All About Gift Tax

When giving assets to a beneficiary, whether cash or property, the government may want to know about it and might even want to collect what the Internal Revenue Service (IRS) refers to as a gift tax. 

Fortunately, a large portion of some gifts or estate assets are excluded from taxation and there are numerous ways to give assets tax-free.

 

Some exclusions are:

Using the annual gift tax exclusion of $15,000

Using the lifetime gift and estate tax exemption

Making direct payments to medical and educational providers on behalf of a loved one

In general, aside from reductions in the taxable estate, there are other perks to giving assets to family members or loved ones while still living. Giving today offers immediate assistance to all beneficiaries while providing the extra enjoyment of witnessing the joy of seeing how the gifts improve their lives.

The gift tax exclusion

Current rules allow funds to be given to any number of people up to $15,000 each in a single year without incurring a taxable gift ($30,000 for if married with a spouse’s gift). The recipient owes no taxes when they receive the gift and does not have to report the gift unless it comes from a foreign source.

If the amount given to any person during the same year exceeds $15,000, the grantor (person making the gift) must file a gift tax return (IRS Form 709). Once the gift exceeds the annual gift tax exclusion, taxes begin to chip away at the lifetime gift and estate tax exemption as discussed next.

The gift and estate tax exemption

The passage of the Tax Cuts and Jobs Act (TCJA) increased the gift and estate tax exemption significantly. Prior to 2018, the exemption amount was $5.49 million. The TCJA increased that amount to $11.7 million for estates 2018 forward. The Federal gift and estate tax rate is 40%.

The $11.7 million exemption applies to gifts and estate taxes combined. Whatever exemption used for gifting reduces the amount eligible for the estate tax. The IRS refers to this as a “unified credit.” Each grantor has a separate lifetime exemption that can be used before any out-of-pocket gift or estate tax is due. In addition, a married couple can combine their exemptions to get a total exemption of $23.4 million with a proper estate plan.

There is one big caveat to be aware of. The $11.7 million exception is temporary and only applies to tax years up to 2025, at which time it will revert to the $5.49 million exemption (adjusted for inflation). It might be a smart move to take advantage of the new exemption before it disappears after 2025. Although, Congress may decide to make these changes permanent after 2025 the exemption expires.

Lock in the higher exemption now

For most people, the gift and estate tax exemption allows for the tax-free transfer of wealth from one generation to the next. There are several other strategies that could be advantageous for those who have acquired enough wealth to surpass the gift and estate tax exemption.

Many individuals find it best to transfer their wealth to their loved ones now, rather than willing it to them later. There are two advantages to giving assets today. First is the chance to see them enjoy the benefits. Second, any increase in the value of the gifted assets could increase in value for beneficiaries, rather than the taxable estate. This would shift the increase in the value of the estate to the next generation and avoid estate tax.

For example: If an individual gives his or her entire estate of $11.7 million to their children today, those assets could increase in value over time. At a growth rate of 5% per year for 10 years, that $11.7 million gift could end up being worth over $19 million, and the heirs will have received the entire amount free from gift or estate taxes. Weigh that against holding those same assets until passing away 10 years later. That increase in value would be taxed at 40%. Additionally, should the gift and estate tax exemption revert to the lower $5.49 million amount (for dates after 2025), the result would be an even larger estate tax amount upon passing.

Ensuring gifts are managed responsibly

One concern many people have when it comes to giving assets away early is that sometimes the person receiving the gift may not be ready to handle the responsibility of managing such a large amount of money or assets. A good example of this is a large amount of money gifted to a young child or teenager. One option for gifting those assets and ensure they are protected from misuse would be to give them to an irrevocable trust and have the child or teenager listed as the beneficiary.

This method allows rules to be set for the trust along with instructions on how the assets will be invested and distributed. For example, create a trust that stipulates the beneficiary can only have access to the income generated once the beneficiary graduates from college. It is also possible to specify when the trust would distribute the assets and at what age, circumstances, etc. There are numerous options when it comes to structuring a trust with each state having its own rules.

Other ways to give tax-free

Make unlimited payments directly to medical providers or educational institutions on behalf of others without incurring a taxable gift or affecting the $15,000 gift exclusion. This method is a great way to assist someone with large medical bills or provide for a family member’s education. For example, it is possible to pay $50,000 tuition for a grandchild’s medical degree by making payments directly to the university, while also gifting an additional $15,000 per year tax-free.

Tax effect to the recipient of gifts

One thing to remember about gifting assets is that the cost basis in the assets will transfer over to the recipient. In other words, if a gifted asset appreciates in value significantly prior to the gift, the recipient could incur a substantial taxable gain when selling that asset. On the other hand, highly appreciated assets that are received as part of an estate on death get a “step up” in basis to the value at death, which means a taxable gain could be avoided if the asset is sold after death. It is important to carefully select what assets can be gifted to minimize the impact of taxes. In general, cash and assets with little appreciation are better for gifts, while highly appreciated assets are better transferred as part of the estate.

In summary

Lifetime gifting can be a great strategy if enough is left over for personal living expenses. For the gift to count, it must be a complete and irrevocable transfer. This article focuses on the federal tax implications for gifting and estates; however, there could be state tax consequences for gifts and estate. Take the time to meet with a tax and estate planning professional to ensure all gift and estate plans are well thought out and properly implemented.

Any accounting, business or tax advice contained in this communication, including attachments and enclosures, is not intended as a thorough, in-depth analysis of specific issues, nor a substitute for a formal opinion, nor is it sufficient to avoid tax-related penalties.

Cryptocurrency and Tax Law

The IRS has increased scrutiny on Bitcoin and other cryptocurrency transactions in its effort to make those aware who previously neglected to declare these forms of virtual investments. The first question on the 2020 tax year Form 1040 for individuals asks about virtual currency transactions. However, the degree to which the investment is taxed depends on a person’s overall income and how long the currency has been held.

If the cryptocurrency was held for one year or less, it is considered short-term capital gains, and profits will be taxed at the overall income rate. Any profits earned on virtual currency that is held longer than one year is considered long-term capital gains and, depending on annual income, are normally taxed at a lower rate.

Purchases made using virtual currency.

Quite a few people invested in Bitcoin when it was relatively low, and many crypto investors decide to sell in 2020 to make a quick profit while the market was high. In addition to declaring capital gains, the IRS also expects a report to be made on gains and losses attached to crypto investment activity or purchases made using cryptocurrency such as Bitcoin.

For example, a crypto investor uses a $10,000 Bitcoin to purchase a new $2,500 computer – an asset that depreciates in value. The IRS expects a calculation based on the value of the Bitcoin at the time of the transaction and recognize any capital gains or losses relative to the cost or fair market value.

Whether or not an investor sold or retained cryptocurrency in 2020, for federal tax purposes, all virtual currency is treated as property; therefore, general tax principles applicable to property transactions also apply to transactions using virtual currency. Even purchasing a cup of coffee with cryptocurrency has tax implications.

Crypto used for services.

Many companies in the tech industry have begun paying employees with Bitcoin and other cryptocurrencies. While the practice is a bit of a novelty, some firms see this as a way to attract more tech-savvy talent.

Both employee and employer should keep a record of the fair market value of the crypto paid as wages, measured in U.S. dollars at the date of receipt. These wages are subject to Federal income tax withholding, Federal Insurance Contributions Act (FICA), and Federal unemployment taxes. All must be reported on Form W-2, Wage and Tax Statement.

On the flip side, employers who pay for services using virtual currency held as an asset must evaluate capital gains or losses for that exchange. The gain or loss is determined by the difference between the fair market value at the time of the exchange for services received and the adjusted basis in the virtual currency exchanged.

Charitable donations and crypto.

 Donating to charity through cryptocurrency can reduce tax liability on the investment According to IRS code Section 170(c), donations made to a charity using virtual currency will not be recognized as income, gain, or loss from the donation. Any charitable deduction made would be recognized as being equal to the fair market value of the virtual currency at the time of donation, provided the investment has been held over a period of one year. Any deductions made using cryptocurrency held for a year or less would be based on the lesser of the virtual currency or the value of the currency at the time of the donation.

Charitable organizations that receive virtual currency should treat the donation as a noncash contribution and can assist a donor by providing the contemporaneous written acknowledgment, something the donor must obtain if claiming a deduction of $250 or more for the virtual currency donation.

It is important to maintain detailed records of all cryptocurrency transactions. This includes receipts and the amount of purchases or donations, plus the value of the virtual currency on the date of each transaction.

For other questions regarding the tax treatment of virtual currency, refer to Notice 2014-21 and Rev. Rul. 2019-24.

Any accounting, business or tax advice contained in this communication, including attachments and enclosures, is not intended as a thorough, in-depth analysis of specific issues, nor a substitute for a formal opinion, nor is it sufficient to avoid tax-related penalties.

Why File a Tax Extension

There are a variety of reasons for filing a tax extension; however, having an extra six months to complete the filing process would be at the top, particularly for the 2020 tax year. Aside from normal tweaks to tax laws, American taxpayers may need extra time to sift through the many changes made through the CARES Act and economic stimulus packages.

Filing an extension provides more time to gather documents to make sure every possible tax credit and deduction gets applied. It is so simple to file a tax extension that millions of taxpayers file personal or business extensions every year.

Who is eligible?

Every American taxpayer is eligible to file for a six-month extension. The IRS does not require an explanation to file. Simply fill out the appropriate extension form and submit it to the IRS by March 15th for most businesses, or April 15th for individuals.

What makes this a good year to file an extension?

With the passing of the Covid relief bills, tax laws and regulations have seen significant changes. Many of the changes that occurred during 2020 are still being interpreted and modified as the upcoming tax deadlines approach. An extension allows time to ensure all eligible new deductions or credits that could not be claimed before are being captured. In addition, the extension avoids having to amend a timely filing for a modification to all new rules, as well as any anticipated changes that could arise from any other legislative bills that may pass this year.

Investment partnerships and K-1s.

A tax extension offers more time to compile and organize tax information for investment 1099s and partnership K-1s. Plus, filing an extension might help prevent mistakes on tax forms made by rushing through a tax return while also allowing the taxpayer time to review the return with a tax professional. Essentially, taking more time to complete complex tax returns could result in a more beneficial tax return.

Might reduce the chance of an IRS audit.

It is a little-known fact that the IRS tends to fill its audit quota in April when most people file their taxes. Waiting to file in September or October could reduce the odds of being audited, as the IRS typically selects fewer returns for a potential examination.

More focused attention by tax preparers.

The first quarter of the year is the busiest for most tax preparers and becomes more hectic closer to April. It could be extremely difficult to book an appointment with a CPA during this period, especially for anyone who might not have felt motivated to get an earlier start on gathering their tax documents. Filing after April allows tax accountants to focus more on the details while having additional time to employ every feasible tax credit.

How do I file an extension?

Any tax professional can file an extension electronically, using Form 4868 or Form 7004, for either an individual or a business. Keep in mind that filing for an extension of time to file your tax return does not also extend your time to pay any tax liability you may have. It is easy to pay the amount due using the IRS and State online secured ACH systems. Please consult your tax professional for assistance in preparing your extension and determining the amount of taxes due by the tax deadline.

Any accounting, business or tax advice contained in this communication, including attachments and enclosures, is not intended as a thorough, in-depth analysis of specific issues, nor a substitute for a formal opinion, nor is it sufficient to avoid tax-related penalties.

Highlights of 2020 Tax Changes & Updates

As the 2021 filing season rapidly approaches, here is a reminder of the federal tax law changes and updates that will affect individual 2020 income tax returns.

For the tax year 2020, the tax rates are the same but there are some changes to the income brackets to account for inflation.

 

 

2020 Marginal Income Tax Rates and Brackets

2020 Marginal Tax Rates Single Tax Bracket Married Filing Jointly Tax Bracket Head of Household Tax Bracket Married Filing Separately Tax

Bracket

10% $0 – 9,875 $0 – 19,750 $0 – 14,100 $0 – 9,875
12% $9,875 – 40,125 $19,750 – 80,250 $14,100 – 53,700 $9,875 – 40,125
22% $40,125 – 85,525 $80,250 – 171,050 $53,700 – 85,500 $40,125 – 85,525
24% $85,525 – 163,300 $171,050 – 326,600 $85,500 – 163,300 $85,525 – 163,300
32% $163,300 – 207,350 $326,600 – 414,700 $163,300 – 207,350 $163,300 – 207,350
35% $207,350 – 518,400 $414,700 – 622,050 $207,351 – 518,400 $207,351 – 311,025
37% Over $518,400 Over $622,050 Over $518,400 Over $311,025

Standard Deductions in 2020

The standard deduction for 2020 went up to adjust for inflation.

Filing Status 2019 2020
Single $12,200 $12,400
Married Filing Jointly and Qualifying Widow(er) $24,400 $24,800
Married Filing Separately $12,200 $12,400
Head of Household $18,350 $18,650

 Health Savings Accounts

The Health Savings Accounts limits for 2020 increased to adjust for inflation.

Inflation-Adjusted Limitations for HSAs 2019

 

2020
Family Self Only Family Self Only
Contribution Limit $7,000 $3,500 $7,100 $3,550
The additional catch-up contribution for taxpayer age 55 or older $1,000 per qualifying spouse  

$1,000

$1,000 per qualifying spouse  

$1,000

Minimum health insurance deductible $2,700 $1,350 $2,800 $1,400
Maximum out of pocket $13,500 $6,750 $13,800 $6,900

Cryptocurrency

In 2019, the IRS issued a revenue ruling (RR 2019-24) on the treatment of crypto. Despite the revenue ruling, many questions remain unanswered about how crypto income and reporting are treated — especially if it involves overseas and international cryptocurrency. Moreover, the draft version of the 2020 1040 tax return has a direct question regarding virtual currency (aka crypto or Bitcoin) on the very first page of the tax return. That is a clear indication of how cryptocurrency has become a key enforcement priority for the US government.

Recovery Rebate Credit

This is a refundable credit for those who did not receive the full Economic Impact Payment in 2020, which is as an advance against a 2020 federal tax credit. Taxpayers must reconcile the amount of the advanced credit received with the amount the taxpayer is due based on the taxpayer’s 2020 income. Although the Economic stimulus payment was limited based on their 2018 or 2019 income, taxpayers will not be required to repay any credit, even if their 2020 income was higher than 2018 or 2019.

Charitable Contributions

The CARES Act makes the following changes to charitable contributions beginning in the tax year 2020 as follows:

  • A $300 above-the-line charitable contribution deduction is now available for taxpayers who take Standard Deduction.
  • The 60% adjusted gross income (AGI) limit on cash contributions by individuals is disregarded.
  • For corporations, the taxable income limit is increased from 10% to 25% on cash charitable contributions.
  • The taxable income limit on contributions of food inventory increased from 15% to 25%.

Noncash property and contributions carried forward from prior years do not qualify for this deduction, the existing 20%, 30%, and 50% limits apply.

Kiddie Tax Changes

For tax years beginning after 2017, the Tax Cuts and Jobs Act (TCJA) changed the rule so that the child’s unearned income would be taxed at the trust and estate tax rates.

For 2020 and beyond, the Secure Act repeals the TJCA kiddie tax rules to pre-TCJA rules wherein a child’s unearned income is taxed at the parent’s or parents’ marginal tax rate. Also, a child’s earned income is taxed at single rates and this has not changed.

Educational Expenses

The SECURE Act added to the list of qualified higher education expenses that are permitted by IRC §529 account distributions to include the following:

  • Costs of certain apprenticeship programs, including fees, books, and supplies.
  • Student loan repayments up to a total of $10,000.

Unemployment Compensation

The COVID-19 pandemic resulted in millions of unemployment claims. For 2020, taxpayers will receive a Form 1099-G and all unemployment insurance benefits received are taxable as ordinary income and must be reported on the recipient’s federal income tax return. However, they are not subject to Social Security and Medicare taxes.

Retirement Plans:

  • Under the CARES Act, taxpayers under age 59 ½ were allowed to take up to $100,000 out of their 401(k)s and IRAs up until the end of 2020 without having to pay an early withdrawal penalty if the taxpayer is impacted by COVID-19. The distribution can be included in income ratably over a 3-year period unless the taxpayer elects otherwise. The taxpayer can also contribute the money back to their retirement plan within three years and treat the transaction as a direct rollover.
  • Under the SECURE Act and for distributions required to be made after December 31, 2019, the age at which individuals must start taking distributions from these retirement plans has been increased from 70 ½ to 72. Under the CARES Act, RMDs are not required for 2020. Initially, the provision stated that you may return an RMD within 60 days if you had already taken the distribution. Notice 2020-51 allows you to return the distribution by August 31, 2020.
  • The SECURE Act allows owners of traditional IRAs to keep putting money in their accounts beyond age 70 ½ starting in 2020.
  • Under the SECURE Act and beginning in 2020, taxpayers can take up to $5,000 (for each spouse) of penalty-free retirement plan distributions for expenses related to the birth or adoption of a child.

Qualified Business Income Deduction

The code provides a deduction of up to 20% of QBI from a US trade or business operated as a sole proprietorship or through a partnership, S Corporation, trust, or estate. Taxpayers whose taxable income is above a phaseout threshold may have their QBI deduction limited or completely phased out. The QBI phased out deduction depends on many factors, including whether a taxpayer’s qualified business income is deemed to be from a specified service trade or business (SSTB) and/or the amount of W-2 wages and the unadjusted basis of assets immediately before acquisition (UBIA).

In the 2020 draft instructions the IRS released to Form 8995 for Qualified Business Income Deduction Simplified Computation, it appears to remove charitable contributions from the list of items the IRS believes should reduce a taxpayer’s QBI. However, the IRS has not published anything that definitively states it no longer considers charitable contributions as deductions in computing QBI.

For taxable years beginning in 2020, the threshold amount under §199A(e)(2) is $326,600 for married filing joint returns, $163,300 for married filing separate returns, and $163,300 for all other returns.

Self-Employed Individuals

  • Credits for Sick and Family Leave – This new credit is for self-employed individuals who were affected by the coronavirus. It allows them to claim a credit similar to sick leave if they were unable to work because they had coronavirus or had to care for someone else who had coronavirus or a credit similar to family leave if they were unable to work because they had to care for their child who had coronavirus. The period covered is April 1 – December 31, 2020, and the credit is claimed on new Form 7202 with their 2020 Individual Income Tax Return.
  • Payroll Tax (Social Security Portion) Deferral – This tax provision permits self-employed individuals to delay paying 50% of the Social Security tax imposed for the period beginning March 27 and ending December 31, 2020.

Deferred tax is payable in the following two years with half paid in 2021 and half paid in 2022. Taxpayers can make an election to defer this tax on Schedule SE, Part III. The actual amount of tax that can be deferred may be limited by the amount of tax that the self-employed individual paid in estimated taxes or had withheld during 2020.

Extender Provisions

On December 27, 2020, as part of the Stimulus bill, President Trump signed into law the Taxpayer Certainty and Disaster Tax Relief Act of 2020, which extended or made permanent several temporary tax code provisions. Below are a few of the key higher impact-extender items for individuals:

  • Reduction in medical expense deduction from 10% to 7.5% was made permanent.
  • Deduction for mortgage insurance premiums was extended through 2021.
  • Repealed the tuition and fees deduction and increased the income limitation of the lifetime learning credit was made permanent.
  • Energy-efficient homes credit was extended through 2021.
  • Exclusion from gross income for discharge of debt income from qualified principal residence debt was extended through 2025.

Author, Elizabeth Shauger, CPA  

Tax Manager, Spiegel Accountancy Corp

 

 

Any accounting, business or tax advice contained in this communication, including attachments and enclosures, is not intended as a thorough, in-depth analysis of specific issues, nor a substitute for a formal opinion, nor is it sufficient to avoid tax-related penalties.

Employee Retention Credit

The recently signed stimulus package included considerable enhancements to the Employee Retention Credit (ERC). The new law, known as the Consolidated Appropriations Act (CAA) expands the ERC under the CARES Act that went into effect January 1, 2021, with the covered wage period extended until June 20, 2021. The new legislation is also retroactive to wages paid after March 12, 2020; so, employers who took Paycheck Protection Program (PPP) loans in 2020 are now eligible to take the ERC, provided these wages are not used for both the credit and PPP loan forgiveness.

 Tax Changes Under CAA 2021

The good news for employers who continued to pay their employees, despite being forced to close their business either fully or partially by a COVID-19 lockdown, is they are now eligible for an ERC refund.

Period of availability: For qualified wages paid after March 12, 2020, and before July 1, 2021, extending availability of the credit to the first two quarters of 2021. These periods may be outside the covered period for many PPP loan borrowers, and the employee retention tax credit is likely available.

Credit amount: The credit amount increased from 50% to 70% of qualified wages, for 2021, which is amended to include the cost to continue providing health benefits.

Maximum credit amount: The credit cap is increased to $7,000 for each of the first two quarters of 2021 ($10,000 in qualified wages X 70% tax credit rate), so that the maximum credit for 2021 will be $14,000. This aggregate $14,000 per employee maximum credit for the first two quarters of 2021 is available even if the employer received the $5,000 maximum credit for wages paid to such employee in 2020.

Credit eligibility requirements: The applicable number of employees increased from 100 to 500. This allows employers who had 500 or fewer full-time in 2019 to be eligible for the credit, even if employees are working, provided they meet other requirements. Note that in calculating this 500-employee threshold, the employees of all affiliated companies sharing more the 50% common ownership are aggregated.

Effective January 1, 2021, business operations that are either fully or partially suspended by a COVID-19 lockdown order, or for a quarter in 2021, if gross receipts are less than 80% of gross receipts for the same quarter in 2019. This differs from the original law in 2020 that stipulated gross receipts of less than 50% qualified.

Because the ERC credit can apply to wages already paid after March 12, 2020, many struggling employers can access this credit by reducing upcoming deposits or requesting an advance credit on Form 7200, Advance of Employer Credits Due To COVID-19 (per IRS website).

Advance payment clause: Advance payment of the credit is allowed for businesses with 500 or fewer employees, based on 70% of average quarterly payroll for the same quarter in 2019. Companies may be allowed to collect the payment prior to the payment of wages. However, if the advance payment is larger than the actual credit calculated, the company will need to repay the excess.

Please contact the Spiegel team for advice and any updates on this new legislation.

Any accounting, business or tax advice contained in this communication, including attachments and enclosures, is not intended as a thorough, in-depth analysis of specific issues, nor a substitute for a formal opinion, nor is it sufficient to avoid tax-related penalties.

Guidance for PPP 2.0

The latest stimulus bill passed by Congress allocates $284 billion to small businesses through the Paycheck Protection Program (PPP). This new legislation is said to have tighter requirements with more relaxed tax regulations. PPP round two reopens the program for first-time borrowers provides better flexibility for spending PPP funds, and, under certain conditions, allows prior loan recipients to apply for a second loan.

Who Qualifies?

For borrowers to be eligible this round, their business must have operated before February of 2020 and must have fewer than 300 employees, which is down from the previous requirement of 500. Qualified borrowers will have loans capped at $2 million, which is down from the $10 million cap in the first round. The lending guidelines for requested funds still have the amount set at 2.5 times monthly payroll, with restaurants and hotels allowed to request 3.5 times their average monthly payroll. Designed to support employees and prevent layoffs, this new bill requires 60% of the loan be used for salaries.

The first round of PPP loans established the covered period for the borrower, depending on when they received their loans. PPP 2.0 allows borrowers to choose between an 8-week or 24-week covered period. This slight change offers borrowers more control over the handling of potential workforce reductions once the PPP funds are depleted.

Chance for Second Loan?

 A recent study by the National Federation of Independent Business (NFIB) reported one-in-four small business owners reported they will soon be closing their doors if current economic conditions do not improve. The NFIB also stated that the majority of PPP borrowers (91%) have spent all their loan funds. Fortunately, these business owners may apply for a second loan also known as a “second draw.” To qualify, these borrowers must have depleted their first round of PPP and show a 25% reduction in revenue in at least one quarter of 2020 compared to the same in 2019.

Eligibility for Non-profits

Stimulus round two made provisions for 501(c)(6) not-for-profit organizations eligibility for PPP loans. These previously forgotten non-profits are often professional organizations, such as chambers of commerce, boards of trade, small business associations, tourism and hospitality coalitions, and social welfare groups. Such organizations can apply for PPP provided they do not receive more than 15 percent of their revenue from lobbying activities and have fewer than 300 employees.

 Spending Allowances & Tax Breaks

 PPP 2.0 allows for funds to be spent on business expenditures other than wages and rent, unlike the first pass. Borrowers are permitted to pay for supplies, software, accounting expenses, and personal protection equipment. Also covered are costs related to property damage or vandalism, which occurred in 2020, due to looting or public disturbances that were not covered by insurance.

Similar to prior legislation, PPP funds will be tax-exempt. Furthermore, the new legislation also stipulates that expenses paid with proceeds of a PPP loan that is forgiven to be considered tax-deductible. This applies to both new and existing former PPP loans. This reverses IRS and Treasury guidance issued this past November that declared borrowers could not deduct PPP expenses if the loan had been forgiven.

 Loan Forgiveness

 Revisions to the new PPP legislation creates a more streamlined loan forgiveness process. Borrowers who receive no more than $150,000 are now offered a simple one-page application. Round one offered this process for loans up to $50k. The simplified form requires borrowers to provide a description of the number of employees the business was able to retain due to the PPP loan, along with an estimate of the total amount of PPP proceeds spent on payroll costs. Borrowers who choose to submit this simplified application should carefully check their calculations and responses due to penalties for producing false statements. It would be prudent to consult with an accounting advisor, especially considering such expenses are now tax-deductible under the new bill.

 How to Get a PPP Loan

 In an effort to address previous criticism of the PPP initiative, minority-owned or economically disadvantaged businesses will be offered the first crack at PPP loans on Monday, January 11, 2021. The SBA is seeking to ensure that small, vulnerable businesses can access this new round of money before larger businesses claim the funds as happened in the first PPP offering. So-called community financial institutions will have access to the $60 billion set aside for businesses that had been previously shut out, with an emphasis on those with 10 or fewer employees or those in low-income areas.

The second round of loan applications is scheduled to begin on January 13th with the deadline to apply on March 31st.  However, keep in mind, applications will no longer be received once the initial second round of funds is depleted.

Any accounting, business or tax advice contained in this communication, including attachments and enclosures, is not intended as a thorough, in-depth analysis of specific issues, nor a substitute for a formal opinion, nor is it sufficient to avoid tax-related penalties.

IRS Changes to Schedule K-1

The Internal Revenue Service (IRS) made significant changes to the Schedule K-1 for the 2020 tax year to improve the quality of information reported by partnerships. This consists of modified instructions for partnerships required to report capital accounts to partners. All partnerships, including limited liability companies taxed as partnerships, are required to report partners’ capital in Box L on the Schedule K-1.

Prior to 2020, a partnership could report partners’ capital using one of the following methods: tax basis, GAAP basis, Section 704(b) basis, or other method. With Notice 2020-43, all partnerships, including limited liability companies taxed as partnerships, are required to report partners’ capital on a tax basis starting with the 2020 tax return. Notice 2020-43 outlines two methods of reporting tax basis capital: Modified Outside Basis Method and Modified Previously Taxed Capital Method. The preliminary instructions for the 2020 Form 1065 provide a third option under consideration: Transactional Approach.

Modified outside basis method. The amount to report as a partner’s beginning capital account under the modified outside basis method is equal to the partner’s adjusted tax basis in its partnership interest as determined under the principles and provisions of subchapter K including, for 1) the partner’s share of partnership liabilities under section 752 and (2) the sum of partner’s section 743(b) adjustments. For purposes of establishing a partner’s beginning capital account, you may rely on the adjusted tax basis information provided by your partners. .

Modified previously taxed capital method. The amount to report as a partner’s beginning capital account under the modified previously taxed capital method is equal to the following: The amount of cash the partner would receive if you liquidated after selling all of the assets in a fully taxable transaction for cash equal to the fair market value of the assets; increased by the amount of tax loss determined without taking into account any section 743(b) basis adjustments that would be allocated to the partner following such a liquidation; and decreased by the amount of tax gain determined without taking into account any section 743(b) basis that would be allocated to the partner following such a liquidation. Instead of using the assets’ fair market value, you may determine the partnership’s net liquidity value, and gain or loss, by using such assets’ bases as determined under section 704(b), as determined for financial accounting purposes, or on the basis set forth in the partnership agreement for purposes of determining what each partner would receive if the partnership were to liquidate, as determined by partnership management.

Transactional approach. The amount to report as a partner’s beginning capital account under the transactional approach is (1) increased by the amount of cash and the tax basis of property contributed by the partner to the partnership (less liabilities assumed by the partnership or to which property is subject) as well as allocations of income or gain made by the partnership to the partner, and (2) decreased by the amount of cash and the tax basis of property distributed by the partnership to the partner (less any liabilities assumed by the partner or to which the property is subject) as well as allocations of loss or deduction made by the partnership to the partner.

The partnership is required to use one of the methods, and the method selected must be used by all partners for the year. While the capital on the K-1 may look different for 2020, the change to tax basis reporting does not cause an economic consequence to the partner. This is strictly a reporting requirement. However, partnerships that do not comply with the new reporting requirements will be subject to late filing penalties for failure to show all required information. For 2020, the late filing penalty is $210 for each month or part of a month, for a maximum of 12 months, multiplied by the total number of persons who were partners in the partnership during any part of the partnership’s tax year.

Check your 2019 K-1 statement to determine the prior method for basis reporting. Many partnerships will opt for the modified previously taxed capital method due to the availability of information. Please contact your Spiegel team with any questions or to discuss your options.

 

Author, Peter Lloyd

Senior Tax Manager, Spiegel Accountancy Corp

Any accounting, business or tax advice contained in this communication, including attachments and enclosures, is not intended as a thorough, in-depth analysis of specific issues, nor a substitute for a formal opinion, nor is it sufficient to avoid tax-related penalties.

2020 COVID-19 Tax Credits for the Workplace

Tax credits for paid sick and family leave

The Families First Coronavirus Response Act (FFCRA) provides two self-employed tax credits to help cover the cost of taking time off due to COVID-19. While most of the text in these laws apply to businesses with employees, it also applies to self-employed individuals.

The tax credit for paid sick leave applies to eligible self-employed taxpayers who are unable to work (including telework or working remotely) due to:

  • Being subject to a federal, state, or local quarantine or isolation order due to COVID-19.
  • Being advised by a health care provider to self-quarantine due to COVID-19. Experiencing COVID-19-related symptoms and seeking a medical diagnosis. If you meet all the requirements, you would be eligible for qualified sick leave for each day during the year that you were unable to work for the above reasons (up to 10 days). The tax credit is worth the lesser of $511 per day or 100% of your average daily self-employment income for the year per day.
  • The only days that may be considered in determining the qualified sick leave equivalent amount are days occurring during the period beginning on April 1, 2020 and ending on December 31, 2020.

Under the expanded Family and Medical Leave Act (FMLA) provision of the FFCRA, you would be eligible for qualified family leave for each day that you were unable to work because you were caring for someone else impacted by COVID-19 (up to 10 days), or your child’s school or childcare provider was closed or unavailable due to COVID-19 (up to 50 days). You can claim a tax credit for the lesser of $200 per day or 67% of your average daily self-employment income for the year per day.

 How do I calculate and claim these tax credits?

The “average daily self-employment income” is calculated as your net earnings from self-employment during the tax year, divided by 260. An individual can claim a credit for both qualified sick leave and qualified family leave, but not both for the same time periods. You can claim both the tax credit for paid sick leave and the tax credit for paid family leave on your 2020 Form 1040 tax return. However, you do not have to wait until the next tax-filing season to benefit from these credits

 Employee Retention Credit

 If you have employees, the Employee Retention Credit (ERC) can help you cover the cost of keeping idle workers on your payroll during the pandemic. The tax credit is worth half of what you spent on wages and employee health plan costs after March 12, 2020, and before January 1, 2021, up to $10,000 per worker.

To qualify, your business must have one of the following:

  • A full or partial suspension of its operations due to governmental orders limiting commerce, travel, or group meetings due to COVID-19.
  • A sufficient decline in gross receipts compared to 2019. The decline begins when there is a 50% drop in a calendar quarter compared to the same quarter in the prior year. The decline does not end until a calendar quarter reaches 80% of the same prior-year quarter. This means that if a quarter drops to less than 50% and the following quarter is at 70%, there is still a decline.

You can claim this credit by reducing your payroll tax deposits. If your employment tax deposits are not enough to cover the full credit, you can get an advance from the IRS by filing Form 7200.

If you received a Paycheck Protection Program loan, you cannot also claim the ERC. You can claim both the paid leave credits and the ERC but not on the same wages.

For more information, contact your tax advisor and/or visit the U.S. Department of Labor website: https://www.dol.gov/agencies/whd/pandemic/ffcra-employer-paid-leave

Any accounting, business or tax advice contained in this communication, including attachments and enclosures, is not intended as a thorough, in-depth analysis of specific issues, nor a substitute for a formal opinion, nor is it sufficient to avoid tax-related penalties.

The 12-Month Rule – Determining the Deductibility of Prepaid Expenses

Taxpayers seeking additional business deductions before the end of the year might consider adopting the 12-month rule by prepaying some business expenditures before year-end. Certain expenses such as insurance, rebates, and licenses can be prepaid before year-end without needing to be capitalized for tax purposes, thus allowing a tax deduction for the current tax year. The 12-month rule must satisfy the requirements of economic performance in order to be utilized. The recurring item exception may provide some relief if the economic performance standard isn’t met.

Basics of the 12-Month Rule

Under normal circumstances, IRS regulations require taxpayers to capitalize (i.e., not deduct) amounts paid for certain prepaid assets. In other words, let’s say you spend $1,000 of your hard-earned money in October on a license that lasts one year. This doesn’t necessarily mean the entire amount is deductible in the tax year the payment is made. Cash-out = tax deduction. Those more familiar with accounting principles will argue that the matching principle needs to be applied, meaning that the deduction should be applied to the period in which it provides a benefit. Meaning, you would deduct 3/12 of the expense in the year the payment is made and 9/12 in the following year. This would be the IRS’ approach (See Reg. Sec. 1.162-3(d)). Taxpayers may be allowed to deduct the full $1,000 amount in the year in which it was paid by applying the 12-month rule. To apply this rule, we must look to Reg. Sec. 1.263(a)-4(f) which states that:

Except as otherwise provided in this paragraph, a taxpayer is not required to capitalize amounts paid to create any right or benefit for the taxpayer that does not extend beyond the earlier of:

  • 12 months after the first date on which the taxpayer realizes the right or benefit; or
  • The end of the taxable year following the taxable year in which the payment is made.

Let’s apply this to our license example. A license that lasts one year was purchased in October of the current year and it is set to expire in September of the following year. The payment creates a right that does not extend 12 months after it is initially created, thus satisfying the first condition. Also, it does not extend past the following taxable year since it ends in September, which satisfies the second condition. If the right had extended beyond September of the following year, the 12-month rule would no longer be satisfied, and the license would need to be deducted ratably over the life of the license.

Exception to the Exception: Understanding Economic Performance

The 12-month rule cannot be universally applied in all situations. If another regulation or code section specifically states that a certain type of prepaid asset is disallowed, the 12-month rule will not apply. Cash basis taxpayers will have slightly different results from accrual basis taxpayers. The rules for cash-basis taxpayers are relatively straight-forward: make the payment, and as long as the conditions above for the 12-month rule are satisfied, the taxpayer is eligible for the deduction. However, in order for this to always be true, economic performance must be satisfied. This is also true for accrual-basis taxpayers, but unlike cash basis taxpayers, accrual basis taxpayers will accrue certain expenses at year-end that a cash basis taxpayer will not.

In basic terms, economic performance is the timing of when a liability owed by a taxpayer is truly treated as being incurred. All of the necessary events need to have happened to determine that a) a liability is fixed, b) the amount can be determined with reasonable accuracy, and c) a specific action or event has taken place. For example, economic performance occurs for the following liabilities:

  • Rent Expense – generally, ratably over the period the taxpayer is entitled to use the property
  • Services – occurs as services are provided
  • Insurance – occurs when payment is made

This means that for prepaid services and prepaid rent, economic performance isn’t satisfied until the property is used or until the service is provided to the taxpayer, respectively. As such, merely paying the liability doesn’t mean the payment can be deducted. However, payment for an insurance premium in the event that needs to take place for economic performance. Assuming the 12-month rule is satisfied, prepaid insurance will be deductible upon payment. A more comprehensive list of prepaid assets and their respective economic performance traits can be found at the end of the article.

Exception to the Exception to the Exception: The Recurring Item Exception

What happens if economic performance hasn’t occurred, but you really want that tax deduction? It’s at the top of your wish list and you’ve been good all year. Surely Santa will step in on your behalf. Well, congratulations! The recurring item exception exists! Reg. Sec. 1.461-5 states that economic performance will be treated as having occurred with respect to liability if:

  1.  The liability is recurring in nature and is either not material, or provides for better matching of income and expense,
  2.  And economic performance will occur before the earlier of 8 1/2 months after year-end, or the filing of the tax return.

For example, a taxpayer accrues an expense for an insurance premium year-end. The premium covers October of the current year to September of the following year. The taxpayer makes the payment on January 15th of the following year. Even though this satisfies the 12-month rule, economic performance has not occurred before year-end since payment has not been made. However, under the recurring item exception, the deduction may be taken since insurance premiums are recurring in nature. It is not material, and payment was made within 8 ½ months of year-end.

Note: The recurring item exception cannot be applied to interest, rents, worker’s compensation, tort, breach of contract, and violation of law.

Bringing It All Together

To see how all of these concepts work together, let’s go through two examples:

Example 1:  Prepaid Advertising

On December 15th, a taxpayer pays a marketing firm $10,000 for advertising services that the taxpayer believes will be performed over the next 3 months. The marketing firm completes the advertising service by February 28th of the following year.

  • 12-Month Rule – The conditions for the 12-month rule are satisfied because the benefit to the taxpayer is realized within 12 months of the payment.
  • Economic Performance – For services, economic performance is satisfied as services are provided. The amount of the liability is fixed and determinable at year-end. However, the services were not provided by the end of the year so economic performance is not satisfied. Economic performance rules trump the 12-month rule, so it’s not looking good for the taxpayer thus far.
  • Recurring Item Exception – The taxpayer argues that they regularly engage marketing firms and the amount paid is not material to their financial statements. Also, the payment was made before filing the tax return.
  • Conclusion – The recurring item exception allows the taxpayer to apply the 12-month rule and the taxpayer is able to take the deduction. Note that for prepaid services, services must be provided within 3 ½ months of the payment being made. Other prepaids, such as prepaid interest, can be paid within 8 ½ months of year-end and still be deductible.

Example 2:  Prepaid Interest

On December 15th, a taxpayer pays an interest obligation of $10,000 related to business debt covering the second half of December and the first half of January of the following year.

  • 12-month Rule – The conditions for the 12-month rule are satisfied because the benefit to the taxpayer is realized within 12 months of the payment.
  • Economic Performance – For interest, economic performance is satisfied as the borrower has use of the money. The amount of the liability is fixed and determinable at year-end. However, the taxpayer cannot “use” the money for January in December, so economic performance is not satisfied. Again, economic performance rules trump the 12-month rule; so, it is still nondeductible.
  • Recurring Item Exception – The taxpayer argues that they regularly pay interest and the amount paid is not material to their financial statements. Also, the payment was made before filing the tax return. However, prepaid interest is one of the exclusively carved out items that cannot be applied by the recurring item exception.
  • Conclusion – Even though the 12-month rule is satisfied, economic performance and the inability to apply the recurring item exception prevent the taxpayer from deducting the prepaid January interest.

As you can see, these concepts work together to provide some relief to taxpayers while still trying to prevent abuse by others who would seek to make large prepayments before year-end for the sole purpose of lowering their tax liability. When determining the deductibility of prepayments for tax purposes, every situation is unique and requires a fair bit of analysis and understanding to make sure the taxpayer takes a defensible position. One should always consult with their tax advisor on their own circumstances to determine best practices.

Prepaid Expenses and Economic Performance

Prepaid Expense Economic Performance
Prepaid Insurance Payment

 

Prepaid Warranty and Service Contracts Payment

 

Prepaid License or Permit Fees Payment

 

Prepaid Taxes Payment

 

Prepaid Dues and Fees Payment

 

Prepaid Rebates Payment

 

Prepaid Rent Ratably over the period of time the taxpayer is entitled to use the property

 

Prepaid Services As services are performed

 

Prepaid Interest Ratably as the taxpayer has use of the money being borrowed

 

Prepaid Goods As the goods are provided to the taxpayer

 

Author, Jonathan Smith, Senior Tax Manager, Spiegel Accountancy Corp

Any accounting, business or tax advice contained in this communication, including attachments and enclosures, is not intended as a thorough, in-depth analysis of specific issues, nor a substitute for a formal opinion, nor is it sufficient to avoid tax-related penalties.

Paycheck Protection Program Tax Treatment

More than 500 like-minded stakeholders are calling on Congress to overturn an Internal Revenue Service rule and allow Paycheck Protection Program (PPP) loan forgiveness to be fully tax-free.

In a December 3, 2020 letter to leaders of the House and Senate, the groups, led by the Associated General Contractors of America, urged lawmakers to enact legislation before the end of the year to correct the tax treatment of loan forgiveness under PPP.

IRS Notice 2020-32 states that “normally deductible business expenses will not be deductible if the business pays the expense with a Paycheck Protection Program loan that is subsequently forgiven,” which the coalition believes is a misinterpretation of the Coronavirus Aid, Relief and Economic Security Act. Section 1106(i) of the CARES Act states business expenses are “includible in gross income of the eligible recipient by reason of forgiveness” and “shall be excluded from gross income,” for purposes of the Internal Revenue Code of 1986. The coalition wants Congress to clarify this contradiction.

“At the onset of the COVID-19 pandemic, Congress responded with speed, cooperation, and an eye to preventing the worst potential economic outcomes. We ask that you bring that same spirit of urgency and cooperation before the end of this session to prevent an avoidable catastrophe for millions of small businesses that, without Congressional action, will face a surprising, and, in many cases, insurmountable tax bill next year,” the groups wrote. Spiegel Accountancy Corp Founding Principal, Jeff Spiegel, says, “Congress needs to act to get this resolved to allow expenses to be deducted.”

“The terms of the PPP are simple: if qualifying small businesses use a federally-guaranteed loan to pay their employees and cover certain non-payroll expenses, the loan will be forgiven,” the letter continued. “From April 3rd, when the program launched, through August 8th, when its authorization expired, the Small Business Administration guaranteed $525 billion in PPP loans to 5.2 million qualifying small businesses nationwide, preserving tens of millions of paychecks for their employees as the pandemic spread throughout the country.”

The coalition noted that if unchanged, the IRS ruling could increase small businesses’ taxes up to 37%.

“Since the IRS issued Notice 2020-32, Congress has signaled that it intends to reverse the ruling,” the letter said. “The Democratic and Republican Chairs of the House Ways and Means and Senate Finance Committees issued public statements saying that the IRS Notice, and, more recently, the IRS Revenue Ruling, is flawed and contrary to Congressional intent.”

The coalition added that the “most recent IRS revenue ruling” has created a renewed sense of urgency for Congress to address the issue before the end of the year.

“Allowing the IRS position to remain unchallenged will result in a significant tax increase on small business owners already suffering from the effects of COVID-19 shutdowns,” the groups wrote. “This tax will hit small business owners after their PPP loan has already been spent, and just as many states are re-imposing mandatory closures of thousands of businesses in the face of spiking numbers of COVID-19 cases. Many PPP loan recipients retained employees on their payrolls, even when there was little to no work to perform, in compliance with the intent of the program to keep people employed and off the unemployment rolls. The IRS changed the rules after businesses took out PPP loans, and business owners are now being asked to pay what amounts to a surtax on their workforce.

“Without Congressional action, businesses will face an unexpected tax bill when they file their taxes for 2020, as they continue to struggle with government-mandated shutdowns or slowdowns. Many of those businesses will close and never re-open. This senseless tax policy stands both the letter and spirit of the PPP on its head,” the letter concluded.

 

Any accounting, business or tax advice contained in this communication, including attachments and enclosures, is not intended as a thorough, in-depth analysis of specific issues, nor a substitute for a formal opinion, nor is it sufficient to avoid tax-related penalties.