Because nothing with taxes is ever easy, the rules are sometimes the same and sometimes different, depending on if the money is in an IRA or in an employer plan such as a 401(k).

The distinction between IRA and 401(k) rules is important because it can trip people up. More than once I have helped a client who took money from their 401(k) plan to make a down-payment on a home and assumed it would be penalty free. The problem is, the exemption for the penalty for a home purchase applies only to IRA withdrawals, not 401(k) withdrawals. 

It’s also important to remember that a withdrawal will still be subject to income taxes*. What we are talking about here is the 10% penalty.

(Unless the withdrawal is from a Roth account or a traditional account with post-tax basis, in which case some or all of the withdrawal may be tax-free. Remember, nothing is ever easy.)

Penalty Exceptions

Consult Form 5329. There is a list of 18 codes that are exemptions from the 10% penalty.

Code 01: Applies to qualified plans only, not to IRAs. If the recipient separated from service after age 55 (or age 50 for certain public safety employees) then the penalty does not apply.

Code 02: A series of substantially equal payments. This basically means that you are withdrawing from the retirement account based on published actuarial tables. Even if you are under age 59 ½, this type of withdrawal is not subject to the 10% penalty.

Code 03: A withdrawal due to disability. You must be totally and permanently disabled. Withdrawals of someone who is totally and permanently disabled are not subject to the 10% penalty.

Code 04: Death distributions. This means you have inherited a retirement account from a deceased person. Your withdrawal as a beneficiary is not subject to the penalty. 

Code 05: 401(k) only – withdrawals to pay for medical expenses exceeding 7.5% of your AGI are not subject to the penalty. Only the portion of expenses above 7.5% of AGI qualifies for the penalty exemption.

Code 06: Certain divorce distributions under a qualified domestic relations order (QDRO). Applies to 401(k) plans only.

Code 07: Applies to IRA withdrawals only – withdrawals of unemployed people to pay insurance premiums are not subject to the 10% penalty.

Code 08: Applies to IRA withdrawals only – withdrawals to pay higher education expenses are not subject to the 10% penalty.

Code 09: Applies to IRA withdrawals only – withdrawals of first-time homebuyers (up to $10,000) are not subject to the 10% penalty.

Code 10: Applies to qualified plans only – withdrawals because of an IRS levy are not subject to the 10% penalty. 

Code 11: Withdrawals made by reservists on active duty for at least 180 days are not subject to the 10% penalty. Applies to qualified plans and IRAs.

Code 12: Distributions incorrectly coded as early distributions on Form 1099-R (i.e. someone over age 59 ½ receives a 1099-R showing that the distribution is subject to the penalty, when in fact they are not subject to the penalty).

Code 13: Distributions from a section 457 plan, which aren’t from a rollover from a qualified retirement plan. A 457 plan is a type of deferred compensation plan that some governmental and non-profit employers offer. These plans are similar to qualified plans but are NOT qualified plans. They have their own rules for distribution of the money. There is no early withdrawal penalty, but again, 457 plans have their own rules on “when” you can access the money, and the withdrawal may be taxable (but not subject to a penalty).

Code 14: Qualified plan withdrawals to people who separated from service by March 1, 1986, and a distribution schedule is in place and being used. These withdrawals are not subject to a penalty. (NOTE: pretty much anyone who is in this boat would likely be over age 59 ½ by now anyway, but the exception still exists.)

Code 15: Distributions of dividends under an ESOP – employee stock option plan. 

Code 16: Per the instructions to Form 5329 – “Distributions from annuity contracts to the extent that the distributions are allocable to the investment in the contract before August 14, 1982.” These withdrawals are not subject to the 10% penalty. 

Code 17: Per the instructions to Form 5329 – “Distributions that are phased retirement annuity payments made to federal employees.”

Code 18: Qualified plan withdrawals under 414(w). What does this mean? Certain qualified plans have “automatic enrollment” provisions. Withdrawals of deferrals made under an automatic enrollment provision not be subject to the 10% penalty.

Code 19: Qualified birth or adoption distributions. Taxpayers can withdraw, from an IRA or a qualified plan, up to $5,000 penalty free up to 1-year after the birth or adoption of a child. 

Code 20: Distributions due to terminal illness. Applies to IRAs and qualified plans. Per the IRS  “Distributions that are made after the date on which your physician has certified that you have an illness or physical condition that can reasonably be expected to result in death in 84 months or less after the date of the certification.” These distributions are not subject to the 10% penalty.

Code 21: Certain corrective distributions in a qualified plan are not subject to the 10% penalty.

Code 99: The instructions for Form 5329 say to enter this code if more than one exception applies.

Other Notes and Tidbits

As said early on, the distribution will generally still be subject to income tax. These exceptions are just for the 10% penalty.

Also, it’s possible that you might be able to access the money for a valid reason but still be subject to the penalty. Take, for example, a hardship distribution from a 401(k) plan. There’s a whole separate set of rules relating to hardship distributions, and you might be able to meet those rules and access the money while still working for the employer. However, those withdrawals are not necessarily exempt from the 10% penalty. 

Mechanics

Use Form 5329, put the proper code(s) on the form, and it will do the math on calculating if any penalty is owed. We will look at an example in an upcoming post.

The post The 10% Penalty on Withdrawals from Retirement Accounts appeared first on Dinesen Tax.

Fix 1: Withdraw the Over-Contribution

This is the fix I see most often, and is usually the best fix. If you catch the over-contribution before you file your tax return, you simply withdraw the over-contribution and it’s as if it never happened. You do need to run an “earnings” calculation, but this is something that the investment platform should be able to handle.

Example: In 2023, Jerry maxed out his Roth IRA with a deposit of $6,500. Unfortunately for Jerry, his AGI was beyond all of the AGI limitations so his allowable Roth contribution was $0. Jerry has made an over-contribution of $6,500. Jerry can withdraw this over-contribution before the due date of his tax return, including extensions, and there is no penalty. Jerry (or more likely, his investment platform) will need to calculate an amount for earnings, and the earnings portion is taxable income on his 2023 tax return (even though the withdrawal happened in 2024). 

Note 1: In these situations I always like for clients to file an extension because it buys extra time to get the over-contribution out. An extension means Jerry has all the way til October 15th to make the withdrawal. Many average clients are deathly afraid of the “E” word but I try to explain it as, it’s just buying time to get the withdrawal done properly. It does not mean we will wait til October 15th to file the return.

Note 2: the earnings are taxable in the current year(i.e. the year of the return) — so let’s say the $6,500 over-deposit had $100 of earnings. Jerry will receive a distribution of $6,600, and the $100 earnings portion is taxable on his 2023 return. What if it’s a loss instead of a gain? This is not deductible. So, if Jerry’s calculation shows, say, a $50 loss, he’ll get $6,450 back from his account. This is not taxable, but Jerry also doesn’t get any deductions for his loss.

Fix 2: Leave In, Pay Penalty, Withdraw Later

I’ve had this happen too: 

Continuing with Jerry from above, let’s say Jerry is one of those “late arrivers” who doesn’t give his tax pro any of his information until October 13th. The tax pro discovers that Jerry over-contributed to his Roth IRA in 2023 by $6,500, but there’s no way that this over-contribution can be withdrawn by October 15th. The fix here would be, pay a 6% penalty on the $6,500 (so, a penalty of $390). Then, withdraw the excess contribution as a 2024 item. No earnings calculation needs to be done; you simply withdraw the $6,500 over-deposit. It is not taxable, and that is the end of it.

Fix 3: Leave In, Call it a Contribution Later

Let’s say Jerry’s AGI problem was caused by a 1-year blip in his AGI. Maybe he sold some stock or something, or came into a large sum of taxable income but it was one-time only. Or maybe in 2024 he lost his job, or whatever. Whatever the case, his income is way down in 2024. If his AGI in 2024 is lower than the Roth AGI thresholds, he can make contributions again.

In this case, Jerry pays a 6% penalty on his 2023 return on the $6,500 over-contribution. Since he knows his AGI will be BELOW the limits in 2024, he can call this a $6,500 contribution for 2024. No penalty in 2024.

Fix 4: Recharacterize to a Traditional IRA

Jerry can also recharacterize the Roth contribution to a traditional IRA contribution (see the note below for additional info as some types of transactions cannot be recharacterized). This must be done by the original due date of the return (NOT including extensions). Traditional IRA contributions also have AGI restrictions, but that is simply a restriction on DEDUCTING the contribution, not a restriction on MAKING the contribution. 

Basically if you want to recharacterize, you must do so by the due date without extension, because the rule is that it must have been a valid contribution to the traditional IRA. Traditional IRA contributions must be made by the due date, without extension, of the return.

(NOTE: the Tax Cuts and Jobs Act prohibits recharacterizing Roth conversions [a conversion from a traditional IRA to a Roth IRA; basically once this type of transaction happens, you can’t undo it. This restriction does not apply to over-contributions.)

Another Option, But Probably Not a Good One

Jerry could also just leave the 2023 over-contribution in his IRA and pay a 6% penalty on $6,500 … but this penalty would apply EVERY YEAR until the over-contribution is withdrawn or until his AGI drops and he can use the 2023 over-contribution as a current-year contribution. Doing this means he would pay a $390 penalty every year, since the money remains “tainted.”

Which Option is Best?

Option 1 is usually the best choice. It avoids penalty and also avoids the hassle of recharacterizing and needing to manage a traditional IRA when really you want a Roth IRA.

Option 2 is best if you aren’t able to make the withdrawal in time before your tax return is due.

Recharacterizing (option 3) is also an option if 1) you can do it by the original due date of the return, and 2) you are okay with a traditional IRA and possibly needing to track after-tax basis in that account.

The post How to Fix Roth IRA Over-Deposits appeared first on Dinesen Tax.

Energy efficient home improvement credit

The Way it Used to Be

Up through 2022 (including 2022), the credit was a maximum of $500 – and that was a lifetime limit. So if you bought an energy efficient refrigerator and installed a few energy efficient windows in 2009 and claimed the maximum of $500, you could never claim the credit again. 

This presented a compliance problem because one needed to track this. Say you claimed $300 in 2009. There would still be $200 left to potentially claim in the future. Someone needed to track that. Tax pros could usually rely on their software for this tracking, but it still needed to be done. 

And then there’s the IRS side – $500 is a small enough amount that it wasn’t likely to get audited, yet this was almost certainly a leaky spot that got abused. 

Enter the changes for 2023.

2023 Changes

For 2023, the $500 lifetime limit is gone, replaced with a $1,200 or $2,000 annual limit. This below is straight from the IRS:

Beginning Jan. 1, 2023, the credit equals 30% of certain qualified expenses, including:

• Qualified energy efficiency improvements installed during the year
• Residential energy property expenses
• Home energy audits
• There are limits on the allowable annual credit and on the amount of credit for certain types of qualified expenses. The credit is allowed for qualifying property placed in service on or after Jan. 1, 2023, and before Jan. 1, 2033.

The maximum credit you can claim each year is:

• $1,200 for energy property costs and certain energy efficient home improvements, with limits on doors ($250 per door and $500 total), windows ($600) and home energy audits ($150)
• $2,000 per year for qualified heat pumps, biomass stoves or biomass boilers
• The credit has no lifetime dollar limit. You can claim the maximum annual credit every year that you make eligible improvements until 2033.

From: https://www.irs.gov/credits-deductions/energy-efficient-home-improvement-credit

Residential Clean Energy Credit

The above section is about the Energy Efficient Home Improvement Credit. There’s a separate credit, called the Residential Clean Energy Credit. This credit is for things such as solar panels, and is 30% of the cost, with no limit. So if you spend $30,000 on solar panels, your credit is $9,000.

The post Residential Energy Credit: Big Changes for 2023 appeared first on Dinesen Tax.

In November, the IRS announced this it was pushing back the changes to Form 1099-K reporting rules again. Let’s examine.

What is Form 1099-K?

Form 1099-K is issued by third-party settlement organizations and third-party network transactions for business transactions.

A third-party settlement organization is sometimes called a merchant processor. Whatever you call them, they are the back-end processor of credit card transactions. So, if you own a business and you take payment via credit cards, you probably have a merchant processor/third-party settlement organization. That entity will send you a Form 1099-K at the end of the year, showing all of the money you took in via credit cards and debit cards during the year.

Then we have third-party network transactions. These are transactions through places such as Venmo and PayPal (and many others). The app holds the money in-between the transaction.

Example: you are in a fantasy football league and you pay your $50 league dues to the commissioner via the commissioner’s Venmo account. The $50 sits at Venmo until the commissioner logs into their account and gets the money. This is an example of a third-party network transaction. 

NOTE: places such as bill.com and Zelle are not in the category of being a third-party network because they don’t hold the money in-between the transaction. This means YOU issue the 1099-NEC when paying through bill.com and Zelle.

Thresholds

Third-party settlement organizations (i.e. merchant processors) send a 1099-K when $600 or more is processed through the processor.

The real issue with 1099-K has always been the payment apps/third-party network transactions. Here’s why.

Historically (since this all started in 2012), third-party network organizations such as PayPal have had a reporting threshold of:

1. $20,000 received AND
2. 200 transactions processed

If the recipient topped BOTH of those thresholds, the organization would issue a 1099-K. 

The law relating to 1099s also says, specific to contract labor, that the payer of contract labor does not need to issue a 1099-NEC if the 1099-K rules apply. The 1099-K rules apply if one or the other of these is true:

1. Payment is made through the contractor’s business account on the app, OR
2. The payer marks “good and services” when making the payment.

If one or the other of those things is true, then the payer doesn’t issue a 1099-NEC. And  this exception applies even if the contractor’s transaction count is below the 1099-K thresholds. 

This creates a hole in income reporting.

Example

This is not a hypothetical; things like this happen all the time.

Joe is a contractor who works for 25 different businesses, each of whom pay him $10,000 for the year. So, Joe makes $250,000 in contract labor. 

If Joe’s customers pay him by check (or a bill-pay service such as bill.com or Zelle), the customer issues a 1099-NEC to Joe, and the Big Bad IRS knows all about Joe’s $250,000 of income. 

But if Joe can get the customers to pay him via Venmo, this is what happens (assuming that they either pay through his business profile, or they mark goods and services when making the payment):

• Joe takes in $250,000 through Venmo – this crosses the $20,000 threshold for a 1099-K to be issued by Venmo, but there’s another threshold to look at;
• Joe only has 25 transactions, well below the 200 transaction threshold – this means Venmo won’t issue a 1099-K.
• Because the payers marked “goods and services” when making the payment, they don’t issue a 1099-NEC.

This means NONE of Joe’s income goes on a reporting form.

One of the major misconceptions in the tax world is that people think they don’t need to report their income if it’s not on a reporting form. This is not true. However, in the real world, there are many “Joe’s” for whom their eyes would light up and they would say “hey, I didn’t get a 1099, so I don’t need to report it.” Or, “I can report whatever I want, because I didn’t get a reporting form.” 

And while this is not right and proper, it’s also hard for the IRS to enforce, because there’s no 1099 issued and thus no paper trail.

Enter the 1099-K Changes

The American Rescue Plan in March of 2021 called for a change – starting in 2022 – to 1099-K reporting for contract labor. ARP said a third party network processor (i.e. the PayPals and Venmos, etc. of the world) should issue a 1099-K if the total amount received through the platform for the year was $600 or more for goods or services.

From the beginning, there has been outrage about this, and so the IRS delayed the implementation of the rule two times now.

(The outrage has been misplaced if not flat-out wrong and misleading – such as tax pros talking about the “IRS is coming for your Venmo transactions!!!! OMG OMG OMG THE OUTRAGE!!!!!!” Well yes, I suppose the government is coming for your Venmo transactions … but only BUSINESS transactions that should have been reported in the first place. But I seem to be in the minority in thinking this.)

Changes Delayed

In December of 2022, the IRS announced that the changes to the reporting threshold for 2022 would NOT take effect – the “usual” threshold of 200 transactions and $20,000 processed would continue to apply for 2022.

And in November of 2023, the IRS announced that the changes were being delayed again, so for 2023 the “usual” threshold of  200 transactions and $20,000 processed would continue to apply for 2023.

The IRS now says a threshold of $5,000 will apply for 2024 1099-K reporting. This appears to be a “transition” year, so the $600 threshold “might” apply for 2025 (we don’t know that for sure, this is my speculation).

The post What’s Going on with Form 1099-K? appeared first on Dinesen Tax.

Let’s talk about beneficial owner reporting. This is a tricky subject for any tax pro to talk about. We are the ones who are on the front lines of telling clients about this, yet we cannot actually do the filing.*

*-I know some tax pros are doing the filing, but the continuing education I have taken on this topic indicates that this report is probably the practice of law and so we should not be doing it. 

What is it? 

This is a required report that you must file with the Financial Crimes Enforcement Network (FinCEN), which is a part of the Treasury Department. 

This filing applies to basically almost all small businesses that are entities, meaning an LLC or a corporation. Congress came up with this in what’s called the Corporate Transparency Act.

Don’t let that term “corporate” fool you, though, because this applies to LLCs as well.

If you’re a sole proprietor or a partnership, you might not need to file this. This means, a sole proprietor who is not an LLC, and a partnership that is not an LLC. It depends on if you have filed something with the Secretary of State. This is something that I cannot advise you on – it’s really a talk to your attorney thing. 

Who are we kidding? All of this is talk to your attorney stuff.

When is This Due?

If you’re an existing business that was in existence before 2024, you have until the end of 2024 to file this report.

If you form a new business in 2024, you have 90 days after formation of the business to submit the filing, and then starting in 2025 and beyond, the first report is due within 30 days of formation.

This filing only needs to be done once. It is not an annual report. However, if there are any changes to anything, those changes must be reported within 30 days.

Accountant Role

Accountants are in the odd position of being the trusted advisor who needs to tell you about this requirement, but we actually can’t do the report. We can’t do any of this. We can’t do the filing, nor can we advise you on anything relating to it, because this is considered the practice of law.

As I said above, some accountants ARE doing the filings, but the continuing education I have taken on this indicates that this is the practice of law and accountants shouldn’t be doing it. Not only that but a lot of the error and omission insurance carriers out there for accountants are saying that they will not cover accountants who do this filing.

So I’m not touching this report, but yet I need to bring it to the attention of my clients. Ultimately, it’s a talk to your attorney sort of thing. 

There’s also a pretty handy FAQ page on the FinCEN website: https://www.fincen.gov/boi-faqs

Penalties

There are very harsh penalties associated with not filing this report when you’re supposed to – $500 per day that you’re late with it.

And not only that, you could go to prison for up to 2 years and be fined up to $10,000! Oh my.

What to do Right Now

I would recommend going to FinCEN.gov and reading the FAQs, and talk to your attorney. If you’re an accountant or tax pro reading this, take some continuing education on this subject, because even though we can’t “do” the filing, we do need to know about it.

The post Beneficial Ownership Reporting and the Tax Practitioner appeared first on Dinesen Tax.

I’ve written about this before but now is a timely time to talk about it again, with tax season underway. 

I prepare a lot of individual tax returns, and one of the most-common compliance issues I see is: people contributing too much into their Roth IRA. One-hundred percent of the time, the person had no idea there was a problem.

IRAs

There are two types of individual retirement accounts you can open – a traditional IRA and a Roth IRA.

• Traditional IRA: deposits (usually called “contributions”) into the plan are tax deductible (usually); withdrawals are (usually) taxable. Not the use of a lot of parenthetical references here. More shortly.
• Roth IRA: deposits are not tax deductible. The flip side is, withdrawals are not taxable at all (as long as the withdrawals are considered qualified).

Now, what is this about “over-deposits” into a Roth IRA?

Contribution Limits

Tax law specifies a maximum amount that you can contribute to an IRA in a year. The limits are:

• 2023: $6,500 ($7,500 if age 50+)
• 2024: $7,000 ($8,000 if age 50+)

This is an overall IRA limit, so if you want to contribute to both a traditional IRA and a Roth IRA, the limit is $6,500 ($7,500) in 2023 overall. 

So, again, what is this about “over-deposits” into a Roth IRA? This is a lot of setup. Well, the setup is important to answering the question.

AGI Restrictions

Adjusted gross income (AGI) restrictions apply to contributions to an IRA. 

In a traditional IRA, those AGI restrictions apply only to the deductibility of contributions into the IRA. You can make the full contribution, but if your AGI is too high (and you are covered by a retirement plan at a job) you might not be able to take a deduction for the contribution. This is a different blog post for a different day.

Now, we finally answer the question about what’s going on with over-contributions to Roth IRAs.

The AGI restrictions relating to Roth accounts actually restrict your ability to put money into the account. From the IRS:

Real World Scenarios

It is very easy for people to run afoul of the Roth IRA AGI restrictions.

Things I have seen:

• People start a Roth IRA on their own, knowing nothing about the AGI restrictions and they don’t tell me about it until sometime later … and their income has always been above the AGI limits.
• People whose investment advisor opens a Roth IRA for them, and the advisor doesn’t tell them about the AGI limits.
• People who have a Roth IRA, and whose income has always been below the AGI thresholds … until this year when they received a big pay raise and they’re now past the thresholds. 
• People who have a Roth IRA, and they file as married filing separately because of income-based repayment on student loans. I caught this for a new client one time, and we had to fix some 5 or 6 years (I can’t remember exactly how many anymore, it’s been a long time) of over-deposits. Note in the IRS chart above, how ridiculously low the AGI thresholds are for married filing separately.

Fixes

We’ll cover fixes in a future post. But the 30,000-foot view is:

• Leave the over-contribution in and pay a 6% penalty … but this money is “tainted,” meaning the 6% penalty will apply on that over-contribution every year.
• Leave the over-contribution in this year and pay the 6% penalty, and if income drops next year, use it as a contribution in that future year (and no more penalty).
• Withdraw the excess contribution by the due date (including extensions) of the return.

Footnote on Roth 401(k)

People (including tax pros) often ask if these AGI limits apply to Roth 401(k) contributions. The answer is no, they don’t. People of any income level can contribute to a Roth 401(k) through an employer.

The post Roth IRA Over-Contributions: Common Problem for Average Taxpayers appeared first on Dinesen Tax.

In the tax bill being debated in Congress, one of the provisions is to expand the child tax credit. The proposal would:

• Increase the refundable portion child tax credit (known as the “additional child tax credit”), for 2023, by $200, to $1,800. And increase it to $1,900 for 2024 and $2,000 for 2025.
• Index both the regular child tax credit (currently $2,000) for inflation, starting with 2024 (it’s still $2,000 for 2023; will be something higher [presumably, depending on the inflation adjustment] for 2024 and each year afterwards).

In this post I wanted to talk about the refundable portion of the child tax credit.

Refundable vs. Non-Refundable

Tax credits come in 2 varieties: non-refundable and refundable.

• Non-refundable = can bring a taxpayer’s tax liability down to $0, but not below $0
• Refundable – can create a refund (essentially treated as a deposit the taxpayer made)

The child tax credit is non-refundable, but part of it may be refundable, depending on the taxpayer’s earned income.

The non-refundable portion of the credit is applied against a taxpayer’s regular income tax, alternative minimum tax, and any payback of premium tax credits (excess advance premium tax credits).

The non-refundable portion does not apply to taxes such as self-employment tax, additional Medicare tax or the net investment income tax, or any penalties relating to early distributions from retirement accounts (the 10% penalty) or other Form 5329 penalties. 

In the video, I show exactly where the non-refundable portion goes on the Form 1040 and which taxes (including those from Schedule 2) it applies against.

Ordering Rules

Want to make your head really spin? Of course you do.

With non-refundable credits, there are ordering rules, meaning there’s a system where certain non-refundable credits are used before other non-refundable credits. For the full ordering rules, see the instructions to Schedule 8812, or the Internal Revenue Manual at 21.6.3.4.1.

For most taxpayers, these credits here are the ones that will show up most often.

• For example, the foreign tax credit, child and dependent care credit (Form 2441), education credits, retirement savings credit, and residential energy credit are all used first
• Then the other dependent credit
• And THEN the child tax credit

If the child tax credit is not used in full at this point, then part of the credit becomes a refundable child tax credit, also known as “additional child tax credit.”

Example 1

Joe and Ellen are married with one child. They qualify for a $2,000 child tax credit. Their tax liability is $7,000, and they have a $600 dependent care benefit (Form 2441). This is their only other credit. The $7,000 tax liability is first reduced by $600 (so down to $6,400) and then reduced by $2,000 for the child tax credit. The child tax credit, in this case, is fully non-refundable, and all used up at this point. There is no additional child tax credit.

Example 2

Let’s say Joe and Ellen’s tax liability is $500. The Form 2441 credit is applied first. This credit is non-refundable, so $500 gets used (and the other $100 of the credit is lost to the wind). This reduces their tax liability to $0. This means, the non-refundable portion of the child tax credit is not used at all. This is where the refundable child tax credit/additional child tax credit comes into play.

Refundable Portion of CTC

The amount of refundable CTC depends on the taxpayer’s earned income. Up to 15% of earned income above $2,500 may be refundable. The maximum refundable portion is $1,600 per child. The proposed bill in Congress would increase the maximum refundable portion to $1,800

Example 3

Continuing with Example 2, let’s say Joe and Ellen’s earned income is $30,000. Up to 15% of earned income above $2,500 is refundable.

$30,000 – $2,500 = $27,500 x 15% = $4,125.

The overall limitation for 2023, though, is $1,600. (Would be $1,800 if this proposal in Congress passes).

So, Joe and Ellen would receive $1,600 as an additional child tax credit. Note that the full CTC would be $2,000 – the unused $400 is lost.

Proposals

The proposal in Congress would increase the maximum refundable portion to $1,800 for 2023 and then $1,900 in 2024 and $2,000 in 2025. The $2,000 full credit amount would be indexed for inflation (i.e. it will increase) starting in 2024.

The post Refundable Child Tax Credit appeared first on Dinesen Tax.

It’s that time of year when people will start receiving 1099s and W-2s. I received one on January 4th, so the season really has begun. 

If you’re an employer wanting to send a 1099 or W-2 electronically to the recipient … did you know that there are hoops you must jump through?

Many Hoops

Providing paper copies to the recipient is always acceptable. This is true even if you’re required to e-file the 1099s or W-2s with the IRS. 

Let’s talk about providing electronic copies of 1099s or W-2s to the recipient. This is where complications set in. Let’s look at the requirements.

Consent

You must obtain consent from the person you are sending to. According to “Form 1099 General Instructions for Certain Information Returns,” the “consent by the recipient must be made electronically and in such a way that shows that she or he can access the statement in the electronic format in which it will be furnished.” https://www.irs.gov/pub/irs-pdf/i1099gi.pdf

So, if you are sending a 1099 by email, get consent by email. 

Disclosures Upon Delivery

You also need to provide a statement to the recipient with all of these things “prominently displayed.”

• If the recipient does not consent to receive the statement electronically, a paper copy will be provided.
• The scope and duration of the consent. For example, whether the consent applies to every year the statement is furnished or only for the statement for a particular year, as applicable, immediately following the date of the consent.
• How to obtain a paper copy after giving consent.
• How to withdraw the consent. The consent may be withdrawn at any time by furnishing the withdrawal in writing (electronically or on paper) to the person whose name appears on the statement. Also, confirmation of the withdrawal will be in writing (electronically or on paper).
• Notice of termination. The notice must state under what conditions the statements will no longer be furnished to the recipient.
• Procedures to update the recipient’s information.
• A description of the hardware and software required to access, print, and retain a statement, and a date the statement will no longer be available on the website.

Format, Posting and Notification

You must also:

• Ensure the electronic format contains all the required information and complies with the applicable revenue procedure for substitute statements to recipients in Pub. 1179.
• Post, on or before the due date, the applicable statement on a website accessible to the recipient through October 15 of that year.
• Inform the recipient, electronically or by mail, of the posting and how to access and print the statement.

The first bullet point is saying that the form must meet the prescribed format for what must be on 1099s. In most cases, you will meet this by simply using the PDFs from the IRS website, or using software to create the form. (NOTE: it’s okay to give copies to the contractor, of PDFs from the IRS website, but you cannot use these PDFs for filing with the IRS!).

The second and third bullet point relate to posting 1099s to a secure site. Which brings us to:

What Does it All Mean?

Can you simply e-mail a 1099 to a contractor? It happens all the time, but is it really right and proper with the requirements? If you obtain “consent,” which, since consent must be in the same format as the delivery method, would seem to simply be you e-mail them to ask if it’s okay, and they say yes. 

Then, make sure to give them the long list of statements which tell them things such as they are entitled to a paper copy if they don’t want an electronic copy. 

But should you be e-mailing 1099s? 

It is allowable to “truncate” SSNs, where the format is XXX-XX-1234. Don’t ever e-mail a form with a full SSN on it. 

However, there are problems with emailing, even if you truncate the SSN. You can do a read-receipt on the email but there may not be great tracking of delivery. And there’s always the issue of sending by accident to the wrong person. 

Various platforms (and maybe your bookkeeping software) take care of these things. For example, I file 1099s through track1099.com. For e-delivery, I enter the recipient’s SSN. The platform then takes care of getting disclosures and sending notices, and there’s a secure link the recipient clicks on, and then they enter their SSN. This way, if I put the wrong email in, the recipient won’t be able to open the form because it requires the recipient to know their SSN and enter it. 

Easier Just to Mail?

Is it easier to simply mail the 1099s? Unless you use a service that can jump through all these hoops, I think the answer is “probably.” 

Resources

As always, don’t use this blog for making final decisions. Consider it “points to ponder.” Resources:

• Form 1099 General Instructions for Certain Information Returns: https://www.irs.gov/pub/irs-pdf/i1099gi.pdf (see page 17)
• Publication 1141 General Rules and Specifications for Substitute Forms W-2 and W-3. https://www.irs.gov/pub/irs-pdf/p1141.pdf (see pages 16 and 17)

(NOTE: this post is mainly about 1099s but the same rules apply to W-2s; see Publication 1141)

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The short answer is, no, a supply chain disruption does not qualify a business for ERC.

The memo analyzes five scenarios.

Scenario 1

Here is Scenario 1 from the memo:

Employer A was not subject to any governmental orders limiting commerce, travel, or group meetings due to COVID-19 at any time. However, during 2020 and 2021, Employer A experienced several delays in receiving critical goods from Supplier 1. At all times during 2020 and 2021, Employer A continued to operate because Employer A had a surplus of the critical goods normally provided by Supplier 1. Employer A assumed that Supplier 1’s delay in delivering critical goods was caused by COVID-19. Employer A inquired and Supplier 1 vaguely confirmed that the delay was due to COVID-19. Supplier 1 did not provide a governmental order from an appropriate governmental authority and Employer A was unable to locate one.

The IRS’s analysis here is that the business does NOT qualify for ERC. The supplier was not shut down, and mere “disruptions” in the delivery of goods does not count.

Here’s another point for thought: the IRS goes on to say that, even if the supplier did have a shutdown order in place, Employer A had enough goods on hand to operate normally:

Even if Employer A received or could locate the governmental orders applicable to Supplier 1, Employer A did not have to cease operations because Employer A had a reserve of critical goods allowing Employer A to continue operations; thus, Employer A did not experience a full or partial suspension of operations due to an inability to obtain Supplier 1’s critical goods. The relevant inquiry is whether Employer A’s trade or business operations could continue; since Employer A was able to continue its own business operations despite the supply chain disruption, it was not subject to a full or partial suspension of operations.

So the qualifier of “a business qualifies if essential supplies were shut down” has a caveat: the business only qualifies if the shutdown of suppliers caused a disruption to the business.

Scenario 2

Per the IRS scenario:

Employer B was not subject to any governmental orders limiting commerce, travel, or group meetings due to COVID-19 at any time. However, certain critical goods from Supplier 2 were stuck at port in State X. Employer B assumed the bottleneck at the port was a result of COVID-19. Employer B could not identify any specific governmental order applicable to Supplier 2 or any specific governmental order that caused the bottleneck at the port. Some news sources stated that COVID-19 was the reason for the bottleneck, while others cited reasons such as increases in consumer spending and aging infrastructure. In addition, Supplier 2 mentioned to Employer B that other critical goods that were not stuck at port would be delayed due to a truck driver shortage. Employer B saw some discussion on social media that the truck driver shortage was because drivers were out sick due to COVID-19.

The analysis here is the same as in Scenario 1 — this business does not qualify. No “government orders” caused the delays. It may be true that COVID caused the delays, but the requirement for ERC qualification is that it must be a “government order.”

Scenario 3

Per the IRS scenario:

Employer C and Supplier 3 are located in a jurisdiction that issued governmental orders suspending both of their business operations for the duration of April 2020. Employer C and Supplier 3’s jurisdiction lifted all orders related to COVID in May 2020. For the remainder of 2020 and 2021, Employer C experienced a delay in receiving critical goods from Supplier 3. Supplier 3 does not provide a reason for the delay, but Employer C assumes the delay is due to the governmental order in place in April 2020.

In this scenario, Employer C qualifies during the time period the written shutdown order was in place (April of 2020). It does not qualify later, even if delays could possibly be tied back to the government order — the order itself expired after April of 2020, and so ERC qualification expires then too.

Scenario 4

Per the IRS scenario:

Employer D was not subject to any governmental orders limiting commerce, travel, or group meetings due to COVID-19 at any time. During 2020 and 2021, Employer D could not obtain critical goods from Supplier 4. However, Employer D was able to obtain the goods from an alternate supplier. The critical goods from the alternate supplier cost 35% more than those from Supplier 4. Employer D could continue to operate its trade or business even though it was not as profitable as in 2019.

The IRS says this business does not qualify for ERC. There were no government orders in place against the business, or its suppliers. (NOTE: the scenario does not say why the business couldn’t obtain supplies from “Supplier 4.”) Per the IRS, the mere fact that the goods from the alternate supplier cost more is NOT a qualifier for ERC.

Scenario 5

The fifth and final scenario in the memo:

Employer E operates a large retail business selling a wide variety of products. Employer E was not subject to any governmental orders limiting commerce, travel, or group meetings due to COVID-19 in 2021. Due to various supply chain disruptions, Employer E was not able to stock a limited number of products and was forced to raise prices on other products that were in limited supply. However, at no time did the product shortage prevent Employer E from continuing to fully operate as a retail business during 2021.

The IRS says this business does not qualify for ERC. There were no written shutdown orders against the business, or against its suppliers.

Conclusion

This memo tracks along with what I have said regarding shutdowns and supply chain issues. If a business can show that an essential supplier was shut down by written government order, and it had an impact on operations then the business likely qualifies. Mere “disruptions” due to COVID do not qualify.

Note that Chief Counsel Memoranda are not authoritative guidance and cannot be cited or used as precedent; however they provide a window into the IRS’s views on various topics.

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I am not a huge fan of S-corps, and quite frankly there’s nothing wrong with being a sole proprietor. There are times where you will actually save money by being a sole proprietor instead of an S-corp. What sort of blasphemy is this???? It has to do with the QBI deduction.

Let’s examine.

Example Where It Makes Sense

There are a lot of words below, so let’s put the comparison right here, and then if you want to walk through the mechanics, you can read the section. We’re saying this proprietor has net income from their Schedule C of $100,000 per year, and their spouse makes $60,000 from a W-2 job, and they take the standard deduction. In the S-corp example, we are saying the proprietor is taking a salary of $60,000 out of the business.

The all-in tax hit is:

• $29,662 as a sole proprietor
• $27,787 as an S-corp
• S-Corp wins by $1,875; converting to an S-corp makes sense as long as the compliance costs (corporate tax preparation, cost of payroll services, etc. are less than $1,875)

Sole Proprietor

The self-employment tax hit is: $100,000 net income from the sole proprietorship x .9235 = $92,350 x .153 = $14,130. They get a deduction equal to 1/2 of that, so $7,065.

Their taxable income before QBI, for income taxes is: $100,000 net income + $60,000 W-2 income – $7,065 deduction for 1/2 of SE tax – $25,100 standard deduction = $127,835.

The QBI deduction is: $100,000 of self-employment income – $7,065 deduction attributed to that income = $92,935 x .2 = $18,587

Taxable income after QBI is: $127,835 – $18,587 = $109,248

Income tax = $15,532 + $14,130 of self-employment tax = $29,662 total tax liability.

S-Corporation

This self-employed person has no doubt heard from their neighbor/parent/brother-in-law in Las Vegas with a drywall business/plumber/hair dresser/etc. (a client really did opine to me one time about tax advice they got from their brother-in-law who runs a drywall business out of the back of his pickup in Las Vegas) that smart people form an S-corp.

And tax pros (CPAs in particular) have adopted as common wisdom (with no backing in actual proof) that 60% of your profit is what your salary should be. Some say 50%.

Before we go further: the “pay 60% in salary and 40% in distributions (or 50/50)” thing that so many tax pros give as “advice” is not based on any kind of IRS-blessed guidance at all. There is no such formula despite what so many tax pros say. 

But since I am in the minority, tilting at windmills on all issues S-corp related, I’ll say: fine, I’ll give into peer pressure and let’s set this person’s salary at 60%, so $60,000.

Off of their business income of $100,000 they’ll subtract $60,000 for the salary. Also subtract out 7.65% of the salary for employer-side FICA taxes ($60,000 x .0765 = $4,590). So the business income passed through from the S-corp is $100,000 – $60,000 – $4,590 = $35,410. (NOTE: I am purposely leaving out state unemployment taxes here to keep it somewhat simpler.)

How does this impact the tax return?

$60,000 salary to the “S-corp spouse” + $60,000 to the other spouse + $35,410 pass-through S-corp income – $25,100 standard deduction = $130,310 taxable income before the QBI deduction.

QBI deduction: $35,410 from the S-corp x .2 = $7,082.

$130,310 – $7,082 = $123,228 taxable income. The tax on this is $18,607 income tax liability. But we can’t forget about the FICA taxes, which are a similar concept to self-employment tax. The FICA is not computed on the tax return; it runs through payroll instead and is taken out as withholding but it’s still there. $60,000 x .153 = $9,180.

$18,607 + $9,180 = $27,787 total tax hit.

When it Doesn’t Make Sense

In this example, we’re playing with bigger numbers now and saying the proprietor has net income of $300,000, they’re married but have no other income, and they take the standard deduction still.

On the S-corp side, the proprietor again decides 60% is the way to set salary, so they take 60% of $300,000, or $180,000 as a salary.

The all-in tax hit is:

• $63,823 as a sole proprietor
• $68,950 as an S-corp
• This proprietor is $6,027 worse off by being an S-corp

Sole Proprietor

The SE tax calculation is a little different here because $300,000 is over the Social Security wage base. Start with $300,000 x .9235 = $277,050. The Social Security wage base is $142,800 for 2021, so the SS piece of SE tax is based on $142,800 x .124 = $17,707. Medicare tax is based on $277,050 x .029 = $8,034. $17,707 + $8,304 = $25,741, and the deduction for 1/2 of SE tax is $25,471 / 2 = $12,871.

$300,000 – $12,871  – $25,100 standard deduction = $262,029  taxable income before the QBI deduction. This is less than their QBI of $287,129, so their QBI deduction is $262,029 * .2 = $52,406.

$262,029 – $52,406 = $209,623 taxable income. The tax on this is $38,352 + SE tax of $25,471 = $63,823 total tax.

S-Corp

FICA taxes on $180,000 of salary are: $142,800 x .062 = $8,854 Social Security tax owed by the employee and that same amount owed by the corporation; and $180,000 x .0145 = $2,610 Medicare tax owed by the employee and that same amount owed by the corporation. Deduction to the S-corp is: $8,854 + $2,610 = $11,464. The total FICA tax here is $22,928.

S-corp net income: $300,000 – $180,000 – $11,464 (the employer side of FICA) = $108,354.

On the shareholder’s return: $180,000 salary + $108,354 pass-through from S-corp = $288,354 – $25,100 standard deduction = $263,254 taxable income before QBI deduction.

QBI is $108,354, the income from the S-corp. $108,354 x .2 = $21,671.

$263,254 – $21,671 = $241,583 taxable income. The tax on this is $46,022 + FICA taxes (employer and employee) of $22,928 = $68,950.

Why is This Worse?

This example turns out the way it does because of the QBI deduction. The self-employment taxes the proprietor saves are wiped out by the increase in income taxes because of the decrease in the QBI deduction. As income gets close to the phase-in thresholds for QBI (but still below the threshold), it’s better to be a sole proprietor. Once income gets past the phase-in level, then it’s better to be an S-corporation because W-2 wages become a part of the calculation.

It Depends

The old “wisdom” of tax pros saying to form an S-corp any time a sole proprietor showed a profit equal to what they could pay as a reasonable salary no longer holds true. For example, I have seen tax pros opine that “all” sole proprietors should form an S-corp once net income hits $40,000 (I’ve seen $30,000 and even $20,000 thrown out too). As with the “60% as your salary” thing, you can’t break this stuff into magical formulas because no such magical formulas exist.

It really depends. Higher-income proprietors who are still below the QBI phase-in/phase-out thresholds might be better off staying a sole proprietor, as in our second example here.

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