Weekly Tax Brief
- Published: 24 May 2022 24 May 2022
Are you a partner in a business? You may have come across a situation that’s puzzling. In a given year, you may be taxed on more partnership income than was distributed to you from the partnership in which you’re a partner.
Why does this happen? It’s due to the way partnerships and partners are taxed. Unlike C corporations, partnerships aren’t subject to income tax. Instead, each partner is taxed on the partnership’s earnings — whether or not they’re distributed. Similarly, if a partnership has a loss, the loss is passed through to the partners. (However, various rules may prevent a partner from currently using his or her share of a partnership’s loss to offset other income.)
Pass through your share
While a partnership isn’t subject to income tax, it’s treated as a separate entity for purposes of determining its income, gains, losses, deductions and credits. This makes it possible to pass through to partners their share of these items.
An information return must be filed by a partnership. On Schedule K of Form 1065, the partnership separately identifies income, deductions, credits and other items. This is so that each partner can properly treat items that are subject to limits or other rules that could affect their correct treatment at the partner’s level. Examples of such items include capital gains and losses, interest expense on investment debts and charitable contributions. Each partner gets a Schedule K-1 showing his or her share of partnership items.
Basis and distribution rules ensure that partners aren’t taxed twice. A partner’s initial basis in his or her partnership interest (the determination of which varies depending on how the interest was acquired) is increased by his or her share of partnership taxable income. When that income is paid out to partners in cash, they aren’t taxed on the cash if they have sufficient basis. Instead, partners just reduce their basis by the amount of the distribution. If a cash distribution exceeds a partner’s basis, then the excess is taxed to the partner as a gain, which often is a capital gain.
Two people each contribute $10,000 to form a partnership. The partnership has $80,000 of taxable income in the first year, during which it makes no cash distributions to the two partners. Each of them reports $40,000 of taxable income from the partnership as shown on their K-1s. Each has a starting basis of $10,000, which is increased by $40,000 to $50,000. In the second year, the partnership breaks even (has zero taxable income) and distributes $40,000 to each of the two partners. The cash distributed to them is received tax-free. Each of them, however, must reduce the basis in his or her partnership interest from $50,000 to $10,000.
More rules and limits
The example and details above are an overview and, therefore, don’t cover all the rules. For example, many other events require basis adjustments and there are a host of special rules covering noncash distributions, distributions of securities, liquidating distributions and other matters. Contact us if you’d like to discuss how a partner is taxed.
- Published: 24 May 2022 24 May 2022
- Published: 18 May 2022 18 May 2022
Are you a charitably minded individual who is also taking distributions from a traditional IRA? You may want to consider the tax advantages of making a cash donation to an IRS-approved charity out of your IRA.
When distributions are taken directly out of traditional IRAs, federal income tax of up to 37% in 2022 will have to be paid. State income taxes may also be owed.
Qualified charitable distributions
One popular way to transfer IRA assets to charity is via a tax provision that allows IRA owners who are age 70½ or older to direct up to $100,000 per year of their IRA distributions to charity. These distributions are known as qualified charitable distributions (QCDs). The money given to charity counts toward your required minimum distributions (RMDs) but doesn’t increase your adjusted gross income (AGI) or generate a tax bill.
Keeping the donation out of your AGI may be important for several reasons. Here are some of them:
- It can help you qualify for other tax breaks. For example, having a lower AGI can reduce the threshold for deducting medical expenses, which are only deductible to the extent they exceed 7.5% of AGI.
- You can avoid rules that can cause some or all of your Social Security benefits to be taxed and some or all of your investment income to be hit with the 3.8% net investment income tax.
- It can help you avoid a high-income surcharge for Medicare Part B and Part D premiums, which kick in if AGI is over certain levels.
- The distributions going to the charity won’t be subject to federal estate tax and generally won’t be subject to state death taxes.
Important points: You can’t claim a charitable contribution deduction for a QCD not included in your income. Also keep in mind that the age after which you must begin taking RMDs is 72, but the age you can begin making QCDs is 70½.
To benefit from a QCD for 2022, you must arrange for a distribution to be paid directly from the IRA to a qualified charity by December 31, 2022. You can use QCDs to satisfy all or part of the amount of your RMDs from your IRA. For example, if your 2022 RMDs are $10,000, and you make a $5,000 QCD for 2022, you have to withdraw another $5,000 to satisfy your 2022 RMDs.
Other rules and limits may apply. Want more information? Contact us to see whether this strategy would be beneficial in your situation.
- Published: 17 May 2022 17 May 2022
Businesses should be aware that they may be responsible for issuing more information reporting forms for 2022 because more workers may fall into the required range of income to be reported. Beginning this year, the threshold has dropped significantly for the filing of Form 1099-K, “Payment Card and Third-Party Network Transactions.” Businesses and workers in certain industries may receive more of these forms and some people may even get them based on personal transactions.
Background of the change
Banks and online payment networks — payment settlement entities (PSEs) or third-party settlement organizations (TPSOs) — must report payments in a trade or business to the IRS and recipients. This is done on Form 1099-K. These entities include Venmo and CashApp, as well as gig economy facilitators such as Uber and TaskRabbit.
A 2021 law dropped the minimum threshold for PSEs to file Form 1099-K for a taxpayer from $20,000 of reportable payments made to the taxpayer and 200 transactions to $600 (the same threshold applicable to other Forms 1099) starting in 2022. The lower threshold for filing 1099-K forms means many participants in the gig economy will be getting the forms for the first time.
Members of Congress have introduced bills to raise the threshold back to $20,000 and 200 transactions, but there’s no guarantee that they’ll pass. In addition, taxpayers should generally be reporting income from their side employment engagements, whether it’s reported to the IRS or not. For example, freelancers who make money creating products for an Etsy business or driving for Uber should have been paying taxes all along. However, Congress and the IRS have said this responsibility is often ignored. In some cases, taxpayers may not even be aware that income from these sources is taxable.
Some taxpayers may first notice this change when they receive their Forms 1099-K in January 2023. However, businesses should be preparing during 2022 to minimize the tax consequences of the gross amount of Form 1099-K reportable payments.
What to do now
Taxpayers should be reviewing gig and other reportable activities. Make sure payments are being recorded accurately. Payments received in a trade or business should be reported in full so that workers can withhold and pay taxes accordingly.
If you receive income from certain activities, you may want to increase your tax withholding or, if necessary, make estimated tax payments or larger payments to avoid penalties.
Separate personal payments and track deductions
Taxpayers should separate taxable gross receipts received through a PSE that are income from personal expenses, such as splitting the check at a restaurant or giving a gift. PSEs can’t necessarily distinguish between personal expenses and business payments, so taxpayers should maintain separate accounts for each type of payment.
Keep in mind that taxpayers who haven’t been reporting all income from gig work may not have been documenting all deductions. They should start doing so now to minimize the taxable income recognized due to the gross receipts reported on Form 1099-K. The IRS is likely to take the position that all of a taxpayer’s gross receipts reported on Form 1099-K are income and won’t allow deductions unless the taxpayer substantiates them. Deductions will vary based on the nature of the taxpayer’s work.
Contact us if you have questions about your Form 1099-K responsibilities.
- Published: 12 May 2022 12 May 2022
Taking care of an elderly parent or grandparent may provide more than just personal satisfaction. You could also be eligible for tax breaks. Here’s a rundown of some of them.
1. Medical expenses. If the individual qualifies as your “medical dependent,” and you itemize deductions on your tax return, you can include any medical expenses you incur for the individual along with your own when determining your medical deduction. The test for determining whether an individual qualifies as your “medical dependent” is less stringent than that used to determine whether an individual is your “dependent,” which is discussed below. In general, an individual qualifies as a medical dependent if you provide over 50% of his or her support, including medical costs.
However, bear in mind that medical expenses are deductible only to the extent they exceed 7.5% of your adjusted gross income (AGI).
The costs of qualified long-term care services required by a chronically ill individual and eligible long-term care insurance premiums are included in the definition of deductible medical expenses. There’s an annual cap on the amount of premiums that can be deducted. The cap is based on age, going as high as $5,640 for 2022 for an individual over 70.
2. Filing status. If you aren’t married, you may qualify for “head of household” status by virtue of the individual you’re caring for. You can claim this status if:
- The person you’re caring for lives in your household,
- You cover more than half the household costs,
- The person qualifies as your “dependent,” and
- The person is a relative.
If the person you’re caring for is your parent, the person doesn’t need to live with you, so long as you provide more than half of the person’s household costs and the person qualifies as your dependent. A head of household has a higher standard deduction and lower tax rates than a single filer.
3. Tests for determining whether your loved one is a “dependent.” Dependency exemptions are suspended (or disallowed) for 2018–2025. Even though the dependency exemption is currently suspended, the dependency tests still apply when it comes to determining whether a taxpayer is entitled to various other tax benefits, such as head-of-household filing status.
For an individual to qualify as your “dependent,” the following must be true for the tax year at issue:
- You must provide more than 50% of the individual’s support costs,
- The individual must either live with you or be related,
- The individual must not have gross income in excess of an inflation-adjusted exemption amount,
- The individual can’t file a joint return for the year, and
- The individual must be a U.S. citizen or a resident of the U.S., Canada or Mexico.
4. Dependent care credit. If the cared-for individual qualifies as your dependent, lives with you, and physically or mentally can’t take care of him- or herself, you may qualify for the dependent care credit for costs you incur for the individual’s care to enable you and your spouse to go to work.
Contact us if you’d like to further discuss the tax aspects of financially supporting and caring for an elderly relative.
- Published: 11 May 2022 11 May 2022
The IRS recently released guidance providing the 2023 inflation-adjusted amounts for Health Savings Accounts (HSAs). High inflation rates will result in next year’s amounts being increased more than they have been in recent years.
An HSA is a trust created or organized exclusively for the purpose of paying the “qualified medical expenses” of an “account beneficiary.” An HSA can only be established for the benefit of an “eligible individual” who is covered under a “high deductible health plan.” In addition, a participant can’t be enrolled in Medicare or have other health coverage (exceptions include dental, vision, long-term care, accident and specific disease insurance).
A high deductible health plan (HDHP) is generally a plan with an annual deductible that isn’t less than $1,000 for self-only coverage and $2,000 for family coverage. In addition, the sum of the annual deductible and other annual out-of-pocket expenses required to be paid under the plan for covered benefits (but not for premiums) can’t exceed $5,000 for self-only coverage, and $10,000 for family coverage.
Within specified dollar limits, an above-the-line tax deduction is allowed for an individual’s contribution to an HSA. This annual contribution limitation and the annual deductible and out-of-pocket expenses under the tax code are adjusted annually for inflation.
Inflation adjustments for next year
In Revenue Procedure 2022-24, the IRS released the 2023 inflation-adjusted figures for contributions to HSAs, which are as follows:
Annual contribution limitation. For calendar year 2023, the annual contribution limitation for an individual with self-only coverage under an HDHP will be $3,850. For an individual with family coverage, the amount will be $7,750. This is up from $3,650 and $7,300, respectively, for 2022.
In addition, for both 2022 and 2023, there’s a $1,000 catch-up contribution amount for those who are age 55 and older at the end of the tax year.
High deductible health plan defined. For calendar year 2023, an HDHP will be a health plan with an annual deductible that isn’t less than $1,500 for self-only coverage or $3,000 for family coverage (these amounts are $1,400 and $2,800 for 2022). In addition, annual out-of-pocket expenses (deductibles, co-payments, and other amounts, but not premiums) won’t be able to exceed $7,500 for self-only coverage or $15,000 for family coverage (up from $7,050 and $14,100, respectively, for 2022).
Reap the rewards
There are a variety of benefits to HSAs. Contributions to the accounts are made on a pre-tax basis. The money can accumulate tax free year after year and can be withdrawn tax free to pay for a variety of medical expenses such as doctor visits, prescriptions, chiropractic care and premiums for long-term care insurance. In addition, an HSA is “portable.” It stays with an account holder if he or she changes employers or leaves the workforce. If you have questions about HSAs at your business, contact your employee benefits and tax advisors.
- Published: 05 May 2022 05 May 2022
If you donate valuable items to charity, you may be required to get an appraisal. The IRS requires donors and charitable organizations to supply certain information to prove their right to deduct charitable contributions. If you donate an item of property (or a group of similar items) worth more than $5,000, certain appraisal requirements apply. You must:
- Get a “qualified appraisal,”
- Receive the qualified appraisal before your tax return is due,
- Attach an “appraisal summary” to the first tax return on which the deduction is claimed,
- Include other information with the return, and
- Maintain certain records.
Keep these definitions in mind. A qualified appraisal is a complex and detailed document. It must be prepared and signed by a qualified appraiser. An appraisal summary is a summary of a qualified appraisal made on Form 8283 and attached to the donor’s return.
While courts have allowed taxpayers some latitude in meeting the “qualified appraisal” rules, you should aim for exact compliance.
The qualified appraisal isn’t submitted separately to the IRS in most cases. Instead, the appraisal summary, which is a separate statement prepared on an IRS form, is attached to the donor’s tax return. However, a copy of the appraisal must be attached for gifts of art valued at $20,000 or more and for all gifts of property valued at more than $500,000, other than inventory, publicly traded stock and intellectual property. If an item has been appraised at $50,000 or more, you can ask the IRS to issue a “Statement of Value” that can be used to substantiate the value.
Failure to comply with the requirements
The penalty for failing to get a qualified appraisal and attach an appraisal summary to the return is denial of the charitable deduction. The deduction may be lost even if the property was valued correctly. There may be relief if the failure was due to reasonable cause.
Exceptions to the requirement
A qualified appraisal isn’t required for contributions of:
- A car, boat or airplane for which the deduction is limited to the charity’s gross sales proceeds,
- stock in trade, inventory or property held primarily for sale to customers in the ordinary course of business,
- publicly traded securities for which market quotations are “readily available,” and
- qualified intellectual property, such as a patent.
Also, only a partially completed appraisal summary must be attached to the tax return for contributions of:
- Nonpublicly traded stock for which the claimed deduction is greater than $5,000 and doesn’t exceed $10,000, and
- Publicly traded securities for which market quotations aren’t “readily available.”
More than one gift
If you make gifts of two or more items during a tax year, even to multiple charitable organizations, the claimed values of all property of the same category or type (such as stamps, paintings, books, stock that isn’t publicly traded, land, jewelry, furniture or toys) are added together in determining whether the $5,000 or $10,000 limits are exceeded.
The bottom line is you must be careful to comply with the appraisal requirements or risk disallowance of your charitable deduction. Contact us if you have any further questions or want to discuss your contribution planning.
- Published: 03 May 2022 03 May 2022
The IRS has begun mailing notices to businesses, financial institutions and other payers that filed certain returns with information that doesn’t match the agency’s records.
These CP2100 and CP2100A notices are sent by the IRS twice a year to payers who filed information returns that are missing a Taxpayer Identification Number (TIN), have an incorrect name or have a combination of both.
Each notice has a list of persons who received payments from the business with identified TIN issues.
If you receive one of these notices, you need to compare the accounts listed on the notice with your records and correct or update your records, if necessary. This can also include correcting backup withholding on payments made to payees.
Which returns are involved?
Businesses, financial institutions and other payers are required to file with the IRS various information returns reporting certain payments they make to independent contractors, customers and others. These information returns include:
- Form 1099-B, Proceeds from Broker and Barter Exchange Transactions,
- Form 1099-DIV, Dividends and Distributions,
- Form 1099-INT, Interest Income,
- Form 1099-K, Payment Card and Third-Party Network Transactions,
- Form 1099-MISC, Miscellaneous Income,
- Form 1099-NEC, Nonemployee Compensation, and
- Form W-2G, Certain Gambling Winnings.
Do you have backup withholding responsibilities?
The CP2100 and CP2100A notices also inform recipients that they’re responsible for backup withholding. Payments reported on the information returns listed above are subject to backup withholding if:
- The payer doesn’t have the payee’s TIN when making payments that are required to be reported.
- The individual receiving payments doesn’t certify his or her TIN as required.
- The IRS notifies the payer that the individual receiving payments furnished an incorrect TIN.
- The IRS notifies the payer that the individual receiving payments didn’t report all interest and dividends on his or her tax return.
Do you have to report payments to independent contractors?
By January first of the following year, payers must complete Form 1099-NEC, “Nonemployee Compensation,” to report certain payments made to recipients. If the following four conditions are met, you must generally report payments as nonemployee compensation:
- You made a payment to someone who isn’t your employee,
- You made a payment for services in the course of your trade or business,
- You made a payment to an individual, partnership, estate, or, in some cases, a corporation, and
- You made payments to a recipient of at least $600 during the year.
Contact us if you receive a CP2100 or CP2100A notice from the IRS or if you have questions about filing Form 1099-NEC. We can help you stay in compliance with all rules.
- Published: 28 April 2022 28 April 2022
Like many people, you may have dreamed of turning a hobby into a regular business. You won’t have any tax headaches if your new business is profitable. But what if the new enterprise consistently generates losses (your deductions exceed income) and you claim them on your tax return? You can generally deduct losses for expenses incurred in a bona fide business. However, the IRS may step in and say the venture is a hobby — an activity not engaged in for profit — rather than a business. Then you’ll be unable to deduct losses.
By contrast, if the new enterprise isn’t affected by the hobby loss rules because it’s profitable, all otherwise allowable expenses are deductible on Schedule C, even if they exceed income from the enterprise.
Note: Before 2018, deductible hobby expenses had to be claimed as miscellaneous itemized deductions subject to a 2%-of-AGI “floor.” However, because miscellaneous deductions aren’t allowed from 2018 through 2025, deductible hobby expenses are effectively wiped out from 2018 through 2025.
Avoiding a hobby designation
There are two ways to avoid the hobby loss rules:
- Show a profit in at least three out of five consecutive years (two out of seven years for breeding, training, showing or racing horses).
- Run the venture in such a way as to show that you intend to turn it into a profit-maker, rather than operate it as a mere hobby. The IRS regs themselves say that the hobby loss rules won’t apply if the facts and circumstances show that you have a profit-making objective.
How can you prove you have a profit-making objective? You should run the venture in a businesslike manner. The IRS and the courts will look at the following factors:
- How you run the activity,
- Your expertise in the area (and your advisors’ expertise),
- The time and effort you expend in the enterprise,
- Whether there’s an expectation that the assets used in the activity will rise in value,
- Your success in carrying on other activities,
- Your history of income or loss in the activity,
- The amount of any occasional profits earned,
- Your financial status, and
- Whether the activity involves elements of personal pleasure or recreation.
Recent court case
In one U.S. Tax Court case, a married couple’s miniature donkey breeding activity was found to be conducted with a profit motive. The IRS had earlier determined it was a hobby and the couple was liable for taxes and penalties for the two tax years in which they claimed losses of more than $130,000. However, the court found the couple had a business plan, kept separate records and conducted the activity in a businesslike manner. The court stated they were “engaged in the breeding activity with an actual and honest objective of making a profit.” (TC Memo 2021-140)
Contact us for more details on whether a venture of yours may be affected by the hobby loss rules, and what you should do to avoid a tax challenge.
- Published: 27 April 2022 27 April 2022
There are many rules that can potentially apply to the sale of business property. Thus, to simplify discussion, let’s assume that the property you want to sell is land or depreciable property used in your business, and has been held by you for more than a year. (There are different rules for property held primarily for sale to customers in the ordinary course of business; intellectual property; low-income housing; property that involves farming or livestock; and other types of property.)
Under the Internal Revenue Code, your gains and losses from sales of business property are netted against each other. The net gain or loss qualifies for tax treatment as follows:
1) If the netting of gains and losses results in a net gain, then long-term capital gain treatment results, subject to “recapture” rules discussed below. Long-term capital gain treatment is generally more favorable than ordinary income treatment.
2) If the netting of gains and losses results in a net loss, that loss is fully deductible against ordinary income (in other words, none of the rules that limit the deductibility of capital losses apply).
The availability of long-term capital gain treatment for business property net gain is limited by “recapture” rules — that is, rules under which amounts are treated as ordinary income rather than capital gain because of previous ordinary loss or deduction treatment for these amounts.
There’s a special recapture rule that applies only to business property. Under this rule, to the extent you’ve had a business property net loss within the previous five years, any business property net gain is treated as ordinary income instead of as long-term capital gain.
Section 1245 Property
“Section 1245 Property” consists of all depreciable personal property, whether tangible or intangible, and certain depreciable real property (usually, real property that performs specific functions). If you sell Section 1245 Property, you must recapture your gain as ordinary income to the extent of your earlier depreciation deductions on the asset.
Section 1250 Property
“Section 1250 Property” consists, generally, of buildings and their structural components. If you sell Section 1250 Property that was placed in service after 1986, none of the long-term capital gain attributable to depreciation deductions will be subject to depreciation recapture. However, for most noncorporate taxpayers, the gain attributable to depreciation deductions, to the extent it doesn’t exceed business property net gain, will (as reduced by the business property recapture rule above) be taxed at a rate of no more than 28.8% (25% as adjusted for the 3.8% net investment income tax) rather than the maximum 23.8% rate (20% as adjusted for the 3.8% net investment income tax) that generally applies to long-term capital gains of noncorporate taxpayers.
Other rules may apply to Section 1250 Property, depending on when it was placed in service.
As you can see, even with the simplifying assumptions in this article, the tax treatment of the sale of business assets can be complex. Contact us if you’d like to determine the tax consequences of specific transactions or if you have any additional questions.