Individual Taxpayers: Year-end Tax Planning Strategies
With the end of the year fast approaching, now is the time to take a closer look at tax planning strategies that could reduce your tax bill for 2021.
General Tax Planning Strategies
General tax planning strategies for individuals include accelerating or deferring income and deductions, as well as careful consideration of timing-related tax planning strategies with regard to investments, charitable gifts, and retirement planning. For example, taxpayers might consider using one or more of the following strategies:
Investments. Selling any investments on which you have a gain (or loss) this year. For more on this, see Investment Gains and Losses, below.
Year-end bonus. If you anticipate an increase in taxable income in 2021, and are expecting a bonus at year-end, try to get it before December 31.
Contractual bonuses are different in that they are typically not paid out until the first quarter of the following year. Therefore, any taxes owed on a contractual bonus would not be due until you file your 2022 tax return in 2023. Please call the office if you have any questions about this.
Charitable deductions. Bunching charitable deductions every other year is also a good strategy if it enables the taxpayer to get over the higher standard deduction threshold under the Tax Cuts and Jobs Act of 2017 (TCJA). Another option is to put money into a donor-advised fund that enables donors to make a charitable contribution and receive an immediate tax deduction. A public charity manages the fund on behalf of the donor, who then recommends how to distribute the money over time. Don’t hesitate to call if you would like more information about donor-advised funds. Scroll down to read more about charitable deductions.
Medical expenses. Medical expenses are deductible only to the extent they exceed a certain percentage of adjusted gross income (AGI); therefore, you might pay medical bills in whichever year they would do you the most tax good. In 2021, deductible medical and dental expenses must exceed 7.5 percent of AGI. By bunching medical expenses into one year, rather than spreading them out over two years, you have a better chance of exceeding the thresholds, thereby maximizing the deduction.
Deductible expenses such as medical expenses and charitable contributions can be prepaid this year using a credit card or check. You can only deduct medical and dental expenses you paid this year – not payments for medical or dental care you will receive in a future year. For example, suppose you charge a medical expense in December but pay the bill in January. Assuming it’s an eligible medical expense, you can take the deduction on your 2021 tax return.
Stock options. If your company grants stock options, then you may want to exercise the option or sell stock acquired by exercising an option this year. Use this strategy if you think your tax bracket will be higher in 2022. Generally, exercising this option is a taxable event; the sale of the stock is almost always a taxable event.
Invoices. If you’re self-employed, send invoices or bills to clients or customers this year to be paid in full by the end of December; however, make sure you keep an eye on estimated tax requirements. Conversely, if you anticipate a lower income next year, consider deferring sending invoices to next year.
Withholding. If you know you have a set amount of income coming in this year that is not covered by withholding taxes, there is still time to increase your withholding before year-end and avoid or reduce any estimated tax penalty that might otherwise be due.
Avoid the penalty by covering the extra tax in your final estimated tax payment and computing the penalty using the annualized income method.
Accelerating or Deferring Income and Deductions
Strategies commonly used to help taxpayers minimize their tax liability include accelerating or deferring income and deductions. Which strategy you use depends on your current tax situation.
Most taxpayers anticipate increased earnings from year to year, whether it’s from a job or investments, so this strategy works well. On the flip side, however, if you are retiring and anticipate a lower income next year or you know you will have significant medical bills, you might want to consider deferring income and expenses to the following year.
In cases where tax benefits are phased out over a certain adjusted gross income (AGI) amount, a strategy of accelerating income and deductions might allow you to claim larger deductions, credits, and other tax breaks for 2021, depending on your situation. Roth IRA contributions, child tax credits, higher education tax credits, and deductions for student loan interest are examples of these types of tax benefits.
Accelerating income into 2021 is also a good idea if you anticipate being in a higher tax bracket next year. This is especially true for taxpayers whose earnings are close to threshold amounts that make them liable for the Additional Medicare Tax or Net Investment Income Tax ($200,000 for single filers and $250,000 for married filing jointly). See more about these two topics below.
Taxpayers close to threshold amounts for the Net Investment Income Tax (3.8 percent of net investment income) should pay close attention to “one-time” income spikes such as those associated with Roth conversions, sale of a home or any other large asset that may be subject to tax.
Examples of accelerating income include:
- Paying an estimated state tax installment in December instead of at the January due date. However, make sure the payment is based on a reasonable estimate of your state tax.
- Paying your entire property tax bill, including installments due in 2022, by year-end. This does not apply to mortgage escrow accounts.
A prepayment of anticipated real property taxes that have not been assessed prior to 2022 is not deductible in 2021.
Under TCJA, the deduction for state and local taxes (SALT) was capped at $10,000. Once a taxpayer reaches this limit the two strategies above are not effective for federal returns.
- Paying 2022 tuition in 2021 to take full advantage of the American Opportunity Tax Credit, an above-the-line tax credit worth up to $2,500 per student that helps cover the cost of tuition, fees, and course materials paid during the taxable year. Forty percent of the credit (up to $1,000) is refundable, which means you can get it even if you owe no tax.
Additional Medicare Tax
Taxpayers whose income exceeds certain threshold amounts ($200,000 single filers and $250,000 married filing jointly) are liable for an additional Medicare tax of 0.9 percent on their tax returns. They may, however, request that their employers withhold additional income tax from their pay to be applied against their tax liability when filing their 2021 tax return next April.
As such, high net worth individuals should consider contributing to Roth IRAs and 401(k) because distributions are not subject to the Medicare Tax. Also, if you’re a taxpayer who is close to the threshold for the Medicare Tax, it might make sense to switch Roth retirement contributions to a traditional IRA plan, thereby avoiding the 3.8 percent Net Investment Income Tax (NIIT) as well (more about the NIIT below).
Alternative Minimum Tax
The alternative minimum tax (AMT) applies to high-income taxpayers that take advantage of deductions and credits to reduce their taxable income. The AMT ensures that those taxpayers pay at least a minimum amount of tax and was made permanent under the American Taxpayer Relief Act (ATRA) of 2012. Furthermore, the exemption amounts increased significantly under the Tax Cuts and Jobs Act of 2017 (TCJA). As such, not as many taxpayers are affected as were in previous years. In 2021, the phaseout threshold increased to $523,600 ($1,047,200 for married filing jointly). Both the exemption and threshold amounts are indexed for inflation.
AMT exemption amounts for 2021 are as follows:
- $73,600 for single and head of household filers,
- $114,600 for married people filing jointly and for qualifying widows or widowers,
- $57,300 for married people filing separately.
Property, as well as money, can be donated to a charity. You can generally take a deduction for the fair market value of the property; however, for certain property, the deduction is limited to your cost basis. While you can also donate your services to charity, you may not deduct the value of these services. You may also be able to deduct charity-related travel expenses and some out-of-pocket expenses, however.
Contributions of appreciated property (i.e. stock) provide an additional benefit because you avoid paying capital gains on any profit.
In 2021, eligible individuals may take an above-the-line deduction of up to $300 ($600 for married taxpayers filing joint tax returns) in cash for charitable contributions made to qualified charitable organizations. Cash contributions include cash, check, electronic fund transfer, or payroll deduction. Taxpayers can claim the deduction even if they do not itemize on their 2021 taxes.
Taxpayers who itemize deductions can take advantage of a temporary suspension of limits on charitable contributions (CARES Act of 2020) that allows them to deduct cash donations to public charities in amounts of up to 100 percent of adjusted gross income (AGI). Normally, the limit for the deduction for cash contributions was 60% of AGI. They may also take advantage of the above-the-line deduction for taxpayers that don’t itemize ($300 for single filers; $600 for married filing jointly).
Keep in mind that a written record of your charitable contributions – including travel expenses such as mileage – is required to qualify for a deduction. A donor may not claim a deduction for any cash contribution, check, or other monetary gifts unless the donor maintains a record of the contribution. A canceled check or written receipt from the charity showing the name of the charity, the date of the contribution, and the amount of the contribution is usually sufficient.
Qualified Charitable Distributions (QCDs). Taxpayers who are age 70 1/2 and older can reduce income tax owed on required minimum distributions (RMDs) – a maximum of $100,000 or $200,000 for married couples – from IRA accounts by donating them to a charitable organization(s) instead.
Starting in 2020, taxpayers required to take required minimum distributions from IRAs, SIMPLE IRAs, SEP IRAs, or other retirement plan accounts can wait until age 72. In prior years, the age was 70 1/2.
Investment Gains and Losses
Investment decisions are often more about managing capital gains than about minimizing taxes. For example, taxpayers below threshold amounts in 2021 might want to take gains, whereas taxpayers above threshold amounts might want to take losses. Tax-loss harvesting – offsetting capital gains with losses – may be a good strategy to use if you have an unusually high income this year or significant losses.
Fluctuations in the stock market are commonplace; don’t assume that a down market means investment losses. If you’ve held the stock for a long time your cost basis may be low.
Minimize taxes on investments by judicious matching of gains and losses. Where appropriate, try to avoid short-term capital gains, which are taxed as ordinary income (i.e., the rate is the same as your tax bracket).
In 2021, tax rates on capital gains and dividends remain the same as 2020 rates (0%, 15%, and a top rate of 20%); however, threshold amounts have been adjusted for inflation as follows:
- 0% – Maximum capital gains tax rate for taxpayers with income up to $40,400 for single filers, $80,800 for married filing jointly;
- 15% – Capital gains tax rate for taxpayers with income of $40,400 to $445,850 for single filers and $80,800 to $501,600 for married filing jointly;
- 20% – Capital gains tax rate for taxpayers with income above $445,850 for single filers, $501,600 for married filing jointly.
Where feasible, reduce all capital gains and generate short-term capital losses up to $3,000. As a general rule, if you have a significant capital gain this year, consider selling an investment on which you have an accumulated loss. You can claim capital losses up to the amount of your capital gains plus $3,000 per year ($1,500 if married filing separately) as a deduction against income.
Wash Sale Rule. After selling a securities investment to generate a capital loss, you can repurchase it after 30 days. This is known as the “Wash Rule Sale.” If you buy it back within 30 days, the loss will be disallowed. Or you can immediately repurchase a similar (but not the same) investment, e.g., an ETF or another mutual fund with the same objectives as the one you sold.
The wash sale rule only applies to stocks and securities. It does not currently apply to cryptocurrencies such as Bitcoin, which means you can sell Bitcoin and immediately buy it back.
If you have losses, you might consider selling securities at a gain and then immediately repurchasing them since the 30-day rule does not apply to gains. That way, your gain will be tax-free, your original investment is restored, and you have a higher cost basis for your new investment (i.e., any future gain will be lower).
Net Investment Income Tax (NIIT)
The Net Investment Income Tax, which went into effect in 2013, is a 3.8 percent tax applied to investment income such as long-term capital gains for earners above a certain threshold amount ($200,000 for single filers and $250,000 for married taxpayers filing jointly). Short-term capital gains are subject to ordinary income tax rates as well as the 3.8 percent NIIT. This information is something to think about as you plan your long-term investments. Business income is not subject to the NIIT, provided the individual business owner materially participates in the business.
Mutual Fund Investments
Before investing in a mutual fund, ask whether a dividend is paid at the end of the year or whether it will be paid early in the following year but be deemed paid this year. The year-end dividend could make a substantial difference in the tax you pay.
Action: You invest $20,000 in a mutual fund in 2021. You opt for automatic reinvestment of dividends, and in late December of 2021, the fund pays a $1,000 dividend on the shares you bought. The $1,000 is automatically reinvested.
Result: You must pay tax on the $1,000 dividend. You will have to take funds from another source to pay that tax because of the automatic reinvestment feature. The mutual fund’s long-term capital gains pass through to you as capital gains dividends taxed at long-term rates, however long or short your holding period.
The mutual fund’s distributions to you of dividends it receives generally qualify for the same tax relief as long-term capital gains. If the mutual fund passes through its short-term capital gains, these are reported to you as “ordinary dividends” that don’t qualify for relief.
Depending on your financial circumstances, it may or may not be a good idea to buy shares right before the fund goes ex-dividend. For instance, the distribution could be relatively small, with only minor tax consequences. Or the market could be moving up, with share prices expected to be higher after the ex-dividend date. To find out a fund’s ex-dividend date, call the fund directly.
Please call if you’d like more information on how dividends paid out by mutual funds affect your taxes this year and next.
Year-End Giving To Reduce Your Potential Estate Tax
The federal gift and estate tax exemption is currently set at $11.70 million in 2021. The maximum estate tax rate is set at 40 percent.
Gift Tax. Sound estate planning often begins with lifetime gifts to family members. In other words, gifts that reduce the donor’s assets are subject to future estate tax. Such gifts are often made at year-end, during the holiday season, in ways that qualify for exemption from federal gift tax. Gifts to a donee are exempt from the gift tax for amounts up to $15,000 a year per donee in 2021 and remain the same for 2022.
An unused annual exemption doesn’t carry over to later years. To make use of the exemption for 2021, you must make your gift by December 31.
- Husband-wife joint gifts to any third person are exempt from gift tax for amounts up to $30,000 ($15,000 each). Though what’s given may come from either you or your spouse or both of you, both of you must consent to such “split gifts.”
- Gifts of “future interests” are assets that the donee can only enjoy at some future period such as certain gifts in trust and generally don’t qualify for exemption. Gifts for the benefit of a minor child, however, can be made to qualify.
If you’re considering adopting a plan of lifetime giving to reduce future estate tax, don’t hesitate to call the office for assistance.
- Cash or publicly traded securities raise the fewest problems. You may choose to give property you expect to increase substantially in value later. Shifting future appreciation to your heirs keeps that value out of your estate. But this can trigger IRS questions about the gift’s true value when given.
- You may choose to give property that has already appreciated. The idea here is that the donee, not you, will realize and pay income tax on future earnings and built-in gain on the sale.
Gift tax returns for 2021 are due on the same date as your income tax return (April 18, 2022). Gifts over $15,000 (including husband-wife split gifts totaling more than $15,000) and gifts of future interests must file a gift tax return. Though you are not required to file if your gifts do not exceed $15,000, you might consider filing anyway as a tactical move to block a future IRS challenge about gifts not “adequately disclosed.” Please call the office if you’re considering making a gift of property whose value isn’t unquestionably less than $15,000.
Tax Rate Structure for the Kiddie Tax
The kiddie tax rules changed under the TCJA. For tax years 2018 through 2025, unearned income exceeding $2,200 is taxed at the rates paid by trusts and estates instead of the parent’s tax rate. For ordinary income (amounts over $12,950), the maximum rate is 37 percent. For long-term capital gains and qualified dividends, the maximum rate is 20 percent.
Exception. If the child is under age 19 or 24 and a full-time student and both the parent and child meet certain qualifications, then the parent can include the child’s income on the parent’s tax return.
Other Year-End Moves
Roth Conversions. Roth conversions allow a taxpayer to convert funds in a pre-tax individual retirement account or 401(k) to a post-tax Roth IRA. The amount withdrawn from the IRA is considered income and subject to tax; however, future Roth IRA distributions are tax-free.
You do not have to convert your entire IRA to a Roth IRA at once; you can convert all or part of it during different tax years. For example, if you have $90,000 in a 401(k), you can convert it over three years – $30,000 in the first year and $30,000 per year for the next two years. This strategy works well for taxpayers who want to eliminate to minimize RMDs (Required Minimum Distributions) at age 72 from their IRAs and leave more of your retirement account funds to heirs.
Converting to a Roth IRA from a traditional IRA makes sense if you’ve experienced a loss of income (lowering your tax bracket) or your retirement accounts have decreased in value. Please call if you would like more information about Roth conversions.
Maximize Retirement Plan Contributions. If you own an incorporated or unincorporated business, consider setting up a retirement plan if you don’t already have one. It doesn’t need to be funded until you pay your taxes, but allowable contributions will be deductible on this year’s return.
If you are an employee and your employer has a 401(k), contribute the maximum amount ($19,500 for 2021), plus an additional catch-up contribution of $6,500 if age 50 or over, assuming the plan allows this, and income restrictions don’t apply.
If you are employed or self-employed with no retirement plan, you can make a deductible contribution of up to $6,000 a year to a traditional IRA (deduction is sometimes allowed even if you have a plan). Further, there is also an additional catch-up contribution of $1,000 if age 50 or over.
Health Savings Accounts. Consider setting up a health savings account (HSA). You can deduct contributions to the account, investment earnings are tax-deferred until withdrawn, and any amounts you withdraw are tax-free when used to pay medical bills. In effect, medical expenses paid from the account are deductible from the first dollar (unlike the usual rule limiting such deductions to the amount of excess over 7.5 percent of AGI). For amounts withdrawn at age 65 or later not used for medical bills, the HSA functions much like an IRA. To learn more about HSAs, please see, Tax Benefits of Health Savings Accounts, below.
529 Education Plans. Maximize contributions to 529 plans, which can now be used for elementary and secondary school tuition as well as college or vocational school.
Don’t Miss Out.
Implementing these strategies before the end of the year could save you money. If you are ready to save money on your tax bill, please contact the office today.
Business Owners: Year-end Tax Planning Strategies
Several end-of-year tax planning strategies are available to business owners to reduce their tax liability. Let’s take a look:
Businesses using the cash method of accounting can defer income into 2022 by delaying end-of-year invoices so that payment is not received until 2023. Businesses using the accrual method can defer income by postponing the delivery of goods or services until January 2022.
Purchase New Business Equipment
Bonus Depreciation. Businesses are allowed to immediately deduct 100% of the cost of eligible property such as machinery and equipment that is placed in service after September 27, 2017, and before January 1, 2023, after which it will be phased downward over a four-year period: 80% in 2023, 60% in 2024, 40% in 2025, and 20% in 2026.
The first-year 100% bonus depreciation deduction is available for qualifying assets even if they are placed in service for only a few days in 2021.
Section 179 Expensing. Businesses should take advantage of Section 179 expensing this year whenever possible. In 2021, businesses can elect to expense (deduct immediately) the entire cost of most new equipment up to a maximum of $1.05 million of the first $2.62 million of property placed in service by December 31, 2021. Keep in mind that the Section 179 deduction cannot exceed net taxable business income. The deduction is phased out dollar for dollar on amounts exceeding the $2.62 million threshold and eliminated above amounts exceeding $3.67 million.
Computer or peripheral equipment placed in service after December 31, 2017, are not included in listed property.
Qualified Property. Qualified property is defined as property that you placed in service during the tax year and used predominantly (more than 50 percent) in your trade or business. Property placed in service and then disposed of in that same tax year does not qualify, nor does property converted to personal use in the same tax year it is acquired.
Taxpayers can also elect to include certain improvements made to nonresidential real property after the date of when the property was first placed in service.
1. Qualified improvement property refers to any improvement to a building’s interior; however, improvements do not qualify if they are attributable to:
- the enlargement of the building,
- any elevator or escalator or
- the internal structural framework of the building.
2. Roofs, HVAC, fire protection systems, alarm systems, and security systems.
These changes apply to property placed in service in taxable years beginning after December 31, 2017.
Real estate qualified improvement property is eligible for immediate expensing, thanks to the CARES Act, which corrected an error in the Tax Cuts and Jobs Act. Taxpayers are also able to amend 2018 tax returns, if necessary.
Please contact the office if you have any questions regarding qualified property.
Other Year-End Moves to Take Advantage Of
Qualified Business Income Deduction. Many business taxpayers – including owners of businesses operated through sole proprietorships, partnerships, and S corporations, as well as trusts and estates, may be eligible for the qualified business income. This deduction is worth up to 20 percent of qualified business income (QBI) from a qualified trade or business for tax years 2018 through 2025. Your taxable income must be under $164,900 for single and head of household filers and $329,800 for married taxpayers filing joint returns to take advantage of the deduction in 2021.
The QBI is complex, and tax planning strategies can directly affect the amount of deduction, i.e., increase or reduce the dollar amount. As such, it is important to speak with a tax professional before year’s end to determine the best way to maximize the deduction.
Small Business Health Care Tax Credit. Small business employers with 25 or fewer full-time-equivalent employees with average annual wages of $50,000 indexed for inflation (e.g., $56,000 in 2020) may qualify for a tax credit to help pay for employees’ health insurance. The credit is 50 percent (35 percent for non-profits).
Business Energy Investment Tax Credit (ITC). Business energy investment tax credits are still available, and businesses that want to take advantage of these tax credits can still do so. Business energy credits include geothermal electric, large wind (expires at the end of 2021), and solar energy systems used to generate electricity, heat, cool, or provide hot water for use in a structure, or to provide solar process heat. There is also a 30 percent tax credit for offshore wind facilities in inland or coastal waters if construction begins before 2026. Hybrid solar lighting systems, which use solar energy to illuminate the inside of a structure using fiber-optic distributed sunlight, are also eligible; excluded, however, are passive solar and solar pool heating systems. Utilities are allowed to use the credits as well.
Repair Regulations. Where possible, end-of-year repairs and expenses should be deducted immediately, rather than capitalized and depreciated. Small businesses lacking applicable financial statements (AFS) can take advantage of de minimis safe harbor by electing to deduct smaller purchases ($2,500 or less per purchase or invoice). Businesses with applicable financial statements can deduct $5,000. Small businesses with gross receipts of $10 million or less can also take advantage of safe harbor for repairs, maintenance, and improvements to eligible buildings. Please call if you would like more information on this topic.
Depreciation Limitations on Luxury, Passenger Automobiles, and Heavy Vehicles. As a reminder, tax reform changed depreciation limits for luxury passenger vehicles placed in service after December 31, 2017. If the taxpayer doesn’t claim bonus depreciation, the maximum allowable depreciation deduction for 2021 is $10,200 for the first year.
Deductions are based on a percentage of business use. A business owner whose business use of the vehicle is 100 percent can take a larger deduction than one whose business use of a car is only 50 percent.
For passenger autos eligible for the additional bonus first-year depreciation, the maximum first-year depreciation allowance remains at $8,000. It applies to new and used (“new to you”) vehicles acquired and placed in service after September 27, 2017, and remains in effect for tax years through December 31, 2022. When combined with the increased depreciation allowance above, the deduction amounts to as much as $18,200 in 2021.
Heavy vehicles, including pickup trucks, vans, and SUVs whose gross vehicle weight rating (GVWR) is more than 6,000 pounds, are treated as transportation equipment instead of passenger vehicles. As such, heavy vehicles (new or used) placed into service after September 27, 2017, and before January 1, 2023, qualify for a 100 percent first-year bonus depreciation deduction as well.
Retirement Plans. Self-employed individuals who have not yet done so should set up self-employed retirement plans before the end of 2021. Call today if you need help setting up a retirement plan.
Dividend Planning. Reduce accumulated corporate profits and earnings by issuing corporate dividends to shareholders.
Paid Family and Medical Leave Credit. A business tax credit is available for employers providing paid family and medical leave to qualifying employees through 2025. Employers must have a written policy in place that meets certain requirements and meet other conditions. The credit, set to expire in 2020, was extended through 2025. It ranges from 12.5% to 25% of wages paid to qualifying employees for up to 12 weeks of family and medical leave per taxable year.
Work Opportunity Tax Credit (WOTC). Extended through 2025 (The Consolidated Appropriations Act, 2021), the Work Opportunity Tax Credit is available for employers who hire long-term unemployed individuals (unemployed for 27 weeks or more) and is generally equal to 40 percent of the first $6,000 of wages paid to a new hire.
Year-end Tax Planning Could Make a Difference in Your Tax Bill
If you’d like more information, please call to schedule a consultation to discuss your specific tax and financial needs and develop a plan that works for your business.
Worker Classification: Employee vs. Contractor
If you hire someone for a long-term, full-time project or a series of projects that are likely to last for an extended period, you must pay special attention to the difference between independent contractors and employees.
Why It Matters
The Internal Revenue Service and state regulators scrutinize the distinction between employees and independent contractors because many business owners try to categorize as many of their workers as possible as independent contractors rather than as employees. They do this because independent contractors are not covered by unemployment and workers’ compensation or federal and state wage, hour, anti-discrimination, and labor laws. In addition, businesses do not have to pay federal payroll taxes on amounts paid to independent contractors.
If you incorrectly classify an employee as an independent contractor, you can be held liable for employment taxes for that worker, plus a penalty. Generally, an employer must withhold and pay income taxes, Social Security and Medicare taxes, as well as unemployment taxes.
How workers are classified also affects how small and medium-size businesses calculate tax credits and deductions such as the Qualified Business Income Deduction, the Employee Retention Credit, and Sick and Family Leave Credits.
The Difference Between Employees and Independent Contractors
Independent Contractors – are individuals who contract with a business to perform a specific project or set of projects. You, the payer, have the right to control or direct only the result of the work done by an independent contractor, and not the means and methods of accomplishing the result.
Example: Sam Smith, an electrician, submitted a bid of $6,400 to a housing complex for electrical work. Per the terms of his contract, every two weeks for the next ten weeks, he will receive a payment of $1,280. This is not considered payment by the hour. Even if he works more or less than 400 hours to complete the work, Sam will still receive $6,400. He also performs additional electrical installations under contracts with other companies that he obtained through advertisements. Sam Smith is an independent contractor.
Labor laws vary by state. Please call if you have specific questions.
Employees – provide work in an ongoing, structured basis. In general, anyone who performs services for you is your employee if you can control what will be done and how it will be done. A worker is still considered an employee even when you give them freedom of action. What matters is that you have the right to control the details of how the services are performed.
Example: Sarah Smith is a salesperson employed on a full-time basis by Rob Robinson, an auto dealer. She works six days a week and is on duty in Rob’s showroom on certain assigned days and times. She appraises trade-ins, but her appraisals are subject to the sales manager’s approval. Lists of prospective customers belong to the dealer. She has to develop leads and report results to the sales manager. Because of her experience, she requires only minimal assistance in closing and financing sales and other phases of her work. She is paid a commission and is eligible for prizes and bonuses offered by Rob. Rob also pays the cost of health insurance and group term life insurance for Sarah. Sarah Smith is an employee of Rob Robinson.
Independent Contractor Qualification Checklist
The IRS, workers’ compensation boards, unemployment compensation boards, federal agencies, and even courts all have slightly different definitions of what an independent contractor is. However, their means of categorizing workers as independent contractors are similar.
One of the most prevalent approaches used to categorize a worker as either an employee or independent contractor is the analysis created by the IRS, which considers the following:
- What instructions the employer gives the worker about when, where, and how to work. The more specific the instructions and the more control exercised, the more likely the worker will be considered an employee.
- What training the employer gives the worker. Independent contractors generally do not receive training from an employer.
- The extent to which the worker has business expenses that are not reimbursed. Independent contractors are more likely to have unreimbursed expenses.
- The extent of the worker’s investment in the worker’s own business. Independent contractors typically invest their own money in equipment or facilities.
- The extent to which the worker makes services available to other employers. Independent contractors are more likely to make their services available to other employers.
- How the business pays the worker. An employee is generally paid by the hour, week, or month. An independent contractor is usually paid by the job.
- The extent to which the worker can make a profit or incur a loss. An independent contractor can make a profit or loss, but an employee does not.
- Whether there are written contracts describing the relationship the parties intended to create. Independent contractors generally sign written contracts stating that they are independent contractors and setting forth the terms of their employment.
- Whether the business provides the worker with employee benefits, such as insurance, a pension plan, vacation pay, or sick pay. Independent contractors generally do not get benefits.
- The terms of the working relationship. An employee generally is employed at will (meaning the relationship can be terminated by either party at any time). An independent contractor is usually hired for a set period.
- Whether the worker’s services are a key aspect of the company’s regular business. If the services are necessary for regular business activity, it is more likely that the employer has the right to direct and control the worker’s activities. The more control an employer exerts over a worker, the more likely it is that the worker will be considered an employee.
Minimize the Risk of Misclassification
If you misclassify an employee as an independent contractor, you may end up before a state taxing authority or the IRS. Sometimes, the issue arises when a terminated worker files for unemployment benefits, and it’s unclear whether the worker was an independent contractor or employee. The filing can trigger state or federal investigations that can cost many thousands of dollars to defend, even if you successfully fight the challenge.
There are ways to reduce the risk of an investigation or challenge by a state or federal authority. At a minimum, you should:
- Familiarize yourself with the rules. Ignorance of the rules is not a legitimate defense. Knowing the rules will allow you to structure and carefully manage your relationships with your workers to minimize risk.
- Document relationships with your workers and vendors. Although it won’t always save you, it helps to have a written contract stating the terms of employment.
Voluntary Classification Settlement Program
The Voluntary Classification Settlement Program (VCSP) is an optional program that provides employers with an opportunity to reclassify their workers as employees for future tax periods for employment tax purposes with partial relief from federal employment taxes for eligible taxpayers that agree to prospectively treat their workers (or a class or group of workers) as employees. Please call the office if you need more information about this program.
Consult a Tax Professional
With the rise of the gig economy, employers may have questions about how to classify workers. If so, don’t hesitate to call the office and speak to a tax professional who can assist you.
Tax Benefits of Health Savings Accounts
While similar to FSAs (Flexible Savings Plans) in that both allow pretax contributions, Health Savings Accounts or HSAs offer taxpayers several additional tax benefits. Let’s take a look:
What is a Health Savings Account?
A Health Savings Account is a type of savings account that allows you to set aside money pretax to pay for qualified medical expenses. Contributions that you make to a Health Savings Account (HSA) are used to pay current or future medical expenses (including after you’ve retired) of the account owner, their spouse, and any qualified dependent.
There are several caveats that individuals should be aware of, however, such as:
- Medical expenses that are reimbursable by insurance or other sources and do not qualify for the medical expense deduction on a federal income tax return are not eligible.
- You cannot be covered by other health insurance with the exception of insurance for accidents, disability, dental care, vision care, or long-term care, and you cannot be claimed as a dependent on someone else’s tax return.
- Spouses cannot open joint HSAs. Each spouse who is an eligible individual who wants an HSA must open a separate HSA.
- Insurance premiums for taxpayers younger than age 65 are generally not considered qualified medical expenses unless the premiums are for health care continuation coverage (such as coverage under COBRA), health care coverage while receiving unemployment compensation under federal or state law.
Tax-Advantaged Savings Accounts
Health Savings Accounts (HSAs) offer a triple tax advantage:
- Contributions are made pretax.
- Growth is tax-free.
- Distributions are tax-free as long as they are used for qualified health care expenses.
Contributions to an HSA, which can be opened through your bank or another financial institution, must be made in cash. Contributions of stock or property are not allowed. An employee may be able to elect to have money deposited directly into an HSA account through payroll withholdings. If your employer does not offer this option, you must wait until filing a tax return to claim the HSA contributions as a deduction. Unlike contributions to FSAs, you may change the amount withheld at any time during the year as well, and unused funds automatically roll over into the next calendar year (there is no “use it or lose it”).
Funds in the account may be invested much like any other retirement savings account; however, less than 10 percent of account holders do so, according to the Employee Benefit Research Institute. Whether funds can be invested depends on whether the HSA administrator offers this option. There may also be a minimum balance requirement, which could limit individuals with smaller account balances.
High Deductible Health Plans
However, a Health Savings Account is not available to everyone and can only be used if you have a High Deductible Health Plan (HDHP). Typically, high-deductible health plans have lower monthly premiums than plans with lower deductibles, but you pay more health care costs yourself before the insurance company starts to pay its share (your deductible).
A high-deductible plan can be combined with a health savings account, allowing you to pay for certain medical expenses with tax-free money that you have set aside. Using the pretax funds in your HSA to pay for qualified medical expenses before you reach your deductible and other out-of-pocket costs such as copayments reduces your overall health care costs.
Calendar year 2021. For the calendar year 2021, a qualifying HDHP must have a deductible of at least $1,400 for self-only coverage or $2,800 for family coverage. The beneficiary’s annual out-of-pocket expenses, such as deductibles, copayments, and coinsurance, are limited to $7,000 for self-only coverage and $14,000 for family coverage. This limit doesn’t apply to deductibles and expenses for out-of-network services if the plan uses a network of providers. Instead, only use deductibles and out-of-pocket expenses for services within the network to figure whether the limit applies.
Last-month rule. Under the last-month rule, you are considered to be an eligible individual for the entire year if you are an eligible individual on the first day of the last month of your tax year (December 1 for most taxpayers).
You can make contributions to your HSA for 2021 until April 15, 2022. Your employer can make contributions to your HSA between January 1, 2022, and April 15, 2022, that are allocated to 2021. The contribution will be reported on your 2021 Form W-2.
Summary of HSA Tax Advantages
- Tax deductible. You can claim a tax deduction for contributions you, or someone other than your employer, make to your HSA even if you don’t itemize your deductions on Schedule A (Form 1040).
- Pretax dollars. Contributions to your HSA made by your employer (including contributions made through a cafeteria plan) may be excluded from your gross income.
- Tax-free interest on earnings. Contributions remain in your account until you use them and are rolled over year after year. Any interest or other earnings on the assets in the account are tax-free. Furthermore, an HSA is “portable” and stays with you if you change employers or leave the workforce.
- Tax-free distributions. Distributions may be tax-free if you pay qualified medical expenses.
- Additional contributions for older workers. Employees, aged 55 years and older are able to save an additional $1,000 per year.
- Tax-free after retirement. Distributions are tax-free at age 65 when used for qualified medical expenses including amounts used to pay Medicare Part B and Part D premiums, and long-term care insurance policy premiums. You cannot, however, use money in an HSA to pay for supplemental insurance (e.g., Medigap) premiums.
Help is Just a Phone Call Away
Please contact the office if you have any questions about health savings accounts.
IRS Charges Fee for Estate Closing Letters
Starting October 28, a new $67 user fee will apply to any estate that requests an estate tax closing letter for its federal estate tax return. This closing letter is formally referred to as IRS Letter 627.
By law, federal agencies are required to charge a user fee to cover the cost of providing certain services to the public that confer a special benefit to the recipient. Moreover, agencies must review these fees every two years to determine whether they are recovering the cost of these services. Under the final regulations, the IRS determined that issuing closing letters is a service that confers a special benefit warranting a user fee. Even though obtaining a closing letter from the IRS can be helpful to an executor of an estate, it is not required by law.
The estate has the option of obtaining from the IRS an account transcript, showing certain information from the estate tax return. It is comparable to that found in a closing letter and may be an acceptable substitute for the estate tax closing letter.
Account transcripts can be used to confirm that an estate tax examination has been completed and the IRS file has been closed. It is the reason that is most often cited for requesting a closing letter. They are available online (and free of charge) to registered tax professionals using the Transcript Delivery System (TDS) or authorized representatives making requests using Form 4506-T.
Closing letter requests and payment of the user fee must be made using Pay.gov, a U.S. Department of the Treasury program, and a secure way to pay U.S. Federal Government Agencies.
Please contact the office with any questions.
Shared Custody and Advance Child Tax Credit Payments
Parents who share custody of their children may be confused about how the advance child tax credit payments are distributed. As such, the first step is to remember that these are advance payments of a tax credit that taxpayers expect to claim on their 2021 tax return. Understanding how the payments work will allow parents to unenroll, if they choose, and possibly avoid a possible tax bill when they file next year.
Let’s take a look at four of the most common questions about shared custody and the advance child tax credit payments:
1. How will the IRS decide which one receives the advance child tax credit payments if two parents share custody?
Who receives 2021 advance child tax credit payments is based on the information on the taxpayer’s 2020 tax return or their 2019 return if their 2020 tax return has not been processed. The parent who claimed the child tax credit on their 2020 return will receive the 2021 advance child tax credit payments.
2. If a parent is receiving 2021 advance child tax credit payments and they shouldn’t be, what should they do?
Parents who will not be eligible to claim the child tax credit when filing their 2021 tax return should go to IRS.gov and unenroll to stop receiving monthly payments. They can do this by using the Child Tax Credit Update Portal. Receiving monthly payments now could mean they have to return those payments when they file their tax return next year. If their custody situation changes and they are entitled to the child tax credit for 2021, they can claim the full amount when they file their tax return next year.
3. How will 2021 advance child tax credit payments be handled for parents who claim their child in alternate years on their tax return?
If the taxpayer claimed their child on their 2020 tax return, the IRS will automatically issue the advance payments to them. When they file their 2021 tax return, they may have to pay back the payments over the amount of the credit they’re entitled to claim. Some taxpayers may qualify for repayment protection and be excused from repaying some or all of the excess amount. Also, if a taxpayer won’t be claiming the child tax credit on their 2021 return, they should unenroll from receiving monthly payments using the Child Tax Credit Update Portal.
4. If one parent receives the advance child tax credit payments even though the other parent will be claiming the child tax credit on their 2021 tax return, will the parent claiming the qualifying child still be able to claim the full credit amount?
Yes. Taxpayers will be able to claim the full amount of the child tax credit on their 2021 tax return even if the other parent is receiving the advance child tax credit payments. The parent receiving the payments should unenroll, but their decision will not affect the other parent’s ability to claim the child tax credit.
If you share custody with another parent and need further clarification about this important tax issue, don’t hesitate to call.
Tips To Avoid Fraud and Scams After a Disaster
Criminals and fraudsters often see disasters as an opportunity to take advantage of victims when they are the most vulnerable, as well as the generous taxpayers who want to help with relief efforts. Generally, these disaster scams start with unsolicited contact – typically a phone call, on social media, by email, or even in person. Reviewing the tips listed below will help taxpayers recognize a scam and avoid becoming a victim.
- Some thieves pretend they are from a charity. They do this to get money or private information from well-intentioned taxpayers.
- Bogus websites use names like legitimate charities. They do this scam to trick people into sending money or providing personal financial information.
- Pretending to be the IRS. Scammers even claim to be working for – or on behalf of – the IRS. The thieves say they can help victims file casualty loss claims and get tax refunds.
- Use a check or credit card. Taxpayers should always contribute by check or credit card to have a record of the tax-deductible donation if they choose to give money.
- Avoid giving out personal information. Donors should not give out personal financial information to anyone who solicits a contribution. This includes things like Social Security numbers or credit card and bank account numbers and passwords.
Taxpayers should also be aware that sometimes when they search for a charity online, they may be directed to a website or social media page that is not affiliated with the actual charity. If in doubt, the best way to check an organization’s eligibility to receive tax-deductible charitable contributions is to visit the Tax Exempt Organization Search tool on the IRS website, IRS.gov. Donations to qualified charities are usually tax-deductible.
If you are a disaster victim, you can call the IRS toll-free disaster assistance line at 866-562-5227. When you call, you will be connected to a phone assistor who will answer questions about tax relief or disaster-related tax issues.
Finally, as a reminder, individual taxpayers can deduct up to $300, and married couples can deduct up to $600 in qualifying charitable contributions for tax year 2021. Itemizing is not necessary.
As always, don’t hesitate to contact the office if you have any questions about charitable contributions or disaster relief and how it affects your tax situation.
Deferred Tax on Gains From Forced Sales of Livestock
Farmers and ranchers forced to sell livestock due to drought may have an additional year to replace the livestock and defer tax on any gains from the forced sales. Here are some important facts to help farmers understand how the deferral works and their eligibility.
1. The one-year extension gives eligible farmers and ranchers until the end of the tax year after the first drought-free year to replace the sold livestock.
2. The farm or ranch must be in an applicable region to qualify for relief. An applicable region is a county or other jurisdiction designated as eligible for federal assistance plus counties contiguous to it.
3. The farmer’s county, parish, city, or district included in the applicable region must be listed as suffering exceptional, extreme, or severe drought conditions by the National Drought Mitigation Center. All or part of 36 states and one U.S. territory are listed.
4. The relief applies to farmers who were affected by drought that happened between September 1, 2020, and August 31, 2021.
5. This relief generally applies to capital gains realized by eligible farmers and ranchers on sales of livestock held for draft, dairy, or breeding purposes. Sales of other livestock, such as those raised for slaughter or held for sporting purposes, or poultry are not eligible.
6. To qualify, the sales must be solely due to drought, flooding, or other severe weather causing the region to be designated as eligible for federal assistance.
7. Farmers generally must replace the livestock within a four-year period instead of the usual two-year period.
8. Qualified farmers and ranchers whose drought-sale replacement period was scheduled to expire at the end of this tax year, December 31, 2021, in most cases, now have until the end of their next tax year. The normal drought sale replacement period is four years. As such, this extension immediately impacts drought sales that occurred during 2017. Furthermore, the replacement periods for some drought sales before 2017 are also affected because of previous drought-related extensions affecting some of these areas.
Please call the office if you want more information about reporting drought sales or other farm-related tax issues.
Advertising and Marketing Costs May Be Tax Deductible
As a small business owner, you may be able to deduct advertising and marketing expenses that help them bring in new customers and keep existing ones. Even better is that these deductions help small businesses save money on their taxes.
Generally, small businesses can’t deduct amounts they pay to influence legislation, which includes advertising in a convention program of a political party or any other publication if any of the proceeds from the publication are for, or intended for, the use of a political party or candidate. Here’s what else you need to know about this valuable tax deduction:
Advertising and marketing costs must be ordinary and necessary.
An ordinary expense is one that is common and accepted in the industry. A necessary expense is one that is helpful and appropriate for the trade or business. An expense does not have to be indispensable to be considered necessary. Advertising and marketing costs that are ordinary and necessary are tax-deductible.
Advertising expenses include:
- Reasonable advertising expenses that are directly related to the business activities.
- An expense for the cost of institutional or goodwill advertising to keep the business name before the public if it relates to a reasonable expectation to gain business in the future. For example, the cost of advertising that encourages people to contribute to the Red Cross or to participate in similar causes is usually deductible.
- The cost of providing meals, entertainment, or recreational facilities to the public as a means of advertising or promoting goodwill in the community.
As always, don’t hesitate to call if you have any questions regarding tax deductions that benefit your small business.
Ready To Reconcile in Quickbooks? How To Prepare
There is no question that account reconciliation is a dreaded chore. So much so that many small business people don’t do it. QuickBooks’ reconciliation tools and its ability to import transactions from your banks make this activity less painful. They also allow you to make reconciliation an ongoing process rather than a once-a-month marathon. But it still takes time and strict attention to detail, and you still have to sit down with your bank statement once a month.
Making account reconciliation a habit is strongly recommended. Doing so has numerous benefits. For example, you will be able to:
- Have confidence that your bank balance in QuickBooks is accurate.
- Match payments to invoices.
- Make sure that your bill payments get posted.
- Catch errors sooner.
- Detect unauthorized access to your accounts.
Before you even attempt a reconciliation using QuickBooks, there are actions you can take ahead of time to minimize the time required and make the process less frantic and frustrating. Here are some tips:
Match Your Real-Life Accounts With Quickbooks Accounts
If you are new to QuickBooks or you haven’t set up accounts that mirror your real-life bank and credit card accounts, you’ll need to do so. We try to avoid sending you to the Chart of Accounts, but you’ll have to create accounts there to store your downloaded transactions.
Open the Company menu and select Chart of Accounts. Click the down arrow next to Account in the lower left corner and select New. This window will open:
Figure 1: QuickBooks needs one account for each bank account or credit card you plan to reconcile.
You are going to want to reconcile your checking account(s), so select Bank and click Continue. Complete the fields on the screen that opens and save the account.
Warning: It is critical that you enter the correct Opening Balance. This is the beginning balance printed on the statement you’re going to reconcile. After you’ve gone through the process once, QuickBooks will supply this for you.
Keep Your Quickbooks Transactions up to Date
If you have connected your QuickBooks file to your online bank, this will be easier. You’ll want to enter any cleared transactions from your statement that are missing in QuickBooks. If you haven’t set up a link to your financial institution, you should do so now. Otherwise, you will have to sign on to your online bank account and locate each cleared transaction for each account. Please call if you need help with this step.
Be clear about the process
Reconciling an account in QuickBooks is similar to how you used to do it using a paper statement and your checkbook register. You will be matching the transactions in one to the other and clicking the ones that correspond. When you’ve finished, QuickBooks should show a $0.00 difference between the two. The software makes suggestions about what to do if it doesn’t – which may or may not work.
This is the most difficult step in reconciling: ending up with a zero difference. We can troubleshoot your reconciliation if you’re not able to complete it correctly.
Enter Interest Earned and Service Fee Amounts
Figure 2: QuickBooks will prompt you, but don’t forget to enter any Service Charges or Interest Earned.
These will probably seem like small amounts, but your reconciliation will not work if you don’t enter any interest earned or bank service charges. These fields will appear at the bottom of the window when you open the Banking menu and select Reconcile.
Back Up Your Quickbooks Company File
Before you begin the reconciliation process, you must back up your QuickBooks company file. If you get hopelessly tangled up in your reconciliation, you want to be able to go back to where you started. Click File | Backup Company |Create Local Backup. You have two choices here: Online backup (cloud-based storage; fees apply) or Local backup (like a USB drive). You should be backing up your QuickBooks file regularly, so do not hesitate to call if you are unsure what to choose or how to set it up.
Once you’ve gone through a reconciliation successfully, the next ones should be easier. But doing it for the first time can be a major challenge. Fortunately, a QuickBooks expert is available to help you through the process or even take over your reconciliation chores completely. If you would like to discuss this further, please call the office.
Tax Due Dates for November 2021
Employers – Income Tax Withholding. Ask employees whose withholding allowances will be different in 2022 to fill out a new Form W-4. The 2022 revision of Form W-4 will be available on the IRS website by mid-December.
Employers – Social Security, Medicare, and withheld income tax. File form 941 for the third quarter of 2021. Deposit any undeposited tax. (If your tax liability is less than $2,500, you can pay it in full with a timely filed return.) If you deposited the tax for the quarter in full and on time, you have until November 10 to file the return.
Certain Small Employers – Deposit any undeposited tax if your tax liability is $2,500 or more for 2021 but less than $2,500 for the third quarter.
Employers – Federal Unemployment Tax. Deposit the tax owed through September if more than $500.
Employees who work for tips – If you received $20 or more in tips during October, report them to your employer. You can use Form 4070.
Employers – Social Security, Medicare, and withheld income tax. File Form 941 for the third quarter of 2021. This due date applies only if you deposited the tax for the quarter in full and on time.
Employers – Nonpayroll withholding. If the monthly deposit rule applies, deposit the tax for payments in October.
Employers – Social Security, Medicare, and withheld income tax. If the monthly deposit rule applies, deposit the tax for payments in October.
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