Author Archives: support33

Could a Tax Torpedo Hit You?

If you’re retiring soon and will be receiving Social Security benefits, or are already retired, you might be hit with an unexpected tax whammy when you file your personal tax return.

Watch out for the “tax torpedo.” This is the name given to the increase in our top marginal tax rate under the complex calculation for Social Security benefits.

Frequently, the tax torpedo affects retirees who must take required minimum distributions (RMDs) from their qualified plans, like 401 (k) plans and IRAs.

The tax you owe on Social Security benefits depends on the amount of your “provisional income” (PI) for the year. PI is the total of your adjusted gross income (AGI), tax-exempt interest income and one-half of the Social Security benefits received. For example, if your AGI is $80,000 and you collect $12,000 in tax-free municipal bond interest and $16,000 in Social Security benefits, your PI is $100,000 ($80,000 plus $12,000 plus $8,000).

There are two tiers for taxing Social Security benefits.

Tier #1: If your PI is between $32,000 and $44,000 ($25,000 and $34,000 for single filers), you must pay tax on the lesser of one-half of your Social Security benefits or 50% of the amount by which your PI exceeds $32,000 ($25,000 for single filers).

Tier #2: If your PI is absolve $44,000 ($34,000 for single filers), you must include in taxable income 85% of the amount by which PI exceeds $44,000 ($34,000 for single filers) plus the lesser of the amount determined under the first tier or $6,000 ($4,500 for single filers). Caveat: In no event can more than 85% of your benefits be taxed. The aforementioned thresholds aren’t indexed for inflation, so you must cope with these relatively low thresholds year after year. And, if that wasn’t bad enough, here’s another problem: You’re the prime target of the tax torpedo once you start taking RMDs from qualified plans and IRAs. Generally, you must begin taking RMDs after age 70 ½ .

Example: For simplicity, let’s say you’re a single filer who is normally in the 22% tax and you are required to withdraw a $1,000 RMD for the 2020 tax year. First, the tax on the RMD is $220, but the $1,000 addition to PI can cause up to an extra $850 of your Social Security benefits to be subject to tax.

As a result, the effective incremental federal income tax on your $1,000 RMD is $407 (22% of $1,850). So, the tax torpedo increases your marginal tax rate from 22% to 40.7% – almost double. How can you fend off the tax torpedo?

  • Assess your current exposure. Determine if the tax torpedo could blow up your tax return.
  • Look ahead. Before you start taking RMDs, you might convert a traditional IRA to a Roth where future payouts are tax free five years after the conversion. In the same vein, you might arrange other no-tax or low-tax payouts.
  • Consider your Social Security status. The tax torpedo is a key factor in determining when to begin receiving benefits, but it’s not the only one.

Tip: Meet with your tax professional to determine the best approach for your situation.

Small Business Tax Strategies
July 2021

Seize 5 New Tax Law Breaks

The new American Rescue Plan (ARP) Act provides more pandemic relief to beleaguered taxpayers.

Below are five tax moves for individuals under the new law.

  1. Collect economic stimulus payments. Previously, Congress authorized payments of up to $1,200 and then $600 per person. On this go-round, the payments are larger, but the dollar amount is phased out at lower income levels. For single filers, the $1,400 payment phases out between $75,000 and $80,000 of adjusted gross income (AGI). The phase-out range for joint filers is between $150,000 and $160,000. In comparison, for the last round of payments, the upper thresholds were $100,000 and $200,000 respectively. The ARP Act also provides a $1,400 payment per dependent, including adult dependents like a child in college or an elderly relative.   If you don’t receive the full amount you’re entitled to, you can claim a credit on your tax return.
  2. Salvage unemployment benefits. The new law extends unemployment benefits for eligible workers with a tax kicker. The final version of the law extends weekly benefits of $300 through September 6. Those benefits were set to run out between March 14 and April 11. More good news, the first $10,200 of unemployment benefits received in 2020 is exempted from federal income tax for folks with a household income under $150,000. Normally, benefits are fully taxable.
  3. Boost child tax credit. The new law enhances the Child Tax Credit (CTC) for 2021. Currently, the CTC is available for children under age 17. The maximum credit, subject to a phase-out beginning at $200,000 of adjusted gross income (AGI) for single filers and $400,000 for joint filers, is $2,000. Of this amount, up to $1,400 is refundable. Under the new law, the CTC for 2021 is increased to $3,600 for each child under age six and $3,000 for each child who is at least age 17. Plus, the entire amount is refundable. But the phase-out begins at $75,000 of AGI for single filers and $150,000 for joint filers.
  4. Raise dependent care credits. Currently, a couple with an AGI above $43,000 who pay qualified childcare expenses can claim a maximum credit of up to $600 for one child; $1,200 for two or more children. Lower income taxpayers are entitled to a higher credit. The ARP Act increases the maximum credit for many families to $4,000 for one child; $8,000 for two or more children. This higher credit would be fully available to households with an AGI of up to $125,000. However, the maximum credit would be further reduced for a family with an AGI of more than $400,000. These changes are effective only for the 2021 tax year.
  5. Reward student loan forgiveness. Generally, forgiveness or cancellation of a loan results in taxable income to the debtor. But prior legislation carved out tax exemptions for student loan forgiveness in certain situations. Now the new law opens for floodgates. No tax may be imposed on forgiveness of both public and private student loans made from 2021 through 2025.

Small Business Tax Strategies
July 2021

New Child Tax Credit

Here is some information on the new advance monthly payments of the child tax credit. It requires the IRS to make advance payments of the credit each month to qualifying families. The advance payments will account for half of a family’s 2021 child tax credit. The IRS will issue these monthly payments to eligible families on July 15, Aug. 13, Sept. 15, Oct. 15, Nov. 15 and Dec. 15.

The IRS will base eligibility for the payments on 2020 or 2019 returns. The agency has started sending letters to more than 36 million families that it believes are eligible for the advance child credit payment. The letters are generally for informational purposes. The IRS plans to send a second round of letters this summer, and that latter mailing list the family’s estimated monthly payment. Want to opt out of monthly payments? The IRS has an online tool for this. You will need a photo ID to use the Service’s Child  Tax Credit Update Portal. See for FAQ and other details on the child credit.

Taxpayers who generally don’t file returns can get child credit payments. But they’ll have to first jump through some hoops. The IRS has options for those not required to file a return for 2019 or 2020 because their income was below the filing threshold. It has an online tool called the Non-Filer Sign-Up Tool, which it hopes most non filers will use. Alternatively, the agency issued procedures for filing simplified returns for 2020. Note that people who used the IRS’s online tool for nonfilers in 2020 to provide information to the IRS for the purpose of qualifying for stimulus payments don’t have to do anything because the IRS already has their data.

Small Business Tax Strategies

July 2021

Learn the Ins and Outs of Education Credits

The Consolidated Appropriations Act (CAA) eases things for some parents of college students.

The CAA repeals the tuition-and-fees deduction once and for all. So you no longer have to choose between the deduction and a higher education tax credit.

However, as under prior law, you can only claim one of the two education credits for a particular student. And another CAA change complicates matters.

Prior to 2021, you could deduct tuition-and-fee expenses, subject to a phase-out, in lieu of a higher education credit. The deduction had expired and been reinstated numerous times. Now the CAA repeals the deduction for 2021 and beyond.

But you still must decide between claiming the American Opportunity Tax Credit (AOTC) and the Lifetime Learning Credit (LLC) for qualified higher education expenses.

  1. AOTC. The maximum annual credit of $2,500 is available for up to four ears of undergraduate study for every eligible student in the family. For example, if you have two kids in college, the maximum credit is doubled to $5,00. However, the AOTC is phased out between $80,000 and $90,000 of modified adjusted gross income (MAGI) for single filers and $160,000 and $180,000 for joint filers. (These phase-out ranges are not indexed for inflation.)
  2. LLC. The maximum credit is $2,000 compared to $2,500 for the AOTC. Also, unlike the AOTC, the LLC credit is a one-per-taxpayer deal. So, if you have two children in school this year, the maximum credit is $2,000. On the plus side, the LLC is available for all years of study, not just the first four years.

For 2020, the LLC is phased out at a lower level than the AOTC. The phase-out range is between $59,000 to $69,000 of MAGI for single filers and $118,000 to $138,000 for joint filers.

New law update: Beginning in 2021, the CAA increases the phase-out ranges for the LLC to match those for the AOTC. But the maximum LLC remains $2,000 per taxpayer for 2021 and beyond. Therefore, unless your child goes past a fourth year of study, you are better off with the AOTC.

Small Business Tax Strategies

May 2021

Getting Remarried? Preserve Home Sale Gain Exclusion

If you play your cards right, you can be excluded from federal income tax gain of up to a half million dollars when you sell your principal residence.

Don’t jeopardize the home sale gain exclusion break. Make sure that you adhere to the strict requirements under the tax law.

In some cases, you might postpone a sale to qualify for the exclusion. Things can get especially tricky if you’re remarrying and you or your spouse – or both of you – own homes you want to sell.

As long as you’ve owned and used your home as your principal residence for at least two years during the five year period ending on the sale date, you can exclude up to $250,000 of home sale profit if you’re single filer or up to $500,000 for joint filers.

Furthermore, there is no current limit on the number of times you can claim the exclusion. If you file a joint return, you can claim the maximum $500,000 exclusion if (1) either spouse meets the two year ownership rule, (2) both spouses meet the two year use rule and (3) neither spouse has claimed the exclusion within the last two years. This is particularly important to remember for those who have divorced or remarried or will do so soon.

For instance, suppose your fiance sold a home in 2020 and claimed the exclusion as a single taxpayer. If you get married and sell your own home in 2021, you can’t claim the larger $500,000 exclusion for your home on a joint return.

This could result in a much bigger taxable gain. Even if you’ve owned the home for more than a year, the gain is taxed at a 15% federal rate or at the maximum 20% rate if your 2021 joint taxable income exceeds $501,600.

Conversely, you might benefit from these rules if you sell a home where you’ve been living on your own and your new spouse hasn’t claimed the exclusion within the last two years. If you and your new spouse live in your home for at least two years, you could qualify for the larger $500,000 gain exclusion.

Small Business Tax Strategies

May 2021

Generate Energy Credits at Home

Are you ready for the first heat wave of the summer? You can cool things down and get a tax break to boot.

Make energy-saving improvements to your home. Many costs will qualify for the residential energy tax credit – a dollar for dollar reduction of your tax bill – on your 2021 return.

This residential energy credit has expired and been reinstated multiple times in the past. The Consolidated Appropriations Act (CAA) extended the credit again through 2021.

The residential credit is equal to 10% of the cost of qualified energy saving items added to your principal residence. But there’s a lifetime limit of $550 and a special dollar limit on certain types of expenses. The list of expenses eligible for this credit includes:

  • Insulation materials.
  • Exterior windows and skylights.
  • Exterior doors.
  • Central air conditioners.
  • Natural gas, propane and oil water heaters or furnaces.
  • Hot water boilers.
  • Electric heat pump water heaters.
  • Certain metal roofs.
  • Biomass stoves.
  • Advanced main air circulating fans.

Currently, the credit for windows is capped at $200; furnaces and boilers at $150; air conditioners, air source heat pumps and biomass stoves at $300; and advanced main air circulating fans at $50. What’s more, the lifetime limit of $500 is reduced by energy credits claimed in prior years.

More good news: The CAA also extends another credit for energy-efficient property. This alternative credit is generally available for residential solar panels or water heating panels plus fuel cell projects, small-wind energy projects and geothermal heat pumps.

The credit rate for energy-efficient property expenditures was scheduled to decrease from 26% to 22% of the cost of qualified expenses or projects placed in service 2021. Now the CAA keeps the 26% credit in place for property placed in service in 2021 and 2022 and allows a 22% credit for property placed in service during 2023.

Also, the new law adds biomass fuel projects to the list of eligible expenses for this credit.

The credit is still set to expire after 2023.

Eat Out on Uncle Sam’s Dime

Although the Tax Cuts and Jobs Act (TCJA) eliminated tax deductions for most business entertainment expenses, you can still write off business meal expenses if certain requirements are met.

Treat your clients to qualified business meals. When appropriate, separate the cost of food and beverage from any entertainment.

To sweeten the pot, the new Consolidated Appropriations Act (CAA), enacted late last year, boosts the allowable deduction for meals provided by restaurants to 100% of cost. In other words, you can deduct the entire cost. But this tax break is only available for a limited time.

In the past, you could deduct 50% of business entertainment expenses “directly related to” or “associated with” your business, including the cost of business meals that preceded or followed a substantial business meeting. In addition, you were able to deduct 50% of meal expenses while traveling away from home or business.

The TCJA generally repeals deductions for business entertainment expenses after 2017. But the TCJA didn’t touch the deduction for business meals while you’re away from home on business, although it was not entirely clear at the time. Later, the IRS issued regulations on deducting food and beverage costs associated with business entertainment.

As before the TCJA, you can deduct 50% of the cost of business meals as long as:

  • The expense is an ordinary and necessary business expense paid or incurred during the tax year in carrying on any trade or business.
  • The expense is not lavish or extravagant under the circumstances.
  • The taxpayer, or an employee of the taxpayer, is present at the furnishing of the food or beverages.
  • The food and beverages are provided to a current or potential business customer, client, consultant or similar business contact.
  • If food and beverages are provided during or at an entertainment activity, the food and beverages must be purchased separately from the entertainment or the cost must be stated separately from the cost of the entertainment.

Accordingly, if you treat a client to a meal and the expense is properly substantiated, you qualify for a business meal deduction. Note that there must be a business purpose to the meal or some reasonable expectation of a business benefit.

For tax deduction purposes, the cost of food and beverages include sales tax, delivery charges and tips that are added to your bill.

IRS regulations provide greater clarity for separating food and beverage expenses from entertainment expenses. They include examples where you can deduct costs when you treat a client to food and beverages at a sporting event.

But you can’t circumvent the rules by arbitrarily inflating amounts charged for food and beverages provided by a restaurant. This applies to expenses paid or incurred from January 1, 2021, through December 31, 2022. So there’s a two year window of opportunity.

In new guidance, the IRS says that this tax break generally applies to restaurants that sell food and beverages for both or either on-site and off-site consumption.

Small Business Tax Strategies

May 2021

5 Ways to Audit-Proof Your Return

Audit rates are at historically low levels. For example, according to the latest available statistics from 2019, the overall rate was only .45%. And with the IRS understaffed and overwhelmed, don’t expect a big increase anytime soon.

Nevertheless, you should not tempt fate. Here are five tips for staying below the radar.

  1. Avoid mistakes. IRS computers are quick to pick up inconsistencies when they match forms they receive with your tax return entries. Ditto for math eros or other inaccuracies like incorrect Social Security numbers (SSNs). Even if you’re using a professional tax return preparer, you could set off alarms if you’ve provided the wrong information. Don’t forget to include all the taxable income reflected on the forms you’ve received.
  2. Be honest. This is one of those times when it pays to tell the truth. Your risk of being audited goes up immeasurably if you flat out lie about income items and deductions. That’s not to say you can’t be aggressive when you’re standing on firm ground, but don’t fudge the facts. Answer this question: Can you face an auditor and stick to your story with proof to back up your claims.
  3. Be realistic. You’re asking for trouble if you show deductions or credits that are outlandish or far greater than someone in similar circumstances would claim. For example, recent legislation authorized a charitable deduction for monetary gifts of up to 100% of your adjusted gross income (AGI) for 2020. But if you even come close to this mark – say, deductions equaling 80% of your AGI – if will likely raise suspicions.
  4. E-file. The pendulum has clearly swung from submitting paper returns to e-filing. Of the more than 165 million returns filed in 2019, an impressive 91.66% were e-filed by tax pros and individual taxpayers. When you e-file your return, the odds of being audited go down dramatically, partially because there’s less chance of making math and other entry mistakes. Of course, if you use a professional preparer, he or she is generally required by law to submit your return electronically, so you don’t have to worry.
  5. Use a tax pro. As alluded to above, you have a lower audit risk – but not zero – when you use a tax pro to prepare your return. Notably, you usually avoid the sort of careless errors that can lead to IRS inquiries. Plus, an experienced and knowledgeable professional can usually spot the “red flags ” that signal trouble and avoid many of them in the first place.

Be aware that there are three main types of audits. The most common type is a correspondence audit where you never meet face-to-face with an examiner. In 2019, almost three quarters of all individual audits were correspondence audits.

The second type is an office audit. Generally, the examiner will spend about 2-4 hours going over certain items on your return. With the third type of audit, the examiner usually comes to your place of business. This is the most serious type of audit and cause for the greatest concern.

What to do if you’re audited?

Despite your best efforts, the IRS might tap you for an audit in the near future. What should you do first?

Strategy: Don’t panic. This normally isn’t life-changing. There’s no reason to get in a tizzy.

Next, the smartest thing you can do is to enlist the services of a tax pro for audits other than correspondence audits. The pro will handle most mattes directly and you won’t have to do much other than answer some questions. Resist the temptation to provide more information than needed – only answer what you’re asked. Don’t volunteer anything else. In other words, if the examiner asks you a “yes or no” question, your answer should be either “yes” or “no” – period.

In most cases, you can emerge relatively unscathed with a tax pro on your side. However, if you’re bound and determined to go it alone, make sure you have supporting documentation that is readily available. Again, don’t volunteer any extra information.

Tip: Stay cool, calm and collected, and you’ll get through it. 

Small Business Tax Strategies

May 2021

Stimulus Update

Democratic lawmakers got a legislative win with passage of the American Rescue Plan Act of 2021. It includes a long-standing Democratic goal: fighting child poverty through the tax code.

There’s a revamped child tax credit for 2021. The law hikes:

  • The $2,000-per-child credit to $3,000
  • $3,600 for kids under 6
  • Let’s 17-year-olds qualify
  • Makes the credit fully refundable
  • Calls the IRS to pay 50% of it in advance to qualifying families

Upper-incomers won’t get the higher credit. It begins to phase out at AGIs of $75,000 for singles, $112, 500 for household heads and $150,000 for joint filers. The credit amount is reduced by $50 for each $1,000 of AGI over the applicable threshold amount. The phaseout is limited to the $1,00 of $1,600 temporary increased credit amount for 2021 and not to the $2,000 credit. So families who aren’t eligible for the $3,000 or $3,600 credit, but who have AGIs at or below $400,000 on joint returns or $200,000 on others, still get the $2,000 credit.

The IRS is required to pay half of the credit in advance. If all goes as planned, it will send out a payment to qualifying families each month from July through December 2021. It will determine eligibility for the credit and payments based on 2020 or 2019 returns. THe amount a family will get each month is based on the AGI, the number of children and the ages of the kids.  Families who qualify for the full $3,000 or $3,600 credit could see checks of $250 or $300 per child for six months. Those with higher incomes who qualify for the $2,000 credit could get monthly payments of $167 per child.

You’ll need to let the IRS know of changes to your family circumstances or AGI. The IRS is developing an online tool so that you can update your 2021 income, marital status and the number of your qualifying children. You can also opt out of advance payments on the portal and instead take the full credit on your 2021 return.

The payments are advances of the 2021 child tax credit and aren’t taxable. On your 2021 Form 1040, you’ll reconcile the payments you got with your actual credit. Some people who receive overpayments needn’t repay the excess to the IRS. Families with 2021 AGIs or below $40,000 for singles, $50,000 for household heads and $60,000 for joint filers won’t have to repay any credit overpayments they get. Families with 2021 AGIs of at least $80,000, $100,000 or $120,000, respectively, will need to repay the full amount of any overpayment when they file their 2021 returns. Those with 2021 AGIs between the thresholds need to repay only part of their overpayments.

This expanded child tax credit is temporary. It applies only for 2021. But Democratice lawmakers want to make it permanent, touting the impact that such a higher and fully refundable credit would have on reducing child poverty.

There are a number of other tax easings in the American Rescue Plan. A third round of stimulus checks of $1,400 for singles and household heads and $2,800 for joint filers, plus $1,400 more for each dependent claimed on the return. They begin to phase out at AGIs of $150,000 for couples, $112,500 for household heads and $75,000 for singles, and end at AGIs above $160,000, $120,000 and $80,000.

The IRS will first look to 2020 returns to determine eligibility for the payments. If a 2020 return hasn’t yet been filed, the IRS will look to 2019. Similar to before, Social Security recipients who typically don’t have to file returns needn’t file. Ditto for those individuals who get Social Security disability or veterans benefits.

People with direct deposit should have received the money or will get it soon. Eligible folks without direct deposit should get a paper check or debit card in the mail. Use the IRS’s Get My Payment online tool to check the status of your stimulus payments. The money is an advance payment of a tax credit on the 2021 return.

Up to $10,200 of unemployment benefits received in 2020 are not taxable for federal income tax purposes. For joint filers, it’s $10,200 of benefits per spouse. The relief applies only to individuals and couples with AGIs of less than $150,000. The IRS has revised the instructions to Schedule 1 of the Form 1040 to reflect this change. The IRS is also urging individuals who already filed their 2020 1040 not to amend it to claim the exclusion. The agency’s head says the IRS plans to automatically issue refunds.

More individuals qualify for the health premium credit for 2021 and 2022 for buying insurance through an Exchange. There are also increased subsidies. The Earned Income Tax Credit for 2021 is higher for workers without children. Also, 2019 earned income can be used to figure the earned income credit for 2021. Working parents get a higher child and dependent care credit for 2021. Up to $4,000 for one child and $8,000 for two or more kids, up from $1,050 and $2,100 for 2020. Parents with up to $125,000 of AGI are eligible for the full credit. Taxpayers with AGIs between $125,000 and $500,000 get a partial credit. Working parents can contribute more to dependent care FSAs in 2021. They can put in up to $10,500 of pre tax wages, up from $5,000, if the plan allows. And most student loan debt forgiven in 2021 through 2025 will be tax-free.

The Kiplinger Tax Letter
March 2021

Did you return your RMD Withdrawal in 2020?

Did you return a 2020 Required Minimum Distribution from your IRA after learning RMDs were waived in 2020? You’ll need to know how to report it on your return, and it’s a tad tricky.

We have written before that required minimum distributions from IRAs and 401(k)s were suspended for 2020. People who took out an RMD in 2020 had until the later of Aug. 31, 2020, or 60 days after the payout to put the money back into the account and treat the distribution and subsequent redeposit as a tax-free rollover.

The 1099-R you get from your IRA custodian will show the original payout. But it won’t account for the later return of the funds. In other words, the tax-free rollover is not shown on the form. Don’t worry, the 1099-R is not wrong. Rollovers are generally not reflected on the 1099-R because custodians know only of the distributions. They are generally not aware of a future rollover.

When filling out your 1040, you should include the total amount of IRA distributions shown on Form 1099-R on line 4a. Then you subtract the amount that you properly and timely returned to the IRA and report the remainder, if $0, on line 4b. Write “Rollover” next to line 4b so the IRS knows why the numbers don’t match. And if federal income taxes were withheld from the original distribution and reported on the 1099-R, remember to claim the withholding on line 25b of the 1040.

The Kiplinger Tax Letter
March 2021