Weekly Tax Brief

The IRS clarifies what counts as qualified medical expenses

Details: Published: 02 May 2023 02 May 2023

If you itemize deductions on your tax return, you may wonder: What medical expenses can I include? The IRS recently issued some frequently asked questions addressing when certain costs are qualified medical expenses for federal income tax purposes.

Basic rules and IRS clarifications

You can claim an itemized deduction for qualified medical expenses that exceed 7.5% of your adjusted gross income. You can also take tax-free health savings account (HSA), health care flexible spending account (FSA) or health reimbursement account (HRA) withdrawals to cover qualified medical expenses. However, qualified medical expenses don’t include those for things that are merely beneficial to your general health.

The answers to the IRS FAQs clarify the following points, starting with the ones we think are most interesting.

As a general rule, the costs of over-the-counter (non-prescription) drugs don’t count as qualified medical expenses. However, the cost of insulin is eligible. Over-the-counter drugs and menstrual care products can be reimbursed tax-free by an HSA, medical expense FSA, or HRA, but the costs don’t count as qualified medical expenses for medical expense deduction purposes.
If you pay for nutritional counseling, the cost is a qualified medical expense only if it treats a specific disease diagnosed by a physician, such as obesity or diabetes.
The cost of a weight-loss program is also a qualified medical expense only if it treats a specific disease diagnosed by a physician such as obesity, diabetes, hypertension or heart disease.
Gym membership costs are qualified medical expenses only if the gym is for the sole purpose of: 1) affecting a structure or function of the body, such as part of a prescribed plan for physical therapy to treat an injury or 2) treating a specific disease diagnosed by a physician such as obesity, hypertension or heart disease. However, the cost of an exercise program that improves general health, such as swimming or dancing, isn’t eligible even if it’s recommended by a doctor.
Food or beverages purchased for weight loss or other health reasons are qualified medical expenses only if the food or beverages: 1) don’t satisfy normal nutritional needs, 2) alleviate or treat an illness and 3) are needed according to a physician. Even if all of these requirements are met, the amount that can be treated as a qualified medical expense is limited to the amount by which the cost of the food or beverages exceeds the cost of products that satisfy normal nutritional needs.
The costs of nutritional supplements are qualified only if they’re recommended as treatment for a specific medical condition diagnosed by a physician.
Smoking cessation program costs are qualified medical expenses because they treat the disease of tobacco use disorder. Similarly, the amounts paid for programs to treat drug and alcohol abuse are qualified medical expenses because they treat the diseases of substance use and alcohol use disorders.
The cost of therapy for treatment of a disease is a qualified medical expense. For example, the cost of therapy to treat a diagnosed mental illness is eligible, but the cost of marital counseling isn’t.
Unsurprisingly, the costs of dental exams, eye exams and physical exams are qualified medical expenses because they provide a diagnosis of whether a disease or illness is present.

Count all eligible expenses

If you meet or are close to the threshold to deduct medical expenses, you want to count every one that’s eligible. Be sure to save documentation and we can evaluate expenses when we prepare your tax return.

Some taxpayers qualify for more favorable “head of household” tax filing status

Details: Published: 30 March 2023 30 March 2023

When preparing your tax return, we’ll check one of the following statuses: Single, married filing jointly, married filing separately, head of household or qualifying widow(er). Filing a return as a head of household is more favorable than filing as a single taxpayer.

For example, the 2023 standard deduction for a single taxpayer is $13,850 while it’s $20,800 for a head of household taxpayer. To be eligible, you must maintain a household, which for more than half the year, is the principal home of a “qualifying child” or other relative of yours whom you can claim as a dependent.

Basic rules

Who is a qualifying child? This is a child who:

Lives in your home for more than half the year,
Is your child, stepchild, adopted child, foster child, sibling, stepsibling (or a descendant of any of these),
Is under age 19 (or a student under 24), and
Doesn’t provide over half of his or her own support for the year.

If the parents are divorced, the child will qualify if he or she meets these tests for the custodial parent — even if that parent released his or her right to a dependency exemption for the child to the noncustodial parent.

A person isn’t a “qualifying child” if he or she is married and can’t be claimed by you as a dependent because he or she filed jointly or isn’t a U.S. citizen or resident. Special “tie-breaking” rules apply if the individual can be a qualifying child of more than one taxpayer.

You’re considered to “maintain a household” if you live in the home for the tax year and pay over half the cost of running it. In measuring the cost, include house-related expenses incurred for the mutual benefit of household members, including property taxes, mortgage interest, rent, utilities, insurance on the property, repairs and upkeep, and food consumed in the home. Don’t include items such as medical care, clothing, education, life insurance or transportation.

Maintaining a home for a parent

Under a special rule, you can qualify as head of household if you maintain a home for a parent of yours even if you don’t live with the parent. To qualify under this rule, you must be able to claim the parent as your dependent.

Marital status

You must be unmarried to claim head of household status. If you’re unmarried because you’re widowed, you can use the married filing jointly rates as a “surviving spouse” for two years after the year of your spouse’s death if your dependent child, stepchild, adopted child, or foster child lives with you and you “maintain” the household. The joint rates are more favorable than the head of household rates.

If you’re married, you must file either as married filing jointly or separately — not as head of household. However, if you’ve lived apart from your spouse for the last six months of the year and your dependent child, stepchild, adopted child, or foster child lives with you and you “maintain” the household, you’re treated as unmarried. If this is the case, you can qualify as head of household.

We can answer questions if you’d like to discuss a particular situation or would like additional information about whether someone qualifies as your dependent.

Some taxpayers qualify for more favorable “head of household” tax filing status

Details: Published: 30 March 2023 30 March 2023

Choosing an entity for your business? How about an S corporation?

Details: Published: 29 March 2023 29 March 2023

If you’re starting a business with some partners and wondering what type of entity to form, an S corporation may be the most suitable form of business for your new venture. Here are some of the reasons why.

A big benefit of an S corporation over a partnership is that as S corporation shareholders, you won’t be personally liable for corporate debts. In order to receive this protection, it’s important that:

The corporation be adequately financed,
The existence of the corporation as a separate entity be maintained, and
Various formalities required by your state be observed (for example, filing articles of incorporation, adopting by-laws, electing a board of directors and holding organizational meetings).

Dealing with losses

If you expect that the business will incur losses in its early years, an S corporation is preferable to a C corporation from a tax standpoint. Shareholders in a C corporation generally get no tax benefit from such losses. In contrast, as S corporation shareholders, each of you can deduct your percentage share of losses on your personal tax return to the extent of your basis in the stock and in any loans you made to the entity. Losses that can’t be deducted because they exceed your basis are carried forward and can be deducted by you in the future when there’s sufficient basis.

Once the S corporation begins to earn profits, the income will be taxed directly to you whether or not it’s distributed. It will be reported on your individual tax return and be aggregated with income from other sources. Your share of the S corporation’s income won’t be subject to self-employment tax, but your wages will be subject to Social Security taxes. To the extent the income is passed through to you as qualified business income (QBI), you’ll be eligible to take the 20% pass-through deduction, subject to various limitations.

Note: Unless Congress acts to extend it, the QBI deduction is scheduled to expire after 2025.

If you’re planning to provide fringe benefits such as health and life insurance, you should be aware that the costs of providing such benefits to a more than 2% shareholder are deductible by the entity but are taxable to the recipient.

Protecting S status

Also be aware that the S corporation could inadvertently lose its S status if you or your partners transfer stock to an ineligible shareholder such as another corporation, a partnership or a nonresident alien. If the S election was terminated, the corporation would become a taxable entity. You would not be able to deduct any losses and earnings could be subject to double taxation — once at the corporate level and again when distributed to you. In order to protect against this risk, it’s a good idea for each shareholder to sign an agreement promising not to make any transfers that would jeopardize the S election.

Before finalizing your choice of entity, consult with us. We can answer any questions you have and assist in launching your new venture.

Two important tax deadlines are coming up — and they don’t involve filing your 2022 tax return

Details: Published: 24 March 2023 24 March 2023

April 18 is the deadline for filing your 2022 tax return. But a couple of other tax deadlines are coming up in April and they’re important for certain taxpayers:

Saturday, April 1 is the last day to begin receiving required minimum distributions (RMDs) from IRAs, 401(k)s and similar workplace plans for taxpayers who turned 72 during 2022.
Tuesday, April 18 is the deadline for making the first quarterly estimated tax payment for 2023, if you’re required to make one.

Here are the basic details about these two deadlines.

Taking a first RMD

RMDs are normally made by the end of the year. But anyone who reached age 72 during 2022 is covered by a special rule that allows IRA account owners and participants in workplace retirement plans to wait until as late as April 1, 2023, to take their first RMD. For an IRA, you must take your first RMD by April 1 of the year following the year in which you turn 72, regardless of whether you’re still employed.

You may have heard the age for beginning RMDs went up. Under the Setting Every Community Up for Retirement Enhancement 2.0 Act (SECURE 2.0), the age distributions must begin increased from age 72 to age 73 starting on January 1, 2023. But if you turned 72 during 2022, you must take your first RMD by April 1.

If your RMDs in any year are less than the required amount for that year, you’ll generally be subject to a penalty.

Making estimated tax payments

You may have to make estimated tax payments for 2023 if you receive interest, dividends, alimony, self-employment income, capital gains or other income. If you don’t pay enough tax during the year through withholding and estimated payments, you may be liable for a tax penalty on top of the tax that’s ultimately due.

Individuals must pay 25% of their “required annual payment” by April 15, June 15, September 15, and January 15 of the following year, to avoid an underpayment penalty. If one of those dates falls on a weekend or holiday, the payment is due the next business day. For example, this year the filing deadline is April 18 for most taxpayers because April 15 falls on a Saturday and April 17 is a holiday in the District of Columbia.

The required annual payment for most individuals is the lower of 90% of the tax shown on the current year’s return or 100% of the tax shown on the return for the previous year. However, if the adjusted gross income on your previous year’s return was more than $150,000 ($75,000 if you’re married filing separately), you must pay the lower of 90% of the tax shown on the current year’s return or 110% of the tax shown on the return for the previous year.

Generally, people who receive most of their income in the form of wages satisfy these payment requirements through the tax withheld from their paychecks by their employers. Those who make estimated tax payments generally do so in four installments. After determining the required annual payment, they divide that number by four and make four equal payments by the due dates.

But you may be able to use the annualized income method to make smaller payments. This method is useful to people whose income isn’t uniform over the year, for example because they’re involved in a seasonal business.

Staying on track

Contact us if you have questions about RMDs and estimated tax payments. We can help you stay on track so you aren’t liable for penalties.

2023 Q2 tax calendar: Key deadlines for businesses and employers

Details: Published: 21 March 2023 21 March 2023

Here are some of the key tax-related deadlines that apply to businesses and other employers during the second quarter of 2023. Keep in mind that this list isn’t all-inclusive, so there may be additional deadlines that apply to you. Contact us to ensure you’re meeting all applicable deadlines and to learn more about the filing requirements.

April 18

If you’re a calendar-year corporation, file a 2022 income tax return (Form 1120) or file for an automatic six-month extension (Form 7004) and pay any tax due.
For corporations pay the first installment of 2023 estimated income taxes.
For individuals, file a 2022 income tax return (Form 1040 or Form 1040-SR) or file for an automatic six-month extension (Form 4868) and pay any tax due.
For individuals, pay the first installment of 2023 estimated taxes, if you don’t pay income tax through withholding (Form 1040-ES).

May 1

Employers report income tax withholding and FICA taxes for the first quarter of 2023 (Form 941) and pay any tax due.

May 10

Employers report income tax withholding and FICA taxes for the first quarter of 2023 (Form 941), if they deposited on time and fully paid all of the associated taxes due.

June 15

Corporations pay the second installment of 2023 estimated income taxes.

The 2022 gift tax return deadline is coming up soon

Details: Published: 16 March 2023 16 March 2023

Did you make large gifts to your children, grandchildren or other heirs last year? If so, it’s important to determine whether you’re required to file a 2022 gift tax return. And in some cases, even if it’s not required to file one, you may want to do so anyway.

Filing requirements

The annual gift tax exclusion has increased in 2023 to $17,000 but was $16,000 for 2022. Generally, you must file a gift tax return for 2022 if, during the tax year, you made gifts:

That exceeded the $16,000-per-recipient gift tax annual exclusion for 2022 (other than to your U.S. citizen spouse),
That you wish to split with your spouse to take advantage of your combined $32,000 annual exclusion for 2022,
That exceeded the $164,000 annual exclusion in 2022 for gifts to a noncitizen spouse,
To a Section 529 college savings plan and wish to accelerate up to five years’ worth of annual exclusions ($80,000) into 2022,
Of future interests — such as remainder interests in a trust — regardless of the amount, or
Of jointly held or community property.

Keep in mind that you’ll owe gift tax only to the extent that an exclusion doesn’t apply and you’ve used up your lifetime gift and estate tax exemption ($12.06 million in 2022). As you can see, some transfers require a return even if you don’t owe tax.

You might want to file anyway

No gift tax return is required if your gifts for 2022 consisted solely of gifts that are tax-free because they qualify as:

Annual exclusion gifts,
Present interest gifts to a U.S. citizen spouse,
Educational or medical expenses paid directly to a school or health care provider, or
Political or charitable contributions.

But if you transferred hard-to-value property, such as artwork or interests in a family-owned business, you should consider filing a gift tax return even if you’re not required to. Adequate disclosure of the transfer in a return triggers the statute of limitations, generally preventing the IRS from challenging your valuation more than three years after you file.

The deadline is April 18

The gift tax return deadline is the same as the income tax filing deadline. For 2022 returns, it’s April 18, 2023 — or October 16, 2023, if you file for an extension. But keep in mind that, if you owe gift tax, the payment deadline is April 18, regardless of whether you file for an extension. If you’re not sure whether you must (or should) file a 2022 gift tax return, contact us.

Changes in Sec. 174 make it a good time to review the R&E strategy of your business

Details: Published: 14 March 2023 14 March 2023

It’s been years since the Tax Cuts and Jobs Act (TCJA) of 2017 was signed into law, but it’s still having an impact. Several provisions in the law have expired or will expire in the next few years. One provision that took effect last year was the end of current deductibility for research and experimental (R&E) expenses.

R&E expenses

The TCJA has affected many businesses, including manufacturers, that have significant R&E costs. Starting in 2022, Internal Revenue Code Section 174 R&E expenditures must be capitalized and amortized over five years (15 years for research conducted outside the United States). Previously, businesses had the option of deducting these costs immediately as current expenses.

The TCJA also expanded the types of activities that are considered R&E for purposes of IRC Sec. 174. For example, software development costs are now considered R&E expenses subject to the amortization requirement.

Potential strategies

Businesses should consider the following strategies for minimizing the impact of these changes:

Analyze costs carefully to identify those that constitute R&E expenses and those that are properly characterized as other types of expenses (such as general business expenses under IRC Sec. 162) that continue to qualify for immediate deduction.
If cost-effective, move foreign research activities to the United States to take advantage of shorter amortization periods.
If cost-effective, purchase software that’s immediately deductible, rather than developing it in-house, which is now considered an amortizable R&E expense.
Revisit the R&E credit if you haven’t been taking advantage of it.

Recent IRS guidance

For 2022 tax returns, the IRS recently released guidance for taxpayers to change the treatment of R&E expenses (Revenue Procedure 2023-11). The guidance provides a way to obtain automatic consent under the tax code to change methods of accounting for specified research or experimental expenditures under Sec. 174, as amended by the TCJA. This is important because unless there’s an exception provided under tax law, a taxpayer must secure the consent of the IRS before changing a method of accounting for federal income tax purposes.

The recent revenue procedure also provides a transition rule for taxpayers who filed a tax return on or before January 17, 2023.

Planning ahead

We can advise you how to proceed. There have also been proposals in Congress that would eliminate the amortization requirements. However, so far, they’ve been unsuccessful. We’re monitoring legislative developments and can help adjust your tax strategies if there’s a change in the law.

Claiming losses on depreciated or worthless stock

Details: Published: 10 March 2023 10 March 2023

Have you bought stock in a company that later dropped in value? While you may prefer to forget such an ill-fated investment, at least you can claim a capital loss deduction on your tax return. Here are the rules that apply when a stock you own is sold at a loss or becomes completely worthless.

Stock sales produce capital losses

Stocks are capital assets and produce capital gains or losses when they’re sold. Your capital gains and losses for the year must be netted against one another in a specific order, based on whether they’re short-term (held one year or less) or long-term (held for more than one year).

If, after netting, you have short-term or long-term losses (or both), you can use them to offset up to $3,000 of ordinary income ($1,500 for married taxpayers filing separately). Any loss in excess of this limit is carried forward to later years, until all of it is either offset against capital gains or deducted against ordinary income in those years, subject to the $3,000 limit. If you have both net short-term losses and net long-term losses, the net short-term losses are used to offset ordinary income before the net long-term losses are used.

If you’ve realized capital gains during the year from stock or other asset sales, consider selling some of your losing positions to offset the gains. A good tax strategy is to sell enough losing stock to shelter your earlier gains and generate a $3,000 loss, since this is the maximum loss that can be used to offset ordinary income each year.

Wash sale rule

If you believe that a stock you own will recover but want to sell now in order to lock in a tax loss, be aware of the wash sale rule. Under it, if you sell stock at a loss and buy substantially identical stock back within the 30-day period before or after the sale date, you can’t claim the loss for tax purposes. In order to claim the loss, you must buy the new shares outside of the period that begins 30 days before and ends 30 days after the sale of the loss stock.

Worthless stock

In some cases, stock you own may have become completely worthless. If so, you can claim a loss equal to your basis in the stock, which is generally what you paid for it. The stock is treated as though it had been sold on the last day of the tax year. This date is important because it determines whether your capital loss is long-term or short-term.

Stock shares become worthless when they have no liquidation value, because the corporation’s liabilities exceed its assets, and no potential value, because the business has no reasonable hope of becoming profitable. A stock can be worthless even if the corporation hasn’t declared bankruptcy. Conversely, stock may still have value even after a bankruptcy filing, if the corporation continues operating and the stock continues trading.

You may not discover that a stock has become worthless until after you’ve filed your tax return for the year of worthlessness. In that case, you can amend your return for that year to claim a credit or refund due to the loss. This can be done for seven years from the date your original return was due, or two years from the date you paid the tax, whichever is later.

Special situation

Other rules may apply. For example, if you’re a victim of a Ponzi-type investment scheme, you may be able to mitigate your financial loss by taking advantage of special tax relief available. Let us know if you have any questions.

Protect the “ordinary and necessary” advertising expenses of your business

Details: Published: 06 March 2023 06 March 2023

Under tax law, businesses can generally deduct advertising and marketing expenses that help keep existing customers and bring in new ones. This valuable tax deduction can help businesses cut their taxes.

However, in order to be deductible, advertising and marketing expenses must be “ordinary and necessary.” As one taxpayer recently learned in U.S. Tax Court, not all expenses are eligible. An ordinary expense is one that’s common and accepted in the industry. And a necessary expense is one that’s helpful and appropriate for the business.

According to the IRS, here are some advertising expenses that are usually deductible:

Reasonable advertising expenses that are directly related to the business activities.
An expense for the cost of institutional or goodwill advertising to keep the business name before the public if it relates to a reasonable expectation to gain business in the future. For example, the cost of advertising that encourages people to contribute to the Red Cross or to participate in similar causes is usually deductible.
The cost of providing meals, entertainment, or recreational facilities to the public as a means of advertising or promoting goodwill in the community.

Facts of the recent case

An attorney deducted his car-racing expenses and claimed they were advertising for his personal injury law practice. He contended that his racing expenses, totaling over $303,000 for six tax years, were deductible as advertising because the car he raced was sponsored by his law firm.

The IRS denied the deductions and argued that the attorney’s car racing wasn’t an ordinary and necessary expense paid or incurred while carrying on his business of practicing law. The Tax Court agreed with the IRS.

When making an ordinary and necessary determination for an expense, most courts look to the taxpayer’s primary motive for incurring the expense and whether there’s a “proximate” relationship between the expense and the taxpayer’s occupation. In this case, the taxpayer's car-racing expenses were neither necessary nor common for a law practice, so there was no “proximate” relationship between the expense and the taxpayer’s occupation. And, while the taxpayer said his primary motive for incurring the expense was to advertise his law business, he never raced in the state where his primary law practice was located and he never actually got any legal business from his car-racing activity.

The court noted that the car “sat in his garage” after he returned to the area where his law practice was located. The court added that even if the taxpayer raced in that area, “we would not find his expenses to be legitimate advertising expenses. His name and a decal for his law firm appeared in relatively small print” on his car.

This form of “signage,” the court stated, “is at the opposite end of the spectrum from (say) a billboard or a newspaper ad. Indeed, every driver’s name typically appeared on his or her racing car.” (TC Memo 2023-18)

Keep meticulous records

There are no deductions allowed for personal expenses or hobbies. But as explained above, you can deduct ordinary and necessary advertising and marketing expenses in a bona fide business. The key to protecting your deductions is to keep meticulous records to substantiate them. Contact us with questions about your situation.

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