Divorcing couples should understand these 4 tax issues

Posted on November 2, 2020November 2, 2020 by CCG

When a couple is going through a divorce, taxes are probably not foremost in their minds. But without proper planning and advice, some people find divorce to be an even more taxing experience. Several tax concerns need to be addressed to ensure that taxes are kept to a minimum and that important tax-related decisions are properly made. Here are four issues to understand if you’re in the midst of a divorce.

Issue 1: Alimony or support payments. For alimony under divorce or separation agreements that are executed after 2018, there’s no deduction for alimony and separation support payments for the spouse making them. And the alimony payments aren’t included in the gross income of the spouse receiving them. (The rules are different for divorce or separation agreements executed before 2019.)

Issue 2: Child support. No matter when a divorce or separation instrument is executed, child support payments aren’t deductible by the paying spouse (or taxable to the recipient).

Issue 3: Your residence. Generally, if a married couple sells their home in connection with a divorce or legal separation, they should be able to avoid tax on up to $500,000 of gain (as long as they’ve owned and used the residence as their principal residence for two of the previous five years). If one spouse continues to live in the home and the other moves out (but they both remain owners of the home), they may still be able to avoid gain on the future sale of the home (up to $250,000 each), but special language may have to be included in the divorce decree or separation agreement to protect the exclusion for the spouse who moves out.

If the couple doesn’t meet the two-year ownership and use tests, any gain from the sale may qualify for a reduced exclusion due to unforeseen circumstances.

Issue 4: Pension benefits. A spouse’s pension benefits are often part of a divorce property settlement. In these cases, the commonly preferred method to handle the benefits is to get a “qualified domestic relations order” (QDRO). This gives one spouse the right to share in the pension benefits of the other and taxes the spouse who receives the benefits. Without a QDRO the spouse who earned the benefits will still be taxed on them even though they’re paid out to the other spouse.

More to consider

These are just some of the issues you may have to deal with if you’re getting a divorce. In addition, you must decide how to file your tax return (single, married filing jointly, married filing separately or head of household). You may need to adjust your income tax withholding and you should notify the IRS of any new address or name change. If you own a business, you may have to pay your spouse a share. There are also estate planning considerations. Contact us to help you work through the financial issues involved in divorce.

Buying and selling mutual fund shares: Avoid these tax pitfalls

Posted on October 26, 2020October 26, 2020 by CCG

If you invest in mutual funds, be aware of some potential pitfalls involved in buying and selling shares.

Surprise sales

You may already have made taxable “sales” of part of your mutual fund investment without knowing it.

One way this can happen is if your mutual fund allows you to write checks against your fund investment. Every time you write a check against your mutual fund account, you’ve made a partial sale of your interest in the fund. Thus, except for funds such as money market funds, for which share value remains constant, you may have taxable gain (or a deductible loss) when you write a check. And each such sale is a separate transaction that must be reported on your tax return.

Here’s another way you may unexpectedly make a taxable sale. If your mutual fund sponsor allows you to make changes in the way your money is invested — for instance, lets you switch from one fund to another fund — making that switch is treated as a taxable sale of your shares in the first fund.

Recordkeeping

Carefully save all the statements that the fund sends you — not only official tax statements, such as Forms 1099-DIV, but the confirmations the fund sends you when you buy or sell shares or when dividends are reinvested in new shares. Unless you keep these records, it may be difficult to prove how much you paid for the shares, and thus, you won’t be able to establish the amount of gain that’s subject to tax (or the amount of loss you can deduct) when you sell.

You also need to keep these records to prove how long you’ve held your shares if you want to take advantage of favorable long-term capital gain tax rates. (If you get a year-end statement that lists all your transactions for the year, you can just keep that and discard quarterly or other interim statements. But save anything that specifically says it contains tax information.)

Recordkeeping is simplified by rules that require funds to report the customer’s basis in shares sold and whether any gain or loss is short-term or long-term. This is mandatory for mutual fund shares acquired after 2011, and some funds will provide this to shareholders for shares they acquired earlier, if the fund has the information.

Timing purchases and sales

If you’re planning to invest in a mutual fund, there are some important tax consequences to take into account in timing the investment. For instance, an investment shortly before payment of a dividend is something you should generally try to avoid. Your receipt of the dividend (even if reinvested in additional shares) will be treated as income and increase your tax liability. If you’re planning a sale of any of your mutual fund shares near year-end, you should weigh the tax and the non-tax consequences in the current year versus a sale in the next year.

Identify shares you sell

If you sell fewer than all of the shares that you hold in the same mutual fund, there are complicated rules for identifying which shares you’ve sold. The proper application of these rules can reduce the amount of your taxable gain or qualify the gain for favorable long-term capital gain treatment.

What tax records can you throw away?

Posted on October 14, 2020October 14, 2020 by CCG

October 15 is the deadline for individual taxpayers who extended their 2019 tax returns. (The original April 15 filing deadline was extended this year to July 15 due to the COVID-19 pandemic.) If you’re finally done filing last year’s return, you might wonder: Which tax records can you toss once you’re done? Now is a good time to go through old tax records and see what you can discard.

The general rules

At minimum, you should keep tax records for as long as the IRS has the ability to audit your tax return or assess additional taxes, which generally is three years after you file your return. This means you potentially can get rid of most records related to tax returns for 2016 and earlier years.

However, the statute of limitations extends to six years for taxpayers who understate their adjusted gross income (AGI) by more than 25%. What constitutes an understatement may go beyond simply not reporting items of income. So a general rule of thumb is to save tax records for six years from filing, just to be safe.

Keep some records longer

You need to hang on to some tax-related records beyond the statute of limitations. For example:

Keep the tax returns themselves indefinitely, so you can prove to the IRS that you actually filed a legitimate return. (There’s no statute of limitations for an audit if you didn’t file a return or if you filed a fraudulent one.)
Retain W-2 forms until you begin receiving Social Security benefits. Questions might arise regarding your work record or earnings for a particular year, and your W-2 helps provide the documentation needed.
Keep records related to real estate or investments for as long as you own the assets, plus at least three years after you sell them and report the sales on your tax return (or six years if you want extra protection).
Keep records associated with retirement accounts until you’ve depleted the accounts and reported the last withdrawal on your tax return, plus three (or six) years.

Other reasons to retain records

Keep in mind that these are the federal tax record retention guidelines. Your state and local tax record requirements may differ. In addition, lenders, co-op boards and other private parties may require you to produce copies of your tax returns as a condition to lending money, approving a purchase or otherwise doing business with you.

There may be relief from tax liability for “innocent spouses”

Posted on October 6, 2020October 6, 2020 by CCG

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.

Why it’s important to plan for income taxes as part of your estate plan

Posted on October 1, 2020October 1, 2020 by CCG

As a result of the current estate tax exemption amount ($11.58 million in 2020), many estates no longer need to be concerned with federal estate tax. Before 2011, a much smaller amount resulted in estate plans attempting to avoid it. Now, because many estates won’t be subject to estate tax, more planning can be devoted to saving income taxes for your heirs.

While saving both income and transfer taxes has always been a goal of estate planning, it was more difficult to succeed at both when the estate and gift tax exemption level was much lower. Here are some strategies to consider.

Plan gifts that use the annual gift tax exclusion. One of the benefits of using the gift tax annual exclusion to make transfers during life is to save estate tax. This is because both the transferred assets and any post-transfer appreciation generated by those assets are removed from the donor’s estate.

As mentioned, estate tax savings may not be an issue because of the large estate exemption amount. Further, making an annual exclusion transfer of appreciated property carries a potential income tax cost because the recipient receives the donor’s basis upon transfer. Thus, the recipient could face income tax, in the form of capital gains tax, on the sale of the gifted property in the future. If there’s no concern that an estate will be subject to estate tax, even if the gifted property grows in value, then the decision to make a gift should be based on other factors.

For example, gifts may be made to help a relative buy a home or start a business. But a donor shouldn’t gift appreciated property because of the capital gain that could be realized on a future sale by the recipient. If the appreciated property is held until the donor’s death, under current law, the heir will get a step-up in basis that will wipe out the capital gain tax on any pre-death appreciation in the property’s value.

Take spouses’ estates into account. In the past, spouses often undertook complicated strategies to equalize their estates so that each could take advantage of the estate tax exemption amount. Generally, a two-trust plan was established to minimize estate tax. “Portability,” or the ability to apply the decedent’s unused exclusion amount to the surviving spouse’s transfers during life and at death, became effective for estates of decedents dying after 2010. As long as the election is made, portability allows the surviving spouse to apply the unused portion of a decedent’s applicable exclusion amount (the deceased spousal unused exclusion amount) as calculated in the year of the decedent’s death. The portability election gives married couples more flexibility in deciding how to use their exclusion amounts.

Be aware that some estate exclusion or valuation discount strategies to avoid inclusion of property in an estate may no longer be worth pursuing. It may be better to have the property included in the estate or not qualify for valuation discounts so that the property receives a step-up in basis. For example, the special use valuation — the valuation of qualified real property used for farming or in a business on the basis of the property’s actual use, rather than on its highest and best use — may not save enough, or any, estate tax to justify giving up the step-up in basis that would otherwise occur for the property.

Tax implications of working from home and collecting unemployment

Posted on September 17, 2020September 17, 2020 by CCG

COVID-19 has changed our lives in many ways, and some of the changes have tax implications. Here is basic information about two common situations.

1. Working from home.

Many employees have been told not to come into their workplaces due to the pandemic. If you’re an employee who “telecommutes” — that is, you work at home, and communicate with your employer mainly by telephone, videoconferencing, email, etc. — you should know about the strict rules that govern whether you can deduct your home office expenses.

Unfortunately, employee home office expenses aren’t currently deductible, even if your employer requires you to work from home. Employee business expense deductions (including the expenses an employee incurs to maintain a home office) are miscellaneous itemized deductions and are disallowed from 2018 through 2025 under the Tax Cuts and Jobs Act.

However, if you’re self-employed and work out of an office in your home, you can be eligible to claim home office deductions for your related expenses if you satisfy the strict rules.

2. Collecting unemployment

Millions of Americans have lost their jobs due to COVID-19 and are collecting unemployment benefits. Some of these people don’t know that these benefits are taxable and must be reported on their federal income tax returns for the tax year they were received. Taxable benefits include the special unemployment compensation authorized under the Coronavirus Aid, Relief and Economic Security (CARES) Act.

In order to avoid a surprise tax bill when filing a 2020 income tax return next year, unemployment recipients can have taxes withheld from their benefits now. Under federal law, recipients can opt to have 10% withheld from their benefits to cover part or all their tax liability. To do this, complete Form W4-V, Voluntary Withholding Request, and give it to the agency paying benefits. (Don’t send it to the IRS.)

We can help

We can assist you with advice about whether you qualify for home office deductions, and how much of these expenses you can deduct. We can also answer any questions you have about the taxation of unemployment benefits as well as any other tax issues that you encounter as a result of COVID-19.

Back-to-school tax breaks on the books

Posted on September 4, 2020September 4, 2020 by CCG

Despite the COVID-19 pandemic, students are going back to school this fall, either remotely, in-person or under a hybrid schedule. In any event, parents may be eligible for certain tax breaks to help defray the cost of education.

Here is a summary of some of the tax breaks available for education.

1. Higher education tax credits. Generally, you may be able to claim either one of two tax credits for higher education expenses — but not both.

With the American Opportunity Tax Credit (AOTC), you can save a maximum of $2,500 from your tax bill for each full-time college or grad school student. This applies to qualified expenses including tuition, room and board, books and computer equipment and other supplies. But the credit is phased out for moderate-to-upper income taxpayers. No credit is allowed if your modified adjusted gross income (MAGI) is over $90,000 ($180,000 for joint filers).
The Lifetime Learning Credit (LLC) is similar to the AOTC, but there are a few important distinctions. In this case, the maximum credit is $2,000 instead of $2,500. Furthermore, this is the overall credit allowed to a taxpayer regardless of the number of students in the family. However, the LLC is also phased out under income ranges even lower than the AOTC. You can’t claim the credit if your MAGI is $68,000 or more ($136,000 or more if you file a joint return).

For these reasons, the AOTC is generally preferable to the LLC. But parents have still another option.

2. Tuition-and-fees deduction. As an alternative to either of the credits above, parents may claim an above-the-line deduction for tuition and related fees. This deduction is either $4,000 or $2,000, depending on the taxpayer’s MAGI, before it is phased out. No deduction is allowed for MAGI above $80,000 for single filers and $160,000 for joint filers.

The tuition-and-fees deduction, which has been extended numerous times, is currently scheduled to expire after 2020. However, it’s likely to be revived again by Congress.

In addition to these tax breaks, there are other ways to save and pay for college on a tax advantaged basis. These include using Section 529 plans and Coverdell Education Savings Accounts. There are limits on contributions to these saving vehicles.

Note: Thanks to a provision in the Tax Cuts and Jobs Act, a 529 plan can now be used to pay for up to $10,000 annually for a child’s tuition at a private or religious elementary or secondary school.

Final lesson

Typically, parents are able to take advantage of one or more of these tax breaks, even though some benefits are phased out above certain income levels. Contact us to maximize the tax breaks for your children’s education.

Will You Have to Pay Tax on Your Social Security Benefits?

Posted on August 27, 2020August 27, 2020 by CCG

If you’re getting close to retirement, you may wonder: Are my Social Security benefits going to be taxed? And if so, how much will you have to pay?

It depends on your other income. If you’re taxed, between 50% and 85% of your benefits could be taxed. (This doesn’t mean you pay 85% of your benefits back to the government in taxes. It merely that you’d include 85% of them in your income subject to your regular tax rates.)

Crunch the numbers

To determine how much of your benefits are taxed, first determine your other income, including certain items otherwise excluded for tax purposes (for example, tax-exempt interest). Add to that the income of your spouse, if you file joint tax returns. To this, add half of the Social Security benefits you and your spouse received during the year. The figure you come up with is your total income plus half of your benefits. Now apply the following rules:

1. If your income plus half your benefits isn’t above $32,000 ($25,000 for single taxpayers), none of your benefits are taxed.

2. If your income plus half your benefits exceeds $32,000 but isn’t more than $44,000, you will be taxed on one half of the excess over $32,000, or one half of the benefits, whichever is lower.

Here’s an example

For example, let’s say you and your spouse have $20,000 in taxable dividends, $2,400 of tax-exempt interest and combined Social Security benefits of $21,000. So, your income plus half your benefits is $32,900 ($20,000 + $2,400 +1/2 of $21,000). You must include $450 of the benefits in gross income (1/2 ($32,900 − $32,000)). (If your combined Social Security benefits were $5,000, and your income plus half your benefits were $40,000, you would include $2,500 of the benefits in income: 1/2 ($40,000 − $32,000) equals $4,000, but 1/2 the $5,000 of benefits ($2,500) is lower, and the lower figure is used.)

Important: If you aren’t paying tax on your Social Security benefits now because your income is below the floor, or you’re paying tax on only 50% of those benefits, an unplanned increase in your income can have a triple tax cost. You’ll have to pay tax on the additional income, you’ll have to pay tax on (or on more of ) your Social Security benefits (since the higher your income the more of your Social Security benefits that are taxed), and you may get pushed into a higher marginal tax bracket.

For example, this situation might arise if you receive a large distribution from an IRA during the year or you have large capital gains. Careful planning might be able to avoid this negative tax result. You might be able to spread the additional income over more than one year, or liquidate assets other than an IRA account, such as stock showing only a small gain or stock with gain that can be offset by a capital loss on other shares.

If you know your Social Security benefits will be taxed, you can voluntarily arrange to have the tax withheld from the payments by filing a Form W-4V. Otherwise, you may have to make estimated tax payments. Contact us for assistance or more information.

More parents may owe “nanny tax” this year, due to COVID-19

Posted on August 18, 2020August 18, 2020 by CCG

In the COVID-19 era, many parents are hiring nannies and babysitters because their daycare centers and summer camps have closed. This may result in federal “nanny tax” obligations.

Keep in mind that the nanny tax may apply to all household workers, including housekeepers, babysitters, gardeners or others who aren’t independent contractors.

If you employ someone who’s subject to the nanny tax, you aren’t required to withhold federal income taxes from the individual’s pay. You only must withhold if the worker asks you to and you agree. (In that case, ask the nanny to fill out a Form W-4.) However, you may have other withholding and payment obligations.

Withholding FICA and FUTA

You must withhold and pay Social Security and Medicare taxes (FICA) if your nanny earns cash wages of $2,200 or more (excluding food and lodging) during 2020. If you reach the threshold, all of the wages (not just the excess) are subject to FICA.

However, if your nanny is under 18 and childcare isn’t his or her principal occupation, you don’t have to withhold FICA taxes. Therefore, if your nanny is really a student/part-time babysitter, there’s no FICA tax liability.

Both employers and household workers have an obligation to pay FICA taxes. Employers are responsible for withholding the worker’s share of FICA and must pay a matching employer amount. FICA tax is divided between Social Security and Medicare. Social Security tax is 6.2% for the both the employer and the worker (12.4% total). Medicare tax is 1.45% each for both the employer and the worker (2.9% total).

If you prefer, you can pay your nanny’s share of Social Security and Medicare taxes, instead of withholding it from pay.

Note: It’s unclear how these taxes will be affected by the executive order that President Trump signed on August 8, which allows payroll taxes to be deferred from September 1 through December 31, 2020.

You also must pay federal unemployment (FUTA) tax if you pay $1,000 or more in cash wages (excluding food and lodging) to your worker in any calendar quarter of this year or last year. FUTA tax applies to the first $7,000 of wages. The maximum FUTA tax rate is 6%, but credits reduce it to 0.6% in most cases. FUTA tax is paid only by the employer.

Reporting and paying

You pay nanny tax by increasing your quarterly estimated tax payments or increasing withholding from your wages — rather than making an annual lump-sum payment.

You don’t have to file any employment tax returns, even if you’re required to withhold or pay tax (unless you own a business, see below). Instead, you report employment taxes on Schedule H of your tax return.

On your return, you include your employer identification number (EIN) when reporting employment taxes. The EIN isn’t the same as your Social Security number. If you need an EIN, you must file Form SS-4.

However, if you own a business as a sole proprietor, you must include the taxes for your nanny on the FICA and FUTA forms (940 and 941) that you file for your business. And you use the EIN from your sole proprietorship to report the taxes. You also must provide your nanny with a Form W-2.

Recordkeeping

Maintain careful tax records for each household employee. Keep them for at least four years from the later of the due date of the return or the date the tax was paid. Records include: employee name, address, Social Security number; employment dates; wages paid; withheld FICA or income taxes; FICA taxes paid by you for your worker; and copies of forms filed.

The tax implications of employer-provided life insurance

Posted on August 12, 2020August 12, 2020 by CCG

Does your employer provide you with group term life insurance? If so, and if the coverage is higher than $50,000, this employee benefit may create undesirable income tax consequences for you.

“Phantom income”

The first $50,000 of group term life insurance coverage that your employer provides is excluded from taxable income and doesn’t add anything to your income tax bill. But the employer-paid cost of group term coverage in excess of $50,000 is taxable income to you. It’s included in the taxable wages reported on your Form W-2 — even though you never actually receive it. In other words, it’s “phantom income.”

What’s worse, the cost of group term insurance must be determined under a table prepared by IRS even if the employer’s actual cost is less than the cost figured under the table. Under these determinations, the amount of taxable phantom income attributed to an older employee is often higher than the premium the employee would pay for comparable coverage under an individual term policy. This tax trap gets worse as the employee gets older and as the amount of his or her compensation increases.

Check your W-2

What should you do if you think the tax cost of employer-provided group term life insurance is undesirably high? First, you should establish if this is actually the case. If a specific dollar amount appears in Box 12 of your Form W-2 (with code “C”), that dollar amount represents your employer’s cost of providing you with group-term life insurance coverage in excess of $50,000, less any amount you paid for the coverage. You’re responsible for federal, state and local taxes on the amount that appears in Box 12 and for the associated Social Security and Medicare taxes as well.

But keep in mind that the amount in Box 12 is already included as part of your total “Wages, tips and other compensation” in Box 1 of the W-2, and it’s the Box 1 amount that’s reported on your tax return

Consider some options

If you decide that the tax cost is too high for the benefit you’re getting in return, you should find out whether your employer has a “carve-out” plan (a plan that carves out selected employees from group term coverage) or, if not, whether it would be willing to create one. There are several different types of carve-out plans that employers can offer to their employees.

For example, the employer can continue to provide $50,000 of group term insurance (since there’s no tax cost for the first $50,000 of coverage). Then, the employer can either provide the employee with an individual policy for the balance of the coverage, or give the employee the amount the employer would have spent for the excess coverage as a cash bonus that the employee can use to pay the premiums on an individual policy.