June 2023
Tax Credits for Electric Vehicles: The Latest from the IRS
The IRS recently issued new guidance on electric vehicles. There are four ways you can potentially benefit from a federal tax credit for an EV you place in service in 2023 or later:
- Purchase an EV, and claim the clean vehicle credit.
- Lease an EV, and benefit from the lessor’s EV discount.
- Purchase a used EV that qualifies for the used EV tax credit.
- Purchase an EV for business use, and claim the new commercial clean vehicle tax credit.
The new clean vehicle credit is available through 2032, with a maximum credit of $7,500.
To qualify for the clean vehicle credit, you must meet specific criteria, including income limits, vehicle price caps, and domestic assembly requirements. The credit amount for vehicles delivered on or after April 18, 2023, depends on the vehicle meeting critical minerals sourcing and/or battery components sourcing requirements.
If you can’t find an EV that qualifies for the credit or your income is too high, you can lease an EV from a leasing company that can claim up to a $7,500 commercial clean vehicle tax credit. The leasing company may then pass on all or part of the credit to you through reduced leasing costs.
For used EV purchases, you can earn a credit of up to $4,000, but you must buy the vehicle from a dealer and meet the law’s income caps and other restrictions.
Finally, if you purchase an EV for business use, you can qualify for the commercial clean vehicle tax credit, which is not subject to critical minerals or battery components rules, making it easier to qualify for this credit starting April 18, 2023.
To claim an EV credit, the seller must complete a seller’s report and provide a copy to you and the IRS. For the clean vehicle credit, you will file IRS Form 8936. For the commercial clean vehicle credit, you will file IRS Form 8936-A.
Using Family Loans to Secure Better Home Loan Interest Rates
Here’s some information on how you can help a family member buy a home by making a loan to them while ensuring that you and the family member benefit from a tax-smart loan structure.
With the current national average interest rates for 30-year and 15-year fixed-rate mortgages at 6.81 percent and 6.13 percent, respectively, family loans can offer a much more attractive alternative. By charging the Applicable Federal Rate (AFR) as interest, you can give the borrower a good deal without giving yourself a tax headache.
The IRS issues new AFRs for term loans every month. The rates for April 2023 are as follows:
- Short-term loan (three years or less): 4.86 percent
- Mid-term loan (over three years but not more than nine years): 4.15 percent
- Long-term loan (over nine years): 4.02 percent
Charging at least the AFR interest rate for a term loan to a family member allows you to avoid federal income tax and gift tax complications.
But if you charge less than the AFR, you may need to navigate some tax complications. The $10,000 and $100,000 loopholes are two tax-law exceptions, which can help you avoid these complications, although they may only be suitable for some home loans.
The $10,000 Loophole (exception): For small below-market loans, the IRS lets you ignore the imputed gift and imputed income rules. But to qualify for this loophole, any and all loans between you and the borrower in question must aggregate to $10,000 or less. If you pass this test, you do not need to worry about not charging interest or charging less than AFR rates.
The $100,000 Loophole (exception): With larger below-market loans, the $100,000 loophole may save you from IRS-imputed interest rules. You are eligible for the $100,000 loophole if the aggregate balance of all outstanding loans (with below-market interest or otherwise) between you and the borrower is $100,000 or less. There is one more caveat – the borrower must not have a net investment income for the year over $1,000. Net investment income is; interest, dividends, capital gains, rental income, royalty income, and non-qualified annuity income.
Example: You loan your adult son a $100,000 interest-free loan to help him buy a home. He has $500 of net investment income for the year. Since his investment income for the year is less than $1,000, your taxable imputed interest income for the year is zero. But if your son’s net investment income is $1,500, your imputed interest is $1,500.
It is crucial to document the loan with a written promissory note and secure it with the borrower’s home for them to claim deductions for qualified residence interest expenses. Ensure the borrower signs the note and includes details such as the interest rate, a schedule of interest and principal payments, and any security or collateral for the loan.
In conclusion, family loans can provide homebuyers with better interest rates than commercial lenders offer, especially if family members charge the AFR. Remember to consider the loan terms and tax consequences when structuring the loan.
Basic Estate Planning
You need an estate plan, regardless of whether or not you are among the ultra-rich. As recent news has shown, even those, who have won the lottery or have substantial wealth can fall victim to poor estate planning.
While federal estate taxes may not concern you, you need the will to have your wishes honored after your death. Without a will, state law dictates the distribution of your assets (Nevada Revised Statutes Chapter 134 Succession), which may not align with your intentions. Additionally, if you have minor children, a will allows you to name a guardian to care for them in the event of your untimely passing.
Your heirs will want to avoid probate because it can be a costly and time-consuming legal process. A living trust gives you a valuable tool to avoid probate. By transferring legal ownership of your assets to the trust, you can ensure that your beneficiaries receive them without suffering through probate.
You can amend your living trust as circumstances change, providing flexibility and control over your assets.
It is also essential to keep your beneficiary designations up-to-date, as they take precedence over wills and living trusts regarding asset distribution.
Additionally, if your estate suffers from federal or state death taxes, you should plan to minimize your exposure.
Estate planning is not a one-time event but a process that you should review and update regularly to accommodate life changes and fluctuations in estate and death tax rules. You should check your estate plan annually to ensure it aligns with your wishes and circumstances.
One Ugly Rule for S Corp Owners Deducting Health Insurance
When your S corporation covers or reimburses your more-than-2-percent-shareholder-employee health insurance expenses, it classifies the payments as box 1 W-2 wages but not box 3 or box 5 wages.
When calculating the amount eligible for the Form 1040 self-employed health insurance deduction, you must use your Medicare wages (listed in box 5 of Form W-2) as your “earned income” rather than the amount reported in box 1.
Here are two examples that show you the impact of this rule:
- Ted’s S corporation pays him $0 in cash wages and reimburses him $18,000 for health insurance. His W-2 shows $18,000 as box 1 wages and $0 as box 3 and box 5 wages. Although Ted has $18,000 in taxable wage income from the corporation’s reimbursement of his health insurance, his Form 1040 self-employed health insurance deduction is $0 due to his lack of Medicare wages.
- Janet’s corporation pays her $107,000 in cash wages and reimburses her $22,000 for health insurance. Janet’s W-2 from her S corporation shows box 1 wages of $129,000, box 3 wages of $107,000, and box 5 wages of $107,000. The IRS allows her Form 1040 self-employed health insurance deduction of $22,000 because her Medicare wages exceed the insurance cost.
To avoid unfavorable tax outcomes, ensure that your S corporation reports Medicare wages (box 5) equal to or greater than the health insurance costs paid or reimbursed.
New Rules Are In Place to Delay IRA Distributions, The Plus And The Minus
When the Secure Act 2.0 was enacted in December 2022, the law delayed the starting age for required minimum distributions (RMDs) to age 73, effective January 1, 2023. The starting date will jump to age 75, effective January 1, 2033.
The new law will not affect you if you start taking RMDs before 2023. If you turn age 72 in 2023, your first distribution will be for 2024 (the year you turn 73).
For those who turn 73 in 2023 through 2032, the starting age for RMDs is 73. The beginning age for RMDs is 75 for those who turn 74 after December 31, 2032.
Delaying distributions sounds good; however, the longer you delay, the more you should accumulate, and the larger the required distributions when you finally start taking them. Remember that unless you have a basis (contributions that were not deductible), 100 percent of the distributions are taxable.
Planning Idea: Direct transfers from IRAs to qualified charities count towards RMDs and are not taxable to the IRA owner and benefit your charity.
Heirs are also taxed at 100 percent of the distribution amount; however, when you pass away, your heirs have 10 years to withdraw from the inherited IRA.
Beneficial Ownership Information Reporting
On September 30, 2022, the Treasury Department’s Financial Crimes Enforcement Network (FinCEN) issued final rules implementing Section 6403 of the Corporate Transparency Act, also known as the BOI rules, to “protect the U.S. financial system from illicit use…”
Under the new beneficial ownership information (BOI) reporting rules, which take effect on January 1, 2024, nearly all businesses will be subject to BOI reporting requirements. FinCEN estimates there will be over 32 million reporting companies at that time.
I will report more on this complex issue in later Tax-Tip letters.
Blog Posts Allowed as Evidence
The IRS can use social media posts against taxpayers. The court addressed whether the blog posts were admissible in a trial on the taxpayer’s claim for innocent spouse relief in its February 13, 2023, decision on Thomas v Commissioner, 160 T.C. No. 4. The U.S. Tax Court found that the blog entries were admissible. So, be careful what you post. It can be held against you, not only socially but with the IRS too.
Travel To a Fancy Hotel Where You Use Your Laptop For CE
When you attend continuing education (CE) seminars or training events, can you deduct travel, meals, and lodging expenses, even at a luxury resort? Example:
Assuming the CE event occurs in the Virgin Islands at a St. Thomas resort and qualifies as a tax-deductible business education event, you could deduct:
- The tuition (say $700),
- Airfare and other travel (say, $5,000),
- Hotel room ($say, $7,000), and
- Meals (say, $1,500)
That’s a $14,200 considerable cost; however, it could be even more or less and still tax deductible. If a CE event is ordinary and necessary to your business, it’s deductible, as is the travel (IRS Reg. Section 1.162-2(b)).
Business Day: Let’s start with more than four hours you spend each workday on education at the resort. Does that rise to the level of a workday?
When you travel to a foreign destination (which St. Thomas qualifies as, for purposes of the travel rules), you do not need to attend classes for eight or more hours for the tax law to call your education day a business day. You have a business day when, during normal business hours, your principal activity is the pursuit of business, (Reg. Section 1.274-4(d)(2)(iii)). Here education qualifies as the pursuit of business.
In tax law, principal or primary means the majority, and in the U.S., our normal workday is eight hours. Thus, you only need to work four hours and one minute to make that day a business day.
Logging in on your laptop for just over four hours and then shutting down means you spent more than four hours pursuing business on each education day.
Many educational events sign you in and out at each educational event for the CE to be honored; again, for more than four hours would meet the qualifications of a business day.
Excluding and Deferring Capital Gain Simultaneously
Is it possible to use IRC Sec 121 – Exclusion of gain on sale of a primary residence up to $500,000 plus use IRC Sec 1031 deferral of gain on investment property simultaneously?
The answer is YES and can be found in Revenue Procedure 2005-14. If the taxpayer owned and lived in residence for two of the preceding five-year period ending on the date of sale or exchange, they qualify for the exclusion of gain of up to $250,000 per taxpayer, $500,000 on a joint return.
Section 1031(a) provides that no gain or loss is recognized on the exchange of property held for productive use in a trade or business or for investment (relinquished property) if the property is exchanged solely for property of like kind (replacement property) that is to be held either for productive use in a trade or business or for investment.
Nowhere in IRC 121 or IRC 1031 does it say you can use both in a single transaction? Now enter Revenue Procedure 2005-14, which states how to accomplish this.
When using this procedure on property that qualifies, taxpayers must apply IRC 121 exclusion first, then IRC 1031. How do you account for the excluded amount? You increase the basis of the exchanged property by the account of the exclusion of gain. The IRS gave some examples of how this application works.
Example 1. Taxpayer A buys a house for $210,000 that A used as A’s principal residence from 2000 to 2004. From 2004 until 2006, A rented the house to tenants and claimed depreciation deductions of $20,000. In 2006, A exchanged the house for $10,000 cash and a townhouse with a fair market value of $460,000 that A intends to rent to tenants. A realizes a gain of $280,000 on the exchange ($10,000 + $460,000 = $470,000) minus ($210,000 – $20,000 = $190,000) = $280,000.
The above example qualifies for both Sec 121 and Sec 1031. The taxpayer owned the property for 2 of 5 years as a primary residence and was exchanged for an investment property on the exchange date. Section 121 does not require the property to be the taxpayer’s principal residence on the date of the sale or exchange. Because it was an investment property on the exchange date for an investment property, then Sec 1031 qualifies.
THE RESULTS ARE AS FOLLOWS:
Amount realized………………………………….$470,000
Less Adjusted basis………………………………$190,000
Realized Gain………………………………$280,000
Less: Gain excluded under Sec 121……………….$250,000
Gain to be deferred……………………….. .$30,000
A’s basis in the replacement property is $430,000, which is equal to the basis of the relinquished property at the time of the exchange ($190,000), increased by the gain excluded under Sec 121 ($250,000, and reduced by the cash A receives ($10,000).
The Rev Proc 2005-14 gives other examples of this procedure; one for a house with a guesthouse, two separate units where taxpayer B uses the house as a primary residence, and the guesthouse as an office in B’s trade or business. IRS gave another example; a single residence used part for residence and part for home office in a sale and exchange.
How to Make Charitable Contributions After TCMJ
The Tax Cuts and Jobs Act of 2017 eliminated personal exemptions and increased the standard deduction, making it more difficult to qualify for charitable deductions. Approximately 33 percent of taxpayers itemized deductions in 2017, compared to less than 10 percent in 2021. One purpose of the Act was to reduce the need to itemize, making the filing process less involved for taxpayers and reducing the need to audit many individual tax returns.
For 2023, the standard deduction is $13,850 for single filers and $27,700 for married filing jointly. Unless your medical expenses exceed 7.5% of your AGI, they do not count toward deductible expenses. The taxes you pay now are limited to $10,000, which is for sales tax, state income tax, and property tax, both real and personal, in addition to medical and taxes are charitable contribution deductions. Other miscellaneous deductions can include gaming losses to the extent of winnings, amortized bond premiums, federal estate tax, impairment-related work expenses, claim repayments, unrecovered pension investments, ordinary loss debt instruments, and some schedule k-1 pass-through deductions.
Bunching may help you exceed the standard deduction. Concentrate your charitable gifts in one year instead of spreading them over several years. Let’s assume you give $10,000 per year to qualified charities; you could accumulate the $10,000 for several years, say four years, then gift one larger amount of $40,000, allowing you to have itemized deduction in that year. This is unacceptable to most taxpayers, as many want to support their organization regularly.
Retirement Account Transfers for those aged 70 ½ or older can transfer directly from their IRA to a qualified charity and not pay tax on the transfer up to $100,000 per year, and the gift counts toward your required minimum distribution (RMD) from the IRA. This benefits the giver in three ways: they still get the standard deduction, do not pay tax on the transfer, and meet their RMD.
Gift-Appreciated Assets in Lieu of Cash Many taxpayers need to remember or know that gifts of appreciated value are counted as a gift of the asset’s fair market value. Assume you gift publicly traded stock worth $20,000 to a charity. Let’s further assume your tax basis is only $2,000. If you sell the stock and give the proceeds to a charity, you must pay tax on the capital gain of $18,000; that gain could be taxed at 0%, 10%, 15%, 20%, or 23.8%, depending upon your tax bracket. If you directly transfer to the charity, no income tax is due.
Why Are The NBA Finals Important To Colorado?
This year’s NBA finals are between the Denver Nuggets and the Miami Heat. When the Miami Heat plays in Denver, part of their earnings are subject to Colorado State income tax, (The Jock Tax).
What is the jock tax? The jock tax is an income tax levied on athletes and other people associated with sports teams earning money outside their home state.
This taxing of individuals playing sports in other states started with California (of course) in 1991. In 1991, following the NBA Finals, California assessed state income taxes against the Chicago Bulls (including Michael Jordon), who played the Los Angeles Lakers in the NBA Finals that year. Illinois then enacted its law, “Michael Jordon’s Revenue,” to tax players who came to Chicago, and other states followed suit.
The good news for the Denver Nuggets is that Florida does not have a state income tax; therefore, no additional tax when playing there.
It has been reported that two-time NBA MVP Nikola Jokic (Denver Nuggets center) took home only about 51% of his $46.9 million annual salary in part due to jock taxes. (Essential Sports reported the Jokic could pay $1.4 million in jock taxes this year.)
When Do You Get To Take Losses On Cryptocurrency?
Losses on digital assets (cryptocurrency) work like stock gains or losses. You have a purchase date, amount (cost or basis), sales date, and proceeds. It is a long-term capital gain if you have a gain and have held the asset for 12 months and a day or longer. If you have a loss, it is either a short-term or long-term capital loss depending on the holding period.
Tax Treatment of Worthless Crypto: The IRS Chief Counsel recently issued an advisement on this subject. While Chief Counsel Advisement should not be cited as precedent, they provide insight into how the IRS might handle a scenario with the same facts and circumstances.
In a recent 2022 case, a taxpayer purchased $1.00 per cryptocurrency unit. By the end of the year, it was worth less than $0.01 per unit and tried to claim worthless under IRC Sec 165.
The results were that if the taxpayer could sell the asset there, it is not a worthless scenario as the asset’s value could increase.
To claim an abandonment loss for non-depreciable property, the following must occur:
- The loss is incurred in a business or transaction entered for profit;
- The loss arises from the sudden termination of usefulness in the business or transaction; and
- The property is permanently discarded from use, or the transaction is discontinued (Reg.1.165-2(a)).
Abandonment is proven by evaluating the surrounding facts and circumstances, which must show an intention to abandon the property and an affirmative act of abandonment (Massey-Ferguson, Inc. v Comm’r, 59 T.C. 220, 225 1972).
It is Officially Summer
I now have more time for tax and estate planning. Please call our office to make an appointment to review your will and trust information for any changes or planning you need to complete.
It is also a good time to review your tax situation for any major changes from last year that affect you, and your business changes that need to be addressed. Financial planning is an ongoing process; now may be the time to review if you haven’t reviewed yours recently. If you have never had a financial plan, consider doing one now.
Have a happy, healthy, and fun-filled summer!
Respectfully,
Al Whalen, EA, ATA, CFP®
Sources:
Bradford Tax Institute
Forbes, Money, Retirement
Accountants Daily Insights
National Association of Tax Professionals (NATP)
Tax Pro Journal
Secure Act 2.0
IRS Revenue Procedure 2005-14
Old Republic Exchange Company
CPA Practice Advisor
Nancy Eade, Proof Reader, Whalen Financial