Weekly Tax Brief

Is it a good time for a Roth conversion?

Details: Published: 02 June 2022 02 June 2022

The downturn in the stock market may have caused the value of your retirement account to decrease. But if you have a traditional IRA, this decline may provide a valuable opportunity: It may allow you to convert your traditional IRA to a Roth IRA at a lower tax cost.

Traditional vs. Roth

Here’s what makes a traditional IRA different from a Roth IRA:

Traditional IRA. Contributions to a traditional IRA may be deductible, depending on your modified adjusted gross income (MAGI) and whether you (or your spouse) participate in a qualified retirement plan, such as a 401(k). Funds in the account can grow tax deferred.

On the downside, you generally must pay income tax on withdrawals. In addition, you’ll face a penalty if you withdraw funds before age 59½ — unless you qualify for a handful of exceptions — and you’ll face an even larger penalty if you don’t take your required minimum distributions (RMDs) after age 72.

Roth IRA. Roth IRA contributions are never deductible. But withdrawals — including earnings — are tax free as long as you’re age 59½ or older and the account has been open at least five years. In addition, you’re allowed to withdraw contributions at any time tax- and penalty-free. You also don’t have to begin taking RMDs after you reach age 72.

However, the ability to contribute to a Roth IRA is subject to limits based on your MAGI. Fortunately, no matter how high your income, you’re eligible to convert a traditional IRA to a Roth. The catch? You’ll have to pay income tax on the amount converted.

Your tax hit may be reduced

This is where the “benefit” of a stock market downturn comes in. If your traditional IRA has lost value, converting to a Roth now rather than later will minimize your tax hit. Plus, you’ll avoid tax on future appreciation when the market goes back up.

It’s important to think through the details before you convert. Here are some of the issues to consider when deciding whether to make a conversion:

Having enough money to pay the tax bill. If you don’t have the cash on hand to cover the taxes owed on the conversion, you may have to dip into your retirement funds. This will erode your nest egg. The more money you convert and the higher your tax bracket, the bigger the tax hit.

Your retirement plans. Your stage of life may also affect your decision. Typically, you wouldn’t convert a traditional IRA to a Roth IRA if you expect to retire soon and start drawing down on the account right away. Usually, the goal is to allow the funds to grow and compound over time without any tax erosion.

Keep in mind that converting a traditional IRA to a Roth isn’t an all-or-nothing deal. You can convert as much or as little of the money from your traditional IRA account as you like. So, you might decide to gradually convert your account to spread out the tax hit over several years.

There are also other issues that need to be considered before executing a Roth IRA conversion. If this sounds like something you’re interested in, contact us to discuss whether a conversion is right for you.

Calculating corporate estimated tax

Details: Published: 31 May 2022 31 May 2022

The next quarterly estimated tax payment deadline is June 15 for individuals and businesses so it’s a good time to review the rules for computing corporate federal estimated payments. You want your business to pay the minimum amount of estimated taxes without triggering the penalty for underpayment of estimated tax.

Four methods

The required installment of estimated tax that a corporation must pay to avoid a penalty is the lowest amount determined under each of the following four methods:

Under the current year method, a corporation can avoid the estimated tax underpayment penalty by paying 25% of the tax shown on the current tax year’s return (or, if no return is filed, 25% of the tax for the current year) by each of four installment due dates. The due dates are generally April 15, June 15, September 15 and January 15 of the following year.
Under the preceding year method, a corporation can avoid the estimated tax underpayment penalty by paying 25% of the tax shown on the return for the preceding tax year by each of four installment due dates. (Note, however, that for 2022, certain corporations can only use the preceding year method to determine their first required installment payment. This restriction is placed on a corporation with taxable income of $1 million or more in any of the last three tax years.) In addition, this method isn’t available to corporations with a tax return that was for less than 12 months or a corporation that didn’t file a preceding tax year return that showed some tax liability.
Under the annualized income method, a corporation can avoid the estimated tax underpayment penalty if it pays its “annualized tax” in quarterly installments. The annualized tax is computed on the basis of the corporation’s taxable income for the months in the tax year ending before the due date of the installment and assuming income will be received at the same rate over the full year.
Under the seasonal income method, corporations with recurring seasonal patterns of taxable income can annualize income by assuming income earned in the current year is earned in the same pattern as in preceding years. There’s a somewhat complicated mathematical test that corporations must pass in order to establish that their income is earned seasonally and that they therefore qualify to use this method. If you think your corporation might qualify for this method, don’t hesitate to ask for our assistance in determining if it does.

Also, note that a corporation can switch among the four methods during a given tax year.

We can examine whether your corporation’s estimated tax bill can be reduced. Contact us if you’d like to discuss this matter further.

The ins and outs of Series EE savings bond taxation

Details: Published: 26 May 2022 26 May 2022

Many people own Series E and Series EE bonds that were bought many years ago. They may rarely look at them or think about them except on occasional trips to a file cabinet or safe deposit box.

One of the main reasons for buying U.S. savings bonds (such as Series EE bonds) is the fact that interest can build up without the need to currently report or pay tax on it. The accrued interest is added to the redemption value of the bond and is paid when the bond is eventually cashed in. Unfortunately, the law doesn’t allow for this tax-free buildup to continue indefinitely. The difference between the bond’s purchase price and its redemption value is taxable interest.

Series EE bonds, which have a maturity period of 30 years, were first offered in January 1980. They replaced the earlier Series E bonds.

Currently, Series EE bonds are only issued electronically. They’re issued at face value, and the face value plus accrued interest is payable at maturity.

Before January 1, 2012, Series EE bonds could be purchased on paper. Those paper bonds were issued at a discount, and their face value is payable at maturity. Owners of paper Series EE bonds can convert them to electronic bonds, posted at their purchase price (with accrued interest).

Here’s an example of how Series EE bonds are taxed. Bonds issued in January 1990 reached final maturity after 30 years, in January of 2020. That means that not only have they stopped earning interest, but all of the accrued and as yet untaxed interest was taxable in 2020.

A $1,000 Series EE bond (paper) bought in January 1990 for $500 was worth about $2,073.60 in January of 2020. It won’t increase in value after that. The entire difference of $1,573.60 ($2,073.60 − $500) was taxable as interest in 2020. This interest is exempt from state and local income taxes.

Note: Using the money from EE bonds for higher education may keep you from paying federal income tax on the interest.

If you own bonds (paper or electronic) that are reaching final maturity this year, action is needed to assure that there’s no loss of interest or unanticipated current tax consequences. Check the issue dates on your bonds. One possible place to reinvest the money is in Series I savings bonds, which are currently attractive due to rising inflation resulting in a higher interest rate.

Partners may have to report more income on tax returns than they receive in cash

Details: 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.

Illustrative example

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.

Partners may have to report more income on tax returns than they receive in cash

Details: Published: 24 May 2022 24 May 2022

IRA charitable donations: An alternative to taxable required distributions

Details: 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.

Businesses: Prepare for the lower 1099-K filing threshold

Details: 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.

Caring for an elderly relative? You may be eligible for tax breaks

Details: 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.

Inflation enhances the 2023 amounts for Health Savings Accounts

Details: 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.

HSA basics

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.

Valuable gifts to charity may require an appraisal

Details: 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.

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