Watch Out for Tax Penalties!
Most taxpayers don’t intentionally incur tax penalties, but many who are penalized are simply unaware of the penalties or the possible damage they can do to their wallets. As tax season approaches, let’s look at some of the more commonly encountered penalties and how they may be avoided.
Underpayment of Estimated Taxes and Withholding Penalty – The United States’ income tax system is a pay-as-you-earn tax system, which means that taxpayers are required to pay their tax liability as they receive income during the year through withholding or by making estimated tax payments. Normally, estimated tax payments are made in four installments that are due by April 15, June 15, September 15, and January 15 of the subsequent year. If a taxpayer owes more than $1,000 when filing their return for the year, the IRS will assess the penalty for underpayment of estimated tax, which is currently 3% of the underpayment. “Safe harbor” payments can protect you from this penalty, which are payments of 90% of the current year’s tax liability or 100% (110% for high-income taxpayers) of the prior year’s tax liability. Farmers and fishermen need only prepay 66-2/3% of their current liability or 100% of their prior year’s liability.
The 100%/110% safe harbor works well when the taxpayer’s tax will be higher than that of the prior year. But when a taxpayer anticipates a large drop in income as compared to the prior year, there can be a huge impact on the necessity of estimated tax payments. The 100% and 110% of the prior year’s tax liability are most likely not viable safe harbor amounts for estimated tax in the lower-income year, and most taxpayers will want to pay 90% of the current year’s tax liability. Please contact this office to see if you need to make any payments and, if so, how much.
Required Minimum Distribution (RMD) Penalty – To prevent an individual from investing in tax-deferred retirement plans, including traditional IRAs, but never withdrawing funds from the plans (which would mean the government wouldn’t ever collect taxes on the retirement funds), retirees must take an RMD each year after reaching the mandatory RMD age. The mandatory distribution age is currently 72. Failing to take the correct minimum distribution (also known as excess accumulation) results in a penalty of 50% of the difference between what should have been withdrawn and what was actually withdrawn. However, the IRS generally is very liberal about abating the penalty in most situations when corrective action is taken.
Late-Filing Penalty – If a return is filed after the due date, including after extensions, a late-filing penalty of 4.5% per month (maximum 22.5%) will be applied. The normal due date for returns is April 15 of the subsequent year. Because of COVID-19, the original due date for 2020 returns was extended to May 17, 2021. Those who had not filed by that date could have requested a further extension to October 15, 2021. If you have not filed your 2019, 2020, or any earlier year’s return, you are encouraged to do so as soon as possible to minimize late-filing penalties.
If a return is over 60 days late, the minimum penalty for failure to file is the lesser of $435 ($450 in 2022) or 100% of the tax shown on the return. While the obvious way to avoid a late-filing penalty is to file in a timely fashion, the IRS will consider abating the penalty if it can be proven that there was reasonable cause and not willful neglect.
Late-Paying Penalty – If the tax owed on a return is paid after the unextended due date of the tax return (usually April 15 but is May 17 for 2020 returns filed in 2021), then the taxpayer will be subjected to a penalty of 1/2% per month (maximum 25%) of the unpaid balance. Taxpayers are frequently caught by this penalty when they need an extension to file their tax return; many fail to realize that the extension does not include an extension on paying. The only way to avoid or minimize this penalty is to have little or no balance due on the return when it is finally filed. The extension form includes a provision to pay the projected balance owed when filing the extension.
Negligence – When underpayment is due to taxpayer negligence or when there are errors in tax valuations, a penalty of 20% of the tax underpayment will be charged. This penalty is frequently encountered when the IRS adjusts a filed return due to unreported income or overstated deductions.
Fraud – The fraud penalty is 75% of the tax unpaid due to fraud.
Dishonored Check – The penalty for dishonored checks of over $1,250 is 2% of the check amount. If the amount is $1,250 or less, the penalty is the amount of the check or $25, whichever is less. If you don’t have sufficient funds to pay your tax when you file your return, rather than writing a check that you know will bounce, you may be able to arrange an installment payment plan with the IRS. You may still incur late-payment charges, but the penalty rate will be lower if you are on a payment plan.
Missing ID Number – A $50 penalty for each missing number applies when a taxpayer doesn’t provide a required Social Security number (SSN) for themselves, a dependent, or another person on their tax return. It is also charged when the taxpayer doesn’t provide their SSN to another person or entity when required.
Early Withdrawal Penalty – If a taxpayer is under age 59½ and withdraws assets (money or other property) from a qualified retirement plan, including traditional IRAs, the taxpayer must pay a 10% additional tax, commonly referred to as the early withdrawal penalty. This tax is 10% of the part of the distribution that the taxpayer was required to include in their gross income for the year of the distribution. A number of exceptions apply to this penalty.
As part of COVID-19 relief, this penalty was waived on distributions of up to $100,000 from qualified retirement plans and traditional IRAs during 2020. Early withdrawals in 2021 and later years are subject to the penalty unless one of the several exceptions applies.
Failure to Report Tips – A penalty will be charged if a taxpayer didn’t report tips to their employer. It equals 50% of the Social Security tax on the unreported tips.
Reporting Foreign Accounts and Assets – There are numerous and substantial penalties for failures to report a variety of foreign accounts and assets, and some of the penalties are even draconian. Please contact this office if you have a foreign financial account, foreign trusts, ownership in a foreign corporation, received foreign gifts, and so on.
Excessive Claim Penalty – If a claim for refund or credit for income tax is made for an excessive amount, the person making the claim is liable for a penalty equal to 20% of the excessive amount. The excessive amount is the amount by which one’s claim for any tax year exceeds the amount of the claim allowable for that tax year.
The penalty doesn’t apply if it is shown that the claim for the excessive amount was made with reasonable cause. The penalty also does not apply if any portion of the excessive amount of credit is subject to an accuracy-related penalty.
Accuracy-Related Penalty for Non-Itemizers – For 2021, taxpayers are allowed a deduction of up to $300 ($600 on married joint returns) for cash contributions to qualified charitable organizations. Usually, only individuals who itemize their deductions can deduct donations to charities. As part of the accuracy-related penalty, a non-itemizing taxpayer who overstates their charitable donation can be penalized by 50% of the tax attributable to the overstatement, rather than the normal 20% penalty.
Frivolous Return – In addition to any other penalties, the law imposes a $5,000 penalty for filing a frivolous return – one that does not contain information needed to establish the correct tax or that shows a substantially incorrect tax because the taxpayer takes a frivolous position or displays a desire to delay or interfere with the tax laws. This includes altering or striking out the pre-printed language above the space where the taxpayer signs. Under limited circumstances, the IRS may reduce the penalty from $5,000 to $500.
Failure to File Information Returns – A taxpayer who, without reasonable cause, fails to file a required information return in the manner the law specifies or by the proper deadline, fails to include all of the information required, or includes incorrect information will be subjected to a penalty of $280 for each return required to be filed during 2021 or 2022. The penalty will be reduced to $50 if the failure is corrected within 30 days of the due date and $110 if corrected by August 1.
Talk with your own tax pro if any of these penalties have been assessed against you, to see if it is possible to have them reduced or removed.
As always folks, don’t trust anything from the internet. These posts are meant to inform and educate, not to advocate for any position. Always reach out to your own tax preparer for your own advice.
The Art of Running a Successful Family Business: Breaking Things Down
At its core, a family business is exactly what it sounds like: a company or other enterprise owned, operated, and actively managed by at least two people from the same family. This can be a parent and their kids, two siblings, or some other configuration — it doesn't actually matter, as the management is made up of people with some type of similar close relation.
According to one recent study, family businesses make up between 80% and 90% of all business enterprises in North America. They contribute approximately 64% to the gross domestic product of this country, equaling roughly $5 trillion every year. Not only that, but they also comprise around 60% of the workforce — making their contribution every bit as significant as it is comprehensive.
Having said that, as is true with so many other types of businesses, simply beginning an enterprise with someone you trust isn't nearly enough to guarantee success. Family organizations often fail the same as others do, and if you truly want to make sure that yours gets off on the right foot, there are a few key things to keep in mind.
Building a Family Business: An Overview
By far, the biggest thing to understand about running a successful family business is that not every family member necessarily has a place in the proceedings.
Indeed, experts agree that this is one of the major traps that most new entrepreneurs, in particular, tend to fall into — a deeply-rooted obligation that kids or other relatives "need" to join the company. The issue is that while this is a kind gesture, it could also create a situation where people with authority aren't invested in being there.
For parents trying to bring their kids into the business, it's far more beneficial to create a situation where they feel free to join the organization should they so choose. It shouldn't feel like an obligation to them, as that will only cause problems later on.
Along the same lines, not every family member is necessarily qualified for this level of responsibility — a similar issue that causes problems from a different perspective. Experience still needs to be the driving force behind what role someone will be given in an organization if any. There's no sense in bringing someone with no experience into an industry and elevating them to a position of authority simply out of some sense of obligation that "there is always a place for you here." Doing so isn't just doing them a disservice — it also dramatically increases the chances that the business will ultimately fail.
Another major pitfall that many family businesses fall into is where the organization simply cannot grow fast enough to support everyone at the same time. If one were to start a business and immediately give their four kids management-level positions, especially in those early days, there might not be enough work to go around. There certainly may not be revenue to support those salaries, either.
Instead, all family businesses need to be created in a strategic way that allows them to grow and scale over time — only bringing new members into the fold when the time is right. And putting them into positions that play to their strengths and talents. As the organization gets larger, there may be enough revenue and work to support additional family members — and only then should new entries be considered.
Beyond that, there are several essential best practices to lean into that can help increase the chances of success for any family business. Communicating openly and often with all parties is critical, especially in making sure that everyone is always on the same page and moving in the right direction. Family members need to be kept abreast of major decisions regarding the company's trajectory and the reality of competitive challenges.
Similarly, it's always important to solidify the values of the family — and thus the business — as early on in this process as possible. Before you even begin to think about a direction for the business, consider how this path might impact the family. If everything is overwhelmingly successful, what will that look like? What does each participating family member see happening in five or even ten years — from their point of view and in the overarching sense of the company? What does the organization stand for, what entity is best for succession and taxes, who is it dedicating itself to serving, and does everyone agree on these things?
The answers to these questions need to impact many of the decisions that one will make moving forward. Exploring the holistic context that your business and family exist within, is extremely important, but almost universally overlooked.
In the end, if you're going to be starting a family business in a leadership position, you also need to respect everyone involved. Remember that just because they're relatives doesn't mean that they cannot bring fair value to the table. They're not there to simply take orders — they're there to offer a unique perspective that you might not have access to through other means. If one or more of your children don't want to join the family business, that's okay — but the qualified ones who do should be given the room they need to perform to the best of their abilities.
Sometimes that means allowing them to give their objective, third-party opinions — even when they don't necessarily align with your own. Sometimes it means them taking a role in the company that you didn't necessarily see for them, so long as it is one that they excel at.
Following these best practices means that you'll end up with something more effective than a traditional family business. You'll have a true legacy that has the potential to last several generations — which in and of itself is the most important benefit of all.
Feel free to reach out with any questions or concerns in running and managing your family business or farm.If your tax pro or bookkeeper isn’t open to these conversations, it’s time to find a new trusted partner. Finances don’t exist in a vacuum, and professionals and business owners need to adapt to the complicated landscape we live in.
As always folks, this post is educational and informational only. Don’t take advice from the internet. Ask your own tax pro or financial advisor for specific information about your situation.
Here’s What Happened in the World of Small Business in October 2021
Here are five things that happened this past month that affect your business.
1) Higher corporate rate appears to fall out of the economic package
Biden’s advisers said that they are pursuing a range of ideas that could still raise substantial sums of money from corporations and the rich, including a tax on billionaires’ assets
Full story via the Washington Post
https://www.washingtonpost.com/us-policy/2021/10/20/white-house-tax-plan/
Why this is important for your business:
It appears policymakers are going after increasing taxes on the super-rich versus many small business owners with their new proposals.
2) Returning to the office can be stressful for many team members. Make it easier by following these 5 tips.
The Covid-19 pandemic and the Delta variant have postponed many office rezonings. For many of your employees, the fear and delays have created added stress. A seasoned therapist shares her top five strategies for making the return to work as stress-free as possible.
Insight via CNBC
Why this is important for your business:
Businesses nationwide are struggling with retention and finding new hires. Make sure you take care of your current team first.
3) Pushback to proposed $600 bank reporting causes the new threshold to increase to $10,000 in annual deposits or withdrawals
The revised version of the bank reporting proposal will also weaken its scope by exempting all wage income from counting toward the $10,000 threshold withdrawal, intending to ensure it applies to only larger account holders.
Details via the Washington Post
https://www.washingtonpost.com/us-policy/2021/10/18/democrats-irs-bank-reporting/
Why this is important for your business:
A higher threshold would have made small business reporting more complicated.
4) Entrepreneur burnout is a real thing.
If your business is a startup or you're an independent consultant with a handful of clients, chances are you're burning the midnight oil binging on caffeine-laced drinks to stay alert and functional.
Here are three ways to avoid entrepreneur burnout from entrepreneur.com.
https://www.entrepreneur.com/article/386772
Why this is important for your business:
As entrepreneurs, we shouldn't want to "hustle harder." We should organize and automate the hustle.
5) Have you noticed? Cyber attacks are on the rise.
This is in part due to COVID-19 — hackers, wanting to take advantage of the chaos caused by the pandemic, growing digitalization, and the pivot to work-from-home, have stepped up their attack efforts over the past 18 months.
Tips to identify critical vulnerabilities from venture beat.
https://venturebeat.com/2021/10/15/cybersecurity-report-reveals-critical-business-vulnerabilities/
Why this is important for your business:
As attacks become more frequent, exploitable assets can become a serious liability for businesses.
As always folks, this post is educational and informational only. Don’t take advice from the internet. Ask your own tax pro or financial advisor for specific information about your situation.
How Understanding the ‘Rule of 72’ Helps You Make Personal Finance Decisions
Though everybody wants their money to grow, few people understand the best way to make that happen. It’s all about where you choose to put your money and the rate of growth you’re able to achieve over a period of time. When you’re trying to figure out how compound interest works, the “rule of 72” is one of the most helpful tools available.
What is the Rule of 72?
The Rule of 72 is a helpful, easy-to-understand formula that predicts how many years it takes money to double based on a specific rate of return. You can use it to make decisions about where to put your money based on how much time you have for it to grow and what your risk tolerance is. If your goal is to have twice as much when you finish as when you start, you can identify the interest rate you need based on how much time you have. All you need is the interest rate to complete the calculation, which is based on the following formula:
72 / interest rate = years to double
With this simple calculation, you can look at the interest rate offered by various savings tools or anticipated growth of investments and see exactly how long it will take for your money to double. Here’s how different rates of interest impact the time needed to double:
At 1%, it will take 72 years for your money to double (72 / 1 = 72)
At 3%, it will take 24 years for your money to double (72 / 3 = 24)
At 6%, it will take 12 years for your money to double (72 / 6 = 12)
At 9%, it will take 8 years for your money to double (72 / 9 = 8)
At 12%, it will take 6 years for your money to double (72 / 12 = 6)
This list provides as clear a picture as anybody could possibly need of the difference between parking your money in a super-safe, standard savings account that pays 0.09%, and investing in a riskier investment such as the stock market, where the average annualized total return for the S&P 500 index has been just shy of 10% over the last 90 years. It’s a 790-year difference when it comes to doubling!
The same formula can be very useful when it comes to taking out loans. Whether you are looking for a new car, a mortgage for a home purchase, or paying interest on your credit card, if you divide 72 by your interest rate, you’ll see exactly how fast the lender (or credit card company) is doubling the money that you’re paying them. It’s a helpful guide to steering clear of usury rates by loan shopping and understanding the advantages of refinancing.
As straightforward as the Rule of 72 is, getting your personal finances in order can be a complicated task. For help with navigating complex decisions, contact our office today to set up a time to discuss your specific needs and goals. We can’t offer you financial advice, our focus is tax prep, but we can tell you how it might affect your taxes and connect you with a trusted partner like a local banker and financial advisor in our network to help you get started taking control of your finances. We succeed when our clients succeed and we’re happy to help you find trusted advisers.
As always folks, this post is educational and informational only. Don’t take advice from the internet. Ask your own tax pro or financial advisor for specific information about your situation.
Should You Get an IRS Identity Protection PIN?
October was data protection month! How can you protect your tax return from fraud?
An Identity Protection PIN (IP PIN) is a six-digit number assigned to eligible taxpayers by the IRS to help prevent the misuse of their Social Security number by ID thieves to file fraudulent federal income tax returns. The IP PIN aids IRS in verifying a taxpayer's identity and accepting only valid returns via electronic filing or paper-filed returns.
For many years, IP PINs were only available to taxpayers with certain specific circumstances, who were residents of certain states, had their identity stolen and who had someone file a tax return using their Social Security number.
In January 2021, the IRS expanded the IP PIN program to all taxpayers who wished to participate in this ID protection program and who can verify their identity. This is especially important for taxpayers who believe their ID has been compromised but is available to all taxpayers as protection if their IDs were to be compromised or believed to have been compromised. Even if a thief already filed a fraudulent return, an IP PIN would still offer protections for later years and prevent taxpayers from being repeat victims of tax-related identity theft.
For security reasons only the taxpayer can apply for an IP PIN; a tax professional can’t provide this service for their client. An IP PIN can be obtained online by using the IRS’ Get an Identity Protection PIN (IP PIN). If you want to request an IP PIN, please be aware that to do so you will need to pass a rigorous identity verification process. If you can’t successfully validate your identity through the Get an IP PIN tool, there are a couple of alternatives. If your adjusted gross income is less than $72,000, you can complete and submit to IRS Form 15227, Application for an Identify Protection Personal Identification Number, to request an IP PIN. Another option if you don’t qualify to apply using Form 15227, is to request an in-person appointment at an IRS Taxpayer Assistance Center. You can find details on these alternative ways of requesting an IP PIN by using the link above. Both the application and appointment methods take longer for the IRS to assign an IP PIN to you than if you apply online.
There are some additional things you should know about an IP PIN:
• This six-digit number is known only to the taxpayer and the IRS.
• Participating in the program is voluntary.
• The IP PIN is used in addition to the Social Security number.
• There is a special place to enter the IP PIN on page 2 of the 1040 near the signature block.
• The IP PIN is valid for one calendar year.
• For security reasons, enrolled participants get a new IP PIN each year.
• Spouses and dependents are eligible for an IP PIN if they can verify their identities.
• IP PIN users should never share their number with anyone but the IRS and their trusted tax preparation provider.
• The IRS will never call, email, or text a request for the IP PIN. Only scammers will do that.
Currently, taxpayers can get an IP PIN for 2021, which should be used when filing any federal tax returns during the rest of the year, including prior year returns. New IP PINs will be available starting in January 2022.
Do we think everyone should get an IP PIN? No, it’s not necessary for everyone and some people may not be able to pass the identity check. One easy way to combat identity theft and ensure your account is safe is to file a return each year, regardless of if you have a filing requirement. This will let you know if there is a return filed under your name already, and prevent anyone from filing as you after your file date.
You can check out the IRS Identity Theft Central Page here for more info on all things Identity Theft.
As always, don’t trust internet advice. Always use the blog as education and news and speak to your own tax preparer about your own situation!
The Ins and Outs of Bookkeeping: All the Best Practices to Get the Best Financial Outcome From Your Organization
If you had to make a list of some of the most critical elements of running a business that most new entrepreneurs don't think enough about until it's far too late, bookkeeping would undoubtedly be right at the top.
On a surface level, bookkeeping is simply the process of keeping accurate, thorough records of the financial affairs of any business. But once you begin to dive deeper, you see that it's about so much more than that.
It's what allows you to maintain a proper cash flow — something that has long been a major pain point for any organization. It's what allows you to make more accurate and informed decisions regarding growth. More than anything, it's what allows you to start making a plan for the future, which in and of itself is the most important benefit of all.
Handling bookkeeping on your own can quickly become a full-time job, which is a bit of an issue since you already have one of those on your plate. But by keeping a few key things in mind, you can enjoy all the benefits of this process with as few of the potential downsides as possible.
The Art of Business Bookkeeping: Breaking Things Down
When it comes to small business bookkeeping, it's critical to understand what you should be doing and, most importantly, when. The financial health of your organization has both short- and long-term ramifications, and the only way to control your own trajectory is to make a list of what you should be doing and why.
On a weekly basis, for example, you'll want to pay close attention to things like your cash flow statement and variable expenses. Cash flow is exactly what it sounds like — the money coming into and out of your business. If you're not paying attention to this, you might not realize that you don't have nearly as much money coming in as you think. This is especially true if you're waiting on client invoices to get paid but have no real idea of when they were sent or when they're due.
You cannot assume that just because your revenue says one thing, you have an equal cash reserve sitting there waiting to be taken advantage of. Especially in the situation with client invoices outlined previously, that isn't always the case. If there is a sudden business opportunity that you're trying to take advantage of or if you need to pay for an urgent expense like a new piece of equipment or machinery, this is not the time to find out that your accounts don't have as much in them as you assumed they did.
Therefore, you need to have a constant idea of how much cash you have on hand, along with the amount of money required to manage critical aspects of your business.
Variable expenses are a related concept, which themselves are defined as those expenses that don't have a fixed monthly or annual rate. If you took out a loan to start your business, it's likely that you have a set, predictable monthly payment. Unless you miss a payment and get hit with some type of penalty, that number isn't going to change.
Marketing, however, is something that changes all the time — particularly if you're experimenting with all the different types of campaigns that you could run. If you've invested in digital advertising on sites like Google, you're probably not going to hit upon the perfect campaign right away. You'll need to run tests to see what works and what doesn't, which will ultimately impact the amount of money you'll pay. If you move into the world of print advertising and run newspaper ads or design fliers, this too will come with an entirely different set of costs.
As a result of this, you need to make sure you understand what your variable expenses are at any given time. Only then will you be able to make the smartest and most informed decisions at the moment.
Additional Considerations About Bookkeeping
Likewise, there are a variety of important bookkeeping-related tasks that you'll want to perform on at least a monthly basis, too.
One of these involves getting a business snapshot — something that gives you a clear, concise idea of where you currently stand and the impacts of the decisions you've made over the past 30 days. A business snapshot will not only give you insight into things like your cash flow, but you'll also get to see sales, expenses, income, and more.
The key thing to understand is that these snapshots actually become more valuable as time goes on. You can compare the last several monthly snapshots to uncover trends and patterns that you may have otherwise missed. This, too, gives you insight into what you can do to improve your operations.
On a monthly basis, you should also make an effort to stay up-to-date on what all your expenses actually are. Yes, there are certain “costs of doing business” that you'll never be able to totally eliminate. But if you take the time at least regularly to look at where your money is going, you put yourself in a better position to find room for improvement.
Case in point: Maybe that investment you made a few months ago isn't paying off nearly as well as you'd hoped. Unless you look at and understand exactly what you're spending, you're not necessarily going to realize that. Armed with this information, you can eliminate these types of expenses and free up valuable cash so that you can funnel it back into other areas of the business where it can do the most good.
Finally, when it comes to a topic as important as bookkeeping, it's important to acknowledge your own limitations. Especially as far as things like taxes are concerned, the stakes of “getting this one wrong” are simply far too high to go at it yourself.
You're a business owner, and while it's absolutely fair to say that your “can-do spirit” has already gotten you quite far, if you're not comfortable handling bookkeeping yourself, you shouldn't feel obligated to do so. Enlisting the help of a trained, experienced professional can immediately help you paint a clear picture of where your business currently stands from a financial perspective and where it might be headed, too. They'll use bookkeeping software that, when combined with their own insight, can help make it far easier to accomplish all the tasks outlined above and more.
A financial professional can step in and make sure that you have a solid foundation from which to build from, all while freeing up as much of your time as possible to focus on those tasks that actually require your full attention.
If you'd like to find out more information about all the best practices that you can use to get the most out of your business, or if you just have any additional questions you'd like to go over with someone in a bit more detail, please don't delay — contact our office today.
As always folks, this post is educational and informational only. Don’t take advice from the internet. Ask your own tax pro or financial advisor for specific information about your situation.
Education Credits are for Children? Think Again!
If you think that education credits are just for sending your children to college, think again—the credits are available to you, your spouse (if you are married), and your dependents. Even if you or your spouse is only attending school part-time, you still may qualify for a tax credit.
There are two education-related credits available: the American Opportunity Tax Credit (AOTC) and the Lifetime Learning Credit (LLC). For either credit, the student must be enrolled in an eligible educational institution for at least one academic period (semester, trimester, or quarter) during the year. An eligible educational institution is any accredited public, nonprofit, or proprietary post-secondary institution that can participate in the U.S. Department of Education’s student aid programs.
The credits phase out for higher-income taxpayers who are married filing jointly or who are unmarried. Those who are married filing separately do not qualify for either credit. The following table provides the qualifications and details for both credits:
*Generally, credits are non-refundable, meaning that they can only be used to offset your tax liability; any amount exceeding your current-year tax liability is lost. However, unlike other credits, the AOTC is partially refundable in most cases.
Many individuals who both work and attend school can be enrolled less than half-time and still qualify for the LLC.
Another interesting twist to education credits is that the taxpayer who qualifies for and claims the student’s exemption for the year gets the credit—even if someone else pays the expenses. Thus, for example, even if a noncustodial parent pays a child’s college expenses, the custodial parent gets the credit if he or she is otherwise qualified. The same applies when grandparents help pay for their grandchild’s education: the grandparents do not qualify for the credit unless they, and not the child’s parents, claim the student as a dependent.
Generally, the educational institution sends a Form 1098-T to the taxpayer (or dependent). This includes the information necessary to complete the IRS form and claim the credit. Sometimes the 1098-T needs to be retrieved online from the educational institution. The law requires the taxpayer to have this 1098-T in hand to claim either of the credits, but credit can be claimed for other qualified expenses.
The qualifying expenses for the AOTC and LLC differ in many cases. See the table below for which expenses qualify for the credits.
These credits can be complicated. Take the time now, before year end to assess your situation and get in touch with your student and tax pro to make sure you get the correct credits.
Fall Tax Planning May Be Wise
Ok, this one’s a long one again folks. But you know the deal. TLDR: Year end planning is a MUST for most of you. Don’t procrastinate! We will be out of the office at the end of December for Christmas break. And your business and financial health doesn’t appreciate being rushed at year end. Give it the time and attention it needs. Click here to schedule your appointment now.
Taxes are like vehicles in that they sometimes need a periodic check-up to make sure they are performing as expected, and if ignored, can cost you money. That is true of taxes as well, especially for 2021, things have been off kilter for most of us and you may have let your finances slide with all the stress and strangeness.
At this time, Biden’s tax plan is NOT in place, has not been passed and will still be subject to plenty of changes. So we are not going to write this post out of fear or hyperbole of some plan that doesn’t exist yet. It’s also subject to plenty of horse trading before it passes, anything we could say at this time will surely be out of date by the time you read this anyway.
The following is a list of potential tax strategies that you might benefit from. Every taxpayer’s situation is unique, and not all the tax strategies suggested here will apply to you. However, opportunities for tax planning are available for all income levels and a variety of tax circumstances, some of which may apply to your situation. But waiting too late in the year may not give you the time needed to take advantage of some of these strategies.
Maximize Education Tax Credits - If you qualify for either the American Opportunity Tax Credit (AOTC) or Lifetime Learning Credit (LLC), check to see how much you have already paid for qualified tuition and related expenses during the year. If it is not the maximum allowed for computing the credits, you can prepay 2022 tuition if it is for an academic period beginning in the first three months of 2022 and use the expense for the 2021 credit.
Employer Health Flexible Spending Accounts - If you contributed too little to cover expenses this year, you may wish to increase the amount you set aside for next year. As a reminder, amounts paid after 2019 for over-the-counter medicine (whether or not prescribed) and menstrual care products are considered medical care and are considered a covered expense. The maximum contribution for 2021 is $2,750.
Maximize Health Savings Account Contributions - If you become eligible to make health savings account (HSA) contributions late this year, you can make a full year’s worth of deductible HSA contributions, even if you were not eligible to make HSA contributions for the entire year. This opportunity applies even if you first become eligible in December. In brief, if you qualify for an HSA, contributions to the account are deductible, or nontaxable if made by your employer (within IRS-prescribed limits); earnings on the account are tax-deferred; and distributions are tax-free if made for qualifying medical expenses. Amounts paid after 2019 for over-the-counter medicine (whether or not prescribed) and menstrual care products are considered medical care and are considered a covered expense. However, only medical expenses you incur after you establish an HSA are eligible for tax-free distribution. It is possible for an HSA to become a supplemental retirement plan if the funds are left to accumulate.
Convert Traditional IRAs to Roth IRAs - If your income is unusually low this year or even negative, you may wish to consider converting your traditional IRA to the more favorable Roth IRA which provides tax free accumulation, and the distributions are tax-free at retirement. The lower income results in a lower tax rate, which provides you an opportunity to convert to a Roth IRA at a lower tax amount.
Don’t Forget Your 2021 Minimum Required Distributions - If you are age 72 or older, you must take required minimum distributions (RMDs) from your IRA, 401(k) plan, and other employer-sponsored retirement plans (but if you are still working, distributions from your current employer’s plan can be postponed in some circumstances). Failure to take a required withdrawal can result in a 50% penalty of the amount of the RMD not withdrawn. If you turned 72 in 2021, you could delay the first required distribution to the first quarter of 2022, but if you do, you will have to take a double distribution in 2022, the one for 2021 and the 2022 RMD. One needs to carefully consider the tax impact of a double distribution in 2022 versus a distribution in both this year and next.
Bunching Deductions - If your tax deductions normally fall short of needing to itemize and the standard deduction you are allowed is greater, or even if you can itemize but only marginally, you may benefit from adopting the “bunching” strategy. To be more proactive, you can time the payments of tax-deductible items to maximize your itemized deductions in one year and take the standard deduction in the next.
Take Advantage of the Zero Capital Gains Rate - There is a zero long-term capital gains rate for those taxpayers whose taxable income is below the 15% capital gains tax threshold. This may allow you to sell some appreciated securities that you have owned for more than a year and pay no or very little tax on the gain.
Defer Deductions – When you itemize your deductions, you may claim only the deductions you paid during the tax year (the calendar year for most folks). If your projected taxable income is going to be negative and you are planning on itemizing your deductions, you might consider putting off some of those year-end deductible payments until after the first of the year and preserving the deductions for next year. Such payments might include house of worship tithing, year-end charitable giving, tax payments (but not those incurring late payment penalties), estimated state income tax payments, medical expenses, etc.
Increase IRA Distributions – Depending upon your projected taxable income, you might consider taking an IRA distribution to add income for the year. For instance, if the projected taxable income is negative, you can take a withdrawal of up to the negative amount without incurring any income tax. Even if projected taxable income is not negative and your normal taxable income would put you in the 24% or higher bracket, you might want to take out just enough to be taxed at the 10% or even the 12% tax rates. Of course, those are retirement dollars; consider moving them into a regular financial account set aside for your retirement. Also be aware that distributions before age 59½ are subject to a 10% early withdrawal penalty.
Defer Capital Gains by Investing in an Opportunity Zone Fund - A unique tax benefit is the ability to defer any capital gain into a qualified opportunity fund (QOF). QOFs are funds that invest in areas in need of development. If you have a capital gain from selling property to an unrelated party, you may elect to defer that gain by investing it into a QOF within 180 days of the sale or exchange. The gain won’t be recognized (i.e., you won’t be taxed on the gain) until your return for the earlier of the year of sale of the QOF or 2026. You can get up to 10% of the deferred gain forgiven entirely by holding the investment for the required time period, and you will pay no tax on any additional gain if the investment is held for 10 years.
Sell Loser Stocks – Although the stock market has been performing well recently you still may have stocks that have declined in value. If you sell them before the end of the year you can use any losses to offset other gains for the year or produce a deductible loss. The net capital loss deductible on a tax return is limited to $3,000 ($1,500 if filing married separate) for the year, but any excess loss carries over to future years. You can repurchase stock in the same company for which you sold shares at a loss after 30 days have passed and avoid the wash sale rules.
Take Steps to Avoid Underpayment Penalties - If you are going to owe taxes for 2021, you can take steps before year-end to avoid or minimize the underpayment penalty. The penalty is applied quarterly, so making a fourth quarter estimated payment only reduces the fourth-quarter penalty. However, withholding is treated as paid ratably throughout the year, so increasing withholding at the end of the year can reduce the penalties for the earlier quarters. This can be accomplished with cooperative employers or by taking a non-qualified distribution from a pension plan, which will be subject to a 20% withholding, and then returning the gross amount of the distribution to the plan within the 60-day statutory rollover limit. Please consult this office to determine if you will be subject to underpayment penalties (there are exceptions) and, if so, the best strategy to avoid or minimize them.
Prepay State and Local Taxes - You probably know that if you are not subject to the alternative minimum tax and you itemize your deductions, you are eligible to deduct both your property taxes and your state income tax. But did you know that you can increase the amount that you deduct on your 2021 tax return by prepaying some taxes? You can ask your employer to boost your state withholding by a reasonable amount or, if you are self-employed, pay your 4th-quarter state estimate due in January in December and increase your deduction. The same is true for your real estate taxes: if you pay your first 2022 installment in 2021, you can take it as part of your 2021 deduction.
But be careful, the state and local tax deduction for any year is limited to a maximum of $10,000, so any amount more than $10,000 would be wasted as a tax deduction.
Don’t Waste the 2021 Annual Gift Tax Exemption – You can give $15,000 each to an unlimited number of individuals in 2021, but you can't carry over unused exclusions from one year to the next. Taxpayers and their spouses can use their gift tax exemptions together to give up to $30,000 per beneficiary. For example, if you are married, have four children and four grandchildren, you can remove $240,000 from your estate tax-free this year. The transfers also may save family income taxes when income-earning property is given to family members who are in the lower income tax brackets and are not subject to the kiddie tax.
Not Needing to File May Be an Opportunity - If your income and tax situation is such that you do not need to file for 2021, don’t overlook the opportunity to bring in some additional income, to the extent it will be tax-free. For instance, if you have appreciated stock that you can sell without incurring any tax, consider selling it, or perhaps take a tax-free IRA distribution if you are 59½ or older or if younger and qualify for an exception to the “early withdrawal” penalty.
Utilize IRA-to-Charity Transfers – If you are age 70½ or over, you can request that your IRA trustee directly transfer funds from your IRA to a charity. Although not deductible as an itemized charitable deduction, the distribution is not taxable. If you are age 72 or over when the IRA to charity direct transfer is made, the distribution can count towards your required minimum distribution for the year. This also reduces your AGI, which in some circumstances can reduce the amount of taxable Social Security income. There is no minimum charitable distribution, but the maximum amount per individual is limited to $100,000 per year. There are some complications if you are age 72 or older, have earned income and make a contribution to the IRA. Check with our office for the details.
Maximize Tax-Deductible Medical Expenses - For example, if you have outstanding medical or dental bills, paying the balance before year-end may be beneficial, but only if you already meet the 7.5% of the AGI floor for deducting medical expenses, or if adding the payments would put you over the 7.5% threshold and you are itemizing your deductions. You can even use a credit card to pay the expenses, but you would only want to do so if the interest expenses you’d incur if you don’t pay off the card right away would be less than the tax savings.
Make Business Purchases - You can reduce taxable income if you make last-minute business purchases such as for office equipment, tools, machinery, and vehicles and write them off using the 100% bonus depreciation or Sec. 179 expensing, provided you place the item(s) into business service by the end of the year. However, you must consider the impact that expensing the items will have on your taxable income and the Sec. 199A 20% pass-through deduction. It may be appropriate to contact this office in advance of any last-minute business acquisition.
Divorced or Separated During the Year – A divorce or separation can have a significant impact on a couple’s tax filings. Filing joint or separate returns, who claims the children, the tax rules related to whether to take the standard deduction or itemize, how income and tax prepayments are allocated, and more are issues to be considered. Best to figure that all out in advance.
Disaster Loss Planning – 2021 has had some significant declared disasters including Hurricane Ida and the wildfires in the West and our mega drought here at home. Any losses incurred because of a federally declared disaster can be claimed on the current year’s tax return or, at the election of the taxpayer, on the prior year’s return (2020 for 2021 disasters), generally providing quicker access to a tax refund. However, care must be exercised to ensure a disaster loss is claimed on the return of the year that will provide the greatest benefit. In addition, after insurance reimbursement is accounted for, the result may not be as expected and should be determined before making the decision of which year to claim a loss.
Increased Charitable Giving Opportunities – 2021 is the final year that the normal 60% of AGI limit on cash contributions has been increased to 100%, giving those with the means and the desire to increase their normal charitable contributions and deduct them as an itemized deduction. The normal 5-year carryover applies to any excess over 100% of AGI.
Those who don’t itemize (currently about 90% of income tax return filers), are allowed to claim a deduction of up to $300 ($600 on a joint return) for cash charitable contributions made in 2021. Normally, only itemizers can deduct their charitable contributions.
Take Advantage of Energy Credits – Two of the major green credits are the solar tax credit and the electric vehicle credit. The solar credit for 2021 is 26% of the cost of the installed solar system but the system must be complete and functional before year’s end to claim the credit in 2021. The credit is not refundable, and any excess has a limited carryover. The credit for electric vehicles must be determined from the IRS website since credit begins to phase out once 200,000 of the vehicle type by manufacturer has been sold.
If you have obtained your medical insurance through a government marketplace, employing some of the strategies mentioned could impact the amount of your allowable premium tax credit.
Residents of states that have an income tax will also need to consider the impact of some of these strategies on their state return.
As you can see, tax planning is complex and involves a variety of strategies, you must talk to your own tax pro about how tax planning may work for you. If you would like to discuss how these strategies and others not included in this article might provide you tax benefits based upon your tax circumstances, or would like to schedule a tax planning appointment, please give the office a call.
As always folks, this post is educational and informational only. Don’t take advice from the internet. Ask your own tax pro or financial advisor for specific information about your situation.
How Long Should You Keep Old Tax Reports?
This is a common question: How long must taxpayers keep copies of their income tax returns and supporting documents?
Generally, individuals should hold on to their income tax records for at least 3 years after the due date of the return to which those records apply. However, if the original return was filed later than the due date, including if the taxpayer received an extension, the actual filing date is substituted for the due date. A few other circumstances can require taxpayers to keep these records for longer than 3 years.
The statute of limitations in many states is 1 year longer than in the federal statute. This is because the IRS provides state tax authorities with federal audit results. The extra year gives the states adequate time to assess taxes based on any federal tax adjustments.
In addition to the potential confusion caused by the state statutes, the federal 3-year rule has a number of exceptions that cloud the recordkeeping issue:
The assessment period is extended to 6 years if a taxpayer omits more than 25% of his or her gross income on a tax return.
The IRS can assess additional taxes without regard to time limits if a taxpayer (a) doesn’t file a return, (b) files a false or fraudulent return to evade taxation, or (c) deliberately tries to evade tax in any other manner.
The IRS has unlimited time to assess additional tax when a taxpayer files an unsigned return.
If none of these exceptions apply to you, then for federal purposes, you can probably discard most of your tax records that are more than 3 years old; however, you may need to add a year or more if you live in a state with a statute of longer duration.
Examples: Susan filed her 2018 tax return before the due date of April 15, 2019. She will be able to safely dispose of most of her tax records after April 15, 2022. On the other hand, Don filed his 2018 return on June 1, 2019. He needs to keep his records at least until June 1,2022. In both cases, the taxpayers should keep their records a year or more beyond those dates if their states have statutes of limitations that are longer than 3 years.
Important note: Although you can discard backup records, do not throw away the copies of any filed tax returns or W-2s. Often, these returns provide data that can be used in future tax-return calculations or to prove the amounts of property transactions, Social Security benefits, and so on. You should also keep certain records for longer than 3 years:
Stock acquisition data. If you own stock in a corporation, keep the purchase records for at least 4 years after selling the stock. The purchase data is needed to prove the amount of profit (or loss) that you had on the sale.
Statements for stocks and mutual funds with reinvested dividends. Many taxpayers use the dividends that they receive from a stock or mutual fund to buy more shares of the same stock or fund. These reinvested amounts add to the basis of the property and reduce the gain when it is eventually sold. Keep these statements for at least 4 years after final sale.
Tangible property purchase and improvement records. Keep records of home, investment, rental-property or business-property acquisitions, as well as all related capital improvements, for at least 4 years after the underlying property is sold.
Sales that create loss carryovers. If you sell stock, mutual funds or investment property at a loss, and your total capital loss for the sale year isn’t fully absorbed by capital gains plus $3,000, the excess loss may be carried forward to be used on the next year’s return and even beyond, depending on the amount of the loss. The IRS could require proof of the original loss if a carry forward year’s return is audited, even many years after the original loss year. So, not only should you keep the return copies to account for the use of the carryforward loss, you should also retain the records to substantiate the original loss until the carryover amount is fully used up, and for at least 4 years after the last year for which a loss is deducted.
Tax return copies from prior years are also useful for the following:
Verifying Income. Lenders require copies of past tax returns on loan applications.
Validate Identity. Taxpayers who use tax-filing software products for the first time may need to provide their adjusted gross incomes from prior years’ tax returns to verify their identities.
The IRS Can Provide Copies of Prior-Year Returns - Taxpayers who have misplaced a copy of a prior year’s return can order a tax transcript from the IRS. This transcript summarizes the return information and includes AGI. This service is free and is available for the most current tax year once the IRS has processed the return. These transcripts are also available for the past 6 years’ returns. When ordering a transcript, always plan ahead, as online and phone orders typically take 5 to 10 days to fulfill. Mail orders of transcripts can take 30 days (75 days for full tax returns). There are three ways to order a transcript:
· Online Using Get Transcript. Use Get Transcript Online on IRS.gov to view, print or download a copy for any of the transcript types. Users must authenticate their identities using the Secure Access process. Taxpayers who are unable to register or who prefer not to use Get Transcript Online may use Get Transcript by Mail to order a tax return or account transcript.
· By phone. The number is 800-908-9946.
· By mail. Taxpayers can complete and send either Form 4506-T or Form 4506T-EZ to the IRS to receive a transcript by mail.
Those who need an actual copy of a tax return can get one for the current tax year and for as far back as 6 years. The fee is $43 per copy (the fee is subject to change, so verify it on the current form). Complete Form 4506 to request a copy of a tax return and mail that form to the appropriate IRS office (which is listed on the form).
If you have questions about which records you should retain and which ones you can dispose of, please give us an email.
Remember folks, never take advice from strangers on the internet! Always talk to your own tax preparer about your specific situation. These posts are meant to educate and inform, and aren't to be taken as actionable advice.
Child Tax Credit Loss
As your children grow older, you can easily be surprised by a larger tax bill. To help ease the possible burden, consider these tax implications as your dependent children age.
A higher tax bill in your future
At age 6: Loss of excess Child Tax Credit. In 2021, the Child Tax Credit is $3,600 for children under the age of 6. This is an extra $600 that will go away after your child ages out of the benefit. Even more important, this benefit is currently scheduled to disappear after 2021.
At age 13: loss of your Dependent Care Credit. If your children are in daycare and you offset some of this cost with the Dependent Care Credit you will lose this benefit when they reach age 13. The impact: a 50% credit against up to $16,000 in qualified daycare expenses in 2021. The good news here is that your children may no longer need the care as they get older.
At age 17 or 18: loss of the Child Tax Credit. While children under the age of 6 get an extra $600, after the age of 17 the balance of this credit goes away. This could amount to a tax bill increase of $2,000 to $3,000 per child, depending on your income. But stay tuned, Congress is actively looking to change this tax benefit.
At age 19 (24 if a full-time student): loss of the Earned Income Tax Credit (EITC). The EITC pays a potential credit worth up to $6,728 for people with three or more qualifying children. Children stop being counted when they turn 19, or when they are 24 if they are full-time students.
What to do
Many of the child-related credits and deductions are meant to offset the cost of raising a child. Prepare now for the inevitable change in your tax situation that occurs when they go away. Here are some ideas:
Know the age triggers. Note the tax years that these changes will occur. If a child is approaching one of these key years, adjust your spending to save a little more during the year to account for the change.
Revise your withholdings. At the beginning of each key year, look at adjusting your withholdings on your paycheck to ease the potential tax burden.
Conduct a tax forecast. Understand what the true impact of the change might be. You may find the tax hit less of a burden than you think. If you need help planning ahead, don’t hesitate to call.
Remember folks, never take advice from strangers on the internet! Always talk to your own tax preparer about your specific situation. These posts are meant to educate and inform, and aren't to be taken as actionable advice.