October 15 is the deadline for individual taxpayers who extended their 2019 tax returns. (The original April 15 filing deadline was extended this year to July 15 due to the COVID-19 pandemic.) If you’re finally done filing last year’s return, you might wonder: Which tax records can you toss once you’re done? Now is a good time to go through old tax records and see what you can discard.
The general rules
At minimum, you should keep tax records for as long as the IRS has the ability to audit your tax return or assess additional taxes, which generally is three years after you file your return. This means you potentially can get rid of most records related to tax returns for 2016 and earlier years.
However, the statute of limitations extends to six years for taxpayers who understate their adjusted gross income (AGI) by more than 25%. What constitutes an understatement may go beyond simply not reporting items of income. So a general rule of thumb is to save tax records for six years from filing, just to be safe.
Keep some records longer
You need to hang on to some tax-related records beyond the statute of limitations. For example:
- Keep the tax returns themselves indefinitely, so you can prove to the IRS that you actually filed a legitimate return. (There’s no statute of limitations for an audit if you didn’t file a return or if you filed a fraudulent one.)
- Retain W-2 forms until you begin receiving Social Security benefits. Questions might arise regarding your work record or earnings for a particular year, and your W-2 helps provide the documentation needed.
- Keep records related to real estate or investments for as long as you own the assets, plus at least three years after you sell them and report the sales on your tax return (or six years if you want extra protection).
- Keep records associated with retirement accounts until you’ve depleted the accounts and reported the last withdrawal on your tax return, plus three (or six) years.
Other reasons to retain records
Keep in mind that these are the federal tax record retention guidelines. Your state and local tax record requirements may differ. In addition, lenders, co-op boards and other private parties may require you to produce copies of your tax returns as a condition to lending money, approving a purchase or otherwise doing business with you.
Contact us if you have questions or concerns about recordkeeping.
© 2020 Covenant CPA
If you file a joint tax return with your spouse, you should be aware of your individual liability. And if you’re getting divorced, you should know that there may be relief available if the IRS comes after you for certain past-due taxes.
What’s “joint and several” liability?
When a married couple files a joint tax return, each spouse is “jointly and severally” liable for the full tax amount on the couple’s combined income. That means the IRS can come after either spouse to collect the entire tax — not just the part that’s attributed to one spouse or the other. Liability includes any tax deficiency that the IRS assesses after an audit, as well as penalties and interest. (However, the civil fraud penalty can be imposed only on spouses who’ve actually committed fraud.)
When are spouses “innocent?”
In some cases, spouses are eligible for “innocent spouse relief.” This generally involves individuals who didn’t know about a tax understatement that was attributable to the other spouse.
To be eligible, you must show that you were unaware of the understatement and there was nothing that should have made you suspicious. In addition, the circumstances must make it inequitable to hold you liable for the tax. This relief may be available even if you’re still married and living with your spouse.
In addition, spouses may be able to limit liability for a tax deficiency on a joint return if they’re widowed, divorced, legally separated or have lived apart for at least one year.
How can liability be limited?
In some cases, a spouse can elect to limit liability for a deficiency on a joint return to just his or her allocable portion of the deficiency. If you make this election, the tax items that gave rise to the deficiency will be allocated between you and your spouse as if you’d filed separate returns.
The election won’t provide relief from your spouse’s tax items if the IRS proves that you knew about the items when you signed the tax return — unless you can show that you signed it under duress. Also, liability will be increased by the value of any assets that your spouse transferred to you in order to avoid the tax.
What is an “injured” spouse?
In addition to innocent spouse relief, there’s also relief for “injured” spouses. What’s the difference? An injured spouse claim asks the IRS to allocate part of a joint tax refund to one spouse. In these cases, one spouse has all or part of a refund from a joint return applied against certain past-due taxes, child or spousal support, or federal nontax debts (such as student loans) owed by the other spouse. If you’re an injured spouse, you may be entitled to recoup your refund share.
Whether, and to what extent, you can take advantage of the above relief depends on your situation. If you’re interested in trying to obtain relief, there’s paperwork that must be filed and deadlines that must be met. We can assist you with the details.
Also, keep “joint and several liability” in mind when filing future tax returns. Even if a joint return results in less tax, you may want to file a separate return if you want to be responsible only for your own tax.
© 2020 Covenant CPA
Does your employer provide you with group term life insurance? If so, and if the coverage is higher than $50,000, this employee benefit may create undesirable income tax consequences for you.
The first $50,000 of group term life insurance coverage that your employer provides is excluded from taxable income and doesn’t add anything to your income tax bill. But the employer-paid cost of group term coverage in excess of $50,000 is taxable income to you. It’s included in the taxable wages reported on your Form W-2 — even though you never actually receive it. In other words, it’s “phantom income.”
What’s worse, the cost of group term insurance must be determined under a table prepared by IRS even if the employer’s actual cost is less than the cost figured under the table. Under these determinations, the amount of taxable phantom income attributed to an older employee is often higher than the premium the employee would pay for comparable coverage under an individual term policy. This tax trap gets worse as the employee gets older and as the amount of his or her compensation increases.
Check your W-2
What should you do if you think the tax cost of employer-provided group term life insurance is undesirably high? First, you should establish if this is actually the case. If a specific dollar amount appears in Box 12 of your Form W-2 (with code “C”), that dollar amount represents your employer’s cost of providing you with group-term life insurance coverage in excess of $50,000, less any amount you paid for the coverage. You’re responsible for federal, state and local taxes on the amount that appears in Box 12 and for the associated Social Security and Medicare taxes as well.
But keep in mind that the amount in Box 12 is already included as part of your total “Wages, tips and other compensation” in Box 1 of the W-2, and it’s the Box 1 amount that’s reported on your tax return
Consider some options
If you decide that the tax cost is too high for the benefit you’re getting in return, you should find out whether your employer has a “carve-out” plan (a plan that carves out selected employees from group term coverage) or, if not, whether it would be willing to create one. There are several different types of carve-out plans that employers can offer to their employees.
For example, the employer can continue to provide $50,000 of group term insurance (since there’s no tax cost for the first $50,000 of coverage). Then, the employer can either provide the employee with an individual policy for the balance of the coverage, or give the employee the amount the employer would have spent for the excess coverage as a cash bonus that the employee can use to pay the premiums on an individual policy.
Contact us if you have questions about group term coverage or how much it is adding to your tax bill.
© 2020 Covenant CPA
If you’re a partner in a business, you may have come across a situation that gave you pause. In a given year, you may be taxed on more partnership income than was distributed to you from the partnership in which you’re a partner.
Why is this? The answer lies in the way partnerships and partners are taxed. Unlike regular corporations, partnerships aren’t subject to income tax. Instead, each partner is taxed on the partnership’s earnings — whether or not they’re distributed. Similarly, if a partnership has a loss, the loss is passed through to the partners. (However, various rules may prevent a partner from currently using his share of a partnership’s loss to offset other income.)
While a partnership isn’t subject to income tax, it’s treated as a separate entity for purposes of determining its income, gains, losses, deductions and credits. This makes it possible to pass through to partners their share of these items.
A partnership must file an information return, which is IRS Form 1065. On Schedule K of Form 1065, the partnership separately identifies income, deductions, credits and other items. This is so that each partner can properly treat items that are subject to limits or other rules that could affect their correct treatment at the partner’s level. Examples of such items include capital gains and losses, interest expense on investment debts and charitable contributions. Each partner gets a Schedule K-1 showing his or her share of partnership items.
Basis and distribution rules ensure that partners aren’t taxed twice. A partner’s initial basis in his partnership interest (the determination of which varies depending on how the interest was acquired) is increased by his share of partnership taxable income. When that income is paid out to partners in cash, they aren’t taxed on the cash if they have sufficient basis. Instead, partners just reduce their basis by the amount of the distribution. If a cash distribution exceeds a partner’s basis, then the excess is taxed to the partner as a gain, which often is a capital gain.
Here’s an example
Two individuals each contribute $10,000 to form a partnership. The partnership has $80,000 of taxable income in the first year, during which it makes no cash distributions to the two partners. Each of them reports $40,000 of taxable income from the partnership as shown on their K-1s. Each has a starting basis of $10,000, which is increased by $40,000 to $50,000. In the second year, the partnership breaks even (has zero taxable income) and distributes $40,000 to each of the two partners. The cash distributed to them is received tax-free. Each of them, however, must reduce the basis in his partnership interest from $50,000 to $10,000.
Other rules and limitations
The example and details above are an overview and, therefore, don’t cover all the rules. For example, many other events require basis adjustments and there are a host of special rules covering noncash distributions, distributions of securities, liquidating distributions and other matters.
© 2020 Covenant CPA
The tax filing deadline for 2019 tax returns has been extended until July 15 this year, due to the COVID-19 pandemic. After your 2019 tax return has been successfully filed with the IRS, there may still be some issues to bear in mind. Here are three considerations.
1. Some tax records can now be thrown away
You should keep tax records related to your return for as long as the IRS can audit your return or assess additional taxes. In general, the statute of limitations is three years after you file your return. So you can generally get rid of most records related to tax returns for 2016 and earlier years. (If you filed an extension for your 2016 return, hold on to your records until at least three years from when you filed the extended return.)
However, the statute of limitations extends to six years for taxpayers who understate their gross income by more than 25%.
You’ll need to hang on to certain tax-related records longer. For example, keep the actual tax returns indefinitely, so you can prove to the IRS that you filed a legitimate return. (There’s no statute of limitations for an audit if you didn’t file a return or you filed a fraudulent one.)
When it comes to retirement accounts, keep records associated with them until you’ve depleted the account and reported the last withdrawal on your tax return, plus three (or six) years. And retain records related to real estate or investments for as long as you own the asset, plus at least three years after you sell it and report the sale on your tax return. (You can keep these records for six years if you want to be extra safe.)
2. You can check up on your refund
The IRS has an online tool that can tell you the status of your refund. Go to irs.gov and click on “Get Your Refund Status” to find out about yours. You’ll need your Social Security number, filing status and the exact refund amount.
3. You can file an amended return if you forgot to report something
In general, you can file an amended tax return and claim a refund within three years after the date you filed your original return or within two years of the date you paid the tax, whichever is later. So for a 2019 tax return that you file on July 15, 2020, you can generally file an amended return until July 15, 2023.
However, there are a few opportunities when you have longer to file an amended return. For example, the statute of limitations for bad debts is longer than the usual three-year time limit for most items on your tax return. In general, you can amend your tax return to claim a bad debt for seven years from the due date of the tax return for the year that the debt became worthless.
We can help
Contact us if you have questions about tax record retention, your refund or filing an amended return. We’re not just available at tax filing time — we’re here all year!
© 2020 Covenant CPA
The extended federal income tax deadline is coming up fast. As you know, the IRS postponed until July 15 the payment and filing deadlines that otherwise would have fallen on or after April 1, 2020, and before July 15.
Retroactive COVID-19 business relief
The Coronavirus Aid, Relief and Economic Security (CARES) Act, which passed earlier in 2020, includes some retroactive tax relief for business taxpayers. The following four provisions may affect a still-unfiled tax return — or you may be able to take advantage of them on an amended return if you already filed.
Liberalized net operating losses (NOLs). The CARES Act allows a five-year carryback for a business NOL that arises in a tax year beginning in 2018 through 2020. Claiming 100% first-year bonus depreciation on an affected year’s return can potentially create or increase an NOL for that year. If so, the NOL can be carried back, and you can recover some or all of the income tax paid for the carryback year. This factor could cause you to favor claiming 100% first-year bonus depreciation on an unfiled return.
Since NOLs that arise in tax years beginning in 2018 through 2020 can be carried back five years, an NOL that’s reported on a still-unfiled return can be carried back to an earlier tax year and allow you to recover income tax paid in the carry-back year. Because federal income tax rates were generally higher in years before the Tax Cuts and Jobs Act (TCJA) took effect, NOLs carried back to those years can be especially beneficial.
Qualified improvement property (QIP) technical corrections. QIP is generally defined as an improvement to an interior portion of a nonresidential building that’s placed in service after the date the building was first placed in service. The CARES Act includes a retroactive correction to the TCJA. The correction allows much faster depreciation for real estate QIP that’s placed in service after the TCJA became law.
Specifically, the correction allows 100% first-year bonus depreciation for QIP that’s placed in service in 2018 through 2022. Alternatively, you can depreciate QIP placed in service in 2018 and beyond over 15 years using the straight-line method.
Suspension of excess business loss disallowance. An “excess business loss” is a loss that exceeds $250,000 or $500,000 for a married couple filing a joint tax return. An unfavorable TCJA provision disallowed current deductions for excess business losses incurred by individuals in tax years beginning in 2018 through 2025. The CARES Act suspends the excess business loss disallowance rule for losses that arise in tax years beginning in 2018 through 2020.
Liberalized business interest deductions. Another unfavorable TCJA provision generally limited a taxpayer’s deduction for business interest expense to 30% of adjusted taxable income (ATI) for tax years beginning in 2018 and later. Business interest expense that’s disallowed under this limitation is carried over to the following tax year.
In general, the CARES Act temporarily and retroactively increases the limitation from 30% to 50% of ATI for tax years beginning in 2019 and 2020. (Special rules apply to partnerships and LLCs that are treated as partnerships for tax purposes.)
Assessing the opportunities
These are just some of the possible tax opportunities that may be available if you haven’t yet filed your 2019 tax return. Other rules and limitations may apply. Contact us for help determining how to proceed in your situation.
© 2020 Covenant CPA
While the COVID-19 crisis has devastated many existing businesses, the pandemic has also created opportunities for entrepreneurs to launch new businesses. For example, some businesses are being launched online to provide products and services to people staying at home.
Entrepreneurs often don’t know that many expenses incurred by start-ups can’t be currently deducted. You should be aware that the way you handle some of your initial expenses can make a large difference in your tax bill.
How expenses must be handled
If you’re starting or planning a new enterprise, keep these key points in mind:
- Start-up costs include those incurred or paid while creating an active trade or business — or investigating the creation or acquisition of one.
- Under the Internal Revenue Code, taxpayers can elect to deduct up to $5,000 of business start-up and $5,000 of organizational costs in the year the business begins. As you know, $5,000 doesn’t get you very far today! And the $5,000 deduction is reduced dollar-for-dollar by the amount by which your total start-up or organizational costs exceed $50,000. Any remaining costs must be amortized over 180 months on a straight-line basis.
- No deductions or amortization deductions are allowed until the year when “active conduct” of your new business begins. Generally, that means the year when the business has all the pieces in place to begin earning revenue. To determine if a taxpayer meets this test, the IRS and courts generally ask questions such as: Did the taxpayer undertake the activity intending to earn a profit? Was the taxpayer regularly and actively involved? Did the activity actually begin?
Expenses that qualify
In general, start-up expenses include all amounts you spend to:
- Investigate the creation or acquisition of a business,
- Create a business, or
- Engage in a for-profit activity in anticipation of that activity becoming an active business.
To be eligible for the election, an expense also must be one that would be deductible if it were incurred after a business began. One example is money you spend analyzing potential markets for a new product or service.
To qualify as an “organization expense,” the expenditure must be related to creating a corporation or partnership. Some examples of organization expenses are legal and accounting fees for services related to organizing a new business and filing fees paid to the state of incorporation.
If you have start-up expenses that you’d like to deduct this year, you need to decide whether to take the elections described above. Recordkeeping is critical. Contact us about your start-up plans. We can help with the tax and other aspects of your new business.
© 2020 Covenant CPA
The economic impact of the novel coronavirus (COVID-19) is unprecedented and many taxpayers with student loans have been hard hit.
The Coronavirus Aid, Relief and Economic Security (CARES) Act contains some assistance to borrowers with federal student loans. Notably, federal loans were automatically placed in an administrative forbearance, which allows borrowers to temporarily stop making monthly payments. This payment suspension is scheduled to last until September 30, 2020.
Tax deduction rules
Despite the suspension, borrowers can still make payments if they choose. And borrowers in good standing made payments earlier in the year and will likely make them later in 2020. So can you deduct the student loan interest on your tax return?
The answer is yes, depending on your income and subject to certain limits. The maximum amount of student loan interest you can deduct each year is $2,500. The deduction is phased out if your adjusted gross income (AGI) exceeds certain levels.
For 2020, the deduction is phased out for taxpayers who are married filing jointly with AGI between $140,000 and $170,000 ($70,000 and $85,000 for single filers). The deduction is unavailable for taxpayers with AGI of $170,000 ($85,000 for single filers) or more. Married taxpayers must file jointly to claim the deduction.
The interest must be for a “qualified education loan,” which means debt incurred to pay tuition, room and board, and related expenses to attend a post-high school educational institution. Certain vocational schools and post-graduate programs also may qualify.
The interest must be on funds borrowed to cover qualified education costs of the taxpayer, his or her spouse or a dependent. The student must be a degree candidate carrying at least half the normal full-time workload. Also, the education expenses must be paid or incurred within a reasonable time before or after the loan is taken out.
It doesn’t matter when the loan was taken out or whether interest payments made in earlier years on the loan were deductible or not. And no deduction is allowed to a taxpayer who can be claimed as a dependent on another taxpayer’s return.
The deduction is taken “above the line.” In other words, it’s subtracted from gross income to determine AGI. Thus, it’s available even to taxpayers who don’t itemize deductions.
Taxpayers should keep records to verify eligible expenses. Documenting tuition isn’t likely to pose a problem. However, take care to document other qualifying expenditures for items such as books, equipment, fees, and transportation. Documenting room and board expenses should be simple if a student lives in a dormitory. Student who live off campus should maintain records of room and board expenses, especially when there are complicating factors such as roommates.
Contact us if you have questions about deducting student loan interest or for information on other tax breaks related to paying for college.
© 2020 Covenant CPA
The coronavirus (COVID-19) pandemic has affected many Americans’ finances. Here are some answers to questions you may have right now.
My employer closed the office and I’m working from home. Can I deduct any of the related expenses?
Unfortunately, no. If you’re an employee who telecommutes, there are strict rules that govern whether you can deduct home office expenses. For 2018–2025 employee home office expenses aren’t deductible. (Starting in 2026, an employee may deduct home office expenses, within limits, if the office is for the convenience of his or her employer and certain requirements are met.)
Be aware that these are the rules for employees. Business owners who work from home may qualify for home office deductions.
My son was laid off from his job and is receiving unemployment benefits. Are they taxable?
Yes. Unemployment compensation is taxable for federal tax purposes. This includes your son’s state unemployment benefits plus the temporary $600 per week from the federal government. (Depending on the state he lives in, his benefits may be taxed for state tax purposes as well.)
Your son can have tax withheld from unemployment benefits or make estimated tax payments to the IRS.
The value of my stock portfolio is currently down. If I sell a losing stock now, can I deduct the loss on my 2020 tax return?
It depends. Let’s say you sell a losing stock this year but earlier this year, you sold stock shares at a gain. You have both a capital loss and a capital gain. Your capital gains and losses for the year must be netted against one another in a specific order, based on whether they’re short-term (held one year or less) or long-term (held for more than one year).
If, after the netting, you have short-term or long-term losses (or both), you can use them to offset up to $3,000 ordinary income ($1,500 for married taxpayers filing separately). Any loss in excess of this limit is carried forward to later years, until all of it is either offset against capital gains or deducted against ordinary income in those years, subject to the $3,000 limit.
I know the tax filing deadline has been extended until July 15 this year. Does that mean I have more time to contribute to my IRA?
Yes. You have until July 15 to contribute to an IRA for 2019. If you’re eligible, you can contribute up to $6,000 to an IRA, plus an extra $1,000 “catch-up” amount if you were age 50 or older on December 31, 2019.
What about making estimated payments for 2020?
The 2020 estimated tax payment deadlines for the first quarter (due April 15) and the second quarter (due June 15) have been extended until July 15, 2020.
These are only some of the tax-related questions you may have related to COVID-19. Contact us if you have other questions or need more information about the topics discussed above.
© 2020 Covenant CPA
Millions of eligible Americans have already received their Economic Impact Payments (EIPs) via direct deposit or paper checks, according to the IRS. Others are still waiting. The payments are part of the Coronavirus Aid, Relief, and Economic Security (CARES) Act. Here are some answers to questions you may have about EIPs.
Who’s eligible to get an EIP?
Eligible taxpayers who filed their 2018 or 2019 returns and chose direct deposit of their refunds automatically receive an Economic Impact Payment. You must be a U.S. citizen or U.S. resident alien and you can’t be claimed as a dependent on someone else’s tax return. In general, you must also have a valid Social Security number and have adjusted gross income (AGI) under a certain threshold.
The IRS also says that automatic payments will go to people receiving Social Security retirement or disability benefits and Railroad Retirement benefits.
How much are the payments?
EIPs can be up to $1,200 for individuals, or $2,400 for married couples, plus $500 for each qualifying child.
How much income must I have to receive a payment?
You don’t need to have any income to receive a payment. But for higher income people, the payments phase out. The EIP is reduced by 5% of the amount that your AGI exceeds $75,000 ($112,500 for heads of household or $150,000 for married joint filers), until it’s $0.
The payment for eligible individuals with no qualifying children is reduced to $0 once AGI reaches:
- $198,000 for married joint filers,
- $136,500 for heads of household, and
- $99,000 for all others
Each of these threshold amounts increases by $10,000 for each additional qualifying child. For example, because families with one qualifying child receive an additional $500 Payment, their $1,700 Payment ($2,900 for married joint filers) is reduced to $0 once adjusted gross income reaches:
- $208,000 for married joint filers,
- $146,500 for heads of household,
- $109,000 for all others
How will I know if money has been deposited into my bank account?
The IRS stated that it will send letters to EIP recipients about the payment within 15 days after they’re made. A letter will be sent to a recipient’s last known address and will provide information on how the payment was made and how to report any failure to receive it.
Is there a way to check on the status of a payment?
The IRS has introduced a new “Get My Payment” web-based tool that will: show taxpayers either their EIP amount and the scheduled delivery date by direct deposit or paper check, or that a payment hasn’t been scheduled. It also allows taxpayers who didn’t use direct deposit on their last-filed return to provide bank account information. In order to use the tool, you must enter information such as your Social Security number and birthdate. You can access it here: https://bit.ly/2ykLSwa
I tried the tool and I got the message “payment status not available.” Why?
Many people report that they’re getting this message. The IRS states there are many reasons why you may see this. For example, you’re not eligible for a payment or you’re required to file a tax return and haven’t filed yet. In some cases, people are eligible but are still getting this message. Hopefully, the IRS will have it running seamlessly soon.
© 2020 Covenant CPA