Are you age 65 and older and have basic Medicare insurance? You may need to pay additional premiums to get the level of coverage you want. The premiums can be expensive, especially if you’re married and both you and your spouse are paying them. But there may be a bright side: You may qualify for a tax break for paying the premiums.

Medicare premiums are medical expenses

You can combine premiums for Medicare health insurance with other qualifying medical expenses for purposes of claiming an itemized deduction for medical expenses on your tax return. This includes amounts for “Medigap” insurance and Medicare Advantage plans. Some people buy Medigap policies because Medicare Parts A and B don’t cover all their health care expenses. Coverage gaps include co-payments, coinsurance, deductibles and other costs. Medigap is private supplemental insurance that’s intended to cover some or all gaps.

Itemizing versus the standard deduction

Qualifying for a medical expense deduction is hard for many people for a couple of reasons. For 2021, you can deduct medical expenses only if you itemize deductions and only to the extent that total qualifying expenses exceeded 7.5% of AGI.

The Tax Cuts and Jobs Act nearly doubled the standard deduction amounts for 2018 through 2025. As a result, fewer individuals are claiming itemized deductions. For 2021, the standard deduction amounts are $12,550 for single filers, $25,100 for married couples filing jointly and $18,800 for heads of household. (For 2020, these amounts were $12,400, $24,800 and $18,650, respectively.)

However, if you have significant medical expenses, including Medicare health insurance premiums, you may itemize and collect some tax savings.

Note: Self-employed people and shareholder-employees of S corporations can generally claim an above-the-line deduction for their health insurance premiums, including Medicare premiums. So, they don’t need to itemize to get the tax savings from their premiums.

Medical expense deduction basics

In addition to Medicare premiums, you can deduct various medical expenses, including those for dental treatment, ambulance services, dentures, eyeglasses and contacts, hospital services, lab tests, qualified long-term care services, prescription medicines and others.

There are also many items that Medicare doesn’t cover that can be deducted for tax purposes, if you qualify. In addition, you can deduct transportation expenses to get to medical appointments. If you go by car, you can deduct a flat 16-cents-per-mile rate for 2021 (down from 17 cents for 2020), or you can keep track of your actual out-of-pocket expenses for gas, oil and repairs.

Claim all eligible deductions

Contact us if you have additional questions about claiming medical expense deductions on your tax return.

© 2021 Covenant CPA

If you’re claiming deductions for business meals or auto expenses, expect the IRS to closely review them. In some cases, taxpayers have incomplete documentation or try to create records months (or years) later. In doing so, they fail to meet the strict substantiation requirements set forth under tax law. Tax auditors are adept at rooting out inconsistencies, omissions and errors in taxpayers’ records, as illustrated by one recent U.S. Tax Court case.

Facts of the case

In the case, the taxpayer ran a notary and paralegal business. She deducted business meals and vehicle expenses that she allegedly incurred in connection with her business.

The deductions were denied by the IRS and the court. Tax law “establishes higher substantiation requirements” for these and certain other expenses, the court noted. No deduction is generally allowed “unless the taxpayer substantiates the amount, time and place, business purpose, and business relationship to the taxpayer of the person receiving the benefit” for each expense with adequate records or sufficient evidence.

The taxpayer in this case didn’t provide adequate records or other sufficient evidence to prove the business purpose of her meal expenses. She gave vague testimony that she deducted expenses for meals where she “talked strategies” with people who “wanted her to do some work.” The court found this was insufficient to show the connection between the meals and her business.

When it came to the taxpayer’s vehicle expense deductions, she failed to offer credible evidence showing where she drove her vehicle, the purpose of each trip and her business relationship to the places visited. She also conceded that she used her car for both business and personal activities. (TC Memo 2021-50)

Best practices for business expenses

This case is an example of why it’s critical to maintain meticulous records to support business expenses for meals and vehicle deductions. Here’s a list of “DOs and DON’Ts” to help meet the strict IRS and tax law substantiation requirements for these items:

DO keep detailed, accurate records. For each expense, record the amount, the time and place, the business purpose, and the business relationship of any person to whom you provided a meal. If you have employees who you reimburse for meals and auto expenses, make sure they’re complying with all the rules.

DON’T reconstruct expense logs at year end or wait until you receive a notice from the IRS. Take a moment to record the details in a log or diary or on a receipt at the time of the event or soon after. Require employees to submit monthly expense reports.

DO respect the fine line between personal and business expenses. Be careful about combining business and pleasure. Your business checking account shouldn’t be used for personal expenses.

DON’T be surprised if the IRS asks you to prove your deductions. Meal and auto expenses are a magnet for attention. Be prepared for a challenge.

With organization and guidance from us, your tax records can stand up to scrutiny from the IRS. There may be ways to substantiate your deductions that you haven’t thought of, and there may be a way to estimate certain deductions (“the Cohan rule”), if your records are lost due to a fire, theft, flood or other disaster. 

© 2021 Covenant CPA

Eligible parents will soon begin receiving payments from the federal government. The IRS announced that the 2021 advance child tax credit (CTC) payments, which were created in the American Rescue Plan Act (ARPA), will begin being made on July 15, 2021.

How have child tax credits changed?

The ARPA temporarily expanded and made CTCs refundable for 2021. The law increased the maximum CTC — for 2021 only — to $3,600 for each qualifying child under age 6 and to $3,000 per child for children ages 6 to 17, provided their parents’ income is below a certain threshold.

Advance payments will receive up to $300 monthly for each child under 6, and up to $250 monthly for each child 6 and older. The increased credit amount will be reduced or phased out, for households with modified adjusted gross income above the following thresholds:

  • $150,000 for married taxpayers filing jointly and qualifying widows and widowers;
  • $112,500 for heads of household; and
  • $75,000 for other taxpayers.

Under prior law, the maximum annual CTC for 2018 through 2025 was $2,000 per qualifying child but the income thresholds were higher and some of the qualification rules were different.

Important: If your income is too high to receive the increased advance CTC payments, you may still qualify to claim the $2,000 CTC on your tax return for 2021.

What is a qualifying child?

For 2021, a “qualifying child” with respect to a taxpayer is defined as one who is under age 18 and who the taxpayer can claim as a dependent. That means a child related to the taxpayer who, generally, lived with the taxpayer for at least six months during the year. The child also must be a U.S. citizen or national or a U.S. resident.

How and when will advance payments be sent out?

Under the ARPA, the IRS is required to establish a program to make periodic advance payments which in total equal 50% of IRS’s estimate of the eligible taxpayer’s 2021 CTCs, during the period July 2021 through December 2021. The payments will begin on July 15, 2021. After that, they’ll be made on the 15th of each month unless the 15th falls on a weekend or holiday. Parents will receive the monthly payments through direct deposit, paper check or debit card.

Who will benefit from these payments and do they have to do anything to receive them? 

According to the IRS, about 39 million households covering 88% of children in the U.S. “are slated to begin receiving monthly payments without any further action required.” Contact us if you have questions about the child tax credit.

© 2021 Covenant CPA

Even after your 2020 tax return has been successfully filed with the IRS, you may still have some questions about the return. Here are brief answers to three questions that we’re frequently asked at this time of year.

Are you wondering when you will receive your refund?

The IRS has an online tool that can tell you the status of your refund. Go to irs.gov and click on “Get Your Refund Status.” You’ll need your Social Security number, filing status and the exact refund amount.

Which tax records can you throw away now? 

At a minimum, keep tax records related to your return for as long as the IRS can audit your return or assess additional taxes. In general, the statute of limitations is three years after you file your return. So you can generally get rid of most records related to tax returns for 2017 and earlier years. (If you filed an extension for your 2017 return, hold on to your records until at least three years from when you filed the extended return.)

However, the statute of limitations extends to six years for taxpayers who understate their gross income by more than 25%.

You should hang on to certain tax-related records longer. For example, keep the actual tax returns indefinitely, so you can prove to the IRS that you filed legitimate returns. (There’s no statute of limitations for an audit if you didn’t file a return or you filed a fraudulent one.)

When it comes to retirement accounts, keep records associated with them until you’ve depleted the account and reported the last withdrawal on your tax return, plus three (or six) years. And retain records related to real estate or investments for as long as you own the asset, plus at least three years after you sell it and report the sale on your tax return. (You can keep these records for six years if you want to be extra safe.)

If you overlooked claiming a tax break, can you still collect a refund for it?

In general, you can file an amended tax return and claim a refund within three years after the date you filed your original return or within two years of the date you paid the tax, whichever is later.

However, there are a few opportunities when you have longer to file an amended return. For example, the statute of limitations for bad debts is longer than the usual three-year time limit for most items on your tax return. In general, you can amend your tax return to claim a bad debt for seven years from the due date of the tax return for the year that the debt became worthless.

Year-round tax help

Contact us if you have questions about retaining tax records, receiving your refund or filing an amended return. We’re not just here at tax filing time. We’re available all year long.

© 2021 Covenant CPA

“Tax day” is just around the corner. This year, the deadline for filing 2020 individual tax returns is Monday, May 17, 2021. The IRS postponed the usual April 15 due date due to the COVID-19 pandemic. If you still aren’t ready to file your return, you should request a tax-filing extension. Anyone can request one and in some special situations, people can receive more time without even asking.

Taxpayers can receive more time to file by submitting a request for an automatic extension on IRS Form 4868. This will extend the filing deadline until October 15, 2021. But be aware that an extension of time to file your return doesn’t grant you an extension of time to pay your taxes. You need to estimate and pay any taxes owed by your regular deadline to help avoid possible penalties. In other words, your 2020 tax payments are still due by May 17.

Victims of certain disasters

If you were a victim of the February winter storms in Texas, Oklahoma and Louisiana, you have until June 15, 2021, to file your 2020 return and pay any tax due without submitting Form 4868. Victims of severe storms, flooding, landslides and mudslides in parts of Alabama and Kentucky have also recently been granted extensions. For eligible Kentucky victims, the new deadline is June 30, 2021, and eligible Alabama victims have until August 2, 2021.

That’s because the IRS automatically provides filing and penalty relief to taxpayers with addresses in federally declared disaster areas. Disaster relief also includes more time for making 2020 contributions to IRAs and certain other retirement plans and making 2021 estimated tax payments. Relief is also generally available if you live outside a federally declared disaster area, but you have a business or tax records located in the disaster area. Similarly, relief may be available if you’re a relief worker assisting in a covered disaster area.

Located in a combat zone

Military service members and eligible support personnel who are serving in a combat zone have at least 180 days after they leave the combat zone to file their tax returns and pay any tax due. This includes taxpayers serving in Iraq, Afghanistan and other combat zones.

These extensions also give affected taxpayers in a combat zone more time for a variety of other tax-related actions, including contributing to an IRA. Various circumstances affect the exact length of time available to taxpayers.

Outside the United States

If you’re a U.S. citizen or resident alien who lives or works outside the U.S. (or Puerto Rico), you have until June 15, 2021, to file your 2020 tax return and pay any tax due.

The special June 15 deadline also applies to members of the military on duty outside the U.S. and Puerto Rico who don’t qualify for the longer combat zone extension described above.

While taxpayers who are abroad get more time to pay, interest applies to any payment received after this year’s May 17 deadline. It’s currently charged at the rate of 3% per year, compounded daily.

We can help

If you need an appointment to get your tax return prepared, contact us. We can also answer any questions you may have about filing an extension.

© 2021 Covenant CPA

The May 17 deadline for filing your 2020 individual tax return is coming up soon. It’s important to file and pay your tax return on time to avoid penalties imposed by the IRS. Here are the basic rules.

Failure to pay 

Separate penalties apply for failing to pay and failing to file. The failure-to-pay penalty is 1/2% for each month (or partial month) the payment is late. For example, if payment is due May 17 and is made June 22, the penalty is 1% (1/2% times 2 months or partial months). The maximum penalty is 25%.

The failure-to-pay penalty is based on the amount shown as due on the return (less credits for amounts paid through withholding or estimated payments), even if the actual tax bill turns out to be higher. On the other hand, if the actual tax bill turns out to be lower, the penalty is based on the lower amount.

For example, if your payment is two months late and your return shows that you owe $5,000, the penalty is 1%, which equals $50. If you’re audited and your tax bill increases by another $1,000, the failure-to-pay penalty isn’t increased because it’s based on the amount shown on the return as due.

Failure to file 

The failure-to-file penalty runs at a more severe rate of 5% per month (or partial month) of lateness to a maximum of 25%. If you obtain an extension to file (until October 15), you’re not filing late unless you miss the extended due date. However, a filing extension doesn’t apply to your responsibility for payment.

If the 1/2% failure-to-pay penalty and the failure-to-file penalty both apply, the failure-to-file penalty drops to 4.5% per month (or part) so the total combined penalty is 5%. The maximum combined penalty for the first five months is 25%. After that, the failure-to-pay penalty can continue at 1/2% per month for 45 more months (an additional 22.5%). Thus, the combined penalties could reach 47.5% over time.

The failure-to-file penalty is also more severe because it’s based on the amount required to be shown on the return, and not just the amount shown as due. (Credit is given for amounts paid via withholding or estimated payments. So if no amount is owed, there’s no penalty for late filing.) For example, if a return is filed three months late showing $5,000 owed (after payment credits), the combined penalties would be 15%, which equals $750. If the actual tax liability is later determined to be an additional $1,000, the failure to file penalty (4.5% × 3 = 13.5%) would also apply for an additional $135 in penalties.

A minimum failure to file penalty will also apply if you file your return more than 60 days late. This minimum penalty is the lesser of $210 or the tax amount required to be shown on the return.

Reasonable cause 

Both penalties may be excused by IRS if lateness is due to “reasonable cause.” Typical qualifying excuses include death or serious illness in the immediate family and postal irregularities.

As you can see, filing and paying late can get expensive. Furthermore, in particularly abusive situations involving a fraudulent failure to file, the late filing penalty can reach 15% per month, with a 75% maximum. Contact us if you have questions or need an appointment to prepare your return.

© 2021 Covenant CPA

If you file a joint tax return with your spouse, you should be aware of your individual liability. And if you’re getting divorced, you should know that there may be relief available if the IRS comes after you for certain past-due taxes.

What’s “joint and several” liability?

When a married couple files a joint tax return, each spouse is “jointly and severally” liable for the full tax amount on the couple’s combined income. That means the IRS can come after either spouse to collect the entire tax — not just the part that’s attributed to one spouse or the other. Liability includes any tax deficiency that the IRS assesses after an audit, as well as penalties and interest. (However, the civil fraud penalty can be imposed only on spouses who’ve actually committed fraud.)

When are spouses “innocent?”

In some cases, spouses are eligible for “innocent spouse relief.” This generally involves individuals who didn’t know about a tax understatement that was attributable to the other spouse.

To be eligible, you must show that you were unaware of the understatement and there was nothing that should have made you suspicious. In addition, the circumstances must make it inequitable to hold you liable for the tax. This relief may be available even if you’re still married and living with your spouse.

In addition, spouses may be able to limit liability for a tax deficiency on a joint return if they’re widowed, divorced, legally separated or have lived apart for at least one year.

How can liability be limited?

In some cases, a spouse can elect to limit liability for a deficiency on a joint return to just his or her allocable portion of the deficiency. If you make this election, the tax items that gave rise to the deficiency will be allocated between you and your spouse as if you’d filed separate returns.

The election won’t provide relief from your spouse’s tax items if the IRS proves that you knew about the items when you signed the tax return — unless you can show that you signed it under duress. Also, liability will be increased by the value of any assets that your spouse transferred to you in order to avoid the tax.

What is an “injured” spouse?

In addition to innocent spouse relief, there’s also relief for “injured” spouses. What’s the difference? An injured spouse claim asks the IRS to allocate part of a joint tax refund to one spouse. In these cases, one spouse has all or part of a refund from a joint return applied against certain past-due taxes, child or spousal support, or federal nontax debts (such as student loans) owed by the other spouse. If you’re an injured spouse, you may be entitled to recoup your refund share.

Whether, and to what extent, you can take advantage of the above relief depends on your situation. If you’re interested in trying to obtain relief, there’s paperwork that must be filed and deadlines that must be met. We can assist you with the details.

Also, keep “joint and several liability” in mind when filing future tax returns. Even if a joint return results in less tax, you may want to file a separate return if you want to be responsible only for your own tax.

© 2020 Covenant CPA

Do you own a business but haven’t gotten around to setting up a tax-advantaged retirement plan? Fortunately, it’s not too late to establish one and reduce your 2019 tax bill. A Simplified Employee Pension (SEP) can still be set up for 2019, and you can make contributions to it that you can deduct on your 2019 income tax return. Even better, SEPs keep administrative costs low.

Deadlines for contributions

A SEP can be set up as late as the due date (including extensions) of your income tax return for the tax year for which the SEP first applies. That means you can establish a SEP for 2019 in 2020 as long as you do it before your 2019 return filing deadline. You have until the same deadline to make 2019 contributions and still claim a potentially substantial deduction on your 2019 return.

Generally, most other types of retirement plans would have to have been established by December 31, 2019, in order for 2019 contributions to be made (though many of these plans do allow 2019 contributions to be made in 2020).

Contributions are optional

With a SEP, you can decide how much to contribute each year. You aren’t required to make any certain minimum contributions annually.

However, if your business has employees other than you:

  • Contributions must be made for all eligible employees using the same percentage of compensation as for yourself, and
  • Employee accounts must be immediately 100% vested.

The contributions go into SEP-IRAs established for each eligible employee. As the employer, you’ll get a current income tax deduction for contributions you make on behalf of your employees. Your employees won’t be taxed when the contributions are made, but at a later date when distributions are made — usually in retirement.

For 2019, the maximum contribution that can be made to a SEP-IRA is 25% of compensation (or 20% of self-employed income net of the self-employment tax deduction), subject to a contribution cap of $56,000. (The 2020 cap is $57,000.)

How to proceed

To set up a SEP, you complete and sign the simple Form 5305-SEP (“Simplified Employee Pension — Individual Retirement Accounts Contribution Agreement”). You don’t need to file Form 5305-SEP with the IRS, but you should keep it as part of your permanent tax records. A copy of Form 5305-SEP must be given to each employee covered by the SEP, along with a disclosure statement.

Although there are rules and limits that apply to SEPs beyond what we’ve discussed here, SEPs generally are much simpler to administer than other retirement plans. Contact us with any questions you have about SEPs and to discuss whether it makes sense for you to set one up for 2019 (or 2020).

© 2020 Covenant CPA

The IRS uses Audit Techniques Guides (ATGs) to help IRS examiners get ready for audits. Your business can use the same guides to gain insight into what the IRS is looking for in terms of compliance with tax laws and regulations.

Many ATGs target specific industries or businesses, such as construction, aerospace, art galleries, child care providers and veterinary medicine. Others address issues that frequently arise in audits, such as executive compensation, passive activity losses and capitalization of tangible property.

How they’re used

IRS auditors need to examine all types of businesses, as well as individual taxpayers and tax-exempt organizations. Each type of return might have unique industry issues, business practices and terminology. Before meeting with taxpayers and their advisors, auditors do their homework to understand various industries or issues, the accounting methods commonly used, how income is received, and areas where taxpayers may not be in compliance.

By using a specific ATG, an auditor may be able to reconcile discrepancies when reported income or expenses aren’t consistent with what’s normal for the industry or to identify anomalies within the geographic area in which the business is located.

For example, one ATG focuses specifically on businesses that deal in cash, such as auto repair shops, car washes, check-cashing operations, gas stations, laundromats, liquor stores, restaurants., bars, and salons. The “Cash Intensive Businesses” ATG tells auditors “a financial status analysis including both business and personal financial activities should be done.” It explains techniques such as:

  • How to examine businesses with and without cash registers,
  • What a company’s books and records may reveal,
  • How to analyze bank deposits and checks written from known bank accounts,
  • What to look for when touring a business,
  • Ways to uncover hidden family transactions,
  • How cash invoices found in an audit of one business may lead to another business trying to hide income by dealing mainly in cash.

Auditors are obviously looking for cash-intensive businesses that underreport their cash receipts but how this is uncovered varies. For example, when examining a restaurants or bar, auditors are told to ask about net profits compared to the industry average, spillage, pouring averages and tipping.

Learn the red flags

Although ATGs were created to help IRS examiners ferret out common methods of hiding income and inflating deductions, they also can help businesses ensure they aren’t engaging in practices that could raise audit red flags. Contact us if you have questions about your business. For a complete list of ATGs, visit the IRS website here: https://bit.ly/2rh7umD

© 2019 Covenant CPA

Once your 2018 tax return has been successfully filed with the IRS, you may still have some questions. Here are brief answers to three questions that we’re frequently asked at this time of year.

Question #1: What tax records can I throw away now? 

At a minimum, keep tax records related to your return for as long as the IRS can audit your return or assess additional taxes. In general, the statute of limitations is three years after you file your return. So you can generally get rid of most records related to tax returns for 2015 and earlier years. (If you filed an extension for your 2015 return, hold on to your records until at least three years from when you filed the extended return.)

However, the statute of limitations extends to six years for taxpayers who understate their gross income by more than 25%.

You’ll need to hang on to certain tax-related records longer. For example, keep the actual tax returns indefinitely, so you can prove to the IRS that you filed a legitimate return. (There’s no statute of limitations for an audit if you didn’t file a return or you filed a fraudulent one.)

When it comes to retirement accounts, keep records associated with them until you’ve depleted the account and reported the last withdrawal on your tax return, plus three (or six) years. And retain records related to real estate or investments for as long as you own the asset, plus at least three years after you sell it and report the sale on your tax return. (You can keep these records for six years if you want to be extra safe.)

Question #2: Where’s my refund?

The IRS has an online tool that can tell you the status of your refund. Go to irs.gov and click on “Refund Status” to find out about yours. You’ll need your Social Security number, filing status and the exact refund amount.

Question #3: Can I still collect a refund if I forgot to report something?

In general, you can file an amended tax return and claim a refund within three years after the date you filed your original return or within two years of the date you paid the tax, whichever is later. So for a 2018 tax return that you filed on April 15 of 2019, you can generally file an amended return until April 15, 2022.

However, there are a few opportunities when you have longer to file an amended return. For example, the statute of limitations for bad debts is longer than the usual three-year time limit for most items on your tax return. In general, you can amend your tax return to claim a bad debt for seven years from the due date of the tax return for the year that the debt became worthless.

We can help

Contact us if you have questions about tax record retention, your refund or filing an amended return. We’re available all year long — not just at tax filing time! 205-345-9898 and info@covenantcpa.com.

© 2019 CovenantCPA