It seems like taxes are a game sometimes. When you know the rules, you can play the game better and save a lot in taxes. The tax code contains the basic rules for this game, and once you know the rules, you can apply the correct strategies.
Here’s the basic strategy:
To avoid the higher rates, here are seven possible tax planning strategies.
Examine your portfolio for stocks that you want to unload, and make sales where you offset short-term gains subject to a high tax rate such as 40.8 percent with long-term losses (up to 23.8 percent).
In other words, make the high taxes disappear by offsetting them with low-taxed losses, and pocket the difference.
Use long-term losses to create the $3,000 deduction allowed against ordinary income. (You are allowed to deduct up to $3,000 of capital losses a year.)
Again, you are trying to use the 23.8 percent loss to kill a 40.8 percent rate of tax (or a 0 percent loss to kill a 12 percent tax, if you are in the 12 percent or lower tax bracket).
As an individual investor, avoid the wash-sale loss rule. Under the wash-sale loss rule, if you sell a stock or other security and purchase substantially identical stock or securities within 30 days before or after the date of sale, you don’t recognize your loss on that sale. Instead, the code makes you add the loss amount to the basis of your new stock.
If you want to use the loss in 2021, then you’ll have to sell the stock and sit on your hands for more than 30 days before repurchasing that stock.
If you have a lot of capital losses or capital loss carryovers and the $3,000 allowance is looking extra tiny, sell additional stocks, rental properties, and other assets to create offsetting capital gains.
If you sell stocks to purge the capital losses, you can immediately repurchase the stock after you sell it—there’s no wash-sale “gain” rule.
Do you give money to your parents to assist them with their retirement or living expenses? How about children (specifically, children not subject to the kiddie tax)? If so, consider giving appreciated stock to your parents and your non-kiddie-tax children. Why? If the parents or children are in lower tax brackets than you are, you get a bigger bang for your buck by
If you are going to make a donation to a charity, consider appreciated stock rather than cash, because a donation of appreciated stock gives you more tax benefit.
It works like this:
Here is an example. You bought a publicly traded stock for $1,000, and it’s now worth $11,000. If you give it to a 501(c)(3) charity, the following happens:
Two rules to know:
If you could sell a publicly traded stock at a loss, do not give that loss-deduction stock to a 501(c)(3) charity. Why? If you sell the stock, you have a tax loss that you can deduct. If you give the stock to a charity, you get no deduction for the loss—in other words, you can just kiss that tax-reducing loss goodbye.
These stock strategies have a long history in tax planning and can benefit you. Use them now that you know them.
As the end of the year approaches, you may be considering what equipment and asset purchases you need to make for your business before the end of the year to get a current year tax deduction.
If you use the asset in your business, you can deduct the full cost using regular depreciation, bonus depreciation, or IRC Section 179 expensing.
Regular depreciation takes three to 39 years depending on the property involved (deducting a portion of the cost each year over the useful life of the asset), while bonus depreciation allows you to deduct 100 percent of the cost of personal property in one year through 2022. Up to $1,050,000 of personal property may also be deducted in one year under IRC Section 179 subject to profit limitations.
If you are considering buying personal property (such as a car, a computer, or other equipment) or real property (such as a building), if you use the property for personal purposes, it’s not deductible. If used for both business and personal, the asset must be used more than 50% for business in order for a portion of the cost to be deducted. If used more than 50% for personal purposes, there is no deduction.
Depreciation won’t begin if you purchase property with the intent of beginning a new business. You must actually be in business to claim depreciation. This doesn’t require that you make sales or earn profits—only that your business is a going concern.
Also, depreciation doesn’t begin the moment you purchase property for your business. It begins only when you place property in service in your business. You don’t have to use the property to place it in service, but the property must be available for use in your active business. This could occur after you purchase the property.
Finally, if you use regular depreciation, you must apply rules called conventions to determine the month in which your depreciation deduction begins. The earlier in the year, the larger your deduction for the first year.
The default rule is that regular depreciation for personal property begins July 1 the first year (mid-year convention). But if you purchase 40 percent or more of your total personal property for the year during the fourth quarter, your depreciation begins at the midpoint of the quarter in which it is placed in service (mid-quarter convention).
First-year depreciation for real property begins at the middle of the month during which the property is placed in service (mid-month convention).
Buying needed equipment and assets for your business before the end of the year can lower your taxable income. (P.S. You should never buy something you don’t need to get a tax deduction.)
It seems to happen each year. I eFile a completed tax return and receive a notice that the eFile was rejected because another return has already been filed with that social security number. Each year, thousands of people become the victims of identity theft and fraud. Whether claiming someone else’s refund, opening a loan or taking money out of a bank account that isn’t theirs – it seems that crime pays and that money is what drives thieves to steal your identity and commit fraud.
What can you do about it? Here are some steps you can take to make it a little bit harder for the bad guys.
Freeze your credit report at each credit reporting agency.
Freezing your credit report prevents people with your identity information from opening loans or credit cards in your name. A lending institution will not issue the credit when an account freeze is in place. When you need it, you can unfreeze your account to obtain the credit you need and then lock it again afterwards. You can also create credit reports for your children and lock them too.
Request an Identity Protection PIN from the IRS.
After a fraudulent tax return is filed using your information, there is a lengthy process to report the fraud and the IRS will issue identity protection PINs that must be included when filing return or the agency will not accept them. You don’t have to wait to become a victim. You can request one from the IRS website now. The agency will send you a new PIN every year to include when filing your return. Don’t lose the PIN and make sure you provide it to your CPA at tax time. Having an identity protection PIN helps prevent thieves from claiming a refund to their bank account at your expense.
Setup your Social Security Administration account online.
Another way thieves attempt to gain at your expense is to request Social Security benefits using your information. The funds go to their bank accounts and you may not even know it has happened. One way to help prevent this is to set up your online account at the ssa.gov website. If your account is already setup, thieves can’t open one before you.
Use pass phrases and different pass phrases at each account.
Remembering all of our passwords can be hard. I know I personally had to reset a few passwords for services I don’t access frequently just this week. Because it becomes hard to remember every password, people often become complacent and use the same password for everything. Having only one password is not good advice. Because data leaks happen, it is best to have a different password for each account or service. Better still is to use pass phrases instead of passwords for each account or service. Some sites require a certain length, special characters, numbers and capital and lowercase letters which makes it even harder to remember. When you sign up for a new The Flintstones fan page, rather than setting up a password such as “Fl!ntst0ne” you should think of a phrase related to the account you are setting up such as “Wilma.I’mHom3”.
You should also make sure that your banking and financial account passwords and pass phrases are different from all the passwords and phrases you use.
Turn on multifactor authentication.
Another way to help protect yourself is to use multi-factor authorization on the accounts. After inputting your newly minted strong pass phrase, you can have the service send you a text or email with a number to use to prove that it is you that is accessing the account. Experts seem to recommend use of text over email for multi-factor authorization as you have to have the phone in hand to receive the text whereas your email could be accessed from anywhere.
Consider using a password manager.
If it is too hard to remember all of your passwords and phrases, consider getting a password manager to assist rather than reverting back to simple passwords. These are secure tools that keep track of your passwords and phrases and keep them private while allowing you to login with a master password or phrase. These are available for phones and for your computer.
Ensure the websites are secure before you input your information.
Making sure that the website you are visiting is the correct one before you begin to type your information is also important. Look for the padlock symbol next to the website address to show the site is secure and verify you are at the correct place.
Question your email.
Spam blockers filter out millions of emails a day but spam, junk and phishing (posing as something else to obtain your credentials) messages still get through. Before clicking on anything in the email, use common sense – are you expecting this “your account has been locked” or “we have detected fraud” or “_________” email. If not, tread cautiously. Hover over the sender’s email address and see if it is coming from who it should – “PayPal Support (firstname.lastname@example.org)” is probably not from PayPal as they don’t send email from a gmail address. You can stop, report the message and then mark it as spam or phishing, delete it and move on. You can also do the same with links in the message – are they taking you to the anticipated site? If the message purports to be from someone you know and seems weird, call them and ask if they sent it.
Avoid online personal trivia games or questionnaires on social media and other sites.
While these may be fun to see the promised result, be it your personality type, how you will die, etc., these “games” are often used to help gather personal information about you that can be used to create fraudulent accounts in your name. Be wary of anything that ask questions about your birthday, month, year and/or any of the questions you might see when setting up security questions.
It has been a while since I have come up for air and had a chance to write a blog post. Tax season from last year seemed to blend in with this year’s. Adding PPP loan 2.0, starting the season late and Congress changing tax code retroactively in the middle of the tax season (and States still trying to adjust to what Congress did) made for head-down, hold your breath and work tax season. My normal Wednesday morning writing blocks were replaced with tax work.
As we eFiled the last un-extended tax return Monday evening, yesterday was spent regrouping and planning the workload for the returns on extension. Today I get to write again.
It seems the virus, while raging in some parts of the world has calmed down in others. Vaccines are being administered. Mask mandates are being lifted. It seems like there is a hope for things coming back to a sense of normalcy. I do not attempt to fool myself into believing that things will go back to normal as we once knew it. My normal won’t be the same as it was before this and neither will your normal, but I look forward to experiencing it.
Many people will be asked to return to the office soon and those who have become accustomed to working from home may not want to go back. There will be a great reshuffling of the labor force. As costs for gas, food and other expenses of life have increased, the jobs that used to pay enough may not pay enough anymore. I suspect we will see certain jobs requiring wage increases to be filled. As people have moved out of certain places, there will be new areas of labor shortages. Normal will be different.
I know I have questioned what my normal will be. Having worked at home for an extended period during the pandemic, I have proven that the expensive lease payment I continued to make for a space I was not using may not be necessary. My clients might enjoy meeting in person once and awhile, but they are also okay with meeting virtually. I enjoyed the improved air quality that came from less commutes being made by everyone. I enjoyed the extra time in my day with family instead of going back and forth between the office. These experiences will shape future choices and what normal for me will become.
For now, the first part of tax season is over, and it is time to come up for a long and deep breath. It is nice to remember what it feels like to breathe.
With the pandemic raging, many employees were asked to work from home to help prevent the spread of the virus. Now that it is tax time, I am getting asked if they can deduct their home office expenses on their tax return.
The bad news is if you are an employee rather than a business owner, under the Tax Cuts and Jobs Act passed in 2017, unreimbursed employee business expenses are not deductible for 2018-2025. This means that if the employer chooses to reimburse you for your home office expenses under an accountable plan, you are lucky and if you aren’t reimbursed, then there is no deduction and you are out of luck.
If you are a business owner, the home office deduction is available to you still.
If you work from home and make your home your principal place of business, you may be able to deduct your home office expenses whether you own or rent your home. It doesn’t have to be an office at home. You might have a workshop or studio.
Many people believe that claiming the home office deduction is an audit flag and as a result, many who qualify for it don’t claim it. The IRS denies that the home office deduction increases the chance of being selected for an audit. If you are entitled to it, you should take and have no fear should you be audited.
To qualify for the home office deduction, you must meet certain requirements. The first requirement is that you have a portion of your home that is used regularly and exclusively for a trade or business. While the IRS doesn’t define what regular use looks like, it does suggest that it should be on a continuing basis and not just for occasional or incidental business. Even a few hours a day will likely satisfy this test. Exclusive use means that the portion of your home that is used for business is only used for business. No personal use is allowed. The space doesn’t have to be a whole room; it can be some part of the room that is only used for business. It doesn’t even have to be part of the house. You can have a freestanding structure such as a garage, barn or studio that is used exclusively and regularly for business.
The second requirement is that your home office is used as your primary place of business. Most self-employed people meet this requirement. You should do most of your work at home. If you do all or most of your work in your home office, your home is your principal place of business.
If you only do administrative work at home, you may still qualify. Building contractors, traveling salespeople, painters, etc. work away from the home but can still qualify for the deduction if they use the office to conduct administrative or management activities (invoicing, bookkeeping, paying bills, etc.) for their business and they have no other fixed location from where they conduct such activities.
If your home doesn’t qualify as your principal place of business, you can still take the deduction if you regularly meet clients or customers in your home office or if you are selling products, retail or wholesale, and store inventory or product at home.
There used to be three ways to deduct this expense but now there are only two. The first is as the home office deduction as part of the Schedule C – Profit and Loss from Sole Proprietorship. The second was as an unreimbursed employee business expense. The third is as an unreimbursed partnership expense if required by the partnership. The first and third are still available to you depending upon how your business is organized. The second was eliminated as part of the TCJA. (If you are not a sole-proprietor, it is best to have your business reimburse you for the business use of your personal home.)
There are two ways to calculate the deduction. The standard method is to find the percentage your home office represents as a piece of the total property square footage and apply it against the total expenses of the home (utilities, depreciation, repairs and maintenance the benefit the entire property, HOA fees, insurance, rent, mortgage interest, property taxes, etc.). If your home office is 50 square feet and your home is 1,500 square feet, you would deduct 3.33% of the total home expenses. If the costs were $5,000, your deduction would be $166.66. You must keep record of these expenses in order to claim them.
The other method is the simplified method. This is a flat $5 per square foot multiplied by the home office square footage. If your home office was 50 square feet, your deduction under this method would be $250. No records to keep. You can’t deduct more than $1,500 under this method (300 square feet home office).
The deduction is limited to your business profits meaning that you can’t deduct more than the profit of your business, but you can deduct unused amounts in the future as a carryforward expense. You will claim the expense on Form 8829.
Every once and awhile, we make a mistake and must make it right. When it comes to the IRS, saying sorry is not sufficient. The IRS can impose almost 150 types of penalties – most common are caused by late filing and late payment.
There are however ways to abate the penalties assessed against you. The first, which should be used carefully and as a last resort because you only get one, is to ask for the penalties to be forgiven under the first-time penalty abatement request. If you have penalties for multiple years, this will only work for one of them. Please discuss how and when to use this abatement request with your CPA.
Perhaps the best penalty abatement is for reasonable cause. You have to qualify to be able to use it but the IRS can waive penalties it assessed against you or your business if there was “reasonable cause” for your actions. If the IRS accepts the abatement, it will only remove the penalties. It will not impact any interest or tax you may owe.
The IRS permits reasonable cause penalty relief for penalties arising in three broad categories:
Contrary to what you might think, the term “reasonable cause” is a term of art at the IRS. This seemingly simple phrase has a precise and detailed definition as it relates to penalty abatement.
Here are three instances where you might qualify for reasonable cause relief:
Here are five instances where you likely do not qualify for reasonable cause penalty relief:
If one of the three reasons above apply (and not primarily the five above), you may request that the IRS abate your penalties for reasonable cause. You must provide the reason (one or more of the three) and provide evidence. Your CPA can help you draft the language in your request to the IRS.
Getting your penalties abated can save you hundreds or thousands of dollars.
I was recently asked by a client if their children needed to file a tax return. As with most answers to tax questions, the answer was “It depends.” (P.S. The answers are most likely the same if you are asking if you need to file an income tax return.)
What does it depend upon?
It depends upon the amount of income amount and type of income.
Earned Income – If your child has earned income (worked a job, received a W-2), they do not need to file a tax return unless that income is greater than the standard deduction (For 2020 it is $12,400). If more than the standard deduction, they need to file.
Self-Employment Income – If you child runs their own business and has a profit of more than $400, they need to file a tax return and may owe self-employment taxes but not income taxes if total income is less than the standard deduction.
Unearned Income – If your dependent child has unearned income such as interest and dividends or passive income, they must file a return if the unearned income exceeds $1,100 or the parents may elect to report this income on their personal return and note “election to modify tax on unearned income of ___ child”. If the parent elects this treatment, the child may not need to file a return if the Earned or Self-Employment Rules above don’t apply. Unearned income over this amount may be subject to “kiddie tax” rates of either the parent’s income tax rate or that of a trust or estate.
The need to file a return is independent of whether or not a parent can claim the child as a dependent.
There are also times your child may want to file a tax return even though they are not required to do so. If they had federal or state income tax withheld on their W-2 or paid estimated taxes, they will need to file to claim the refund. There are also times that a non-dependent child may want to file in order to claim certain tax credits such as the earned income credit or the recovery rebate credit (stimulus checks not received.)
As business owners and individuals, we go about our days doing the things we do, noticing everything that is fit into our little jar of life. We own what is in our jar.
I recently had the opportunity to take a hot air balloon ride in the early morning to catch the sunrise. There, in a little basket, I began to rise and soon I began to see things I couldn’t see from the ground. My view increased and I experienced a sunrise, something I have seen before, differently. I was able to see the expanse of the river, the green of the fields, the vastness of the desert and mountains. I saw what others could not see without going up.
As a CPA, I help people all the time and I enjoy doing it. One of the things I enjoy most is to help people read what is on the label of their “jar” and help them understand what it means as well as what is outside of the jar. We can’t read the labels when we are in our jars. Some business owners have figured out how to get out of their jars and look at the labels themselves. Most need someone’s help. I love providing that help. It is wonderful to provide clarity and help them see the view from up here.
Over the last few months, I have lost one of my clients to COVID-19 and added a new client who lost their father to the virus. Both the surviving spouse and the daughter had questions about what to do or what needs to be done when a loved one passes. I thought I would take a moment and highlight some of the important considerations.
If a loved one passes away and you serve as the executor or inherit assets, you need to consider your duties and so some tax planning.
Filing the Final Form 1040 for Unmarried Decedent
If the decedent was unmarried, an initial step is to file his or her final Form 1040.
That return covers the period from January 1 through the date of death. The return is due on the standard date: for example, April 15, 2021, for someone who dies in 2020, or October 15, 2021, if you extend the return to that date.
Filing Tax Returns. You, as the executor, may need to file
You won’t need to file Form 1041 when all the decedent’s income-producing assets bypass probate and go straight to the surviving spouse or other heirs by contract or by operation of law—assets such as
If the estate is valued at $11.58 million or less and the decedent did not make any sizable gifts before death, you don’t have to file Form 706. But even if you don’t have to file Form 706, you may want to file it anyway to preserve the portability election.
Surviving Spouse May Be Able to Use Joint Return Rates for Two Years Following Deceased Spouse’s Year of Death
The benefits of the married-filing-joint status are extended to a qualified widow or widower for the two tax years following the year of the deceased spouse’s death.
In general, to be a qualified widow/widower for the year, the surviving spouse must be unmarried as of the end of the year.
If Decedent Had a Revocable Trust
To avoid probate, many individuals and married couples of means set up revocable trusts to hold valuable assets, including real property and bank and investment accounts.
These revocable trusts are often called “living trusts” or “family trusts.” For federal income tax purposes, they are properly described as “grantor trusts.”
As long as the trust remains in revocable status, it is a grantor trust, and its existence is disregarded for federal income tax purposes. Therefore, the grantor or grantors are treated as still personally owning the trust’s assets for federal income tax purposes, and tax returns of the grantor(s) are prepared accordingly.
Basis Step-Ups for Inherited Assets
If the decedent left appreciated capital gain assets—such as real property and securities held in taxable accounts, the heir(s) can increase the federal income tax basis of those assets to reflect fair market value as of
When the inherited asset is sold, the federal capital gains tax applies only to the appreciation (if any) that occurs after the applicable magic date described above. The step-up to fair market value can dramatically lower the tax bill.
You should work with brokers to update basis information of stocks and bonds and may need to obtain appraisals of real estate or other assets to support the step-up basis.
Co-ownership. If the decedent was married and co-owned one or more homes and/or other capital gain assets with the surviving spouse, the tax basis of the ownership interest(s) that belonged to the decedent (usually half) is stepped up.
Community property. If the decedent was married and co-owned one or more homes and/or other capital gain assets with the surviving spouse as community property in one of the nine community property states (Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin), the tax basis of the entire asset—not just the half that belonged to the decedent—is stepped up to fair market value.
This strange-but-true rule means the surviving spouse can sell capital gain assets that were co-owned as community property and only owe federal capital gains tax on the appreciation (if any) that occurs after the applicable magic date. That means little or no tax may be owed. Good!
Medical Expenses of the Decedent. The decedent’s medical expenses provide you with planning opportunities to
Life Insurance Proceeds. In general, life insurance proceeds paid to beneficiaries of the policy are not taxable to the beneficiaries.
Inheritance and Tax. In most cases, if an asset has already been taxed then the beneficiaries will not owe tax on the inheritance. If the asset has not yet been taxed, such as IRAs and retirement accounts, the beneficiaries will need to pay tax on the distributions they receive when received. If the assets represent income of the estate and are distributed to the beneficiaries, the beneficiaries will need to pay tax on that distributed income. Some states may have an inheritance tax that will be owed even if there isn’t an imposed federal tax.
This blog allows you to experience the raw, gut wrenching drama of human conflict through accounting in each of its three stages: preparing to do battle, the thrill of victory and the agony of defeat.