IRS Issue Number: 2023-13
What the IRS is doing and what you can do to avoid Employee Retention Credit scams
The IRS shared new steps the agency is taking to prevent honest taxpayers from falling victim to Employee Retention Credit (ERC) scams. The IRS continues to warn small businesses about aggressive promoters encouraging the filing potentially ineligible claims. The IRS urges small businesses to check ERC with a trusted tax professional instead of relying on a promotion company.
The steps include a moratorium on processing new ERC claims through at least the year’s end to prevent further abuse from predatory promoters using the ERC to scam businesses and organizations. Special withdrawal options and settlement initiatives are being prepared to help businesses misled into claiming the ERC. In addition, the IRS understands the valuable impact of the ERC credit and is working to process valid ERC claims filed before the moratorium, but with increased scrutiny.
New resources to help businesses navigate complex ERC:
- Special eligibility checklist. The IRS created a new ERC eligibility checklist that provides a quick, high-level way for employers to determine if they might qualify to claim the ERC or need to resolve an improper claim. Given that aggressive promoters may have misled some small businesses, this checklist is an essential reference tool to use along with checking with a trusted tax professional.
- New FAQs. The IRS also updated the Frequently asked questions about ERC with new questions and answers.
Be aware of the warning signs of aggressive promotion for the ERC. Aggressive tactics are a red flag.
Check IRS.gov/ERC for updates and ways to report a scam involving ERC, sometimes called the Employee Retention Tax Credit or ERTC.
IRS expands use of chatbots to help answer questions on critical notices; expands on technology that’s served 13 million taxpayers
The new chatbot feature will assist taxpayers in receiving CP2000, CP2501, and CP3219A notices.
Notices like CP2000 are only computer-generated letters matching data sent to the IRS by third-party reporting companies and then matched against what the taxpayer reported on their tax return. Any discrepancies generate the CP2000. Knowing that NO human has reviewed this data until you open the letter is essential. It is entirely computer-generated.
Why Some Business Owners Prefer Individual HSAs
When enacted, the Affordable Care Act (ACA) eliminated most small business health plans that reimbursed individually purchased health insurance. Consequently, many small business owners chose health savings accounts (HSAs) or provided no health coverage.
As of 2022, over 35 million HSAs were active, with assets amounting to $104 billion. The Devenir survey expects this to increase by 43 million accounts with $150 billion in assets by 2025.
- To open an HSA, you must have high-deductible health insurance.
- 2023 contribution limits are $3,850 for individuals and $7,750 for families. These limits increase slightly in 2024.
- If you’re 55 or older by the end of the year, you can contribute an extra $1,000.
- HSAs come with substantial tax benefits, including deductible contributions, tax-free earnings, and tax-free withdrawals for qualified health expenses.
Monies taken from HSAs are tax-free when used for qualified medical expenses. If you don’t use the funds for medical expenses, they grow. Once you reach the Medicare age;
- You can withdraw the funds and pay taxes or
- Use the funds tax-free for medical expenses.
You generally cannot make HSA contributions if you have a non-high-deductible health plan that overlaps with the high-deductible program. Similarly, you cannot contribute to an HSA and a general-purpose healthcare flexible spending account (FSA) in the same year.
HSAs are similar to IRAs. They are trust or custodial accounts you set up at banks, insurance companies, or brokerage firms. The purpose of your HSA is solely to pay your qualified medical expenses. Like IRAs, HSAs can offer various investment options, though some trustees might limit choices to more conservative options.
The benefits of HSAs have grown significantly in recent years, making them a mainstream and advantageous choice for many. Given their tax advantages and flexibility, the HSA could be a good fit for you as a business owner.
Business Travel By Car, Train, Plane or Boat
Say you will travel from your home in Washington, D.C., to San Francisco.
Will the tax law allow you to travel to San Francisco by car, train, plane, boat, or your choice?
Answer. Yes. But special rules apply. You need to know these rules to guarantee your deductions.
Travel by Car
The tax code does not dictate the fastest or cheapest form of travel. Therefore, you can travel for business by automobile or other vehicle from Washington, D.C., to San Francisco.
When you travel by automobile, your direct route expenses for meals, lodging, and other costs of sustaining life on the road are deductible in addition to the vehicle expenses.
Side trips, say to the Grand Canyon, count as personal days and miles. You can combine business and pleasure, but you can deduct only the business part.
You might ask: how many miles do I drive in my direct route to qualify the day as a business day? There’s no guidance here. This is a facts and circumstances test. Here are some facts and circumstances:
- You need to prove that your days traveling in the direct route to San Francisco were business days. In general, this requires passing the primary purpose test, where time spent is an essential factor.
Example. On day three of the trip, you spend one hour packing and unpacking and five hours driving 300 miles in a direct route from Washington, D.C., to San Francisco. Day three of this trip is a business day. Your miles are business miles. In addition, you deduct your meals, lodging, and other expenses of sustaining life for the day.
What If You Bring Your Family?
When you travel by car, you spend nothing extra to have the family in the car.
But family presence makes the trip smell more like a vacation than a business trip. This gives you another reason to ensure your records are in good shape.
Example. You stop at a hotel, and the single rate is $209 a night, and the two-person rate is $229. You are limited to the $209 rate—what it would have cost you if you traveled alone.
With meals, your business meals are deductible. Meals for your other family members are non-deductible personal meals.
Travel by Train
Your travel by train faces no special rules other than the reasonably direct route.
You can deduct the cost of the tickets if you buy sleeping rooms or travel by first class or coach.
Example. You travel by train for business from Washington, D.C., to San Francisco. You buy a sleeping room on the train for the trip. Your Amtrak travel fare is $3,000, and it is fully deductible.
Travel by Plane
By plane, you can travel in coach, in first class, by charter, or in your aircraft.
No special rules apply to commercial travel. You deduct the cost of getting to your business destination by a reasonably direct route.
Example. Say you take a side trip to Kansas City from Washington, D.C., to San Francisco. You calculate your deduction based on the direct route airfare and deduct that. Say you spent $900 on the trip that included Kansas City. If the direct route fare to San Francisco was $500, you deduct $500, and $400 is the cost of your personal side trip.
Travel by Boat
Special rules apply to travel by boat. For this purpose, your boat is considered a cruise ship, and any vessel that sails is a cruise ship.
If you travel by cruise ship from Washington, D.C., to San Francisco, you may not deduct more than the daily luxury boat limits, which for 2023 are as follows:
$1,128 a day from 1/1 to 3/31
$996 a day from 4/1 to 4/30
$796 a day from 5/1 to 5/31
$1,076 a day from 6/1 to 9/30
$776 a day from 10/1 to 10/31
$734 a day from 11/1 to 11/30
$1,128 a day from 12/1 to 12/31
Example. You travel from Washington, D.C., to San Francisco in November by cruise ship. It takes ten days. The law limits your cruise ship deduction to a maximum of $7,340 per business traveler ($734 x 10).
Qualified Charitable Deductions
The Tax Cuts and Jobs Act (TCJA) made permanent in the law the ability to directly transfer from an IRA account to a qualified charity if the taxpayer is age 70 ½ or older. The maximum amount that may be transferred is $100,000. This law applies to both spouses on a joint return. Therefore, if both spouses are above 70 ½ years of age and have separate IRA accounts, then the maximum transfer amount per year is $200,000.
Charitable contribution amounts are limited to 60% of AGI when you itemize your deductions. The standard deduction for a married couple over age 65 is $28,700 for 2023. Most individuals do not qualify to itemize; therefore, transferring directly from your IRA to the charity give several benefits:
- The transfer is not reportable income.
- It counts for Required Minimum Distributions (RMDs).
- You still get the full standard deduction.
- Lower reportable income lowers your Modified Adjusted Gross Income (MAGI) which effects:
(a). Medicare part B fees
(b). Additional Medicare tax of 0.9% for income over $250,000 MFJ, $125,000 MFS, Others $200,000.
(c). Net Investment Income Tax (NIIT) of 3.8% on passive income over the above limits.
(d). Capital Gains Rates, 0%, 15%, 20%, or 23,8% bases on MAGI.
(e). Deductible child care expenses.
(f). Child and other dependent credits.
Remember you do not need to be wealthy to consider this program. All of the above benefits are available if you meet the above mentioned qualifications. This is one of those WIN, WIN, LOSE scenarios. You win as per above and the charity wins receiving the contribution and the IRS (government) loses tax revenue.
This program is not available to other retirement plans only IRAs, therefore, if you have a 401k, 457, pension or profit-sharing plan, you must transfer to an IRA first and then move to the charity.
New Retirement Plan Limits For 2023
SEP-IRA Up to 20% of your net self-employment income, not to exceed $66,000.
401(k) Employees can contribute $22,500 ($30,000 if 50 or older). Employer: 20% of your net self-employment income, but at most $66,000, considering your employee and employer contributions ($73,500 if 50 or older).
SOLO 401(k) Contribution of up to $22,500 ($30,000 if 50 or older) of the wage for employee plus 25 percent of wage employer contribution maximum of $66,000 combined.
SIMPLE IRA Employee $15,500 ($19,000 if 50 or older). Employer contribution 1). A matching contribution equal to the lesser of 3 percent of the defined self-employment income or the amount of your elective deferral, or 2). A non-elective contribution of 2 percent of your defined self-employment income is limited to $330,000.
TRADITIONAL IRA $6,500 ($7,500 if 50 or older)
ROTH IRA $6,500 ($7,500 if 50 or older)
DEFINED BENEFIT PLAN Actuarially determined the amount needed to fund annual retirement benefits of up to $265,000.
NOTE: The above plans have additional restrictions, income limits, and regulations; contact our office for more information.
Benefits Of Employing Spouse and Children For Self-employed Owners
For the self-employed, there are many benefits to employing family members; here are a few:
- Children under 18 are exempt from FICA, Medicare, FUTA, and most states’ unemployment tax.
- The child can earn up to $13,850 and not owe income tax.
- The child can earn up to $20,350, contribute $6,500 to deductible IRA and not owe tax.
- Children under 18 or 22, if a full-time student can still be a qualifying dependent of parents, providing parents pay over half the support.
- Any compensation paid to the child is tax deductible, reducing the parent’s income and self-employment taxes.
- As an employer, you can provide an educational assistance plan.
- Employing your spouse will allow you to provide an IRS Section 105 Plan. Sec 105 plan allows all medical expenses to be deductible on Schedule C. Medical expenses include health insurance, out-of-pocket medical expenses, and prescription drug costs.
- Spouse wage is subject to withholding, social security, and Medicare tax but is exempt from FUTA and unemployment tax.
- Self-employed owners can offer retirement plan benefits that include your spouse.
- When traveling on business, your spouse’s expenses are deductible when accompanying you.
- If you provide a high deductible health plan, you can establish an HSA plan to benefit yourself and your spouse.
Earned Income Tax Credit and Child Tax Credit
Two years ago, I mentioned that the IRS estimated that over $28 billion per year was lost to erroneous credits issued to the EITC and CTC.
The IRS paid $18.2 billion in improper EITC payments in 2022 alone, and despite this, they just announced that they will be doing fewer audits in this area. They want to focus enforcement efforts on higher-income individuals, large partnerships, and corporations.
The IRS closed nearly 260,000 EITC audits. Per the National Taxpayer Advocate, 18% were closed as “no change” to taxes owed, 38% were closed were closed with tax due after the taxpayer didn’t respond to the IRS notice, and 25% were closed with tax due after the taxpayer responded but neither agreed nor disagreed with IRS findings.
“HAS For Employees? Beat the Dreaded 35% Penalty Tax”
The Affordable Care Act (ACA) changed the landscape for small businesses that offered health benefits for their employees.
Before the ACA, many small businesses reimbursed some or all of their employees’ individually purchased health insurance.
The ACA makes that illegal and imposes a $100-a-day, per-employee penalty for such reimbursements without using one of the newer health reimbursement accounts—namely the ICHRA or the QSEHRA.
That brings us to two other choices:
- As a small employer with fewer than 50 employees, you can offer no health benefits and face no federal law penalties.
- You can use the health savings account (HSA) to help employees with their health benefits without facing the hurdles of the ACA.
But here’s the kicker: The one thing you need to consider when you make the HSA contributions is the discrimination rules (which are called “comparability” rules in the HSA world). If you violate these rules, the IRS forces you to pay a draconian tax of 35 percent of your total HSA contributions.
Fortunately, it’s easy to avoid discrimination—even when you favor one group of employees over another—when you follow three simple rules.
What Employers Must Know
Before we get to the three simple rules, the general rule to know as an employer is that you must make “comparable” contributions to all employees with a high-deductible health plan (HDHP). (Employees are not eligible for HSA contributions unless they have an HDHP.)
What if some employees have an HDHP and some don’t? You don’t have to give any benefit to the non-HDHP employees. For purposes of HSA tax law, you can give them nothing and ignore them.
But for your HDHP employees, you have to make comparable contributions. You do that by following the three rules below:
Rule 1—Determine the Categories of Your HDHP Employees
You have to make comparable contributions only to employees who are in the same “category.”
For two or more employees to fall into the same category, they must have identical answers to both of the following questions:
- Is the employee a full-time, part-time, or former employee?
- How many dependents are covered under the employee’s HDHP?
Full-time versus part-time. Part-time employees work fewer than 30 hours per week, and full-time employees work 30 hours or more per week.
Number of dependents covered. The HSA rules provide four options:
- Self-only HDHP
- Family HDHP covering the employee plus one dependent (“self plus one”)
- Family HDHP covering the employee plus two dependents (“self plus two”)
- Family HDHP covering the employee plus three or more dependents (“self plus three or more”)
Example 1. You have three full-time employees:
- Sam has a self-only plan.
- Joe has a family plan covering himself and his son.
- Kim has a family plan covering herself and her husband.
Only Joe and Kim are in the same category because they have self-plus-one HDHP coverage. Sam is in a different category because he has coverage for himself only.
Example 2. In addition to the three employees above, you have a part-time employee named Barbara with a family plan covering herself and her husband. Barbara is in a category separate from Joe and Kim. Even though she has self-plus-one coverage, she is part-time, whereas Joe and Kim are full-time.
Rule 2—Calculate a Comparable Amount
Contributions are comparable if you give each employee in the same category either:
- the same amount of money, or
- the same percentage of the plan’s deductible.
You make this determination each month.
Example. At the beginning of the year, you have two employees, and you hire a new employee who begins work on May 1. All three employees have the same HDHP.
You decide to contribute $100 per month to each employee’s HSA. For the two employees with you for the entire year, you contribute $1,200 total to each of their HSAs. For the new employee, you contribute $800 since that employee worked only eight months of the year.
Rule 3—Treat Yourself Differently
Unless you operate your business as a C corporation, tax law does not treat you as a normal employee with regard to the contributions your business makes to your personal HSA.
You take the deduction on your Form 1040 if you’re a sole proprietor.
If you operate as an S corporation, you treat the S corporation contribution as compensation and then take the deduction on your Form 1040.
For 2023, you can contribute a maximum of $3,850 to a self-only plan, $7,750 to a family plan, and an additional $1,000 for individuals over age 55.
Should You Convert Your Personal Vehicle to Business Use?
If you can convert a personal vehicle to business use, you can increase your tax benefits without spending money or driving another business mile.
Here’s an example: Once Mel and Sharon, his wife, started using both cars, they had 73.7 percent business use of each vehicle. Before they agreed to switch cars every week, Mel drove one car and achieved 93.3 percent business use. After the switch, business miles were applied to each vehicle.
If you are single and have two or more vehicles, you are likely to come out ahead by using all cars for business. Why? Let’s look at an example.
Jim has three cars with the following basis for depreciation:
- $50,000 for vehicle 1
- $33,000 for vehicle 2
- $27,000 for vehicle 3
If Jim drives only vehicle 1 for business, the most he could deduct for depreciation would be $50,000. But if he drives all three, the most he could deduct would be $110,000.
You get the idea.
Now, let’s get into some of the rules.
Depreciating the Former Personal Vehicle
When you convert a personal vehicle to business use, the law sees you as placing the vehicle in service in your business at that time. That means you can begin depreciating the asset and claiming tax deductions on that placed-in-service date.
To determine the basis for depreciation, use the lesser of:
- fair market value on the date of conversion from personal to business use or
- adjusted basis of the property (generally the amount you paid for the vehicle plus the cost of any improvements).
Example 1. Your spouse paid $43,000 for her personal vehicle. Today, when you convert it to business use, it has a fair market value of $31,000. Your basis for depreciation is $31,000.
Bonus Depreciation and Section 179 Expensing
You may not use Section 179 expensing on assets you convert from personal to business use.
But you likely can use bonus depreciation. This depends on when you acquired the vehicle that you are converting from personal to business use:
- If you acquired the vehicle before September 28, 2017, you may not claim bonus depreciation by converting that vehicle to business use in 2023.
- If you acquired the vehicle on or after September 28, 2017, you use today’s 2023 bonus depreciation rules on the converted car.
Example 2. Henry converted his 2016 personal SUV to business use in 2023. He may not claim bonus depreciation on the 2016 SUV.
Example 3. Helen converted her personal 2021 SUV, which has a gross vehicle weight rating (GVWR) of over 6,000 pounds, to business use in 2023 when it had a fair market value of $35,000—far less than the $60,000 she paid for it. Helen will use the SUV 70 percent for business.
She can deduct $19,600 in bonus depreciation ($35,000 x 70 percent business use x 80 percent bonus depreciation). In addition, Helen can claim MACRS depreciation on the remaining basis and 70 percent of her vehicle operating expenses.
Bonus Depreciation Rule You Must Know
The law makes bonus depreciation your method of depreciation if you don’t elect out of it on your tax return. This is unusual. Generally, you must take action to qualify for an additional tax break. But with bonus depreciation, you are in for the tax break if you don’t elect out of it.
And beware: when you “don’t elect out” of bonus depreciation, the 80 percent 2023 bonus depreciation deduction applies to all assets in the class.
Example 4. You place in service a vehicle that’s in the five-year class, and also seven other non-vehicle five-year-class assets. You must claim 80 percent bonus depreciation on either (a) all eight assets or (b) none.
Key point. To get to the “none,” you must elect out of bonus depreciation for this class of assets on your tax return.
Three Bonus Depreciation Basics for Vehicles:
1. Optional mileage rates. When 2023, you place a business vehicle in service and elect to use the IRS optional mileage rate of 65.5 cents a mile, your 28 cents-a-mile depreciation deduction is included inside the 65.5 cent mileage rate. So, for the optional mileage rate user, that’s it—there’s no bonus or other depreciation.
2. Heavy vehicles. SUVs, crossover vehicles, pickup trucks with beds six feet long or longer, cargo vans, and certain passenger vans with GVWRs in excess of 6,000 pounds are exempt from the luxury vehicle limits and thus qualify for 2023 bonus depreciation of up to 80 percent.
3. Luxury passenger vehicles. Cars with curb weights of 6,000 pounds or lighter and SUVs and other vehicles from number 2 above with GVWR of 6,000 pounds or less with acquisition dates after September 27, 2027, qualify for bonus depreciation of up to $8,000.
Basis When You Sell
There’s a trick to basis when you sell property that you converted from personal to business use—you have a rule for calculating losses and then a different rule for calculating gains:
- Losses. To calculate losses, use your tax return’s adjusted basis (i.e., the lower cost or market basis at the time of conversion minus depreciation).
- Gains. To calculate gains, use the original cost basis minus post-conversion depreciation. In most cases, actual cost gives you a higher basis and, thus, less tax on your gains. So don’t accidentally use an adjusted basis.
When it comes to your taxes, most personal assets other than your home are disappointments because:
- you pay taxes on personal gains, and
- you may not deduct the personal losses.
However, converting a personal vehicle or another personal asset to business use creates tax benefits. And you create these new tax benefits without spending any new money.
Want To Leave The United States? You May Have To Pay These Taxes
When you leave the U.S. to live in another country, you essentially have two choices from a tax perspective, which can cost you a pretty penny:
- First, you can leave the country and take up residence elsewhere. But if you choose this option, beware: the U.S. continues to tax you on your worldwide income, regardless of where you earn or derive it from.
- Second, you can formally renounce your American citizenship or long-term residency and expatriate. This option also has potential financial pitfalls because the U.S. may impose an “exit tax” on you before you leave.
The rules behind this exit tax are complex, but whether you will be required to pay it depends mainly on whether you are classified for tax purposes as a “covered expatriate.”
Are You a Covered Expatriate?
American citizens and long-term residents can voluntarily give up their status as citizens, residents, and expatriates.
Once you give up your status, the IRS will consider you either an “expatriate” or a “covered expatriate.” If you’re an expatriate, the exit tax will not apply, and you’re good to go. There’s nothing more to it. You still have U.S. assets and must pay U.S. taxes on those assets.
But if the tax law deems you a covered expatriate, you must pay the exit tax.
In most cases, a covered expatriate is a person who meets one of the following three tests:
- Income tax test. You’ll be deemed a covered expatriate if you paid an average of $190,000 in income tax in the five years before you expatriate.
- Net worth test. You’re also a covered expatriate if your net worth is $2,000,000 or more on the date you give up your U.S. citizenship or long-term residency.
- Compliance test. Finally, if you fail to certify, under penalty of perjury, that you met all your tax obligations for the five years preceding your expatriation, you’re a covered expatriate.
What Is the Exit Tax?
Under the exit tax regime, the government requires you to pay income taxes on the unrealized gain in all your property, subject to a few minor exceptions, as if you sold that property the day before your departure.
In other words, the law deems that you sold all your property at fair market value on the date of your departure, even though you did not. You then pay taxes on this imaginary gain.
Under today’s law, you can exit in 2023 and exclude up to $821,000 of gain (adjusted annually for inflation).
You Can Pay Later, But…
You didn’t collect any cash in the mark-to-market deemed sale of your assets, so you might need more cash to pay your taxes. The U.S. government might help you by allowing you to pay later if you post “adequate” security as collateral for the debt, such as a bond. The following rules also apply to this payment deferral election:
- Once you make the election, it’s irrevocable.
- You can elect to defer tax on some property but not others.
- You must waive any right under any U.S. treaty that would otherwise prevent collection of the taxes.
- You pay interest on any taxes you defer.
- You or your estate must pay the expatriate taxes due when you dispose of the property or die.
Easing the Pain
To ease the pain slightly, eligible deferred compensation items, such as IRAs, pensions, and stock option plans, are not part of the deemed sale and, thus, are not taxed at the time of expatriation.
Instead, the government makes the payor withhold 30 percent on any taxable payment to a covered expatriate.
To qualify for this temporary relief, the deferred compensation must be “eligible.” That means:
- the payor of the deferred compensation must be a U.S. entity or a foreign entity that has agreed to submit to U.S. withholding and other requirements;
- you tell the payor that you are no longer an American citizen and
- you permanently waive any claims you might otherwise have had to reduce or eliminate the tax under a tax treaty.
I’m a Covered Expatriate—What Can I Do?
Though the situation is a sticky wicket, all hope may not be lost.
According to the net worth test, you are a covered expatriate only if your net worth is $2,000,000 or more. You might structure your assets with some thoughtful planning to avoid this classification.
Depending on the circumstances, direct gifting before expatriation might be one solution. Another solution might be through the creation of trusts before the big day; expatriation.
It Is Cold, Flu, and COVID Season, so please stay healthy!
Next month’s letter will be devoted to Year-End Tax Planning.
Al Whalen, EA, ATA, CFP®
Bradford Tax Institute
Accountants Daily Insights
Kiplinger Tax Letter
National Association of Tax Professionals (NATP)
CPA Practice Advisor
The Tax Book
Nancy Eade, Proof Reader, Whalen Financial