Currently, there are estate tax credits that will shelter your estate from tax of $12.06 Million of estate valuation and that is per spouse. Most taxpayers are not affected by estate taxes as only about 1% of Americans have an estate of $10 million or more, however, in 2026 that changes. The exemption goes back to $5 Million and adjusts for inflation estimated to be about $6 million then. If you are in this rarified group of taxpayers, then it means you need to do some serious tax planning before 2026. I would suggest as soon as possible as president Biden in his “Build Back Better” proposed legislation wanted to reduce the exemption to $3.5 million and stop the step-up basis rule.
What About Gifting?
Currently, there is an annual $16,000 gift tax exclusion per person per year. This means you can gift to as many individuals as you wish up to $16,000 per year and it does not affect your lifetime gift or estate tax exemption.
There are other areas of gifting:
- Gifting appreciated value assets to lower tax bracket individuals
- Use of Charitable Remainder Trust
- Use of Charitable Lead Trust
- Qualified Personal Residence Trust
- Gifting highly appreciated assets to charities
- Use of Donor Advised Funds
- If age 72 or older gift up to $100,000 per year directly from an IRA to a qualified charity
There are other planning tools to use when considering creative estate and gift planning strategies that we will discuss in more detail in future letters.
IRS is Waiving Late-Filing Penalties
The Internal Revenue Service said Wednesday it was waiving late-filing penalties and issuing refunds to 1.6 million taxpayers who missed extended filing deadlines for the tax year 2019 and 2020 federal income tax returns.
The automatic refunds of penalties and interest to individual and business taxpayers will total $1.2 billion. That works out to an average refund of about $750.
Tax preparers said the decision was a rare step from the agency. It has traditionally kept deadlines in place and even extended the two years tax-filing deadlines. In the end, the IRS said the Covid-19 pandemic struggles, both for taxpayers and the agency, were the reason for the decision.
The penalty for missing deadlines adds up. For individual taxpayers, the IRS assesses a failure-to-file penalty typically assessed at 5% of the unpaid taxes for each month, with a cap of 25% until paid. For business returns, it is an even higher penalty.
Corporate Alternative Minimum Tax at 15% Not 11% as Reported Last Month
The act introduces a new corporate alternative minimum tax (AMT). The last corporate AMT was repealed by the law known as the Tax Cuts and Jobs Act (TCJA), P.L. 115-97, in 2017.
The new corporate AMT is based on book income rather than taxable income. Specifically, it imposes a 15% tax on the excess of the corporation’s adjusted financial statement income over its corporate AMT foreign tax credit for the year. The new corporate AMT applies only to certain large corporations, specifically corporations (but not S corporations, regulated investment companies, or real estate investment trusts) with an average annual adjusted financial statement income of more than $1 billion for the three consecutive tax years ending with the tax year, or, for members of certain foreign-parented multinational groups, where the combined annual adjusted financial statement income of all members of the group is $1 billion for three consecutive years and the member has average annual adjusted financial statement income of more than $100 million.
A new Sec. 56A defines “adjusted financial statement income.” It generally means a corporation’s net income (or loss) as set forth in the taxpayer’s applicable financial statement, as defined in Sec. 451(b)(3). Adjusted financial statement income is reduced by the amount of tax depreciation deductions the taxpayer claims when calculating taxable income for the year.
Sec. 56A also provides for general adjustments for other situations such as financial statements that cover different tax years, consolidated financial statements of related entities, and corporations that are partners in a partnership. Also, adjustments are made for certain items of foreign income, for effectively connected income, for certain taxes, and for other items.
The new corporate AMT generates a minimum tax credit under Sec. 53 that the taxpayer can then use against regular tax liabilities in future years.
The act introduces a new corporate AMT foreign tax credit in Sec. 59(l). The corporate AMT foreign tax credit is available to taxpayers who claim a foreign tax credit.
The new corporate AMT is effective for tax years beginning after Dec. 31, 2022.
The AICPA has expressed concerns about basing tax liability on the nontax criterion of book income. The two have several distinct “key conceptual differences … including the concept of materiality”. A letter the AICPA wrote to congressional tax-writing committee leaders on Aug. 4 stated; “Public policy taxation goals should not have a role in influencing accounting standards or the resulting financial reporting. Independence and objectivity of accounting standards are the backbones of our capital markets system.”
Clean energy provisions for individuals
The Sec. 25C nonbusiness energy property credit is extended through 2032 and is renamed the energy-efficient home improvement credit. The credit now equals 30% of the sum of the amount paid or incurred by the taxpayer for energy-efficient improvements installed during the tax year, the amount of residential energy property expenditures paid or incurred by the taxpayer during the tax year, and the amount paid by the taxpayer for home energy audits. (Previously, the credit equaled 10% of the amount paid or incurred for qualified energy-efficiency improvements plus the amount of residential energy property expenditures paid or incurred by the taxpayer during the tax year.)
The amount of the 25C credit is changed from a $500 maximum lifetime credit to a credit of up to $1,200 per year. Certain limits also apply to the credit for purchases of certain types of qualifying property and home audits.
The modified Sec. 25C credit is available for property placed in service after Dec. 31, 2022.
The act extended the Sec. 25D residential energy-efficient property credit through 2034 and renamed it the residential clean energy credit. Qualified battery storage technology expenditures are added to the list of qualifying expenses.
The act also extended the Sec. 45L new energy-efficient home credit through 2032. The amount of the credit is increased, and various modifications are made to the energy savings requirements. The changes apply to dwelling units acquired after Dec. 31, 2022.
Inflation Reduction Act (IRA) Credits:
- Clean Vehicle Credits
The act modified the $7,500 Sec. 30D credit for electric vehicles in several ways. First, it changes the name of the credit to the clean vehicle credit. It also imposes a requirement that the final assembly of the vehicle must occur in North America (effective Aug. 16, 2022). The act also removes the limitation on the number of vehicles eligible for the credit, so electric vehicles purchased from manufacturers that had formerly reached their cap will now be eligible for the credit. However, there are price caps, so the credit is not allowed for cars with a manufacturer’s suggested retail price over $55,000 or for vans, SUVs, or pickup trucks with a manufacturer’s suggested retail price over $80,000.
However, the act imposes a new requirement that a percentage of critical minerals used in the car must have been extracted or processed in the United States or in a country with which the United States has a free trade agreement or recycled in North America. This requirement phases in and applies to 40% of such minerals before 2024 and to 80% after 2026. A percentage of the battery components for the vehicle must also be manufactured or assembled in North America. This requirement applies to 50% of a battery’s components before 2024 and phases in until it applies to 100% of a battery’s components after 2028.
The credit is allowed once per vehicle (and includes a requirement that the taxpayer includes the vehicle identification number on the return). Also, the credit is not allowed for taxpayers whose modified adjusted gross income (MAGI) exceeds certain thresholds ($300,000 on joint returns, $225,000 for heads of household, and $150,000 for single taxpayers).
The changes to Sec. 30D is generally effective for vehicles placed in service after Dec. 31, 2022 (the final assembly requirement, as noted, was effective when the law was enacted). The credit will expire after 2032. Taxpayers who purchased a clean vehicle or entered into a written binding contract to purchase a clean vehicle between Jan. 1 and Aug. 15, 2022, but placed it in service on or after Aug. 16, can elect to have the former Sec. 30D credit rules apply to that vehicle.
The act also creates a new credit for used clean vehicles (new Sec. 25E). Qualified buyers can claim a credit of up to $4,000. Their MAGI must be under $150,000 on joint returns, $112,500 for heads of household, and $75,000 for single taxpayers. The sales price for the used vehicle must be $25,000 or less. The used clean vehicle credit applies to vehicles acquired after Dec. 31, 2022.
The act also creates a new credit for qualified commercial clean vehicles (new Sec. 45W). The credit equals the lesser of 15% of the basis of the vehicle or the “incremental cost” of the vehicle. For commercial clean vehicles with no gasoline or diesel engine, the credit amount is the lesser of 30% of the basis of the vehicle or the “incremental cost.” The incremental cost is the amount of the cost, of the commercial clean vehicle exceeding 702 the cost of comparable gasoline or diesel-powered vehicle. The credit cannot exceed $7,500 for vehicles with a gross vehicle weight under 14,000 lbs. and cannot exceed $40,000 for all other vehicles. The commercial clean vehicle credit is effective for vehicles acquired after Dec. 31, 2022.
The Sec. 30C alternative fuel vehicle refueling property credit is extended through 2032 and modified. The maximum credit is increased from $30,000 to $100,000. The changes are effective for property placed in service after Dec. 31, 2022.
- Clean energy manufacturing
The act extends the Sec. 48C advanced energy project credit by making allocations for up to $10 billion more in awards for qualified investments, effective Jan. 1, 2023.
The act also creates a new advanced manufacturing production credit (new Sec. 45X) for U.S. production of various photovoltaic cells and other solar and wind energy properties.
To encourage the clean production of electricity, the act creates a new credit in Sec. 45Y for the production of electricity at qualified facilities. Qualified facilities (which includes certain expansions of existing facilities) must be placed in service after Dec. 31, 2024, and have a greenhouse gas emissions rate of zero. New Sec. 48E creates a clean electricity investment credit, effective for eligible property placed in service after Dec. 31, 2024. Qualified facilities under Sec. 48E and 45Y are made five-year property under Sec. 168(e)(3)(B).
The act also creates a clean fuel production credit in new Sec. 45Z for clean transportation fuels produced in the United States. The credit is based on the emissions rate of the fuel compared to a base rate of 50 kg of CO2-equivalent global warming potential per metric million British thermal units. The credit is effective for qualified fuel produced after Dec. 31, 2024.
- Energy provisions for businesses
The Sec. 45 credit for electricity produced from certain renewable sources (including geothermal, solar, and wind facilities) is extended through 2024. The base credit amount is modified. The credit rate reduction for qualified hydroelectric production and marine and hydrokinetic renewable energy is eliminated after 2022.
The Sec. 48 energy credit is extended through 2024 and modified. For certain energy properties (defined in Sec. 48(a)(3)(A)(vii)), the credit is extended through 2034. The phaseout of the credit for certain energy properties is modified.
Sec. 48 is also amended to provide an increase in the energy credit for qualified solar and wind facilities placed in service in connection with low-income communities.
The Sec. 45Q credit for carbon oxide sequestration is modified and extended. Under the act, construction of a qualified facility must begin before Jan. 1, 2033. The applicable dollar amount for purposes of the credit is modified.
The act creates a zero-emission nuclear power production credit (in new Sec. 45U). The credit equals 0.3 cents times the kilowatt hours of electricity produced by the taxpayer at a qualified nuclear power facility and sold by the taxpayer to an unrelated person during the tax year, minus a reduction amount. The 0.3 cents amount will be adjusted for inflation. The credit is effective for electricity produced and sold after Dec. 31, 2023.
Several alternative fuel credits are extended through 2024. These include the Sec. 40A biodiesel and renewable fuel credit; the Sec. 6426 biodiesel mixture credit; the Sec. 6426 alternative fuel credit; the Sec. 6426 alternative fuel mixture credit; and payments for alternative fuels under Sec. 6427. The second-generation biofuel incentives under Sec. 40 are also extended through 2024.
The act creates a new sustainable aviation fuel credit in new Sec. 40B, effective for fuel sold or used after Dec. 31, 2022.
The act also creates a credit for the production of clean hydrogen in new Sec. 45V, effective for hydrogen produced after Dec. 31, 2022. Alternatively, taxpayers can elect to treat clean hydrogen production facilities as energy property under Sec. 48, in which case no credit would be available under new Sec. 45V or 45Q (the carbon oxide sequestration credit).
The act changed the method for determining the maximum amount of the Sec. 179D energy-efficient commercial buildings deduction. The efficiency standard is also modified — for tax years after 2022, the energy-efficient property will have to be installed as part of a plan to reduce overall applicable energy costs by 25% compared to a reference building under the American Society of Heating, Refrigerating, and Air Conditioning Engineers and the Illuminating Engineering Society of North America’s Reference Standard 90.1-2007, rather than 50%.
The former Sec. 179D lifetime cap on the deduction is generally converted to a rolling three-year cap. The final determination period is extended to four years from two. These changes are effective for tax years beginning after Dec. 31, 2022.
The act also introduces an alternative deduction under Sec. 179D for taxpayers that retrofit property to be more energy efficient. This change is effective for property placed in service after Dec. 31, 2022, if it is placed in service pursuant to a qualified retrofit plan.
- Treating Clean Energy Tax Credits as Payments
Under new Sec. 6417, eligible taxpayers can elect to treat certain energy credits as tax payments. For facilities owned by S corporations or partnerships, the S corporation or partner will make the election.
The credits eligible for this election include:
- The Sec. 30C alternative fuel refueling property credit;
- The Sec. 45(a) renewable electricity production credit;
- The Sec. 45Q carbon oxide sequestration credit;
- The Sec. 45U zero-emission nuclear power production credit;
- The Sec. 45V clean hydrogen production credit;
- The Sec. 45W qualified commercial vehicle credit (for tax-exempt entities only);
- The Sec. 45X credit for advanced manufacturing production;
- The Sec. 45Y clean electricity production credit;
- The Sec. 45Z clean fuel production credit;
- The Sec. 48 energy credit;
- The Sec. 48C qualifying advanced energy project credit
- The Sec. 48E clean electricity investment credit.
Under new Sec. 6418, eligible taxpayers generally can transfer these credits (except the qualified commercial vehicle credit) in any tax year to another taxpayer. Any amount paid by the transferee taxpayer must be in cash, is not deductible by the transferee taxpayer, and is not included in the transferor taxpayer’s income.
Both of these provisions are effective for tax years beginning after Dec. 31, 2022.
- Other tax provisions
The limitation amount for the Sec. 41(h) research credit against payroll tax for small businesses is increased by $250,000, for tax years beginning after Dec. 31, 2022.
The Sec. 461(l)(1) limitation on excess business losses of noncorporate taxpayers is extended through 2028. The TCJA limited individuals from using more than $250,000 ($500,000 for married taxpayers filing jointly) of business losses to offset nonbusiness income, but the effective date was delayed. The provision finally became effective in 2021. It was originally scheduled to run through 2026.
The act levies an excise tax on drug manufacturers during periods when they are not in compliance with drug price negotiation requirements imposed by the act, which are designed to lower the price of certain single-source drugs.
Finally, the act makes permanent the Sec. 4121 coal tax to fund the black lung disability trust fund.
The act appropriates approximately $80 billion in funds for the IRS. Funds are directed to taxpayer services ($3 billion), enforcement ($46 billion), operations ($25 billion), and business systems modernization ($5 billion). The act also directs the IRS to study the cost of developing and running a free direct e-file system.
The Congressional Budget Office estimates that the IRS enforcement appropriations will increase federal revenues by $204 billion through 2031.
Before the act was passed, Treasury Secretary Janet Yellen wrote to IRS Commissioner Charles Rettig, directing him that the increased IRS enforcement funds should not be used to increase audits of small businesses or taxpayers with household incomes under $400,000.
The AICPA submitted comments to Congress on several of the tax provisions in the bill and plans to submit comments to the IRS on needed priority implementation guidance from the legislation.
Tax-Free Conversion From Partnership to S Corporation
Let’s say you’re considering converting your partnership into an S corporation. The reason might be to reduce exposure for you and the other owners to Social Security and Medicare taxes, which come in the form of self-employment tax for partners.
Specifically, each partner’s share of net partnership income is usually fully exposed to the self-employment tax. For 2022, the self-employment tax rate is a painful 15.3 percent on the first $147,000 of net self-employment income. On net self-employment income above $147,000, the self-employment tax rate drops to 2.9 percent.
For a shareholder-employee of an S corporation, the Social Security and Medicare taxes come in the form of the FICA tax. But for shareholder-employees, the FICA tax hits only amounts paid as salaries. Distributions of the remaining corporate cash flow are FICA-tax-free.
Whatever the reason for wanting to convert your partnership into an S corporation, here’s an explanation and a summary of the key federal income tax implications.
Good news: You can transfer the business assets, liabilities, and operations of your partnership to a C corporation by incorporating the partnership. This can potentially be a totally federal-income-tax-free transaction under Section 351 of our beloved Internal Revenue Code. Or it can be mostly tax-free.
Then you can turn the C corporation into an S corporation.
Section 351 treatment for the incorporation of a partnership is allowed when all the following requirements are met:
- One or more persons (which can include the partnership itself or its partners) transfer property (assets, which can include cash) to the corporation.
- The transfer is solely in exchange for the stock of the corporation.
- The person or persons (the partnership itself or its partners) are in control of the corporation immediately following the transfer. Control means owning at least 80 percent of the stock.
- The transaction has a business purpose. The IRS created this additional requirement, but meeting it should not be a problem. For instance, incorporating to take advantage of the liability protection offered by the corporate form of doing business would be an acceptable purpose. So would providing for the orderly transfer of ownership of a business from one generation to the next.
The Internal Revenue Service mistakenly posted information from approximately 120,000 individuals on its website before discovering the error on Aug. 26 and taking it down. The information came from Form 990-T, the business tax returns filed by tax-exempt organizations.
Inflation Is Surging, So Are Federal Tax Collections
The latest inflation report confirms that prices for just about everything continues to rise, with the Consumer Price Index (CPI) up 8.3 percent over the last year and many categories up even higher, including food (11.4 percent) and energy (23.8 percent). While not part of the CPI, another measure of inflation (call it the Taxpayer Price Index?) is also surging: federal tax collections are up 23 percent over the last year, according to the latest data from the Congressional Budget Office (CBO). At the current pace, federal tax collections will reach a record high of about $5 trillion in nominal dollars for the fiscal year (FY) 2022 ending September 30, which is about $1 trillion more than last year’s $4 trillion in collections (also a record).
As a share of GDP, federal tax collections are on track to hit a multi-decade high of about 20.2 percent in FY 2022, up from 18.1 percent last fiscal year and exceeding the last peak of 20 percent set during the dot-com bubble in FY 2000. Federal tax collections are approaching the all-time high of 20.5 percent of GDP set in 1943 during World War II. Compared to average federal tax collections in the post-war era of 17.2 percent of GDP, this year’s collections are set to exceed that level by 3 percentage points.
The Tax Cuts and Jobs Act was signed into law in November 2017 by Former President Donald Trump and that is what is contributing to the highest revenue ever collected. President Biden’s Inflation Reduction Act doesn’t affect tax increases until 2023.
When you lower taxes it increases the incentive to expand the GDP and when you increase taxes it does the reverse.
The results of gathering more tax revenue when you lower rates and give tax incentives have been proven once again. That was the purpose of the Tax Cuts and Jobs Act (TCJA) of 2017 signed into law under Former President Donald Trump.
Remember, many of the tax provisions of TCJA sunset (go away) in 2026 unless extended by the current administration (unlikely). Again the need for more estate and tax planning.
It is already the end of September and open enrollment for Medicare is almost here. If you are turning age 65 or want to review your current Medicare Insurance products, you can do so by calling our office at 702-878-3900 and we can assist you.
Andrew Whalen, of Whalen Financial, is ranked 10th out of the top 25 Next Gen Advisors to Watch!
Sources of Tax-Free Income That Do Not Affect Modified Adjusted Gross Income (AGI)
Here are the 17 that jumped out at me:
- Roth IRAs
- Social Security benefits up to the taxable limits
- Tax-free IRA withdrawals (on top of tax-free Social Security)
- Home sale gains of up to $250,000 ($500,000 if married, filing jointly)
- Tax-free capital gains and dividends when you hit the sweet spot – call me for sweet spot information.
- Capital gains sheltered with capital losses
- Stepped-up inherited assets
- Section 1031 real estate exchanges when held until death
- Qualified small business tax gains
- Section 529 college savings plans used for education
- Coverdell Education Savings Accounts use for education
- Age 72 or older IRA transfers directly to charity up to $100,000 per year
- Investment in Opportunity Zones left for 10 years or longer
- Federal, State, and Private disability income
- Life insurance proceeds from the policy that is still in force.
- Health Savings Accounts (HSA) distributions used for medical expenses
- Annuity income that is basis only
Why are the above tax-free sources important? Your (MAGI) can determine how much of your other sources of income are taxable and how much of your itemized deduction you have to give up. MAGI also determines what your Medicare Part B Premium payment will be, the higher the MAGI the higher your premium.
How Long A Period of Time does The IRS have To Audit Your Return?
Normally the IRS has three years to audit your return, that is three years from the later of the due date for filing or the date you actually filed.
- Not filing your return, keeps the audit statute open indefinitely.
- Under reporting your income by 25%, doubles the three years to six years.
- If you do not sign your return, the IRS does not consider it a valid return, therefore, the same rules for non-filing apply.
- If your return is incomplete, it is three years after making the correction necessary to file a completed return.
- The three years are also doubled to six years if you omit more than $5,000 in foreign income.
- Omit Form 3520 for gifts of inheritances from foreign nationals opens unlimited statute of limitation.
- Omit Form 8938 for overseas assets opens unlimited statute of limitation
- If you own part of a foreign corporation, it can trigger reporting, including filing an IRS
Form 5471. Failure to file Form 5471 generally is a penalty of $10,000 per form. Note, that there is a separate penalty imposed on Form 5471 if; late, incomplete, or inaccurate.
As we enter the Fall and Winter months of this year, I wish everyone a healthy balance for the rest of 2022 and beyond and let everyone know I am available for your questions and concerns.
Al Whalen, EA, ATA, CFP®
Bradford Tax Institute
The Tax Book
Inflation Reduction Act (HR 5376)
Accountant’s Daily Insight
The Tax Foundation
California Society of Enrolled Agents
Accounting Today Publication
Robert Wood, www.woodllp.com