Category Archives: Tax and Financial News

Plan for Business Continuity if Second Wave of COVID Hits

November, 2020

With winter around the corner and the threat of seasonal viruses looming, a second wave of COVID-19 poses a real threat to our health and business operations, according to Johns Hopkins Medicine.

Statistics from the Centers for Disease Control and Prevention (CDC) reveal that the 2019-2020 flu season took 24,000 lives and sickened 39 million individuals. Then when we add the fact that there are children who might not be receiving vaccinations – be it for the measles, whooping cough, and others – due to COVID-19, the risk for infections multiply.

Based on these factors, there’s a real possibility of a second wave of COVID-19 and other seasonal illnesses impacting business operations for the worse.

As the State of Washington’s Department of Commerce explains, there are many things that businesses can do to prepare for a second wave of the coronavirus. Here are a few recommendations that can be applied and modified, depending on the type of business.

The Washington State Department of Commerce recommends businesses use their digital presence, such as email, a website, blog or social media, to inform and connect with customers. There’s a balance that companies need to find between marketing and selling products or services and not sounding tone-deaf to the situation that COVID-19 has created.

For example, by creating a brief blog or social media post, companies can acknowledge that COVID-19 is a stressful time for everyone, but the company will still be there for them. Explaining how they’re taking care of their employees (social distancing, letting employees work from home and/or take time off for themselves or family members) and how they’re welcoming customers in-store or making house calls (with masks, social distancing, using technology when appropriate), it can create empathy and promote a sense of goodwill.

Another way to leverage digital communication channels is to create a standalone email address to funnel visitor and customer questions regarding COVID-19 concerns.

Planning on how to deal with food that won’t be used is an important step for organizations that deal with mass quantities of food. For schools, colleges, or universities that were open but have closed or others that want to make contingencies to close, the Environmental Protection Agency (EPA) recommends a few different avenues to make good use of food that would otherwise spoil. Organizations should make plans to donate to food banks or food rescue organizations; and there is also the EPA’s Excess Food Opportunities Map, which can direct unused food to composting options for businesses.

Another way for companies to prepare for a second wave of COVID-19, as the State of Washington’s Department of Commerce points out, is to ensure all documents are up-to-date and accessible via hard copy and electronically. Example documents include minutes and resolutions from official business meetings, tax records – especially any recently filed quarterly estimate payments – and lists of vendors. Companies also should ensure that digital files are encrypted, protected by passwords and that the cloud provider has a firewall, security scanning, and continually addresses vulnerabilities.

Business owners should have contingency plans to deal with supply chain issues. One way to mitigate supplier issues, according to McKinsey & Company, is to negotiate with existing suppliers that have cash or liquidity issues.

By offering essential suppliers with loans, often at attractive interest rates compared to lenders, as a way to keep suppliers in business, businesses may be able to negotiate for exclusive or high priority production agreements. This can be done while looking for alternate suppliers, either domestically or in other parts of the world.

While the second wave of COVID-19 is a real possibility, taking steps to prepare for any surge in cases will help companies increase their chances to make it out of the pandemic.

Sources

https://www.hopkinsmedicine.org/health/conditions-and-diseases/coronavirus/first-and-second-waves-of-coronavirus

https://www.epa.gov/coronavirus/recycling-and-sustainable-management-food-during-coronavirus-covid-19-public-health#02

A ‘Between Waves’ COVID-19 Planner for Small Businesses

https://www.mckinsey.com/business-functions/operations/our-insights/coronavirus-and-technology-supply-chains-how-to-restart-and-rebuild

https://www.epa.gov/coronavirus/recycling-and-sustainable-management-food-during-coronavirus-covid-19-public-health

Our Top 6 Year-End Tax Planning Tips

This has been a year of economic and tax uncertainty with the impact of the COVID-19 pandemic, potential stimulus bills and the presidential election. As a result, tax planning may be more important than usual this year. To help guide you, we will cover six year-end tax planning strategies – three for individuals and three for businesses.

Individual Year-End Tax Planning Tips and Strategies

1. Take advantage of above-the-line charitable deductions.

Unlike previous years, where taxpayers needed to itemize their deductions in order to see any tax benefit from charitable deductions, everyone can benefit on their 2020 tax return. The CARES Act created an above-the-line charitable deduction for taxpayers who don’t itemize. In order to benefit from the $300 cash contributions deduction, make sure to donate before the end of the year if you haven’t already.

2. Stimulus Check Impact

The CARES Act also created the stimulus payments of up to $1,200 per taxpayer and $500 per qualified dependent child. While the initial round of stimulus checks was based on 2018 or 2019 tax return filing information, these stimulus payments are technically pre-paid 2020 tax credits. As a result, your 2020 tax return will calculate the credit due based on your income level, and there’s nothing but good news here. If your 2020 return shows you should receive an additional credit, you can claim it on your return. But if your return shows a credit less than a stimulus check you’ve already received, there is no claw back.

3. Investment With Opportunity Zones

Congress created powerful incentives for investing in very specific geographic regions by creating special tax treatment for “opportunity zones.” Investments in opportunity zones offer taxpayers the potential to defer tax on gains until as late as 2026. Moreover, there is the potential to recognize only 90 percent of gains on investments held for at least five years; and no tax on those held for 10 years (there are other rules, but they are out of the scope of this article). As a result, investments in opportunity zones can provide tax-free potential and protect against future tax law changes.

Business Year-End Tax Planning Tips and Strategies

1. Accelerate AMT Refunds

The Tax Cuts and Jobs Act repealed the corporate Alternative Minimum Tax (AMT) and let companies claim all of their unused AMT credits in any taxable year beginning after 2017 but before 2022. The CARES Act accelerated the refund timeline, letting companies claim all their unused credits in either 2018 or 2019. For many, the most effective way to take advantage of this is to file a tentative refund claim on Form 1139, which must be done by Dec. 31, 2020.

2. Use Current Losses for Quick Refunds

The CARES Act brought back a tax provision that allows businesses to take current losses and offset them against income from prior years and receive refunds now. Net operating losses (NOLs) that are the result of 2018, 2019 and 2020 business activity can be carried five years back to claim refunds against taxes paid.

Careful consideration should be given to the strategy for claiming these NOL carry-backs because, depending on the type of business entity, your tax rate may have been higher in some of the five available years versus others. Make sure to leverage any tax rate arbitrage to maximize your benefit.

3. Payroll Tax Deduction Timing

Another provision of the CARES Act gives employers the option to postpone payment of their portion of Social Security taxes until the end of 2020. The deferred amounts are due half by the end of 2021 and 2022. This may be great from a liquidity perspective; however, depending on your businesses accounting, this could also mean a deferral of the deductibility of this expense as well. You should weigh the liquidity benefits of the deferral versus the value of a current year deduction – especially considering the accelerated NOL provisions discussed above.

Conclusion

These are just a few of the potential year-end tax planning strategies you can employ before the end of 2020. Make sure to consider these and speak with your tax advisor to see what makes the most sense for your situation.

What’s Next for a Stimulus Bill?

The Senate Republicans’ slimmed-down stimulus bill recently failed to materialize after receiving less than the 60 votes needed to move forward. The “skinny” stimulus bill, with a price tag of only $650 billion, was intended to be a way to quickly inject stimulus into the economy and bypass both the multi-trillion-dollar Republican HEALS Act and the Democratic HEROES Act.

The current stimulus limbo leaves millions of Americans in a position of uncertainty. Four main areas that the Senate bill intended to address but are now up in the air include a second round of stimulus checks and the impact on struggling tenants and homeowners, as well as the long-term unemployed.

Next Round of Stimulus Checks

The first stimulus bill, the CARES Act, sent more than $300 billion in stimulus checks to Americans back in March to help mitigate the effects of COVID-19 slowdowns. While this helped millions, many people’s jobs or businesses remain impaired due to the economic impact of the pandemic, and they are hoping for a second stimulus check to help them get by.

With the failure of the Senate bill and the stalemate in the House, the chances of a second round of checks continues to diminish. On the bright side, the U.S. Treasury noted it is ready to print and mail the checks as soon as something is authorized.

Troubled Tenants and Homeowners

The economic fallout from the pandemic placed many tenants and homeowners in the position of being evicted or foreclosed. The CARES Act from March placed a temporary moratorium on evictions and foreclosures, sparing millions. Following this measure, President Trump issued an executive order in August granting the CDC authority to cease evictions as a measure to prevent the spread of COVID-19. The CDC took this order and announced a stop to all evictions until the end of 2020.

For homeowners with federally backed mortgages, the CARES Act moratoriums on single-family foreclosures were also extended until the end of 2020. Moreover, many states passed laws protecting those without federally backed loans from foreclosure.

For both renters and homeowners, these protections will disappear once we enter 2021 unless the government steps in with new legislation or regulations. Keep in mind that for both renters and mortgage holders, payments are being deferred and not canceled – so ultimately, they will still need to make the payments.

Long-Term Unemployment

Millions remain unemployed due to the pandemic; without federal help, their unemployment benefits will expire soon. The CARES Act gave an additional 13 weeks of benefits on top of the initial 26 weeks of unemployment insurance benefits; however, for those impacted on the front-end of the pandemic, these extended benefits will expire at the end of November.

The Senate bill included $300 per week of benefits through the last week of 2020; however, with this failing and without additional aid to state funds, the long-term unemployed won’t have anything to rely on if Congress does nothing.

Conclusion

Democrats responded with a smaller version of their original second-round stimulus bill, coming in a price tag of $2.2 trillion, down from the original $3.4 trillion. This is likely too high a price tag still to garner Republican support. If nothing happens before the mid-October recess, then we will all be waiting until after the Nov. 3 election.

Taxes and Tariffs: The U.S. Response to France’s Digital Tax

How it All Started

Back in July of 2019, France passed what was dubbed a “digital tax” targeting the largest tech companies. Impacting approximately 30 big companies such as Amazon, Google, Facebook and Apple, the tax applies to revenues earned from digital services of companies that earn more than $830 million in total and at least $27.86 million in France. The tax levy is a 3 percent charge on revenue from digital services.

The United States soon responded with threatening 100 percent tariffs on certain classes of French luxury goods, such as wine, champagne, cheese and makeup. These tariffs were estimated to cover more than $2.4 billion in French goods per year.

Responses on Both Sides

French President Emmanuel Macron came out to comment that the digital tax is not intended to be an anti-American move, and that big tech companies of all stripes could be covered by the tax. The criteria that determines who is subject to the digital tax, however, means that essentially only American companies are the ones being taxed.

Some in the United States claim it’s as simple as jealously over our strong technology sector, while others say that the main motivation for the French tax is a need to mitigate burgeoning budget deficits.

President Trump’s Reaction

Rarely one to back down on international trade issues, President Donald Trump criticized the digital tax for unfairly targeting American tech companies, going so far as to call out the European Union as behaving worse than China in its trading relationship with the United States. He reiterated his stance that he’s willing to fight tariffs with tariffs.

Negotiations with the EU

U.S. and European Union officials are negotiating an agreement over taxing big tech, but that didn’t stop the current treasury secretary from threatening more retaliatory tariffs. Steven Mnuchin, the treasury secretary, recently said that the United States will impose new tariffs on French automobile imports if the issue isn’t resolved to America’s satisfaction. He claimed the digital tax is purely arbitrary, hence his random call for taxing automobiles in response. Moreover, Mnuchin called the tax “discriminatory in nature” at the World Economic Forum in Davos Switzerland.

Taxes and Tariffs on Hold

For now, France is delaying the implementation of its digital tax through the end of 2020 in response to U.S. pressure on threatened luxury goods and automobile tariffs. They aim to come to a resolution before year-end with the Trump administration. French Finance Minister Bruno Le Maire is optimistic an agreement can be worked out and believes entering a trade war with the United States would be foolish.

The Future

Currently, other European countries, including Britain and Italy, are acting against big tech companies they believe don’t pay their fair share of taxes to their countries. Treasury Secretary Mnuchin said that the United States is willing to go to bat and protect its companies with retaliatory tariffs in these cases as well. For now, not much is settled – but we should see a clearer direction before the year is out.

When Should You Switch Your Side Hustle to a Business Entity Structure?

Starting a side hustle today is easier than ever. Between the numerous websites that act as marketplaces and project jobs that can be found on the internet, almost anyone can turn a skill or hobby they have into something they can make money off. Many people who do this are just looking to make a little extra money on the side, but this side hustle can turn into something bigger – and this is where the tax and legal questions come in.

Sole Proprietorship

For someone just starting or looking to make a little extra on the side, there’s nothing special you need to do when it comes to filing your federal taxes. Just complete an extra form that is called Schedule C of your personal tax return. This is referred to as doing business as a sole proprietorship.

But that is where the simplicity stops. While organizing your business, the default way as a sole proprietor takes the least effort and expense; however, there are risks associated with this path, particularly legal liability risks.

Legal Risks

The biggest problem is that the sole proprietorships form leaves personal as well as business assets exposed to the risk of being sued. Lawyers will often recommend that the moment a business has paying clients, it should be converted to an LLC or corporation to provide legal protection by separating the business and personal assets.

While this legal advice is technically true, it doesn’t consider the cost benefit of the situation. The problem is that the costs of forming and running an LLC or corporation can easily exceed the money earned from a side hustle. Combine this with the probability of getting sued at all (in each personal situation) and for most side hustles, it’s simply not worth it to form an LLC or corporation. The key question then is when is it worth it to switch from a sole proprietorship to an LLC or a corporation?

When Side Hustle Grows Up

What about the taxation issue? Generally, tax savings aren’t a good reason to convert a sole proprietorship to an LLC or corporation. Particularly, making the move from a sole proprietorship to a single member LLC will not help for tax purposes and in fact may only increase your chances of an audit. Moreover, operating as an LLC will cost more both for the initial filing as well as ongoing annual expenses. Legal liability remains the main reason to convert the entity structure.

Hidden Tax Issues

All three pass-through entity types (sole proprietor, LLC and S-Corporations) calculate your income in the exact same way under current laws. There is however a hidden tax to consider: the self-employment tax. Self-employment taxes are paid on all sole proprietor earnings, but only on the salary portion of LLC or S-Corp earnings. Any profits over and above your salary are considered dividend payments and are not subject to self-employment taxes.

Unfortunately, the income level needed to change entity structures depends on each individual situation, but you’ll need the savings to at least cover the initial and long-term compliance costs of filings, fees and tax preparation costs. Let’s look at two examples to see how this works.

Imagine a business is earning $100,000 in net profit and from this you pay yourself $40,000 as salary and take the remaining $50,000 as dividends. At the current 15.3 percent self-employment tax rate, this translates into a savings of $7,650. Now imagine a side hustle that only earns $25,000 from which you take $15,000 as salary and the remaining $10,000 as dividends. This only translates into $1,530 in tax savings.

In the first case above, you’ve not only generated enough tax savings to more than cover your tax preparation and filing costs, but you’ll end up with more money in your pocket and have stronger legal protection. In the second case, you’ll barely save enough to cover your costs – and you’ll create more work for yourself.

Conclusion

Your side hustle might be small right now, but tomorrow it could grow into the next big thing, so make sure your organizational structure makes sense now.

2020 Tax Brackets, Deductions, Plus More

Beginning on Jan. 1, 2020, the Internal Revenue Service (IRS) has new annual inflation adjustments for tax rates, brackets, deductions and retirement contribution limits. Note, the amounts below do not impact the tax filing you make in 2020 for the tax year 2019. These amounts apply to your 2020 taxes that you will file in 2021.

2020 Tax Rates and 2020 Tax Brackets

Below are the new 2020 tables for personal income tax rates. There are separate tables each for individuals, married filing jointly couples and surviving spouses, heads of household and married filing separate; all with seven tax brackets for 2020.

Tax Brackets & Rates – Individuals
Taxable Income Between Tax Due
$0 – $9,875 10%
$9,876 – $40,125 $988 plus 12% of the amount over $9,875
$40,126 – $85,525 $4,617 plus 22% of the amount over $40,125
$85,526 – $163,300 $14,605 plus 24% of the amount over $85,525
$163,301 – $207,350 $33,271 plus 32% of the amount over $163,300
$207,351 – $518,400 $47,367 plus 35% of the amount over $207,350
$518,400 and Over $156,234 plus 37% of the amount over $518,400

 

Tax Brackets & Rates – Married Filing Jointly and Surviving Spouses
Taxable Income Between Tax Due
$0 – $19,750 10%
$19,751 – $80,250 $1,975 plus 12% of the amount over $19,750
$80,251 – $171,050 $9,235 plus 22% of the amount over $80,250
$171,051 – $326,600 $29,211 plus 24% of the amount over $171,050
$326,601 – $414,700 $66,542 plus 32% of the amount over $326,600
$414,701 – $622,050 $94,734 plus 35% of the amount over $414,700
$622,050 and Over $167,306 plus 37% of the amount over $622,050

 

Tax Brackets & Rates – Heads of Households
Taxable Income Between Tax Due
$0 – $14,100 10%
$14,101 – $53,700 $1,410 plus 12% of the amount over $14,100
$53,701 – $85,500 $6,162 plus 22% of the amount over $53,700
$85,501 – $163,300 $13,158 plus 24% of the amount over $85,500
$163,301 – $207,350 $31,829 plus 32% of the amount over $163,300
$207,351 – $518,400 $45,925 plus 35% of the amount over $207,350
$518,400 and Over $154,792 plus 37% of the amount over $518,400

 

Tax Brackets & Rates – Separately
Taxable Income Between Tax Due
$0 – $9,875 10%
$9,876 – $40,125 $988 plus 12% of the amount over $9,875
$40,126 – $85,525 $4,617 plus 22% of the amount over $40,125
$85,526 – $163,300 $14,605 plus 24% of the amount over $85,525
$163,301 – $207,350 $33,271 plus 32% of the amount over $163,300
$207,351 – $311,025 $47,367 plus 35% of the amount over $207,350
$311,025 and Over $83,653 plus 37% of the amount over $311,025

 

Trusts and Estates have four brackets in 2020, each with different rates.

Tax Brackets & Rates – Trusts and Estates
Taxable Income Between Tax Due
$0 – $2,600 10%
$2,601 – $9,450 $260 plus 12% of the amount over $2,600
$9,451 – $12,950 $1,904 plus 35% of the amount over $9,450
$12,950 and Over $3,129 plus 37% of the amount over $12,950

 

Standard Deduction Amounts

Amounts for standard deductions see a slight increase from 2019 to 2020 based on indexing for inflation. Note that again as in 2019, there are no personal exemption amounts for 2020.

Standard Deductions
Filing Status Standard Deduction Amount
Single $12,400
Married Filing Jointly & Surviving Spouses $24,800
Married Filing Separately $12,400
Heads of Household $18,650

 

Alternative Minimum Tax (AMT) Exemptions

Like the above, the AMT exemption amounts are increased based on adjustments for inflation, with the 2020 exemption amounts as follows.

 

Alternative Minimum Tax (AMT) Exemptions
Filing Status Standard Deduction Amount
Individual $72,900
Married Filing Jointly & Surviving Spouses $113,400
Married Filing Separately $56,700
Trusts and Estates $25,400

 

Capital Gains Rates

Capital gains rates remain unchanged for 2020; however, the brackets for the rates are changing. Taxpayers will pay a maximum 15 percent rate unless their taxable income exceeds the 37 percent threshold (see the personal tax brackets and rates above for your individual situation). If a taxpayer hits this threshold, then their capital gains rate increases to 20 percent.

Itemized Deductions

Below are the 2020 details on the major itemized deductions many taxpayers take on Schedule A of their returns.

  • Medical Expenses – The floor remains unchanged from 2019 to 2020, so you can only deduct these expenses that exceed 10 percent of your AGI.
  • State and Local Taxes – The SALT deductions also remain unchanged at the federal level with a total limit of $10,000 ($5,000 if you are married filing separately).
  • Mortgage Deduction for Interest Expenses – The limit on mortgage interest also remains the same with the debt bearing the interest capped at $750k ($375k if you are married filing separately).

Retirement Account Contribution Limits

Finally, we look at the various retirement account contribution limits for 2020.

  • 401(k) – Annual contribution limits increase $500 to $19,500 for 2020
  • 401(k) Catch-Up – Employees age50 or older in these plans can contribute an additional $6,500 (on top of the $19,500 above for a total of $26,000) for 2020. This $500 increase in the catch-up provision is the first increase in the catch-up since 2015.
  • SEP IRAs and Solo 401(k)s – Self-employed and small business owners, can save an additional $1,000 in their SEP IRA or a solo 401(k) plan, with limits increasing from $56,000 in 2019 to $57,000 in 2020.
  • The SIMPLE – SIMPLE retirement accounts see a $500 increase in contribution limits, rising from $13,000 in 2019 to $13,500 in 2020.
  • Individual Retirement Accounts – There are no changes here for IRA contributions in 2020, with the cap at $6,000 for 2020 and the same catch-up contribution limit of $1,000.

Conclusion

There are no dramatic changes in the rates, brackets, deductions or retirement account contribution limits that the vast majority taxpayers tend to encounter for 2020 versus 2019. Most changes are simply adjustments for inflation. Enjoy the stability – as history has shown, it likely won’t last long.

How to Defer, Avoid Paying Capital Gains Tax on Stock Sales

How to Defer, Avoid Paying Capital Gains Tax on Stock SalesThe markets are hitting all-time highs, so if you are thinking of selling stocks now or in the near future, there is a good chance that you will have capital gains on the sale. If you’ve held the stocks for more than a year, then they will qualify for the more favorable long-term capital gains tax (instead of being taxed at ordinary income rates for short-term sales). But the total tax due can still be enough to warrant some tax planning. Luckily, the tax laws provide for several ways to defer or even completely avoid paying taxes on your securities sales.

1. Using Tax Losses

Utilizing losses is the least attractive of all the options in this article since you obviously had to lose money on one security in order to avoid paying taxes on another. The real play here is what is often referred to as tax-loss harvesting. This is where you purposely sell shares that are at a loss position in order to offset the gains on profitable sales and then redeploy this capital somewhere else. You’ll need to carefully weigh where to put the money from the sale of the shares sold at a loss as you can’t just buy the same stocks back. This is considered a “wash sale” and invalidates the strategy.

2. The 10 Percent to 15 Percent Tax Bracket

For taxpayers in either the 10 percent or 12 percent income tax brackets, their long-term capital gains rate is 0 percent. The income caps for qualifying for the 12 percent income tax rate is $39,375 for single filers and $78,750 for joint filers in 2019 ($40,000 and $80,000, respectively in 2020). Also, keep in mind that the stock sales themselves add to this limit – so calculate carefully.

Aside from selling appreciated securities yourself, another way to take advantage of the 0 percent bracket is to gift the stock to someone else instead of selling the securities and then giving the cash. Beware, however, as trying to do this with your kids can disqualify the 0 percent treatment because the kiddie tax is triggered on gifted stock sold to children younger than 19 or under 24 if a full-time student.

3. Donate

Donating appreciated securities is where we start to get into the more beneficial strategies. This technique only makes sense if you were already planning to make charitable contributions. Say for example you are planning to donate $10,000 to an organization and are in the 25 percent tax bracket. In order to write a donation check for $10,000, you would have had to earn $13,333 in income to sell the same amount of stock in order to have $10,000 left after taxes to make a cash donation in that amount.

If you donate appreciated stock instead, you only need to donate securities valued at $10,000 and you get to deduct $10,000 as a charitable deduction. That avoids the capital gains tax completely. Plus, it generates for you a bigger tax deduction for the full market value of donated shares held more than one year – and it results in a larger donation.

4. Qualified Opportunity Zones

This is the newest and most complicated (as well as controversial) way to defer or avoid capital gains taxes. Opportunity Zones were created via the Tax Cuts and Jobs Act to encourage investment in low-income and distressed communities. Qualified Opportunity Zones can defer or eliminate capital gains tax by utilizing three mechanisms through Opportunity Funds – the investment vehicle that invests in Opportunity Zones.

First, they offer a temporary deferral of taxes on previously earned capital gains if investors place existing assets into Opportunity Funds. These capital gains defer taxation until the end of 2026 or whenever the asset is disposed of – whichever is first.

Second, capital gains placed in Opportunity Funds for a minimum of five years receive a step-up in basis of 10 percent – and if held for at least seven years, 15 percent.

Third, they offer an opportunity to permanently avoid taxation on new capital gains. If the opportunity fund is held for at least 10 years, the investor will pay no tax on capital gains earned through the Opportunity Fund.

Again, the caveat here is that the details of Opportunity Zone investments can be extremely complicated, so it’s best not to attempt this one on your own. Consult with your tax advisor.

5. Die with Appreciated Stock

Unfortunately, while probably the least popular method for readers, this is certainly the most effective. When a person passes away, the cost basis of their securities receives a step-up in basis to the fair market value to the date of their death. As an example, if you purchased Amazon stock for $50 per share and when you pass away it is worth $1,700 per share, your heir’s basis in the inherited stock is $1,700. This means if they sell it at $1,700, they pay no tax at all.

Conclusion

None of the above methods are loopholes or tax dodges; they are all completely legitimate. However, your ability to take advantage of these techniques will depend on your income level, personal goals and even your age. As a result, it’s best to consult with your tax advisor to see what makes sense for your personal situation.

Tax Changes 2019

Tax Changes 2019With the start of the fourth quarter of 2019 underway, it’s time to see what the Internal Revenue Service (IRS) will expect of filers for their 2019 taxes. The following are a list of major changes that filers need to be aware of:

1. Removal of the Affordable Care Act’s (ACA) Individual Mandate Penalty

With the passage of the Tax Cuts and Jobs Act (TCJA), filers and households who failed to carry adequate health insurance according to the ACA’s minimum coverage requirements will no longer have to pay the penalty on their 2019 taxes. This is because the TCJA lowered the penalty to zero dollars permanently. In previous years, households not meeting ACA health insurance requirements were mandated to pay either 2.5 percent of household income or $347.50 per child and $695 per adult, up to $2,085.

2. Greater Medical Expense Deduction Requirements

2019 filers are only able to deduct out-of-pocket medical expenses that exceed 10 percent of their adjusted gross income (AGI). The threshold was lowered to 7.5 percent for the 2017 and 2018 tax years by the TCJA, but will revert to the original 10 percent threshold in 2019.  

3. Changes to Treatment of Alimony

The TCJA removed the ability for those paying alimony to their former spouse to deduct these payments for the 2019 tax year. The IRS also removed deductibility for alimony or separate maintenance payments for divorce or separation agreements signed off after Dec. 31, 2018. If a divorce or separation agreement that provides for alimony or separate maintenance payments was agreed to before Dec. 31, 2018, and is then modified after Dec. 31, 2018, such payments lose deductibility. Former spouses receiving alimony or separate maintenance payments from an agreement created or modified after Dec. 31, 2018, are not required to report such payments on their tax return.  

4. Contribution Limits Raised for Retirement Accounts

Those with 401(k), almost all 457 plans, the federal government’s Thrift Savings Plan and 403(b) account plans can contribute $19,000 in 2019, an increase of $500 from 2018’s $18,500 limit. Taxpayers 50 and older can still contribute another $6,000 for 2019, a catch-up contribution. Taxpayers with Individual Retirement Accounts (IRAs) can contribute $6,000 in 2019, $500 more than 2018’s $5,500 limit. Those 50 years or older can add another $1,000 to their IRA accounts in 2019. The increase in IRA contribution limits is the first increase since 2013.     

5. Increased HSA Contribution Limits

Health Savings Accounts’ contribution limits for 2019 have increased, according to the IRS. For an individual or a self-only High Deductible Health Plan, 2019’s contribution limit is raised to $3,500, or $50 more than 2018’s contribution limit of $3,450. For a family high deductible health plan, 2019’s contribution limit is raised to $7,000, $100 more than 2018’s contribution limit of $6,900. The catch-up contribution is an extra $1,000 for account holders age 55 or older.

6. Increasing Standard Deduction Allowances

For those choosing not to itemize their deductions in 2019, the IRS has increased standard deduction amounts for filers. For single filers and those filing as married filing separately, the standard deduction increased by $200, to $12,200. For those filing as head of household, the standard deduction increased by $350, to $18,350. For those choosing to file married filing jointly, there’s an increased allowance of $400, to $24,400.

7. 2019 Income Brackets

With the new tax year comes higher income tax brackets. Depending on how much taxpayers made in 2019, the following are the new income level brackets:

  • 37 percent: Individual single taxpayers making more than $510,300 or married couples filing jointly making $612,350.
  • 35 percent: Individuals making more than $204,100, or $408,200 for married couples filing jointly.
  • 32 percent: Individuals making more than $160,725, or $321,450 for married couples filing jointly.
  • 24 percent: Individuals making more than $84,200, or $168,400 for married couples filing jointly.
  • 22 percent: Individuals making more than $39,475, or $78,950 for married couples filing jointly.
  • 12 percent: Individuals making more than $9,700, or $19,400 for married couples filing jointly.
  • 10 percent: Individuals making up to $9,700, or $19,400 for married couples filing jointly.

How to Get the IRS to Pre-Approve Your Taxes

IRS to Pre-Approve Your TaxesIt might seem odd, but it is possible to get the IRS to give you a straight-forward and binding answer to ambiguous tax positions in advance. How does this happen, you ask? The answer is through an IRS private letter ruling.

IRS private letter rulings provide many benefits, but they are not easy to obtain. There are costs, potential delays, and even then, you run the risk of not being granted a ruling. This dynamic might seem odd as the entire point of applying for a private letter ruling is to obtain certainty. If your position is weak from a tax law perspective, the government could refuse to rule on it. Alternatively, if the position you are seeking is obviously correct, the government might refuse to rule as well because they don’t like to issue “comfort rulings.” Essentially, the only way to get the government to rule is to make a request regarding a position that is in the middle.

If you believe the tax position in question lies somewhere in the middle, requesting a private letter ruling may make sense. If you are more likely one of the outliers, then requesting a tax opinion usually makes more sense. The problem is that tax opinion, unlike private letter rulings, doesn’t bind the IRS.

Deciding Which Path to Take

If the relative certainty of the tax position in question doesn’t provide enough guidance, how do you decide to go after a tax opinion versus a private letter ruling? To make the choice, it helps to understand more details.

First, tax opinions can cover a broader range of topics and can be written about pretty much anything; rulings cannot. In fact, the IRS has an explicit list of subjects that it will not produce private letter rulings on (they modify it occasionally, but there’s always a list). As a result, the first step is to assess the list as this might make the choice for you.

Second, don’t request a private letter ruling unless there is a good chance you think it will be granted. For one, rulings are not cheap with fees often costing upward of $25,000 to obtain a ruling. If you get a “No” ruling against your position, you can withdraw the request to take the ruling off the books, but you may or may not get the fee back. Moreover, when you withdraw a request for a ruling, the IRS sends a notice to your local IRS field office, potentially flagging your return for audit.

Third, opinions can be quick and obtained in as little as a few days or weeks. Rulings, on the other hand, often take months. Also consider that a request for a ruling must be specific and there is little room for modification after filing. Opinions have more flexibility.

Private Letter Ruling Process

Given the specificity and consequence of requesting a ruling, there are intermediate steps to help you test the water before you go all in. Nearly all ruling requests start by initiating a discussion with the IRS to get their general view on your proposed ruling. After this, the taxpayer usually submits a brief memo covering the facts and ruling they are looking to obtain. Next, there are more meetings either in person or by phone with IRS attorneys involved. At this point, if everything looks good, you can prepare and submit the actual ruling request. If you back out at this point, you avoid triggering any fees (IRS fees – not your lawyers or accountants) or audit notices.

Benefits of a Ruling Versus an Opinion

The reason taxpayers go through the time, expense and effort to obtain rulings instead of opinions is that they have several advantages. First, rulings are binding on the IRS. Second, you don’t need to consider penalty protection. Most of all, they provide certainty. Given the difficulty in obtaining a ruling, they generally make financial sense only when a taxpayer has a seriously substantial tax position in play, or at least will over time, and he wants to protect against future audits and legal challenges.

The Five Key IRS Rules of Taxation for Lawsuit Settlements

Coming out on the winning side of a lawsuit as a plaintiff can be a gratifying feeling, especially if there is a financial settlement involved. There is likely a sense of both relief and vindication. Unfortunately, far too often people are in for a shock when they realize that they must pay taxes on the award. You can even be taxed on your attorney fees! However, a little tax planning can go a long way, especially if you do it before the settlement is finalized and the award is substantial. Below are the five key rules to know so you can make the right move.

  1. The Origin of the Claim Largely Determines the Tax Consequences
    The taxation of legal settlements is based on the origin or reason of the claim. For example, if you win a wrongful termination suit against an employer, your award will be taxed as both wages and likely some other income for whatever is allocated to emotional damages. On the other hand, if you sue the contractor who built your house for damage caused by his negligence, the settlement might not be deemed income at all and you could treat it as a reduction of the purchase price of the real asset. There are many exceptions in this area, and it always depends on the facts and circumstances of the case.
  2. Physical Injuries Produce Tax-Free Awards, but Emotional Distress and Damages Are Taxable
    Damages received for suits involving a physical injury or illness are tax-free. Suits for emotional distress and defamation are taxable, including the physical symptoms of emotional distress (gastrointestinal problems, etc.). Be careful as the latter can be ambiguous, so agreeing on the nature of a physical symptom as the cause or result of emotional distress is best done with the defendant before you finalize the case.
  3. Allocating Damages
    Legal disputes typically involve several issues and courses of conduct. As a result, settlements typically have multiple types of consideration, each with potentially different tax treatments. If the plaintiff and defendant both agree on the tax treatment before finalizing the case, then you can allocate the total damages to certain categories and save taxes. Such agreements are technically non-binding on the IRS, but they are rarely challenged.
  4. Attorney Fees 
    Plaintiffs who use a contingent fee lawyer are typically taxed on receiving 100 percent of the money recovered. This means you have to pay taxes even on the portion of your settlement that the lawyers keep as their fee. This is still the case even if your contingent fees are paid directly by the defendant. In clear cases of physical injury where the entire settlement is non-taxable, there’s no issue – but if your award is taxable, you’ll need to be careful.

    Take an example where you collect a contingent fee settlement for emotional distress and receive $200,000, with your lawyer taking 30 percent or $60,000. In this case, you’ll typically be liable for taxes on the entire $200,000 and not just the $140,000 you keep. To make matters worse, aside from legal fees in employment and certain whistleblower claims, there’s no corresponding deduction for legal fees. There are potential ways to mitigate this, but tax advice early in the process is key.

  5. Punitive Damages and Interest
    Generally, punitive damages and interest are always taxable. For example, take a case where you are hurt in an automobile crash and receive $100,000 in compensatory damages and another $3 million in punitive damages. The $100,000 is tax-free, whereas the $3 million is taxable.

    Interest is treated similarly. Even if you receive a tax-free type of settlement, but it took time to finalize the settlement through the pre- or post-judgement process, the interest you receive is taxable. Therefore, it is often advantageous to settle a case instead of having it go to judgement.

Conclusion

The taxation of legal settlements and awards are nuanced and largely depend on the facts and circumstances of the case at hand. There are, however, many opportunities through proper tax planning to minimize the tax consequences, but only if you are proactive and plan early in the process.