Don’t Miss the Opportunity for a Spousal IRA

Article Highlights: 

  • Spousal IRA 
  • Compensation Requirements 
  • Maximum Contribution 
  • Traditional or Roth 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 their own IRA, otherwise known as a spousal IRA, as long as they have adequate compensation. 

The maximum amount that a non-working or low-earning spouse can contribute is the same as the limit for a working spouse, which is $6,000 for 2020. If the non-working spouse’s age is 50 or older, that spouse can also make “catch-up” contributions (limited to $1,000), raising the overall contribution limit to $7,000. These limits apply provided that the couple together has compensation equal to or greater than their combined IRA contributions. 

Example: Tony is employed, and his W-2 for 2020 is $100,000. His wife, Rosa, age 45, has a small income from a part-time job totaling $900. Since her compensation is less than the year’s contribution limit, she can base her contribution on their combined compensation of $100,900. Thus, Rosa can contribute up to $6,000 to an IRA for 2020. 

Both spouses’ contributions can be made either to a traditional or Roth IRA or split between them as long as the combined contributions don’t exceed the annual contribution limit. Caution: The deductibility of the traditional IRA and the ability to make a Roth IRA contribution are generally based on the taxpayer’s income: 

  • Traditional IRAs – There is no income limit restricting contributions to a traditional IRA. However, suppose the working spouse is an active participant in any other qualified retirement plan. In that case, a tax-deductible contribution can be made to the IRA of the non-participant spouse only if the couple’s adjusted gross income (AGI) doesn’t exceed $196,000 in 2020 (up from $193,000 in 2019). 
  • Roth IRAs – Roth IRA contributions are never tax-deductible. Contributions to Roth IRAs are allowed in full if the couple’s AGI doesn’t exceed $196,000 in 2020 (up from $193,000 in 2019). The contribution is ratebly phased out for AGIs between $196,000 and $206,000 (up from a range of $193,000 to $203,000 in 2019). Thus, no contribution is allowed to a Roth IRA once the AGI exceeds $206,000. 

Example: Rosa from the previous model can designate her IRA contribution as either a traditional deductible IRA or a nondeductible Roth IRA because the couple’s AGI is under $196,000. Had the couple’s AGI been 201,000, Rosa’s allowable contribution to a deductible traditional or Roth IRA would have been limited to $3,000 because of the phase-out. The other $3,000 could have been contributed to a conventional IRA and designated as nondeductible. 

Please contact us if you would like to discuss IRAs or need assistance with your retirement planning.

Is That Inheritance Taxable?

Article Highlights: 

  • Estate Tax 
  • Estate Tax Exemption 
  • Fair Market Value at Date of Death 
  • Step up in Basis 
  • Community Property 
  • Deferred Untaxed Income 

Are inheritances taxable? This is a frequently misunderstood taxation issue, and the answer can be complicated. When someone passes away, all of their assets (their estate) will be subject to estate taxation, and whatever is left after paying the estate tax passes to the decedent’s beneficiaries. 

Sound bleak? Don’t worry, very few decedents’ estates ever pay any estate tax, primarily because the tax code exempts a liberal amount of the estate’s value from taxation; thus, only extensive estates are subject to estate tax. In fact, with the passage of the Tax Cuts & Jobs Act (tax reform), the estate tax exemption has been increased to $11,580,000* for 2020 and will be inflation-adjusted in future years. That generally means that estates valued at $11,580,000* or less will not pay any federal estate taxes, and those over the exemption amount only pay estate tax on the excess amount. Of interest, there are less than 10,000 deaths each year. The decedent’s estate exceeds the exemption amount, so there will be no estate tax for most estates, and the beneficiaries will generally inherit the entire estate. 

* Note that, as with anything tax-related, the exemption is not always a fixed amount. Prior gifts must reduce it above the annual gift exemption, and it can be increased for a surviving spouse by the decedent’s unused exemption amount. 

Of course, once a beneficiary (also referred to as an heir) receives the inherited asset, any income generated by that property—be it interest from cash, rent from real estate, dividends from stocks, etc.—will be taxable to the beneficiary, just as if the property had always been the beneficiaries. 

Because the value of an estate is based upon the fair market value (FMV) of the assets owned by the decedent on the date of their death (or in some cases, an alternative valuation date six months after the decedent’s date of death, which is rarely used), the beneficiaries will generally receive the inherited assets with a basis equal to the same FMV determined for the estate. What this means to a beneficiary is that if they sell an inherited asset, they will measure their gain or loss from the inherited basis (FMV at date of death). 

Example #1: Joe inherits shares of XYZ Corporation from his father. Because XYZ Corporation is a publically traded stock, the FMV can be determined by what it is trading for on the stock market. Thus, if the inherited basis was $40 per share and the shares are later sold for $50 a share, Joe will have a taxable gain of $10 ($50 – $40) per share. The increase will also be a long-term capital gain since all inherited assets are treated as being held long-term by the beneficiary. On the flip side, if the shares are sold for $35 a share, Joe would have a tax loss of $5 per share. 

Example #2: Joe inherits his father’s home. Like other inherited property, Joe’s basis is the FMV of the house on the date of his father’s death. However, unlike the stock, the FMV, which could be determined from the trading value, the home needs to be appraised to determine its FMV. It is highly recommended that a certified appraiser perform the appraisal and be done reasonably close in time to the decedent’s death date. This is frequently overlooked and can cause problems if the IRS challenges the amount used for the basis. 

This FMV valuation of inherited assets is frequently referred to as a step-up in basis, which is a misnomer because the FMV can, under some circumstances, also be a step down in basis. 

If the decedent was married at the time of death and resided in a community property state, and if the couple held the property as community property, the beneficiary spouse will generally receive a basis equal to 100% of the FMV of the property, even though the spouse will have only inherited the deceased spouse’s share. 

Not all inherited assets received by the beneficiary fall under the FMV regime. If the decedent held assets that included deferred untaxed income, they would be treated differently by the beneficiary. Examples of those include inherited: 

Traditional IRA Accounts – These are taxable to the beneficiaries. Still, special rules generally allow a spouse beneficiary to spread the income over the surviving spouse’s lifetime, while the distribution period is capped at ten years for most non-spouse beneficiaries if the decedent died after 2019. Previously, the rules allowed most non-spouse beneficiaries of decedents who died before 2020 to use a lifetime distribution method. 

Roth IRAs – Qualified distributions are not taxable to the beneficiary. 

Compensation – Amounts received after the decedent’s death as compensation for their services. 

Pension Payments – These are generally taxable to the beneficiary. 

Installment Sales – Sometimes taxpayers will structure sales, usually of real property, so that the buyer pays the seller for the purchase with interest over several years. This is referred to as an installment sale. Whoever receives an installment obligation due to the seller’s death is taxed on the installment payments the same as the seller would have been had the seller lived to receive the payments.

This is just an overview of issues related to being the beneficiary of an inheritance. If you have questions about the tax ramifications of a potential or actual estate, please contact us.

Renting Your Home or Vacation Home for Short Periods

Article Highlights: 

  • Airbnb, VRBO, and HomeAway 
  • Rented for Fewer than 15 Days During the Year 
  • The 7-day and 30-day Rules 
  • Exceptions to the 30-Day Rule 
  • Schedule C Reporting 

Many taxpayers rent out their first or second homes without considering tax consequences. Some of these rules can be beneficial, while others can be very detrimental. If you rent your home to others, you should be aware of some special tax rules that apply to you. 

Even if you rent out your property using rental agents or online rental services that match property owners with prospective renters (such as Airbnb, VRBO, or HomeAway), it is still your responsibility to properly report the rental income and expenses on your tax return. 

Special (and sometimes complicated) taxation rules can make the rents that you charge tax-free. However, other situations may force your rental income and expenses to be treated as a business reported on Schedule C, as opposed to a rental activity reported on Schedule E. 

The following is a synopsis of the rules governing short-term rentals. 

Rented for Fewer than 15 Days During the Year – When a property is rented for fewer than 15 days during the tax year, the rental income is not reportable. The expenses associated with that rental are not deductible. Interest and property taxes are not prorated. The full amounts of the qualified mortgage interest and property taxes are reported as itemized deductions (as usual) on the taxpayer’s Schedule A. 

The 7-Day and 30-Day Rules – Rentals are generally passive activities, which means that losses from these activities are usually the only deductible up to the number of gains from other passive activities. However, an activity is not treated as a rental if either of these statements applies: 

A. The average customer use of the property is for seven days or fewer—or 30 days or fewer if the owner (or someone on the owner’s behalf) provides significant personal services. 

B. The owner (or someone on the owner’s behalf) provides extraordinary personal services without regard to the property’s average period of customer use.

If the activity is not treated as a rental, it will be treated as a trade or business. The income and expenses, including prorated mortgage interest and real property taxes, will be reported on Schedule C. IRS Publication 527 states: “If you provide substantial services that are primarily for your tenant’s convenience, such as regular cleaning, changing linen, or maid service, you report your rental income and expenses on Schedule C.” Substantial services do not include the furnishing of heat and light, the cleaning of public areas, the collecting of trash, or other such general amenities. 

The exception to the 30-Day Rule – If the personal services provided are similar to those that generally are provided in connection with long-term rentals of high-grade commercial or residential real property (such as public area cleaning and trash collection). If the rental also includes maid and linen services that cost less than 10% of the rental fee, then the personal services are neither significant nor extraordinary for the 30-day Rule. 

Profits and Losses on Schedule C – Typically, if you own and operate a business that isn’t set up as a corporation, your business’s income and expenses would be reported on Schedule C as part of your income tax return. You would pay self-employment tax (Social Security and Medicare taxes), as well as income tax, on the profit. However, suppose you have a profit from a rental activity. In that case, it is not subject to self-employment tax even when reported as self-employment income unless you are a real estate dealer. Suppose you have a loss from this type of activity. In that case, it is still treated as a passive activity loss unless you meet a material participation test—generally by providing 500 or more hours of personal services during the year related to the rental or qualifying as a real estate professional. Losses from passive activities are deductible only up to the passive income amount, but unused losses can be carried forward to future years. A special allowance for real estate rental activities with active participation permits a loss against nonpassive income of up to $25,000. This phases out when modified adjusted gross income is between $100K and $150K. However, this allowance does not apply when the activity is reported on Schedule C.

These rules can be complicated; please contact us to determine how they apply to your particular circumstances and what actions you can take to minimize tax liability and maximize tax benefits from your rental activities.

What Happens if I Receive an IRS CP2000 Notice?

Few things can send a chill down your spine more than mail from the IRS. Just seeing the agency’s name on an envelope’s return address creates anxiety. If you find yourself in that position and open the mail to find a CP2000 notice inside, you don’t need to panic — but you need to know what to do. 

What Is a CP2000 Notice? 

The Internal Revenue Service sends out CP2000 notices to taxpayers whose submitted tax returns do not reflect what’s been submitted by employers and others that provide the agency with information on the income you’ve received over the course of the tax year. Though these forms are not notifications that you’re subject to an audit, they do carry the full weight of an IRS inquiry, and as such, you are required to respond fully and promptly by the indicated deadline. 

The CP2000 is not just a notice that something doesn’t look right. Also known as an underreported inquiry, it is a notification that the income information the agency has received about you via forms like your W-2 and any 1099s does not match the information you’ve provided on your tax return. It can also point to issues the agency has regarding credits or deductions that you’ve taken. In addition to detailing those discrepancies, it will also suggest the amount of tax you owe based on the new information. The amount of penalty that the agency has calculated would be appropriate based on the information they have. 

A CP2000 notification is not the final word on monies owed or penalties. These notifications are computer-generated, and the system is not considered infallible. Taxpayers can file appeals arguing against both the determination and the penalties, and these appeals frequently address the situation entirely or significantly reduce the amount owed. But they do need to be answered. 

What should you do if you receive a CP2000 Notice? 

The first thing to do is to take a deep breath. A CP2000 notice is no reason for panic, but it is a reason to reach out to our tax office. That’s because a specific process needs to be followed, and it must be completed within the time frame that the IRS dictates. The process involves investigation and response at its core, but the steps are more complicated than that. If you’re a current client, contact our office so we can help you with these steps. If you aren’t a client yet, it’s highly recommended that you contact us and don’t try to undergo this complicated process alone: 

  • Determine whether you do owe the taxes that the IRS has indicated that you owe. To do that, you’ll need to retrieve all of the documents and statements you’ve received under your Social Security Number for the year to ensure that you included everything on your tax return. 
  • If you find that you failed to include all income, you’ll need to recalculate your taxes, determining whether the missed information impacts deductions or credits that you’re owed or that you took. This calculation can then be compared to the number that the IRS provided for both the taxes you owe and the penalty that has been suggested.
  • If you believe that the IRS calculation is correct, respond using the form provided, including any monies owed. If the amount exceeds your ability to pay at the moment, the IRS offers the ability to ask for an installment agreement. 
  • If you believe that the IRS calculation is wrong or only partially correct, you will need to provide documentation of why and submit that information to the agency. If some of their information is correct and your tax return needs to be modified, including the corrected return. Note that there is a difference between a fixed return, which you should use – and an amended return. Once the IRS reviews your corrections, they will either accept them and make the correction on your behalf or reject your response. 
  • If you agree that errors existed and want to discuss the IRS’s penalties, the underreported notice response can be used for these purposes. 
  • Await a response from the IRS. If you have not heard back in eight weeks, you can either call to determine the outcome of your case or check online to see whether a resolution has been noted. If the agency denies your response, you can file an appeal. 

Avoiding the same problem in the future 

It’s essential to keep in mind that if you’ve left necessary income information off of your tax return once, there may be a problem within your information-gathering process that needs to be fixed. Take care to avoid future mistakes by gathering all of your income information before submitting your return. If you’re not sure whether you have all of your wage and income transcripts, you can request copies from the agency (though they are not likely to be complete until late May, long after the filing deadline.) It’s also a good idea to go back and make sure that previously-filed returns are also error-free. If you find the same issue, quickly filing an amended return will save you from having to pay a hefty penalty. 

If you need professional help 

Receiving a CP2000 notice is intimidating, and seeking professional assistance with the process is a smart move. If you’d like our help with responding, start by gathering the following:

  • A copy of the notice and the associated tax return.
  • Tax returns from the year before and after the return notice was sent.
  • Copies of any responses you’ve submitted and any other CP2000 notices you’ve received in the past.
  • Any documents associated with deductions or expenses related to the subject of the CP2000.

With those things in hand, please contact us if you need assistance.

Employee Holiday Gifts May Be Taxable

Article Highlights: 

  • De Minimis Fringe Benefits 
  • Cash Gifts 
  • Gift Certificates 
  • Group Meals 
  • FICA and Wage Withholding 

It is common practice this time of year for employers to give their employees gifts. A gift is infrequently offered and has a fair market value so low that it is impractical and unreasonable to account for it; the gift’s value would be treated as a de minimis fringe benefit. It would be tax-free to the employee, and its cost would be tax-deductible by the employer. 

De Minimis Benefits – In general, a de minimis benefit is one that, considering its value and the frequency with which it provides, is so minor as to make accounting for it unreasonable or impractical. De minimis benefits are excluded from income under Internal Revenue Code section 132(a)(4) and include items not expressly excluded under other Code sections. Examples of de minimis benefits include such things as: 

  • Controlled, occasional employee use of a company photocopier. 
  • Occasional snacks, coffee, doughnuts, etc., furnished to employees. 
  • Occasional tickets for entertainment events are given to employees. 
  • Holiday Gifts from the employer to the employees. 
  • Occasional meal money or transportation expenses paid for by the employer for employees working overtime. 
  • Group-term life insurance on the life of an employee’s spouse or dependent with a face value, not more than $2,000. 
  • Flowers, fruit, books, etc., are provided to employees under particular circumstances, such as birthdays or illnesses. 
  • Personal use of a cell phone provided by an employer primarily for business purposes.

In determining whether a benefit is de minimis, you should always consider its frequency and value. An essential element of a de minimis benefit is that it is occasional or unusual in frequency. It also must not be a form of disguised compensation. 

Whether an item or service is de minimis depends on all the facts and circumstances. Also, suppose a benefit is too large to be considered de minimis. In that case, the entire value of the benefit is taxable to the employee, not just the excess over a designated de minimis amount. The IRS has ruled previously that items with a value exceeding $100 cannot be considered de minimis, even under unusual circumstances. 

Holiday Gifts – A cash gift, regardless of the amount, is considered additional wages and subject to employment taxes (FICA) and withholding taxes. Caution: If the gift recipient is a W-2 employee, the employer may not issue them a Form 1099-NEC or a 1099-MISC for a holiday gift of cash; the amount must be treated as W-2 income. 

When an employer gives gift certificates, debit cards, or similar items that are convertible to cash, the value is considered additional wages regardless of the amount. However, suppose the gift is a non-transferable coupon and convertible only into a turkey, ham, gift basket, or the like at a particular establishment. In that case, the gift coupon is not treated as a cash equivalent. 

Holiday group meals, cocktail parties, picnics, or similar events for employees are also treated as de minimis fringe benefits. 

If you have questions about the tax treatment of holiday gifts to employees, please contact us

Preparing for 2021: Tax Planning Strategies for Small Business Owners

If you are a small business owner, every penny of your income counts. This means that you want to optimize your revenue and minimize your expenses and your tax liability. Unfortunately, far too many entrepreneurs are not well-versed in the tricks and tools available to them and end up paying far more than they need to. You don’t need an accounting degree to take advantage of tax-cutting tips. Here are a few of our favorites. 

Think About Changing to a Different Type of Tax Structure 

When you started your business, one of the first decisions you needed to make was whether you wanted to operate as a sole proprietor, partnership, LLC, S corporation, or C corporation. But as more time goes by, the initial reasons for structuring your business the way that you did may no longer be applicable or in your best interest from a tax perspective. There is no requirement that you stick with the business structure you initially chose. 

Ever since the Tax Cuts and Jobs Act of 2017 (TCJA) changed the highest corporate income tax rate from 35% to 21%, sole proprietorships, LLCs, partnerships, and S corporations can realize significant tax savings by electing to be taxed as a C corporation. This simple change can make sense if these pass-through businesses’ owner is taxed at a high tax bracket. If so, all you need to do is fill out and file Form 8832. Before doing so, make sure that the tax savings you can realize are a reasonable tradeoff for the other reasons that you may have initially selected the structure you are currently in. 

Pass-Through Businesses Can Get a 20% 

One of the most impactful changes that the TCJA made for pass-through businesses whose income is passed-through for taxation as their owners’ income is a valuable tax break known as the qualified business income (QBI) deduction. For eligible recipients, this deduction is worth a maximum 20% tax break on the income they receive from the business – but determining whether or not you qualify can be a challenge. 

There are several restrictions on taking advantage of the deduction, particularly regarding specified service trade or businesses (SSTBs) whose owners either earn too much income or rely specifically on their employees’ or owners’ reputation or skill. Though architecture and engineering firms escape this limitation, other business models – including medical practices, law firms, professional athletes and performing artists, financial advisors, investment managers, consulting firms, and accountants – fall into the category that loses out of their income is too high. In 2019 single business owners of SSTBs began phasing out at $160,700 and are excluded once their income exceeds $210,700, while those who are married filing a joint return phase out at $321,400 and are excluded at $421,400. To calculate the deduction, use Part II of Form 8995-A

Businesses that are not SSTBs are eligible to take the deduction even when they pass the upper limits of the thresholds, but only for either half of the business owners’ share of the W-2 wages paid by the business or a quarter of those wages plus 2.5% of their share of qualified property. 

These limitations and specifications for what type of business is and is not eligible are head-spinning. Though it is tempting to take the deduction simply, it’s a good idea to confirm whether you qualify and how to claim it with our office before moving forward. 

Know How You’re Going to Pay Your Taxes

It is gratifying to live the dream of owning your own small business, but the hard work required to generate revenue makes paying taxes extra painful. This is especially true because of the “pay as you go” tax system that the United States uses, asking business owners to make estimated quarterly payments. While employees pay their taxes ahead via payroll deductions withheld by their employers, no such automatic system is set up for small business owners. That leaves many with the temptation of delaying making payments to maintain liquidity. 

Unfortunately, failing to pay taxes quarterly can put you in the uncomfortable position of still having to pay at one point, with the additional burden of penalties and interest resulting from your delay. Though setting aside the money to pay taxes requires discipline, doing so will save you from the penalties charged by the IRS. These are calculated based on the amount you should have paid each quarter multiplied by your shortfall and the effective interest rate during the specific quarter (established as 3 percent over the federal short-term rate – C corporations pay a different rate). Even if you don’t calculate your quarterly estimated rates correctly, the safe harbor rule allows small businesses to pay the lower amount, which is either 90% of the tax due on your current year return or 100% of the tax shown on your last filed tax return. For those whose AGI was over $150,000 in the previous tax year, the safe harbor percentage is 110% of the previous year’s taxes. 

It is always a good idea to increase the amount you send in if you have a higher-income year. By doing a simple calculation of your safe harbor number and dividing it by four, you have a reasonable quarterly payment that you can safely send in on the due dates (April 15th, June 15th, September 15th, and January 15th of the following year). By setting aside the appropriate percentage that you will owe from each payment you receive, you can easily set aside the money you will need to pay and entirely avoid concerns about penalties or interest. Payment is most easily submitted using the online link for IRS Direct Pay, though many people opt for sending in the paper vouchers for IRS Form 1040-ES, along with a check. There is also an EFTPS system available for C Corporations’ use. 

Choose Your Accounting Method Carefully

Each small business owner calculates their income and revenue differently, with many using a method of accounting that is based on when money is received rather than when an order is placed and counts expenses when they are paid rather than the item or service ordered. This is known as the cash method of accounting. 

Whatever method of accounting you use, smart business owners can strategically adjust their approach—reporting their annual income based on cash receipts to reduce their end-of-year revenues, especially if there is reason to believe that next year’s income will be lower or they anticipate being in a lower tax bracket. 

An example of how this approach would be helpful can be seen in a business that expects to add new employees in the new year. Between that expense and other improvements planned, it makes sense to anticipate that net income will be down. The tax bracket for the business will be lower, so any work is done or orders placed towards the end of the current tax year should be accounted for when payments arrive so that the income can be taxed at a lower rate. The contrast to this is if you anticipate your business revenue to increase and be forced into a higher tax bracket in the new year. In that case, it makes sense to try to collect monies for work done in the current year early so that you can take advantage of your current, lower tax rate. This can be done for business expenses such as office supplies and equipment, which can be deferred and accelerated in the same way so that you can take advantage of tax deductions in the most advantageous way. 

Establish and Make Deposits Into a 401(k) or SEP 

One of the smartest ways to lower your taxable income is to contribute to a retirement account. Not only does doing so reduce your business’ tax liability, but it also ensures a more secure future. As a small business owner, either a 401(K) plan or a Simplified Employee Pension (SEP) plan will do the trick while benefiting both you and those who work for you in the future. 

While a 401(k) that is established before year-end will let you deduct any contributions you make (with contributions limited to the lower of $57,000 or the employee’s total compensation), business owners who fail to set up this type of plan by December 31st can still turn to the SEP as an alternative. Though SEP contributions are restricted to 25% of the business owner’s net profit, less the SEP contribution itself (technically 20%), a SEP can be established, and contributions made up until the extended due date of your return. Suppose you obtain an extension for filing your tax return. In that case, you have until the end of that extension period to deposit the contribution, regardless of when you file the return.

If You Took Out a PPP Loan, Plan on it Being Forgiven 

Many small businesses took advantage of the PPP loans that were offered by the government in the face of the COVID-19 crisis. While these loans were attractive because they are forgivable and gave businesses a chance to survive the dire circumstances, in April of 2020, the IRS issued Notice 2020-32, which indicated that even though the forgivable loans can be excluded from gross income, the expenses associated with the money received cannot be deducted. This effectively erases the tax benefit initially offered because losing the employee and expense deduction increases the business’ income and profitability. 

There is some chance that this issue will be resolved by Congress, as it contradicts the original intent of the tax benefit that accompanied the PPP funds, but that action has not yet been taken. It’s a good idea to talk to our office about this as soon as possible. Having to pay taxes on expenses incurred may be particularly challenging in the face of the difficulties the pandemic has imposed. Being financially prepared to pay more taxes than you originally intended may be a bitter pill to swallow. However, it will still be better than paying penalties and interest if you fail to pay what the government says that you owe. 

Though all of these strategies can be helpful, they may not all be appropriate for your situation. Keep them in mind as you go into the end of the year, and be prepared to ask questions to determine which apply to you when you speak with our office. Contact us to discuss tax planning for your business today.

Gambling and Tax Gotchas

Article Highlights: 

  • Winnings 
  • Losses 
  • Social Security Income 
  • Health Care Insurance Premium Subsidies 
  • Medicare B & D Premiums 
  • Online Gambling Accounts 

Gambling is a recreational activity for many taxpayers, and as one might expect, the government takes a cut if you win and won’t allow you to claim a loss above your winnings. There are far more tax issues related to gambling than you might expect, and they may impact your taxes in more ways than you might believe. Here is an overview of the many issues and the “gotchas,” that can affect you. 

Reporting Winnings – Taxpayers must report the full amount of their gambling winnings for the year as income on their 1040 returns. Gambling income includes, but is not limited to, winnings from lotteries, raffles, lotto tickets and scratchers, horse and dog races, and casinos, as well as the fair market value of cars, houses, trips, or other non-cash prizes. The full amount of the winnings must be reported, not the net, after subtracting losses. The last statement’s exception is that the cost of the winning ticket or winning spin on a slot machine is deductible from the gross winnings. For example, if you put $1 into a slot machine and won $500, you would include $499 as the number of your gross winnings, even if you’d previously spent $50 feeding the machine. 

Frequently, taxpayers with winnings only expect to report those winnings included on Form W-2G. However, while that form is only issued for “Certain Gambling Winnings,” the tax code requires all winnings to be reported. All winnings from gambling activities must be included when computing the deductible gambling losses, which is always an issue in a gambling loss audit. 

GOTCHA #1 – Since you can’t net your winnings and losses, the full amount of your winnings ends up in your adjusted gross income (AGI). The AGI is used to limit other tax benefits, as discussed later. So, the higher the AGI, the more your other tax benefits may be limited.

Reporting Losses – A taxpayer may deduct gambling losses suffered in the tax year as a miscellaneous itemized deduction (not subject to the 2% of AGI limitation), but only to the extent of that year’s gambling gains. 

GOTCHA #2 – If you don’t itemize your deductions, you can’t deduct your losses. Thus, individuals taking the standard deduction will end up paying taxes on all of their winnings, even if they had a net loss. 

Social Security Income – For taxpayers receiving Social Security benefits, whether those benefits are taxable depends upon the taxpayer’s income (AGI) for the year. The taxation threshold for Social Security benefits is $32,000 for married taxpayers filing jointly, $0 for married taxpayers filing separately, and $25,000 for all other filing statuses. If the sum of AGI (before including any SS income), interest income from municipal bonds, and one-half the amount of SS benefits received for the year exceeds the threshold amount, 50–85% of the SS benefit is taxable. 

GOTCHA #3 – If your gambling winnings push your AGI for the year over the threshold amount, your gambling winnings—even if you had a net loss—can cause up to 85% of your Social Security benefits to become taxable.

Health Insurance Subsidies – Lower-income individuals who purchase their health insurance from a government marketplace are given a subsidy in the form of a tax credit to help pay the cost of their health insurance. Most people eligible for the tax credit use it to reduce their monthly health insurance premiums. That tax credit is based upon the AGIs of all members of the family. The higher the family income, the lower the subsidy becomes. 

GOTCHA #4 – The addition of gambling income to your family’s income can result in significant reductions in the health insurance subsidy, requiring you to pay more for your family’s health insurance coverage for the year. If your subsidy was based upon your estimated income for the year, your premiums were reduced by applying the subsidy in advance. If you subsequently had some gambling winnings, then you could get stuck with paying back some or all of the subsidy when you file your return for the year.

Medicare B & D Premiums – If you are covered by Medicare, the amount you are required to pay (generally withheld from your Social Security benefits) for Medicare B premiums is normally $144.60 per month and is based on your AGI two years prior. However, if that AGI was above $87,000 ($174,000 for married taxpayers filing jointly), the monthly premiums can increase to as much as $491.60. If you also have prescription drug coverage through Medicare Part D, and if your AGI exceeds the $87,000/$174,000 threshold, your monthly surcharge for Part D coverage will range from $12.20 to $76.40 (2020 rates). 

GOTCHA #5 – The addition of gambling winnings to your AGI can result in higher Medicare B & D premiums.

Online Gambling Accounts – If you have an online gambling account, there is a good chance that the account is with a foreign company. All U.S. persons with a financial interest or signature authority over foreign accounts with an aggregate balance of over $10,000 anytime during the prior calendar year must report those accounts to the Treasury by the April due date for filing individual tax returns or face draconian penalties. 

GOTCHA #6 – Regardless of whether you are a gambling winner or loser, if your online account was over $10,000, you will be required to file FinCEN Form 114 (Report of Foreign Bank and Financial Accounts), commonly referred to as the FBAR. For non-willful violations, civil penalties up to $10,000 may be imposed. The penalty for willful violations is the greater of $100,000 or 50% of the account’s balance at the violation time. The $10,000 and $100,000 penalty amounts are subject to adjustment for inflation, and after February 19, 2020 are $13,481 and $134,806, respectively.

Other Limitations – Those as mentioned above are the most significant “gotchas.” Numerous different tax rules limit tax benefits based on AGI, as discussed in gotcha #1. These include medical deductions, certain casualty losses, child and dependent care credits, the Child Tax Credit, and the Earned Income Tax Credit, to name a few. 

If you have questions related to gambling and taxes, please contact us.

What Happens if You Missed the October 15th Tax Extension Deadline?

We’ve all been there. Life is super busy. We have to take care of our families and friends, work obligations, and other everyday responsibilities. With all of the hustle and bustle, you realize that the October 15th tax extension deadline has passed, and unfortunately, you still haven’t filed. What should you do now? 

This article provides guidance when you miss the tax extension deadline and the next steps you should take. 

Will I Be Penalized for Filing After the Deadline? 

Yes, if you missed the October 15th filing deadline, you can be penalized. The IRS allowed you an additional six-month extension of time to file your taxes (from April 15th to October 15th). That was not an extension to pay taxes, only an extension to complete your return. In addition to any interest and penalties that you may owe as a result of failing to file (and pay) your tax on time, you will now be subject to a late filing fee on any unpaid taxes. The penalty, which includes interest, is generally 5% per month of any outstanding balance for up to 5 months. This penalty can increase to up to 25% of the remaining balance owed. To make matters worse, the interest continues to accrue until any liability is finally paid. 

If you file your taxes more than 60 days late, you may receive an additional penalty of $435. That is the minimum late filing penalty, which is the lesser of what you owe in taxes or the $435. It’s crucial to go ahead and file even if you can’t pay the outstanding balance in full and work with the IRS to create a payment arrangement. Even if you are missing some information you need to file, you can file now and amend later when the information becomes available. 

What Happens if the IRS Owes Me a Refund? 

For taxpayers who believe they are owed a refund from the Internal Revenue Service, you have three years from the original due date of the return to file and claim your refund. However, if you wait too long, you will forfeit any refund you might be entitled to. 

If you are filing your tax return after the October 15th deadline and do not owe any tax, there will be no late filing penalties or interest. 

What Happens If I Don’t File My Return? 

Suppose you don’t file your tax return with the IRS. In that case, they will likely create a substitute return on your behalf based on income data such as W-2s, 1099s, and other documentation provided to them by your employer and other financial institutions. 

It’s important to understand that this substitute return will not include any calculations for credits and deductions that you may be qualified for. Consequently, the substitute return will likely result in a higher balance owed and penalties than if you prepared your return. 

What Happens If I Can’t Pay the Tax Balance Owed? 

If you can’t pay your tax obligations with the IRS, it is crucial to go ahead and get the tax return filed and then work with the Internal Revenue Service to set up a payment plan. 

The IRS’ Fresh Start Program allows taxpayers with balances of less than $25,000 to set up a monthly installment plan, allowing you to make payments on your balance over several years. 

There is an “Offer In Compromise” option that allows you to settle your tax debt for less than the amount owed for those experiencing more financial difficulty. 

The interest and penalties for filing your tax return after the final tax deadline can be severe. It is important to get your return filed, even if you need to make arrangements to pay the balance owed to the IRS. 

If you have any questions about the steps you should take if the October 15th tax extension deadline has passed you by, or for more information about our tax planning and preparation services, please contact us.

Tax Consequences of Losing Your Job

Article Highlights: 

  • Severance Pay 
  • Unemployment Compensation 
  • Health Insurance 
  • Employer Pension Plan 
  • Coronavirus-related Distributions 
  • Home Sale 

If you lost your job, there are several tax issues you may encounter. How you deal with these issues can profoundly impact your taxes and finances. The following are typical issues related to tax treatment: 

Severance Pay – Your employer may provide you with severance pay. Severance pay and payment for unused vacation time will be included in your W-2 income, and both are fully taxable. 

Unemployment Compensation – If you do not find another job right away, you generally qualify for unemployment compensation. Unemployment benefits, both the regular benefits you receive from your state unemployment department and the enhanced unemployment payments during the COVID-19 emergency, are taxable for federal purposes and may or may not be taxable by your state of residence. To minimize the tax you may owe when you file your 2020 tax return; you may want to request federal income tax withholding of 10% of the unemployment benefit amount. Do that by submitting a Form W-4V (Voluntary Withholding Request) to your state’s unemployment office. 

Health Insurance – If you lose your job and have health insurance through your employer’s group health coverage plan, you will need to determine your available options for continued coverage via COBRA or a replacement policy. If you give up coverage, you may be subject to penalties in some states for not being insured. 

  • COBRA Coverage – The Consolidated Omnibus Budget Reconciliation Act (COBRA) requires continuation coverage to be offered to covered employees, their spouses, former spouses, and dependent children when group health coverage would otherwise be lost. COBRA continuation coverage is often more expensive than the amount that active employees must pay for group health coverage because they usually cover part of employees’ coverage costs. 102% of the total cost can be charged to individuals receiving continuation coverage (the extra 2% covers administration costs). COBRA generally applies to private-sector employers with 20 or more employees and state or local governments that offer group health coverage to their employees. In most cases, COBRA coverage is limited to 18 months. 
  • Health Insurance Marketplace Coverage – When existing health coverage is lost, a family may purchase health insurance through a government health insurance marketplace outside of the standard enrollment window. Depending upon your income for the year, you may qualify for the premium tax credit for the part of the year when you don’t have coverage through your employer, which will help pay for the insurance. Suppose coverage was already through a marketplace and not your employer; you should notify the Marketplace that you’ve lost your job and that your income has decreased, as you may then be eligible for a higher advance premium tax credit. However, advise the Marketplace once you are employed again to make appropriate adjustments to the advance premium tax credit amount. This may alleviate having to repay some of the credit when you file your 2020 return. 

Employer Pension Plan – Depending upon your employer’s pension plan, you may have the option of leaving your retirement funds in the employer’s plan or moving the funds to your IRA account. You can have the funds transferred to your IRA or take a distribution and roll it into your IRA within 60 days. However, this is where a tax trap exists; for distribution, the employer is required to withhold 20% for federal taxes, meaning only 80% of the funds will be available to roll over, and the remaining 20% will end up being taxable unless you can make up the difference with other funds. 

If you ever want to roll those funds into a new employer’s retirement plan, those retirement distributions should not be commingled with other IRA accounts. 

Should you be tempted not to roll the funds over, be aware that the distribution will generally be taxable, and if you are under the age of 59½, there will also be a 10% early withdrawal penalty. However, the CARES Act allows qualified taxpayers to make COVID-19-related distributions from qualified plans or IRAs (not to exceed $100,000 from January 1, 2020, to December 31, 2020) and receive favorable tax treatment. These distributions are penalty-free; they are taxed over three years and can be redeposited to an IRA or qualified plan within three years. 

Home Sale – If you relocate and have to sell your home and have owned and occupied the house as your primary residence for 2 of the previous 5 years, you will be able to exclude up to $250,000 of the gain ($500,000 if you are married and you and your spouse qualify for the exclusion). If you do not meet the 2-out-of-5-years qualifications, you will be allowed a prorated gain exclusion because you have lost your job.

As you can see, several issues may apply when a job loss occurs; this is even more relevant during the coronavirus emergency. To learn more about how these issues might affect your particular situation, please contact us

How to File Taxes After Moving to a New State

Moving to a new state can be an incredible new adventure. No matter what takes you to your new residence, you can’t forget about taxes. Here’s what you need to know about filing taxes in your new state as you settle into your new routine. 

Establish Residency in Your New State

Even if you haven’t sold your home or severed all ties with your previous hometown, you will need to make as many connections with your new residence as possible.

  • Change your mailing address 
  • Get your driver’s license and voter registration in your new state 
  • Register children for school (if applicable) in your new state 
  • Move your personal belongings and family pets to your new home 

This will help prove that you have fully moved from the original state and are no longer subject to taxes there as a resident. 

Cut Ties with Your Previous Jurisdiction 

If you have a second home in another state or you are still working or doing business in your previous state, you may still qualify as a resident in that state for tax purposes. 

If you still have ties in your previous state, make sure you understand the residency qualifications so that you can avoid any surprises at tax time. 

Determine What Kind of Tax Return Is Required 

Unless you moved on January 1st of the calendar year, you are likely – at a minimum – a part-year resident of each state. 

Typically, this means that you will allocate your income, deductions, credits, and other tax items based on the number of days you lived in each state. You would file a part-year tax return in each state unless the state that you are moving from or moving to does not have a state income tax requirement. 

Check Your Eligibility for Tax Credits, and Other Tax Benefits That You May Be Eligible for in Your New State 

The forms that each taxpayer may use are consistent when completing your federal tax return. However, no two states are exactly alike when it comes to filing a tax return. Credits and other benefits that you may be eligible for in one state may not apply in another state. 

You may find that you now qualify for extra credits or other incentives not previously available to you. 

Get Help from a Tax Professional 

When it comes to your taxes, it’s best to contact a tax professional if you’re unsure of the steps to take when completing your tax forms. 

We can assist with tax planning and identifying tax credits and deductions. Your Tarlow advisor can help you avoid mistakes when completing your tax return that can result in costly interest and penalties. Please contact us for more information.