Court of Appeals Rules for Clergy

Article Highlights:

  • Internal Revenue Code Section 107
  • Court Ruling
  • Employee Status
  • Self-employed Status
  • Parsonage Allowance
  • Self-employment Tax
  • Exemption from Self-employment Tax

If you read our previous article related to a Wisconsin District Court ruling, you will recall that the judge in that case had ruled that Sec. 107(2) of the Internal Revenue Code was unconstitutional.

Section 107 of the Internal Revenue Code provides that a minister’s gross income doesn’t include the rental value of a home provided by the house of worship. If the home itself isn’t provided, then a rental allowance paid as part of compensation for ministerial services is excludable. This benefit is generally referred to as a parsonage allowance. Thus, a minister can exclude the fair rental value (FRV) of the parsonage from income under IRC Sec. 107(1), or the rental allowance under Sec. 107(2), for income tax purposes. The Sec. 107(2) rental allowance is excludable only to the extent that it is for expenses such as rent, mortgage payments, utilities, repairs, etc., used in providing the minister’s main home, and only up to the amount of the home’s FRV.

Good news for clergy members: a 3-judge panel of the 7th U.S. Circuit Court of Appeals has unanimously overturned the lower court’s decision and ruled that Sec. 107 is constitutional; therefore, housing allowances continue to be excludable from income tax.

It is unknown whether those who brought the suit will ask the full 7th Circuit to review the case or appeal it to the U.S. Supreme Court and, if so, whether the Supreme Court will take it up.

Here is an overview of how members of the clergy (from all faiths) are taxed on their income. When we refer to “church” in this article, please read that to include mosques, synagogues, temples, etc. Members of the clergy are taxed on not just their salary but on other fees and contributions that they receive in exchange for performing services such as marriages, baptisms, funerals, and masses. As a result, clerics will generally report their income in two ways:

As an Employee – As an employee, clerics will receive a W-2 from the church showing the amount of their income that is subject to tax, any amount paid as a nontaxable housing allowance (discussed later), and any withholding.

Any expenses incurred as a W-2 employee are included on Form 2106 (Employee Business Expenses) and if the cleric also receives a nontaxable parsonage allowance, the expenses must be divided between the taxable W-2 income and nontaxable parsonage allowance. Unfortunately, for years 2018 through 2025 the deduction for employee business expenses has been suspended by tax reform. The suspension affects all employee business expenses, not just those of clergy employees.

As a Self-Employed Individual – Income received other than as an employee of a church is reported as self-employment income. Typically, this would include all income that is not included in the W-2 from the church, including fees charged for services, such as weddings, funerals, and other gatherings. This income and any expenses associated with it are reported on Schedule C and are subject to the self-employment tax.

Parsonage Allowance – As was discussed previously, as the subject of the court ruling, a member of the clergy can qualify to have a rental allowance excluded from his or her taxable income if that allowance is provided as remuneration for services that are ordinarily the duties of a minister of the gospel. The following are the qualifications and details of the parsonage allowance:

  • It is only excludable to the extent that it is used for expenses related to the minister’s housing (e.g., for rent, mortgage payments, utilities, and repairs).
  • The rental allowance is not excludable to the extent that it exceeds reasonable compensation for the minister’s services.
  • The allowance only applies to the minister’s primary residence.
  • The allowance cannot exceed a home’s FRV, including furnishings and appurtenances such as garages, plus the cost of utilities.
  • In advance of the payment, the employing organization must designate the allowance by an official action. If a minister is employed by a local congregation, the designation must come from the local church, instead of from the church’s national organization.
  • The portion of the minister’s business expenses that is attributable to tax-free income is not deductible. This rule does not apply to home-mortgage interest or to taxes that are deductible in full if the minister itemizes deductions.
  • Retired clerics can exclude a home’s rental value or a rental allowance if the home is furnished as compensation for past services and authorized under a convention of a national church organization. However, this exclusion does not extend to the widow or widower of a retired cleric.

Although it is not subject to income tax, a parsonage allowance is subject to the self-employment tax unless the minister is exempt (as discussed below).

Self-Employment Tax – A minister who hasn’t taken a vow of poverty is subject to self-employment tax on income from services performed as a minister.

An ordained minister may be granted an exemption from the self-employment tax for ministerial services only. To qualify, the church employing the minister must qualify as a religious organization under Code Section 501(c)(3). The application for an exemption is filed with Form 4361 (Application for Exemption from Self-Employment Tax for Use by Ministers, Members of Religious Orders, and Christian Science Practitioners).

To claim an exemption from the self-employment tax, the minister must meet all of the following conditions and file Form 4361 to request exemption from the self-employment tax. The minister must:

  • Be conscientiously opposed to public insurance because of his or her individual religious considerations or because of the principles of his or her religious denomination (not because of general conscience).
  • File for non-economic reasons.
  • Inform the church’s or order’s ordaining, commissioning, or licensing body that he or she is opposed to public insurance, if he or she is a minister or a member of a religious order (other than a vow-of-poverty member). This requirement doesn’t apply to Christian Science practitioners or readers.
  • Establish that the organization that ordained, commissioned, or licensed him or her (or his or her religious order) is a tax-exempt religious organization.
  • Establish that the organization is a church (or a convention or association of churches).
  • Not have previously filed Form 2031 (Revocation of Exemption from Self-Employment Tax for Use by Ministers, Members of Religious Orders, and Christian Science Practitioners) to elect for Social Security coverage.

Form 4361 must be filed on or before the return’s extended due date for the second tax year when the individual has net self-employment earnings of $400 or more (part of which is from services as a minister). A late application will be rejected.

The time for applying starts over when a minister who previously was not opposed to accepting public insurance (i.e., Social Security benefits) enters a new ministry (e.g., joins a new church and adopts beliefs that include opposition to public insurance). However, the IRS has said that there is no second chance to apply for exemption if a minister is ordained in a different church but does not change his or her beliefs regarding public insurance (i.e., the minister opposed the acceptance of public insurance in both faiths).

Careful consideration should be made before applying for an exemption from the self-employment tax, as once the decision is made, the election is irrevocable.

If you have questions related to any of these issues or how they may apply to your situation, please contact us.

Employees’ Fringe Benefits after Tax Reform

Article Highlights:

  • Qualified Parking
  • Transit Passes
  • Bicycle Commuting
  • Commuting
  • Moving Deduction
  • Achievement Awards
  • Group Term Life Insurance
  • Dependent Care Benefits
  • Qualified Educational Assistance Programs

Tax reform made a lot of changes, some of which impacted employees’ fringe benefits. This article reviews the most frequently encountered fringe benefits, including those that were and were not impacted by tax changes. These changes can affect both a business’s bottom line and its employees’ deductions.

BENEFITS IMPACTED BY TAX REFORM

Qualified Transportation Fringe Benefits – Qualified transportation fringe benefits include parking, transit passes, commuter (van pool) transportation, and bicycle commuting.

  • Qualified parking – The tax-free fringe benefit for qualified parking is still available to employees and is capped at $265 per month for 2019, up from $260 in 2018.
  • Transit Passes – The tax-free fringe benefit for transit passes is also still available to employees, up to $265 per month for 2019, an increase from $260 in 2018.
  • Bicycle Commuting – Unfortunately, tax reform did away with the $20-per-month tax-free reimbursement for the cost of an employee commuting to work on a bicycle.
  • Commuting – Tax reform killed the monthly commuting fringe benefit (which was $260 in 2018) except when necessary for ensuring the safety of an employee. When allowed, the maximum amount is the same as the transit pass fringe benefit.

However, even though they are excludable fringe benefits for employees, after 2017, employers can no longer deduct their expenses for parking or mass transit passes or commuter highway vehicle transportation provided to their employees.

Moving expenses – Before 2018 and after 2025, taxpayers who move because of a change in work location who meet certain distance and time requirements are able to deduct their moving costs in excess of any tax-free reimbursement from their employer. However, that deduction is suspended for 2018 through 2025, and any employer reimbursement is taxable and included in the employee’s W-2.

There is one exception: moving expenses are still deductible for military members on active duty for moves pursuant to military orders.

Achievement awards – Employee achievement awards are excludable from income only to the extent that the award does not exceed $400 for any one employee or $1,600 for a qualified plan award. A qualified plan award means an employee achievement award awarded as part of an established written plan or program of the business that does not discriminate in favor of highly compensated employees.

Tax reform added the provision that to be tax-free, the award must be a tangible item. So awards of the following would be taxable to the employee recipient: cash, cash equivalents, gifts cards, gift coupons, gift certificates (other than if the employer pre-selected or pre-approved a limited selection), vacations, meals, lodging, tickets for theater or sporting events, stock, bonds, or similar items.

BENEFITS NOT IMPACTED BY TAX REFORM

Group Term Life Insurance – The first $50,000 of group term life insurance coverage provided by an employer is a tax-free fringe benefit that does not add anything to the employee’s overall tax bill. But the cost of employer-paid group term coverage in excess of $50,000 is treated as taxable income and added to the employee’s W-2. The cost of that insurance coverage is based on an IRS table and is frequently higher than the employer is actually paying for the insurance, which creates phantom income.

For older employees, the after-tax cost of the additional coverage frequently exceeds the cost for an individual term policy. It may be appropriate for certain employees to only utilize the first $50,000 in coverage and acquire an individual policy for any additional needed coverage.

Dependent Care Benefits – Employers can establish dependent care assistance plans for the exclusive benefit of their employees. The payments received under the plan that are used by employees to pay dependent care expenses are excludable from employees’ income, up to the lower of:

  1. The employee’s earned income (for married employees, this is the earned income of the lower-paid spouse) or
  2. $5,000 ($2,500 for married filing separate).

Dependent care assistance that exceeds the limits must be included in an employee’s income for the year the dependent care is provided, even though it is not paid to the employee until later.

Qualified Educational Assistance Programs – If an employer has a written qualified educational assistance program, an employee may receive, on a tax-free basis, up to $5,250 each year for any form of instruction or training that improves or develops his or her capabilities, whether or not it is job-related or part of a degree program. However, no deduction or credit may be taken by the employee for any amount excluded from the employee’s income as an education assistance benefit.

These are just a few of the fringe benefits that may have tax consequences. Please give us a call if you have any questions related to them or other possibly excludable fringe benefits.

Gift and Estate Tax Primer

Article Highlights:

  • Exemptions from Gift and Estate Taxes
  • Annual Gift-Tax Exemption
  • Gifts for Medical Expenses and Tuition
  • Lifetime Exemption from Gift and Estate Taxes
  • Spousal Exclusion Portability
  • Qualified Tuition Programs
  • Basis of Gifts

The tax code places limits on the amounts that individuals can gift to others (as money or property) without paying taxes. This is meant to keep individuals from using gifts to avoid the estate tax that is imposed upon inherited assets. This can be a significant issue for family-operated businesses when the business owner dies; such businesses often have to be sold to pay the resulting inheritance (estate) taxes. This is, in large part, why high-net-worth individuals invest in estate planning.

Exemptions – Current tax law provides both an annual gift-tax exemption and a lifetime unified exemption for the gift and estate taxes. Because the lifetime exemption is unified, gifts that exceed the annual gift-tax exemption reduce the amount that the giver can later exclude for estate-tax purposes.

Annual Gift-Tax Exemption – This inflation-adjusted exemption is $15,000 for 2018 and 2019 (up from $14,000 for 2013–2017). Thus, an individual can give $15,000 each to an unlimited number of other individuals (not necessarily relatives) without any tax ramifications. When a gift exceeds the $15,000 limit, the individual must file a Form 709 Gift Tax Return. However, unlimited amounts may be transferred between spouses without the need to file such a return – unless the spouse is not a U.S. citizen. Gifts to non-citizen spouses are eligible for an annual gift-tax exclusion of up to $155,000 in 2019 (up from $152,000 in 2018).

Example: Jack has four adult children. In 2019, he can give each child $15,000 ($60,000 total) without reducing his lifetime unified exemption or having to file a gift tax return. Jack’s spouse can also give $15,000 to each child without reducing either spouse’s lifetime unified exemption. If each child is married, then Jack and his wife can each also give $15,000 to each of the children’s spouses (raising the total to $60,000 given to each couple) without reducing their lifetime unified tax exemptions. The gift recipients are not required to report the gifts as taxable income and do not even have to declare that they received the gifts on their income tax returns.

If any individual gift exceeds the annual gift-tax exemption, the giver must file a Form 709 Gift Tax Return. However, the giver pays no tax until the total amount of gifts in excess of the annual exemption exceeds the amount of the lifetime unified exemption. The government uses Form 709 to keep track of how much of the lifetime unified exemption that an individual has used prior to that person’s death. If the individual exceeds the lifetime unified exemption, then the excess is taxed; the current rate is 40%.

All gifts to the same person during a calendar year count toward the annual exemption. Thus, in the example above, If Jack gives one of his children a check for $15,000 on January 1, any other gifts that Jack makes to that child during the year, including birthday or Christmas gifts, would mean that Jack would have to file a Form 709.

Gifts for Medical Expenses and Tuition – An often-overlooked provision of the tax code allows for nontaxable gifts in addition to the annual gift-tax exclusion; these gifts must pay for medical or education expenses. Such gifts can be significant; they include

  • tuition payments made directly to an educational institution (whether a college or a private primary or secondary school) on the donee’s behalf – but not payments for books or room and board – and
  • payments made directly to any person or entity who provides medical care for the donee.

In both cases, it is critical that the payments be made directly to the educational institution or health care provider. Reimbursements to the donee do not qualify.

Lifetime Exemption from Gift and Estate Taxes – The gift and estate taxes have been the subject of considerable political disagreement over the past few years. Some want to abolish this tax, but there has not been sufficient support in Congress to actually do that; instead, the inflation-adjusted lifetime exemption amount has been increasingly annually. In 2019, the lifetime unified exemption is $11.4 million per person. By comparison, in 2017 (prior to the recent tax reform), the lifetime unified exemption was $5.49 million. The lifetime exemption for the gift and estate taxes has not always been unified; in 2006, the estate exclusion was $2 million, and the gift exclusion was $1 million. The tax rates for amounts beyond the limit have varied from a high of 46% in 2006 to a low of 0% in 2010. The 0% rate only lasted for one year before jumping to 35% for a couple of years and then settling at the current rate of 40%.

This history is important because the exemptions can change significantly at Congress’s whim – particularly based on the party that holds the majority.

Spousal Exclusion Portability – When one member of a married couple passes away, the surviving member receives an unlimited estate-tax deduction; thus, no estate tax is levied in this case. However, as a result, the value of the surviving spouse’s estate doubles, and there is no benefit from the deceased spouse’s lifetime unified tax exemption. For this reason, the tax code permits the executor of the deceased spouse’s estate (often, the surviving spouse) to transfer any of the deceased person’s unused exclusion to the surviving spouse. Unfortunately, this requires filing a Form 706 Estate Tax Return for the deceased spouse, even if such a return would not otherwise be required. This form is complicated and expensive to prepare, as it requires an inventory with valuations of all of the decedent’s assets. As a result, many executors of relatively small estates skip this step. As discussed earlier, the lifetime exemption can change at the whim of Congress, so failing to take advantage of this exclusion’s portability could have significant tax ramifications.

Qualified Tuition Programs – Any discussion of the gift and estate taxes needs to include a mention of qualified tuition programs (commonly referred to as Sec 529 plans, after the tax-code section that authorizes them). These plans are funded with nondeductible contributions, but they provide tax-free accumulation if the funds are used for a child’s post-secondary education (as well as, in many states, up to $10,000 of primary or secondary tuition per year). Contributions to these plans, like any other gift, are subject to the annual gift-tax exclusion. Of course, these plans offer tax-free accumulation, so it is best to contribute funds as soon as possible.

Under a special provision of the tax code, in a given year, an individual can contribute up to 5 times the annual gift-tax exclusion amount to a qualified tuition account and can then treat the contribution as having been made ratably over a five-year period that starts in the calendar year of the contribution. However, the donor then cannot make any further contributions during that five-year period.

Basis of Gifts – Basis is the term for the value of an asset; it is used to determine the profit when an asset is sold. The basis of a gift is the same for the giver and the recipient, but this amount is not used for gift-tax purposes; instead, the fair market value is used.

Example: In 2019, Pete gifts shares of stock to his daughter. Pete purchased the shares for $6,000 (his basis), and they were worth $22,000 in fair market value when he gifted them to his daughter. Their value at the time of the gift is used to determine whether the gift exceeds the annual gift-tax exclusion. Because the gift’s value ($22,000) is greater than the $15,000 exclusion, Pete will have to file a Form 709 Gift Tax Return to report the gift; he also must reduce his lifetime exemption by $7,000 ($22,000 – $15,000). His daughter’s basis is also equal to the asset’s original value ($6,000); when she sells the shares, her taxable gain will be the difference between the sale price and $6,000. Thus, Pete has effectively transferred the tax on the stock’s appreciated value to his daughter. If Pete’s daughter instead inherited the shares upon Pete’s death, her basis would be the fair market value of the stock at that time ($22,000) is she sold them for $22,000 she would have no taxable gain.

This is only an overview of the tax law regarding gifts and estates; please call us for further details or for advice about your specific situation.

Is Your Small Business as Profitable as It Can Be?

There is an excellent chance that even if you’re an expert in your particular industry, you’re probably not an expert in small business finances. This may not seem like that big of an issue on the surface; however, in order to make the best decisions possible for your company, you need work from complete and accurate information. It’s easy to see how failing to grasp the financial side of the equation can quickly cause problems everywhere else.

For example, just because your company looks profitable on the surface doesn’t necessarily mean that this is the case. In fact, there are a number of clear ways in which your small business might not be as profitable as it could be that are certainly worth exploring.

Not Everything Is About Sales

Maybe the most important thing for you to understand is that just because sales are high does NOT mean that your company is experiencing profitable growth in the way you think it is. This is actually just one small part of a much larger (and more complicated) story.

Sales could be going up AND profits could be going down in a number of ways. Maybe you’re selling a higher volume of low-margin items while also not selling as many high-margin goods. Perhaps the cost to actually make your product has increased higher (and faster) than your revenue. It’s possible that your operating expenses are so high that even though you’re increasing sales, your business is still not as profitable as it could be.

The lesson here is that you need to look beyond sales growth to find out what is really happening with your company. If you discover a problem like those outlined above, come up with a specific solution designed to address those particular issues in the most effective way possible.

Dive Deep Into Your Line-Item Profits

Likewise, you need to recognize the difference between bottom-line profits and line-item profits — particularly in terms of the health of your business year-over-year. Instead of just looking at the bottom line, look at the tangible contribution that each product or service makes to that bottom line.

Break down all of your sales by product lines, individual products and services. Is Product A losing so much money that it is eating into the profits generated by the hugely successful Product B? If that’s the case, Product B probably isn’t as “successful” as you thought it was.

Don’t Forget About Margins

Finally, paying attention to your profit margin percentages can tell you a number of critical things about the financial health of your company, essentially all at the same time. You’ll be able to determine whether:

  • You’re correctly pricing and promoting your products in a way that drives profitable growth.
  • All of the products and services you’re offering are profitable to begin with.
  • The true value of the relationships you’re forging with your customers, and how long they last on average.
  • If you’re allocating resources in the most efficient way possible, thus maximizing profitability whenever possible.

Again — determining whether or not your small business is as profitable as it can be involves a lot more than just looking at any one particular line item on a balance sheet. Often, it is a combination of many things — each representing their own individual piece of the puzzle that is your company. Only by understanding the bigger picture will you have the information you need to see where you truly stand and be in a position to determine what you need to do about it moving forward.

In the end, the most important thing for you to understand is that while you may be an expert in running your small business, you’re probably not (nor are you expected to be) an expert in small business finances. Those are two entirely separate concepts and should always be treated as such.

Partnering with the right financial professional isn’t something that you do after your organization is already up and running. It should be a natural part of the process of launching a business in the first place. There are so many decisions that will ultimately affect your cash-flow and taxes moving forward — from the financial structure that you set up to the entity you choose during formation. One wrong move at any of these points can artificially limit your ability to make money, and that is a difficult position for any entrepreneur to be in.

Instead, partner with a seasoned financial professional immediately and look to this person for insight and guidance as often as possible. If nothing else, they will make sure that the foundation upon which your company is built is as strong as possible — thus eliminating many and even all of the potential issues that could hold you back in the future. If you have any questions about implementing these and additional strategies to make your small business as profitable as possible, please call us.

Read This before Tossing Old Tax Records!

Article Highlights:

  • Reasons to Keep Records
  • Statute of Limitations
  • Maintaining Record of Asset Basis

If you are a neat-nick and your tax return for last year has been completed and filed, you are probably thinking about getting rid of the tax records related to that return. On the other hand, if you are afraid to dump old records, you are probably looking for a box to put them in so you can store them away. Well, you do have to keep them for a period of time, but not forever.

Generally, tax records are retained for two reasons: (1) in case the IRS or a state agency decides to question the information on your tax returns or (2) to keep track of the tax basis of your capital assets, so that you can minimize your tax liability when you dispose of those assets.

With certain exceptions, the statute of limitations for assessing additional taxes is three years from the return’s due date or its filling date, whichever is later. However, the statute in many states is one year longer than that of federal law. In addition, the federal assessment period is extended to six years if more than 25% of a taxpayer’s gross income is omitted from a tax return. In addition, of course, the three-year period doesn’t begin elapsing until a return has been filed. There is no statute of limitations for the filing of false or fraudulent returns to evade tax payments.

If none of the above exceptions applies to you, then for federal purposes, you can probably discard most of your tax records that are more than three years old; you will want to add a year to that time period if you live in a state with a longer statute.

Examples – Sue filed her 2015 tax return before the due date of April 15, 2016. She will be able to safely dispose of most of her 2015 records after April 15, 2019. On the other hand, Don filed his 2015 return on June 2, 2016. He needs to keep his records until at least June 2, 2019. In both cases, the taxpayers should keep their records for a year or two longer if their states have statutes of limitations longer than three years. Note: If a due date falls on a Saturday, Sunday, or a holiday, the actual due date is the next business day.

The problem with discarding all of the records for a particular year once the statute of limitations has expired is that many taxpayers combine their normal tax records with the records that substantiate the basis of their capital assets. The basis records need to be separated and should not be discarded until after the statute has expired for when a given asset was disposed of. Thus, it makes more sense to keep separate records for each asset. The following are examples of records that fall into the basis category:

  • Stock-acquisition data – If you own stock in a corporation, keep the purchase records until at least four years after the year when you sell the stock. This data is necessary for proving the amount of profit (or loss) from the sale. If your sales for a given year result in a net loss of more than $3,000, you may need to keep your purchase and sale records for even longer. This is because $3,000 is the maximum capital loss that can be deducted in any one year, so the excess loss must be carried over to the following year(s) until it is used up. If the IRS audits a return that includes a carryover loss, it will ask to see the records from the original purchase, even if it happened more than three years in the past. Thus, don’t dispose of such records until the statute of limitations has passed for the last year when you claimed a carryover loss.
  • Stock and mutual fund statements (if you reinvest dividends) – Many taxpayers use the dividends that they receive from stocks or mutual funds to buy more shares of the same stock or fund. These reinvested amounts add to the basis of the property and reduce the gain when They are eventually sold. Keep all such dividend statements for at least four years after the final sale.
  • Tangible property purchase and improvement records – Keep records of home, investment, rental-property, or business-property acquisitions; the related capital improvements; and the final settlement statements from the sale for at least four years after the underlying property is sold.

For example, when Congress instituted the large $250,000 home-sale-gain exclusion (which is $500,000 for married couples filing jointly) many years ago, homeowners began to be laxer in maintaining their home-improvement records, thinking that the large exclusions would cover any potential appreciation in their home’s value. Now, that exclusion may not always be enough to cover the gains from a sale, particularly for markets where property values have steadily risen; thus, keeping records of all such home improvements is vital.

What about the Tax Returns Themselves? Although the backup documents that you use to prepare your returns can usually be disposed of after the statutory period has expired, you may want to consider indefinitely keeping a copy of the tax returns themselves (the 1040, the attached schedules/statements, and the state return). If you just don’t have room to keep copies of your paper returns, digitizing them is an option.

Before discarding any records, it is a good idea to make sure that they will not be needed down the road. If you have questions about whether to retain certain records, please contact us.

Receive Payments the Right Way in QuickBooks: Your Options

One of the reasons we like QuickBooks is because it uses language and processes that are familiar to small businesspeople. Instead of using the term “accounts receivable,” it has a menu label that says Customers and menu items that use phrases like Create Invoices and Receive Payments. You would have to go into the Chart of Accounts to find standard accounting terminology – and we do not recommend that you do that without consulting with us first.

Yet when you’re doing customer-related tasks, you’re following a traditional accounts receivable workflow, a series of steps that completes a sales cycle, like Estimate | Invoice | Payment | Deposit. QuickBooks keeps it simple for you and doesn’t often force you into unfamiliar territory.

One of the more pleasant elements of accounts receivable is the process of receiving customer payments. There’s more than one way to do this, and it’s very important that you use the correct way in each situation.

Payment Methods 

Before you record your first payment, you’ll need to make sure that QuickBooks is set up to accommodate its Payment Method. QuickBooks comes with some standard types, but you can add, edit, and delete your own options (though not those that are built in to the software). Open the Lists menu and click Customer & Vendor Profile Lists, then Payment Method List. This window will open:

You can work with Payment Method options in this window.

To use any of the commands in the Payment Method drop-down list, you’d highlight the method by clicking on it and opening the options list by clicking the down arrow in that field.

Note: When you add or change an existing entry, the window that opens contains fields for both Payment Method and Payment Type. They should be identical or at least very similar.

Settling an Invoice

If your company sends invoices, you’ll need to record their matching payments in the Customer Payment window. Click Customer | Receive Payments or the Receive Payments icon on the home page. There’s also a button for this in the toolbar in an open invoice. However you get there, here’s what it looks like:

You’ll record payments that customers send in response to invoices in this window.

Select a customer in the RECEIVED FROM field, and any outstanding invoices will appear in the table below. The CUSTOMER BALANCE appears in the upper right corner. Enter the PAYMENT AMOUNT and verify the date.

Click in the box for the correct payment method to the right. If it’s a check, enter the number in the CHECK # field. If you choose CREDIT DEBIT, you can enter the card details in the small window that opens. If you provided this information in the customer’s record and chose that as the PREFERRED PAYMENT METHOD, it should fill it in automatically.

Note: To set a PREFERRED PAYMENT METHOD, which will save time, open the customer record and click the small pencil icon in the upper right. Click Payment Settings and complete the fields in that window.

If the customer has paid less than the balance due, you can either LEAVE THIS AS AN UNDERPAYMENT or WRITE OFF THE EXTRA AMOUNT. Select one of those two options in the lower left and save your work when you’re done.

Instant Payments

You’ll use a different form when a customer gives you a payment in exchange for the goods or services you provided, without receiving an invoice. Click Customers | Enter Sales Receipts to open a window like this:

If a customer gives you a payment without receiving an invoice, you’ll provide them with a Sales Receipt.

You’ll complete this form much like you did the CUSTOMER PAYMENT window, except you won’t be applying the payment to an existing invoice.

Tip: If you have a merchant account or are willing to get one, you can record payments and email sales receipts at remote locations on your mobile device. We can walk you through the setup.

Receiving payments from customers is one of the easier tasks you’ll do as a QuickBooks user, but if you don’t use the software’s tools correctly, your books will be difficult to untangle. We can help ensure that you’re doing this element of your work right from the start; please contact us to schedule a consultation.

What Are the Differences Between an IRS Tax Lien and a Tax Levy?

If you’re reading this, the chances are high that you’re one of the many, many people who have received a notice from the Internal Revenue Service. Some level of correspondence with the IRS is natural ‒ particularly leading up to and in the immediate aftermath of tax season. But if you’ve received notification that the government is about to file a tax lien or tax levy against you, suddenly you’re talking about an entirely different ballgame.

But the most important thing you can do at this point is stay calm. Yes, both of these notices mean that your financial situation has just gotten significantly more complicated. But you do have rights in each scenario that you would do well to protect at all costs.

What Is an IRS Tax Lien?

An IRS tax lien is a very specific type of claim that the government (in this case, the Internal Revenue Service) makes on your property. That property can include but is not limited to real estate and other types of assets. Typically, this is something that occurs when you’re past due on your income taxes and you’ve failed to make proper arrangements to get yourself back up-to-date again.

A tax lien can affect you in a number of different ways, all of which are less than ideal. Even though tax liens no longer appear on your credit report, your credit rating will still suffer ‒ thus harming your ability to get a loan or secure new credit for your business. Tax liens also usually appear during title searches, which can impact your ability to sell your house or refinance the mortgage you already have.

What Is an IRS Tax Levy?

A tax lien is essentially the first part in a two-step process. That second step takes the form of a tax levy, which involves the actual seizure of the property in question in an effort to pay the tax money you owe. Via a tax levy, the IRS can do everything from garnish your wages, seize assets like real estate or even take control of your bank accounts to get their money.

At the very least, you’re likely to go through wage garnishment ‒ meaning that you’ll be taking home far less money at the end of the week in your paycheck. A 21-day hold might be placed on your bank account in an effort to encourage you to “work things out,” and if you don’t, they may even try to seize your home as a last resort.

Luckily, there are a few things that the IRS CAN’T seize even by way of a tax levy. These include things like unemployment benefits, certain pension benefits, disability payments, workers’ compensation and others.

What Can I Do About Them?

Thankfully, even in the unfortunate event of a lien or levy, you do still have some options available to you.

More than anything, if you CAN pay your tax bill, you SHOULD pay your tax bill. If necessary, get on an IRS payment plan to help you get back up-to-date. Yes, your past due balance will continue to accrue both interest and penalties until you’ve paid it off. But the choice between paying interest and losing your house isn’t really a choice at all.

It’s also important for you to actively work to protect your rights if you feel it necessary to do so. After receiving either a lien or a levy notice, you can always file an appeal with the IRS Office of Appeals if you feel you’re being treated unfairly. It is within your right to ask for a conference with the IRS agent’s manager so that your case can be reviewed by a fresh set of eyes. If nothing else, this is a great way to make sure that your side of the story is known.

You can also apply for a Withdrawal of the Notice of Federal Tax Lien, which will remove the public notice of a tax lien filing. If the IRS has notified you that any of your property is about to be seized, you can file something called a Certificate of Discharge. This will remove the property in question from the effects of the tax lien, allowing you to sell something like your home (or another asset) without worrying.

A seasoned Tarlow tax professional can assist with these challenges. Please call us with any questions and for assistance.

Tax Tips for IRA Owners

Article Highlights:

  • Early Withdrawals
  • Excess Contributions
  • Multiple Rollovers
  • No Traditional IRA Contributions in the Year Reaching age 70½
  • Failing to Take a Required Minimum Distribution (RMD)
  • Late Contributions
  • Switch the Type of IRA
  • Backdoor Roth IRA
  • Alimony as Compensation
  • Spousal IRA
  • Saver’s Credit
  • IRA-to-Charity Direct Transfers

There are both opportunities and pitfalls for IRA owners, and while you definitely don’t want to get caught up in a pitfall, you may want to take advantage of the opportunities. IRAs come in two varieties: the traditional and the Roth. The traditional generally provides a tax deduction for a contribution and tax-deferred accumulation, with distributions being taxable. On the other hand, there is no tax deduction for making a Roth contribution, but the distributions are tax-free.

It leaves taxpayers with a significant decision, with long-term consequences of whether to contribute to traditional or Roth IRA. If you can afford to make the contributions without a tax deduction, then the Roth IRA is probably the better choice in most circumstances. However, some high-income restrictions limit the deductibility of a traditional IRA and the ability to contribute to a Roth IRA.

Pitfalls – Here are some of the pitfalls that can be encountered with IRAs:

  • Early withdrawals – IRAs were designed by the government to be retirement resources, and to deter individuals from tapping these accounts before retirement they added what is called an early withdrawal penalty of 10% of the taxable amount of the IRA distribution. The penalty generally applies for distributions made before reaching age 59-½, but there are some exceptions to the penalty.
  • Excess contributions – The tax code sets the maximum amount that can be contributed to an IRA annually. Contributions in excess of those limits are subject to a nondeductible 6% excise tax penalty, and this penalty continues to apply each year until the over-contribution is corrected.
  • Multiple rollovers – A rollover is where you take possession of the IRA funds for a period of time (up to 60 days) and then redeposit the funds into the same or another IRA. Only one IRA rollover is allowed in a 12-month period and all IRAs are treated as one for purposes of this rule. If more than one rollover is made in a 12-month period, the additional distributions are treated as taxable distributions and the rollover is treated as an excess contribution, with both causing significant tax and penalties. Rollovers can be avoided by directly transferring assets between IRA trustees.
  • No Traditional IRA contributions in year reaching age 70½ – Individuals cannot make a Traditional IRA contribution in the year they reach the age 70½ or any year thereafter. This rule doesn’t apply to Roth IRAs. Contributions to a traditional IRA made in the year you turn 70½ (and for subsequent years) are treated as excess contributions and are subject to the nondeductible 6% excise tax penalty until corrected.
  • Failing to take a required minimum distribution (RMD) – Individuals who have traditional IRA accounts must begin taking RMDs in the year they turn 70½ and in each year thereafter. However, the distribution for the year when an individual reaches age 70½ can be delayed to the next year without penalty if the distribution is made by April 1 of the next year. Failing to take a distribution is subject to a penalty equal to 50% of the RMD. The IRS will generally waive the penalty for non-willful failures to take the RMD, provided the individual has a valid excuse and the under-distribution is corrected. The RMD rules don’t apply to Roth IRAs while the owner is alive.

Opportunities – Here are some of the opportunities that can be encountered with IRAs:

Late contributions – If you forgot to make an IRA contribution or just decided to do so for the prior year, the tax law allows you to make a retroactive contribution in the subsequent year, provided you do so before the unextended April filing due date. As an example, you can make an IRA contribution for 2018 through April 15, 2019. This is also a benefit for taxpayers who were not previously sure they could afford to make a contribution.

Switch the type of IRA – If you make an IRA contribution for a year, tax law allows you to switch the designation of that contribution from a traditional IRA to a Roth IRA, or vice versa, provided you do so before the unextended April filing due date.

Backdoor Roth IRA – Contributing to a Roth IRA is not allowed if the individual’s modified adjusted gross income (AGI) exceeds a specified amount based on filing status. For example, the limits for 2019 are $203,000 if filing a joint return, $10,000 if filing married separate, or $137,000 for all others. If a high-income taxpayer would like to contribute to a Roth IRA but cannot because of the income limitation, there is a work-around that will allow the high-income individual to fund a Roth IRA. Here is how that backdoor Roth IRA works:

  1. First, a contribution is made to a traditional IRA. For higher-income taxpayers who participate in an employer-sponsored retirement plan, a traditional IRA is allowed but is not deductible. Even if all or some portion is deductible, the contribution can be designated as not deductible.
  2. Then, since the law allows an individual to convert a traditional IRA to a Roth IRA without any income limitations, the non-deductible traditional IRA can be converted to a Roth IRA. Since the traditional IRA was non-deductible, the only tax related to the conversion would be on any appreciation in value of the traditional IRA before the conversion is completed.One potential pitfall to the backdoor Roth IRA is often overlooked by investment counselors and taxpayers alike that could result in an unexpected taxable event upon conversion. For distribution or conversion purposes, all of your IRAs (except Roth IRAs) are considered one account, and any distribution or converted amounts are deemed taken ratably from the deductible and non-deductible portions of the traditional IRA, and the portion that comes from the deductible contributions would be taxable. So, the conversion tax implications should be considered before employing the backdoor Roth strategy.

Alimony as compensation – In order to contribute to an IRA, an individual must receive “compensation.” For IRA purposes, compensation includes taxable alimony received. Thus, for purposes of determining IRA contribution and deduction limits, individuals who receive taxable alimony and separate maintenance payments may treat the alimony as compensation, for purposes of making either a traditional or a Roth contribution, allowing alimony recipients to save for their retirement.

Spousal IRA – One frequently overlooked tax benefit is the “spousal IRA.” Generally, IRA contributions are only allowed for taxpayers who have compensation (the term “compensation” includes wages, tips, bonuses, professional fees, commissions, taxable alimony received, and net income from self-employment). Spousal IRAs are the exception to that rule and allow a non-working or low-earning spouse to contribute to his or her own IRA, otherwise known as a spousal IRA, based upon his or her spouse’s compensation (as long as it is enough to support the contribution).

Saver’s credit – The saver’s credit, for low- to moderate-income taxpayers, helps offset part of the first $2,000 an individual voluntarily contributes to an IRA or other retirement plans. The saver’s credit is available in addition to any other tax savings resulting from contributing to an IRA or retirement plans. Like other tax credits, the saver’s credit can increase a taxpayer’s refund or reduce the tax owed. The maximum saver’s credit is $1,000 ($2,000 for married couples if both spouses contribute to a plan). The application of this credit is very limited. Please call for additional details.

IRA-to-charity direct transfers – Individuals age 70½ or over must withdraw annual RMDs from their IRAs. These folks can take advantage of a tax provision allowing taxpayers to transfer up to $100,000 annually from their IRAs to qualified charities. This provision may provide significant tax benefits, especially if you would be making a large donation (although it also works for small amounts) to a charity anyway.

Here is how this provision, if utilized, plays out on a tax return:

(1) The IRA distribution is excluded from income;
(2) The distribution counts toward the taxpayer’s RMD for the year; and
(3) The distribution does NOT count as a charitable contribution.

At first glance, this may not appear to provide a tax benefit. However, by excluding the distribution, a taxpayer with itemized deductions will lower his or her AGI, which will help with other tax breaks (or punishments) that are pegged at AGI levels, such as medical expenses, passive losses, and taxable Social Security income. In addition, non-itemizers essentially receive the benefit of a charitable contribution to offset the IRA distribution.

Please call us for further details or to schedule an appointment to discuss IRA planning strategies that are customized to your unique circumstances.

Defer Gains with Qualified Opportunity Funds

If you have a large capital gain from the sale of a stock, asset, or business and would like to defer that gain with the possibility of excluding some of it from taxation, you may want to check out the new investment vehicle created by tax reform, called a qualified opportunity fund (QOF).

Congress, as a means of helping communities that have not recovered from the past decade’s economic downturn, included a provision in the Tax Cuts and Jobs Act intended to promote investments in certain economically distressed communities through QOFs. Investments in QOFs provide unique tax incentives that lawmakers designed to encourage taxpayers to participate in these funds.

Reinvesting Gains – Taxpayers who have a capital gain from selling or exchanging any non-QOF property to an unrelated party may elect to defer that gain if it is reinvested in a QOF within 180 days of the sale or exchange. Only one election may be made with respect to a given sale or exchange. If the taxpayer reinvests less than the full amount of the gain in the QOF, the remainder is taxable in the sale year, as usual. Only the gain need be reinvested in a QOF, not the entire proceeds from the sale. This is in sharp contrast to a 1031 exchange where the entire proceeds must be reinvested to defer the gain.

The gain income is deferred until the date when the QOF investment is sold or December 31, 2026, whichever is earlier. At that time, the taxpayer includes the lesser of the following amounts as taxable income:

a. The deferred gain or
b. The fair market value of the investment, as determined at the end of the deferral period, reduced by the taxpayer’s basis in the property. (Basis is explained below.)

A taxpayer who holds a QOF investment for 10 years or more before selling it can elect to permanently exclude the gain from the sale that is in excess of the originally deferred gain (i.e., the appreciation).

Qualified Opportunity Fund Basis – The basis of a QOF that is purchased with a deferred gain is $0 unless either of the following increases apply:

(a) If the investment is held for 5 years, the QOF’s basis increases from $0 to 10% of the deferred gain.

(b) If the investment is held for 7 years, the QOF’s basis increases from $0 to 15% of the deferred gain.

If, on December 31, 2026, a taxpayer holds a QOF that was purchased with deferred gains, the original deferred gain, or if less, the difference between the fair market value of the QOF reduced by the basis, must be included as gross income on that taxpayer’s 2026 return; the basis of the investment will then be increased by the amount of this included gain.

If the QOF investment is held for at least 10 years before being sold, the taxpayer can elect to increase the basis to the property’s fair market value. This adjustment means that the QOF’s appreciation is not taxable when it is sold.

Example 1: On June 30, 2018, Phil sold a rental apartment building for $3 million, resulting in a gain of $1 million. Within the statutory 180-day window, he invested that $1 million into a QOF and elected to defer the gain from the building’s sale. On July 1, 2026, he then sold the QOF for $1.5 million. Because Phil held the investment for over 7 years, its basis is enhanced by $150,000 (15% of $1 million). Because the investment’s fair market value is greater than the original deferred gain, he must include a taxable gain of $1.35 million ($1.5 million – $150,000) in his 2026 gross income. 

Example 2: The facts here are the same as in Example 1, except Phil waited to sell the QOF until 2030, meaning that he held it for nearly 12 years. On December 31, 2026, the fair market value of the QOF was $1 million. Because he had the investment on December 31, 2026, he was required to include $850,000 ($1 million – $150,000) of deferred gain on his 2026 return, the lesser of the $1 million gain he deferred or the FMV less his basis. He then increases his basis in the QOF from $0 to $850,000. After selling the QOF for $1.5 million in 2030, Phil elected to permanently exclude the gain by increasing his basis to $1.5 million (the fair market value on the date of the sale). Thus, he has no gain ($1.5 million – $1.5 million) in 2030.

Mixed Investments – If a taxpayer’s investment in a QOF consists of both deferred gains and additional investment funds, it is treated as two investments; this provides the tax benefits of both types: the temporary gain deferral and the permanent gain exclusion (which applies only to the deferred gain).

Qualified Opportunity Funds – To defer capital gains-related taxes through the recently enacted opportunity-zone program, taxpayers must invest in a QOF – an investment vehicle that is organized as a corporation or a partnership for the purpose of investing in properties within qualified opportunity zones. These investments cannot be in another QOF, and the properties must have been acquired after December 31, 2017. The fund must hold at least 90% of its assets in the qualified-opportunity-zone property, as determined by averaging the percentage held in the fund on the last days of the two 6-month periods of the fund’s tax year. Taxpayers may not invest directly in qualified opportunity zone property.

Partnerships – Because a QOF that is purchased with deferred capital gains has a basis of zero, taxpayers who invest in QOFs that are organized as partnerships may be limited to deducting the losses that these partnerships generate.

Qualified Opportunity Zones – A low-income census tract can be specifically designated as a qualified opportunity zone after a nomination from the governor of that community’s state or territory. Once the qualified opportunity zone nomination is received in writing, the U.S. Treasury Secretary can certify the community as a qualified opportunity zone. Once certified, zones retain this designation for 10 years.

If you have a capital gain or potential gain and would like to explore the tax ramifications for your particular situation of deferring the gain into a QOF, please call us.

How to Pay Your Federal Taxes

If you aren’t one of those lucky Americans who gets a tax refund from the IRS, you might be wondering how you go about paying your balance due. Here are some electronic and manual payment options that you can use to pay your federal income tax:

  • Electronic Funds Withdrawal – You can pay using funds from your bank account when your tax return is e-filed. There is no charge by the IRS for using this payment method, and payment can be arranged by your tax return preparer, allowing for e-filing of your return and submitting an electronic funds withdrawal request at the same time.
  • Direct Pay – You can schedule and make a payment directly from your checking or savings account using IRS Direct Pay. There is no fee for this service, and you will receive an e-mail notification when the funds have been withdrawn. Payments, including estimated tax payments, can be scheduled up to 30 days in advance. You can change or cancel the payment up to two business days before the scheduled payment date.
  • Electronic Federal Tax Payment System – This is a more sophisticated version of the IRS’s Direct Pay that allows not only federal income tax but also employment, estimated and excise tax payments to be made over the Internet or by phone from your bank account, with a robust authentication process to ensure the security of the site and your private information. This is a free service. Payments, which can be scheduled up to 365 days in advance, can be changed or cancelled up to two days prior to the scheduled payment date. You can use IRS Form 9783 to enroll in the system or enroll at EFTPS.gov – but do so well in advance of the date when a payment is due because the government will use U.S. mail to send you a personal identification number (PIN), which you will need to access your EFTPS account.
  • Send a Check – You can also pay the old-fashioned way by sending in a check along with a payment voucher. The payment voucher – IRS Form 1040-V – includes the information needed to associate your payment with your IRS account. IRS addresses for where to send the payment and your check are included with Form 1040-V.
  • Pay with Cash – Taxpayers without bank accounts or those who would just prefer to pay in cash can do so by making a cash payment at a participating 7-Eleven store. Taxpayers can do this at more than 7,000 locations nationwide. Taxpayers can visit IRS.gov/paywithcash for instructions on how to pay with cash. There is a very small charge for making a cash payment, and the maximum amount is $1,000 per payment. But don’t wait until the last minute, as it will take up to a week for the IRS to receive the cash payment.

The IRS also has a mobile app that allows taxpayers to pay with their mobile device. Anyone wishing to use a mobile device can access the IRS2Go app to pay with either Direct Pay or by debit or credit card. IRS2Go is the official mobile app of the IRS and is available for download from Google Play, the Apple App Store or the Amazon App Store.

If you are unable to pay the taxes that you owe, it is generally in your best interest to make other arrangements to obtain the funds needed to fully pay your taxes, so that you are not subjected to the government’s penalties and interest. Here are a few options to consider when you don’t have the funds to pay all of your tax liability.

  • Credit Card – Another option is to pay by credit card by using one of the service providers that works with the IRS. However, as the IRS will not pay the credit card discount fee, you will have to pay that fee. You will also have to pay the credit card interest on the payment.
  • Installment Agreement – If you owe the IRS $50,000 or less, you may qualify for a streamlined installment agreement that will allow you to make monthly payments for up to six years. You will still be subject to the late payment penalty, but it will be reduced by half. In addition, interest will also be charged at the current rate, and you will have to pay a user fee to set up the payment plan. By signing up for this arrangement, you agree to keep all future years’ tax obligations current. If you do not make payments on time or if you have an outstanding past-due amount in a future year, you will be in default of the agreement, and the IRS will then have the option of taking enforcement actions to collect the entire amount you owe. If you are seeking an installment agreement exceeding $50,000, the IRS will need to validate your financial condition and your need for an installment agreement through the information you provide in the Collection Information Statement (in which you list your financial information). You may also pay down your balance to $50,000 or less to take advantage of the streamlined option.
  • Tap a Retirement Account – This is possibly the worst option for obtaining funds to pay your taxes because it jeopardizes your retirement and the distributions are generally taxable at the highest bracket, which adds more taxes to the existing problem. In addition, if you are under age 59.5, such a withdrawal is also subject to a 10% early-withdrawal penalty, which will compound the problem even further.
  • Family Loan – Although it may be uncomfortable to ask, obtaining a loan from a relative or friend is an option because this type of loan is generally the least costly, in terms of interest.

Whatever you decide, don’t just ignore your tax liability, as that is the worst thing you can do, and it can only make matters worse. Please call to discuss your payment options.