IRS Questions and Answers on COVID-19 IRA and 401(k) Loans & Distributions

The CARES Act stimulus package substantially relaxed the rules around certain retirement account loan and distribution requirements, but with much confusion. As a result, the IRS recently put out a FAQ document to address the COVID-19 rule relaxation around IRA and 401(k) loans and distributions. This important information should come as welcome news for the nearly one percent of all retirement plan holders who have already taken a distribution under the new rules, according to Fidelity Investments.

Who’s eligible?

If you, a spouse or dependent tested positive for COVID-19, you automatically qualify. You also may qualify under less direct circumstances, such as experiencing economic hardship due to being quarantined, laid off, receiving a reduction in work hours, or missing work because you don’t have childcare. Business owners who are forced to close or reduce operating hours also qualify.

How Much Can I Take Out?

COVID-19 impacted individuals can take up to $100k in distributions without paying the 10 percent penalty imposed on early withdrawals by people under 59 1/2 years old. The $100,000 limit is the total for all the plans you have. For example, if you take $70k out of your 401(k), you can take only up to $30k out of your IRA under these rules. You will still owe taxes on the distributions as ordinary income; however, you are able to pay the taxes owed over a three-year period.

Can I Pay Myself Back?

The law also allows you to pay yourself back. Taxpayers can replace their distributions if they do so within a three-year timeframe. This means that if you take out a distribution in 2020, start to pay the taxes owed over the three-year rule and then pay back the distribution in 2022, you’ll be able to amend your 2020 and 2021 returns to get a refund, as well as not pay the tax you would have owed in 2022.

How Do Loans Work?

The maximum amount you can borrow increases from $50,000 to $100,000. You also can borrow the entire amount of your plan balance up to this limit (net of any outstanding loans). Moreover, for any loans you already have within the plan, the due date for payments due through the end of 2020 can be postponed for up to one year.

Is There Anything Else I Should Know?

Yes. First, there is more guidance coming from the IRS. Second, if you are eager to know what this formal guidance will look like, you can turn to the Hurricane Katrina relief rules from 2005 as this is what is expected will apply for the COVID-19 measures as well. Lastly, the IRS will generate a new form 8915E where taxpayers will report the repayment of COVID-19 covered distributions.

Be Right About Free Money: Potential Legal Risks of the Paycheck Protection Loan Program

Paycheck Protection Loan ProgramOne of the most important provisions of the CARES Act for small businesses is called the Paycheck Protection Program (PPP). The PPP is a $349 billion program designed to assist small businesses (fewer than 500 employees) facing financial difficulties as a result of the COVID-19 pandemic through specifically structured loans.

The loan program offers funding to cover payroll for up to eight weeks, with the intent of stemming from unemployment. These loans can be forgiven and essentially become a grant if your business meets certain criteria with no need to repay the money.

As the old saying goes, there’s no such thing as a free lunch – or in this case, free government money. There are potential legal risks that could jeopardize the forgivability of the loan.

Conditional Grants

Another way to look at the PPP loans is as conditional grants. The U.S. Small Business Administration (SBA) notes that loans will be forgiven in full if the funds are used for appropriate costs. Covered costs include payroll, mortgage interest, rent and utilities. Further, the payroll costs must account for at least 75 percent of the loan proceeds used. The employer needs to maintain or quickly rehire employees and maintain wage and salary levels in order to receive 100 percent forgiveness.

The Devil’s in the Certification Details

The loan application process requires certain certifications. Businesses that are still operating need to certify that the current economic uncertainty makes the loan necessary to keep operations going.

If this seems vague, it’s because it is. There probably isn’t a small business out there that is not facing significant uncertainty in the current climate. The problem is that the certification standard the PPP lays out is extremely subjective. As a result, with the encouragement for businesses to apply, many may do so under the impression that they will have their loan fully forgiven to only run into trouble later if they don’t meet the certification standards.

Legal Risks

By not providing any definition about the nature or extent of the required impact to operations that would make the loan request “necessary to support ongoing operations,” the SBA is making both applicants and lenders apprehensive.

Some law firms are even warning clients via their newsletters about potential legal exposure under the False Claims Act (FCA). Legal counsels are cautioning that a misrepresentation included in an application could result in FCA liability. Businesses must navigate between being as aggressive as possible to bolster their application while staying within the rules of the program.

More Certification Guidance is Needed

The government agencies involved need to provide more clear and objective guidance on the conditions needed to meet the certification requirements of the loan application process. Without clear and definable guidance as to what constitutes facing economic uncertainty, small businesses could face problems in the future.

Objective criteria such as a percentage of revenue decline or order capacity would provide a rather bright-line test and give both guidance to businesses and confidence in the process. 

Should You File an Amended 2018 Return?

Amended 2018 Tax ReturnDuring the holiday season in December, Congress passed the Consolidated Budget Appropriations Act of 2020. Included in this Act was a tax package that renewed more than 24 tax provisions through what are known as extenders. An extender makes a tax provision effective retroactively. Some of the extender provisions are rather esoteric, so we’ll only focus on those most applicable to the broader taxpayer base.

Extenders in More Detail

Among the widely applicable extender provisions, there are the following. It’s best to check with your tax professional to see which of the more than two dozen extenders may apply to your personal situation.

  • Deducting PMI (private mortgage insurance) if you itemize
  • The delusionality of some types of tuition and fees
  • The ability to exclude debt forgiveness on a qualified residence

Wait, I Don’t Understand What Happened?

Most people are probably wondering at this point how they can obtain the benefit of these retroactive changes, which were not allowed when they filed their original 2018 tax return. The answer is to file an amended tax return – or Form 1040X.

Taxpayers often need to file an amended return when they receive updated or changed inputs, such as when a brokerage sends a corrected Form 1099. Unlike this situation where the basis of your filing changed due to updated information, with the extenders you’ll only want to file if it’s to your benefit.

But Do I Have to File an Amended Return?

Tax law does not actually require that a taxpayer file an amended return when learning the original return submitted did not reflect the correct amount of tax. The assumption is that it was correct the first time. Amendments are allowed, but they are not mandatory.

If you do choose to file an amended return, you have to adjust everything to reflect the tax law and any changes in the information received. You are not allowed to pick and choose only the favorable difference between the original and amended filing.

OK, But Should I File an Amended Return?

The answer to this question is probably a tax accountant’s favorite – it depends.

The most frequent worry among taxpayers is that filing an amended return will trigger an IRS audit. This fear arises from the fact that generally returns are filed and processed electronically, but all amended returns are processed by live people. The biggest risk here is to not include a full explanation of the changes in the return, including what is different, why it’s changed and the basis for the difference.

Refund or No Refund – Does it Matter?

Another question that often perplexes taxpayers is whether they should file an amended return if doing so will not result in an additional refund. Just because your amended tax return won’t result in a check in your mailbox, there are situations where it’s still to your benefit. One example is if the amended return will increase your capital or passive loss carryforwards.

The Sands of Time

Since amended returns are processed by people and not electronically, the turn-around time is a bit longer than most returns. The IRS says amended tax returns typically take eight to 12 weeks, but it’s often longer.

Conclusion

While you might not have to file an amended return, it could be to your benefit from either the tax extenders, corrected information that arrived after your initial filing or a combination of both. Every taxpayer situation is different, so it’s best to consult us.

Taxes and Tariffs: The U.S. Response to France’s Digital Tax

How it All Started

Back in July of 2019, France passed what was dubbed a “digital tax” targeting the largest tech companies. Impacting approximately 30 big companies such as Amazon, Google, Facebook and Apple, the tax applies to revenues earned from digital services of companies that earn more than $830 million in total and at least $27.86 million in France. The tax levy is a 3 percent charge on revenue from digital services.

The United States soon responded with threatening 100 percent tariffs on certain classes of French luxury goods, such as wine, champagne, cheese and makeup. These tariffs were estimated to cover more than $2.4 billion in French goods per year.

Responses on Both Sides

French President Emmanuel Macron came out to comment that the digital tax is not intended to be an anti-American move, and that big tech companies of all stripes could be covered by the tax. The criteria that determines who is subject to the digital tax, however, means that essentially only American companies are the ones being taxed.

Some in the United States claim it’s as simple as jealously over our strong technology sector, while others say that the main motivation for the French tax is a need to mitigate burgeoning budget deficits.

President Trump’s Reaction

Rarely one to back down on international trade issues, President Donald Trump criticized the digital tax for unfairly targeting American tech companies, going so far as to call out the European Union as behaving worse than China in its trading relationship with the United States. He reiterated his stance that he’s willing to fight tariffs with tariffs.

Negotiations with the EU

U.S. and European Union officials are negotiating an agreement over taxing big tech, but that didn’t stop the current treasury secretary from threatening more retaliatory tariffs. Steven Mnuchin, the treasury secretary, recently said that the United States will impose new tariffs on French automobile imports if the issue isn’t resolved to America’s satisfaction. He claimed the digital tax is purely arbitrary, hence his random call for taxing automobiles in response. Moreover, Mnuchin called the tax “discriminatory in nature” at the World Economic Forum in Davos Switzerland.

Taxes and Tariffs on Hold

For now, France is delaying the implementation of its digital tax through the end of 2020 in response to U.S. pressure on threatened luxury goods and automobile tariffs. They aim to come to a resolution before year-end with the Trump administration. French Finance Minister Bruno Le Maire is optimistic an agreement can be worked out and believes entering a trade war with the United States would be foolish.

The Future

Currently, other European countries, including Britain and Italy, are acting against big tech companies they believe don’t pay their fair share of taxes to their countries. Treasury Secretary Mnuchin said that the United States is willing to go to bat and protect its companies with retaliatory tariffs in these cases as well. For now, not much is settled – but we should see a clearer direction before the year is out.

When Should You Switch Your Side Hustle to a Business Entity Structure?

Side Business, How to File for Business EntityStarting a side hustle today is easier than ever. Between the numerous websites that act as marketplaces and project jobs that can be found on the internet, almost anyone can turn a skill or hobby they have into something they can make money off. Many people who do this are just looking to make a little extra money on the side, but this side hustle can turn into something bigger – and this is where the tax and legal questions come in.

Sole Proprietorship

For someone just starting or looking to make a little extra on the side, there’s nothing special you need to do when it comes to filing your federal taxes. Just complete an extra form that is called Schedule C of your personal tax return. This is referred to as doing business as a sole proprietorship.

But that is where the simplicity stops. While organizing your business, the default way as a sole proprietor takes the least effort and expense; however, there are risks associated with this path, particularly legal liability risks.

Legal Risks

The biggest problem is that the sole proprietorships form leaves personal as well as business assets exposed to the risk of being sued. Lawyers will often recommend that the moment a business has paying clients, it should be converted to an LLC or corporation to provide legal protection by separating the business and personal assets.

While this legal advice is technically true, it doesn’t consider the cost-benefit of the situation. The problem is that the costs of forming and running an LLC or corporation can easily exceed the money earned from a side hustle. Combine this with the probability of getting sued at all (in each personal situation) and for most side hustles, it’s simply not worth it to form an LLC or corporation. The key question then is when is it worth it to switch from a sole proprietorship to an LLC or a corporation?

When Side Hustle Grows Up

What about the taxation issue? Generally, tax savings aren’t a good reason to convert a sole proprietorship to an LLC or corporation. Particularly, making the move from a sole proprietorship to a single-member LLC will not help for tax purposes and in fact may only increase your chances of an audit. Moreover, operating as an LLC will cost more both for the initial filing as well as ongoing annual expenses. Legal liability remains the main reason to convert the entity structure.

Hidden Tax Issues

All three pass-through entity types (sole proprietor, LLC and S-Corporations) calculate your income in the exact same way under current laws. There is however a hidden tax to consider: the self-employment tax. Self-employment taxes are paid on all sole proprietor earnings, but only on the salary portion of LLC or S-Corp earnings. Any profits over and above your salary are considered dividend payments and are not subject to self-employment taxes.

Unfortunately, the income level needed to change entity structures depends on each individual situation, but you’ll need the savings to at least cover the initial and long-term compliance costs of filings, fees and tax preparation costs. Let’s look at two examples to see how this works.

Imagine a business is earning $100,000 in net profit and from this, you pay yourself $40,000 as salary and take the remaining $50,000 as dividends. At the current 15.3 percent self-employment tax rate, this translates into a savings of $7,650. Now imagine a side hustle that only earns $25,000 from which you take $15,000 as salary and the remaining $10,000 as dividends. This only translates into $1,530 in tax savings.

In the first case above, you’ve not only generated enough tax savings to more than cover your tax preparation and filing costs, but you’ll end up with more money in your pocket and have stronger legal protection. In the second case, you’ll barely save enough to cover your costs – and you’ll create more work for yourself.

Conclusion

Your side hustle might be small right now, but tomorrow it could grow into the next big thing, so make sure your organizational structure makes sense now.

2020 Tax Brackets, Deductions, Plus More

Beginning on Jan. 1, 2020, the Internal Revenue Service (IRS) has new annual inflation adjustments for tax rates, brackets, deductions and retirement contribution limits. Note, the amounts below do not impact the tax filing you make in 2020 for the tax year 2019. These amounts apply to your 2020 taxes that you will file in 2021.

2020 Tax Rates and 2020 Tax Brackets

Below are the new 2020 tables for personal income tax rates. There are separate tables each for individuals, married filing jointly couples and surviving spouses, heads of household and married filing separate; all with seven tax brackets for 2020.

Tax Brackets & Rates – Individuals
Taxable Income Between Tax Due
$0 – $9,875 10%
$9,876 – $40,125 $988 plus 12% of the amount over $9,875
$40,126 – $85,525 $4,617 plus 22% of the amount over $40,125
$85,526 – $163,300 $14,605 plus 24% of the amount over $85,525
$163,301 – $207,350 $33,271 plus 32% of the amount over $163,300
$207,351 – $518,400 $47,367 plus 35% of the amount over $207,350
$518,400 and Over $156,234 plus 37% of the amount over $518,400

 

Tax Brackets & Rates – Married Filing Jointly and Surviving Spouses
Taxable Income Between Tax Due
$0 – $19,750 10%
$19,751 – $80,250 $1,975 plus 12% of the amount over $19,750
$80,251 – $171,050 $9,235 plus 22% of the amount over $80,250
$171,051 – $326,600 $29,211 plus 24% of the amount over $171,050
$326,601 – $414,700 $66,542 plus 32% of the amount over $326,600
$414,701 – $622,050 $94,734 plus 35% of the amount over $414,700
$622,050 and Over $167,306 plus 37% of the amount over $622,050

 

Tax Brackets & Rates – Heads of Households
Taxable Income Between Tax Due
$0 – $14,100 10%
$14,101 – $53,700 $1,410 plus 12% of the amount over $14,100
$53,701 – $85,500 $6,162 plus 22% of the amount over $53,700
$85,501 – $163,300 $13,158 plus 24% of the amount over $85,500
$163,301 – $207,350 $31,829 plus 32% of the amount over $163,300
$207,351 – $518,400 $45,925 plus 35% of the amount over $207,350
$518,400 and Over $154,792 plus 37% of the amount over $518,400

 

Tax Brackets & Rates – Separately
Taxable Income Between Tax Due
$0 – $9,875 10%
$9,876 – $40,125 $988 plus 12% of the amount over $9,875
$40,126 – $85,525 $4,617 plus 22% of the amount over $40,125
$85,526 – $163,300 $14,605 plus 24% of the amount over $85,525
$163,301 – $207,350 $33,271 plus 32% of the amount over $163,300
$207,351 – $311,025 $47,367 plus 35% of the amount over $207,350
$311,025 and Over $83,653 plus 37% of the amount over $311,025

 

Trusts and Estates have four brackets in 2020, each with different rates.

Tax Brackets & Rates – Trusts and Estates
Taxable Income Between Tax Due
$0 – $2,600 10%
$2,601 – $9,450 $260 plus 12% of the amount over $2,600
$9,451 – $12,950 $1,904 plus 35% of the amount over $9,450
$12,950 and Over $3,129 plus 37% of the amount over $12,950

 

Standard Deduction Amounts

Amounts for standard deductions see a slight increase from 2019 to 2020 based on indexing for inflation. Note that again as in 2019, there are no personal exemption amounts for 2020.

Standard Deductions
Filing Status Standard Deduction Amount
Single $12,400
Married Filing Jointly & Surviving Spouses $24,800
Married Filing Separately $12,400
Heads of Household $18,650

 

Alternative Minimum Tax (AMT) Exemptions

Like the above, the AMT exemption amounts are increased based on adjustments for inflation, with the 2020 exemption amounts as follows.

 

Alternative Minimum Tax (AMT) Exemptions
Filing Status Standard Deduction Amount
Individual $72,900
Married Filing Jointly & Surviving Spouses $113,400
Married Filing Separately $56,700
Trusts and Estates $25,400

 

Capital Gains Rates

Capital gains rates remain unchanged for 2020; however, the brackets for the rates are changing. Taxpayers will pay a maximum 15 percent rate unless their taxable income exceeds the 37 percent threshold (see the personal tax brackets and rates above for your individual situation). If a taxpayer hits this threshold, then their capital gains rate increases to 20 percent.

Itemized Deductions

Below are the 2020 details on the major itemized deductions many taxpayers take on Schedule A of their returns.

  • Medical Expenses – The floor remains unchanged from 2019 to 2020, so you can only deduct these expenses that exceed 10 percent of your AGI.
  • State and Local Taxes – The SALT deductions also remain unchanged at the federal level with a total limit of $10,000 ($5,000 if you are married filing separately).
  • Mortgage Deduction for Interest Expenses – The limit on mortgage interest also remains the same with the debt bearing the interest capped at $750k ($375k if you are married filing separately).

Retirement Account Contribution Limits

Finally, we look at the various retirement account contribution limits for 2020.

  • 401(k) – Annual contribution limits increase $500 to $19,500 for 2020
  • 401(k) Catch-Up – Employees age50 or older in these plans can contribute an additional $6,500 (on top of the $19,500 above for a total of $26,000) for 2020. This $500 increase in the catch-up provision is the first increase in the catch-up since 2015.
  • SEP IRAs and Solo 401(k)s – Self-employed and small business owners, can save an additional $1,000 in their SEP IRA or a solo 401(k) plan, with limits increasing from $56,000 in 2019 to $57,000 in 2020.
  • The SIMPLE – SIMPLE retirement accounts see a $500 increase in contribution limits, rising from $13,000 in 2019 to $13,500 in 2020.
  • Individual Retirement Accounts – There are no changes here for IRA contributions in 2020, with the cap at $6,000 for 2020 and the same catch-up contribution limit of $1,000.

Conclusion

There are no dramatic changes in the rates, brackets, deductions or retirement account contribution limits that the vast majority taxpayers tend to encounter for 2020 versus 2019. Most changes are simply adjustments for inflation. Enjoy the stability – as history has shown, it likely won’t last long.

How to Defer, Avoid Paying Capital Gains Tax on Stock Sales

The markets are hitting all-time highs, so if you are thinking of selling stocks now or in the near future, there is a good chance that you will have capital gains on the sale. If you’ve held the stocks for more than a year, then they will qualify for the more favorable long-term capital gains tax (instead of being taxed at ordinary income rates for short-term sales). But the total tax due can still be enough to warrant some tax planning. Luckily, the tax laws provide for several ways to defer or even completely avoid paying taxes on your securities sales.

1. Using Tax Losses

Utilizing losses is the least attractive of all the options in this article since you obviously had to lose money on one security in order to avoid paying taxes on another. The real play here is what is often referred to as tax-loss harvesting. This is where you purposely sell shares that are at a loss position in order to offset the gains on profitable sales and then redeploy this capital somewhere else. You’ll need to carefully weigh where to put the money from the sale of the shares sold at a loss as you can’t just buy the same stocks back. This is considered a “wash sale” and invalidates the strategy.

2. The 10 Percent to 15 Percent Tax Bracket

For taxpayers in either the 10 percent or 12 percent income tax brackets, their long-term capital gains rate is 0 percent. The income caps for qualifying for the 12 percent income tax rate is $39,375 for single filers and $78,750 for joint filers in 2019 ($40,000 and $80,000, respectively in 2020). Also, keep in mind that the stock sales themselves add to this limit – so calculate carefully.

Aside from selling appreciated securities yourself, another way to take advantage of the 0 percent bracket is to gift the stock to someone else instead of selling the securities and then giving the cash. Beware, however, as trying to do this with your kids can disqualify the 0 percent treatment because the kiddie tax is triggered on gifted stock sold to children younger than 19 or under 24 if a full-time student.

3. Donate

Donating appreciated securities is where we start to get into the more beneficial strategies. This technique only makes sense if you were already planning to make charitable contributions. Say for example you are planning to donate $10,000 to an organization and are in the 25 percent tax bracket. In order to write a donation check for $10,000, you would have had to earn $13,333 in income to sell the same amount of stock in order to have $10,000 left after taxes to make a cash donation in that amount.

If you donate appreciated stock instead, you only need to donate securities valued at $10,000 and you get to deduct $10,000 as a charitable deduction. That avoids the capital gains tax completely. Plus, it generates for you a bigger tax deduction for the full market value of donated shares held more than one year – and it results in a larger donation.

4. Qualified Opportunity Zones

This is the newest and most complicated (as well as controversial) way to defer or avoid capital gains taxes. Opportunity Zones were created via the Tax Cuts and Jobs Act to encourage investment in low-income and distressed communities. Qualified Opportunity Zones can defer or eliminate capital gains tax by utilizing three mechanisms through Opportunity Funds – the investment vehicle that invests in Opportunity Zones.

First, they offer a temporary deferral of taxes on previously earned capital gains if investors place existing assets into Opportunity Funds. These capital gains defer taxation until the end of 2026 or whenever the asset is disposed of – whichever is first.

Second, capital gains placed in Opportunity Funds for a minimum of five years receive a step-up in basis of 10 percent – and if held for at least seven years, 15 percent.

Third, they offer an opportunity to permanently avoid taxation on new capital gains. If the opportunity fund is held for at least 10 years, the investor will pay no tax on capital gains earned through the Opportunity Fund.

Again, the caveat here is that the details of Opportunity Zone investments can be extremely complicated, so it’s best not to attempt this one on your own. Consult with your tax advisor.

5. Die with Appreciated Stock

Unfortunately, while probably the least popular method for readers, this is certainly the most effective. When a person passes away, the cost basis of their securities receives a step-up in basis to the fair market value to the date of their death. As an example, if you purchased Amazon stock for $50 per share and when you pass away it is worth $1,700 per share, your heir’s basis in the inherited stock is $1,700. This means if they sell it at $1,700, they pay no tax at all.

Conclusion

None of the above methods are loopholes or tax dodges; they are all completely legitimate. However, your ability to take advantage of these techniques will depend on your income level, personal goals and even your age. As a result, it’s best to consult with your tax advisor to see what makes sense for your personal situation.