Thinking about your tax plans for this year?
Keep in mind this popular tax write-off:
The 20% qualified business income deduction. Self-employed people, farmers, and individual owners of pass-through entities, such as partnerships, LLCs, S corporations and certain trusts, can take the break, subject to limitations for upper-income individuals. Eligible individuals claim it on line 13 of Form 1040 and attach Form 8995 or 8995-A to their returns.
The write-off is temporary. It ends after 2025, as do most other provisions in the 2017 tax reform law that affect individual taxpayers and estates.
QBI is your allocable share of income less deductions from a business. It doesn’t include wages, dividends, capital gain or loss, nonbusiness income, reasonable compensation from S firms or guaranteed payments from partnerships. If you own an interest in an S corporation, partnership or a multimember LLC, the K-1 you receive will report your share of the firm’s QBI and other related items.
Two special limitations apply to individuals with higher taxable incomes … in excess of $329,800 for joint filers and $164,900 for others. Note that taxable income excludes the 20% deduction, and the numbers are adjusted for inflation annually.
First, the break phases out for those in specified service trades or businesses. An SSTB is a business involving the performance of services in certain fields: Health, law, accounting, actuarial science, performing arts, consulting, athletics, finance, brokerage, investment management, and securities trading and dealing. IRS regulations delve into each SSTB and set forth lots of rules and exceptions. If you’re in one of these service fields and your taxable income exceeds $429,800 for joint returns … $214,900 for others … the deduction is zero for that business.
Second, there is a W-2 wages-paid limitation that applies for upper-incomers not engaged in an SSTB. It caps the deduction at 20% of QBI from the business or, if lower, a figure based on wages paid by the business and the unadjusted basis of tangible, depreciable property used in the business and not fully depreciated.
Schedule E rental income may also be eligible for the 20% QBI deduction.
But applying the QBI rules to income from rentals of real property is thorny. IRS regs say the rental activity must generally rise to the level of a trade or business, a standard which depends on each taxpayer’s particular facts and circumstances. Alternatively, there is a safe harbor if at least 250 hours a year of qualifying time are devoted to the activity by the taxpayer, employees or independent contractors.
President Biden on the campaign trail called for repealing the QBI write-off for individuals making over $400,000, consistent with his other ideas to tax the rich.
However, this proposal isn’t in his tax plans that he set out earlier this year.
That doesn’t mean other Democratic lawmakers won’t try to push for changes. Senate Finance Com. head Ron Wyden (D-OR) is looking at ways to revamp the break.
More on advance monthly payments of the child tax credit. One element of the 2021 child tax credit regime requires IRS to make advance payments of the credit each month to qualifying families. The advance payments will account for half of a family’s 2021 child tax credit. IRS will issue these monthly payments to eligible families on July 15, Aug. 13, Sept. 15, Oct. 15, Nov. 15 and Dec. 15.
IRS will base eligibility for the payments on 2020 or 2019 returns.
The agency has started sending letters to more than 36 million families that it believes are eligible for the advance child credit payment. The letters are generally for informational purposes. IRS plans to send a second round of letters this summer, and that latter mailing will list the family’s estimated monthly payment.
Want to opt out of monthly payments? IRS has an online tool for this. You will need a photo ID to use the Service’s Child Tax Credit Update Portal. See www.irs.gov/childtaxcredit2021 for FAQ and other details on the child credit.
Taxpayers who generally don’t file returns can get child credit payments.
But they’ll have to first jump through some hoops. IRS has options for those not required to file a return for 2019 or 2020 because their income was below the filing threshold. It has an online tool called the Non-Filer Sign-Up Tool, which it hopes most nonfilers will use. Alternatively, the agency issued procedures for filing simplified returns for 2020. Note that people who used IRS’s online tool for nonfilers in 2020 to provide information to IRS for purposes of qualifying for stimulus payments don’t have to do anything, because IRS already has their data.
IRAs & Plans
Here’s an idea to help a child or grandchild who is working this summer:
You can contribute to a Roth IRA for him or her … up to $6,000 for 2021, but not more than the child’s 2021 earnings. Earnings grow tax-free inside the Roth. If you go down this path, you have until April 18, 2022, to make this contribution. The payin counts toward your $15,000-per-donee gift tax exclusion ($30,000 if married).
This can provide a nice nest egg. And there are key tax advantages to Roths. Distributions after age 59½ are nontaxable. Contributions can be pulled out free of tax at any time. And $10,000 of earnings can be taken out tax-free to buy a first house.
There is no general hardship exception to the 10% tax on early 401(k) payouts. A lawyer who was laid off from her job took money from her terminated 401(k) account and used the funds to pay expenses. She was under 55 at the time of the withdrawal. The early distribution is subject to the 10% additional tax (Woll, TC Oral Order).
Note this rule on matching contributions for employers with SIMPLE IRAs: Matches must be based on a participant’s entire calendar-year compensation, regardless of when he or she starts or stops contributing to the plan during the year. Take a worker with a salary of $60,000 who starts contributing to his plan on Oct. 1 and puts in $2,000 over the last three months of the year. The plan’s matching payin is $1,800 … 3% of $60,000 (most SIMPLEs have a 3% match). In this example, if the employee had put in $1,500, the employer match would fall to $1,500 because matches are the lesser of 3% of salary or what the employee contributes.
Bankruptcy creditors can’t grab a debtor’s inherited 401(k) account. A woman inherited a 401(k) from a friend and filed bankruptcy soon after. The bankruptcy trustee argued that an inherited 401(k) should be treated the same as an inherited IRA, which the Supreme Court ruled in 2014 is not exempt from the bankruptcy estate. A bankruptcy court disagreed, saying a 401(k) inherited from a nonspouse prior to bankruptcy is not property of the estate, in part because of the transfer restrictions under federal pension and retirement law. The plan states that the 401(k) can’t be reached by creditors, and account owners cannot pledge or assign it (in re Dockins, Bankruptcy Court, W.D., N.C.).
Obamacare remains the law of the land, now that the Supreme Court ruled that the challengers of the health care law don’t have a legal right to sue because they cannot show a fairly traceable past or future injury (Calif. v. Texas). Note that the Court did not even have to reach the substantive questions before it: Whether the individual mandate is valid when the penalty for noncompliance is $0, and, if so, whether the individual mandate can be severed from the rest of the law.
The Court’s decision means that many Obamacare taxes are still in place.
Among them: The 3.8% surtax on net investment income of single filers with modified adjusted gross incomes over $200,000 … $250,000 for joint filers. The 0.9% surtax on earned income of upper-income individuals. The employer mandate. The $2,750 cap on health FSA payins. Plus the excise tax on indoor tanning salons.
Receiving two types of disability payments leads to a tax conundrum. A federal worker who retired on disability received annuity payments from the Federal Employees Retirement System and Social Security disability benefits. By law, the SS disability benefits partially offset his FERS annuity payments. He took a loss deduction for the offset. An appeals court says the annuity reduction is not a deductible loss, affirming a 2018 Tax Court decision (Staples, 10th Cir.).
Expenses incurred before a firm commences business aren’t deductible, an appeals court confirms in this case in which an inventor deducted costs for a venture formed to manufacture and market a device to enhance television viewing. Although time and money were spent developing the device, business hadn’t yet begun. The venture was still in the premanufacturing phase (Provitola, 11th Cir.). Note that once their business begins, firms can make an election to deduct $10,000 of the preopening costs and amortize the remaining expenses over 180 months.
Settlement proceeds received from an attorney malpractice suit are taxable. A woman sued her divorce attorney for malpractice, alleging he was negligent in representing her in her divorce. The parties later settled for $175,000. She claimed the settlement was nontaxable, arguing that but for the lawyer’s negligence, she would have received more tax-free money in her divorce. The Tax Court disagreed, saying the settlement agreement made clear the payment was in lieu of claims arising out of the legal malpractice lawsuit (Holliday, TC Memo. 2021-69).
Successful litigants are generally taxed on their gross settlement or award …
Without reduction for attorney fees. In the case described above, the lawyer who represented the woman in the malpractice lawsuit received the $175,000, deducted his $73,500 in attorney fees, and sent her a net check of $101,500. The full $175,000 is taxable to her. In the past, non-business-related legal fees were generally deductible on Schedule A as a miscellaneous itemized deduction, subject to the 2%-of-AGI threshold. The 2017 tax reform law nixed this class of write-offs, so now individuals generally cannot deduct these attorney fees.
A nonprofit set up to benefit one individual doesn’t qualify for tax exemption, IRS privately rules. The group was set up by the family of a cancer patient to offset the patient’s medical costs through fund-raising. The group’s earmarking of the proceeds for the family member doesn’t meet the required public benefit test.
Operating a golf course for members is not a charitable activity, IRS says in a private ruling. A nonprofit corporation that sells golf memberships to individuals applied for tax exemption as a 501(c)(3) charitable organization. The group’s amenities are available only to golf club members and their families and guests. Its funding comes from membership dues and revenues from activities at the golf clubhouse. The group is neither organized nor operated exclusively for exempt purposes.
IRS disagrees with a 2020 appeals court case favorable to payroll agents.
The court let a professional employer organization claim the FICA tip credit. The credit, which is available to restaurant employers, is equal to FICA tax paid by the business on tips to servers that exceed the portion of tips that are treated as part of the employee’s minimum wage. Here, the PEO contracted with its clients to provide all employer payroll functions, taking responsibility for the reporting, collection and payment of employment taxes on wages paid and all related costs. The PEO reported the payroll tax withholdings on its own tax forms under its name and employer identification number. The 11th Circuit Court of Appeals said the PEO had control over the wage payments and is the true employer.
The Service says it won’t follow the holding in cases outside the 11th Circuit.
A scam that targets payroll and human resource professionals is back. Fraudsters are sending out phony e-mails to payroll departments asking for W-2 data, a list of employees and more. The e-mails purport to be official correspondence from higher-ups in the firm or organization. The cybercriminals use the information they get for nefarious purposes, such as filing fraudulent tax returns claiming refunds.
Here are steps firms can take if a data theft related to the W-2 scam occurs: Let IRS know of the data loss by e-mail at firstname.lastname@example.org. Put “W2 data loss” in the subject line. Provide the business name, employer identification number, name and phone number of the contact person, summary of how the breach occurred and the number of employees impacted. The Service will then contact you by phone. Report the data theft to the police and FBI. And notify affected employees.
Noncompliance with backup withholding rules is costing billions of dollars. Backup withholding is required by payers of nonemployee compensation, interest, dividends and the like to payees who provide an invalid tax ID number or don’t supply one at all. Treasury inspectors identified 440,000 Form 1099 filings for 2018 with a missing or incorrect TIN, in which the payer failed to withhold at the required 24% rate, amounting to $13.3 billion of uncollected income tax. Most of these filings were on the form for the reporting of nonemployee compensation.
If you unexpectedly owed money to IRS when you filed your 2020 return …
Or your refund was too small or large … consider checking your withholding. IRS has a tax withholding estimator on its website to help individuals figure out whether they are having the right amount of income tax withheld from their paychecks, retirement distributions, etc. The online tool asks about various sources of income in addition to wages, and it also provides tips on tax credits and various deductions. It estimates how much additional or less withholding, if any, people should request.
Retirees should keep in mind this popular income tax withholding strategy. Tax withheld at any point in the year is treated as if evenly paid throughout the year. Some retirees rely on this rule to have taxes they expect to owe withheld from an RMD. Kiplinger regularly advises retirees who are falling short on their tax withholding to have more federal income tax withheld from a year-end IRA distribution. You could also hike withholding from Social Security, pension or annuity payments.