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Avoiding an IRS Tax Audit
Just 0.45 percent of taxpayers were audited in fiscal year 2019. Still, with taxes becoming more complicated every year, there is an even greater possibility of confusion turning into a tax mistake and an IRS audit. Avoiding "red flags" like the ones listed below could help.
Red Flags That Trigger IRS Audits
What To Do if You Are Audited
If you've received correspondence from the IRS in the U.S. mail that indicates that you are being audited, don't try to handle it yourself. Instead, contact the office immediately for assistance.
Taxpayers who have been audited or otherwise interacted with the IRS should know that they have the right to know when the IRS has finished the audit. The right to finality is one of ten basic taxpayer rights - known collectively as the Taxpayer Bill of Rights. All taxpayers dealing with the IRS are entitled to these rights.
Renting Out a Second Home
In general, income from renting a vacation home for 15 days or longer must be reported on your tax return on Schedule E, Supplemental Income and Loss. You should also keep in mind that the definition of a "vacation home" is not limited to a house. Apartments, condominiums, mobile homes, and boats are also considered vacation homes in the eyes of the IRS. Tax rules on rental income from second homes can be confusing, especially if you rent the home out for several months of the year and use the home yourself.
Minimal Rental Use
However, there is one provision that is not complicated; homeowners who rent out their property for 14 or fewer days a year can pocket the rental income tax-free. In other words, if you live close to a vacation destination such as the beach or mountains, you may be able to make some extra cash by renting out your home (principal residence) when you go on vacation as long as it's two weeks or less. Although you can't take depreciation or deduct for maintenance, you can deduct mortgage interest, property taxes, and casualty losses on Schedule A (1040), Itemized Deductions.
Dividing Expenses Between Rental and Personal Use
A vacation home is considered a residence if personal use exceeds 14 days or more than 10 percent of the total days it is rented to others (if that figure is greater). When you use a vacation home as your residence and also rent it out to others, you must divide the expenses between rental use and personal use. You may not deduct the rental portion of the expenses that are more than the rental income.
Let's say you own a beach house (your "second home") and rent it out during the summer between mid-June and mid-September. You and your family also vacation at the house for one week in October and two weeks in December. The rest of the time, the house is unused.
Tax Reform and Vacation Rentals
Under tax reform, the amount of interest a homeowner can write off is limited to mortgage loan amounts of $750,000 or less for tax years 2018-2025. If you own a second home as well, the two mortgages combined could exceed the $750,000 cap. In addition, property tax deductions (combined with state income taxes) are capped at $10,000.
If you do not rent out your second home, you could be losing out on deductions (taxes and mortgage interest) that lower your taxable income. Therefore, it is prudent to consider renting out your second home as a vacation rental since you would then be able to deduct these expenses and possibly others such as Homeowners Association fees, maintenance expenses, and utilities. Furthermore, you can still use the home 14 days a year (more if you stay there for home maintenance-related activities) and deduct these expenses. Even if you use it more than 14 days a year, you can still deduct these expenses proportional to the amount of rental use.
Net Investment Tax
If you have a rental income, you may be subject to the Net Investment Income Tax (NIIT), a 3.8 percent tax that applies to individuals, estates, and trusts that have net investment income above applicable threshold amounts.
Tax laws are complicated. If you have any questions about renting out your second home or any other tax matters, please call.
Tax Breaks for Families With Children
If you have children, one or more of these tax credits and deductions could help your family reduce the amount of tax owed when you file your 2020 tax return. Let's take a look:
1. Child Tax Credit
Generally, taxpayers can claim the Child Tax Credit for each qualifying child under the age of 17. The maximum credit is $2,000 per child. Taxpayers who get less than the full amount of the credit may qualify for the Additional Child Tax Credit (see below). The refundable portion of the credit is $1,400 so that even if taxpayers do not owe any tax, they can still claim the credit. A $500 nonrefundable credit is also available for dependents who do not qualify for the Child Tax Credit (e.g., dependents age 17 and older).
2. Child and Dependent Care Credit
If you pay someone to take care of your dependent to work or look for work, you may qualify for a credit of up to $1,050 or 35 percent of $3,000 of eligible expenses. For two or more qualifying dependents, you can claim up to 35 percent of $6,000 (or $2,100) of eligible expenses. The credit percentage is reduced for higher-income earners but not below 20 percent, regardless of the amount of adjusted gross income. This tax credit is nonrefundable.
Even if you don't have dependent children if you care for an elderly relative and can claim them as a dependent, you might be able to take the Child and Dependent Care Credit. Please call for details.
3. Earned Income Tax Credit
Taxpayers who worked but earned less than $56,844 in 2020 could qualify for this credit, which is worth up to $$6,660 in 2020. Taxpayers may qualify with or without children.
Due to the pandemic, taxpayers can use their 2019 earned income to figure your EITC, if their 2019 earned income was more than their 2020 earned income.
4. Additional Child Tax Credit
This refundable tax credit is for certain individual taxpayers for whom the Child Tax Credit exceeds the amount of income tax owed. The credit is worth $1,400 and may give you a refund even if you do not owe any tax.
Due to the pandemic, taxpayers may be able to use their 2019 earned income to figure this credit if their 2019 earned income is more than your 2020 earned income.
5. Adoption Credit.
It is possible to claim a tax credit for certain costs paid to adopt a child. For details, see Form 8839, Qualified Adoption Expenses.
6. Education Tax Credits
An education credit can help with higher education costs. Two credits are available: the American Opportunity Tax Credit and the Lifetime Learning Credit. These credits may reduce the amount of tax owed. If the credit cuts a taxpayer's tax to less than zero, it could mean a refund. Taxpayers may qualify even if they owe no tax. Complete Form 8863, Education Credits, and file a return to claim these credits.
7. Student Loan Interest
Taxpayers may be able to deduct interest paid on a qualified student loan. They can claim this benefit even if they do not itemize deductions. If you're not sure if the interest you paid on a student or educational loan is deductible, don't hesitate to call.
If you have any questions about tax credits and deductions that could benefit your tax situation, please contact the office.
Small Business Tax Roundup
Tax changes due to recent legislation such as the Tax Cuts and Jobs Act and the CARES Act affect both individual taxpayers and small businesses. In 2020, the IRS issued several guidance documents and final rules and regulations that clarified several tax provisions affecting businesses. Here are five of them:
PPP Expenses Now Deductible
Deductions for the payments of eligible expenses are now allowed when such payments would result (or be expected to result) in the forgiveness of a loan (covered loan) under the Paycheck Protection Program (PPP). Previous IRS guidance disallowed deductions for the payment of eligible expenses when the payments resulted (or could be expected to result) in forgiveness of a covered loan.
The COVID-related Tax Relief Act of 2020 amended the Coronavirus Aid, Relief, and Economic Security Act (CARES Act) to say that no deduction is denied and no tax attribute is reduced. Furthermore, no basis increase is denied because of the exclusion from gross income of the forgiveness of an eligible recipient's covered loan. This change applies to taxable years ending after March 27, 2020.
Meals and Entertainment
The Tax Cuts and Jobs Act (TCJA) eliminated the deduction for any expenses related to activities generally considered entertainment, amusement, or recreation for tax years after 2017. While taxpayers may still deduct business expenses related to food and beverages as long as certain requirements are met, certain questions remained.
Recent IRS regulations provided clarification for several of these issues: disallowance of the deduction for expenditures related to entertainment, amusement, or recreation activities, and including the applicability of certain exceptions to this disallowance. The regulations also provide guidance to determine whether an activity is considered entertainment. The final regulations also address the limitation on the deduction of food and beverage expenses.
Like-kind Exchanges of Real Property
The 2017 Tax Cuts and Jobs Act (TCJA) limited like-kind exchange treatment to exchanges of real property. As such, effective January 1, 2018, exchanges of personal or intangible property such as vehicles, artwork, collectibles, patents, and other intellectual property generally do not qualify for nonrecognition of gain as like-kind exchanges.
Furthermore, like-kind exchange treatment applies only to exchanges of real property held for use in a trade or business or for investment. An exchange of real property held primarily for sale does not qualify as a like-kind exchange.
Under the IRS's final regulations, real property includes land and generally anything permanently built on or attached to land. In general, it also includes property that is characterized as real property under applicable State or local law. Certain intangible property, such as leaseholds or easements, also qualify as real property under section 1031.
Property not eligible for like-kind exchange treatment prior to the enactment of the TCJA remains ineligible. Neither the TCJA nor the final regulations change whether the properties exchanged are of like kind.
Qualified Transportation Fringe and Commuting Expenses
The 2017 TCJA generally disallows deductions for qualified transportation fringe (QTF) expenses and does not allow deductions for certain expenses of transportation and commuting between an employee's residence and place of employment.
Final regulations address the disallowance of the deduction for expenses related to QTFs provided to an employee of the taxpayer, including providing guidance and methodologies to determine the amount of QTF parking expenses that is nondeductible. The final regulations also address the disallowance of the deduction for expenses of transportation and commuting between an employee's residence and place of employment.
Relief for Developers of Offshore Renewable Energy Projects
Renewable energy projects constructed offshore or on federal land are ordinarily subject to significant delays that can result in project completion times of up to twice as long as other renewable energy projects. These delays threaten taxpayers' ability to satisfy requirements to claim the production tax credit and the investment tax credit.
To address this hurdle, the Treasury Department and the IRS have determined that it is necessary to extend the safe harbor period to up to 10 calendar years after the year in which construction of the project began.
The extension of the safe harbor for these projects provides flexibility for taxpayers constructing renewable energy projects offshore or on federal land to satisfy the beginning of construction requirements despite ordinary course delays that threaten their ability to claim tax credits.
For more information about small business tax updates under tax reform, the CARES Act, or the COVID-related Tax Relief Act of 2020, please call.
Capital Gains Tax on Sale of Stocks
Apps like Robinhood make it easy for everyone to play the stock market. If you're a retail investor who made money last year buying and selling stocks, you may owe capital gains tax when you file your tax return this year. If you lost money, you may be able to deduct that loss and reduce your income.
Here's what you need to know about capital gains tax:
Capital Gains and Losses Defined
A capital gain or loss is the difference between your basis - the amount you paid for the asset - and the amount you receive when you sell an asset. All capital gains (or losses) must be reported on your tax return.
Losses Limited to $3,000
If your capital losses are more than your capital gains, you can deduct the difference as a loss on your tax return to reduce other income, such as wages. This loss is limited to $3,000 per year, or $1,500 if you are married and file a separate return.
Carryover of Losses Allowed
If your total net capital loss is more than the limit you can deduct, you can carry it over to next year’s tax return.
Long and Short Term Gains and Losses
Capital gains and losses are classified as long-term or short-term. Generally, if you hold the asset for more than one year before you dispose of it, your capital gain or loss is long-term. If you hold it one year or less, your capital gain or loss is short-term.
Net Capital Gain
If your long-term gains are more than your long-term losses, the difference between the two is a net long-term capital gain. If your net long-term capital gain is more than your net short-term capital loss, you have a net capital gain. Subtract any short-term losses from the net capital gain to calculate the amount of net capital gain you must report.
Capital Gains Tax Rates
The tax rates that apply to net capital gain depend on your income, but are generally lower than tax rates that apply to other income such as wages. The maximum tax rate on a net capital gain is 20 percent; however, for most taxpayers a zero or 15 percent rate will apply. If your income is above a certain amount you may be subject to the 3.8 percent Net Investment Income Tax (NIIT) on these capital gains.
Reporting Capital Gains and Losses
Report capital gains or losses using Form 8949, Sales and Other Dispositions of Capital Assets and Schedule D (Form 1040), Capital Gains and Losses to summarize capital gains and losses.
Please contact the office if you need more information about reporting capital gains and losses.
Tax Credits for Electric Vehicles and Plug-in Hybrids
Tax credits are still available for Qualified Plug-in Electric Drive Motor Vehicles, including passenger vehicles and light trucks. The credit applies to vehicles acquired after 12/31/2009 and is limited to $7,500. State and/or local incentives may also apply.
The credit amount is varied and is based on the capacity of the battery used to power the vehicle: $2,500 plus, for a vehicle that draws propulsion energy from a battery with at least 5-kilowatt hours of capacity, $417, plus an additional $417 for each kilowatt-hour of battery capacity above 5-kilowatt hours.
The credit begins to phase out for a manufacturer's vehicles when at least 200,000 qualifying vehicles manufactured by that manufacturer have been sold for use in the United States (determined on a cumulative basis for sales after December 31, 2009). Phaseouts have been initiated for Tesla, Inc. and General Motors, which means that for tax year 2020, the credit has been reduced to $0. In 2019, the credit was equal to $1,875.
The following requirements must also be met:
The credit is claimed on Form 8936, Qualified Plug-in Electric Drive Motor Vehicle Credit and reported on the appropriate line of your Form 1040, U.S. Individual Income Tax Return. For vehicles purchased in 2010 or later, this credit can be used toward the alternative minimum tax (AMT).
If the qualifying vehicle is purchased for business use, the credit for the business use of an electric vehicle is reported on Form 3800, General Business Credit.
Special Tax Rules for Children With Investment Income
Special tax rules may apply to some children who received investment income in 2020 or expect to receive it in 2021. The rules may affect the amount of tax and how to report the income. Here are five important points to keep in mind if your child has investment income:
1. Investment Income. Investment income generally includes interest, dividends, and capital gains. It also includes other unearned income, such as from a trust.
2. Parent's Tax Rate. If your child's total investment income is more than $2,100, then your tax rate may apply to part of that income instead of your child's tax rate. See the instructions for Form 8615, Tax for Certain Children Who Have Unearned Income.
3. Parent's Return. You may be able to include your child's investment income on your tax return if it was more than $1,100 but less than $11,000 for the year. If you make this choice, then your child will not have to file his or her own return. See Form 8814, Parents' Election to Report Child's Interest and Dividends, for more information.
4. Child's Return. If your child's investment income was $11,000 or more in 2020, then the child must file their own return. File Form 8615 with the child's federal tax return.
5. Net Investment Income Tax. Your child may be subject to the Net Investment Income Tax if they must file Form 8615. Use Form 8960, Net Investment Income Tax, to figure this tax.
If you have any questions about your child's investment income, help is just a phone call away.
Claiming the Credit for Other Dependents
Taxpayers with dependents who don't qualify for the child tax credit may be able to claim the credit for other dependents. The maximum amount of the credit is $500 for tax year 2020. To take the credit, your dependent must meet certain conditions.
For example, the dependent you are claiming must be age 17 or older and have an individual taxpayer identification number. Other dependents also include dependent parents or other qualifying relatives supported by the taxpayer and dependents living with the taxpayer who aren't related to the taxpayer.
Here are some additional facts about the credit for other dependents:
1. The credit begins to phase out when the taxpayer's income is more than $200,000 ($400,000 for married couples filing a joint tax return).
2. Taxpayers can claim the credit for other dependents in addition to the child and dependent care credit and the earned income credit.
3. The dependent must be a U.S. citizen, national or resident alien.
4. A taxpayer can claim this credit if they claim the person as a dependent on the taxpayer's return.
5. The dependent cannot be used to claim the child tax credit or additional child tax credit.
For more information about this and other tax credits that could lower your taxes this year, please contact the office.
Unemployment Benefits Identity Theft Scam Alert
During 2020, millions of taxpayers were impacted by the COVID-19 pandemic through job loss or reduced work hours. Some taxpayers who faced unemployment or reduced work hours applied for and received unemployment compensation from their state. As a reminder, unemployment benefits are taxable income and must be reported on tax returns.
Starting in January 2021, unemployment benefit recipients should have received a Form 1099-G, Certain Government Payments in the mail from the agency paying the benefits. The form shows the amount of unemployment compensation they received during 2020. In some states, taxpayers may be able to receive their Form 1099-G by visiting their state's unemployment website where they signed up for account benefits to obtain their account information.
Unfortunately, scammers are taking advantage of the pandemic by filing fraudulent claims for unemployment compensation using stolen personal information of individuals who had not filed claims. Due to these fraudulent claims, payments went to the identity thieves. The individuals whose names and personal information were taken did not receive any of the payments.
Taxpayers who receive an incorrect Form 1099-G for unemployment benefits they did not receive should contact the issuing state agency to request a revised Form 1099-G showing they did not receive these benefits. It is important to note that individuals who a state has identified as ID theft victims should not have been issued Forms 1099-G.
Taxpayers who cannot obtain a timely, corrected form from states should still file an accurate tax return, reporting only the income they received. A corrected Form 1099-G showing zero unemployment benefits in cases of identity theft will help taxpayers avoid being hit with an unexpected federal tax bill for unreported income.
Taxpayers do not need to file a Form 14039, Identity Theft Affidavit, with the IRS regarding an incorrect Form 1099-G. The identity theft affidavit should be filed, but only if the taxpayer's e-filed return is rejected because a return using the same Social Security number has already been filed.
Additionally, if taxpayers are concerned that their personal information has been stolen and want to protect their identity when filing their federal tax return, they can request an Identity Protection Pin (IP PIN) from the IRS. An Identity Protection PIN is a six-digit number that prevents someone else from filing a tax return using a taxpayer's Social Security number. The IP PIN is known only to the taxpayer and the IRS, and this step helps the IRS verify the taxpayer's identity when they file their electronic or paper tax return.
Don't hesitate to call if you have any questions about this topic.
There's Still Time To Make an IRA Contribution for 2020
If you haven't contributed funds to an Individual Retirement Account (IRA) for tax year 2020, or if you've put in less than the maximum allowed, you still have time to do so. You can contribute to either a traditional or Roth IRA until the April 15, 2021, due date, not including extensions.
Be sure to tell the IRA trustee that the contribution is for 2020. Otherwise, the trustee may report the contribution as being for 2021 when they get your funds.
Generally, you can contribute up to $6,000 of your earnings for tax year 2020 (up to $7,000 if you are age 50 or older). You can fund a traditional IRA, a Roth IRA (if you qualify), or both, but your total contributions cannot be more than these amounts.
Traditional IRA. You may be able to take a tax deduction for the contributions to a traditional IRA, depending on your income and whether you or your spouse, if filing jointly, are covered by an employer's pension plan.
Each year, the IRS announces the cost of living adjustments and limitations for retirement savings plans.
Saving for retirement should be part of everyone's financial plan, and it's important to review your retirement goals every year to maximize savings. If you need help with your retirement plans, give the office a call.
Tax Due Dates for March 2021
Businesses - File information returns (for example, certain Forms 1099) for certain payments you made during 2020. However, Form 1099-NEC reporting nonemployee compensation must be filed by February 1. There are different forms for different types of payments. Use a separate Form 1096 to summarize and transmit the forms for each type of payment. See the General Instructions for Certain Information Returns for information on what payments are covered, how much the payment must be before a return is required, what form to use, and extensions of time to file.
Payers of Gambling Winnings - File Form 1096, Annual Summary and Transmittal of U.S. Information Returns, along with Copy A of all the Forms W-2G you issued for 2020. If you file Forms W-2G electronically, your due date for filing them with the IRS will be extended to March 31. The due date for giving the recipient these forms remains February 1.
Farmers and Fishermen - File your 2020 income tax return (Form 1040 or Form 1040-SR) and pay any tax due. However, you have until April 15 to file if you paid your 2020 estimated tax by January 15, 2021.
Health Coverage Reporting - If you are an Applicable Large Employer, file paper Forms 1094-C, Transmittal of Employer-Provided Health Insurance Offer and Coverage Information Returns, and 1095-C with the IRS. For all other providers of minimum essential coverage, file paper Forms 1094-B, Transmittal of Health Coverage Information Returns, and 1095-B with the IRS. If you are filing any of these forms with the IRS electronically, your due date for filing them will be extended to March 31.
Large Food and Beverage Establishment Employers - with employees who work for tips. File Form 8027, Employer's Annual Information Return of Tip Income and Allocated Tips. Use Form 8027-T, Transmittal of Employer's Annual Information Return of Tip Income and Allocated Tips, to summarize and transmit Forms 8027 if you have more than one establishment. If you file Forms 8027 electronically your due date for filing them with the IRS will be extended to March 31.
Health Coverage Reporting to Employees - If you are an Applicable Large Employer, provide Form 1095-C, Employer-Provided Health Insurance Offer and Coverage, to full-time employees. For all other providers of minimum essential coverage, provide Form 1095-B, Health Coverage, to responsible individuals.
Employees who work for tips - If you received $20 or more in tips during February, report them to your employer. You can use Form 4070.
Employers - Nonpayroll withholding. If the monthly deposit rule applies, deposit the tax for payments in February.
Employers - Social Security, Medicare, and withheld income tax. If the monthly deposit rule applies, deposit the tax for payments in February.
Partnerships - File a 2020 calendar year income tax return (Form 1065). Provide each partner with a copy of their Schedule K-1 (Form 1065-B) or substitute Schedule K-1. To request an automatic 6-month extension of time to file the return, file Form 7004. Then file the return and provide each partner with a copy of their final or amended (if required) Schedule K1 (Form 1065) by September 15.
S Corporations - File a 2020 calendar year income tax return (Form 1120S) and pay any tax due. Provide each shareholder with a copy of Schedule K-1 (Form 1120S), Shareholder's Share of Income, Credits, Deductions, etc., or a substitute Schedule K-1. If you want an automatic 6-month extension of time to file the return, file Form 7004 and deposit what you estimate you owe in tax.
S Corporation Election - File Form 2553, Election by a Small Business Corporation, to choose to be treated as an S corporation beginning with calendar year 2021. If Form 2553 is filed late, S corporation treatment will begin with calendar year 2022.
Electronic Filing of Forms - File Forms 1097, 1098, 1099 (except Form 1099-MISC), 3921, 3922, and W-2G with the IRS. This due date applies only if you file electronically. The due date for giving the recipient these forms generally remains February 1.
Electronic Filing of Form W-2G - File copies of all the Form W-2G (Certain Gambling Winnings) you issued for 2020. This due date applies only if you electronically file. The due date for giving the recipient these forms remains February 1.
Electronic Filing of Forms 8027 - File copies of all the Forms 8027 you issued for 2020. This due date applies only if you electronically file.
Electronic Filing of Forms 1094-C and 1095-C and Forms 1094-B and 1095-B - If you're an Applicable Large Employer, file electronic forms 1094-C and 1095-C with the IRS. For all other providers of minimum essential coverage, file electronic Forms 1094-B and 1095-B with the IRS.
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