Tarlow CARES Act Update

The Senate passed the Coronavirus Aid, Relief, and Economic Security Act (CARES Act), to provide additional financial assistance to individual and business taxpayers due to the coronavirus pandemic. As of this writing, the House just passed the CARES Act and it is now being sent to President Trump for signature.

Amendments to the Families First Coronavirus Response Act

The CARES Act changes sections of the Families First Coronavirus Response Act (FFCRA), enacted on March 18, 2020. One update is that employers subject to the FFCRA may elect to provide even more paid leave than stated by the FFCRA.  Note, the related payroll tax credits are capped at the FFCRA’s mandatory paid leave wage amounts.

In addition, the CARES Act expands eligible employees under the paid leave provisions of the FFCRA to workers who were laid off not earlier than March 1, 2020, had worked for the employer for at least 30 of the last 60 calendar days prior to being laid off, and were rehired by the employer.

Employers subject to the FFCRA may receive an advance, including any refundable portions, of FFCRA payroll credits to help cover the expense of providing the required paid leave under the FFCRA.

CARES ACT INDIVIDUAL PROVISIONS

Recovery Checks

Individual taxpayers will receive a recovery rebate check of $1,200 per individual and $2,400 for married couples filing jointly, plus $500 for each qualifying dependent child. The recovery rebate phases out for taxpayers whose adjusted gross income exceeds $150,000 for joint returns, $112,500 for head of household, and $75,000 for all other taxpayers.

The amount a taxpayer receives is based on information from the taxpayer’s 2019 tax return; if the taxpayer has not yet filed a 2019 return, the amount is based on the 2018 tax return.

Retirement Plans

The bill liberalizes the retirement plan rules, for 2020, for premature distribution penalties, plan loans and required minimum distributions (RMDs).

The 10% premature early withdrawal penalty is waived for distributions of up to $100,000 from qualified retirement accounts and individual retirement accounts for coronavirus-related purposes. In addition, the federal income tax on such distributions can be paid over a three-year period. The law also provides that these distributions can be recontributed back to the plan within a three-year period without affecting that year’s contribution cap.

The bill provides more flexible rules concerning loans from certain retirement accounts for coronavirus-related relief. The maximum amount of loans (when combined with existing loans) which can be taken from the plan is the lesser of $100,000 (up from $50,000) or 100% of the participant’s accrued benefit (up from 50%).

Charitable Contributions Deduction Modifications

Taxpayers who do not otherwise elect to itemize deductions are allowed an above-the-line deduction in 2020 for up to $300 for charitable contributions made in cash (not stock) to any qualifying Section 501(c)(3) public charity, excluding donor-advised funds.

In addition, for individuals who itemize, the CARES Act temporarily increases limitations on deductions for charitable contributions made in 2020. For individuals, the 60 percent of adjusted gross income limitation is suspended for 2020 for cash contributions to qualifying organizations, excluding donor-advised funds. For contributions of food inventory, the limitation is increased from 15 percent to 25 percent. Excess contributions may be carried forward to future years based on the existing charitable contribution carryforward rules.

Employer Payments of Student Loans Assistance Program

Through December 31, 2020, employers may provide a student loan repayment benefit of up to $5,250 annually to employees tax-free. This extends to both new student loan repayment benefits and other educational assistance provided by an employer under current law.

Expanded Unemployment Insurance Benefits

The CARES Act provides increased unemployment insurance benefits for individuals (including those who are self-employed) who become unemployed, partially unemployed or are unable to work due to COVID-19 on or after January 27, 2020, and on or before December 31, 2020. In general, the unemployment benefit a recipient receives is increased by $600 per week. Benefits may vary by state.

CARES ACT PROVISIONS FOR SMALL BUSINESS OWNERS

The 7(a) loan program, administered by the U.S. Small Business Administration (SBA), provides financial assistance to small businesses. Overall, the CARES Act authorizes an additional $349 billion for general 7(a) business loans. For SBA Express loans, the statutory $350,000 limit is increased to $1 million through December 31, 2020.  In general, the SBA responds to Express loans within 36 hours, compared to standard 7(a) loans, which may take weeks to process.

Recipients of 7(a) loans may be eligible for loan forgiveness on covered loans in an amount equal to the sum of the costs incurred on or after February 15, 2020, and on or before June 30, 2020, due to payroll cost, mortgage interest payments, rent or utility payments.

In addition, the CARES Act gives the SBA authority to provide paycheck protection loans to help employers cover costs, including wages, paid leave and state taxes on employee wages. These benefits are available to employers with no more than 500 employees, including nonprofit organizations.

Employee Retention Credit

An eligible employer is allowed a credit against applicable employment taxes for each calendar quarter equal to 50% of qualified wages for each employee for such calendar quarter.

  • The amount of qualified wages for any employee taken into account by an employer for all calendar quarters is limited to $10,000.
  • The credit is limited to the employment taxes owed as reduced by other credits for all employees of the eligible employer for such calendar quarter.

An eligible employer is one who (a) was carrying on a trade or business during calendar year 2020; (b) with respect to any calendar quarter for which (i) operations are fully or partially suspended due to orders from an appropriate government authority limiting commerce, travel, or group meetings due to COVID-19 or (ii) in which (beginning in first calendar quarter after 12/31/2019) there has been a significant decline in gross receipts (i.e., less than 50% gross receipts for the same quarter in the prior year and ending with calendar quarter for which gross receipts are greater than 80% same calendar quarter in prior year). Tax-exempt organizations can also benefit from this credit.

Employer and Self-Employer Individual Deferral of Payroll Taxes

Employers and self-employed individuals can defer the payment of the employer portion of employment taxes or self-employment taxes due during the “payroll tax deferral period” to December 31, 2021, and December 31, 2022.  50% of the deferred taxes will be required to be paid on these dates.  Penalties will not apply for failure to make timely deposits for withholding these amounts.

The Payroll Tax Deferral Period is defined as the period beginning on date of enactment to January 1, 2021. This does not appear to be retroactive to January 1, 2020.

Net Operating Loss (NOL) Rules

Rules limiting the use of net operating losses under the Tax Cuts and Jobs Act (TCJA) are suspended under the Stimulus Bill.

  • NOLs from 2018, 2019 or 2020 are eligible to be carried back for five years.
  • Additionally, the 80% limit on use of NOL carryforwards is also temporarily removed so that the NOL can fully offset income.

Limitation of Individuals’ Use of Business Losses

Under the TCJA, non-corporate taxpayers’ net business losses were limited under IRC section 461(l) to $250,000 ($500,000 for a joint filer). The Stimulus Bill would permit use of net business losses without limit for the 2018 tax year through 2020.

Corporate Alternative Minimum Tax Credit Refund

Under the TCJA, a C corporation with alternative minimum tax credits was entitled to a refund of these credits over a four-year period — 2018, 2019, 2020 and 2021. Under the Stimulus Bill, the corporation can receive the refund over a two-year period 2018 and 2019. Furthermore, if there will be any delay in filing the 2019 C corporation return, an election can be made to include the entire refundable amount in 2018.

Business Interest Limitation Under IRC Section 163(J)

The TCJA includes a limitation on the use of net business interest expense to 30% of Adjusted Taxable Income. The Stimulus Bill amends this rule for 2019 and 2020 and increases the limit from 30% of Adjusted Taxable Income to 50%. Additionally, since it is likely that 2020 income will be lower than in 2019 due to the current economic circumstance, an election can be made to use the 2019 Adjusted Taxable Income for the 2020 tax year.

Bonus Depreciation

The Tax Cuts and Jobs Act intended to permit immediate write-off of costs related to Qualified Improvement Property. Due to a drafting error, this provision was not put into that legislation and caused QIP only to be eligible for depreciation over 39 years. The Stimulus Bill fixes this drafting error and specifically permits bonus depreciation to be taken on qualified costs retroactively. This allows amendment of 2018 and 2019 filed returns and provide a source of cash, particularly for those in the hospitality industry.

Excise Tax Exemption

The bill also provides a temporary exception from excise tax on alcohol which is used to produce hand sanitizer.  We are waiting to see if the House of Representatives made changes to these provisions. Clearly, they are all intended to provide additional cash to taxpayers.

Tarlow is Here to Help — Contact Us with Questions

At Tarlow, our Partners and staff members are closely monitoring tax-related legislation and regulations. We will continue to update you by sending communications about relevant news and changing guidelines.  If you have any questions, please contact your Tarlow advisor.

Important Tarlow Tax Update: President Trump Extends Tax Filing Deadline

In a tweet on Friday, March 20, 2020, President Trump has directed Treasury Secretary Steven Mnuchin to extend the tax filing deadline to July 15, giving taxpayers more time to file their taxes in the midst of the coronavirus pandemic.

“At @realDonaldTrump’s direction, we are moving Tax Day from April 15 to July 15,” said Mnuchin. “All taxpayers and businesses will have this additional time to file and make payments without interest or penalties.”

Earlier this week, the administration moved the payment deadline to July 15; however, the American Institute of CPAs, the National Society of Accountants, the National Conference of CPA Practitioners, and additional groups pointed out that was not enough. Many taxpayers are dealing with the effects of the COVID-19 pandemic and cannot access their offices and do not have their tax records.  A group of senators introduced bipartisan legislation on Thursday, March 19 to extend the tax filing deadline.

We will provide you with updates on these issues and more as soon as more information is available.

Click here to read the full update on Accounting Today 

Tarlow Tax Update for March 18, 2020

The Treasury Department and the IRS have decided on an extension for the time to make payments of federal income taxes; however, the April 15 filing deadline remains in effect. Taxpayers can request a six-month filing extension to Oct. 15, 2020.

Individuals and corporate taxpayers have 90 days to remit tax payments due with their 2019 income tax returns subject to certain limitations. Further details from the Treasury Department are expected to be approved shortly and we will communicate updates to you as they are announced.

The payment extension applies to both individuals and corporations with payments due April 15.

Included in the relief provisions announced by the Treasury Department are:

  • Individuals can defer up to $1 million in taxes due.
  • Corporations can defer up to $10 million in taxes due.
  • Payments of estimated quarterly tax payments paid by self-employed workers and businesses are also being considered for extension.  The first quarter estimated tax payment for individuals is due April 15.
  • It is critical to note that these payment deadlines apply to federal returns; they do not automatically apply to your state filing and payment requirements.

Stimulus Plans in the Works

Congress and the Trump administration are working on various relief packages. The House of Representatives passed the Families First Coronavirus Response Act (the Act). The Act includes payroll tax credits to assist employers in paying wages to employees needing time off due to the virus. This legislation has now moved to the Senate. We will provide additional details once it passes both chambers.

The President is proposing an $850 billion stimulus package as part of a more comprehensive relief package to maintain liquidity in the economy and assist industries hurt by this pandemic. The administration is also seeking ways to get cash to Americans as soon as possible.

We are all experiencing unprecedented circumstances, and income taxes and economic stimulus are no exceptions. Tarlow Partners and staff members remain dedicated to providing the superior level of service our clients have always received from us.  We are committed to preparing and filing your tax returns in a manner that is both timely and responsive to your needs and any concerns.  As always, should you have any questions concerning these tax filing and payment relief measures, please do not hesitate to contact us.  We will communicate additional updates as legislation is announced and approved.

New Twist for Kiddie Tax with a Refund Opportunity

Article Highlights:

  • Appropriations Act of 2020 
  • Children’s Tax-Filing Requirements 
  • Two Methods for 2018 and 2019 
  • Amendment Possibility for a Dependent Child 
  • Standard Deduction 
  • Wages 
  • Self-employment Income 
  • Investment Income 
  • Parents’ Election 
  • Who Is Responsible for Filing? 
  • Retirement Savings Opportunity 
  • Signing the Return 

On December 20, 2019, President Trump signed into law the Appropriations Act of 2020, which included several tax law changes, including retroactively extending specific tax provisions that expired after 2017 or were about to expire, some retirement and IRA plan modifications, and other changes that will, as a whole, impact a large portion of U.S. taxpayers. This article is one of a series of articles dealing with those changes and how they may affect you.

Your dependent child who worked during the year or had investment income, such as interest or dividends, may be required to file a tax return, depending upon the type and amount of the income. Years ago, to prevent parents from putting their investments in their children’s names to avoid or significantly reduce the tax on their investment income, Congress passed what is commonly referred to as the kiddie tax. The kiddie tax taxes children’s income in excess of a small allowance at the parent’s top tax rate.

More recently, as part of the 2017 tax reform, Congress modified the kiddie tax structure, so that the children’s investment income above the small allowance ($2,200 for 2019) is taxed at the fiduciary tax rates*, which can very quickly reach the maximum tax rate. On the other hand, the tax reform virtually doubled the standard deduction (it is $12,200 for 2019 for someone using the single filing status), providing children with substantial tax-free income from working.

That change to the kiddie tax structure created an unintentional tax increase for survivors of service members and first responders who died in the line of duty. As a result, Congress has decided to scrap the new method, which used fiduciary rates, and to revert to the original kiddie tax computation, beginning in 2020, resulting in the child’s net unearned income being taxed at the parents’ tax rate, if it’s higher than the child’s tax rate.

Amended Return Possibility – Taxpayers can choose whichever method provides the lowest tax for 2018 and 2019 and can amend the 2018 return if it allows for a better outcome. This will especially benefit taxpayers with substantial unearned income.

Unearned income generally includes investment income such as taxable interest, dividends (including capital gain distributions), and capital gains, as well as rents, royalties, pension income, survivor benefits, the taxable part of Social Security benefits, taxable scholarship and fellowship grants not reported on Form W-2, and other income types.

A dependent child is defined as being either under the age of 19 during the tax year or under 24 if he/she is a full-time student. Also, to be a dependent, the child needs to live with you for more than half of the year (unless he/she is away due to a temporary absence that includes living away from home while attending school). Although there are no support requirements, the child cannot be self-supporting. When considering whether the child is self-supporting, don’t confuse support for the child with the child’s income. Saved income is not used for support.

How a Child’s Income Is Taxed

  • Wages – When children only have earned income (wages), they file their own tax return and can claim the standard deduction. Thus, only their earnings above the standard deduction, which is $12,200 for 2019, is subject to income tax. As a result, if their earnings are less than the standard deduction, they need not file a tax return unless it would need to be submitted for them to claim a refund of withheld income taxes. 
  • Self-Employed Income – If your child is an entrepreneur and has net income from self-employment, then in addition to income tax, he/she may owe self-employment tax. Self-employment tax is only assessed if the net self-employment income is above $433. Thus, if your child’s self-employment net income is more than $433, he/she must file a return, even if the total income is less than the standard deduction. 
  • Investment Income – If your children only have investment income, such as interest and dividends, their standard deduction for 2019 will be $1,100. For the kiddie tax computation, any investment income over $2,200 (the special allowance previously mentioned in this article) will be taxed, either at fiduciary rates – which start at 10% and reach 37% when the investment income above the special allowance reaches $12,750 (the TCJA method) – or at their parents’ marginal tax rate (the pre-TCJA method that Congress brought back). 
  • Earned Income and Investment Income – This is the most complicated because the standard deduction is the greater of $1,100 or the child’s earned income plus $350. Still, it should not exceed the $12,200 standard deduction for a single individual, while the special allowance for the kiddie tax is $2,200. Generally, in this situation and using the TCJA method, investment income over $350 will be taxed at fiduciary rates, and earned income over the remaining standard deduction will be taxed at the regular single tax rates. Otherwise, if the TCJA method isn’t used, the child’s tax will be the greater of the tax on all of the child’s income or the sum of the tax on the child’s earned income plus the child’s share of the allocable parent tax. The TCJA method is only available for 2018 and 2019. 

Parents’ Election – Parents may elect to include their child’s interest and dividend income (including capital gain distributions) on their own tax return if the total is less than $11,000, instead of the child filing a return of his/her own. However, this election cannot be made if the child has other types of income, either earned or unearned. Also, filing in this manner may result in a more significant tax liability.

Who Should Be Responsible for Filing the Child’s Return? Whether your children’s income is earned or unearned, they may be too young to prepare their tax returns. Then, the responsibility to do so is yours. If your children can file their return, you may want to provide them with this important lesson of being a taxpayer. However, if you make them responsible for submitting their return, make sure they check the “dependent of another” box, or else the IRS will deny you the dependency for the child and create a mess that will be difficult to straighten out.

Retirement Savings Opportunity – If your children have earned income, they can set aside money in an IRA for their eventual retirement. However, they may be reluctant to give up any of their hard-earned money from their summer job or regular employment. A child or young adult is probably not at a stage in life to begin thinking about retirement. However, if you, a grandparent, or others have the financial resources to do so, the amount of an IRA contribution could be gifted to the children, giving them a great start toward their retirement savings and hopefully a continuing incentive to save for their retirement. The maximum amount they can contribute for 2019 is the lesser of their earned income or $6,000.

Roth IRAs are a better alternative; unlike traditional IRAs, Roths provide tax-free income at retirement. However, the contribution to a Roth is not deductible; thus, income over $12,200 would not be tax-free. Even so, the tax rate at the lower-income level is only 10%, and it may be worth paying a small tax now to gain the tax-free retirement income provided by a Roth IRA. An IRA contribution for 2019 can be made up to April 15, 2020.

Signing the Return – Parents who prepare their children’s return can either have them sign for themselves or do so on their behalf, thus signing for them as their guardian or parent. Preparing your children’s return is a good idea in either case, as this notation provides with you the ability to speak on your child’s behalf if the IRS audits or questions the return.

A child’s return can be tricky to prepare. Please contact us for your child’s tax-preparation needs. 

*Fiduciary tax rates are the income tax rates for trusts and estates. 

No Employees This Quarter? You Still May Need to File IRS Form 941

As an employer, you have plenty of obligations when it comes to filing taxes. Among these is the need to file IRS Form 941, the Employer’s Quarterly Federal Tax Return, on the last day of each month following the end of a quarter. Sticking to these deadlines — April 30, July 31, October 31 and January 31 — is essential for remaining in compliance and avoiding an inquiry from the Internal Revenue Service.

What is Form 941, and Who Has to Submit It?

Form 941 is a summary of the total taxes withheld during the previous quarter by anybody —business or individual — that compensates an employee or employees.

If you are an employer who pays wages to household employees or agricultural employees, you are exempt from this rule. Those who employ seasonal workers who don’t get paid during one or more quarters of the year are exempt as well.

All other employers are required to submit the form, regardless of whether they pay employees during a given quarter or not. This is a common misconception that is important to be aware of to remain compliant.

What the Form Contains

Form 941 requires a significant amount of information, including how many employees a business pays, what the total wages paid were for the quarter, as well as what the total withholding of taxes was for the quarter.

It’s necessary to gather all payroll records and other documentation for the quarter, including reports of any taxable tips that your employees indicated that they received to fill the information out accurately. Once calculated, the employer must send in the form, the appropriate withholding and federal income tax, and 1.45 percent of all taxable wages for the Medicare tax payment. Social Security payments of 6.2 percent of each employee’s wages must also be submitted (up to $132,900 for tax year 2019). For those employees paid more than $200,000 per year, employers also must withhold the Additional Medicare Tax.

Penalties for Failure to File

Form 941 must be submitted four times per year by the above-referenced dates and employers who fail to do so face significant penalties of a percentage of whatever tax had been due for each month or portion of a month that is delayed. As you may imagine, this penalty can add up quickly. According to IRS Publication 15 (2020), these are the penalty rates for amounts not timely or adequately deposited:

  • 2% – Deposits made 1 to 5 days late. 
  • 5% – Deposits made 6 to 15 days late. 
  • 10% – Deposits made 16 or more days late, but before ten days from the date of the first notice, the IRS sent asking for the tax due. 
  • 10% – Amounts that should have been deposited, but instead were paid directly to the IRS, or paid with your tax return. (See “Payment with return” within Pub. 15 for an exception.) 
  • 15% – Amounts still unpaid more than ten days after the date of the first notice the IRS sent asking for the tax due or the day on which you received notice and demand for immediate payment, whichever is earlier.

Balancing Out the Year

At tax time, businesses need to reconcile the amount reported on the four Form 941s they submitted with the employee wages reported on the W-2 forms provided to employees so that they can fill out their tax returns. The total of the Form 941s should be the same as the total on the W-2s, as well as on the Form W-3 that employers file with the IRS. Contact us for assistance or any questions regarding your Form 941 requirements.

Did You Pay Tax on Home Mortgage Debt Relief in 2018? You May Be Entitled to a Refund

Article Highlights:

  • Appropriations Act of 2020 
  • Cancellation-of-Debt (COD) Income 
  • Retroactively Extended Special Exclusion 
  • Home Affordable Modification Program (HAMP) 
  • Amended Return 

On December 20, 2019, President Trump signed into law the Appropriations Act of 2020, which included several tax law changes, including retroactively extending specific tax provisions that expired after 2017 or were about to expire, several retirement and IRA plan modifications, and other changes that will impact a large portion of U.S. taxpayers as a whole. This article is one of a series of articles dealing with those changes and how they may affect you.

When a taxpayer’s debt is forgiven (i.e., credit card, auto loan, or home mortgage debt), it is then referred to as cancellation-of-debt (COD) income. COD income becomes taxable income to the taxpayer unless the debt is discharged in a bankruptcy proceeding or the taxpayer qualifies for one of the tax law exclusions providing relief from taxation of COD income.

The decline in the real estate market over a decade ago, combined with the recession, left many homeowners upside-down. Their mortgages were significantly higher than the value of their home. As a result, many homes went back to the lenders via foreclosure, abandonment, and voluntary reconveyance, leaving taxpayers with taxable COD income.

To alleviate this situation and relieve homeowners from COD income, Congress created a particular rule in 2007 that allowed taxpayers to exclude COD income from taxation if the income arose from cancellation of the debt used to acquire the taxpayer’s primary residence. This debt is termed acquisition debt. However, this particular provision expired at the end of 2017, and those facing a similar problem after 2017 were stuck paying taxes on the COD income.

Thankfully, Congress has retroactively extended that special exclusion (home mortgage debt relief) back to 2018 and through 2020. By making it retroactive, if you were required to pay tax on forgiven home acquisition debt income in 2018, then your 2018 return can be amended, and you can recover those tax dollars you paid in 2018.

This exclusion may also apply to home debt discharged as part of the Home Affordable Modification Program (HAMP). Under this program, certain qualifying individuals could have their mortgage debt reduced so they could afford to remain in their homes. Although this program ended in 2016, the debt was forgiven over three years, which means, in some cases, taxpayers may have had debt forgiveness (COD income) in 2018. This COD income will probably qualify for income exclusion that will result in a refund of taxes if the taxpayer amends their 2018 tax return.

If you have questions related to home mortgage debt relief or if you paid taxes on home mortgage debt relief in 2018, please contact us

The Difference Between an Audit, a Review, and a Compilation

When it comes time for financial documents to be corroborated, the three options available are a compilation, a review, and an audit. Each of these represents a very different degree of effort and investigation, and therefore each provides differing levels of confidence for investors and lenders. Let’s take a closer look at all three.

The Compilation

A compilation requires the least amount of work from an auditor. Although it costs less than an audit or compilation and takes the least amount of time, it provides the lowest level of assurance about the accuracy of the information presented. This is because in a compilation, the auditor does little more than hand over the original financial statements that were prepared internally by the company’s management, with no due diligence performed even to determine whether the information contained in the documents is accurate or true. It relies entirely on the information originally presented.

The Review

A review demands significantly more work on the part of the auditor, who is expected to determine the accuracy of the information contained in the financial documents presented to them through a series of inquiries and analytical procedures. Because some of the information contained in the financial documents presented by management has been tested, a review provides a moderate degree of assurance that the information is correct and can be trusted.

The Audit

An audit requires a much higher degree of due diligence than either a compilation or a review. It represents a significant amount of time spent making sure that all of the disclosures and ending balances that are contained in the organization’s financial statements are accurate, including time spent testing internal controls, confirming the engagement and statements from third parties, and examining all source documents in order to make sure that they are representative of the true situation at hand. An audit will often include a physical inspection where appropriate, as well as other procedures that are designed to confirm or refute the information that management has presented.

Though an audit will take the most time and be the most expensive procedure, it also provides the highest level of assurance for those considering investing in an organization or lending it money.

Please contact us with any questions relating to the different options for financial documents to be corroborated.

Employer’s Pension Startup Credit Substantially Increased

Article Highlights:

  • Eligible Plans
  • Eligible Expenses
  • Qualification Rules
  • Credit Amount

On December 20, 2019, President Trump signed into law the Appropriations Act of 2020, which included a number of tax law changes, including retroactively extending certain tax provisions that expired after 2017 or were about to expire, a number of retirement and IRA plan modifications, and other changes that will impact a large portion of U.S. taxpayers as a whole. This article is one of a series of articles dealing with those changes and how they may affect you.

If you are considering establishing a qualified pension plan for your business, you may be entitled to the Credit for Small Employer Pension Startup Costs. Eligible small employers that adopt a new plan, such as a 401(k), a SIMPLE plan, or a simplified employee pension plan (SEP), may claim a non-refundable credit.

The first credit year is the tax year that includes the date when the plan becomes effective or, electively, the preceding tax year. Examples of qualifying expenses include the costs related to changing the employer’s payroll system, consulting fees, and set-up fees for investment vehicles.

There are some qualification rules, the most predominant being:

  • The business did not employ, in the preceding year, more than 100 employees with compensation of at least $5,000.
  • The plan must cover at least one not–highly compensated employee.
  • The plan must be a new plan; during the three prior years, the employer must not have had a qualified employer plan for which contributions were made or in which benefits accrued for substantially the same employees who are in the plan for which the credit is being claimed.
  • If the credit is for the cost of a payroll-deduction IRA plan, the plan must be made available to all employees who have worked with the employer for at least three months.

Before 2020, this non-refundable credit was limited to the lesser of $500 or 50% of administrative and retirement-education expenses for the plan, for each of the plan’s first three years.

The Appropriations Act of 2020 increased the maximum credit for years beginning after 2019 to the greater of $500 or, the lesser of (a) $250 multiplied by the number of non-highly compensated employees of the eligible employer who are eligible to participate in the plan, or (b) $5,000.

The term “highly compensated employee” generally means any employee who (a) was a 5% owner at any time during the year or the preceding year, or (b) had compensation from the employer over $130,000 (2020 amount, which is inflation-adjusted for future years) during the year.

If you have questions related to starting a company pension plan or qualifying for this credit, please contact us. 

Divorced, Separated, Married or Widowed This Year? You May Face Complications at Tax Time

Article Highlights:

  • Separated Taxpayers
  • Divorced Taxpayers
  • Recently Married Taxpayers
  • Widowed Taxpayers
  • Filing Status
  • Joint and Several Liability
  • Who Claims the Children
  • Alimony
  • Community Property States
  • Affordable Care Act

Taxpayers are frequently blindsided when their filing status changes because of a life event such as marriage, divorce, separation or the death of a spouse. These occasions can be stressful or ecstatic times, and the last thing most people will be thinking about is their taxes. But the ramifications are real, and the following are some of the major tax complications for each situation.

Separated 

Separating from a spouse is probably the most complicated life event and is undoubtedly stressful for the family involved. For taxes, a separated couple can file jointly, because they are still married, or file separately.

  • Filing Status

     If the couple has lived apart from each other for the last 6 months of the year, either or both of them can file as head of household (HH), provided that the spouse(s) claiming HH status paid over half the cost of maintaining a household for a dependent child, stepchild or foster child. A spouse not qualifying for HH status must file as a married person filing separately if the couple chooses not to submit a joint return. The married filing separate status is subject to a host of restrictions to keep married couples from filing separately to take unintended advantage of the tax laws.

  • In most cases, a joint return results in less tax than two returns filed as married separately. However, when married taxpayers file joint returns, both spouses are responsible for the tax on that return (referred to as joint and several liability). What this means is that one spouse may be liable for all of the tax due on a return, even if the other spouse earned all of the income on that return. This holds true even if the couple later divorces, so when deciding whether to file a joint return or separate returns, taxpayers who are separated and possibly on the path to a divorce should consider the risk of potential future tax liability on any joint returns they file.
  • Children

     Who claims the children can be a contentious issue between separated spouses. If they cannot agree, the spouse with custody for the greater part of the year is entitled to claim the child as a dependent along with the associated tax benefits. When determining who had custody for the more significant part of the year, the IRS goes by the number of nights the child spent at each parent’s home and ignores the actual hours spent there in a day.

  • Alimony

    Alimony is the term for payments made by one spouse to the other spouse for the support of the latter spouse. Under tax law before tax reform, the recipient of the alimony includes it as income, and the payer deducts it as an above-the-line expense, on their separate returns. The tax reform rule is that alimony is non-taxable to the recipient if it is received from divorce agreements entered into after December 31, 2018, or pre-existing agreements that are modified after that date to treat alimony as non-taxable. Therefore, post-2018 agreement alimony cannot be handled by the recipient as earned income for purposes of an IRA contribution and can’t be deducted by the payer.

  • Payment for the support of children is not alimony. To be treated as alimony by separated spouses, the payments must be designated and required in a written separation agreement. Voluntary payments do not count as alimony.
  • Community Property

    Nine U.S. states – Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin – are community property states. Generally, community income must be split 50–50 between spouses according to their resident state’s community property law. This often complicates the allocation of income between spouses, and they generally cannot file based upon their income alone.

Divorced 

Once a couple is legally divorced, tax issues become clearer because each former spouse will file based upon their own income and the terms of the divorce decree related to spousal support, custody of children and division of property.

  • Filing Status

     An individual’s marital status as of the last day of the year is used to determine the filing status for that year. So, if a couple gets divorced during the year, they can no longer file together on a joint return for that year or future years. They must, unless remarried, either file as single or head of household (HH). To file as HH, an unmarried individual must have paid over half the cost of maintaining a household for a dependent child or dependent relative who also lived in the home for more than half the year. There is an exception: a dependent parent doesn’t need to live in their child’s home for the child to qualify for HH status). If both ex-spouses meet the requirements, then both can file as head of household.

  • Children

     Normally, the divorce agreement will specify which parent is the custodial parent. Tax law specifies that the custodial parent is the one entitled to claim the child’s dependency and associated tax benefits unless the custodial parent releases the dependency to the other parent in writing. The IRS provides Form 8332 for this purpose. The release can be made for one year or multiple years and can be revoked, with the revocation becoming effective in the tax year after the year the revocation is made.

  • Most recently, family courts have been awarding joint custody. If the parents cannot agree on who can claim a child as a tax dependent, then the IRS’s tie-breaker rule will apply. This rule specifies that the one with custody the more significant part of the year, measured by the number of nights spent in each parent’s home, is entitled to claim the child as a dependent. The parent requesting the dependency is also eligible to take advantage of other tax benefits, such as childcare credits and higher education tuition credits.
  • Alimony

    See alimony under “separated.”

Recently Married

When a couple marries, their incomes and deductions are combined, and they must file as married individuals.

  • Filing Status

    If a couple is married on the last day of the year, they can either file a joint return combining their incomes, deductions and credits or file as married separately. Generally, filing jointly will provide the best overall tax outcome. But there may be extenuating circumstances requiring them to file as married separately. As mentioned earlier, married filing separate status is riddled with restrictions to keep married couples from taking undue advantage of the tax laws by filing separate returns. 

  • Combining Income

     The tax laws include numerous provisions to restrict or limit tax benefits to higher-income taxpayers. The couple’s combined incomes may well be enough that they’ll encounter some of the higher income restrictions, with unpleasant tax results.

  • Affordable Care Act

     If one or both spouses acquired their insurance through a government marketplace and were receiving a premium supplement, their combined incomes may exceed the eligibility level to qualify for the supplement, which may have to be repaid.

Widowed

When one spouse of a married couple passes away, a joint return is still allowed for the year of the spouse’s death. Furthermore, the widow or widower continues to use the joint tax rates for up to two additional years, provided the surviving spouse hasn’t remarried, and has a dependent child living at home. This provides some relief for the survivor, who would otherwise be straddled with an unexpected tax increase while also facing the potential loss of some income, such as the deceased spouse’s pension and Social Security benefits.

If any of these situations are relevant to you, please contact us for additional details that may also apply concerning your specific set of circumstances.

Congress Passes Last-Minute Tax Changes

Article Highlights: 

  • Discharge of Qualified Principal Residence Indebtedness
  • Mortgage Insurance Premiums
  • Above-the-Line Deduction for Qualified Tuition and Related Expenses
  • Medical AGI Limits
  • Residential Energy (Efficient) Property Credit
  • Employer Credit for Paid Family and Medical Leave
  • Maximum Age Limit for Traditional IRA Contributions
  • Penalty-Free Pension Withdrawals in Case of Childbirth or Adoption
  • Increase in Age for Required Minimum Pension Distributions
  • Difficulty of Care Payments Qualifying for IRA Contributions
  • Expansion of Sec. 529 Plan Uses
  • Required Distributions Modified for Inherited IRAs and Retirement Plans
  • Increase in Penalty for Failure to File
  • Major Change to Kiddie Tax Rules

Congress, at almost the last minute, has passed a large number of tax changes, including retirement plan issues that will become effective in 2020, as well as extensions through 2020 of several tax provisions that had expired or were about to end. The list of changes is quite large, so we have only included those that are most likely to affect individual tax returns. Here is a run-down on some of the new tax provisions: 

TAX EXTENDERS 

The tax changes retroactively revive several provisions that had previously expired or were going to at the end of 2019 and extend them through 2020. So, review them carefully to see if any of them provide you with an opportunity to amend your return for a refund. 

Discharge of Qualified Principal Residence Indebtedness – When an individual loses his or her principal residence to foreclosure, abandonment, short sale, or has a portion of their loan forgiven under the HAMP mortgage-reduction plan, they will generally end up with cancellation-of-debt (COD) income. COD income is equal to the amount of debt on the home that is forgiven by the lender. To the extent that the mortgage debt becomes COD income, it is taxable income unless the taxpayer can exclude it based on specific provisions in the tax code. 

After the housing market crashed a few years back, Congress added the qualified principal residence COD exclusion. The COD exclusion allowed taxpayers to exclude up to $2 million ($1 million if married filing separately) of COD income, to the extent it was discharged debt used to acquire the home, termed acquisition debt. Equity debt was not eligible for the exclusion. However, equity debt is deemed to be released first, thus limiting the exclusion if both equity and acquisition debt is involved in the transaction. 

This COD exclusion that was temporarily added in 2007 was extended and then expired at the end of 2017. Under the current legislation, the exclusion for qualified principal residence indebtedness is retroactively extended through 2020. Thus, if you paid taxes on primary residence COD income in 2018, be sure to call attention to that fact so your return can be amended for a refund. 

Mortgage Insurance Premiums – For tax years 2007 through 2017, taxpayers could deduct the cost of premiums for mortgage insurance on a qualified personal residence as an itemized deduction. The premiums were deducted as home mortgage interest on Schedule A. To be deductible: 

  • The premiums must have been paid in connection with acquisition debt (note: acquisition debt includes refinanced acquisition debt).
  •  The mortgage insurance contract must have been issued after December 31, 2006.
  • It must be for a qualified residence (first and second homes).
  • The deductible amount of the premiums phases out ratably by 10% for each $1,000 by which the taxpayer’s adjusted gross income (AGI) exceeds $100,000 (10% for each $500 by which a married separate taxpayer’s AGI exceeds $50,000).
  • Qualified mortgage insurance means mortgage insurance provided by the: 
  • Dept. of Veterans Affairs (VA),
  • Federal Housing Administration (FHA)
  • Rural Housing Services (RHS)
  • Private mortgage insurance.

This deduction was previously allowed through 2017 and has retroactively been extended through 2020. 

Above-the-Line Deduction for Qualified Tuition and Related Expenses – An above-the-line deduction for qualified tuition and related expenses for higher education has been available since 2002 and was previously extended through 2017. For purposes of the higher education expense deduction, “qualified tuition and related expenses,” has the same definition as for the American Opportunity and Lifetime Learning credits for higher education expenses – that is, with certain exceptions, tuition, and fees paid for an eligible student (the taxpayer, the taxpayer’s spouse, or a dependent) at an eligible higher education institution. The deduction – up to $2,000 or $4,000, depending on AGI – is not allowed for joint filers with an AGI of $160,000 or more ($80,000 for other filing statuses), except no deduction is allowed for taxpayers using the married filing separate status. The phase-out amounts are not inflation-adjusted. The same expenses can’t be used for both an education credit and the tuition and fees deduction. 

This deduction was previously allowed through 2017 and has retroactively been extended through 2020. 

Medical AGI Limits – For 2017 and 2018, individuals could claim an itemized deduction for unreimbursed medical expenses, to the extent that such costs exceeded 7.5% of their AGI. For the post-2018 years, the percent of AGI increased to 10%. The provision retroactively extends the lower threshold of 7.5% through 2020. 

Residential Energy (Efficient) Property Credit – This non-refundable credit has been available in one form or another since 2006 through 2017, with credit amounts varying from 10% to 30% and the maximum credit ranging from $500 to $1,500. Most recently, the credit percentage was 10%, with a lifetime credit amount limited to $500. This credit is best described as an energy-saving credit since it applies to improvements to the taxpayer’s existing primary home to make it more energy-efficient. Generally, it applies to insulation, storm windows and doors, certain types of energy-efficient roofing materials, energy-efficient central air-conditioning systems, water heaters, heat pumps, hot water systems, circulating fans, etc.

The recent legislation extends this credit through 2020, with a lifetime credit cap of $500. 

Caution: The lifetime credit extends to returns going back to 2006. 

Employer Credit for Paid Family and Medical Leave – This credit provides an employer with credit for paid family and medical leave, which permits eligible employers to claim an elective general business credit based on eligible wages paid to qualifying employees with respect to family and medical leave. The maximum amount of family and medical leave that may be taken into account for any qualifying employee is 12 weeks per taxable year. The credit is variable and only applies if the leave wages are at least 50% of the individual’s normal wages. The credit percentage is 12.5% and increases by 0.5%, up to a maximum of 25%, for each percentage point that the payment rate exceeds 50%. 

The credit was originally only for 2018 and 2019 but has been extended through 2020. 

RETIREMENT PLAN AND IRA CHANGES 

Maximum Age Limit for Traditional IRA Contributions – The legislation repeals the maximum age for making traditional IRA contributions, which prior to this legislation, prohibited traditional IRA contributions after an individual reached the age of 70½. The provision is effective for contributions made for taxable years beginning after December 31, 2019. 

Penalty-Free Pension Withdrawals in Case of Childbirth or Adoption – The legislation allows a penalty-free but taxable distribution of up to $5,000 from a qualified plan made within one year of birth. Or, in the case of a finalized adoption of an individual aged 18 or younger, or an individual who is physically or mentally incapable of self-support. You can repay distributions later to avoid the tax on the distribution. 

Increase in Age for RMDs – For decades, individuals were required to begin taking distributions from their traditional IRAs and qualified plans once they reached age 70½. These distributions, commonly referred to as a required minimum distribution or RMD, have never been adjusted to account for increases in life expectancy. The legislation changes the required beginning date for mandatory distributions to age 72, effective for distributions required to be made after December 31, 2019, with respect to individuals who attain the age of 72 after this date. 

Special Rule – Difficulty of Care Payments – Many home health-care workers do not have a taxable income because their only compensation comes from “difficulty of care” payments that are exempt from taxation under Code Section 131. Because such workers do not have taxable income, they cannot save for retirement in a defined contribution plan or IRA. This provision will allow home health-care workers to contribute to a qualified plan or IRA by amending the tax code so that tax-exempt difficulty of care payments are treated as compensation, for purposes of calculating the contribution limits to defined contribution plans and IRAs. This is effective for plan years after December 31, 2015, and IRA contributions after the act’s date of enactment (December 20, 2019). 

Sec. 529 Plan Modifications – Sec. 529 plans (also referred to as qualified state tuition plans) were originally created to allow tax-free accumulation saving accounts for a child’s education but generally limited the funds’ use to post-secondary education tuition and certain college fees. Since then, Congress has continued to expand the use of funds to include supplies, books, equipment, and reasonable room and board expenses for attending college. With the passage of the tax reform at the end of 2017, Congress allowed up to $10,000 a year to be used for elementary and secondary school tuition expenses. This new legislation adds the following to the list of qualified expenses: 

  • Qualified higher-education expenses associated with registered apprenticeship programs certified by the Secretary of Labor under Sec. 1 of the National Apprenticeship Act 
  • Payment of education loans, up to a maximum of $10,000 (reduced by the amount of distributions so treated for all prior taxable years), including those for siblings

These changes are effective for distributions made after December 31, 2018. 

RMDs for Designated Beneficiaries – The legislation modifies the required minimum distribution rules with respect to defined contribution plan and IRA balances upon the account owner’s death. Under the legislation, distributions to individuals other than the surviving spouse of the employee (or IRA owner), disabled or chronically ill individuals, individuals who are not more than ten years younger than the employee (or IRA owner), or a child of the employee (or IRA owner) who has not reached the age of majority must generally be distributed by the end of the tenth calendar year following the year of the employee’s or IRA owner’s death. A special rule for children requires any remaining undistributed funds to be distributed within ten years after they reach the age of maturity. 

This is a significant change since beneficiaries previously had options to take certain lifetime payouts. This will require careful planning to minimize the tax on the distributions. The change applies to distributions for employees or IRA owners who die after December 31, 2019.

Penalty for Failure to File – The legislation increased the minimum penalty for failure to file a tax return within 60 days of the return’s due date to $435, up from $330, for returns with a due date (including extensions) after December 31, 2019. Thus, the $435 penalty will apply to 2019 returns and will be inflation-adjusted for future years. 

Kiddie Tax – The tax reform enacted late in 2017 changed how the income of dependent children is taxed, causing a child’s unearned income to be taxed at fiduciary rates that very quickly reach the maximum tax rate of 37%. That change created an unintentional tax increase for survivors of service members and first responders who died in the line duty. This last-minute change reverts the kiddie tax computation to the pre-tax reform method for years beginning in 2020. It also allows taxpayers to choose whichever method provides the lowest tax for 2018 and 2019. Taxpayers can amend their 2018 return if doing so will provide a better outcome. 

The changes are extensive and, in many cases, open the door to amending prior years’ returns. If you have any questions or think any of these changes might benefit you for a prior year, please contact us