Author Archives: Jeramiah Young

2020 YEAR-END TAX PLANNING LETTER FOR INDIVIDUALS

Dear Client:

Due to the coronavirus pandemic (COVID-19) and the enactment of legislation to offset the economic burden wrought by COVID-19, as well as a legislation passed at the end of 2019, there is a lot to consider when reviewing year-end tax planning options that may be available to reduce your 2020 tax liability.

In December of 2019, the SECURE Act was signed into law. This legislation extended several expiring deductions and tax credits and provided some taxpayer-friendly changes to retirement-related rules. In 2020, the first piece of COVID-19 tax-related legislation signed into law was the Families First Coronavirus Response Act (Families First Act), which responded to the coronavirus outbreak by providing, among other things, four types of tax credits for employers and self-employed individuals. The Families First Act was followed by the biggest piece of legislation for the year – the Coronavirus Aid, Relief, and Economic Security Act (CARES Act). The CARES Act, as well as subsequent coronavirus-related legislation, will most likely impact your tax return in some way. The following are some of the considerations we should explore when discussing the tax breaks from which you may benefit, as well as the strategies we can employ to help minimize your taxable income and resulting federal tax liability.

Effect of CARES Act Rebate on Your 2020 Tax Return

Under the CARES Act, individuals with income under a certain level are entitled to a recovery rebate tax credit. These are direct payments (sometimes referred to as “stimulus checks”) to individuals by the government. Most, but not all, of these stimulus checks have already been sent out to eligible individuals during 2020.

The government issued the rebates based on 2019 income tax returns, or 2018 returns for individuals who had not yet filed their 2019 tax return. The calculation for the correct amount of the rebate will be part of your 2020 tax return. If your 2020 tax return indicates a rebate larger than your stimulus check (because, for example, your income went down or you had another child), any additional amount can be claimed as a credit against your 2020 tax bill. On the flip side, if the 2020 rebate calculation shows an amount in excess of what you were entitled to, you do not have to repay that excess.

Filing Status

Your tax return filing status can impact the amount of taxes you pay. For example, if you qualify for head-of-household (HOH) filing status, you are entitled to a higher standard deduction and more favorable tax rates. To qualify as HOH, you must be unmarried or considered unmarried (i.e., legally separated or living apart from a spouse) and provide a home for certain other persons. If you are in such a situation, we need to review whether you qualify for HOH filing status.

If you are married, you’ll either be filing your return using the married filing jointly or married filing separately filing status. Generally, married filing separately is not beneficial for tax purposes, but in some unique cases, such as when one party earns substantially less or when one party may be subject to IRS penalties for issues relating to their tax reporting, it may be advantageous to file as married filing separately.

 

Income, Deductions, and Credits

Income from Repayment of Student Loan Debt. The CARES Act excludes from income certain student loan debt repaid by an individual’s employer. Thus, if an employer repaid some or all of your student loan debt after March 27, 2020, and before 2021, that repayment, which would otherwise be taxable income to you, is not includible in your income.

Standard Deduction versus Itemized Deductions. The Tax Cuts and Jobs Act of 2017 (TCJA) substantially increased the standard deduction amounts, thus making itemized deductions less attractive for many individuals. For 2020, the standard deduction amounts are: $12,400 (single); $18,650 (head of household); $24,800 (married filing jointly); and $12,400 (married filing separately). If the total of your itemized deductions in 2020 will be close to your standard deduction amount, we should evaluate whether alternating between bunching itemized deductions into 2020 and taking the standard deduction in 2021 (or vice versa) could provide a net-tax benefit over the two-year period. For example, you might consider doubling up this year on your charitable contributions rather than spreading the contributions over a two-year period. If these contributions, along with your mortgage interest, medical expenses (discussed below), and state income and property taxes (subject to the $10,000 deduction limitation on such taxes that applies to both single individuals and married couples filing jointly; and the $5,000 limitation on such expenses for married filing separately returns), exceed your standard deduction, then itemizing such expenses this year and taking the standard deduction next year may be appropriate.

Medical Expenses, Health Savings Accounts, and Flexible Savings Accounts. For 2020, your medical expenses are deductible as an itemized deduction to the extent they exceed 7.5 percent of your adjusted gross income. To be deductible, medical care expenses must be primarily to alleviate or prevent a physical or mental disability or illness. They don’t include expenses that are merely beneficial to general health, such as vitamins or a vacation. Deductible expenses include the premiums you pay for insurance that covers the expenses of medical care, and the amounts you pay for transportation to get medical care.  Depending on what your taxable income is expected to be in 2020 and 2021, and whether itemizing deductions would be advantageous for you in either year, you may want to accelerate any optional medical expenses into 2020 or defer them until 2021. The right approach depends on your income for each year, expected medical expenses, as well as your other itemized deductions.

You may also want to consider health saving accounts (HSAs) if you don’t already have one. These are tax-advantaged accounts which help individuals who have high-deductible health plans (HDHPs). If you are eligible to set up such an account, you can deduct the amount you contribute to the account in computing adjusted gross income. These contributions are deductible whether you itemize deductions or not. Distributions from an HSA are tax free to the extent they are used to pay for qualified medical expenses (i.e., medical, dental, and vision expenses). For 2020, the annual contribution limits are $3,550 for an individual with self-only coverage and $7,100 for an individual with family coverage.

In addition, if you are not already doing so and your employer offers a Flexible Spending Account (FSA), consider setting aside some of your earnings tax free in such an account so you can pay medical and dental bills with pre-tax money. The maximum amount that the IRS will allow to be set aside in 2021 is expected to be $2,750.  FSA funds can be used to pay deductibles and copayments, but not for insurance premiums. You can also spend FSA funds on prescription medications, as well as over-the-counter medicines, generally with a doctor’s prescription. Reimbursements for insulin are allowed without a prescription. And finally, FSAs may also be used to cover costs of medical equipment like crutches, supplies like bandages, and diagnostic devices like blood sugar test kits.

Charitable Contributions. While the tax benefits of making charitable contributions and taking an itemized deduction for such contributions were tamped down as a result of the increase in the standard deduction in the TCJA, the CARES Act modified the charitable contribution rules for 2020 tax returns. As a result, an eligible individual can claim an above-the-line deduction of up to $300 for qualified charitable contributions made during 2020. The above-the-line deduction is not available for contributions made after 2020. An eligible individual is an individual who does not elect to itemize deductions. Thus, absent this provision, anyone taking the standard deduction would be ineligible to take a charitable contribution deduction. A qualified charitable contribution is a cash contribution paid in 2020 to an eligible charitable organization. Contributions of noncash property, such as goods or securities, are not qualified contributions.

As in prior years, you can reap a larger tax benefit by donating appreciated assets, such as stock, to a charity. Generally, the higher the appreciated value of an asset, the bigger the potential value of the tax benefit. Donating appreciated assets not only entitles you to a charitable contribution deduction but also helps you avoid the capital gains tax that would otherwise be due if you sold your stock.  However, it’s important to also keep in mind that tax deductions for contributions of appreciated long-term capital gain property may be limited to a certain percentage of your adjusted gross income depending on the amount of the deduction.

Finally, if you have an individual retirement account and are 70 1/2 years old and older, you are eligible to make a charitable contribution directly from your IRA. This is more advantageous than taking a distribution and making a donation to the charity that may or may not be deductible as an itemized deduction. If your itemized deductions, including the contribution, are less than your standard deduction, then you receive no tax benefit from making the donation in this manner. By making the donation directly from your IRA to a charity, you eliminate having the IRA distribution included in your income. This in turn reduces your adjusted gross income (AGI). And because various tax-related items, such as the medical expense deduction or the taxability of social security income or the 3.8 percent net investment income tax, are calculated based on your AGI, a reduced AGI can potentially increase your medical expense deduction, reduce the tax on social security income, and reduce any net investment income tax.

Expenses Incurred While Working from Home. Although more people have been working from home this year due to the pandemic, related expenses are not deductible if you are an employee. TCJA eliminated the deductibility of such expenses when it suspended the deduction for miscellaneous itemized expenses that was available before 2018. However, if you are self-employed and worked from home during the year, tax deductions are still available. Thus, if you have been working from home as an independent contractor, we should discuss what expenses you have incurred that might reduce your taxable income.

Mortgage Interest Deduction. If you sold your principal residence during the year and acquired a new principal residence, the deduction for any interest on your acquisition indebtedness (i.e., your mortgage) could be limited. The mortgage interest deduction on mortgages of more than $750,000 obtained after December 14, 2017, is limited to the portion of the interest allocable to $750,000 ($375,000 in the case of married taxpayers filing separately). If you have a mortgage on a principle residence acquired before December 15, 2017, the limitation applies to mortgages of $1,000,000 ($500,000 in the case of married taxpayers filing separately) or less. However, if you operate a business from your home, an allocable portion of your mortgage interest is not subject to these limitations.

Interest on Home Equity Indebtedness. You can potentially deduct interest paid on home equity indebtedness, but only if you used the debt to buy, build, or substantially improve your home. Thus, for example, interest on a home equity loan used to build an addition to your existing home is typically deductible, while interest on the same loan used to pay personal expenses, such as credit card debt, is not.

Sale of a Home. If you sold your home this year, up to $250,000 ($500,000 for married filing jointly) of the gain on the sale is excludible from income. However, this amount is reduced if part of your home was rented out or used for business purposes. Generally, a loss on the sale of a home is not deductible. But again, if you rented part of your home or otherwise used it for business, the loss attributable to that portion of the home is deductible.

Discharge of Qualified Principal Residence Indebtedness: If you had any qualified principal residence indebtedness which was discharged in 2020, it is not includible in gross income.

Deductions for Mortgage Insurance Premiums: You may be entitled to treat amounts paid during the year for any qualified mortgage insurance as deductible qualified residence interest if the insurance was obtained in connection with acquisition debt for a qualified residence.

Qualified Business Income Pass through Tax Break. Under the qualified business income tax break, a 20 percent deduction is allowed for qualified business income from sole proprietorships, S corporations, partnerships, and LLCs taxed as partnerships. If you qualify for the deduction, which is available to both itemizers and non itemizers, it is taken on your individual tax return as a reduction to taxable income. This tax break is subject to some complicated restrictions and limitations, but the rules that apply to individuals with taxable income at or below $163,300 ($326,600 for joint filers; $163,300 for married individuals filing separately) are simpler and more permissive than the ones that apply above those thresholds.

Child and Dependent Tax Credit. For 2020, you may claim as much as a $2,000 credit for each child under age 17. The amount of the credit is reduced for taxpayers with modified adjusted income over $200,000 ($400,000 for married filing jointly) and eliminated in full for taxpayers with modified adjusted gross income over $240,000 ($440,000 for married filing jointly). In addition, you may be eligible for a $500 credit for certain dependents. The $500 credit applies to two categories of dependents: (1) qualifying children for whom a child tax credit is not allowed (because, for example, you do not have a social security number for that child), and (2) certain qualifying relatives.

Education-Related Deductions and Credits. Certain education-related tax deductions, credits, and exclusions from income may apply for 2020. Tax-free distributions from a qualified tuition program, also referred to as a Section 529 plan, of up to $10,000 are allowed for qualified higher education expenses. Qualified higher education expenses for this purpose include tuition expenses in connection with a designated beneficiary’s enrollment or attendance at an elementary or secondary public, private, or religious school, i.e. kindergarten through grade 12. It also includes expenses for fees, books, supplies, and equipment required for the participation in certain apprenticeship programs and qualified education loan repayments in limited amounts. A special rule allows tax-free distributions to a sibling of a designated beneficiary (i.e., a brother, sister, stepbrother, or stepsister). As a result, a 529 account holder can make a student loan distribution to a sibling of the designated beneficiary without changing the designated beneficiary of the account. In addition, if your modified adjusted gross income level is below certain thresholds, the following are also available for 2020: a deduction of up to $4,000 for qualified tuition and related expenses, an exclusion from income for education savings bond interest received; a deduction for student loan interest; and a lifetime learning credit of up to $2,000 for tuition and fees paid for the enrollment or attendance of yourself, your spouse, or your dependents for courses of instruction at an eligible educational institution.

 

Retirement Planning

CARES Act and SECURE Act Changes. Several taxpayer-favorable changes were made in the CARES Act and the SECURE Act with respect to retirement plans and distributions from those plans including the following:

(1) The required minimum distribution rules for 2020 are waived so no one is required to take such a distribution and include it in taxable income in 2020.

(2) The age limit for making contributions to a traditional individual retirement account (IRA), previously 70 ½ years old, was repealed in 2020. Thus, anyone who is otherwise eligible may make a contribution to a traditional IRA.

(3) A new type of retirement plan distribution was added to the list of early distributions that are exempted from the 10-percent penalty for early withdrawals. You can now receive a distribution from an applicable eligible retirement plan of up to $5,000 without penalty if the distribution is either a qualified birth or adoption distribution.

(4) Taxpayers impacted by the coronavirus can withdraw up to $100,000 from a retirement plan without penalty.  This withdrawal is generally includible in income over a three-year period.  Call our office to find out about the requirements for the coronavirus (COVID-19) related distribution.

(5) The required beginning date for required minimum distributions has been increased to 72 years old from 70 ½ years old. The former rules apply to employees and IRA owners who attained age 70½ prior to January 1, 2020. The new provision is effective for distributions required to be made after December 31, 2019, with respect to individuals who attain age 70½ after December 31, 2019.

Retirement Plan Contributions. If you can afford to do so, investing the maximum amount allowable in a qualified retirement plan will yield a large tax benefit. If your employer has a 401(k) plan and you are under age 50, you can defer up to $19,500 of income into that plan for 2020. Catch-up contributions of $6,500 are allowed if you are 50 or over. If you have a SIMPLE 401(k), the maximum pre-tax contribution for 2020 is $13,500. That amount increases to $16,500 if you are 50 or older. The maximum IRA deductible contribution for 2020 is $6,000 and that amount increases to $7,000 if you are 50 or over.

Life Events

Life events can have a significant impact on your tax liability. For example, if you are eligible to use head of household or surviving spouse filing status for 2019, but will change to a filing tax status of single for 2020, your tax rate will go up. If you married or divorced during the year and changed your name, you need to notify the Social Security Administration (SSA). Similarly, the SSA should be notified if you have a dependent whose name has been changed. A mismatch between the name shown on the tax return and the SSA records can cause problems in the processing of tax returns and may even delay tax refunds. Let me know if you have been impacted by a life event, such as a birth or death in your family, the loss of a job or a change in jobs, or a retirement during the year. All of these can affect you tax situation.

Impact of Future Legislation

Because it is unclear what, if any, tax legislation may be coming next year, we’ll need to base our year-end planning on existing law.

Please call me at your convenience so we can set up an appointment to discuss your 2020 tax return and determine if any estimated tax payment may be due before year end.

Sincerely,

Karen A. Phelps, CPA

 

 

 

2020 YEAR-END TAX PLANNING LETTER FOR BUSINESSES

Dear Client:

Tax legislation enacted at the end of 2019, as well as new tax laws enacted in 2020 in response to the coronavirus pandemic (COVID-19), will most assuredly affect your business’s 2020 income tax return. The plethora of legislation contains many new provisions which are likely to minimize your business’s 2020 tax liability. As a result, there are actions we may need to take before year end to ensure we take full advantage of all the opportunities introduced by these pieces of legislation. Additionally, amended returns, which could generate significant refunds to you, may be in order.

In December of 2019, the Further Consolidated Appropriations Act, 2020, was signed into law. Included in that new law was the SECURE Act of 2019, which not only extended certain expiring tax credits, such as the employer credit for paid family and medical leave, it also made favorable changes to certain provisions relating to employer-provided retirement plans.

In 2020, the first piece of COVID-19 legislation signed into law was the Families First Coronavirus Response Act (Families First Act), which responded to the coronavirus outbreak by providing, among other things, payroll tax credits for leave required to be paid under the newly enacted Emergency Paid Sick Leave Act (EPSLA) and Emergency Family and Medical Leave Expansion Act (EFMLEA). The Families First Act was followed by the biggest piece of legislation for the year – the Coronavirus Aid, Relief, and Economic Security Act (CARES Act). Included in the CARES Act was the Paycheck Protection Program (PPP), a program authorized by the Small Business Administration (SBA) to guarantee $349 billion in new loans to eligible businesses and nonprofits affected by coronavirus/COVID-19. Such loans may also qualify for tax-free loan forgiveness. We need to evaluate the changes made by the CARES Act, as well as subsequent coronavirus-related legislation, to determine their impact on your business’s tax liability. The following are some of the considerations we need to review when deciding what year-end actions may be appropriate to reap the most benefit to you and your business’s bottom line.

Depreciation Deductions

Among the many changes made by the CARES Act, the one which may have the most impact is the correction of a technical error made in the Tax Cuts and Jobs Act of 2017 (TCJA). That error resulted in the 15-year recovery period that applied to qualified leasehold improvements, qualified restaurant property, and qualified retail improvement property being eliminated for such property placed in service after 2017. After the TCJA, the depreciation period for such property, now referred to as “qualified improvement property,” was 39 years and, as a result, did not meet the requirements for additional first-year depreciation (i.e., bonus depreciation). Under the CARES Act, qualified improvement property is now depreciated over a 15-year life and meets the criteria for taking bonus depreciation. The change is effective as if it were included in the TCJA. Thus, if your business is affected by this change, we can file amended returns to claim refunds for the deductions that should have been available to you had the technical error not happened.

Relaxed Rules for Deducting Net Operating Losses

The CARES Act also temporarily removed the 80 percent limitation on taxable income for deducting net operating losses (NOLs) for 2020. In addition, the CARES Act amended the rules for NOLs to provide for a five-year carryback of any NOL arising in 2018, 2019, and 2020. As a result, if applicable, your business can take such NOLs into account in the earliest tax year in the carryback period and carry forward unused amounts to each succeeding tax year. Alternatively, you can waive this carryback period and instead carry forward any NOLs to offset income in future years. Depending on expected tax rates and cash flow in future years, this waiver option may make more sense than carrying back any NOLs.

Retirement Plans and Other Employee Benefits

You can reap substantial tax benefits, as well as non-tax benefits, by offering a retirement plan and/or other fringe benefits to employees. Businesses that offer such benefits have a better chance of attracting and retaining talented workers. This, in turn, reduces the costs of searching for and training new employees. Contributions made to retirement plans on behalf of employees are deductible and you may be eligible for a tax credit for setting up a qualified plan. In addition, business owners can take advantage of the retirement plan themselves, as can their spouse. Where a spouse is not currently on the payroll of a business, consideration should be given to adding the spouse as an employee and paying a salary up to the maximum amount that can be deferred into a retirement plan. So, for example, if your spouse is 50 years old or over and receives a salary of $25,000, all of it could go into a 401(k), leaving him or her with a retirement account but no taxable income.

To help employees with medical expenses, your business might consider setting up a high deductible health plan paired with a health savings account (HSA). The benefits to a business include savings on health insurance premiums that would otherwise be paid to traditional health insurance companies and having employee wage contributions to the plan not being counted as wages and thus neither the employer nor the employee is subject to FICA taxes on the payroll contributions. As for employees, they can reap a tax deduction for funds contributed to the HSA, which they can invest the funds for future medical costs because there is no use-it-or-lose-it limit like there is for most flexible spending accounts; thus the funds can grow tax free and be used in retirement.

Your business might also consider establishing a flexible spending arrangement (FSA) which allows employees to be reimbursed for medical expenses and is usually funded through voluntary salary reduction agreements with the employer. The employer has the option of making or not making contributions to the FSA. Some of the benefits of an FSA include the fact that contributions made by the business can be excluded from the employee’s gross income, no employment or federal income taxes are deducted from the contributions and reimbursements to the employee are tax free if used for qualified medical expenses.

In addition, the SECURE Act made substantial changes to retirement plan-related provisions from which your business may benefit. For one, it increased the credit available for small employer pension plan startup costs. The credit is available for qualified startup costs of an eligible small employer that adopts a new qualified retirement plan, SIMPLE IRA plan, or SEP, provided that the plan covers at least one non-highly compensated employee. Qualified startup costs are expenses connected with the establishment or administration of the plan or retirement-related education for employees with respect to the plan. The credit, which applies for up to three years, was increased to the lesser of (1) a flat dollar amount of $500 per year, or (2) 50 percent of the qualified startup costs.

The SECURE Act also extended through 2020 an employer credit for paid family and medical leave. The credit allows eligible employers to claim a general business credit equal to an applicable percent of the amount of wages paid to qualifying employees during any period in which such employees are on family and medical leave, provided that the rate of payment under the program is at least 50 percent of the wages normally paid to an employee.

The SECURE Act also extended the work opportunity credit through 2020. Under this provision, an employer can take a 40 percent credit for qualified first-year wages paid or incurred with respect to employees who are members of a targeted group of employees.

Qualified Business Income Deduction

If you participate in a business as sole proprietor, a partner in a partnership, a member in an LLC taxed as a partnership, or as a shareholder in an S corporation, you may be eligible for the qualified business income (QBI) deduction. The QBI deduction is generally 20 percent of qualifying business income from a qualified trade or business.

Employee Payroll Tax Deferrals

In a Payroll Tax Memorandum issued in August, President Trump directed Treasury Secretary Mnuchin to use his authority to defer the withholding, deposit, and payment of employee social security taxes, as well as taxes imposed under the Railroad Retirement Tax Act (RRTA) on railroad employees, for the period of September 1, 2020, through December 31, 2020. Because these taxes are not forgiven, and must be repaid at the end of the year, such a deferral could result in numerous practical challenges, such as what happens if an employee leaves before he or she repays the payroll taxes. If you have deferred an employee’s payroll taxes under this Presidential directive, we need to discuss your options.

Extension of Time to Pay Employment Taxes

Under the CARES Act, a business can delay payment of applicable employment taxes for the period beginning on March 27, 2020, and ending before January 1, 2021 (i.e., the payroll tax deferral period). Generally, under this provision, the business is treated as having timely made all deposits of applicable employment taxes that would otherwise be required during the payroll tax deferral period if all such deposits are made not later than the “applicable date,” which is (1) December 31, 2021, with respect to 50 percent of the amounts due, and (2) December 31, 2022, with respect to the remaining amounts. For self-employed taxpayers, the payment for 50 percent of the self-employment taxes for the payroll tax deferral period is not due before the applicable date. For purposes of applying the penalty for underpayment of estimated income taxes to any tax year which includes any part of the payroll tax deferral period, 50 percent of the self-employment taxes for the payroll tax deferral period are not treated as taxes to which that penalty applies.

PPP Loan

If your business obtained funds through the PPP program, we should discuss the steps and documentation necessary to ensure that your loan is fully forgiven.

Impact of Future Tax Legislation

Because it is unclear what, if any, tax legislation may be coming next year, we’ll need to base our year-end planning on existing law.

Please call me at your convenience so we can discuss potential strategies to reduce your taxable income and tax liability for 2020.

Sincerely,

Karen A. Phelps, CPA