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5 Tax Tips for Gig Economy

According to recent data from the Federal Reserve, nearly one out of every three Americans is involved in the gig economy (aka “sharing economy”).

Strategy: Find out about the tax consequences. Workers in the gig economy have tax obligations and opportunities like those of other self-employed individuals.

Notably, you must pay taxes on your earnings, but you could be entitled to some offsetting deductions.

Here are 5 tax tips that can help you avoid problems and maximize available tax benefits.

  1. Don’t hide taxable income. ‘Fess up to the IRS about the earnings from your gig, even if it’s only a sideline business. For instance, if you receive payment in the form of money, goods, property or services, the income is taxable on your personal return. In addition, separate cash tips must be treated as taxable income. See IRS Pub. 334, Tax Guide for Small Business, for more details.
  2. Report large cash transactions. Any business taxpayer, including a participant in the gig economy, who receives more than $10,000 in cash in a single transaction (or in a series of related transactions) is required to file Form 8300, Report of Cash Payments over $10,000 Received in a Trade or Business, within 15 days after receiving payment.
  3. Green light biz deductions.  Generally, you can deduct ordinary and necessary business expenses incurred as a participant in the sharing economy, including deductions for your vehicle if you’re an Uber or Lyft driver. For 2020, you can use a flat rate of 57.5 cents per business mile (down from 58 cents per mile in 2019), plus related tolls and parking fees, instead of deducting your actual expenses. Similarly, an Airbnb landlord can write off most business expenses. Typically, the deductions are claimed on Schedule C as a self-employed.
  4. Avoid estimated tax penalty. If you’re participating in the gig economy, you will have to make quarterly installment payments of “estimated tax” or adjust your withholdings from another job, or both. Use Form 1040-ES, Estimated Tax for Individuals, to help figure out these payments. Generally, to avoid an estimated tax penalty, you must pay at least 90% of your current year tax liability or 100% of the prior year’s liability (110% if your AGI for the prior year exceeded $150,000).
  5. Keep good records. Recordkeeping is essential for tracking taxable income and deductible expenses. This also helps you substantiate claimed deductions if the IRS ever challenges them. Your recordkeeping system should include a summary of all business transactions. Generally, it is best to record transactions daily. Want to know more? The IRS has created the “Sharing Economy Resource Center”. It is designed to aid taxpayers participating in the gig economy.

Source: Small Business Tax Strategies, April 2020

The Secure Act Brings Bevy of Changes

The Holiday season brought a multitude of changes to retirement planning, with President Trump signing the Setting Every Community Up for Retirement Enhancement Act into law in December. Here are some of the most notable ways the Secure Act affects retirement savings so you can start adjusting your retirement strategy. (Unless noted, all changes apply starting in 2020.)

RMD begins at age 72. Required minimum distributions (RMDs) from 401(k) plans and traditional IRAs are a thorn in the side of many retirees. RMDs generally had to begin in the year you turned 70 ½.

The Secure Act pushes that age that triggers RMDs from 70 ½ to 72, which means you can let your retirement funds grow an extra 1 ½ years before tapping into them. That can result in a significant boost to overall retirement savings for many seniors.

The new rules apply to those who turn 70 ½ in 2020 or later. If you turned 70 ½ in 2019, you still must take your first RMD by April 1, 2020, and your second by year-end 2020.

No IRS age cap. With many people working and living longer, having a cap on IRA contributions was a hindrance for older workers. The Secure Act repeals the rule that prohibited contributions to a traditional IRA by taxpayers age 70 ½ and older. Now you can continue to put away money in a traditional IRA if you work into your seventies and beyond.

As before, there are no age-based restrictions on contributions to a Roth IRA. Workers 50 and older can contribute a combined total of $7,000 to a traditional and a Roth IRA for 2020.

‘Stretch’ IRA eliminated. Now for some bad news, which many of our readers feared coming true: The Secure Act eliminates the rules that allow non-spouse IRA beneficiaries to “stretch” required minimum distributions from inherited accounts over their own lifetimes. Instead, all assets from an inherited IRA generally must now be distributed by non-spouse beneficiaries within 10 years of the IRA owner’s death. (The rule applies to inherited assets in 401(k) account or other defined contribution plan, too.)

There are some exceptions to the general rule: Distributions over the life expectancy of a non-spouse beneficiary are allowed if the beneficiary is a minor, disabled, chronically ill or not more than 10 years younger than the deceased IRA owner. For minors, the exception only applies until the child reaches the age of majority. At that point, the 10-year rule kicks in.

If the beneficiary is the IRA owner’s spouse, RMDs are still delayed until the year that the deceased IRA owner would have reached age 72 (age 70 ½ before the new retirement law). And a surviving spouse still has the option to take the money as his or her own.

If you banked on having your heirs stretch the IRAs they were to inherit, it’s time to overhaul your estate plans. Some strategies to consider: doing Roth IRA conversions so your heirs will inherit tax-free income instead of taxable income from a traditional IRA, drawing down your IRA for living expenses and bequeathing other assets to heirs, and using RMDs to buy life insurance with heirs as beneficiaries for the income-tax-free death proceeds. Contact an estate-planning lawyer to redo any trusts you set up that incorporated the stretch strategy.

401(k) for part-time employees. Part-time workers need to save for retirement, too. However, employees who haven’t worked at least 1,000 hours during the year typically aren’t allowed to participate in their employer’s 401(k) plan.

That’s about to change. Starting in 2021, the new law guarantees 401(k) plan eligibility for employees who worked at least 500 hours per year for at least three consecutive years. The part-timer must also be 21 years old by the end of the three-year period. The new rule doesn’t apply to collectively bargained employees.

Source: Kiplinger Retirement Report, February 2020

Withhold on RMD to Simplify Paying Taxes

For many retirees, paying taxes isn’t a one-time-a-year task. Instead, many must pay estimated taxes four times a year. The first quarterly payment is due in April, the same day as your tax return for the prior year.

If you’re still working, you probably don’t need Form 1040-ES, which you use to figure estimated taxes. Withholding on your paychecks should ensure compliance with the tax system’s pay-as-you-earn demands. But if you’re retired, chances are you need to make estimated payments. Don’t assume payments are due every three months. The payment deadlines typically fall in April, June, September and the following January. You’re basically supposed to figure how much tax you’ll owe for the current tax year and send it along to the IRS in four equal installments.

Pay at least 90% of your current tax year’s liability or 100% of what you owed the previous tax year, and you will have done your duty and be protected from an underpayment penalty. (That 100% of last year’s taxes rises to 110% if your prior year adjusted gross income was more than $150,000.)

Not only can making those estimates be a pain, writing those checks can disrupt your cash flow. Many taxpayers simply divide the previous year’s tax bill by four and send 25% on each payment date to wrap themselves in the “100% of last year’s tax bill” exception.

But depending on the source of retirement income, you may be able to satisfy the IRS via withholding from those payments. Unlike withholding from paychecks, withholding from retirement income is almost always voluntary. (The exception: Nonperiodic payouts from company retirement plans, including lump sums, are hit with 20% withholding for the IRS.)

If you want federal taxes withheld from Social Security benefits, you must file form W-4V (“V” is for voluntary) with the Social Security Administration. You can ask that 7%, 10%, 12% or 22% of each monthly benefit be carved off for the IRS. When it comes to pension or annuity payments, you control how much will be withheld by filing a Form W-4P with the payor. The worksheet for the form is like the one that Form W-4 employees use to set withholdings from wages.

For IRS distributions, the law requires that 10% be withheld for the IRS unless you tell the custodian otherwise. You can block withholding altogether or ask that as much as 100% be withheld.

A Better Way

Speaking of IRAs, a little-known opportunity may free you from withholding on multiple income sources and from the hassle of filing estimated taxes. We call it the RMD solution.

Starting at age 72, retirees must take required minimum distributions from the traditional IRAs, based on the balance in the accounts on the previous December 31 divided by a factor provided by the IRS.

If you don’t need the money to live on, wait until December to take your RMD and ask the sponsor to withhold a big chunk for the IRS, enough to cover your estimated tax on the IRA payout and all of your other taxable income for the year.

Although estimated tax payments are considered made when you send in the checks – and must be paid as your receive your income during the year – amounts withheld from IRA distributions are considered paid evenly throughout the year, even if made in a lump sum payment at year-end.

So if your RMD is large enough to cover your entire tax bill, you can keep your cash safely ensconced in the IRA most of the year, avoid withholding on other sources of retirement income, skip quarterly estimated payments…and still avoid the underpayment penalty.

Source: Kiplinger Retirement Report, February 2020

Passing the Social Security Benefits Earnings Test

A big reason experts advise waiting until at least full retirement age to claim Social Security: You get to skip the benefits earnings test, which hits early claimers who are still working. But there are actually two earnings tests – and the second test can help early retirees leaving work midyear avoid the trap.

The Social Security Administration always applies the annual earning test first. Based on that test, the agency temporarily withholds $1 of a worker’s benefits for every $2 earned over $18,240 in 2020. In a year the worker hits full retirement age, the test is more generous – the worker forfeits $1 in benefits for every $3 in 2020 earnings above $48,600.

In the month a worker hits full retirement age – poof! – the earnings test goes away. The worker can earn whatever he or she likes, and the monthly benefit amount will be adjusted upward to consider all benefits forfeited in the past.

But if you’re tripped up by the annual test, you still have a shot at your full benefit. The agency will apply a monthly earnings test and set your payments according to whichever test is better for you. “It helps people who retire in the middle of the year not to be penalized,” says Jim Blair, a former Social Security district manager and a partner at Premier Social Security Consulting, in Sharonville, Ohio.

The monthly test can be used for only one year, usually the first year of retirement. And it comes into play generally for midyear retirees who have already earned more than the annual limit. Those who pass the monthly earnings test can receive 100% of their benefits for any whole month the agency considers them retired, regardless of total annual earnings.

Taking the Monthly Test

Here’s how the monthly earnings test works: If you are under full retirement age for all of 2020, you are considered retired in any month you earn $1,520 or less. If you reach full retirement age in 2020, you are considered retired in any month you earn $4,050 or less.

Say a beneficiary turns 62 in June. He wants to start benefits in July after working through the end of June and making $80,000 in 2020. On an annual basis, he’d get no benefit. But in July through December, if he earns $1,520 or less each month, the monthly earnings test would open the door to full benefits.

“You have to be careful if you go up to $1,521 – then the agency would add the $80,000,” Blair says. In that case, you would lose a check for that month, but not for the other months when benefits are below the monthly threshold. “A sneaky five-Friday payday month might end up passing the monthly earnings amount,” he says.

When retiring in the year you reach full retirement age, the earnings test only applies in the months prior to the month of your birthday. The higher threshold of $4,050 would apply if the monthly test is used in 2020. The earnings tests count only earned income from a job or self-employment; investment income, for example, and retirement-plan payouts are ignored.

If you work while claiming early benefits, call Social Security with your estimated earnings so you don’t get more benefits than you are due. “Eventually, earnings are posted to your record and they’ll see they overpaid,” Blair says. The agency will want the money back – and will withhold benefit checks until the overpayment is cleared.

Source: Kiplinger’s Retirement Report, February 2020

Paying Capital Gains Tax Twice Isn’t Nice

If you’ve invested in mutual funds, you have probably realized capital gains and dividends from your investments over the years.

Strategy: Don’t overpay your tax liability when you sell mutual fund shares. Despite improvements in digital record keeping, it’s still easy to inadvertently pay tax twice on mutual fund distributions when you’ve reinvested proceeds.

For example, say you bought mutual fund shares four years ago for $10,000. The fund paid out $500 in capital gain dividends each year for a total of $2,000. You elected to have these amounts reinvested in more shares of the fund. Then you sold all your shares in 2019 for $15,000.

Because you paid $10,000 and sold the shares at $15,000, you might think you had a $5,000 gain…right? Wrong. Your tax basis in the shares is $12,000 (original cost of $10,000 + $2,000 of reinvested dividends that you paid tax on). So, your taxable gain is actually $3,000 ($15,000 – $12,000). If you inadvertently report a $5,000 gain, you’re effectively paying tax twice on the $2,000 reinvested dividends. Note that the federal income tax rate on long-term capital gains and qualified dividends is 15% for most folks (20% for high-income investors).

Extend 529 Plan Tax Benefits

Did you set up your Section 529 account for a child who is graduating in May? It doesn’t mean that the good times have to end.

Strategy: Roll over any unused funds into an account for another child. The rollover is completely exempt from tax.

In other words, you don’t have to shut down the Section 529 plan after one of your children is out of school. The only requirement is that distributions must begin by the time the last beneficiary turns age 30.

A Section 529 plan is an educational savings plan operated by one of the states. As long as certain requirements are met, there’s no income tax on the accumulation of earnings within the plan, plus qualified distributions for amounts like tuition are exempt from tax. Furthermore, contributions to the plan may be sheltered from gift tax by the annual gift tax exclusion. (You can make five years’ worth of contributions in one year.)

What happens when your youngest child graduates? You can close down the account simply by notifying the plan administrator and pocketing the remaining balance, if any. But there’s a tax price to pay at this point: You will owe tax on the portion of the distribution representing earnings.

Drive Up Biz Car Write-Offs

The tax code allows most business drivers to benefit from a convenient standard mileage rate. But the fastest and easiest way isn’t always the best way.

Strategy: Compare the standard mileage rate results to your actual costs. Despite the extra recordkeeping hassles, the actual expense method may produce a much bigger annual deduction, if you switch methods at this point in the year.

Also, note that the standard mileage rate dropped a half peny in 2020 to 57.5 cents per business mile (plus business-related tolls and parking fees), down from 58 cents per mile in 2019. (IR-2019-215, 12/31/19)

When you use your vehicle for business driving, you can deduct your out-of-pocket expenditures – such as gas, oil, repairs, insurance, registration fees, tries, etc. – attributable to the business use of the vehicle used for business (subject to a small add- back for expensive vehicles). However, in lieu of writing off actual expenses, business drivers can claim the standard mileage rate deduction, which is adjusted annually by the IRS. In this case, you don’t have to keep track of all your vehicle operating expenses, but you still must document the date, place, business relationship, business purpose and mileage for each business-related trip.

The standard mileage rate method is much easier to use, but the actual expense method is likely to produce a much bigger deduction. Frequently, the key to the comparison is the annual depreciation allowance available to business drivers using the actual expense method. Depreciation is already built into the standard mileage rate.

To further tilt things in favor of the actual expense method, the Tax Cuts and Jobs Act (TJCA) hiked the limits for the depreciation deductions for so-called “luxury autos,” as well as increasing bonus depreciation available for the first year a vehicle is placed in service in 2019 and used 100% for business, the maximum first-year luxury auto depreciation is $18,100 if $8,000 of bonus depreciation is claimed.

Of course, these figures must be adjusted based on the percentage of business use, but they still provide a powerful tax incentive to go the actual expense method route.

Example: Normally, you drive 12,000 business miles a year. For simplicity, let’s say you acquired your car in January and the total depreciation allowance for 2020, including bonus depreciation, will be $15,000.

You begin keeping the records needed for the actual expense method in the second half of the year. The estimated cost of driving the car, including all expenses stated above, is 40 cents a mile. Also, you expect to incur $500 in business-related parking fees and tolls for the year.

Now let’s compare the two methods.

●  If you use the standard mileage rate, your deduction for 2020 is limited to a total of $7,400 (12,000 miles x 57.5 cents per mile + $500).

●  If you use the actual expense method, you can deduct $2,900 in operating expenses and parking fees (6,000 miles x 40 cents per mile + $500), plus a whopping $15,000 in depreciation, for a total of $17,900.

Result: You come out $10,500 ahead with the actual expense method ($17,900 – $7,400) even though you don’t start keeping the required records until July!