Category: Tax Tips

If you receive a notice from the IRS, do not automatically assume it is correct and submit payment to make it go away. Because of all the recent tax law changes and so little time to implement the changes, the IRS can be wrong more often than you think. These IRS letters, called correspondent audits, need to be taken seriously, but not without undergoing a solid review. So what should you do if you receive one?

Stay calm. Try not to over-react to the correspondence. This is easier said than done, but remember that the IRS sends out millions of these types of correspondence each year. The vast majority of them correct simple oversights or common filing errors.

Open the envelope! You would be surprised how often taxpayers are so stressed by receiving a letter from the IRS that they cannot bear to open the envelope. If you fall into this category, try to remember that the first step in making the problem go away is to open the correspondence.

Conduct a careful review. Review the letter. Understand exactly what the IRS is telling you needs changed and determine whether or not you agree with their findings. The IRS rarely sends correspondence to correct an oversight in your favor, but sometimes it happens.

Respond timely. The IRS will tell you what it believes you should do and within what time frame. Ignore this information at your own risk. Delays in responses could generate penalties and additional interest payments.

Get Help. You are not alone. Getting assistance from someone who deals with this all the time makes the process go much smoother.

Correct the IRS error. Once the problem is understood, a clearly written response with copies of documentation will cure most of these IRS correspondence errors. Often the error is due to the inability of the IRS computers to conduct a simple reporting match. Pointing out the information on your tax return might be all it takes to solve the problem.

Certified mail is your friend. Any responses to the IRS should be sent via certified mail or other means that clearly show you replied to their inquiry before the IRS’s deadline This will provide proof of your timely correspondence. Lost mail can lead to delays, penalties, and additional interest tacked on to your tax bill.

Don’t assume it will go away. Until receiving definitive confirmation that the problem has been resolved, you need to assume the IRS still thinks you owe the money. If no correspondence confirming the correction is received, a written follow-up to the IRS will be required.

We’re always being reminded to save for retirement in tax-advantaged accounts like 401(k)s or IRAs. But did you know the government does an about-face and forces us to take money out of those accounts once we reach retirement? It’s called the required minimum distribution (RMD) rule. Here are some tips you should know about RMDs well before you reach retirement age.

The one year hiatus is gone. The required minimum distribution rules were suspended in 2020. They are now reactivated for 2021. This will catch many by surprise, so remind any loved ones over the age of 72 to make their distribution calculation!

Penalties are high. Rules require you to withdraw a certain amount of money every year from tax-deferred retirement plans like 401(k)s and traditional IRAs after you reach age 72, whether you want to or not. These withdrawals are then taxed as ordinary income. If you don’t follow these rules, the IRS can assess a penalty equal to 50 percent of the amount that should have been withdrawn, on top of the regular tax due.

Start thinking about withdrawals early. One of the biggest mistakes is waiting until age 72 to start thinking about required distributions. Remember, you can start withdrawing funds from retirement accounts without penalty after you reach age 59½. If you start planning a tax-efficient withdrawal strategy before required distribution rules kick in, you can manage what tax rate will be applied to your retirement distributions.

Distribution amounts are based on complex tables. How much you’re required to withdraw is based in part on the average life expectancy of someone your age. A calculation based on IRS life expectancy tables, plus your prior year retirement account balance, is used to determine your required withdrawals. The good news is that the financial institution handling your retirement account will usually do the calculation for you.

There are exceptions to distributions if you still work. If you reach age 72 and you’re still working for an employer providing you with a 401(k), you usually don’t have to take a distribution from that account as long as you don’t own 5 percent or more of the company. However, you still must take funds from other plans where you have assets.

Not all accounts require distributions. Not all retirement accounts require you to take a required minimum distribution. Roth IRA accounts, for example, avoid the minimum distribution requirement while giving you some extra flexibility to manage your other taxable withdrawals during retirement.

RMD rules can be confusing, and are a good example of why tax planning is such an important component of a retirement strategy. Please call if you have questions about any tax obligations related to your retirement accounts.

There will be a lot of political rhetoric about increasing the national debt with trillions more in spending, adding billions to allow the IRS to audit high income taxpayers, and creating more changes in the tax code in the next few months.

To help you break through the media clutter, here is the latest information on who pays individual income taxes. The information comes directly from the IRS. It includes the latest published tax data for the 2018 tax year collected in 2019. It represents the first read on the impact of tax collections after implementation of the Tax Cuts and Jobs Act. While this time period is pre-COVID, it should give you an objective view of the current nature of the tax system without the impact of additional federal spending and the impact of unemployment due to the pandemic.

How to read: The top 10% of Adjusted Gross Income (AGI) taxpayers reported approximately 47.7% of the income and paid 71.4% of the total individual income tax collected in 2019 for 2018 tax returns.

Note: The above figures net out “negative” income tax returns for those who filed a tax return, but due to adjustments and credits have negative adjusted gross income.

Source: Internal Revenue Service, SOI Bulletin – Selected Income and Tax Items, Shares of Adjusted Gross Income and Total Income Tax and Average Tax Rates. All figures are based on estimates from sampling conducted by the Internal Revenue Service using 2019 tax filing data that encompass 2018 tax returns. Income means Adjusted Gross Income (AGI) as reported on individual income tax returns.

Observations

• The individual tax system is progressive. 97% of the taxes paid comes from 50% of the people filing tax returns.
• In 2001, per the IRS, the top 1% paid 33.2% of all income taxes. That number is now 40.1% in 2018. Over that same time period, the lowest 50% saw their tax burden decrease from 4.9% to 2.9%.
• Since over 70% of the income tax comes from 10% of taxpayers, you can understand how hiring more auditors to audit high income taxpayers may seem to make sense. It is the only place to get more revenue, since high income taxpayers are the ones paying most of the tax and the trend in rule changes is benefiting other taxpayer groups.
• The information above only include those required to file a tax return. If the data included all households, the percentage of income tax paid by households would weight payment of tax more highly toward the upper AGI households.

How to read the rhetoric

Everyone should pay their fair share. It is an interesting phrase, but what does it mean? How much, exactly, is a fair share for upper income groups? The top 25% currently pay 87% of the tax. Should it be 90%? 95%? All of it? Conversely, are they talking about the 50% of taxpayers that is paying 3% of total income taxes? You will need to decide, but when applying the IRS statistics, it seems like word speak without substance.

We have a progressive tax system. The IRS statistics noted above show this to be true. And even with the impact of the 2018 Tax Cuts and Jobs Act, the progressive nature of the system still holds true.

Tax cuts favor the wealthy. Yes, tax cuts favor the wealthy because that’s who currently pays the majority of income taxes. Tax increases also always hit higher income taxpayers…for the same reason. Part of the philosophical discussion surrounds the purpose of the income tax: is it to pay for spending or is it to redistribute wealth and convert income of some taxpayers into free and low cost benefits for others?

Higher income taxes hurt small business. This is true, but perhaps in more ways than you think. Most small business tax payments are rolled into these individual income tax numbers. This is because most small businesses have their business profits taxed on their personal tax return as flow through entities. So changes in individual tax rates impact most small businesses which in turn impacts their ability to invest in their businesses and employees. To help solve this problem, the tax code contains a tax break called the qualified business income deduction.

It’s hard to believe a little over a year ago the COVID 19 pandemic hit everyone. As things slowly turn back to normal, you need to be ready for the normalizing of the tax rules and adjusting to new ones. Here is how you can be prepared.

Required minimum distributions. If you are age 72 or older, you must once again plan to take the minimum required distribution from your retirement account in 2021. The one-year waiver of this required distribution is now over.

Penalty-free distributions from retirement accounts. While penalty-free distributions from retirement accounts is still available for those in presidentially declared disaster areas, the distribution benefit for pandemic related reasons is expiring. Remember, if you had to make withdrawals you will need to pay income tax on the distributions unless you repay the funds in a timely manner.

Unemployment taxation. Federal unemployment benefits continue to be extended through various federal spending programs. Late breaking rules make $10,200 of last year’s unemployment benefits tax-free on most federal tax returns. But that doesn’t mean you won’t be taxed on these benefits this year. If there are not withholdings from these payments, you may be required to send in estimated tax payments.

Businesses need to stay alert. While the original PPP loan program is now in forgiveness mode, there are new loans and active programs to help cover the cost of employees affected by the pandemic. The best course of action is to stay aware of ever-changing federal and state landscape.

Rules and benefit programs relating to the pandemic are not over. But as social distancing rules adjust, so too must you to the changing tax law landscape.

Hot housing market requires tax knowledge

With housing prices skyrocketing, more homeowners are considering cashing out to multiples over list price! Especially since one of the largest tax breaks available to most individuals is the ability to exclude up to $250,000 ($500,000 married) in capital gains on the sale of your personal residence. Making the assumption that this gain exclusion will always keep you safe from tax can be a big mistake. Here is what you need to know.

The rule’s basics

As long as you own and live in your home for two of the five years before selling your home, you qualify for this capital gain tax exclusion. In tax-speak you need to pass three hurdles:

• • Main home. This tax term defines what a main home is. It can be a traditional home, a condo, a houseboat, or mobile home. Main home also means the place of primary residence when you own two or more homes.
  • Ownership test. You must own your home during two of the past five years.
  • Residence test. You must live in the home for two of the past five years.
  • Other nuances.
    • You can pass the ownership test and the residence test at different times.
    • You may only use the home gain exclusion once every two years.
    • You and your spouse can be treated jointly OR separately depending on circumstances.

When to pay attention

You have been in your home for a long time. The longer you live in your home, the more likely you will have a large capital gain. Long-time homeowners should check to see if they have a capital gains tax problem prior to selling their home.

You have old home gain deferrals. Prior to the current rules, home-gains could be rolled into the next home purchased. These old deferred gains reduce the cost of your current home and can result in a capital gains exposure.

Two homes into one. Newly married couples with two homes have potential tax liability as both individuals may pass the required tests on their own property but not on their new spouse’s property. Prior to selling these individual homes, you may wish to create a plan of action that reduces your tax exposure.

Selling a home after divorce. Property transferred as a result of a divorce is not deemed a sale of your home. However, if the ex-spouse that retains the home later sells the home, it may have an impact on the amount of gain exemption available.

You are helping an older family member. Special rules apply to the elderly who move out of a home and into assisted living and nursing homes. Prior to selling property, it is best to review options and their related tax implications.

You do not meet the five-year rule. In some cases you may be eligible for a partial gain exclusion if you are required to move for work, disability, or unforeseen circumstances.

Other situations. There are a number of other exceptions to the home gain exclusion rules. This includes foreclosure, debt forgiveness, inheritance, and partial ownership.

A final thought

The key to obtaining the full benefit of this tax exclusion is in retaining good records. You must be able to prove both the sales price of your home and the associated costs you are using to determine any gain on your property. Keep all sales records, purchase records, improvement costs, and other documents that support your home’s capital gain calculation.

What you need to know

The whirlwind of tax changes just keeps going. Now if you have children 17 or under there is a new, higher child tax credit in place for 2021. Here is what you need to know:

Age matters. The old credit was for children under the age of 17. The new credit goes through age 17 and includes an increased credit for children under the age of 6.

The new credit amount. The child tax credit goes from $2,000 per qualifying child up to $3,000 per child. The amount increases to $3,600 per child if your child is under the age of six.

Fully refundable. You will get the child tax credit even if you do not owe tax. The old rules required $2,500 in minimum earnings and only up to $1,400 of the credit was refundable.

Phaseouts just got a lot more complicated. As with the past child tax credit, you can only receive the credit if your income is below a threshold amount. The $200,000 threshold for unmarried taxpayers and $400,000 threshold for married taxpayers is still in place for the first $2,000 of the 2021 credit. To get the entire $3,000 or $3,600 credit in 2021, your adjusted gross income must be under $75,000 for single taxpayers, $112,500 for head of household taxpayers, and $150,000 for married taxpayers.

New periodic payments. The new child tax credit also allows you to receive monthly payments for 50 percent of the credit from July 2021 through December 2021. There will be a new IRS website to opt out of receiving monthly payments if you prefer to receive your entire child tax credit when you file your 2021 tax return in 2022.

Unless noted, the other requirements to receive the child tax credit stay in place. So you must still pass rules for the relationship test and support tests to qualify. As always, should you have questions please feel free to contact us.

Now is the time to make your estimated tax payment

Despite the individual tax filing due date being delayed until May 17, 2021, there is no delay in paying first quarter estimated tax payments for the 2021 tax year. So it is time to review your tax situation for the 2021 tax year and make an estimated quarterly tax payment using Form 1040-ES.

First quarter due date: Thursday, April 15, 2021

You are required to withhold or prepay throughout the 2021 tax year at least 90 percent of your 2021 total tax bill, or 100 percent of your 2020 federal tax bill.* A quick look at your 2020 tax return and a projection of your 2021 tax obligation can help determine if a quarterly payment might be necessary in addition to what is being withheld from any paychecks.

Here are some things to consider:

Underpayment penalty. If you do not have proper tax withholdings throughout the year, you could be subject to an underpayment penalty. A quick payment at the end of the year may not be enough to avoid the underpayment penalty.

W-2 withholdings have special treatment. A W-2 withholding payment can be made at any time during the year and be treated as if it was made throughout the year. If you do not have enough to pay the estimated quarterly payment now, you may be able to adjust your W-2 wage withholdings to make up the difference.

Self-employed. In addition to paying income taxes, self-employed workers must also account for paying Social Security and Medicare taxes. Creating and funding a savings account for this purpose can help avoid the cash flow hit each quarter to pay your estimated taxes.

Use your refund? An alternative option to pay your 2021 first quarter estimated tax is to apply some or all of your 2020 tax refund.

ALERT! The tricky part of this approach in 2021 is with the individual tax filing due date being delayed until May 17, 2021, the IRS hasn’t announced whether it will apply a penalty to 2020 refunds applied to 2021’s tax obligation as a first quarter payment if made after April 15.

Pay more in the first quarter. By paying a little more than necessary in the first quarter, you can be in a position to adjust future estimated tax payments downward later in the year if your 2021 tax obligation appears like it will be lower than you originally thought.

Not sure if you need to make a quarterly payment? Take a quick look at your 2020 tax return to see the amount of tax you paid. Divide the tax by the number of paychecks for the year. Is enough being withheld from your paycheck? Consider adjusting your withholdings with your employer if you think it is necessary to cover your 2021 tax bill.

*If your income is more than $150,000 ($75,000 if married filing separate), you must pay 110 percent of your 2020 tax obligation to be safe from an underpayment penalty on your 2021 tax return.

Good news, that is sometimes not so good

For some reason, some believe it is better to receive than give when it comes to filing taxes. While that may help your savings account, it is not always a great idea. Here’s why.

You are giving the IRS an interest-free loan. Granted, interest rates are pretty low, but every dollar you earn money on, is one more dollar of yours and one less of Uncle Sam’s.

Debt costs a lot. While interest on savings is low, the same is not necessarily true for credit card and other forms of debt. Why not lower your withholdings throughout the year and use the extra money to pay down your debt?

IRS identity theft is common. The longer you have your money in the hands of the IRS, the higher the chance some unsavory character is going to try to get it for themselves. Should this happen to you, the IRS will fix the problem….eventually. In the meantime, there is paperwork and tons of hurdles to overcome while your refund is delayed.

You could fund something else. Instead of money being parked at the IRS, you could be investing in your retirement or funding a Health Savings Account to pay for medical expenses in pre-tax dollars! So in addition to saving money in interest, you could actually be lowering your tax bill!

Let’s face it, sometimes knowing you get a refund versus a tax bill is less stressful. But, for the savvy taxpayer you can possible accomplish both!

Wouldn’t it be nice to have a source of nontaxable income? You may be more fortunate than you realize. Here are several types of income that the IRS does not tax.

1. Tax-free interest. The federal government does not tax municipal bond interest. This includes bonds issued by a state or municipality. The tax-free benefit increases the higher your income, but caution must be taken to ensure the underlying municipality is not in dire financial condition.

2. Health insurance premiums. Most health insurance premiums are tax free (for now). This could change in the future to help pay for health care reform, but for most people this benefit can currently be paid using pre-tax dollars.

3. Income from Roth IRA and Roth 401(k) accounts. While the amounts contributed into these retirement savings accounts are taxed, any earnings made on the contributions are tax free for federal income tax purposes as long as holding period and distribution rules are followed.

4. Health savings accounts (HSA). Contributions are deductible while earnings are tax free as long as disbursements from the account are used to pay for qualified health care expenses.

5. Child support received. Child support income you receive is free from federal tax.

6. Car pool revenue. While commuting expenses are not generally deductible, any reimbursement of your commuting expenses by fellow passengers is not reportable as income.

7. Home sale gains. Up to $250,000 ($500,000 for married filing jointly) of capital gains on a sale of your principal residence can be tax free.

8. Up to 14 days of rental income. If you rent out your home or vacation property, up to 14 days of this rental income each year can be tax free.

9. Certain employer compensation. In addition to health care premiums, there are a number of employee benefits that are not taxable. All have limits, but every tax-free dollar is money in your pocket. These include:

• Airline miles earned on business credit card expenses
• Certain employee-provided tuition expenses
• Qualified adoption expense reimbursement
• Up to $50,000 in employer-paid term life insurance
• Flexible spending accounts for dependent care and health care
• Commuting expense benefits for parking and mass transit commuting

Remember, when you pay for something in pre-tax dollars, it’s like giving yourself a raise. Take advantage of as many tax-free income opportunities as possible.

What you need to know

Individual tax filing due date: May 17, 2021 (was April 15, 2021)

Unemployment income: $10,200 per person not subject to federal tax (was taxable)

A surprise tax break for 2020 was passed into law in March of 2021. This late, late, late law change is creating havoc within the system. So much so that the individual tax filing due date AND payment of tax is delayed from April, 15 to May 17, 2021. Furthermore, unemployment income received by millions of taxpayers in 2020 may now be tax free! Here is what you need to know.

Background

Unemployment compensation was received by millions of Americans during the pandemic. While it’s welcome income during a tough time if you’ve lost your job, it’s classified as taxable income to be reported on your tax return.

The recently passed American Rescue Plan now makes part of your unemployment benefits free from federal taxation. Specifically, the first $10,200 of 2020 unemployment compensation or as much as $20,400 if your spouse also received unemployment is now tax free. The benefit is for households with adjusted gross income under $150,000. Depending on your tax bracket, this tax break could mean $1,200 or more in taxes saved on your 2020 return.

The problem

The legislation which contains this tax break didn’t become law until March of 2021, three months after the end of the tax year and after millions of Americans already filed their 2020 tax return! And to make matters worse, the IRS has no time to figure out how this tax break will be reported on your 2020 tax return. And Congress also passed legislation that requires the IRS to send millions more economic recovery payments PLUS develop a system to be in place immediately to send monthly enhanced child tax credit payments to families starting in July!

The net result is an overwhelming of the Treasury Department and the IRS, who are already buried because of the pandemic and other prior programs passed into law.

The result

Tax filing delay. You now have until May 17, 2021 to file your 2020 individual tax return and pay the tax. This move from the traditional April 15 filing deadline DOES NOT impact first quarter estimated tax payments or extended filing due dates in September and October 2021.

Tax-free unemployment income. If you received unemployment compensation in 2020, here’s what you need to know:

• If you’ve already filed your 2020 tax return: Wait for further instructions. Lawmakers are currently asking the IRS if it’s possible to automatically make adjustments and issue a refund if you’ve already filed your 2020 return. Issuing an automatic refund will avoid the need to file an amended tax return. So there is no need to call, we can only wait for clarification.
• If you HAVE NOT filed your 2020 tax return: Filing your tax return will be delayed until guidance is received from the IRS and it is deployed into tax filing software. The IRS is changing one of its schedules and then providing the information to software companies. Once this guidance is received, delayed tax filings can proceed. In the meantime, DO NOT delay turning in your tax information as returns can still be prepared and be ready to be filed once IRS guidance is received.

While this legislation is creating chaos in preparing tax returns, rest assured every effort will be made to get your tax return filed as soon as possible. So, if you have not already done so, please continue to send in your information so your return can be filed as soon as is possible.