Disaster-Related Tax Losses May Be Less Than Expected

Article Highlights:

  • Limitation to Losses within Disaster Areas
  • Cost versus Market Value
  • Home Tax Losses
  • Home Tax Gains
  • Replacement Properties
  • Home Gain Exclusion

The late-2017 tax-reform package changed the rules for personal casualty losses, which now are only deductible if they occur in a federally declared disaster area. As a result, if a home is destroyed in a forest fire or other disaster within a declared disaster zone, the homeowner can claim a casualty loss on that year’s tax return. However, if a home is destroyed as a result of a normal accident, or is destroyed in a natural disaster but lies outside of a disaster zone, the homeowner cannot claim a casualty loss. Currently, the rules are only in effect for the years 2018 through 2025. Because of these rules, you should also make sure that your home insurance coverage is adequate.

Even those who have deductible losses may quickly find out that they cannot claim as much in tax losses as they expected. This is because the losses are not based on the cost of replacing the home; instead, they are based on the original cost of the home (plus any improvements prior to the date of the casualty). For those who have owned their homes for a long time before a casualty, the tax benefits of the resulting loss are greatly diminished.

This all stems from the fact that a casualty loss on a home is valued at the lesser of the home’s cost or its current market value (minus any insurance reimbursements). Because real estate generally appreciates in value, most casualty losses are based on the original cost of the home rather than on its current value or its replacement cost.

Example #1: Joe and Susan purchased their home many years ago for $125,000, but its current market value is $400,000. Their home is then destroyed as a result of a federally declared disaster. They did not have insurance. Thus, their casualty loss is only $125,000 (the original cost), as that is less than the current market value. Thus, even though they suffered a $400,000 financial loss, the tax loss is only $125,000. (Even worse, the actual deductible loss is even less, as reductions of $100 per casualty and 10% of adjusted gross income must first be applied.)

If a home is insured, then an actual financial loss due to a disaster can actually result in a tax gain.

Example #2: The circumstances are the same as in Example #1, except Joe and Susan’s homeowners’ insurance paid them 100% of the home’s current value. For tax purposes, the $125,000 original cost must be used; the insurance reimbursement is then subtracted from that cost to determine the casualty loss. As a result, after the $400,000 reimbursement, Joe and Susan actually have a $275,000 tax gain ($400,000 minus $125,000) instead of a loss.

Luckily, the new tax law includes a provision in which the homeowner can treat the involuntary conversion of a principal residence due to destruction (among other situations) as a sale. Such sales are eligible for the home-sale gain exclusion, provided that the taxpayers meet certain requirements for length of ownership and occupancy. Married taxpayers who file jointly can exclude up to $500,000 of home-sale gain after such a disaster, provided that they have owned and lived in the destroyed home for at least 2 of the prior 5 years. (For a single taxpayer, that exclusion is $250,000.) Thus, in Example 2, if Joe and Susan meet these requirements, they can exclude all of their $275,000 gain (because it is less than $500,000). If the gain is greater than this limit, the remaining amount can be deferred, provided that the taxpayer purchases a replacement residence.

The insurance proceeds that homeowners receive for a destroyed residence (or its contents) are treated as a common pool of funds. If those funds are used to purchase a property that is similar to lost property, then the taxpayer must recognize the gain only to the extent that the funding pool exceeds the cost of the replacement property. The period for replacing damaged or lost property is four years, starting with the end of the first taxable year when any part of a gain due to involuntary conversion is realized.

Under all circumstances, homeowner’s insurance is appropriate; in fact, mortgage lenders generally require it. Be sure that your home is insured for an appropriate amount that includes any appreciation.

As you see, disaster-related casualty losses can be tricky, and the results can be unexpected. Please contact us if you have experienced a disaster-related loss or if you have any questions.

What Is the Statute of Limitations on Unpaid Taxes?

If you have unpaid taxes that you haven’t yet been making payments toward, it might make you fearful that the IRS will come a-knocking one day to collect on what you owe. Tax debt can quickly snowball from interest, penalties, late fees, and the amount of the taxes due.

However, a lot of the scaremongering surrounding the IRS is largely sensationalized in media and daily conversation. Agents won’t come bursting through your door just because you have tax debt. Instead, they must follow due process in accordance with the Internal Revenue Service Restructuring and Reform Act of 1998 (RRA). This means that you will always receive written notice concerning your balance due as well as collection actions and any requests for payment plans or settling your account.

However, if you haven’t received further notification concerning what you owe, you may be able to ride out the little-known statute of limitations on tax debt collections, which is 10 years.

What the 10-Year Statute of Limitations Entails

Your tax debt can actually be canceled in 10 years if the IRS makes no efforts to collect on your account – and if you also don’t contact the IRS. However, it’s not as simple as just waiting a decade without ever paying the taxes you owe. There are conditions that must be satisfied. The first is that this 10-year time frame doesn’t begin when you filed that tax return with a balance due or when you realized you owed taxes you couldn’t pay.

The official statute of limitations date begins once you receive written notice from the IRS concerning what you owe. You may receive a notice of deficiency with an actual tax bill or a substitute tax return if you didn’t file by the due date. So, if you filed your tax return on June 15, 2019, and got a notice in the mail dated September 1, your statutory period would begin September 1, not June 15. This date is called the CSED (Collection Statute Expiration Date), and if you make it to September 1, 2029, without further collection actions, then you can actually get your entire tax bill from this period canceled. (Note: Future tax bills, such as next year’s taxes you also can’t afford to pay on the due date, do not count toward this.)

However, the IRS will not notify you of this. While the date of assessment is also generally when that notice is received, the IRS has argued over when the assessment date actually was. Some situations can also delay the CSED by halting the clock on the 10-year time frame, such as:

  • Filing for bankruptcy
  • Being outside the U.S. for at least six months
  • Military deferment
  • Submitting an offer in compromise to settle back taxes
  • Filing a lawsuit against the IRS
  • Having your assets held in court custody due to divorce, judgments against you, etc.

It takes six months after bankruptcy cases settle to get the clock restarted on the CSED, so this means the IRS has more time to take collection actions against you, and the IRS will tend to ramp up these efforts before the statute of limitations expires.

State Tax Debt

Unlike the IRS, state tax departments do not have reciprocity with the RRA or the Taxpayer Bill of Rights. Taxpayers who are subject to state income tax need to find out what options, if any, are offered by their state tax department. State tax departments may actually take harsher collection actions since they don’t have to have oversight committees and the option for taxpayers to settle back taxes or make payment plans, and they do not have a statute of limitations on collections. The IRS tends to get a bad rap in movies and on TV, but it’s actually the state tax departments that are more likely to show up unannounced or issue liens a lot sooner.

It’s very rare than anyone rides out the statute of limitations, and it’s usually due to extenuating circumstances like disability or a debilitating business closure. If enough time has passed that you think you might be able to go the whole 10 years without payments or responses to collection actions, you must keep fastidious records of all correspondence with the IRS. If the IRS sent you little or no mail in the time period after the time you think the CSED kicked off, you may qualify for the statute of limitations but should not intentionally try to ride it out without the guidance of a tax professional specializing in tax relief and resolution issues.

If you have any questions about the statute of limitations on unpaid taxes, please contact us.

See the U.S. Tax System Illustrated in One Complex Map

Not sure whether you should hire a tax professional to file your taxes? Thinking that maybe this year you’ll do it yourself? You may want to think again after taking a look at a new graphic released by the Taxpayer Advocate Service (TAS). The organization, which is dedicated to helping taxpayers resolve tax problems, releases a map every year that’s designed to help us all understand the workings of the tax system.

To truly understand just how complicated America’s tax system is, take a look at the newest TAS chart:

If you were to Google, “Why are taxes so complicated in the U.S.?” You would receive endless options for pages and websites looking to give you an explanation. Reviewing the top results will make it clear that even though we were promised taxes so simple that we could send them in on a postcard, the Tax Cuts and Jobs Act of 2017 made the situation even more complicated. Even tax professionals are still scratching their heads and trying to figure the whole thing out.

Though the leader of TAS, National Taxpayer Advocate (NTA) Nina Olson’s goal is to “recommend changes that will prevent problems,” her hopes for doing that are as dashed as the average taxpayer’s when she looks at this year’s chart. “Anyone looking at this map will understand that we have an incredibly complex tax system that is almost impossible for the average taxpayer to navigate,” she said.

In the face of increasing complexity, what’s a taxpayer to do to make sure that their taxes are prepared properly and in a way that minimizes their tax liability? The only good answer seems to be to seek professional help.

Hire a Tax Professional.

It’s tempting to try to make your way through your tax forms yourself, especially with the advent of so many off-the-shelf, do-it-yourself tax programs. But in light of the complexities that the process involves, you are subject to a wide margin of error. We strongly recommend that you retain an accounting firm that is on top of every rule change and regulation, as it is issued. If you’re on the fence, just consider what you’d have to do to get even a basic understanding of the impact of the latest tax reform law: for instance, reading this 14-page document from the IRS. Unfortunately, reading this document is not likely to make things particularly clear or easy to understand.

When you consider the amount of studying you would have to do just to understand the basics, and not even scratch the surface of the extra deductions and credits that you may be entitled to, there’s no doubt that it’s worth your investment to hire a tax professional. It’s the decision that 72% of small business owners have made, acknowledging that the money they spend on these services is well worth it.

If you have any questions or would like to discuss your particular tax situation and planning options, please contact us.

Earn Tax-Free Income from Working Abroad

Article Highlights:

  • Tax-Free Income from Working Abroad
  • Foreign Earned Income and Housing Exclusions
  • Foreign Self-Employment Income
  • Claiming or Revoking the Exclusion

U.S. citizens and resident aliens are taxed on their worldwide income, whether they live inside or outside of the U.S. However, qualifying U.S. citizens and resident aliens who live and work abroad may be able to exclude from their income all or part of their foreign salary or wages, or amounts received as compensation for their personal services. In addition, they may also qualify to exclude or deduct certain foreign housing costs.

This exclusion applies to both employees and self-employed individuals. In addition to the excludable income, this can also be an attractive option to individuals who wish to travel the world while still earning income from their employer or self-employment clients.

You can have payroll disbursements and client payments deposited in your U.S. bank account, charge expenses on your credit card, and use online banking to make credit card payments, thus avoiding any foreign bank account reporting.

You will still have to file a U.S. 1040 tax return and report your income the same way as if you were living and working in the U.S. However, if you meet certain requirements, you will be able to exclude some or all of your foreign earnings from income tax.

To qualify for the foreign earned income exclusion, a U.S. citizen or resident alien must:

  • Have foreign earned income (income received for working in a foreign country, including payroll disbursements from a U.S. employer and self-employment income);
  • Have a tax home in a foreign country; and
  • Meet either the bona fide residence test or the physical presence test.

The foreign earned income exclusion amount is adjusted annually for inflation. For 2019, the maximum is up to $105,900 per qualifying person. If the taxpayers are married and both spouses work abroad and meet either the bona fide residence test or the physical presence test, each one can choose the foreign earned income exclusion. Together, they can exclude as much as $211,800 for the 2019 tax year, but if one spouse uses less than 100% of his or her exclusion, the unused amount cannot be transferred to the other spouse.

In addition to the foreign earned income exclusion, qualifying individuals may also choose to exclude or deduct a foreign housing amount from their foreign earned income. The amount of qualified housing expenses eligible for the housing exclusion and housing deduction is generally limited to 30% of the maximum foreign earned income exclusion. The housing amount limitation is $31,770 for the 2019 tax year. However, the limit will vary depending on where the qualifying individual’s foreign tax home is located and the number of qualifying days in the tax year. The foreign earned income exclusion is limited to the actual foreign earned income minus the foreign housing exclusion. Therefore, to exclude a foreign housing amount, the qualifying individual must first figure the foreign housing exclusion before determining the amount for the foreign earned income exclusion.

It’s important to note that foreign earned income does not include the following amounts:

  • Pay received as a military or civilian employee of the U.S. Government or any of its agencies.
  • Pay for services conducted in international waters (not a foreign country).
  • Pay in specific combat zones, as designated by a Presidential Executive Order, that is excludable from income.
  • Payments received after the end of the tax year when the services were performed to earn the income.
  • The value of meals and lodging that are excluded from income because they were furnished for the employer’s convenience.
  • Pension or annuity payments, including Social Security benefits.

A qualifying individual may also claim the foreign earned income exclusion on foreign-earned self-employment income. The excluded amount will reduce the individual’s regular income tax but will not reduce his or her self-employment tax. Also, the foreign housing deduction—instead of a foreign housing exclusion—may be claimed.

A qualifying individual claiming the foreign earned income exclusion, the housing exclusion, or both must figure the tax on the remaining non-excluded income using the tax rates that would have applied had the individual not claimed the exclusions. In other words, the exclusion is “off the bottom,” not “off the top.”

Once the foreign earned income exclusion is chosen, a foreign tax credit—or a deduction for foreign income taxes—cannot be claimed on the income that can be excluded. If a foreign tax credit or tax deduction is claimed for any of the foreign taxes on the excluded income, the foreign earned income exclusion may be considered revoked.

Other issues to consider are as follows:

Earned income credit – Once the foreign earned income exclusion is claimed, the earned income credit cannot be claimed for that year.

Timing of election – Generally, a qualifying individual must initially choose the foreign earned income exclusion with one of the following income tax returns:

  • A return filed by the due date (including any extensions);
  • A return amending a timely filed return;
  • An amended return, which generally must be filed by the later of 3 years after the filing date of the original return or 2 years after the tax is paid; or
  • A return filed within 1 year from the original due date of the return (determined without regard to any extensions).

A qualifying individual can revoke an election to claim the foreign earned income exclusion for any year. This is done by attaching a statement to the tax return revoking one or more previously made choices. The statement must specify which choice(s) are being revoked, as the election to exclude foreign earned income and the election to exclude foreign housing amounts must be revoked separately. If an election is revoked, and if the qualifying individual again wishes to choose the same exclusion within 5 years, he or she must apply for approval by requesting a ruling from the IRS.

State Tax – If your U.S. state of residence when departing the U.S. is one with state income tax, you may be required to report all of the foreign income on the state tax return, unless there is an exception.

If you are considering working abroad, please contact us before you make your decision. We can provide information on foreign earned income and housing allowance exclusions, or about how to meet the bona fide residence or physical presence tests.

The IRS Has Cryptocurrency on Its Radar

Article Highlights:

  • IRS Focus
  • About Cryptocurrency
  • Tax Treatment
  • IRS Compliance Program
  • Letters Being Sent

If you own cryptocurrency, you should know that the IRS has owners of cryptocurrency in its sights because many cryptocurrency owners are not reporting or paying taxes on their cryptocurrency transactions. In fact, the IRS is so focused on this issue that it recently issued warning letters to over 10,000 taxpayers suspected to be under-reporting their digital profits.

About Cryptocurrency – If you are unfamiliar with the term cryptocurrency, the short definition is a form of digital money that is not controlled by any central authority. The first cryptocurrency created was Bitcoin, back in 2009. Since then, over 4,000 other cryptocurrencies have been created. Cryptocurrency can be digitally traded between users and can be purchased for, or exchanged into, U.S. dollars, euros, and other real or virtual currencies.

Tax Treatment – One of the big issues of cryptocurrency is how it is treated for tax purposes. The IRS says that it is property, so that every time it is traded, sold, or used as money in a transaction, it is treated much the same way as a stock transaction would be. The gain or loss over the amount of its original purchase cost must be determined and reported on the owner’s income tax return. That treatment applies for each transaction every time it is sold or used as money in a transaction.

Example A: A taxpayer buys Bitcoin (BTC) so he can make online purchases without the need for a credit card. He buys one BTC for $2,425 and later uses it to buy goods worth $500 (let’s say BTC was trading at $2,500 at the time he made his purchase). He has a $75 ($2,500 – $2,425) reportable capital gain. This is the same result that would have occurred if he had sold the BTC at the time of the purchase and used cash to purchase the goods. This example points to the complicated record-keeping requirement for tracking BTC’s basis. Since this transaction was personal in nature, no loss would be allowed if the value of BTC had been less than $2,425 at the time the goods were purchased. Of course, if the taxpayer in this example only sold a fraction of a Bitcoin – enough to cover the $500 purchase – the gain would only be $15: $500/$2500 = .2 x 2425 = 485; 500 – 485 = 15

For most, cryptocurrency is generally treated as a capital asset, so any gain is a capital gain, and if the gain is held for more than year and a day, any gain will be taxed at the more favorable long-term capital gains rates. If the cryptocurrency is being held as an investment and the sale results in a loss, then the loss may be deductible. Capital losses first offset capital gains during the year, and if a loss remains, taxpayers are allowed a $3,000-per-year loss deduction against other income, with a carryover to the succeeding year(s) if the net loss exceeds $3,000.

When cryptocurrency is used as payment to an employee, the usual payroll withholding and reporting rules still apply.  If used to make payments to an independent contractor, 1099 form reporting is still required. If the individual receiving payment in cryptocurrency is subject to backup withholding, the payer is required to withhold the required amount. In all reporting and withholding instances, the amounts must be in U.S. dollars.

IRS Compliance Program – That brings us to the issue at-hand. The IRS began sending letters to taxpayers at the end of August, and more than 10,000 taxpayers will receive one of three varieties of letters. If you received one of these letters, do not ignore it! The IRS compiled this list of taxpayers that it feels has not been reporting their cryptocurrency transactions from various ongoing IRS compliance efforts. The following is a synopsis of the types of letters:

Letter 6173 – Requires a response from the taxpayer, either by the taxpayer providing a statement to the IRS that they have already complied with the required reporting or by filing a return that reports their cryptocurrency transactions. For situations where the taxpayer had already filed a return, but had left off the cryptocurrency transactions, an amended return (Form 1040X) will need to be filed. Taxpayers who ignore this letter may face a full-blown audit by the IRS and could be subject to penalties.

Letter 6174 – This is a “soft notice” that does not require a response, and the IRS says it won’t be following up on it. However, the notice also warns that if the taxpayer had cryptocurrency gains and fails to amend their return or continues to be noncompliant on future returns despite receiving the letter, the taxpayer will be in hot water.

Letter 6174-A – The taxpayer isn’t required to respond to the letter, but does need to correct their prior returns in which cryptocurrency transactions have been omitted. The IRS warns of future enforcement action if the taxpayer doesn’t amend their return(s) or file their delinquent returns. After receiving the letter, the taxpayer can’t use an excuse of not knowing the law for failing to report their cryptocurrency gains.

Last year, the IRS announced a virtual (crypto) currency compliance campaign to address tax noncompliance related to virtual currency use through outreach and examinations of taxpayers. The IRS announced that it will remain actively engaged in addressing non-compliance related to virtual currency transactions. They will do so through a variety of efforts, ranging from taxpayer education to audits and criminal investigations.

Taxpayers who do not properly report the income tax consequences of virtual currency transactions are liable for the tax, penalties and interest. In some cases, taxpayers could be subject to criminal prosecution.

If you have received one of these IRS letters – or even if you haven’t received correspondence from the IRS, but have unreported cryptocurrency transactions from past years, please contact us. We can provide assistance in responding to the letter or in preparing the amended or late original returns to report your cryptocurrency transactions.

Does Your Tax ID Number Need to be Renewed?

Article Highlights:

  • Expiring ITINs
  • IRS Currently Accepting Renewal Applications
  • Family Renewal Options
  • How to Renew
  • Common Errors to Avoid

According to the Internal Revenue Service (IRS), about two million Individual Taxpayer Identification Numbers (ITINs) are set to expire at the end of 2019.

ITINs are used by people who file taxes or have payment obligations under U.S. law, but who are not eligible for a Social Security number. ITIN holders who have questions can visit the ITIN information page on the IRS website.

Any ITIN that has not been used on a federal tax return at least once in the last three consecutive years will expire on Dec. 31, 2019. In addition, ITINs with middle digits 83, 84, 85, 86 or 87 that have not already been renewed will also expire at the end of the year. ITINs with middle digits of 70 through 82 expired in past years. Taxpayers with these ITIN numbers who have not already renewed their ITIN can renew at any time. Note: It is important to understand that ITINs with middle digits 83 through 87 will expire regardless if they were used for filing returns in the last three years.

The IRS is currently accepting ITIN renewal applications – Taxpayers whose ITIN is expiring and who need to file a tax return in 2020 must submit a renewal application. Federal returns that are submitted in 2020 with an expired ITIN will be processed. However, exemptions and/or certain tax credits will be disallowed, and the taxpayers will be notified by mail advising them to renew their ITIN. Once the ITIN is renewed, any applicable exemptions and credits will be reinstated, and any applicable refunds will be issued. Therefore, renewing early will avoid these last-minute hassles and delays in receiving refunds.

Family renewal option – Taxpayers with an ITIN containing middle digits 83, 84, 85, 86 or 87, as well as all previously expired ITINs, have the option to renew ITINs for their entire family at the same time. Those who have received a renewal letter from the IRS can choose to renew the family’s ITINs together, even if family members have an ITIN with middle digits that have not been identified for expiration. Family members include the tax filer, spouse and any dependents claimed on the tax return.

How to renew an ITIN – To renew an ITIN, a taxpayer must complete a Form W-7 and submit all required documentation. Taxpayers submitting a Form W-7 to renew their ITIN are not required to attach a federal tax return. However, taxpayers must still note a reason why they need an ITIN on the Form W-7. See the Form W-7 instructions for detailed information. An application package can be submitted in one of three ways:

  1. By mail, along with original identification documents or copies certified by the agency that issued them, to the IRS address listed on the Form W-7 instructions. The IRS will review the identification documents and return them within 60 days.
  2. Work with Certified Acceptance Agents (CAAs) authorized by the IRS to help taxpayers apply for an ITIN. CAAs can authenticate all identification documents for primary and secondary taxpayers. They can also verify that an ITIN application is correct before submitting it to the IRS for processing and authenticate the passports and birth certificates for dependents. This saves taxpayers from mailing original documents to the IRS.
  3. In advance, call and make an appointment at a designated IRS Taxpayer Assistance Center to have each applicant’s identity authenticated in person instead of mailing original identification documents to the IRS. Each family member applying for an ITIN or renewal must be present at the appointment and must have a completed Form W-7 and required identification documents. See the TAC ITIN authentication page on the IRS website for more details.

Common errors to avoid – There are several common errors that can slow down ITIN renewal applications:

  • Mailing identification documentations without a Form W-7
  • Missing information on the Form W-7
  • Insufficient supporting documentation, such as U.S. residency documentation or official documentation to support name changes.
  • The IRS no longer accepts passports that do not have a date of entry into the U.S. as a stand-alone identification document for dependents from a country other than Canada or Mexico, or dependents of U.S. military personnel overseas. A dependent’s passport must have a date of entry stamp, otherwise the following additional documents to prove U.S. residency are required:
    • U.S. medical records for dependents under age 6,
    • U.S. school records for dependents under age 18, and
    • U.S. school records (if a student), rental statements, bank statements or utility bills listing the applicant’s name and U.S. address, if over age 18.

If you have questions or need assistance completing a renewal, please contact us.

Facing a Huge Gain from a Real Estate Sale?

Article Highlights:

  • Adjusted Basis
  • Passive Loss Carryovers
  • Installment Sale
  • Tax-Deferred Exchange
  • Tax on Net Investment Income
  • Qualified Opportunity Fund
  • Home Sale Exclusion

If you are contemplating selling real estate property, there are a number of issues that could impact the taxes that you might owe. Fortunately, there are steps you can take to minimize the gain, defer the gain, or spread it over several years. The first and possibly most important issue is adjusted basis. When computing the gain or loss from the sale of property, your gain or loss is measured from your adjusted basis in the property. Thus, your gain or loss would be the sales price minus the sales expenses and adjusted basis.

Adjusted Basis – So, what is adjusted basis? Determining adjusted basis can sometimes be complicated. In a simplified overview, it is a dollar amount that starts with your acquisition value and is then adjusted up for improvements to the property, down for depreciation taken on the property, and down for any casualty losses claimed on the property. The acquisition value could be the price you paid for the property, the fair market value of an inheritance at the date of the decedent’s death, or, in the case of a gift, the donor’s adjusted basis at the time of making the gift.

It is extremely important to keep track of your basis, since it is a key factor in determining gain or loss upon the sale of the property. Failure to maintain proper records and supporting documentation could result in a significant income tax liability.

Passive Loss Carryover – If the property was a rental and the rental operated at a loss, there is a chance that the losses were not fully deductible in the year(s) of the loss because of the passive loss limitation rules. In this case, you will have a passive loss carryover that can be used to offset the gain. In addition, current year passive losses and passive loss carryovers you may have from other properties can also be used to offset any gain from selling a rental property.

Next, you have to decide whether you want to take (i.e., report on your tax return) all the income in one year or whether to attempt to spread the income over a period of years with an installment sale (by carrying back a loan). Or you can defer the income into a replacement property through a tax-deferred exchange.

Installment Sale – In an installment sale, the seller acts as the lender to the buyer. That can entail holding the first trust deed or taking back a second trust deed for only a portion of the loan amount. However, second trust deeds are as the name implies: They are second in line to be paid if the buyer defaults on the loan and thus are riskier. When they are set up as an installment sale, part of the gain is reported for each year that payments are received, generally as capital-gain income. In addition, the interest that the buyer pays the seller is taxable as ordinary income to the seller. Installment sales can be structured as short- or long-term loans, but remember, the buyer can always pay off the loan early or refinance. Either of these actions would make the balance of the profit from the sale taxable at that time.

Tax Deferred Exchange – Another option if the property is held for investment or used in a trade or business is to defer the gain in the future. This is accomplished by using the rules of IRS Code Section 1031, which allows the taxpayer to acquire like-kind property and defer the gain into the replacement property, which also must be used for business or be held for investment. However, the rules for like-kind exchanges are complicated, have strict timing issues, and require advance planning with a professional familiar with Section 1031 rules.

Net Investment Income Tax – Adding complications to the sale-planning issue is the surtax on net investment income. This 3.8% additional tax kicks in when a taxpayer’s modified adjusted gross income (MAGI) exceeds $200,000 ($250,000 for married joint filers and $125,000 for married individuals filing separately). Gain from the realty sale is included in the MAGI and could cause the MAGI threshold to be exceeded, resulting in this surtax applying to some or all of the realty gain. However, it may be minimized, or possibly eliminated, by using an installment sale and spreading the gain over several years or deferring down the road with a tax-deferred exchange.

Qualified Opportunity Fund (QOF) – Taxpayers who have a capital gain from selling or exchanging any 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. One exception is that the gain from the subsequent sale of the QOF cannot be deferred into another QOF. 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.

Home Sale Exclusion – If the real estate is your home (primary residence), there are special rules. Generally, if you own and occupy the home in two out of the five years prior to the sale, you will be able to exclude a substantial portion of your gain. The tax-deferred exchange rules do not apply to personal-residence sales. The amount of the home exclusion can be as much $250,000 ($500,000 for married couples filing jointly). There are even special rules that allow a reduced exclusion under certain special circumstances.

As you can see, the result of selling real estate property can include several tax issues, and minimizing current taxes requires some careful planning. Please contact us for assistance in planning your real estate transactions.

How to File Taxes After Getting Married

Article Summary:

  • Filing Options
  • Married Filing Jointly
  • Unpleasant Consequences
  • Pleasant Consequences
  • Married Filing Separately
  • Notifying SSA, IRS, employers
  • Other Issues to Consider

A taxpayer’s filing status for the year is based upon his or her marital status at the close of the tax year. Thus, if you get married on the last day of the tax year, you are treated as married for the entire year. The options for married couples are to file jointly or separately. Both statuses can result in surprises – some pleasant and some unpleasant – for individuals who previously filed as unmarried.

Individuals filing jointly must combine their incomes, and if both spouses are working, combining income can trigger several unpleasant surprises, as many tax benefits are eliminated or reduced for higher-income taxpayers. To follow are some of the more frequently encountered issues created by higher incomes:

  • Being pushed into a higher tax bracket
  • Causing capital gains to be taxed at higher rates
  • Reducing the childcare credit
  • Limiting the deductible IRA amount
  • Triggering a tax on net investment income that only applies to higher-income taxpayers
  • Causing Social Security income to be taxed
  • Reducing the Earned Income Tax Credit
  • Reducing or eliminating medical deductions

Generally, filing separately will not alleviate the issues because the tax code includes provisions to prevent married taxpayers from circumventing the loss of tax benefits that apply to jointly filing higher-income taxpayers by filing separately.

On the other hand, if only one spouse has income, filing jointly will generally result in a lower tax because of the lower joint tax brackets and a higher standard deduction, double the amount for single individuals ($24,400 for 2019), if the couple does not itemize deductions. In addition, some of the higher-income limitations that might have applied to an unmarried individual with the same amount of income may be reduced or eliminated on a joint return.

Filing as married but separate will generally result in a higher combined income tax for married taxpayers. For instance, if a couple files separately, the tax code requires both to itemize their deductions if either does so, meaning that if one itemizes, the other cannot take the standard deduction. Another example relates to how a married couple’s Social Security (SS) benefits are taxed: on a joint return, none of the SS income is taxed until half of the SS benefits plus other income exceeds $32,000. On a married-but-separate return, and where the spouses have lived together at any time during the year, the taxable threshold is reduced to zero.

Aside from the amount of tax, another consideration that married couples need to be aware of when deciding on their filing status is that when married taxpayers file jointly, they become jointly and individually responsible (often referred to as “jointly and severally liable”) for the tax and interest or penalty due on their returns. This is true even if they later divorce. When using the married-but-separate filing status, each spouse is only responsible for his or her own tax liability.

Once a couple files as married filing jointly they cannot undo that. However, if they file separately, they can later amend that filing status to married filing jointly.

As soon as a couple is married, the Social Security Administration should be notified of any name changes, and if they’ve moved, the IRS needs to be notified of the couple’s new address.

If either or both newlyweds purchased their health insurance through a government marketplace, the marketplace should be advised of the couple’s marriage. Any advance premium tax credit (APTC) being applied to pay the insurance premiums can be adjusted when necessary. Doing so could prevent having to repay some or all the APTC when filing their federal return(s) for the year of the marriage.

Of course, the couple needs to notify their employers of their new marital status so any affected benefits can be updated. Usually new W-4 forms should be prepared and given to their employers so income tax withholding can be revised for the new filing status.

Other issues that may come into play and should be considered are:

  • If one of the spouses has an outstanding liability with the IRS or state taxing authority, that situation could jeopardize any future refund on a jointly filed return.
  • It may be appropriate not to commingle income from assets a spouse wants to maintain as separate property or where the spouses want to name separate beneficiaries.
  • Individuals marrying later in life may wish to keep their incomes separate or only pay the tax on their own income.

If you have questions or would like an appointment to evaluate the impact of marriage on your tax liability before getting married, please contact us.

Looking Ahead to 2019 Taxes

Article Highlights:

  • Solar Credit
  • Plug-In Electric Vehicle Credit
  • Penalty for Not Having Health Insurance
  • Medical Deduction Restrictions
  • New Alimony Rules
  • Standard Deduction Increase
  • Increased Retirement Contributions
  • Federal Tax Brackets Increase

You have your 2018 tax return filed, or perhaps on extension, and now it is time to look forward to the changes that will impact your 2019 return when you file it in 2020.

Keeping up with the constantly changing tax laws can help you get the most benefit out of the laws and minimize your taxes. Many tax parameters, such as the standard deduction, contributions to retirement plans, and tax rates, are annually inflation adjusted, while some tax changes are delayed and take effect in future years. On top of all that, Congress is considering the retroactive extension of some tax provisions that expired after 2017, as well as, proposing new tax legislation.

The inflation adjustments shown are not the only items adjusted for inflation. For a full list, see IRS Revenue Procedure 2018-57.

At any rate, here are some changes that might affect your 2019 return:

  1. Solar Credit– Although the solar credit remains at 30% for 2019, as a reminder, the credit rate will drop to 26% in 2020. This means that for each $1,000 spent on qualified solar property, the credit will be $40 less in 2020 than if the expense were paid and the credit was claimed in 2019. However, this is a non-refundable credit, meaning it can only offset your tax liability, but the unused credit can carry over to a future tax year if the credit is allowed; it is currently scheduled to end after 2021. So, be cautious of overzealous salespeople trying to talk you into an expenditure for which you may not get the full credit.
  2. Plug-In Electric Vehicle Credit– Although the credit amounts have not changed, the credit begins to phase-out for each manufacturer after it produces its 200,000th qualifying vehicle. For example, the very popular Tesla vehicle did qualify for the full credit in 2018. However, Tesla has entered the phase-out stage, and for 2019, the credit is only $3,750 for purchases in the first six months of the year, then drops to $1,875 for vehicles bought through the rest of 2019 and is zero for post-2019 purchases. If you are contemplating buying a plug-in electric vehicle, check the IRS website for the current credit by manufacturer.
  3. Penalty for Not Being Insured– The Affordable Care Act required individuals to have health insurance and imposed a “shared responsibility payment” – really a penalty – for those who didn’t comply. The penalty could have been as much as $2,085 for most families. That penalty will no longer apply in 2019 or the foreseeable future.
  4. Medical Deductions Further Restricted– Unreimbursed medical expenses are allowed as an itemized deduction to the extent they exceed a percentage of a taxpayer’s adjusted gross income (AGI). As part of the Affordable Care Act, Congress increased that percentage from 7.5% to 10%. That increase was temporarily rescinded in the most recent tax form. However, starting with the 2019 returns and for the foreseeable years, the AGI medical floor will be 10% of AGI. This is where the “bunching” strategy may benefit your ability to deduct medical expenses. This means paying as much of your medical expenses as possible in a single year so that the total will exceed the AGI floor and your overall itemized deductions will exceed the standard deduction. Example: Your child is having orthodontic work done, which will cost a total of $12,000, and the dentist offers a payment plan. If you pay in installments, you will spread the payments out over several years and may not exceed the medical AGI floor in any given year. However, by paying all at once, you will exceed the floor and get a medical deduction. 
  5. New Alimony Rules– For divorces and separation agreements entered after 2018, the alimony paid is not deductible, and the alimony received is not taxable. In addition, the alimony recipient can no longer make an IRA contribution based on the alimony received.It is important to understand that this treatment of alimony only applies to alimony payments paid under agreements entered into after 2018 or under prior agreements modified after 2018 that include this new provision. For agreements entered before 2019 that haven’t been modified, the old rules continue to apply: the alimony paid is deductible, and the alimony received is included in income. Also, an IRA deduction can be made based upon the taxable alimony received.
  6. Standard Deduction– The standard deduction, which is inflation adjusted annually, is used by taxpayers who do not have enough deductions to itemize. For 2019, the standard deductions have increased as follows:

    •  Single: $12,200 (up from $12,000 in 2018)
    • Married filing jointly: $24,400 (up from $24,000 in 2018)
    • Married filing separately: $12,200 (up from $12,000 in 2018)
    • Head of household: $18,350 (up from $18,000 in 2018)

    Individuals who are blind and/or age 65 or over are allowed standard deduction add-ons. These add-ons are for the taxpayer and spouse but not for dependents. The add-on amounts are $1,300 for those filing jointly (unchanged from 2018) and $1,650 for all others (up from $1,600 in 2018).

  7. Increased Retirement Contributions– All IRA and retirement contributions are subject to inflation adjustment, meaning the allowable amounts may be increased each year. This gives you the opportunity to increase your retirement savings in 2019.

    • Simplified Employee Pension (SEP) Plans – The maximum amount for 2019 is $56,000 (up from $55,000 in 2018).
    • Individual Retirement Accounts (IRAs) – For both traditional and Roth IRAs, the maximum contribution has been increased to $6,000 (up from $5,500 in 2018). This is the first change to IRAs since 2013. The additional amount taxpayers age 50 and over can contribute remains unchanged at $1,000.
     401(k) Plans – The maximum employee contribution has been increased to $19,000 (up from $18,500 last year). The additional amount for taxpayers who’ve reached age 50 remains unchanged at $6,000.
    • Simple Plans – The maximum elective contribution is $13,000 (up from $12,500 in 2018). The additional amount for taxpayers age 50 and older remains unchanged at $3,000.
    • Health Savings Accounts (HSAs) – Although meant to be a way for individuals covered by a high-deductible health plan to save money for future medical expenses, these plans can also be used as a supplemental retirement plan. Contributions are deductible, earnings accumulate tax-free, and if distributions are used for qualified medical expenses, they are tax-free. However, when used as a supplemental retirement plan, the distributions would be taxable. The following are the contribution limits for 2019:

    • Self-only coverage: $3,500 (up from $3,450 last year)
    • Family Coverage: $7,000 (up from $6,900)

  1. Federal Tax Brackets– The tax brackets were inflation adjusted (by approximately 2% over the 2018 brackets), meaning more of your income is taxed at a lower bracket in 2019 than it was in 2018. As an example, here are the brackets for 2019 for taxpayers using the single filing status:

    10%: $9,700 or less
     12%: More than $9,700 but not more than $39,475
    • 22%: More than $39,475 but not more than $84,200
     24%: More than $84,200 but not more than $160,725
    • 32%: More than $160,725 but not more than $204,100
    • 35%: More than $204,100 but not more than $510,300
     37%: Applies to taxable incomes of more than $510,300

    These are the brackets for married taxpayers filing jointly:

    • 10%: $19,400 or less
     12%: More than $19,400 but not more than $78,950
    • 22%: More than $78,950 but not more than $168,400
    • 24%: More than $168,400 but not more than $321,450
    • 32%: More than $321,450 but not more than $408,200
     35%: More than $408,200 but not more than $612,350
    • 37%: Applies to taxable incomes of more than $612,350

    For other filing statuses, see Revenue Procedure 2018-57.

    Note: These are step functions, so for example, the first $9,700 of taxable income is taxed at 10%, the next $29,775 ($39,475 − $9,700) is taxed at 12%, and so forth.

For further information or to request a 2019 tax planning appointment, please contact us.

States’ SALT Deduction Workarounds Shot Down

Article Highlights:

  • Limit on Tax Allowed as an Itemized Deduction
  • States’ Attempted Workarounds
  • Supreme Court Ruling
  • Final Regulations
  • Notice 2019-12

The Treasury Department and the IRS have essentially shot down efforts by several states to help their residents circumvent the $10,000 cap on the itemized deduction for state and local taxes (SALT).

When the Tax Cuts and Jobs Act (TCJA), aka tax reform, was passed, it imposed a $10,000 limit on the SALT deduction; this limitation had a greater impact on the residents of states that imposed the highest taxes on their residents. As it turns out, the states with the highest taxes – income or property taxes, or a combination of the two – are all blue (Democratic) states; thus, many saw it as political retribution, causing some state leaders to seek a workaround.

Ultimately, several affected states, including New Jersey, New York, and Connecticut, developed similar schemes to skirt the $10,000 limitation. Here’s how their workarounds were supposed to have worked.

  1. Federal tax law names state and local governments as qualified charities, thus allowing gifts to them to be deducted as a charitable itemized deduction.
  2. The states created charitable funds; in turn, a contributor to the fund would receive tax credits.
  3. The tax credits could then be used against contributors’ SALT liabilities on their state income tax returns or, in some cases, property tax bills. Effectively, taxpayers would get a charitable deduction for their tax payments.

However, the challenge for these arrangements has turned out to be a 1986 Supreme Court ruling that says that if the taxpayer receives something in return (referred to as “quid pro quo” in legalese) for a contribution, the deductible portion of the contribution is reduced by the fair market value (FMV) of what is received in return for making the contribution.

This concept has been applied uniformly to all charitable contributions since the Supreme Court ruling, which is why many written substantiations from charities will include the FMV of items provided to the donor in return for the donor’s charitable contribution.

As a result, when the final tax regulations for the SALT limitation were issued, they followed the Supreme Court ruling and treated the tax credits provided in return for the contribution as “quid pro quo” and not allowable to deduct as a charitable contribution.

Since the states only allowed tax credits for a portion of the contribution, typically 85% to 90%, the portion not allowed as a tax credit on the state return can be deducted as a charitable contribution on the taxpayer’s federal return.

Fortunately for taxpayers, in the preamble to the final regulations, the Treasury indicated its concern that the regulations could create unfair consequences for individuals who had made a charitable contribution in return for tax credits. Consequently, simultaneously with releasing the final regulations, the IRS published Notice 2019-12 saying it intends to publish a proposed regulation to provide a safe harbor for certain individuals who make a charitable contribution in return for tax credits. Under the safe harbor, an individual may treat the portion of a state or local tax payment that is or will be disallowed as “quid pro quo” contributions. To qualify for the safe harbor, taxpayers must itemize deductions for federal tax purposes, and their total state and local tax liability for the year must be less than $10,000. Until the proposed regulations are issued, taxpayers may rely on Notice 2019-12. The following examples are based on those in Notice 2019-12.

Example #1 – The taxpayer makes a $500 payment to a local or state-run charity and receives a dollar-for-dollar credit against the taxpayer’s state income tax credit. The taxpayer’s state tax liability is $500 or more. For federal purposes, this $500 contribution can be treated as a tax payment, subject to the $10,000 SALT limitation. Without the safe harbor provision, the taxpayer would not be allowed any deduction for the $500 payment because the regulations require that the amount claimed as a charitable contribution must be reduced by the state credit amount, in this example $500 – $500 = $0.

Example #2 – The taxpayer makes a $7,000 payment to a local or state-run charity and receives a dollar-for-dollar credit against the taxpayer’s state income tax. Under state law, the credit may be carried forward for three taxable years. The taxpayer’s state tax liability for year 1 is $5,000. The taxpayer applies $5,000 of the credit against the year 1 state tax liability and carries the balance forward to year 2, when it is used against the taxpayer’s year-2 state tax liability. The taxpayer’s year-2 state tax liability exceeds $2,000. For federal purposes, the contribution is treated as a tax payment, with the $5,000 being treated as a year-1 tax deduction and the $2,000 treated as a year-2 tax deduction. Both the $5,000 and $2,000 are subject to the $10,000 SALT limitation.

Example #3 – The taxpayer makes a $7,000 payment to a local or state-run charity. In return for the contribution, the taxpayer receives a real property tax credit of $1,750, which is 25% of the contribution, and applies it to his $3,500 property tax bill. For federal purposes, the $1,750 is treated as a property tax payment, subject to the $10,000 SALT limitation. The balance of the contribution, $5,250, can be deducted as a charitable contribution.

If you have questions related to this issue or about the $10,000 limit on SALT deductions, please contact us.