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.
On December 27, 2020, President Trump signed the Consolidated Appropriations Act, 2021 (CCA2021) into law. With it comes some changes to the tax code.
First, as I previously wrote about, expenses related to PPP Loan Forgiveness are now Deductible and a second round of funding was authorized.
Second, the Employee Retention Tax Credit was changed to allow a 70% credit of certain qualified wages up to $28,000 per year and was extended to July 1, 2021 and those who received PPP loan funds are now eligible if they meet certain criteria.
Third, Recovery Rebates (read advance tax credits) of additional $600 per individual (taxpayers and dependents under 17) for those with incomes less than $75,000 for individuals and $150,000 for married filing joint with no qualifying children.
Paid Sick Leave and Family Leave Tax Credits were extended through the first quarter of 2021. While previously required for certain sized employers in 2020, participation is voluntary in 2021 but the credit is available to those who do.
Fifth, business meal deductions are temporarily increased from 50% deductible to 100% deductible for 2021 and 2022 for business meals provided at a restaurant. A business meal must have a client or employee present and business must be discussed just prior, during or just after the meal. Meals while traveling for business are also considered business meals.
Sixth, a correction for residential rental property. Under the prior law (TCJA), a real property trade or business could elect out of the limitation on the deductibility of business interest if it elected to depreciate residential property over 30 years. The law previously required a 40 year life.
Seventh, the above the line charitable deduction for those who do not itemize was increased to $300 for individuals and $600 for married filing joint. Those who overstate the deduction will be subject to 50% penalties.
There were also a couple of changes that apply to related controlled foreign corporations and the deferral of the employee side payroll taxes which do not apply to most taxpayers.
Happy New Year! Congress gave us some additional support at year-end.
The biggest news is that Loan Proceeds Are Not Taxable (forgiven or not). The COVID-related Tax Relief Act of 2020 reiterates that your PPP loan forgiveness amount is not taxable income to you.
The second big news is Expenses Paid with Forgiven Loan Money Are Tax-Deductible. As you may remember from a previous blog post, the IRS took the position that expenses paid with PPP loan forgiveness monies were not deductible. Lawmakers disagreed but were unable to get the IRS to change its position. The IRS essentially told lawmakers, “If you want the expenses paid with a PPP loan to be deductible, change the law.”
And that’s precisely what lawmakers did. The COVID-related Tax Relief Act of 2020 states that “no deduction shall be denied, no tax attribute shall be reduced, and no basis increase shall be denied, by reason of the exclusion from gross income.”
In plain English, the expenses paid with monies from a forgiven PPP loan are now tax-deductible, and this change goes back to March 27, 2020, the date the Coronavirus Aid, Relief, and Economic Security (CARES) Act was enacted.
In addition to those pieces of good news, Congress also authorized a Second Round of PPP Loan Funding for those who received funding in the first round. This second round or PPP 2.0 is available if you meet the following qualifications:
Congress kept the same funding requirements as the first round but added a bit more funds available to the hotel or restaurant (NAICS Code 72) industry where they can get 3.5 instead of 2.5 times monthly qualified payroll.
They also added a few new categories of expenses to the forgiveness calculation. You still have to use at least 60% for payroll but can now spend the remaining amount on:
So if you qualified for the first round and you had at least 25% reduction in revenue in one quarter of 2020 compared to 2019, reach out to your lender to make sure you apply when they start accepting round two applications.
In this world there are few times where you can have your cake and eat it too. Is there a way you could give your employees a bonus that you get to deduct and they don’t have to claim as income? The answer to that is almost always “no” but this year, there might be a way.
COVID-19 and the president’s earlier declaration of a federal disaster for the states and territories of the United States of America invoked Section 139 of the Internal Revenue Code and the ability of an employer to make qualified disaster relief payments. Under the code, an employer can make relief payments to their employees that are both deductible to the employer and non-taxable to the employee. Most commonly, we see these declarations and payments made during the time of natural disasters, but the pandemic by way of the President’s declaration also qualifies.
Granted, an employer just can’t write a bonus check and call it a relief payment. The employer must do some due diligence about what qualifies as a qualified employer provided relief payment in order to provide tax-free funds to impacted employees. These relief payments do not have to be the same for each employee (but may be) nor do they have to be given to every employee. In other words, the employer has the discretion to help an employee that has been impacted more by the disaster than another by giving more to that employee.
A qualified disaster relief payment is for the following purposes:
A key here is that the payments made are reasonable in nature and for necessary expenses. They also cannot be for something that has already been accounted for by insurance or other means. (For example, if your health insurance plan covered testing of your employees, you couldn’t include the cost of the testing in your relief payment.)
The payments do not have to have significant documentation. In addition, proof of these expenses does not have to be provided by the employee.
Personally, I have seen money spent on protective gear, cleaning supplies and sanitizers as a result of the pandemic that I would not have normally spent. I have seen my home utilities increase as work and school from home happened. I have seen family members need to be tested and quarantine while awaiting results from possible exposure or symptoms and miss work. I have seen counseling visits and other therapy to help with the stress and anxiety that have come from the pandemic. All of these costs would not have been incurred absent the pandemic.
It is my belief that as long as the amounts are reasonable and for necessary expenses related to the pandemic and the purpose of the payment is documented, an employer can make pandemic related qualified relief payments to their employees for these and perhaps other expenses.
While not technically a bonus, providing a qualified relief payment to employees at this time of year provides a great tax deduction to the employer and tax-free money to impacted employees.
The Year in Review
It has been a busy year for Federal Income Taxation. In response to the pandemic, President Trump declared a nationwide emergency which allows states and territories to receive federal aid without needing to make individual requests. It also means certain losses under the disaster can be deducted in the prior year and certain assistance received is not taxable.
Congress passed the Families First Coronavirus Response Act (FFCRA) and created certain credits for certain employers (50-500 employees, less than 50 employees – participation is not mandatory) including emergency paid sick leave and emergency family and medical leave.
Congress then passed the Coronavirus Aid, Relief and Economic Security Act (CARES) which included aid to individuals and provisions to assist businesses. A key component of this act was the Payroll Protection Program Loan. This was a low interest rate loan that had the potential of forgiveness if spent on certain expenses including payroll. Congress had intended these loans to be non-taxable but failed to incorporate the proper language in the bill and the IRS is currently deeming any expenses paid for with a forgiven loan amount as non-deductible, essentially making the forgiven loan taxable. We hope that Congress corrects the language before adjourning for the year.
The CARES Act also provided individual stimulus payments of up to $1,200 per person, ($2,400 for a married couple and $500 for each qualifying dependent subject to income limitations). The amount paid is actually an advance payment of a 2020 tax return credit. As it was based on 2018 or 2019 income, there will be a true-up on your 2020 tax return. If you are entitled to a higher amount than received, you may get it as part of a refund or credit on your 2020 return. If you were overpaid based on your 2020 income, you will not owe the government.
Under the CARES Act, required minimum distributions from retirement plans were waived in 2020 allowing an individual to leave funds in the plan and keep 2020 income lower. The Act also allowed for certain loans from plans, temporary removal of early distribution penalties, and income staggering for Coronavirus-related distributions.
Net Business Loss limitations were also suspended for 2018, 2019 and 2020. This would allow claims for refunds where the business loss may have been limited. The limitation returns in 2021.
The CARES Act also created a $300 above the line charitable deduction for individuals who do not itemize. It also removed the 60% AGI limitation for 2020 and individuals can deduct up to 100% of their income (AGI) from made charitable contributions in 2020.
Several payroll related credits were also created for businesses including the Employee Retention Credit (for those who did not receive PPP loans) and Deferral of Employer Component of Payroll Taxes. Other business tax related items included in the Act are Corporate AMT Credit Refund, NOL Carryback extension, Bonus Depreciation, Business Interest Expense limitation adjustments and a temporary increase to the corporate charitable deduction.
2020 Tax Planning
As long term capital gains are taxed favorably compared to short term capital gains, you should consider holding capital assets for at least 12 months and a day to take advantage of the favorable rates (0%, 15% or 20% depending on income level). You may also consider gifting appreciated stock to charity or relatives in lower tax brackets who may pay less or no tax when the shares are sold. You may also want to harvest unrealized losses in your portfolio to offset current year gains.
Net Investment Income Tax (NIIT)
A 3.8% tax is assessed on net investment income (interest, dividends, capital gains, rental income and passive activities) if income is more than $200,000 for individuals or $250,000 for married couples. The impact of this tax can be lessened by using installment sales to spread income over many years thus potentially keeping your income below the threshold. You may also harvest unrealized loss positions in your portfolio to lower harvested gains. You may also consider investing in tax-exempt income as it is not subject to the NIIT.
Small Business Owners
As a business owner you have additional tools to assist in minimizing your tax bill.
If you file using the cash basis method on your taxes, you may consider deferring billing and collections until year-end thus pushing the receipt into 2021. If you file under the accrual method, you can delay shipping products or delivering service.
You may also accelerate your expenses by paying for business expenses by year-end. Remember that credit card charges are deductible in the year made rather than paid.
You may consider hiring your child. Having your child work in the family business allows them to pay tax on their wages at their tax rate and if they are under age 17, their wages are exempt from social security, Medicare and federal unemployment taxes. They should be paid through payroll, given a W-2 and be paid reasonably for the age and skills of the child. They can make up to $12,000 a year before they will pay income tax and $18,000 a year if they make an IRA contribution (maximum is $6,000).
If you have a home office that is used primarily for business activities, you may be able to take the home office deduction as a self-employed individual. Owners of S-Corporations, Partners or Multi-Member LLCs can be reimbursed for necessary home office deductions under an accountable plan and the business may take the deduction. You may also choose to reimburse these costs of your employees if they were working from home during the pandemic.
You may also consider acquiring assets you need for the business. It never makes sense to buy an asset solely to get a tax deduction but if you need it for your business, it is better bought in December than January. With Section 179 and bonus depreciation rules, you may be able to deduct the entire purchase in the current tax year.
If you itemize your deductions, you can deduct qualified medical expenses that exceed 7.5% of your adjusted gross income. Medical expenses that qualify are health insurance premiums (not deducted elsewhere), long term care insurance premiums, medical and dental services, prescription drugs, mental health services and prescribed medical equipment. As such, you may consider bunching elective medical procedures into 2020 if it will help you exceed the 7.5% limitation. The threshold will likely be increased to 10% in 2021.
With the additional $300 charitable deduction for those who do not itemize and increased limitations for those do, 2020 is a great year to donate to charity. Consider making your annual giving for next year in this year. Donate appreciated stock and avoid paying the capital gains tax and get a fair market value deduction for stocks held more than one year. You can also do the inverse and sell depreciated stock, harvest the loss and donated the cash proceeds to charity. This allows you to keep the loss and help the charity. (Remember the $3,000 per year capital loss deduction limitation.)
You may also max out your retirement contributions to lower your tax bill, whether it is your 401k or IRA. Remember contributions to ROTH accounts are not deductible but still a good savings vehicle.
Spending and Savings Account Contributions
If you have a Flexible Spending Account (FSA), you may contribute up to $2,750 and have it excluded from income. While generally these funds are “use it or lose it”, your employer may allow you to carryover $500.
If you qualify to make contributions to a Health Savings Account (HSA), you may contribute up to $3,550 as a single individual or $7,100 for family coverage. If you are 55 or older you may make an additional $1,000 contribution ($2,000 for a married couple both 55 or over).
Qualified Charitable Distributions (QCD)
If you have reached 70 ½, you can donate up to $100,000 per year from a IRA account directly to a qualified charity. The donation meets the minimum distribution requirement but is also excluded from your income. (Keep in mind that you cannot take a charitable deduction for this distribution. For 2020, you do not have a minimum distribution requirement.)
You can make up to $15,000 of tax-free gifts to individuals. Gifts over that amount in a calendar year are subject to gift tax. Married couples can elect to split gifts and therefore give up to $30,000 to an individual in 2020.
With the economic troubles caused by the pandemic, many individuals lost their jobs and were able to receive unemployment benefits including additional federal funds. While a lifesaver while unemployed, you should be aware that unemployment benefits are taxable and should be reported on your income tax return. You should plan for the tax hit if you have not already.
States have also made tax changes as a result of the pandemic including income sourcing, nexus and residency rules.
We are bound to see new tax changes as Congress looks to add stimulus and we start a new administration with a new tax policy. As Benjamin Franklin said, “In this world, nothing can be said to be certain except death and taxes.”
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.