Lots of tax breaks were enacted in 2020. They were included in the coronavirus relief laws passed by Congress to help stimulate the economy.
The issue now is how to report them on 2020 returns that IRS will begin accepting Feb. 12.
Let’s focus on four new breaks on the 1040 and related schedules and forms filed by individuals.
We’ll begin with the recovery rebate credit …
The tax break related to stimulus payments. The two rounds of stimulus checks paid to individuals in 2020 and earlier this year are advance payments of a special refundable tax credit. On your 2020 return, you’ll reconcile the payments you got with the credit you are eligible for. Use the Recovery Rebate Credit Worksheet in the 1040 instructions for this purpose. If the credit exceeds the amounts received, claim the balance on line 30 of the 1040. Do not include anything on line 30 if the payments you received are equal to or more than the credit you are entitled to.
Be sure to properly account for the stimulus payments you received. You should have gotten a letter from IRS stating the amount of your first payment. IRS hasn’t yet sent a notice for the second payment, but it says it intends to do so. You can also go to www.irs.gov/Account to set up a Secure Access account with multifactor authorization to check the payments IRS says that it sent to you.
Accidentally doubling up on the tax break can slow down any tax refund that you are otherwise entitled to and increase IRS scrutiny of your entire return.
Nonitemizers can write off up to $300 of charitable cash contributions on line 10b of the 2020 1040. This means filers can take the standard deduction and a deduction for up to $300 of cash donations paid to a 501(c)(3) organization. The $300 cap applies whether you file a single, head-of-household or joint return. (Note that for 2021 returns only, the ceiling is $600 for couples who file jointly.)
Schedule SE has been revised to allow for deferral of self-employment taxes. Self-employeds can defer a portion of their SECA tax on earnings from self-employment from March 27 to Dec. 31, 2020, with half of the deferred amount due Dec. 31, 2021, and the rest on Dec. 31, 2022. Figure the maximum deferral on Part III of Schedule SE. Include the total SECA tax on line 4, Schedule 2 of the 1040. The deferred amount goes on line 12e of Schedule 3. Opting for deferral doesn’t prevent self-employeds from taking an above-the-line deduction for 50% of their total SECA tax for the year.
If you got a coronavirus-related distribution from your 401(k) or IRA in 2020 …
Don’t forget to fill out Form 8915-E. These distributions are tax-favored. The 10% fine on early payouts is waived. The regular income tax on the distributions can be paid over three years. And amounts recontributed over the three-year time span will be treated as rollovers. Use Form 8915-E to spread out the tax on these payouts. Income tax paid on a distribution that is later rolled over within three years of the payout can be recovered by filing an amended return on Form 1040-X.
A few notes on the federal tax consequences of payments you may have gotten:
Stimulus payments are not taxable. They are instead treated as an advance of a special 2020 tax credit included on your 1040 … the recovery rebate credit.
Interest received from IRS on late tax refunds is taxable income. For 1040s filed by July 15, 2020, the interest ran from April 15 through the refund date.
Unemployment benefits are also taxable, and you can request withholding.
Got a 1099-G form in the mail for unemployment benefits you never received?
You’re not alone. IRS put out a warning that identity theft scammers used stolen personal information of individuals to file fraudulent claims for unemployment compensation. The benefits were then paid to the scammers. But state governments have issued the 1099-Gs reporting unemployment benefits to the innocent victims whose stolen information is the data the state has on file.
Don’t contact IRS about a false 1099-G. Instead, call the state agency that issued it, explain the circumstances and ask the agency to send a corrected form.
Lots of our readers have asked us whether RMDs will be suspended for 2021.
We don’t think this is likely to happen. An extension of the 2020 waiver was not included in the year-end stimulus package. Our forecast could change, though, depending on the length of the country’s coronavirus-related economic slump and the stock market’s performance through the first quarter or so of 2021.
The 10% additional tax on early withdrawals is a tax, the Tax Court decides. A 42-year-old woman who took a distribution from her workplace retirement plan argued that she wasn’t liable for the 10% levy because it was a penalty or other amount that required prior written supervisory approval. The Court rejected her claim, saying the levy is a tax and not a penalty, addition to tax or additional amount. As a result, prior written supervisory approval is unnecessary (Grajales, 156 TC No. 3).
File Form 8606 with your 1040 if you’ve made nondeductible payins to IRAs. If you don’t, they will be treated the same as deductible contributions when withdrawn.
And keep the records until three years after accounts are depleted. Remember that all distributions from your traditional IRA will be subject to tax unless you can show otherwise. Same goes for nondeductible contributions to 401(k)s. So retain copies of Form 8606 and your 1040s for each year such payins are made. Also, keep Form 5498 or similar statements that reflect the amount of IRA payouts.
Talk of Congress increasing the federal gasoline tax is starting again …
But it still remains a long shot. The 18.4¢-per-gallon federal gas tax hasn’t been raised since 1993. There was a pretty strong push to increase it in early 2018. For example, the U.S. Chamber of Commerce proposed to hike the tax to 43.4¢ … 5¢ a year for five years … and index it to account for fuel price increases. Former President Trump also supported it for a while before he dropped the idea. That effort went nowhere. And in the present, Transportation Secretary Pete Buttigieg implied that a higher tax could be on the table before later backtracking on the idea.
Odds are better of gas tax hikes at the state level to help raise revenues to shore up state transportation budgets for fixes to roads, tunnels, bridges, etc.
U.S. persons needn’t report foreign accounts holding only virtual currency.
But this will be changing. The Financial Crimes Enforcement Network says it plans to amend its rules to include virtual currency as reportable accounts. But any pending regulations won’t apply to the reporting of 2020 foreign accounts.
Remember the reporting rules if you have an overseas account. U.S. persons with foreign accounts whose total value exceeded $10,000 at any time in 2020 are required to electronically submit FinCEN Form 114 by April 15 to report them.
Payments from a closely held corporation to its shareholders get scrutiny. An oft-litigated issue is whether compensation paid by a closely held C corp to its owners should instead be reclassified as a disguised distribution of profits.
Take this case in which a corporation paid large, year-end management fees to its three owners. The Tax Court determined, based on the facts and circumstances, that the payments to shareholders are disguised distributions of profits, or dividends. Among the factors the Court found important: Each year, the amounts were paid in a lump sum at year-end. The corporation had no history of paying dividends. The percentage of the fees received by each shareholder roughly corresponded to their respective ownership interests in the firm. The company made the payments without valuing or quantifying the services the shareholders provided. And the firm had little taxable income after deducting the fees (Aspro, Inc., TC Memo. 2021-8).
Your tax home isn’t always where you live. A self-employed attorney who had law practices in D.C. and Minn. divided his time between the two locales. He lived in Minn., and he stayed in a hotel or temporary apartment while in D.C. In general, your tax home is where your principal place of business is located. The Tax Court said the lawyer’s tax home is in D.C. He spent more days working in D.C., most of his business and income was derived from his D.C. practice, and his work in D.C. was indefinite or indeterminate … not temporary. His write-off for the cost of his D.C. lodging is toast (Soboyede, TC Summ. Op. 2021-3).
Partners have income from the discharge of the partnership’s debt, the Tax Court rules. The partnership had four individual partners. One of them regularly made loans to the firm, which all parties treated as indebtedness. Years later, when the partnership ceased operations and filed its final return, the partnership treated those loans as contributions, and the partners weren’t called on to repay the amount. The Court agreed with IRS that the partners had discharge-of-debt income, saying it was clear that the cash infusions were loans and the partnership would not repay the debt (Hohl, TC Memo. 2021-5).
On IRS’s compliance strategy list: Retirement plans of the self-employed. Audits are ongoing of some sole proprietors who file a 5500-series form and attach Schedule C to their 1040 return. Issues eyed include whether the taxpayer properly took the self-employment retirement deduction on Schedule 1 of the 1040 rather than on Schedule C, and whether the filer calculated earned income correctly.
IRS is doing a better job of monitoring self-employeds’ SEP deductions, according to Treasury inspectors. A person must have earnings from self-employment to contribute to a SEP. In a 2014 report, inspectors reviewed returns from 2011 and found a significant number of cases in which individual filers claimed write-offs for SEP contributions on returns where no Schedule C or F was attached. A review of 2017 returns found a much smaller number of these taxpayers. Inspectors want IRS to do even more to reduce the discrepancies, but IRS says no, pointing out the minimal incidence of noncompliance and its limited resources.
Relief for a couple who didn’t file Form 8822 to tell IRS of an address change.
They get their day in Tax Court. If IRS concludes that a person owes taxes, it must send a deficiency notice by certified or registered mail to the last-known address before assessing an amount due and beginning collection proceedings. Actual receipt of the notice by the taxpayer is immaterial. A couple who moved never got a notice because IRS sent it to the address on their latest return and not to their new address. They claimed IRS was notified of the change when they filed a power of attorney on Form 2848 and an extension on Form 4868. The Tax Court didn’t agree, but an appeals court has now reversed the lower court (Gregory, 3rd Cir.).
Claiming the earned income tax credit on your tax return? Know the rules.
It’s an audit red flag. The Service averages about 300,000 EITC audits a year out of more than 25 million returns taking the credit. These exams are done by mail.
Over 40% of EITC errors pertain to the eligibility of a qualifying child. A qualifying child must be a son, daughter, stepchild, foster child, sibling or descendant of the above who lived with you for more than half the year and is under age 19. There are two exceptions to the age requirement: Full-time students must be younger than 24, and permanently and totally disabled children can be any age.
Battling abusive syndicated conservation easement deals is a top IRS priority.
And the Dept. of Justice is getting involved, developing criminal investigations in the most egregious cases. Two tax pros in Atlanta recently pled guilty to tax fraud for promoting a scheme involving over $1 billion in fraudulent charitable deductions. IRS chief Charles Rettig said it was the first conservation easement criminal case, and a DOJ official warned that more prosecutorial efforts on this issue were on tap.
Preparers can now electronically submit Forms 2848 and 8821 to IRS …
And use taxpayer digital signatures. IRS has a new portal on its website called “Submit Forms 2848 and 8821 Online” that can be used by tax professionals with a Secure Access account. See www.kiplinger.com/letterlinks/edocs for details. Alternatively, the forms can be mailed or faxed to IRS with handwritten signatures. Form 2848 is the power-of-attorney document needed for audits and inquiries. And Form 8821 permits IRS to disclose information to a tax pro or other person.
Here’s something that could make a comeback in the next couple of years:
Minimum competency rules for unenrolled preparers … those who aren’t CPAs, enrolled agents or lawyers. IRS’s National Taxpayer Advocate, tax preparer groups and some Democratic lawmakers want Congress to enact a law authorizing IRS to conduct preparer oversight. The odds of this idea getting legislative approval within the next year or so have gone up a bit, especially with Sen. Ron Wyden (D-OR), a proponent of preparer regulation, taking the helm of the Senate Finance Com.
Preparers of returns claiming refundable credits or head of household:
Attach the required Form 8867 due diligence checklist to individual returns. Those who don’t abide by the rules are subject to a penalty of $540 for each failure. Say a preparer does a return for a client who claims the head-of-household filing status, earned income credit and child credit, and fails to attach Form 8867 to the 1040. That preparer could potentially be liable for a $1,620 fine for that one client’s return.
IRS routinely mails letters to preparers who flout the due diligence rules.
Looking for a new tax preparation software program for this year?
Kiplinger’s Personal Finance magazine ranked six of the most popular ones and decided that FreeTaxUSA’s tax software program gives the most bang for the buck. The programs were reviewed based on cost, ease of use, availability of tax assistance, functionality, how they handled economic stimulus payments and other factors. Go to www.kiplinger.com/letterlinks/taxsoftware2021 to view the rankings in full.