partial suspension, even if you did not lose any money).
  2. Your gross receipts for a 2021 calendar quarter are less than 80 percent of gross receipts from the same quarter in calendar year 2019.
  3. As an alternative to number 2 above, using the preceding quarter to your 2021 calendar quarter, your gross receipts are less than the comparable quarter in 2019.

You can see by the rules that the government wants to help your small business. Take advantage.

One final note. You may not double-dip. Wages you use for the ERC may not be used for the Paycheck Protection Program (PPP), family leave credit, or similar COVID-19 programs.

Loophole: Harvest Tax Losses on Bitcoin and Other Cryptocurrency

Here’s something to know about cryptocurrencies.

Because cryptocurrencies are classified as “property” rather than as securities, the wash-sale rule does not apply if you sell a cryptocurrency holding for a loss and acquire the same cryptocurrency before or after the loss sale.

You just have a garden-variety short-term or long-term capital loss, depending on your holding period. No wash-sale rule worries. This favorable federal income tax treatment is consistent with the long-standing treatment of foreign currency losses.

That’s a good thing, because folks who actively trade cryptocurrencies know that prices are volatile. And this volatility gives you two opportunities:

  1. profits on the upswings
  2. loss harvesting on the downswings

Let’s take a look at the harvesting of losses:

  • On day 1, Lucky pays $50,000 for a cryptocurrency.
  • On day 50, Lucky sells the cryptocurrency for $35,000. He captures and deducts the $15,000 loss ($50,000 – $35,000) on his tax return.
  • On day 52, Lucky buys the same cryptocurrency for $35,000. His tax basis is $35,000.
  • On day 100, Lucky sells the cryptocurrency for $15,000. He captures and deducts the $20,000 loss ($35,000 – $15,000) on his tax return.
  • On day 103, Lucky buys the same cryptocurrency for $15,000.
  • On day 365, the cryptocurrency is trading at $55,000. Lucky is happy.

Observations:

  • Assuming Lucky had $35,000 in capital gains, Lucky deducted his $35,000 in cryptocurrency capital losses. If he had no capital gains, he had a $3,000 deductible loss and carried the other $32,000 forward to next year.
  • On day 365, Lucky has his cryptocurrency, which was his plan on day 1. He thought it would go up in value. It did, from its original $50,000 to $55,000.
  • Lucky’s tax basis in the cryptocurrency on day 365 is $15,000.

Here’s what Lucky did:

  1. He kept his cryptocurrency.
  2. He banked $35,000 in losses.

Be alert. Losses from crypto-related securities, such as Coinbase, can fall under the wash-sale rule because the rule applies to losses from assets classified as securities for federal income tax purposes. For now, cryptocurrencies themselves are not classified as securities.

Planning point. If you want to harvest losses, make sure you hold a cryptocurrency and not a security.

Don’t Make a Big Mistake by Filing Your Tax Return Late

Three bad things happen when you file your tax return late.

What’s Late?

You can extend your tax return and file during the period of extension; that’s not a late-filed return.

The late-filed return is filed after the last extension expired. That’s what causes the three bad things to happen.

Bad Thing 1

The IRS notices that you filed late or not at all.

Of course, the “I didn’t file at all” people receive the IRS’s “come on down and bring your tax records” letter. In general, the meeting with the IRS about non-filed tax returns does not go well.

For the late filers, the big problem is exposure to an IRS audit. Say you’re in the group that the IRS audits about 3 percent of the time, but you file your tax return late. Your chances of an IRS audit increase significantly, perhaps to 50 percent or higher.

Simply stated, bad thing 1 is this: file late and increase your odds of saying “Hello, IRS examiner.”

Bad Thing 2

When you file late, you trigger the big 5 percent a month, not to exceed 25 percent of the tax-due penalty.

Here, the bad news is 5 percent a month. The good news (if you want to call it that) is this penalty maxes out at 25 percent.

Bad Thing 3

Of course, if you owe the “failure to file” penalty, you likely also owe the penalty for “failure to pay.” The failure-to-pay penalty equals 0.5 percent a month, not to exceed 25 percent of the tax due.

The penalty for failure to pay offsets the penalty for failure to file such that the 5 percent is the maximum penalty during the first five months when both penalties apply.

But once those five months are over, the penalty for failure to pay continues to apply. Thus, you can owe 47.5 percent of the tax due by not filing and not paying (25 percent plus 0.5 percent for the additional 45 months it takes to get to the maximum failure-to-pay penalty of 25 percent).

The Principal Residence Gain Exclusion Break

The $250,000 ($500,000, if married) home sale gain exclusion break is one of the great tax-saving opportunities.

Unmarried homeowners can potentially exclude gains up to $250,000, and married homeowners can potentially exclude up to $500,000. You as the seller need not complete any special tax form to take advantage.

To take full advantage of the principal residence gain exclusion break, you must pass two tests: the ownership test and the use test.

  • To pass the ownership test, you must have owned the home for at least two years out of the five-year period ending on the sale date.
  • To pass the use test, you must have used the home as your principal residence for at least two years out of the five-year period ending on the sale date.

Key point. These two tests are completely independent. In other words, periods of ownership and use need not overlap.

If you’re married and you and your spouse file your tax returns separately, you can potentially qualify for two separate $250,000 exclusions.

If you’re married and file jointly, you qualify for the $500,000 joint-filer exclusion if

  • either you pass or your spouse passes the ownership test for the property and
  • both you and your spouse pass the use test.

When you file jointly, it’s also possible for both you and your spouse to individually pass the ownership and use tests for two separate residences. In that case, you and your spouse would qualify for two separate $250,000 exclusions.

Each spouse’s eligibility for the $250,000 exclusion is determined separately, as if you were unmarried. For this purpose, a spouse is considered to individually own a property for any period the property is actually owned by either spouse.

The other big qualification rule for the home sale gain exclusion privilege goes like this: the exclusion is generally available only when you have not excluded an earlier gain within the two-year period ending on the date of the later sale. In other words, you generally cannot recycle the gain exclusion privilege until two years have passed since you last used it.

You can claim the larger $500,000 joint-filer exclusion only if neither you nor your spouse took advantage of it for an earlier sale within the two-year period. If one spouse claimed the exclusion within the two-year window but the other spouse did not, the exclusion is limited to $250,000.

President Biden’s Proposed Tax Legislation

  1. INDIVIDUAL TAXES – President Biden’s proposed tax changes will have devasting effects on millions of Americans. He wants to increase taxes on the wealthy. Most Americans will agree with this as we have had a progressive tax structure since 1913 when the individual tax system started. The more you make the higher your income is taxed by percentage. Let’s look at what he wants:
  2. Individual income tax increase raises will see the top individual income tax rate go to 39.6%
  3. Capital Gains Tax increase, tax capital gain over $1 million go to 39.6% plus 3.8% Medicare Surtax when AGI exceeds $200,000 single or $250,000 joint return, that’s as high as 43.4% not including state income tax.
  4. BUSINESS TAXES The American Jobs Plan (Biden infrastructure plan) would raise taxes on corporations in several ways according to The Tax Foundation: He wants to raise the percentage from 21% to 28% on corporate income and tighten inversion regulations, plus raise taxes on foreign earnings of US corporations (this will drive more business abroad). He wants to raise the tax on Global intangible Low Tax Income (GILTI) to 21 percent. Impose a 15 percent minimum tax on corporate book income which would be levied on a firms financial profits instead of taxable income for firms with revenue over 100 million. Repeal the Foreign – Derived Intangible Income (FDII) deduction, which incentivizes firms to move intellectual property (IP) into the US. Provide a tax credit for certain onshoring activity and deny expense deductions on jobs that were offshored. Increase corporate tax enforcement. Eliminate certain deductions and credits for the fossil fuel industry. The effects of the above action would make the US the least competitive of all nations placing us as the highest corporate rate in the world. Remember higher corporate taxes are passed on to consumers and corporate employees and companies may choose not to stay here. (like California companies, they have the right to leave).
  5. Impose Net Investment Income Tax (NIIT) on active pass-through income above $400,000, effecting millions of small businesses (Partnerships, S-Corporations and Trust) and make the passive loss limitation permanent. These are the largest employers in America, therefore, higher tax equals less employment.
  6. ESTATE TAXES Current estate tax exclusion prevent the estate under $11.7 million from estate tax per person. In addition, when someone die, his or her assets get a step-up in basis equal to the fair market value as of the date of death, therefore, there is no capital gain tax immediately after death and if you had depreciation on assets like rental properties you get to start over with the stepped-up value and all prior depreciation is forgiven. President Biden wants to lower the estate tax exemption to $3.5 million. In addition, when someone dies, he wants to impose a capital gains tax on the unrealized appreciation in your assets (home, stocks, bonds, business, farm, ranch, rentals, raw land, etc.) no step-up in value. That means everyone who dies will leave their heirs an income tax liability. Your primary home will still be allowed IRC Sec 121 exclusion $250,000 of gain on primary residence will be excluded, however, everything else gets hammered and remember that rate could be as high as 43.4%.
  7. This new tax bill will end up costing most Americans more in tax, cost of living expense and less wage benefits. Estimates are on average $6,000 per year.
  8. In 2015 the top 1% of income earners paid as much as the bottom 95%.
  9. In 2017 the following were the statistics: (IRS.gov statistics)

Top 1% income earners AGI over $515,000 paid 38.47% of taxes

Top 5% income earners AGI over $208,053 paid 59.14% of taxes

Top 10% income earners AGI over $145,135 paid 70.08% of taxes

Top 25% income earners AGI over $83,682 paid 86.1% of taxes

Top 50% income earners AGI over $41,740 paid 96.89% of taxes

Bottom 50% income earners AGI under $41,740 paid 3.11% and much if not all of that was paid with credits (childcare credit earned income credit, etc.)

  1. The question always in our progressive system of taxation is how much should someone making more than me be paying for the benefits that we all have? What is fair? The percentage is relative, if the country needs more money to operate, then collect it from someone other than me, is how most feel.
  2. Tax Policy Center (TPC) “released estimateson the portion of households with no federal income tax liability, finding that in 2020, about 60.6 percent of households did not pay income tax, up from 43.6 percent of households in 2019. Much of the 2020 increase was due to pandemic-related factors, but the growing share of households paying no income tax should be kept in mind when evaluating the progressivity of the federal income tax system and proposed tax hikes on higher earners. While 2020 was an unusual year due to expanded government support through the tax code to combat the pandemic’s economic effects and due to lower household incomes, it continues an ongoing trend of fewer households paying income tax due to long-running expansions in the Child Tax Credit (CTC) and Earned Income Tax Credit (EITC). TPC finds that in 2020, out of 176.2 individuals and married couples who could file a tax return, about 144.5 million of them actually filed a tax return. Of the 144.5 million, 75.1 million filers paid no taxes after deductions and credits. Another 32 million households did not file a tax return. In total, about 107 million Americans (or 60.6 percent of households) paid no federal income taxes.”

Special Per Diem Rates Each year the IRS update the special per diem rate for taxpayers to use in substantiating the amount or ordinary and necessary business expenses incurred while traveling away from home. Foe 2021 M&IE (meals and entertainment expense), continental U.S. (CONUS) is $69 up from $66 in 2020 and M&IE outside continental US (OCONUS) it is $74 up from $71 in 2020.

Advanced Child Tax Credit Families will need Letter 6419 to quickly and accurately fill out their 2021 federal income tax return next year. For most families that receive the monthly advance credit are only receiving about half the amount that they are due, therefore, look for the letter 6419 so you can get the balance owed to you.

I realize that individual and business taxation is not everyone’s favorite subject and some of what is in this letter may be confusing, but that is why I am available to answer your questions. Remember there is no charge for consultation. I wish you the best of health and wealth.

Respectfully,

Al Whalen, EA, ATA, CFP®

al@whalengroup.com

www.whalengroup.com

Phone: 702-878-3900

FAX: 702-878-7200

For almost 40 years Al has been enrolled to practice before the Internal Revenue Service and a Certified Financial Planner™ for 34 years. Al hosted one of the longest running financial shows in America on radio “Let’s Talk Money” from 1980 to 2008.

THE WHALEN GROUP Tax-Saving Tips

Is Your Travel Day Personal or a Tax-Deductible Business Day?

 

When you travel to a business location where you spend the night, you are in travel status. But will the tax rules make this a business or personal night?

 

The rules also affect your costs during the day. When you have an overnight business travel day, you generally deduct your costs of sustaining life for the day, such as breakfast, lunch, dinner, snacks, drinks, lodging, and taxis.

 

Business days also are important in determining how much of your travel cost you may deduct. For example, on a seven-day trip to London, one business day makes the airfare deductible.

 

Yep, you heard that right. Six personal days and one business day in London—you deduct 100 percent of the airfare.

 

Transportation days are the trickiest days.

 

Days spent traveling to or returning from a destination outside the United States are treated as business days—provided you use a “reasonably direct route” and you don’t engage in “substantial diversions for non-business reasons” that prolong your travel time.

 

If you don’t use a reasonably direct route, you count as business days the amount of time that a reasonably direct route would have taken.

 

Similarly, if you engage in substantial non-business diversions, you count as business days the amount of time it would have taken without such diversions.

 

These rules apply to whatever mode of transportation you use. So if you travel by airplane and don’t take a reasonably direct route, you count as business travel days the number of days an airplane would take to reach your destination by a reasonably direct route. The same is true for travel by car or cruise ship.

 

Once you are at your business travel destination, if a Saturday, a Sunday, a legal holiday, or another reasonably necessary standby day intervenes while you endeavor to conduct your business with reasonable dispatch, you treat such a day as a business day.

 

2 Ways to Fix Tax Return Mistakes Before the IRS Discovers Them

 

If you made an error on your tax return, don’t worry—there are two easy ways to fix it:

 

  1. A superseding return
  2. A qualified amended return

 

A superseding return is an amended or corrected return filed on or before the original or extended due date. The IRS considers the changes on a superseding return to be part of your original return.

 

A qualified amended return is an amended return that you file after the due date of the return (including extensions) and before the earliest of several events, but most likely when the IRS contacts you with respect to an examination of the return. If you file a qualified amended return, you avoid the 20 percent accuracy-related penalty on that mistake.

 

When it comes to the IRS, an ounce of prevention is worth a pound of cure. If you made a mistake, fix it as soon as you know about it, which will save you penalties, increased interest accruals, and the headache of an IRS review of your return.

 

Find the Winning Tax Law for Your IRS Audit

 

If you are suffering or about to suffer an IRS audit, you should know how your tax positions stack up against the IRS examiners’ positions.

 

In most cases, you are discussing the facts, not the law, and you prove your facts with receipts, canceled checks, and logbooks. Once you get into the law, the rules of engagement work pretty much as described below.

 

Here are three general rules on the persuasiveness of tax documents:

 

  • Statutes and regulations are highly persuasive with both the courts and the IRS.
  • The next-best authority with the courts is prior case law.
  • The next-best authorities with the IRS are IRS documents. But as you’ll see, IRS documents range from very strong to very weak.

 

Your tax dispute always begins with the IRS.

 

At the earliest stages of the audit, you work with auditors and agents whose knowledge of the law comes primarily (or solely) from IRS documents, not statutes or court cases. As you advance your case within the IRS, you deal with supervisors and officers who are more knowledgeable and pay more attention to the code, regulations, and (to a lesser extent) court cases.

 

Throughout the audit, one thing remains constant: IRS documents remain hugely important at all levels within the IRS.

 

After the tax code and regulations, the first type of official IRS publication is a revenue ruling. The revenue ruling reads like a condensed court case and describes how the IRS applies the law to a particular set of facts.

 

The second type of official publication is the revenue procedure. The IRS uses the revenue procedure to administer the law by updating dollar amounts for inflation and by explaining procedures for making elections or filing forms.

 

The third type of official publication is the acquiescence or non-acquiescence. At its discretion, the IRS can issue a statement indicating its agreement (acquiescence) or disagreement (non-acquiescence) with a Tax Court ruling.

 

Last, you’ll find notices and announcements that describe the IRS’s official position on recent issues. You’ll also find private letter rulings and technical advice memoranda that carry weight with the IRS.

 

The IRS also publishes IRS forms, instructions, publications, and FAQs (guides). The guides are less technical than official pronouncements, and they don’t include citations. The IRS writes the guides in clear terms so that non-professionals can easily understand them.

 

Most tax disputes begin and end with the IRS. So where do court cases fit into your legal research? Court cases matter at the IRS level for two reasons:

 

  • At the highest level of IRS review (appeals), IRS officers consider court cases.
  • Court cases usually describe all the statutes, regulations, and other important IRS documents you need in order to support your case. Plagiarizing court cases is not only within the rules for engagement with the IRS but also a great strategy!

 

Once your tax dispute leaves the IRS and enters court, your best sources of tax authority are statutes, regulations, and prior court cases.

 

Garage Space as a Home Office

 

Do you claim a tax deduction for a home office?

 

Should you include or exclude your garage space in your calculations of business-use percentage?

 

Ronald Culp earned an office deduction for 78 percent of his home. That’s a nice percentage, but what’s really interesting is how the court looked at Mr. Culp’s home in deciding that 78 percent business use.

 

Here’s how the court made the computation that produced the 78 percent business use of Mr. Culp’s home:

 

  • The court counted the garage as office space because it could find no basis in law or fact for excluding it. (The garage held two printing presses and a large paper cutter that were integral to Mr. Culp’s business.)
  • Regarding the utility room in the basement where the water heater and furnace were located, the court said that this space failed the exclusive business-use standard for the home-office deduction and that such space counted as personal space.
  • The attic, which measured 1,128 square feet, contained only 100 square feet of usable space. The court ruled that the other 1,028 square feet were not functional, because that footage was not accessible due to the slope of the roofline and/or the lack of flooring.

 

Observation. The printing took place in the garage, but the IRS said that such space was not usable space, and the IRS did not want it counted in the calculations. The taxpayer and the court agreed that the space should be counted in the calculations. Will this be true for other garages?

 

According to the court’s description in a different case, Gene Moretti rented a 5.5-room house consisting of two bedrooms, a den, a living room, a dining room, and a half-kitchen. The court noted that “the house also had a garage” and that Mr. Moretti claimed business use of the den, living room, dining room, and garage.

 

The court concluded that only the den met the regular and exclusive use requirements for qualification as an office in the home.

 

To calculate the business percentage, the court used the number-of-rooms method and calculated that one room (the den) of the 5.5 rooms represented the business-use percentage of this home. The court ignored the garage even though Mr. Moretti tried to claim it as office space.

 

The two-garage case. In an effort to save time, the court tried two separate day-care cases together. Each case involved the use of a garage.

 

In both of these court cases, the IRS excluded the garages from its computations.

 

The court took the opposite view. First, it included both garages in the business-use-of-home calculations. Although it found that one garage met the requirements for the home-office deduction and one garage did not, the key point is that both garages were included in the calculations.

 

In conclusion, we see in these court cases that the IRS often excluded the garages, whereas the courts were eager to include them. Since you start any disagreement over your tax return with the IRS, this should work to your advantage.

 

You might think that the rules are a little unclear in this area. That’s true.

 

The science involved in tax law is finding cases, rulings, procedures, and publications that support your position. The art form is putting your spin on the deduction. That’s all you can do when neither the law nor the regulations give clear advice.

 

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.

Charitable Contribution Made the Best Way  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 $100,000 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 is not taxable to you, 3) This amount of IRA is forever removed from future income and estate tax,  4) The charity of your choice benefits from your generosity and 5) this method does not increase your Modified Adjusted Gross Income which could cause more social security to be taxed, increase in Medicare premium payments required, less medical deductions and so much more. .  This planning is a 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.  This has not been changed by the SECURE ACT.

 

Minimum Required Distributions (RMDs) are now not required until age 72 and if 2021 is the first year for RMD, then you have until April 1, 2022 to make your 2021 distribution.  Just remember that if you wait until 2022 you will need to make two distributions, one for 2021 and one for 2022.

 

Code Section 105 Plan for the Self-Employed  Section 105 works well for sole proprietors who are able to legitimately employ a spouse who is active in the business. An employed spouse will be treated as any other employee, with the business owner offering medical benefits as part of the employee’s compensation package.

 

Benefits of the Plan

A Section 105 Plan allows a qualified business owner to deduct 100% of:

  • Health insurance and dental insurance premiums for eligible employee(s) and family. This also includes qualified long-term care insurance.
  • Uninsured (out-of-pocket) medical, dental, and vision care expenses for eligible employee(s) and family.
  • Life, disability income, contact lens, hearing aid, Medicare Part A, Medicare Supplemental, optical/vision, and cancer insurance premiums for eligible employee(s).

The are numerous other reason a sole proprietor may wish to employ his or her spouse and we will consider then in future letters.

 

Respectfully,

Al Whalen, EA, ATA, CFP®

al@whalengroup.com

al@whalenfinancial.com

Web Site:  www.whalengroup.com

Phone:  702-878-3900

FAX:  702-878-7200

YEAR-END TAX PLANNING FOR 2020

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, 2019, you mail a rent check for $36,000 to cover all of your 2020 rent.  Your landlord does not receive the payment in the mail until Thursday, January 2, 2020. Here are the results:

  1. You deduct $36,000 in 2019 (the year you paid the money).
  2. The landlord reports $36,000 in 2020 (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 2019, he would have had to pay taxes on the rent money in 2019.

 

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, 2020. (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 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 2020 income by moving that income to 2021.

 

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 by  December 31, and get a deduction for 100 percent of the cost in 2020.

 

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, (Ibid).

 

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. You should use an Accountable Plan to accomplish this.  Thus, submit your expense report and have the corporation on the Cash Method Of Accounting make its reimbursement to you before midnight on December 31st .

 

Retirement Plans  Owners of companies should consider putting retirement plans into service before December 31st .  They may be funded in 2021 for 2020 if started by year-end.

 

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.

 

Net Operating Loss Deduction (NOL):

 

The Coronavirus Aid, Relief, and Economic Security (CARES) Act made two changes to the TCMJ. Under TCMJ NOLs were no longer able to be carried back to priors years and must have been carried forward offsetting only 80% of taxable income.  The CARES Act new changes:

 

  1. The CARES Act allows NOLs arising in tax years beginning in 2018, 2019, and 2020 to be carried back five (5) years for refunds against prior taxes. IRC 172(a)
  2. The CARES Act allows application of 100 percent of NOL to carry back years. IRC 172(b)(1)(D)

 

If you have an NOL for 2018 or 2019 you can file an amended tax return, for 2019 only you file for a quick refund, file a tentative refund claim before December 31, 2020 or file an amended return later.

 

 

 

 

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 $321,480 for a married couple filing jointly, $160,700 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.  The limitations phase out for joint filers with taxable income between $315,000 and $415,000 and for all other taxpayers with taxable income between $157,500 and $207,500.

 

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 2020.  Depending on their business model, taxpayers also may be able to increase the new deduction by increasing W-2 wages before year-end.

 

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. A 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 $1,020,000 and the investment ceiling is $2,550,000.  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 2019 gets the deduction if elected. The election is made when filing your 2020 tax return in 2021 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 if 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 2020.

 

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:   IRC Sec 274(n) Employee meals were 100 percent deductible. Now meals are limited to 50 percent deductible, unless they are staff meals and meetings which are 100% deductible.

 

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.

 

Increased Employers Deduction:  (IRC 127 as amended by The CARES Act)  Effective for payments made after March 27, 2020 and before January 1, 2021, employers can pay the principal or interest of an employee’s qualified education loan and exclude the benefit from the employee’s taxable income.

 

Qualified Improvement Property (QIP):  The CARES Act made changes to the qualified improvement property (QIP)error made by the Tax Cuts and Jobs Act (TCJA).  QIP is any improvement made by the taxpayer to the interior portion of a building 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.  If you have such property on a already files 2018 or 2019 return, and  it’s on that return as 39-year property.  You now have to change it to 15-year property, eligible for both bonus depreciation and Section 179 expensing, therefore amended returns will be required.

 

 

INDIVIDUAL TAX ISSUES

 

Required Minimum Distribution (RMD) Rules:    Under the SECURE ACT (Public Law 116-94), no minimum distribution is required for calendar year 2020 from an IRA, or from an employer-provided qualified retirement plan that is a defined contribution plan.  The next RMDs will be for calendar year 2021.  This provision waves the 2020 RMD rules for lifetime distributions to employees and IRA owners and for after-death distributions to beneficiaries. This Act also changes the 70 ½ age requirement for starting distributions to age 72.

 

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,  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.  This has not been changed by the SECURE ACT.

 

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.  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 2019 long-term capital gains rate are 0% for taxable income under $39,375 single, and $78,750 married filing jointly. The 15% capital gains rate applies to taxable income up to taxable income up to $434,550 for filing single and $488,850 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 2019, but the 10% excise tax on early withdrawals before age 59 ½ is avoided providing, 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.

 

IRA Contribution Age Limit:  In prior Law  you could only contribute to an IRA until age 70 ½ if you otherwise qualified, now there is no age limit thanks to the SECURE Act.

 

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 2020 to make health savings account (HSA) contributions, you can make a full year’s worth of deductible HSA  contributions for 2020. The HSA 2020 limits are; $3,550 for self-only coverage and $7,100 for family coverage. People age 55 or older get $1,000 more.

 

(IRC 106, 220 and 223)  Effective for distributions from HSAs and Archer MSAs for amounts paid after December 31, 2019, and reimbursements from Health FSAs and HSAs for expenses incurred after December 31, 2019, qualified medical expenses are no longer limited to those medicines and drugs that are prescribed by a physician.  Thus all medicines and drugs can be reimbursed tax free without a prescription or recommendation by a physician.  Over-the-counter medicines and drugs include amounts paid for menstrual care products.

 

 

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 any 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 2020 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.  For 2020 Maximum Capital Gains/ Qualified Dividends Tax Rate Breakpoints:

MFJ or QW Maximum rate = 0% at $80,000 or less

MFJ or WQ Maximum rate = 15% at $496,600 or less

Single Maximum rate = 0% = at $40,000 or less

Single Maximum rate = 15% at $441,450 or less

HOH Maximum rate = 0% at 53,600 or less

HOH Maximum rate = 15% at $469,050 or less

NOTE:  Capital gains/qualified dividends above the 15% breakpoint are taxed at 20%, unless the 25% or 29% rates apply.

 

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 TCJA 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 2020 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, depending upon the outcome of the 2020 presidential election.  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 $11,580,000  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, 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, The CARES Act increased that to 100% for 2020.

 

Charitable Deduction Without Itemizing:   (The CARES Act)  Effective for 2020, up to $300 of qualified charitable contribution are deductible as above-the-line deduction in calculating AGI without the taxpayer having to itemize deductions.

 

Home Mortgage Interest:  IRC Sec 163(h) prior to TCJA 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 2026:  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.

 

 

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:  As of the date of this letter, I do not have the 2018 data.

 

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

 

NOTEIn 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.

 

The Tax Code’s Compliance Burden:   According to an analysis of data reported by the Office of Information and Regulatory Affairs (OIRA), altogether, complying with the Tax Code in 2018 consumed 8.02 billion hours for recordkeeping, learning about the law, filling out the required forms and schedules, and submitting information to the Internal Revenue Service (IRS).  The opportunity Cost of the Time Burden is estimated at $273.18 billion, the Out of Pocket Cost Associated with Tax Forms another $91.36 Billion for a total of $364.54 billion.  That is approximately 18 cents for every dollar collected just on compliance. Source: National Taxpayers Union Foundation Analysis of OIRA and BLS Data

 

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, The increase (COLA) for 2021 is 1.3%. Enjoy the raise!

 

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 for here in America yet it is also a time to remember those less fortunate, those suffering from illness (especially COVID-19), storms, fires, and other issues.  Happy Thanksgiving to all.

 

Respectfully,

 

Al Whalen, EA, ATA, CFP®

al@whalengroup.com

www.whalengroup.com

 

Attachment:

  The Tax Book Social Security COLA Increase

 

Sources:

The Tax Cuts and Jobs Act of 2017

The CARES Act of 2020

The Secure Act of 2020

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

Global CPE

 

Tax Saving Tips September 2020

Still Time to Get $150,000 from the SBA

Can your business use an infusion of cash to deal with losses caused by the COVID-19 pandemic?

The hugely popular federal Payroll Protection Program (PPP) that paid forgivable loans to millions of businesses ended on August 8 (although it could come back in revised form). But you can still obtain a low-interest Emergency Income Disaster Loan (EIDL) of up to $150,000 from the Small Business Administration (SBA).

Do You Qualify for an EIDL?

You can qualify for an EIDL if your business has fewer than 500 employees and has suffered “substantial economic injury” due to the COVID-19 pandemic. You have suffered economic injury if you’re unable to pay your normal business operating expenses and other bills, or to sell or produce your goods or services because of the pandemic.

You can obtain an EIDL even if you already received a PPP loan. However, you may not use the EIDL to pay the same payroll costs or other expenses you pay with a PPP loan.

How Much Can You Borrow?

The SBA is currently capping EIDLs at $150,000. The amount you receive is intended to cover six months of your business operational expenses. For most small businesses, the loan amount is based on gross revenues minus cost of goods sold during the period from February 1, 2019, through January 31, 2020, divided by two.

What Are the Loan Terms?

These are 30-year loans at a 3.75 percent interest rate. You don’t have to make any payments until one year after you receive the loan (interest continues to accrue during the one-year delay). There is no prepayment penalty.

How Do You Apply?

You apply for an EIDL with the SBA, and the loan is funded directly from the U.S. Treasury. Unlike with PPP loans, banks are not involved. You can apply online, and the SBA has created a streamlined application.

Do You Need to Have Collateral or Make Guarantees?

The SBA does not require a personal guarantee for an EIDL of less than $200,000.

Collateral is required only if the loan is over $25,000.

For loans over $25,000, the SBA obtains a security interest in all tangible and intangible property your business owns or acquires, including inventory, equipment, and receivables. The SBA files a UCC-1 lien against your business.

How You Can Use the Money

The money is supposed to be used to help you carry on your business until life gets back to normal. You can use the money to pay normal operating expenses, such as employee salaries and benefits, rent, utilities, and fixed debt payments. You can continue to take your owner’s draw for work you actually perform for the business.

But EIDLs are not supposed to be used to replace lost sales, fund business expansion, start a new business, or refinance long-term debt. Nor can you use them to pay yourself dividends or bonuses. As you can see, EIDLs can be a useful source of low-interest financing during these troubled times.

Seven Things to Know Before You Take Out an EIDL

SBA EIDLs can be a great source of low-interest funding for businesses struggling with the economic impact of the COVID-19 pandemic.

Unlike PPPs, EIDLs are not forgivable—borrowers have to pay them back. But they have a low 3.75 percent interest rate and a long 30-year repayment period. Borrowers can repay them at any time without penalty.

To obtain an EIDL, borrowers must sign a loan authorization and agreement, a note, and a security agreement filled with fine print. Many of these provisions could have a significant impact on the borrower’s business for the life of the loan—up to 30 years.

It is vital to understand the terms and conditions before taking out any loan, including an EIDL. Here are seven key provisions borrowers should be aware of.

  1. No Changes to the Business

Without SBA approval, EIDL borrowers may not sell the business or change its ownership structure. This includes removing or adding a business partner.

  1. 2. No Distributions outside the Usual Course of Business

The owners may not make distributions outside the usual course of business without SBA approval. This includes loans, advances, bonuses, or asset transfers to owners, employees, or other companies.

Distributions within the usual course of business are permitted. SBA officials have said this includes distributions of net income to owners of a pass-through business, such as an S corporation or a limited liability company.

  1. Strict Record-Keeping Requirements

The SBA imposes strict record-keeping requirements on EIDL borrowers. They must keep itemized receipts showing how they spend the loan funds. Also required is a full set of financial and operating statements, which must be furnished to the SBA each year. The SBA also has the option of requiring an expensive review of the borrower’s records by an independent CPA.

  1. Using Other COVID-19 Payments to Pay the SBA

EIDLs are intended to cover disaster losses not compensated by other sources. If an EIDL borrower obtains grants, loans, insurance proceeds, or lawsuit recoveries to help defray COVID-19-related losses, the borrower is required to notify the SBA. The SBA may require that such money be used to repay the EIDL.

But a business may obtain both a PPP loan and an EIDL so long as it doesn’t use them for the same expenses.

  1. Strict Collateral Requirements

Businesses that borrow more than $25,000 are required to pledge all their business’s personal property as collateral. Such collateral includes present and future inventory, equipment, deposit accounts, promissory notes, negotiable instruments, and receivables.

The SBA obtains a security interest in all such collateral the borrower has at the time of the loan, or collateral it acquires or creates in the future. The borrower must

  • obtain hazard insurance for its collateral, and
  • ask the SBA for permission before selling or otherwise disposing of its collateral, other than selling inventory in the ordinary course of business.
  1. Buy American

EIDL borrowers must promise to buy American-made equipment and products with the loan proceeds, to the extent feasible.

  1. Penalties for Violations

Penalties for violations of the EIDL terms can be severe. The SBA can demand immediate repayment of the entire loan if the borrower breaches any of its terms. The SBA also reports defaults to credit reporting agencies.

Borrowers who misapply EIDL funds—for example, using them to pay personal expenses—are liable to the SBA for an amount equal to one-and-a-half times the original loan.

PPP Update: Two New Rules for Owners of S and C Corporations

The PPP rules are still changing.

During the past month, the SBA issued a new set of frequently asked questions (FAQs) and a new interim final rule, which in combination create the following good news for the PPP:

  • More forgiveness. The $20,833 cap on corporate owner-employee compensation applies to cash compensation only. It’s not an overall compensation limit as the SBA had stated in its prior interim guidance. Under this new rule, the owner-employee can add retirement benefits on top of the cash compensation, creating a new higher cap.
  • Escape owner status. You are not an owner-employee if you have less than a 5 percent ownership stake in a C or an S corporation. Therefore, the cap on forgiveness for this newly defined non-owner-employee is not $20,833 but rather $46,154.

The new rules override prior guidance and have significance for PPP loan forgiveness today—and perhaps for obtaining additional loan monies retroactively (if Congress reinstates the PPP along with a round for businesses that suffered a big drop in revenue).

Here’s one example of how the new rules benefit John, an S corporation owner.

Example. John, the sole owner and worker, operates his business as an S corporation. His 2019 W-2 shows $140,000 in Box 1, of which $20,000 is for health insurance. In addition, the S corporation pays state unemployment taxes of $500 on John’s income and contributes $20,000 to his pension plan.

Based on the facts in the example, the corporation is eligible for up to $25,000 of PPP loan forgiveness, as follows:

  • $20,833 on John’s salary (the cap), which the corporation pays to John at his regular rate in less than 10 weeks during the covered period;
  • $4,167 on John’s retirement ($20,000 x 20.83 percent); and
  • zero on the unemployment taxes because they were paid out in January, before the covered period began.

Advantage. Prior guidance limited forgiveness to $20,833. John’s S corporation gains $4,167 in additional forgiveness thanks to the new FAQs, assuming that the S corporation’s loan amount is $25,000 or more (which is possible).

The good news in the new guidance is that the corporate retirement contributions on behalf of owner-employees now count for additional forgiveness when the owner-employee has cash compensation greater than $100,000. And with the C corporation, the new guidance allows health insurance for the owner-employee.

The Importance of Keeping a Mileage Log

What is the unpardonable sin in an IRS audit?

 

Suppose you just received a letter from the IRS telling you that you are the subject of an IRS audit. What one record receives special attention? What one record can create a nightmare for you? What one record makes the IRS suspect that you are the keeper of lousy records?

Think of the record you most hate keeping. That’s the one we are talking about. You have probably guessed what that record might be.

Red-Flag Record for the IRS Examiner

Once your audit examination begins, the examiner likes to see this record. If the record is missing or lacking, the IRS examiner knows that your other records probably are lacking, too. This record—the one you probably hate keeping—is the mileage log on your vehicle or vehicles.

The IRS notes that a taxpayer’s failure to keep a mileage log on vehicles indicates that the activity under examination is not being conducted in a businesslike manner.

Do as the Tax Form Says

As a one-owner or husband-and-wife-owned business, regardless of whether it’s a corporation, a partnership, or a proprietorship, you file a tax form that asks you for the following information about your vehicles:

  1. Do you have evidence to support the business/investment use claimed? (If “yes,” is the evidence written?)
  2. List your total business/investment miles on each vehicle.
  3. List your total commuting miles on each vehicle.
  4. List your total personal miles on each vehicle.

IRS Form 4562 has columns for answers to the above questions for up to six vehicles used by either a sole proprietor or an owner of more than 5 percent of a corporation, a partnership, or another entity. The mileage log is the record of proof that you need to use for your answers to the tax form questions.

Do What the Audit Would Require

Above, we said to do as the IRS form says. For additional clarification, it is good to know what information the IRS, in a correspondence audit, requires you to provide related to that tax form:

  1. Send copies of repair receipts, inspection slips, and other records showing total mileage for the year.
  2. Send copies of logbooks and other records to support the business mileage claimed.
  3. Provide a copy of your appointment book or calendar of business activities for the year.
  4. If you are claiming actual expenses, provide copies of paid bills, invoices, and canceled checks for automobile expenses. These would include gas, oil, tires, repairs, insurance, interest, tags, taxes, parking fees, and tolls.
  5. Send a copy of the bill of sale or other verification to establish your basis in the vehicle, including the trade-in of another vehicle.

Note that the IRS is looking for

  • a match of the repair bill odometer reading with the mileage in your logbook;
  • a match of the inspection slip odometer reading with the mileage in your logbook;
  • the mileage between repair stops, to see whether that ties in with your claimed mileage; and
  • a business purpose that ties in with your appointment book or other calendar of business activities.

Takeaways

If you want to avoid big trouble during an IRS audit, keep a good mileage log. This takes just minutes a day.

The mileage log is often one of the first records that an IRS examiner will look at. A good mileage log shows that you know the rules and you respect them. Many IRS audits end favorably and quickly upon presentation of a good mileage log.

Taxing Social Security and What to Do About It

 

Many people pay into social security all their working life and when they start receiving their social security benefits they are surprised to learn they may have to share some of their benefits with the government.  Social Security benefits can be added to taxable income at; 0%, 50% or 85% , how much depends upon your provisional income or Modified Adjusted Gross Income.

Start by adding 50% of the social security benefits, all tax exempt interest to other income that make your adjusted gross income (minus certain deductions like those for higher education).  The result is your provisional income.

Social Security benefits are not taxed if provisional income is less than $25,000 single filer or $32,000 for joint filers. When provisional income is between $25,000 and $34,000 for single filer, or $32,000 and $44,000 joint filers, up to 50% of benefits can be taxed. As much as 85% of those benefits are subject to tax when provisional income exceeds $34,000 for single or $44,000 on a joint return. IRS Publication 915, page 16 has a worksheet to help. So what can one do to reduce or eliminate this burden?

Reducing your Adjusted Gross Income (AGI) is the answer to reducing or eliminating social security benefits subject to tax. The following are some ways to accomplish this:

  1. Pre-retirement ROTH conversions, shifting money from a traditional IRA to a ROTH IRA generally make sense as distributions from ROTHs are not taxable and do not increase AGI.
  2. When you reach the age of required minimum distribution (RMD) from IRAs currently age 72, transfers directly to a qualified charity do not count as income for AGI purposes.
  3. Investing in tax-efficient assets rather than high interest or high dividend investments which increase AGI, matching capital gains with capital losses. Remember capital gains greater than capital losses when sold may not be taxable for income tax purposes, however, will increase the provisional income AGI.
  4. Investments in annuities either deferred annuities that can be annuitized at retirement or immediate annuities that will produce little taxable income yet provide an income benefit for life.
  5. If you work part-time after retirement contributions to an IRA reduces AGI.
  6. Life insurance policy withdrawals are not taxable (not even reportable) so long as the policy stays as life insurance, therefore, many use the cash value build up as another retirement income source. Distributions do not increase AGI.

There are many ways to address this issue, however, you might just have to bite the bullet and pay tax on your social security benefits. If you have planned so well as to exceed the provisional income limits and your required income levels are that high, no level of planning might help.

Remember too, that Modified Adjusted Gross Income controls other taxable issues and cost:

  1. Your Medicare Part B cost are determined by your MAGI
  2. The tax rate on long-term capital gains depend upon your MAGI
  3. The tax rate on qualified dividend income depends upon MAGI.
  4. Contributions can be limited to IRAs and ROTH IRAs if MAGI is too high.
  5. The deductibility of student loan interest
  6. The American Opportunity Tax Credit
  7. The Lifetime Learning Credit
  8. Child Tax Credit and Credit for other dependents
  9. Retirement Savings Contribution Credit
  10. Adoption Expense Credit or Exclusion
  11. The Earned Income Tax Credit
  12. Additional Medicare Tax on net investment income
  13. Personal Exemption Deduction

These are some deduction, credits and cost associated with MAGI. You should always consult a good Financial Advisor and Tax Consultant for planning purposes.

 

Next Month’s Letter Will Cover Year-End Tax Planning

Respectfully,

 

Al Whalen, EA, CFP®

(702) 878-3900

al@whalengroup.com

www.whalengroup.com

Sources:

  Bradford Tax Institute

  Kiplinger Retirement Report

  IRS Publication 915