Understanding why Emotional Distress Damages Are Taxable but Physical Sickness Damages Are Not

The general rule for compensatory damages for personal physical injuries is that they are tax free under Section 104 of the Internal Revenue Code. Yet exactly what is physical is not so clear.  For example, if you make claims for emotional distress, your damages are taxable. If you claim the defendant caused you to become physically sick, those can be tax free. If emotional distress causes you to be physically sick, that is taxable. The order of events and how you describe them matters to the IRS.  If you are physically sick or physically injured, and your sickness or injury produces emotional distress, those emotional distress damages should be tax free. Much of this seems artificial, but wording is very important. Some of the distinctions come from a footnote in the legislative history to the tax code adding the ‘physical’ requirement. It says “emotional distress” includes physical symptoms, such as insomnia, headaches, and stomach disorders, which may result from such emotional distress.  All compensatory damages flowing from a physical injury or physical sickness are excludable from income.  For example, in Domeny v. Commissioner, Ms. Domeny suffered from multiple sclerosis (MS). Her MS got worse because of workplace problems, including an embezzling employer. As her symptoms worsened, her physician determined that she was too ill to work. Her employer terminated her, causing another spike in her MS symptoms. She settled her employment case and claimed some of the money as tax free. The IRS disagreed, but Ms. Domeny won in Tax Court. Her health and physical condition clearly worsened because of her employer’s actions, so portions of her settlement were tax free. 

Tired young businessman working at home using lap top and looking Anxious

In Parkinson v. Commissioner, a man suffered a heart attack while at work. He reduced his hours, took medical leave, and never returned. He sued in state court for intentional infliction and invasion of privacy. His complaint alleged that the employer’s misconduct caused him to suffer a disabling heart attack at work, rendering him unable to work. He settled and claimed that one payment was tax free. When the IRS disagreed, he went to Tax Court. He argued the payment was for physical injuries and physical sickness brought on by extreme emotional distress. The IRS said that it was just a taxable emotional distress recovery.

The Tax Court said damages received on account of emotional distress attributable to physical injury or physical sickness are tax free. The court distinguished between a “symptom” and a “sign.” The court called a symptom a “subjective evidence of disease of a patient’s condition.” In contrast, a “sign” is evidence perceptible to the examining physician. The Tax Court said the IRS was wrong to argue that one can never have physical injury or physical sickness in a claim for emotional distress. The court said intentional infliction of emotional distress can result in bodily harm. Notably, the settlement agreement in Parkinson was not specific about the nature of the payment or its tax treatment. And it did not say anything about tax reporting. There was little evidence that medical testimony linked Parkinson’s condition to the actions of the employer. Still, Parkinson beat the IRS. Damages for physical symptoms of emotional distress such as headaches, insomnia, and stomachaches might be taxable. Yet physical symptoms of emotional distress have a limit. For example, ulcers, shingles, aneurysms, and strokes may all be an outgrowth of stress. It seems difficult to regard them all as ‘mere symptoms of emotional distress.’ Extreme emotional distress can produce a heart attack, which is not a symptom of emotional distress. The Tax Court in Parkinson agreed.  Medical records and settlement agreement language can significantly help.

To exclude a payment from income on account of physical sickness, you need evidence of making the claim that the defendant caused or exacerbated his condition. In addition, you need to show the defendant was aware of the claim, and at least considered it in making payment. To prove physical sickness, you need evidence of medical care, and evidence that you actually claimed the defendant caused or exacerbated his condition.

The more medical evidence the better. Moreover, if there is a scant record of medical expenses in the litigation, consider what you can collect at settlement time. A declaration from the plaintiff will help for the file. A declaration from a treating physician or an expert physician is appropriate, as is one from the plaintiff’s attorney. Prepare what you can at the time of settlement or, at the latest, before you file your tax return. Do as much as you can contemporaneously.

Whenever possible, settlement agreements should be specific about the tax treatment of your damage award. The IRS is likely to view everything as income unless you can prove otherwise. Try to be explicit in the settlement agreement about the amount you will receive as wages or other taxable and what form they will be reported on.  You do not want to be surprised by receiving a W-2 or a 1099 the following January of the year after the settlement.

 If you have any questions, feel free to call Gregory Spadea at 610-521-0604. The Law Offices of Spadea & Associates, LLC provides year round tax planning and tax return preparation.

The 2022 Inflation Reduction Act

The 2022 Inflation Reduction Act (the Act) includes numerous tax provisions – most notably an array of new tax credits relating to energy efficient homes, businesses, and vehicles. It also provides several new healthcare and prescription drug benefits for individuals, including a $2,000 Medicare out-of-pocket cap for prescription drugs, a $35 Medicare monthly insulin cap, and a three-year extension of the expanded Affordable Care Act health insurance subsidy.

The following is a summary of the Act’s key provisions that may affect you.

Extension and Modification of Plug-In Electric Vehicle Tax Credit (Renamed Clean Vehicle Credit)

While favorable changes to the credits for “clean” vehicles, including a new credit for used vehicles, are a significant part of the legislation, there is also a new requirement that a certain percentage of vehicle components be manufactured or assembled in North America and a provision that vehicles with battery components that were manufactured or assembled by certain foreign entities will not qualify. The Act also imposes new income limits on who can claim the credit as well as price limits based on vehicle type.

Currently, buyers of qualifying plug-in electric vehicles (EVs) are eligible for a nonrefundable tax credit of up to $7,500. The tax credit phases out once a vehicle manufacturer has sold 200,000 qualifying vehicles. Also, through 2021, a tax credit of up to $8,000 was allowed for fuel cell vehicles (the base credit amount was $4,000, with up to an additional $4,000 available based on fuel economy). Heavier fuel cell vehicles qualified for up to a $40,000 credit.

The Act modifies the tax credit for plug-in EVs, allowing certain clean vehicles to qualify and eliminating the current per manufacturer limit. The credit is renamed the clean vehicle credit and the modified credit is $3,750 for any vehicle meeting a critical-minerals requirement, and $3,750 for any vehicle meeting a battery-components requirement. The maximum credit per vehicle is $7,500. Clean vehicles include plug-in EVs with a battery capacity of at least 7 kilowatt hours and fuel cell vehicles. Qualifying vehicles include those that had their final assembly occur in North America. Sellers are required to provide taxpayer and vehicle information to the Treasury Department for tax credit eligible vehicles. Only vehicles made by qualified manufacturers, who have written agreements with, and provide periodic reports to, the Treasury Department qualify.

For vehicles placed in service after 2023, qualifying vehicles do not include any vehicle with battery components that were manufactured or assembled by certain foreign entities. For vehicles placed in service after 2024, qualifying vehicles do not include any vehicle in which applicable critical minerals in the vehicle’s battery are from certain foreign entities. Taxpayers must include the vehicle identification number (VIN) on their tax return to claim a tax credit.

To receive the $3,750 critical-minerals portion of the credit, the vehicle’s battery must contain a threshold percentage (in value) of critical minerals that were extracted or processed in a country with which the United States has a free trade agreement or recycled in North America. The threshold percentage is 40 percent through 2023, increasing to 50 percent in 2024, 60 percent in 2025, 70 percent in 2026, and 80 percent after 2026.

To receive the $3,750 battery-components portion of the credit, the percentage of the battery’s components manufactured or assembled in North America must also meet certain threshold amounts. For vehicles placed in service through 2023, the percentage is 50 percent. The percentage increases to 60 percent for 2024 and 2025, 70 percent for 2026, 80 percent for 2027, 90 percent for 2028, and 100 percent after 2028.

Certain higher-income taxpayers are not eligible for the credit. Specifically, no credit is allowed if the current year or preceding year’s modified adjusted gross income (AGI) exceeds $300,000 for married taxpayers ($225,000 in the case of head of household filers; $150,000 in the case of other filers).

Credits are only allowed for vehicles that have a manufacturer’s suggested retail price of no more than $80,000 for vans, SUVs, or pickup trucks, and $55,000 for other vehicles. Taxpayers are only allowed to claim the credit for one vehicle per year. Starting in 2024, taxpayers purchasing eligible vehicles can elect to transfer the tax credit to the dealer, so long as the dealer meets certain requirements. This provision does not apply to vehicles acquired after December 31, 2032.

Credit for Previously-Owned Clean Vehicles

The Act creates a new tax credit for buyers of previously owned qualified clean (plug-in electric and fuel cell) vehicles. The maximum credit is $4,000 and is limited to 30 percent of the vehicle purchase price. No credit is allowed for taxpayers above certain modified AGI thresholds. Married taxpayers filing a joint return cannot claim the credit if their modified AGI is above $150,000 ($112,500 in the case of head of household filers; $75,000 in the case of other filers). The taxpayer’s modified AGI is the lesser of modified AGI in the tax year or prior year.

Credits are only allowed for vehicles with a sale price of $25,000 or less with a model year that is at least two years earlier than the calendar year in which the vehicle is sold. This credit can only be claimed for vehicles sold by a dealer and on the first transfer of a qualifying vehicle. Taxpayers can only claim this credit once every three years and must include the VIN on their tax return to claim a tax credit.

Starting in 2024, taxpayers purchasing eligible vehicles can elect to transfer the tax credit to the dealer, so long as the dealer meets certain registration, disclosure, and other requirements. The credit does not apply to vehicles acquired after December 31, 2032.

Extension, Increase, and Modifications of the Nonbusiness Energy Property Tax Credit (Renamed as the Energy Efficient Home Improvement Credit)

For years before 2022, a 10 percent tax credit, subject to a $500 per taxpayer lifetime limit, was available for qualified energy-efficiency improvements and expenditures for residential energy property on an individual’s primary residence.

The Act extends the credit through 2032. In addition, beginning in 2023, the Act modifies and expands the credit, by:

  • increasing the credit rate to 30 percent and increasing the annual per-taxpayer limit from $600 to $1,200, with a $600 per-item limit;
  • for geothermal and air source heat pumps and biomass stoves, there is an annual credit limit of $2,000, and limits for expenditures on windows and doors are also increased, while biomass stoves are now eligible for tax credits;
  • allowing a 30 percent credit, of up to $150, for home energy audits.

Restoration of 30 Percent Residential Energy Efficient Tax Credit (Renamed the Residential Clean Energy Credit)

A tax credit is currently provided for the purchase of solar electric property, solar water heating property, fuel cells, geothermal heat pump property, small wind energy property, and qualified biomass fuel property. Initially, the credit rate was 30 percent through 2019. It was then reduced to 26 percent through 2022, and was scheduled to be reduced to 22 percent in 2023 before expiring at the end of that year.

The Act extends the credit through December 31, 2034, restoring the 30 percent credit rate, beginning in 2023 through 2032, and then reducing the credit rate to 26 percent in 2033 and 22 percent in 2034. Qualified battery storage technology is also added to the list of eligible property.

Alternative Fuel Refueling Property Credit

Through 2021, taxpayers were allowed a tax credit for the cost of any qualified alternative fuel vehicle refueling property installed at a taxpayer’s principal residence. The credit was equal to 30 percent of these costs, limited to $30,000 for businesses at each separate location with qualifying property, and $1,000 for residences. The Act extends this credit through December 31, 2032, and makes certain additional modifications.

Please let me know if you have questions or would like to meet to discuss the ramifications of the Act’s various tax credit provisions or any of the Act’s other provisions.

Extension of Health Insurance Subsidy

A health insurance subsidy is available through a premium assistance credit for eligible individuals and families who purchase health insurance through Exchanges offered under the Patient Protection and Affordable Care Act (PPACA). The premium assistance credit is refundable and payable in advance directly to the insurer on the Exchange. Individuals with incomes exceeding 400 percent of the poverty level ($54,360 for a one-person household in 2022) are normally not eligible for these subsidies. However, legislation passed in 2021 eliminated this limitation for 2021 and 2022 so that anyone can qualify for the subsidy. That legislation also limited the percentage of a person’s income paid for health insurance under a PPACA plan to 8.5 percent of income. The Act extends these provisions through 2025.

Prescription Drug and Vaccine Cost Improvements

The Act –

  • eliminates beneficiary cost-sharing above the annual out-of-pocket spending threshold under the Medicare prescription drug benefit beginning in 2024;
  • caps Medicare annual out-of-pocket spending for prescription drugs at $2,000 beginning in 2025 (with annual adjustments thereafter);
  • establishes a program, beginning in 2025, under which drug manufacturers provide discounts to beneficiaries who have incurred costs above the annual deductible;
  • eliminates cost-sharing under the Medicare prescription drug benefit for adult vaccines that are recommended by the Advisory Committee on Immunization Practices, and requires coverage, without cost-sharing, of such vaccines under Medicaid and the Children’s Health Insurance Program (CHIP); and
  • caps cost-sharing under the Medicare prescription drug benefit for a month’s supply of covered insulin products at (1) for 2023 through 2025, $35; and (2) beginning in 2026, either $35, 25 percent of the government’s negotiated price, or 25 percent of the plan’s negotiated price, whichever is less.

Feel Free to Call

If you would like to talk about how you might be able to take advantage of the Act’s energy incentives or have questions about any of its provisions, please call Gregory J. Spadea at 610-521-0604.  The Law Offices of Spadea & Associates, LLC provides year round tax and estate planning to individuals and small businesses.

Age Related Tax Milestones

As I grow older, I am reminded of the Steve Miller song, Fly Like An Eagle where he sings “time keeps on slipping, slipping, slipping into the future…”.  This blog covers some important age-related tax milestones that I witness every tax season and that you should keep in mind as you get older.

Ages 0–23

The so-called “Kiddie Tax” rules can potentially apply to your child’s (or grandchild’s) investment income until the year he or she reaches age 24. Specifically, a child’s investment income in excess of the applicable annual threshold is taxed at the parent’s marginal tax rate.

Hour glass image for tax lawyer blog Greg Spadea

Note: For 2018 and 2019, the unfavorable income tax rates for trusts and estates were used to calculate the Kiddie Tax. Recent legislation changed this for 2020 by once again linking the child’s tax rate to the parent’s marginal tax rate. However, you may elect to apply this change to your 2018 and 2019 tax years. If we feel an election would be beneficial for 2018, we may recommend amending your return.

For 2020 and 2021, the investment income threshold is $2,200. A child’s investment income below the threshold is usually taxed at benign rates (typically 0% for long-term capital gains and dividends and 0%, 10%, or 12% for ordinary investment income and short-term gains). Note that between ages 19 and 23, the Kiddie Tax is only an issue if the child is a full-time student. For the year the child turns age 24 and for all subsequent years, the Kiddie Tax ceases to be an issue.

Age 18 or 21

A custodial account set up for a minor child comes under the child’s control when he or she reaches the age of majority under applicable state law which is 21 in Pennsylvania.  If there’s a significant amount of money in the custodial account, this issue can be a big deal. Depending on the child’s maturity level and dependability, you may or may not want to take steps to ensure that the money in the custodial account is used for expenditures you approve of such as college tuition.

Age 30

If you set up a Coverdell Education Savings Account (CESA) for a child (or grandchild), it must be liquidated within 30 days after he or she turns 30 years old. To the extent earnings included in a distribution are not used for qualified higher education expenses, they are subject to federal income tax plus a 10% penalty tax. Alternatively, the CESA account balance can be rolled over tax-free into another CESA set up for a younger family member.

Age 50

If you are age 50 or older as of the end of the year, you can make an additional catch-up contribution to your Section 401(k) plan (up to $6,500 for 2020), Section 403(b) plan (up to $6,500 for 2020), Section 457 plan (up to $6,500 for 2020), or SIMPLE-IRA (up to $3,000 for 2020), assuming the plan permits catch-up contributions. You also can make an additional catch-up contribution (up to $1,000 for 2019 or 2020) to your traditional or Roth IRA. The deadline for making IRA catch-up contributions for the 2019 tax year is 4/15/20.

Age 55

If you permanently leave your job for any reason, you can receive distributions from the former employer’s qualified retirement plan without being socked with the 10% early distribution penalty tax. This is an exception to the general rule that the taxable portion of qualified retirement plan distributions received before age 59½ are subject to the 10% penalty tax. Note that this exception applies only if you have attained age 55 on or before your separation from service.

Age 59½

You can receive distributions from all types of tax-favored retirement plans and accounts including IRAs, Section 401k accounts, pensions and tax-deferred annuities without being hit with the 10% early distribution penalty tax. Before age 59½, the penalty tax will apply to the taxable portion of distributions unless an exception is available.

Age 62

You can choose to start receiving Social Security retirement benefits. However, your benefits will be lower than if you wait until reaching full retirement age, which is age 66 for those born between 1943 and 1954. Also, if you work before reaching full retirement age and your earnings exceed $18,950, your 2021 Social Security retirement benefits will be further reduced.

Age 66

You can start receiving full Social Security retirement benefits at age 66 if you were born between 1943–1954. You will not lose any benefits if you work in years after the year you reach the full retirement age of 66, regardless of how much income you have in those years. However, if you will reach age 66 in 2021, your benefits may be reduced if your income from working exceeds $50,520.

Note: If you were born after 1954, your full retirement age goes up by two months for each year before leveling out at age 67 for those born in 1960 or later.

Warning: Under current law, up to 85% of your Social Security benefits may be subject to federal income tax, depending on your provisional income level. Provisional income equals your gross income from other sources plus tax-exempt interest income and 50% of your Social Security benefits. Contact us if you have questions or want more information.

Age 70

You can choose to postpone receiving Social Security retirement benefits until you reach age 70. If you make this choice, your benefits will be higher than if you start earlier.

An often-overlooked issue that you must factor into the breakeven age is when you would come out ahead by postponing benefits. For example, if your normal retirement age is 66 and you wait until age 70 to begin receiving benefits, you forego benefits for four years. It would take 12½ years to reach the breakeven point. Are you sure you will still be around and able to enjoy the higher benefit at age 82½?  Fortunately, I can prepare a report to help you decide when to take social security based on your current earnings, other retirement income and your health.

Age 72

At this age, you must begin taking annual Required Minimum Distributions (RMDs) from tax-favored retirement accounts such as traditional IRAs, SIMPLE IRAs, SEP accounts, or 401k accounts and pay the resulting income taxes. However, you do not need to take any RMDs from Roth IRAs set up in your name. The initial RMD is for the year you turn 72 if you had not reached age 70½ by December 31, 2019.  You can postpone taking the initial RMD until April 1 of the year after you reach the magic age.  If you choose that option, however, you must take two RMDs in that same year: one by the April 1 deadline (the RMD for the previous year) plus another by December 31 (the RMD for the current year). For each subsequent year, you must take another RMD by December 31. There’s one more exception: If you are still working after reaching age of 72, and you do not own over 5% of the employer, you can postpone taking any RMDs from the employer’s plan until after you have actually retired.

Thanks to a change included in the Setting Every Community Up for Retirement Enhancement Act (the SECURE Act), the age after which you must begin taking RMDs is increased from 70½ to 72. This favorable change only applies to individuals who attain age 70½ after December 31, 2019.  So, if you turned 70½ in 2019 or earlier, you are unaffected. If you turn 70½ in 2020 or later, you will not need to begin taking RMDs until after attaining age 72.

Conclusion

Remember that almost all adults should do at least some estate planning. In uncomplicated situations, nothing more than a simple will and updated beneficiary designations may be required. If you have a larger estate, taking steps to confront realities about your heirs and to reduce exposure to the federal estate tax and income tax and any Pennsylvania inheritance tax may be advisable. Please call Gregory J. Spadea at 610-521-0604, if you think your estate plan needs updating.

2021 Consolidated Appropriations Act

2021 Consolidated Appropriations Act Which Includes $900 Billion in Covid-19 Relief

On December 27, 2020, President Trump signed into law a $900 billion Covid-19 relief package for individuals and businesses. Highlights of the relief package, include $600 payments to individual taxpayers with adjusted gross income (AGI) of $75,000 or less (or $112,500 AGI for heads of households), payments of $1,200 to joint filers with AGI of $150,000 or less, and an additional $600 payment for each qualifying child. For businesses, additional time is provided for paying previously deferred payroll taxes, another round of Paycheck Protection Program (PPP) loans is available, and borrowers with PPP loans may take deductions for expenses paid with PPP loan proceeds. The legislation also extends numerous expiring tax provisions for both individuals and businesses. President Trump sharply criticized the package and demanded changes before ultimately signing it into law, as passed. Consolidated Appropriations Act, 2021 (12/27/2020).

2021 Consolidated Appropriations Act Which Includes $900 Billion in Covid-19 Relief

Executive Summary

Highlights of the year-end Covid-19 related legislation include:

  • Additional unemployment assistance which provides 11 weeks of $300 per-week emergency unemployment benefits, an extension of expiring pandemic-related unemployment assistance, and protection for individuals who received pandemic-related unemployment benefit overpayments through no fault of their own and are now unable to repay the funds;
  • A second round of direct cash assistance payments of $600 for each family member, subject to certain family adjusted gross income limitations, with mixed-status families now eligible where only one spouse has a social security number;
  • The creation of a Paycheck Protection Program (PPP) Second Draw loan program with a maximum loan amount of $2 million made available for businesses that employ 300 or less employees and have used, or will use, the full amount of their first PPP loan;
  • A new rule establishing that business expenses paid with the proceeds of a forgiven PPP loan are deductible (effectively overriding prior law and IRS guidance issued earlier this year);
  • Eligibility to use 2019 income to determine the earned income tax credit and the additional child tax credit;
  • A permanent reduction in the adjusted gross income threshold for medical expense deductions from 10 percent to 7.5 percent;
  • An expansion of the carryover and grace period policies relating to employees with unused amounts in their health and dependent care flexible spending accounts;
  • A three month extension of credits reimbursing employers for paid sick and family leave paid to employees due to Covid-19;
  • An increase in the income threshold at which the Lifetime Learning Credit phases out;
  • Additional time for employees and employers to pay back deferred employee payroll tax amounts from the President’s August memorandum;
  • An extension and expansion of the employee retention tax credit;
  • Permanent and temporary extensions of expiring tax provisions (“tax extenders”); and
  • A 100-percent deduction for business meal and beverage expenses, including any carry-out or delivery meals, provided by a restaurant that are paid or incurred in 2021 and 2022.

Legislative Components

The relief package’s tax provisions and the PPP extension appear in three separate bills that were part of the 2,124-page Consolidated Appropriations Act, 2021 as follows:

  • The Covid-Related Tax Relief Act of 2020 (Covid-Related Tax Relief Act), which extends and modifies earlier Covid relief provisions from the Families First Coronavirus Response Act (Families First Act) and the Coronavirus Aid, Relief, and Economic Security Act (CARES Act).
  • The Economic Aid to Hard-Hit Small Businesses, Nonprofits, and Venues Act (Economic Aid Act), which extends and modifies the Paycheck Protection Program.
  • The Taxpayer Certainty and Disaster Tax Relief Act of 2020 (Disaster Tax Relief Act), which extends numerous expiring tax breaks and adds several new ones.

The provisions of greatest interest to tax practitioners fall in the following categories spanning the three bills: (i) Covid-related tax relief, (ii) Paycheck Protection Program extension and enhancement, (iii) tax extenders, (iv) miscellaneous tax provisions, and (v) disaster tax relief.

I. COVID-19 RELATED TAX RELIEF

Additional 2020 Recovery Rebates for Individuals and Amendments to CARES Act Recovery Rebates

Sections 272 and 273 of the Covid-Related Tax Relief Act provide a refundable tax credit in the amount of $600 per eligible family member. The credit is $600 per taxpayer ($1,200 for married filing jointly), in addition to $600 per qualifying child. The credit phases out starting at $75,000 of modified adjusted gross income ($112,500 for heads of household and $150,000 for married filing jointly) at a rate of $5 per $100 of additional income.

The provision also provides for the Department of Treasury to issue advance payments based on the information on 2019 tax returns. Eligible taxpayers treated as providing returns through the nonfiler portal in the first round of Economic Impact Payments, provided under the CARES Act, will also receive payments. The Treasury Department may issue advance payments for Social Security Old-Age, Survivors, and Disability Insurance beneficiaries, Supplemental Security Income recipients, Railroad Retirement Board beneficiaries, and Veterans Administration beneficiaries who did not file 2019 returns based on information provided by the Social Security Administration, the Railroad Retirement Board, and the Veterans Administration.

Taxpayers receiving an advance payment that exceeds the amount of their eligible credit will not be required to repay any amount of the payment. If the amount of the credit determined on the taxpayer’s 2020 tax return exceeds the amount of the advance payment, taxpayers will receive the difference as a refundable tax credit.

In general, taxpayers without an eligible social security number are not eligible for the payment. However, married taxpayers filing jointly where one spouse has a social security number (SSN) and one spouse does not are eligible for a payment of $600, in addition to $600 per child with an SSN. The provision aligns the eligibility criteria for the new round of Economic Impact Payments and the credit for the Economic Impact Payments provided by the CARES Act.

Advance payments are generally not subject to administrative offset for past due federal or state debts. In addition, the payments are protected from bank garnishment or levy by private creditors or debt collectors. Additionally, the provision instructs the Treasury Department to make payments to the United States territories that relate to each territory’s cost of providing the credits.

Tax Treatment of PPP Loans

Section 276 of the Covid-Related Tax Relief Act provides that gross income does not include any amount that would otherwise arise from the forgiveness of a PPP loan. This provision also (1) overrides current law (and IRS guidance) preventing the deduction of expenses paid with tax-exempt income by allowing businesses to deduct business expenses paid with the proceeds of a PPP loan that is forgiven, and (2) provides that the tax basis and other attributes of the borrower’s assets will not be reduced as a result of the loan forgiveness. The provision is effective as of the date of enactment of the CARES Act (3/27/2020).

Employee Retention Tax Credit Modifications

Sections 206 and 207 of the Disaster Tax Relief Act extend and expand the CARES Act employee retention tax credit (ERTC) and makes technical corrections. Beginning on January 1, 2021 and through June 30, 2021, the provision:

  • Increases the credit rate from 50 percent to 70 percent of qualified wages;
  • Expands eligibility for the credit by reducing the required year-over-year gross receipts decline from 50 percent to 20 percent and provides a safe harbor allowing employers to use prior quarter gross receipts to determine eligibility;
  • Increases the limit on per-employee creditable wages from $10,000 for the year to $10,000 for each quarter;
  • Increases the 100-employee delineation for determining the relevant qualified wage base to employers with 500 or fewer employees;
  • Allows certain public instrumentalities to claim the credit;
  • Removes the 30-day wage limitation, allowing employers to, for example, claim the credit for bonus pay to essential workers;
  • Allows businesses with 500 or fewer employees to advance the credit at any point during the quarter based on wages paid in the same quarter in a previous year;
  • Provides rules to allow new employers who were not in existence for all or part of 2019 to be able to claim the credit; and
  • Retroactive to March 13, 2020, the provision: (1) clarifies the determination of gross receipts for certain tax-exempt organizations; (2) clarifies that group health plan expenses can be considered qualified wages even when no other wages are paid to the employee, consistent with IRS guidance; and (3) provides that employers who receive PPP loans may still qualify for the ERTC with respect to wages that are not paid for with forgiven PPP proceeds.

Extension of Credits for Paid Sick and Family Leave

Section 286 of the Covid-Related Tax Relief Act extends the refundable payroll tax credits for paid sick and family leave, enacted in the Families First Coronavirus Response Act (Families First Act), through the end of March 2021. It also modifies the tax credits so that they apply as if the corresponding employer mandates were extended through the end of March 2021. This provision is effective as if included in Families First Act.

Election to Use Prior Year Net Earnings from Self-Employment in Determining Average Daily Self-Employment Income for Purposes of Credits for Paid Sick and Family Leave

Section 287 of the Covid-Related Tax Relief Act provides an election for an individual who elects the credit for paid sick or family leave to use prior year net earnings from self-employment income, rather than current year earnings, in calculating the income tax credit available.

Extension of Certain Deferred Payroll Taxes

On August 8, 2020, the President Trump issued a Presidential Payroll Tax Memorandum allowing employers to defer withholding employees’ share of social security taxes or the railroad retirement tax equivalent from September 1, 2020, through December 31, 2020, and requiring employers to increase withholding and pay the deferred amounts ratably from wages and compensation paid between January 1, 2021, and April 31, 2021.

Under the Payroll Tax Memorandum, the deferral is only available with respect to any employee with wages or compensation, as applicable, payable during any bi-weekly pay period of less than $4,000, calculated on a pre-tax basis, or the equivalent amount with respect to other pay periods. This equates to wages of $104,000 per year. The Payroll Tax Memorandum provides that the amounts deferred are not subject to any penalties, interest, additional amounts, or additions to the tax. The Payroll Tax Memorandum also authorizes the Treasury Secretary to issue guidance to implement these orders and directs the Treasury Secretary to explore avenues, including legislation, to eliminate the obligation to repay the deferred taxes. Under the Payroll Tax Memorandum, penalties and interest on deferred unpaid tax liability would begin to accrue on May 1, 2021.

Section 274 of the Covid-Related Tax Relief Act extends the repayment period through December 31, 2021. Additionally, penalties and interest on deferred unpaid tax liability will not begin to accrue until January 1, 2022.

Clarification of Educator Expense Deduction for PPE

Section 275 of the Covid-Related Tax Relief Act requires the IRS to issue guidance or regulations providing that personal protective equipment (PPE) and other supplies used for the prevention of the spread of Covid-19 are treated as eligible expenses for purposes of the educator expense deduction. Such regulations or guidance will be retroactive to March 12, 2020.

Emergency Financial Aid Grants

Section 277 of the Covid-Related Tax Relief Act provides that certain emergency financial aid grants under the CARES Act are excluded from the gross income of college and university students. The provision also holds students harmless for purposes of determining eligibility for the American Opportunity and Lifetime Learning tax credits. The provision is effective as of March 27, 2020, the date of enactment of the CARES Act.

Clarification of Tax Treatment of Certain Loan Forgiveness and Other Business Financial Assistance Under the Coronavirus Relief Legislation

Section 278 of the Covid-Related Tax Relief Act clarifies that gross income does not include forgiveness of certain loans, emergency EIDL grants, and certain loan repayment assistance, each as provided by the CARES Act. The provision also clarifies that deductions are allowed for otherwise deductible expenses paid with the amounts not included in income by this section, and that tax basis and other attributes will not be reduced as a result of those amounts being excluded from gross income. The provision is effective for tax years ending after March 27, 2020..

Authority to Waive Certain Information Reporting Requirements

Section 279 of the Covid-Related Tax Relief Act gives the Treasury Department authority to waive information filing requirements for any amount excluded from income by reason of the exclusion of covered loan amount forgiveness from taxable income, the exclusion of emergency financial aid grants from taxable income or the exclusion of certain loan forgiveness and other business financial assistance under the CARES Act from income.

Application of Special Rules to Money Purchase Pension Plans

The CARES Act temporarily allows individuals to make penalty-free withdrawals from certain retirement plans for coronavirus-related expenses, permits taxpayers to pay the associated tax over three years, allows taxpayers to recontribute withdrawn funds, and increases the allowed limits on retirement plan loans. Section 280 of the Covid-Related Tax Relief Act clarifies that money purchase pension plans are included in the retirement plans qualifying for these temporary rules. The provision applies retroactively as if included in Section 2202 of the CARES Act.

Election to Waive Application of Certain Modifications to Farming Losses

Section 281 of the Covid-Related Tax Relief Act allows farmers who elected a two-year net operating loss carryback prior to the CARES Act to elect to retain that two-year carryback rather than claim the five-year carryback provided in the CARES Act. This provision also allows farmers who previously waived an election to carry back a net operating loss to revoke the waiver. These clarifications are aimed at eliminating unnecessary compliance burdens for farmers. The provision applies retroactively as if included in the CARES Act.

II. PAYCHECK PROTECTION PROGRAM EXTENSION AND ENHANCEMENT

Section 311 of the Economic Aid Act creates a second loan from the Paycheck Protection Program (PPP), called a “PPP Second Draw” loan for smaller and harder-hit businesses, with a maximum loan amount of $2 million. In order to receive a PPP Second Draw loan, eligible entities must: employ not more than 300 employees, have used or will use the full amount of their first PPP; and must demonstrate at least a 25 percent reduction in gross receipts in the first, second, or third quarter of 2020 relative to the same 2019 quarter (although applicable timelines for businesses that were not in operation in Q1, Q2, and Q3, and Q4 of 2019 are provided). Applications submitted on or after January 1, 2021, are eligible to utilize the gross receipts from the fourth quarter of 2020.

In addition to the creation of the PPP Second Draw, Section 304 of the Economic Aid Act expands the list of eligible expenses for which a PPP loan may be used. Additional eligible expenses include (1) covered operations expenditures; (2) covered property damage costs; (3) covered supplier costs; and (4) covered worker protection expenditures.

Eligible and Noneligible Entities

Entities eligible for the PPP Second Draw include businesses, certain non-profit organizations, housing cooperatives, veterans’ organizations, tribal businesses, self-employed individuals, sole proprietors, independent contractors, and small agricultural co-operatives. Entities ineligible include entities listed in 13 C.F.R. 120.110 and subsequent regulations (except for entities from that regulation which have otherwise been made eligible by statute or guidance, and except for nonprofits and religious organizations); entities involved in political and lobbying activities including engaging in advocacy in areas such as public policy or political strategy or an entity that otherwise describes itself as a think tank in any public document, entities affiliated with entities in the People’s Republic of China; and registrants under the Foreign Agents Registration Act.

Loan Terms

In general, borrowers may receive a loan amount of up to 2.5 times the average monthly payroll costs in the one year prior to the loan or the calendar year. Seasonal employers may calculate their maximum loan amount based on a 12-week period beginning February 15, 2019 through February 15, 2020. New entities may receive loans of up to 2.5 times the sum of average monthly payroll costs. Entities in industries assigned to NAICS Code 72 (Accommodation and Food Services) may receive loans of up to 3.5 times average monthly payroll costs. Businesses with multiple locations that are eligible entities under the initial PPP requirements may employ not more than 300 employees per physical location. Waiver of affiliation rules that applied during initial PPP loans apply to a second loan. An eligible entity may only receive one PPP second draw loan. Fees are waived for both borrowers and lenders to encourage participation. For loans of not more than $150,000, the entity may submit a certification attesting that the entity meets the revenue loss requirements on or before the date the entity submits its loan forgiveness application and non-profit and veterans organizations may utilize gross receipts to calculate their revenue loss standard.

Loan Forgiveness

Borrowers of a PPP Second Draw loan are eligible for loan forgiveness equal to the sum of their payroll costs, as well as covered mortgage, rent, and utility payments, covered operations expenditures, covered property damage costs, covered supplier costs, and covered worker protection expenditures incurred during the covered period. The 60/40 cost allocation between payroll and non-payroll costs in order to receive full forgiveness will continue to apply.

Churches and Religious Organizations

Churches and religious organizations are eligible for PPP Second Draw loans.

Safe Harbor on Restoring Full-time Employees and Salaries and Wages Applies

The rule of reducing loan forgiveness for a borrower reducing the number of employees retained and reducing employees’ salaries in excess of 25 percent applies.

Maximum Loan Amount for Farmers and Ranchers

A specific loan calculation for the first round of PPP loans for farmers and ranchers who operate as a sole proprietor, independent contractor, self-employed individual, who report income and expenses on a Schedule F, and were in business as of February 15, 2020, is established. These entities may utilize their gross income in 2019 as reported on a Schedule F. Lenders may recalculate loans that have been previously approved to these entities if they would result in a larger loan. This provision applies to PPP loans before, on, or after the date of enactment (i.e., December 27, 2020), except for loans that have already been forgiven.

Seasonal Employer

A seasonal employer is defined as an eligible recipient which: (1) operates for no more than seven months in a year, or (2) earned no more than 1/3 of its receipts in any six months in the prior calendar year.

Eligibility of News Organizations for Loans

Eligible FCC license holders and newspapers with more than one physical location are eligible for a PPP Second Draw loan, as long as the business has no more than 500 employees per physical location or the applicable Small Business Administration size standard; and includes eligible Code Sec. 511 public colleges and universities that have a public broadcasting station if the organization certifies that the loan will support locally focused or emergency information.

Prohibition on Use of Loan Proceeds for Lobbying Activities

An eligible entity is prohibited from using proceeds of the covered loan for lobbying activities, lobbying expenditures related to state or local campaigns, and expenditures to influence the enactment of legislation, appropriations, or regulations.

III. TAX EXTENDERS

The Disaster Tax Relief Act permanently extends the following tax provisions:

  • Reduction in medical expense deduction floor from 10 percent of adjusted gross income (AGI) to 7.5 percent of AGI;
  • Energy efficient commercial buildings deduction;
  • Exclusion from income of certain tax benefits for volunteer firefighters and emergency medical responders;
  • Repeal of deduction for qualified tuition and related expenses, replaced with increased income limitation on lifetime learning credit;
  • Railroad track maintenance credit;
  • Modification of the uniform capitalization rules and reduction of excise tax rate for beer, wine, and distilled spirits;
  • Refunds in lieu of reduced rates for certain craft beverages produced outside the United States;
  • Disallowance of reduced excise tax rates for smuggled or illegally produced beer, wine, and spirits;
  • Minimum processing requirements for reduced distilled spirits rates; and
  • Modification of single taxpayer rules with respect to beer, wine, and distilled spirits.

The Disaster Tax Relief Act extends the following tax provisions through December 31, 2025:

  • Look-thru rule for related controlled foreign corporations;
  • New markets tax credit;
  • Work opportunity credit;
  • Exclusion from gross income of discharge of qualified principal residence indebtedness;
  • Seven-year recovery period for motorsports entertainment complexes;
  • Expensing rules for certain qualified film and television and live theatrical productions;
  • Oil Spill Liability Trust Fund financing rate;
  • Empowerment zone tax incentives;
  • Employer credit for paid family and medical leave;
  • Exclusion from income for certain employer payments of student loans; and
  • Carbon oxide sequestration credit.

The Disaster Tax Relief Act extends the following tax provisions through December 31, 2023:

  • Residential energy-efficient property credit; and
  • Energy credit under Code Sec 48.

The Disaster Tax Relief Act extends the following tax provisions through December 31, 2021:

  • Credit for electricity produced from certain renewable resources;
  • Treatment of mortgage insurance premiums as qualified residence interest;
  • Credit for health insurance costs of eligible individuals;
  • Indian employment credit;
  • Mine rescue team training credit;
  • Classification of certain race horses as three-year property;
  • Accelerated depreciation for business property on Indian reservations;
  • American Samoa economic development credit;
  • Second generation biofuel producer credit;
  • Nonbusiness energy property credit;
  • Qualified fuel cell motor vehicles credit;
  • Alternative fuel refueling property credit;
  • Two-wheeled plug-in electric vehicle credit;
  • Production credit for Indian coal facilities;
  • Energy efficient homes credit;
  • Extension of excise tax credits relating to alternative fuels; and
  • Black Lung Disability Trust Fund excise tax.

IV. MISCELLANEOUS TAX PROVISIONS

Temporary Rule Preventing Partial Plan Termination

Section 209 of the Disaster Tax Relief Act provides that a qualified retirement plan will not be treated as having a partial termination under Code Sec. 411(d)(3) during any plan year which includes the period beginning on March 13, 2020, and ending on March 31, 2021, if the number of active participants covered by the plan on March 31, 2021, is at least 80 percent of the number of active participants covered by the plan on March 13, 2020.

Temporary Allowance of Full Deduction for Business Meals

Effective for amounts paid or incurred after December 31, 2020, Section 210 of the Disaster Tax Relief Act amends Code Sec. 274(n)(2) to provide that the 50 percent limitation on the deduction for food or beverage expenses does not apply to expenses for food or beverages provided by a restaurant and paid or incurred before January 1, 2023.

Temporary Special Rule for Determination of Earned Income

Section 211 of the Disaster Tax Relief Act provides that, if the earned income of a taxpayer for the taxpayer’s first tax year beginning in 2020 is less than the taxpayer’s earned income for the preceding tax year, the credits allowed under Code Sec. 24(d) (i.e., child tax credit) and Code Sec. 32 (i.e., earned income tax credit) may, at the taxpayer’s election, be determined by substituting the taxpayer’s earned income for the preceding tax year for the earned income for the taxpayer’s first tax year beginning in 2020. For these purposes, in the case of a joint return, the earned income of the taxpayer for the preceding year means the sum of the earned income of each spouse for the preceding tax year.

Certain Charitable Contributions Deductible by Non-Itemizers

Section 212 of the Disaster Tax Relief Act provides that, in the case of any tax year beginning in 2021, if an individual does not elect to itemize deductions, the deduction under Code Sec. 170 for a charitable contribution equals the deduction, not in excess of $300 ($600 in the case of a joint return), which would be determined under Code Sec. 170 if the only charitable contributions taken into account in determining the deduction were contributions made in cash during the tax year to an organization described in Code Sec. 170(b)(1)(A) and not (1) to a Code Sec. 509(a)(3) supporting organization, or (2) for the establishment of a new, or maintenance of an existing, donor advised fund (as defined in Code Sec. 4966(d)(2)). In addition, the penalty under Code Sec. 6662(a) for an underpayment attributable to an overstatement of the deduction for charitable contributions by non-itemizers is increased from 20 percent to 50 percent of the underpayment.

Modification of Limitations on Charitable Contributions

The increase of the limitation for the deduction for donations of food inventory in a tax year from 15 percent to 25 percent under Section 2205 of the CARES Act is extended by Section 213 of the Disaster Tax Relief Act through 2021. Under the CARES Act, the increased deduction limitation for food inventory donations is available only to taxpayers other than C corporations.

Temporary Special Rules for Health and Dependent Care Flexible Spending Arrangements

Section 214 of the Disaster Tax Relief Act provides that, for plan years ending in 2020 or 2021, a plan that includes a health flexible spending arrangement or dependent care flexible spending arrangement will not fail to be treated as a cafeteria plan under the Code merely because the plan or arrangement permits participants to carry over any unused benefits or contributions remaining in any such flexible spending arrangement from the 2020 or 2021 plan year to the next plan year.

In addition, a plan that includes a health flexible spending arrangement or dependent care flexible spending arrangement will not fail to be treated as a cafeteria plan under the Code merely because the plan or arrangement extends the grace period for a plan year ending in 2020 or 2021 to 12 months after the end of such plan year, with respect to unused benefits or contributions remaining in a health flexible spending arrangement or a dependent care flexible spending arrangement.

A plan that includes a health flexible spending arrangement will not fail to be treated as a cafeteria plan under the Code merely because the plan or arrangement allows an employee who ceases participation in the plan during calendar year 2020 or 2021 to continue to receive reimbursements from unused benefits or contributions through the end of the plan year in which such participation ceased (including any grace period).

V. DISASTER TAX RELIEF

Disaster Tax Relief in General

Section 301 of the Disaster Tax Relief Act provides relief for individuals and businesses in Presidentially declared disaster areas for major disasters declared on or after January 1, 2020, through February 25, 2021. The relief generally applies to incident periods beginning on or after December 28, 2019. It does not apply to areas for which a major disaster has been so declared only by reason of Covid-19.

Special Disaster Related Rules for Use of Retirement Funds

Section 302 of the Disaster Tax Relief Act provides an exception to the 10 percent early retirement plan withdrawal penalty for qualified disaster relief distributions (not to exceed $100,000 in qualified disaster distributions cumulatively). Amounts withdrawn are included in income ratably over 3 years or may be recontributed to a retirement plan to avoid taxable income and restore savings. It also allows for the re-contribution of retirement plan withdrawals for home purchases cancelled due to eligible disasters, and provides flexibility for loans from retirement plans for qualified disaster relief.

Employee Retention Credit for Employers Affected by Qualified Disasters

Section 303 of the Disaster Tax Relief Act provides a tax credit for 40 percent of wages (up to $6,000 per employee) paid by a disaster-affected employer to a qualified employee. The credit applies to wages paid without regard to whether services associated with those wages were performed. Certain tax-exempt entities are provided the option to claim the credit against payroll taxes.

Other Disaster Related Tax Relief Provisions

Section 304 of the Disaster Tax Relief Act temporarily suspends limitations on the deduction for charitable contributions associated with qualified disaster relief. With respect to uncompensated losses arising in the disaster area, the provision eliminates the current law requirements that personal casualty losses must exceed 10 percent of adjusted gross income to qualify for deduction. The provision also eliminates the current law requirement that taxpayers must itemize deductions to access this tax relief.

Low-Income Housing Tax Credit

Section 305 of the Disaster Tax Relief Act increases the 2021 and 2022 state ceilings for 9-percent low-income housing tax credit allocations for allocations to qualified disaster zones. The maximum increase across 2021 and 2022 is equal to $3.50 multiplied by the number of state residents in disaster zones and is capped at 65 percent of the state’s 2020 low-income housing tax credit ceiling. The provision also allows an additional year for properties provided disaster allocations to place buildings in service.

Please call Gregory J. Spadea at 610-521-0604, if you have any questions.  The Law Offices of Spadea & Associates, LLC prepares tax returns year round.    

How To Deduct An Ordinary Loss of Up to $100,000 on Qualified Small Business Corporate Stock Under Section 1244 of the Internal Revenue Code

Unfortunately, not all startup companies succeed, however when they fail, all is not lost.  In what may otherwise be considered a complete loss, there are some potential tax benefits available to certain original individual shareholders of corporations in this position.   

After selecting the type of entity to form, if a corporation is the most favorable, I recommend making an S election and issuing Section 1244 stock for this newly incorporated entity.  As long as certain requirements are met, the original investors can claim an ordinary loss of up to $100,000 if the venture is unsuccessful and the stock is ultimately sold for a loss.  

Under normal circumstances, when you invest in corporate stock, any resulting loss on its sale is treated as a capital loss where the loss can offset capital gains and then up to $3,000 of ordinary income per year with the excess capital losses carried forward.  

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Under Section 1244 of the Internal Revenue Code, an ordinary loss deduction for a loss on stock from a “qualified small business corporation” can offset ordinary income and any capital gains. You can deduct up to $100,000 of losses from Section 1244 stock in any one year if  married and file a joint return, or $50,000 if you file as single.  

To qualify under Section 1244, these five requirements must be adhered to:  

1. The stock must be acquired in exchange for cash or property contributed to the corporation. Investors cannot receive shares as compensation for their services. However, cancellation of indebtedness may be sufficiently valid consideration.  

2. The corporation must issue the stock directly to the investors. They cannot acquire the stock from another shareholder, so gifts or inheritance of the shares will not qualify.  

3. The corporation must be an actual, operating company. During the past five years, it must have received less than 50% of its gross receipts from rents, royalties, dividends and other investment income. If the corporation is less than five years old, this test applies to the years it existed.  

4. The stock must be issued by a “small business corporation” defined as a corporation with invested capital of $1,000,000 or less. It can be an S corporation or a C corporation.  

5. The entity must be a domestic corporation.  

Under the current 2020 tax tables, a long-term capital gain that results from the sale of this Section 1244 stock will be taxed at the regular preferential rate of 15% for most individuals or 20% for high-income individuals with taxable income over $441,450. The 3.8% Net Investment Income Tax (NIIT) may also be due.  

Section 1244 of the Internal Revenue Code is the small business stock provision enacted to allow shareholders of domestic small business corporations to deduct a loss on the disposal of such stock as an ordinary loss rather than as a capital loss, which is limited to only $3,000 annually.   A loss on Section 1244 stock is reported on Form 4797 of your personal income tax return, not Schedule D.  

I recommend that when the corporation is set up, corporate records should document that the stock issued qualified as Section 1244 stock. The corporation and the individual shareholders should retain information about the qualifying stock purchased such as the number of shares received, date the stock was issued and price paid for the stock.  

If a partnership purchases Section 1244 stock of another corporate entity and later disposes of the stock at a loss, the partnership entity may pass the ordinary loss through to its partners. Note that for a partner to claim the loss as an ordinary loss instead of a capital loss, the partner must have been a partner when the stock was originally issued and remained so until the time of the loss. 

Alas, if an S corporation owns Section 1244 stock and passes a loss on the stock to its shareholders, they may not deduct the loss as an ordinary loss. Instead, they must deduct the loss as a capital loss.   Shareholders in S corporations who plan to invest in Section 1244 stock issued by other corporations should be certain to 1) acquire the stock directly from the issuing corporation themselves or 2) purchase the stock through a partnership in which they are partners. Assuming all other requirements are met, the stock will qualify as Section 1244 stock, and the taxpayers may deduct as ordinary losses any future losses realized on the stock up to $100,000 per year for joint filers.  

An additional tax planning strategy would be to have the S corporation issue Section 1244 stock to its shareholders. This way, the shareholders will be certain to realize the best of both worlds. They receive the benefit of having items of income and deduction passed through to them from the S corporation. In addition, should they subsequently sell the S corporation stock at a loss, the loss would be deductible as an ordinary loss up to $100,000 per year for joint filers, rather than as a capital loss. 

If you have any questions about Section 1244 stock, call Gregory J. Spadea at 610-521-0604. 

Investment and Income Tax Strategies for Individuals

2020 Year-end Tax Planning Strategies for Individuals

Now is an ideal time to consider year-end strategies that may benefit you, and plan for 2021.

Results of the election on November 3, 2020 may require a need to revisit this checklist. For example, if you anticipate your marginal income tax rates to increase next year, whether due to increased income or changes to tax legislation, you may want to look to ways to accelerate income and defer deductions.

Offset capital gains

Harvest your losses by selling taxableinvestments.

Harvest your gains by selling taxable investment if you have capital loss carryovers or year-to-date losses for the current year. Short-term losses are most effective at offsetting capital gains. Note: wait at least 31 days before buying back a holding sold for a loss to avoid the IRS wash sale rule.

Evaluate if you should delay purchasing mutual fund shares until 2021 to avoid capital gains on brand new investments.

Defer or reduce income (if you anticipate being in a lower taxable income bracket in 2021 or later)

If possible, defer income and the sale of capital gain property until 2021 or later to postpone taxable income to the following year.

Consider using an RBC Credit Access Line to cover any short-term income distribution gaps.

Bunch your itemized medical expenses in the same year in order to meet the threshold percentage of your adjusted gross income to claim such deductions.

In December, make your January mortgage payment (i.e., the payment due no later than January 15) so you can deduct the interest on your 2020 tax return.

Increase your W-2 federal withholding amount in preparation for a significant tax bill or to avoid the under- withholding tax penalty.

If you have concerns that you may be subject to the Alternative Minimum Tax (AMT), speak with your tax advisor before deferring income or accelerating deductions, as your AMT status could limit your ability to benefit from these actions.

If you feel you will be in a lower income tax bracket in the future and can accept the risk of receiving payments over time, use installment sale agreements to spread out any potential capital gains among future taxable periods.

For 2020 only, consider not taking your RMD if you are in a higher income tax bracket in 2020 than you expect to be in 2021 or future years.

Retirement planning

Maximize your IRA contributions. You may be able to deduct annual contributions of up to $6,000 to your traditional IRA and $6,000 to your spouse’s IRA. If you are 50 or older, take advantage of catching up on IRA contributions and certain qualified retirement plans. You may be able to contribute and deduct an additional $1,000.

Take your Required Minimum Distribution (RMD) if you are age 72 or older.

Consider increasing or maximizing your 401(k) and retirement account contributions.

Consider contributions to a Roth 401(k) plan (if your employer allows and you are in a lower income tax bracket now than you expect to be in the future).

Avoid mandatory tax withholding by making a direct rollover distribution to an eligible retirement plan, including an IRA.

Avoid taking IRA distributions prior to age 59½ or a 10% early withdrawal penalty may apply.

Consider setting up a Roth IRA for each of your childrenwho have earned income.

Consider converting from a traditional IRA to a Roth IRA if in a low marginal income tax bracket. Partial Roth IRA conversions are permissible.

Investment and income tax strategies

Explore taking employer stock from tax-deferred accounts (net unrealized appreciation strategy) to take advantage of capital gains tax rules.

Determine the optimal time to begin taking Social Security benefits, which you can apply for between ages 62 and 70.

If you have been impacted by the COVID-19 pandemic as defined by the IRS, you may be eligible to take a COVID-19- related distribution from an eligible retirement plan. The deadline for taking such a distribution is December 30, 2020, and you may withdraw up to an aggregate limit of $100,000 from all eligible plans and IRAs. You have to pay income tax on the COVID-19-related distribution, but the 10% penalty for withdrawals before age 59 ½ does not apply and the taxes can be paid over three income tax years.

If you have business losses that flow through to your individual tax return in 2020, consider a Roth conversion or harvest capital gains to create income that is offset by the business loss.

Make a Roth IRA contribution if under the applicable earnings limitation  for tax  year  2020. If you file taxes as a single person, your Modified Adjusted Gross Income (MAGI) must be under $139, 000. If your married filing jointly your MAGI must be under $206,000.

Gifting strategies

Give to loved ones

Consider making gifts of up to $15,000 per person allowed under federal annual gift tax exclusion. Use assets likely to appreciate significantly for optimum income tax savings.

Make sure that your estate plan is up to date, and that you have a will, revocable trust, health care directive and power of attorney in place.

Give to those in need—charity

Make a charitable donation (cash or even old clothes) before the end of the year. Remember to  keep  all  of your receipts from the recipient charity. If the charitable contribution is made very close to year end, consider using a credit card to record that they can be deducted in the current year.

Use appreciated stock rather than cash when contributing to charities. This may help you avoid income tax on the built-in gain in the stock, while at the same time maximizing your charitable deduction.

If you are over 70½ in 2020 and would like to make a donation to charity from your IRA, you can donate up to $100,000 each year directly to qualified charities using a Qualified Charitable Distribution. You avoid taxes through a direct transfer of funds from your IRA custodian to qualified charities. It is a particularly effective way to direct your required minimum distribution.

Set up a donor-advised fund for an immediate income tax deduction and provide immediate and future benefits to charity over time.

Consider “bunching” several years of charitable contributions into one year with a gift to a donor-advised fund to make your contributions more tax-efficient.

Itemize personal residence and mortgage interest*

Up to $250,000 ($500,000 for married couples filing jointly) of the gain from the sale of your principal residence can be excluded from federal income tax, if you lived in the house for 2 of the last 5 years and other requirements are met.

Interest on up to $750,000 of mortgage indebtedness incurred after December 14, 2017, is allowed as an itemized deduction if used to purchase or improve a home.

For mortgages incurred December 14, 2017, or earlier, interest will be deductible on up to $1,000,000 of debt (the old cap), even if refinanced after December 14, 2017.

Set yourself up for success when doing your 2020 taxes

Send capital gains and investment income information to your accountant for a more accurate year-end projection.

Check your Health Savings Account contributions for 2020.If you qualify, you can contribute up to $3,550 (individually) or $7,100 (family), and an additional $1,000 catch-up if you are age 55 or older. Confirm you’ve spent the entire balance in your Flexible Spending Accounts for the year.

Revisit contribution amounts to your 529 plan college savings accounts.

Review Medicare Part D plan to potentially make a change during open enrollment, which begins in October.

Planning for 2021

Discuss major life events with your tax attorney to ensure you have clarity in your current situation and direction for tomorrow. Thisincludes family, job or employment changes and significant elective expenses (real estate purchases, college tuition payments, etc.).

Ensure your account preferences and risk tolerance and investment objectives are up to date with your financialadvisor.

Double check your beneficiary designations (employer- sponsored retirement plans, 401(k)s, IRAs, Roth IRAs, annuities, life insurance policies, deferred compensation plans, etc.), transfer on death (TOD) designations and payable on death (POD) designations. They should be updated as necessary and align with your estate plan.

Review to ensure you have designated a trusted contact person on each of your accounts to help protect your assets against fraud and financial exploitation.

* Interest on mortgage or home equity debt not used to purchase or improve a personal residence is no longer allowable as an itemized deduction.

Am I Paying Too Much Real Estate Tax on my Delaware County Home

Determining If Your Assessed Value Is Too High

First, look up your property’s current real estate tax assessment on the Delaware County Property Public Access website located at http://delcorealestate.co.delaware.pa.us/pt/forms/htmlframe.aspx?mode=content/home.htm

then enter your Parcel ID Number or address to get your assessed value.  You can also find the assessed value on your property tax bill.

Beginning this year Delaware County has moved to taxing 100% of the assessed value. Therefore, you need to compare the current fair market value to the current real estate tax assessment you just located on the Delaware County website above. If the current assessed value is higher than the current fair market value you should hire the law Offices of Spadea & Associates, LLC by July 26, 2021 to file an annual Real Estate Tax Assessment Appeal by August 1, 2021.

Tax Fees Involved                                                                                                                               

If you purchased the property after August 1, 2020 and have a HUD-1 settlement sheet (that is less than 12 months old) you can use the sales price from the HUD-1 as the Fair Market Value, and do not need an appraisal.  However, if you bought the property at a short sale or foreclosure, or bought it before August 1, 2020 (more than a year ago), you must have an Appraisal to appeal the property tax assessment.  The Cost of an Appraisal is about $400.  The filing fee is typically $50 and is made payable to “Delaware County Treasurer” but is waived this year.  The Law Offices of Spadea & Associates, LLC will help you file the application and attend the hearing on your behalf in late September.  You pay us nothing if we are unable to reduce your assessment.  There are two types of assessment appeals, one is the annual appeal and the other is the interim assessment appeal. 

Annual Appeals                                                                                                                             The annual appeal allows property owners to appeal their assessment once a year.  Annual appeals must be filed by August 1 of each year.  Remember, in the case of an annual appeal, the Board decision does not take effect until tax bills are issued the following tax year.  The Law Offices of Spadea & Associates, LLC will represent you at the hearing which is typically in late September and present evidence such as a recent appraisal with pictures.  The Board will determine the current fair market value for the property based on the appraisal and settlement sheet presented at the hearing.  The Board generally renders a decision within 10 weeks of the hearing date and notifies the property owner in writing.  If you do not agree with the Board’s findings you have the right to file an appeal within 30 days to the Court of Common Pleas. 

Interim Assessment Appeals                                                                                                           The interim assessment represents the value difference (increase) attributable to any assessable improvement to the land and the resulting increase in land value, if any. Assessable improvements include, but are not limited to; new construction of a primary structure or the addition to any such structure and the construction of any ancillary, contributory improvements such as swimming pools, sheds, garages, etc.

If a property is subject to an interim assessment, a property owner will receive an “Interim Real Estate Assessment Notice.” This Notice will inform the property owner of the old assessment and new assessment. The bottom portion of the Notice contains an APPEAL REQUEST FORM. In order to perfect an appeal of an Interim Assessment, the property owner must return the bottom portion of the Interim Notice to the Assessment Office to request receipt of an Appeal Application within forty (40) days of the date of notification of the assessment change.  The appeal date will be noted on the Interim Real Estate Assessment Appeal Notice at the top right and bottom right or this notice.

To file either an interim or annual appeal, contact Gregory J. Spadea at the Law Offices of Spadea & Associates, LLC in Ridley Park, Pennsylvania at 610-521-0604.

The 2020 Coronavirus Aid Relief and Economic Security (CARES) Act

Here’s a highlight of what we perceived as important based on the calls we’ve been getting. 

We have posted the link to the SBA Economic Injury Disaster Loan and attached the application for Payday Protection Program on our resource page.

Coronavirus Covid-19 graphic
  • Recovery Rebates for Individuals – CARES provides direct rebates of up to $1,200 for each qualified adult ($2,400 for married couples) and $500 per child. The full rebate amount is available if you have income at or below $75,000 ($150,000 for married couples), phases out as income increases and is capped with income above $99,000 ($198,000 for married couples). The money should be directly deposited into your account by late April.
  • Pandemic Unemployment Insurance – CARES expands existing state-level unemployment insurance benefits for individuals by the Corona economic downturn. It adds $600 per week to existing state-level benefits through the end of July. For those in need, CARES provides an extra 13 weeks of benefits beyond what states usually permit. Pandemic Unemployment Assistance will even cover many who were typically excluded from a state’s program like independent contractors, free lancers, self-employed individuals, “gig” workers (i.e. Lyft or Uber drivers) and even those laid off from religious institutions. It will not be available to those who are compensated for working remotely or are receiving paid leave.
  • Retirement Plans – CARES waives the normally imposed 10% penalty for premature withdrawals from retirement accounts up to $100,000 and permits 3 years for repayment. If not repaid, income is spread over 3 years. The limit of $50,000 for loans from qualified loans is increased to $100,000. Required Minimum Distributions are suspended for 2020.
  • Student Loans – CARES defers payments on federal student loans through September 30, 2020. Employer payments on employee student loans is a tax-free fringe benefit for 2020 (not to exceed $5,250 decreased by other educational assistance programs).
  • Net Operating Loss Changes – The tax act passed at the end of 2017 eliminated a taxpayer’s ability to carry back an NOL, only to be carried forward (indefinitely) and, even then, limited to 80% of income. For tax years beginning before 1/1/2021, the CARES Act will now allow net operating losses to be carried BACK to offset 100% of income for the prior 5 years (i.e. 2013 thru 2017). YOU SHOULD CONSIDER HAVING US FILE AN AMENDED RETURN FOR BACK TO 2013 TO CLAIM AND RECEIVE A POSSIBLE TAX REFUND. The Act also allows NOLs stemming from tax years beginning after 12/31/2020 to offset 100% of income going forward rather than 80% limitation.
  • Employee Retention Credit – CARES provides employers subject to disruption due to COVID-19 by helping to continue paying employees. Any size employer may be eligible for a 50% refundable tax credit of up to $10,000 of wages plus health insurance paid per eligible employee. Qualified employers will access the funds via a payroll tax credit. The enterprise must have been disrupted by COVID-19 enough to effectively cause a loss of 50% of revenue from the same quarter of the prior year. The retention credit ends when revenue increases to at least 80% of what the business earned in a comparable quarter of the prior year. We found an answer to one question posed – employers are NOT eligible for the credit if they receive a small business loan pursuant to the CARES Act.
  • Payroll Tax Payments – CARES permits employers of any size, even sole proprietors, to delay payment of their 2020 payroll taxes until 2021 and 2022. 50% of the 2020 payments will be due in 2021, and the balance will be due in 2022. Keep in mind, FICA taxes are imposed on both employers and employees’ wages at a rate of 6.2% for the Social Security tax and 1.45% for the Medicare Tax. Self-employed individuals pay a corresponding self-employment tax effectively twice that amount. The CARES Act allows an employer to defer the employer portion of the social security tax.
  • Increased Incentives for Charitable Contributions – The CARES Act attempts to get funds to charitable organizations quickly by allowing both individuals and businesses to claim increased deductions for all cash contributions. Since we’ve so many people now taking the standard deduction, the Act permits an “above the line” deduction of up to $300 during 2020. Limitations for 2020 are relaxed so that individuals can take an itemized deduction for cash contributions of up to 100% of their gross income while corporations can deduct up to 25% of its taxable income. We understand donor advised funds or private foundations do not qualify for these laxed limitations for 2020. Perhaps limited applicability but a pretty neat item for our restaurant/food related clients is that the Act increases the allowable deduction for contribution of food inventory by business made during 2020.
  • Paycheck Protection Program – CARES enable employers (including self-employed individuals) with less than 500 employees to participate in an 8-week loan program for up to 250% of the monthly payroll brought about by the economic uncertainty as long as they maintain their payroll during this COVID-19 emergency. These loans will be made available through Commercial Banks that are authorized SBA lenders on April 3, 2020. No personal guaranties or collateral are required on these non-recourse loans. As long as the employer maintains payroll, there is forgiveness available for the portion of the loans used for covered payroll costs, interest (not principal) on mortgage loans, utilities and interest on any other debt obligations incurred before the covered period. The maximum payroll is $10,000,000 while the loan amount is limited to $100,000 annualized per employee, including wages, vacation, parental, medical, family or sick leave, retirement benefits, tips, health care benefits, etc. Seasonal businesses should calculate the 2.5 months’ payroll using the 12-week period beginning Feb. 15, 2019. Alternatively, the business may choose the period beginning March 1, 2019, and ending June 30, 2019. Seasonal businesses will multiply this average by 2.5. Employers cannot cut employees’ pay by more than 25%. In order to bring back on payroll employees that may have already been furloughed, this loan program is retroactive back to February 15, 2020. The program removes the “Credit Elsewhere Test,” which usually required an extensive analysis to determine whether the borrower had the ability to obtain some or all of the requested loan funds from alternative sources, without causing undue hardship.  That test could also have required them to utilize those alternative sources first before trying to obtain the SBA loan.
  • While the CARES Act includes loan forgiveness, please take note of how much of any such loan will be eligible for forgiveness.  The law refers to the “covered period” meaning the 8-week period starting at the date of the origination of the loan. Loan recipients are eligible for a certain amount of forgiveness but the forgiveness is reduced if the employer reduces its workforce during the 8-week covered period when compared to other periods in 2019 and 2020, or reduces employee salaries by more than 25% during the covered period. These reductions can be avoided when an employer rehires employees and increases pay during the given time period.
  • The loans have a maximum maturity of 10 years with interest rates for any portion of the loan that is not forgiven not to exceed 4%. Lenders are required to give borrowers a complete payment deferral on all principal, interest and fees of not less than 6 months and not more than 1 year on all loans under CARES.
  • Economic Injury Disaster Loan –  Small business owners in all U.S. states, Washington D.C., and territories are eligible to apply for an Economic Injury Disaster Loan advance of up to $10,000. This advance will provide economic relief to businesses that are currently experiencing a temporary loss of revenue. Funds will be made available following a successful application. This loan advance will not have to be repaid.  A link to apply for the loan online is on our website resource page.
  • Please note that any business that receives an Economic Injury Disaster Loan under Section 7(b) of the Small Business Act must reduce the amount received from CARES’ Payroll Protection Program loan.

If you have any questions please call Gregory J. Spadea at 610-521-0604.

Understanding The Tax Rules Relating to Personal Use of Vacation Homes

Understanding the Tax Rules Relating to Personal Use of Vacation Homes

There are three basic rules for treating expenses and income in connection with vacation homes. It all depends on the number of days the home is rented versus the days that it is used for personal purposes.

1) When the personal use of the vacation home exceeds the greater of 14 days or 10% of the days it is actually rented all the expenses are only deductible to the extent of rental income. For example repairs, utilities, insurance, depreciation, and so on are deductible only to the extent of gross income less mortgage interest and property taxes attributable to rental use. However, you cannot claim a loss on the rental, while net income in excess of expenses is taxable.

Gregory Speadea Attorney TAx Lawyer article on Vacation Home

2) When the vacation home is rented out for less than 15 days during the year, there are no tax ramifications. In other words, you don’t recognize rental income or deduct rental expenses.

For example, say you rent a beach house in Ocean City. You and your family use the beach house most of the summer. Then you rent out the place the two weeks after Labor Day. In effect, all of the rental income is tax-free.

Note: You still can claim those itemized deductions you would be entitled to if you did not receive any rental income. This includes mortgage interest limited to all mortgages up to $1,000,000, used to buy, construct, or improve your first home and second home for tax years prior to 2018. Beginning in 2018, this mortgage limit is lowered to $750,000. In addition, for tax years beginning in 2018 there is a $10,000 deduction limit for state and local income taxes and real property taxes.

3) When your personal use of the home does not exceed the greater of 14 days or 10% of the days the vacation home is rented out, the above limits do not apply. All expenses attributable to the rental are deductible – even if you show a loss. However the amount of the loss may be limited by the passive loss rules.

What constitutes a “personal use day” for these purposes? Any day that the home is used by an owner of the family (or family member), someone who pays less than a fair market rental or someone who uses the home under a barter or exchange agreement-even if a fair rental is paid. The amount of time spent at the vacation home doesn’t matter. For instance, if you use the home for just one hour, the whole day is considered a personal use day.

However, a day will not count as a personal day if you spend the time cleaning up or fixing up the place. And that’s true if even if the rest of the family comes along just for the ride.

How do the passive loss rules affect things? In general, losses from so-called passive activities can only be used to offset income from passive activities. The rental activity of your vacation home, by its very nature, will be considered a passive activity.

But there’s still a way to get around the rules. If you “actively participate” in the rental activity, you can use up to $25,000 of loss to offset non-passive income, such as wages and portfolio income. The $25,000 offset is available in full if your adjusted gross income (AGI) is below $100,000. It is phased out until it completely disappears for an AGI above $150,000.

What constitutes active participation? The requirement can be satisfied by regular, continuous and substantial involvement in the rental activity. Examples: participation in management decisions such as approving new tenants, scheduling or supervising repairs, deciding on rental terms, etc. In order to qualify under this exception, you must own at least a 10% interest in the property. Please refer to my blog Understanding What A Real Estate Professional is Under the Passive Activity Loss Rules.

Remember the passive activity loss rules do not come into play at all if your personal use exceeds the 14 days or 10% of the days rented because you cannot deduct the rental loss. If you have any questions contact Gregory J. Spadea at 610-521-0604.

Seven Year-End Tax Tips for 2018

Here are 7 tax moves for you to consider before the end of the year.

1. Defer income to next year. Consider opportunities to defer income to 2019, particularly if you think you may be in a lower tax bracket then. For example, you may be able to defer a year- end bonus or delay the collection of business debts, rents, and payments for services. Doing so may enable you to postpone payment of tax on the income until next year.

2. Accelerate deductions and take capital losses. You might also look for opportunities to accelerate deductions into the current tax year. If you itemize deductions, paying medical expenses, mortgage interest, and charitable deductions before the end of the year, instead of paying them in early 2019, could make a difference on your 2018 return.

3. Harvest Capital Gains and Losses. Any appreciated stocks that you have held for a year and a day you can lock in the lower capital gains rate by selling at year end. You should also consider selling any stocks that can generate capital losses which you can deduct up to $3,000 after netting all your capital losses against all your capital gains. Keep in mind after you sell a stock you can buy it back after 31 days to avoid the wash sale rules.

4. Maximize retirement contributions. Deductible contributions to a traditional IRA, SIMPLE IRA or SEP IRA or pre-tax contributions to an employer-sponsored retirement plan such as a 401(k), can reduce your 2018 taxable income. If you haven’t already contributed up to the maximum amount allowed, consider doing so by year-end.

5. Take any required minimum distributions. Once you reach age 70½, you generally must start taking required minimum distributions (RMDs) from traditional IRAs and employer- sponsored retirement plans. However an exception may apply if you’re still working for the employer sponsoring the plan). Take any distributions by the date required — the end of
the year for most individuals. The penalty for failing to do so is substantial: 50% of any amount that you failed to distribute as required.

6. Beware of the 3.8% net investment income tax. This additional tax may apply to some or all of your net investment income if your modified adjusted gross income (AGI) exceeds
$200,000 ($250,000 if married filing jointly, $125,000 if married filing separately, $200,000 if head of household).

7. Bump up withholding if you expect to owe tax. If it looks as though you’re going to owe federal income tax for the year, especially if you think you may be subject to an estimated tax penalty, consider asking your employer to increase your withholding for the remainder
of the year to cover the shortfall. The biggest advantage in doing so is that withholding is considered as having been paid evenly through the year instead of when the dollars are actually taken from your paycheck. This strategy can also be used to make up for low or missing quarterly estimated tax payments. With all the recent tax changes, it may be especially important to review your withholding for 2018.

If you have any questions or need any help preparing your taxes please call Gregory J. Spadea at 610-521-0604. The Law Offices of Spadea & Associates, LLC prepares tax returns and advises business and individual clients on estate and tax planning year round.

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