Tax Saving Tips Covid_19

Say Goodbye to 100 Percent Bonus Depreciation

October 18, 2022 by John Sanchez

All good things must come to an end. On December 31, 2022, one of the best tax deductions ever for businesses will end: 100 percent bonus depreciation.

Since late 2017, businesses have used bonus depreciation to deduct 100 percent of the cost of most types of property other than real property. But starting in 2023, bonus depreciation is scheduled to decline 20 percent each year until it reaches zero in 2027.

For example, if you purchase $100,000 in equipment for your business and place it in service in 2022, you can deduct $100,000 using 100 percent bonus depreciation. If you wait until 2023, you’ll be able to deduct only $80,000 (80 percent).

Does this mean you should rush out and purchase business property before 2022 ends to take advantage of the 100 percent bonus depreciation? Not necessarily. For many businesses, an alternative is not going away: IRC Section 179 expensing.

Both IRC Section 179 expensing and bonus depreciation allow business owners to deduct in one year the cost of most types of tangible personal property, plus off-the-shelf computer software. Both can be used for new and used property acquired by purchase from an unrelated party. Both also can be used to deduct various non-structural improvements to non-residential buildings after they are placed in service.

Moreover, the two deductions aren’t mutually exclusive. You can apply Section 179 expensing to qualifying property up to the annual limit and then claim bonus depreciation for any remaining basis. Starting in 2023, when bonus depreciation will be less than 100 percent, any basis left after applying Section 179 and bonus depreciation will be deducted with regular depreciation over several years.

But there are some significant differences between the two deductions:

Section 179 expensing is subject to annual dollar limits that don’t apply to bonus depreciation. But the limits are so large that they don’t affect most smaller businesses.
Section 179 expensing requires more than 50 percent business use to qualify for and retain the Section 179 deduction. For bonus depreciation, you face the more than 50 percent business use requirement only for vehicles and other listed property.
Unlike bonus depreciation, Section 179 expensing is limited to your net taxable business income (not counting the Section 179 deduction) and cannot result in a loss for the year.
The 2022 Section 179 deduction is limited to $27,000 for SUVs. There is no such limit on bonus depreciation.
You can use bonus depreciation to deduct land improvements with a 15-year class life, such as sidewalks, fences, driveways, landscaping, and swimming pools.

Generally, there is no great need to purchase and place the property in service by the end of 2022 to take advantage of 100 percent bonus depreciation. But there can be exceptions.

For example, if you own a rental property and want to make substantial landscaping or other land improvements, you’ll get a larger one-year depreciation deduction using 100 percent bonus depreciation in 2022 than if you wait until 2023, when the bonus will be only 80 percent.

Avoid These Mistakes When Converting to an S Corporation

At first glance, the corporate tax rules for forming an S corporation appear simple. They are not.

Basic Requirements

Here is what your business must look like when it operates as an S corporation:

The S corporation must be a domestic corporation.
The S corporation must have fewer than 100 shareholders.
The S corporation shareholders can be only people, estates, and certain types of trusts.
All stockholders must be U.S. residents.
The S corporation can have only one class of stock.

Simple, right? But what often appears simple on the surface is not so simple at all.

Don’t Forget Your Spouse

If you live in a community property state, your spouse by reason of community property law may be an owner of your corporation. This can be true whether or not your spouse has stock in his or her own name.

If your spouse is an owner, your spouse has to meet all the same qualification requirements you do. This can raise two issues:

If your spouse does not consent to the S corporation election on Form 2553, your S corporation is not valid.
If your spouse is a non-resident alien, your S corporation is not valid.

Converting an LLC to an S Corporation

Method 1. To convert your LLC to an S corporation for tax purposes, you can use a method we call “check and elect.” It’s easy—just two steps. First, you “check” the box to make your LLC a C corporation. Then, you “elect” for the IRS to tax your C corporation as an S corporation. Here’s how you take the two steps:

File IRS Form 8832 to check the box that converts your LLC to a C corporation.
Then file Form 2553 to convert your C corporation into an S corporation.

Method 2. Your LLC can skip the C corporation step and directly elect S corporation status by filing Form 2553.

Loans That Terminate S Corporation Status

Don’t make a bad loan to your S corporation. With the wrong type of loan, you enable the IRS to treat that loan as a second class of stock that disqualifies your S corporation.

Small loans are okay. If the loan is less than $10,000 and the corporation has promised to repay you in a reasonable amount of time, you escape the second-class-of-stock trap.

Larger loans are more closely scrutinized. If you have a larger loan, your loan escapes the second-class-of-stock trap if it meets the following requirements:

The loan is in writing.
There is a firm deadline for repayment of the loan.
You cannot convert the loan into stock.
The repayment instrument fixes the interest rate so that the rate is outside your control.

Buying an Electric Vehicle? Know These Tax Law Changes

There’s good and bad news if you’re in the market for an electric or plug-in hybrid electric vehicle.

The good news is that the newly enacted Inflation Reduction Act includes a wholly revamped tax credit for electric vehicles that starts in 2023 and continues through 2032.

The bad news is that the credit, now called the “clean vehicle credit,” comes with many new restrictions.

The clean vehicle credit remains at a maximum of $7,500. But beginning in 2023, to qualify for the credit,

you will need an adjusted gross income of $300,000 or less for marrieds filing jointly or $150,000 or less for singles; and
you will need to buy an electric vehicle with a manufacturer’s suggested retail price below $80,000 for vans, SUVs, and pickup trucks, or $55,000 for other vehicles.

But that’s not all. The 2023-and-later credit includes new domestic assembly and battery sourcing requirements.

The new law reduces or eliminates the credit when the vehicle fails the battery sourcing requirements. Currently, no electric vehicle will qualify for the full $7,500 credit. Manufacturers are working feverishly to change this, but it could take a few years.

The new credit is not all bad—it eliminates the cap of 200,000 electric vehicles per manufacturer. Thus, popular electric vehicles manufactured by GM, Toyota, and Tesla can qualify for the new credit if they meet the price cap and other requirements.

And then, starting in 2024, you can qualify for a credit of up to $4,000 when purchasing a used electric vehicle from a dealer (not an individual). But income caps also will apply to this credit.

Also, starting in 2024, you’ll be able to transfer your credit to the dealer in return for a cash rebate or price reduction. This way, you can benefit from the credit immediately rather than waiting until you file your tax return.

If you are locked out of the new credit because your income is too high or you wish to purchase a too-expensive electric vehicle, consider buying a qualifying electric vehicle (assembled in North America) on or before December 31, 2022.

If you buy an electric vehicle for business use in 2023, you have a second option: the commercial clean vehicle credit.

Claim Your Employee Retention Credit

If you had W-2 employees in 2020 and/or 2021, you need to look at the Employee Retention Credit (ERC).

As you likely know, it’s not too late to file for the ERC. And now is a good time to get this done.

You can qualify for 2020 credits of up to $5,000 per employee and 2021 credits of up to $7,000 per employee for each of the first three quarters. That’s a possibility of $26,000 per employee.

One of our clients—let’s call him John–had 10 employees during 2020 and 2021. He qualified for $260,000 of tax credits (think cash). You could be like John.

You claim and adjust the ERC using IRS Form 941-X, which you can file anytime on or before March 15, 2024, if you file your taxes as a partnership or an S corporation, or April 15, 2024, if you file on Schedule C of your Form 1040 or as a C corporation.

You have three ways to qualify for the ERC:

Significant decline in gross receipts. Here, you compare the gross receipts quarter by quarter to those in 2019. To trigger any ERC under this test, you need a drop of more than 50 percent in 2020 and a drop of more than 20 percent in 2021.
Government order that causes more than a nominal effect. Here, your best bet is to use the safe harbor for nominal effect. This requires looking at either your 2019 quarterly receipts or your 2019 quarterly hours worked by employees, and seeing that the 2020 or 2021 shutdown order would have affected the 2019 figures by more than 10 percent.
Government order causes a modification to your business. Here, you also have a safe harbor. The IRS deems that the federal, state, or local COVID-19 government order had a more-than-nominal effect on your business if it reduced your ability to provide goods or services in the normal course of your business by not less than 10 percent.

The ERC can help all businesses that qualify, even those businesses that did not suffer during the COVID-19 pandemic.

If you have questions, don’t hesitate to contact me.

Tax-Saving Tips (Deduction)

February 13, 2022 by John Sanchez

Make Sure You Grab Your Home Internet Deduction

If you do some work at home, you’re probably using your home internet connection. Are your monthly internet expenses deductible? Maybe.

The deduction rules depend on your choice of business entity (proprietorship, corporation, or partnership).

Deduction on Schedule C

If you operate your business as a sole proprietorship or as a single-member LLC, you file a Schedule C to report your business income and expenses. As a Schedule C taxpayer, you may deduct ordinary and necessary expenses, which include business-related internet subscription fees.

You can deduct your use of your home internet whether or not you claim the home-office deduction, as follows:

If you claim the home-office deduction on your Form 1040, the internet expense goes on line 21 (utilities) of IRS Form 8829 as either a direct or an indirect expense.
If you do not claim the home-office deduction, enter the business portion of your internet expenses as utilities expenses on line 25 of your Schedule C.

Deduction When You Operate as a Corporation

When you operate your business as a corporation, you are an employee of that corporation. Because of the Tax Cuts and Jobs Act (TCJA), the only way for you to reap the benefits of the home internet deduction (or a home office) is to have your corporation reimburse you for the deduction. In the case of a reimbursed employee expense,

the corporation deducts the expense as a utility expense, and
you receive the reimbursement as a tax-free reimbursed employee business expense.

Why is the reimbursement method the only way for the corporate owner to get the deduction? The TCJA eliminated the 2018-2025 deduction for miscellaneous itemized expenses. These include unreimbursed employee expenses, such as internet connection fees.

Deduction When You Operate as a Partnership

If you have deductible home internet expenses and/or a home office and operate as a partner in a partnership, you have two ways to get a tax benefit:

Deduct the costs as unreimbursed partner expenses (UPE) on your personal return.
Or get reimbursed tax-free from your partnership via an accountable plan (think “expense report”).

Substantiating Your Home Internet Expense Deduction

Where business owners can run into trouble with the IRS is in substantiating their internet expense deduction.

You should have no problem showing the total cost for your home internet connection—just total your monthly bills. The problem is in establishing what percentage of the total cost was for business, because only that percentage is deductible.

Ideally, you should keep track of how much time you use your home internet connection for business and how much time for personal use. A simple log or notation on your business calendar or appointment book—indicating approximately how many hours you were online for business each day while working at home—should be sufficient.

Google it and you can find software and apps that will track your internet use.

Instead of tracking your home internet use every day throughout the year, you could use a sampling method such as that permitted for tracking business use of vehicles and other listed property. There is no logical reason the IRS shouldn’t accept such a sampling for internet use.

Selling Your Home to Your S Corporation

The strategy behind creating an S corporation and then selling your home to that S corporation comes into play when

you want to convert your home to a rental property and take advantage of the exclusions, or
you need more time to sell the home to realize the benefits of the $250,000 exclusion ($500,000 if filing a joint return).

With this strategy, one question often comes up: If a married couple sells their home to their S corporation to be a rental property, can the owners be the renters?

Answer: No. In this situation, the tax code treats your S corporation as you, the individual taxpayer, and thus you would be renting from yourself, and that would produce no tax benefits.

In effect, the S corporation renting the residence to the owner of the S corporation is the same as homeowners renting their residence to themselves. It produces no tax benefits.

On the other hand, your S corporation could rent the home for use as a principal residence to your son or daughter or other related party, and the tax code would treat that rental the same as any rental to a third party.

Reverse Mortgage as a Tax Planning Tool

When you think of the reverse mortgage, you may not think of using it as a tax planning tool.

If you are house rich but cash poor, the reverse mortgage can

give you the cash you desire,
save you a boatload of both income and estate taxes, when used in the right circumstances.

With a reverse mortgage, you as the borrower don’t make payments to the lender to pay down the mortgage principal over time. Instead, the reverse happens: the lender makes payments to you, and the mortgage principal gets bigger over time.

You can receive reverse mortgage proceeds as a lump sum, in installments over a period of months or years, or as line-of-credit withdrawals. After you pass away or permanently move out, you or your heirs sell the property and use the net proceeds to pay off the reverse mortgage balance, including accrued interest.

So, with a reverse mortgage, you can keep control of your home while converting some of the equity into much-needed cash.

In contrast, if you sell your residence to raise cash, it could involve an unwanted relocation to a new house and trigger a taxable gain way in excess of the federal home sale gain exclusion break—up to $500,000 for joint-filing couples and up to $250,000 for unmarried individuals.

The combined federal and state income tax hit from selling could easily reach into the hundreds of thousands of dollars.

For instance, the current maximum federal income tax rate on the taxable portion of a big home sale gain is 23.8 percent—20 percent for the “regular” maximum federal capital gains rate plus another 3.8 percent for the net investment income tax. And that’s just what you have to pay the feds.

With the reverse mortgage, you can avoid paying income taxes on the sale. And perhaps even better yet, you can avoid estate taxes.

The federal income tax basis of an appreciated capital gain asset owned by a deceased individual, including a personal residence, is stepped up to fair market value as of the date of the owner’s death or (if the estate executor chooses) the alternate valuation date six months later.

When the value of an asset eligible for this favorable treatment stays about the same between the date of death and the date of sale by your heirs, there will be little or no taxable gain to report to the IRS—because the sale proceeds are fully offset (or nearly so) by the stepped-up basis. Good!

Big Tax Break: Qualified Improvement Property

Do you own or lease non-residential (think “commercial”) real property for your business, or rent non-residential real property to others?

If so, interior improvements you make to the property may be fully deductible in a single year instead of over multiple years.

But to be deducted instantly, the improvements must fit into the category that the tax code calls “qualified improvement property” (QIP).

What Is QIP?

Ordinarily, non-residential real property is depreciated over 39 years. And so are improvements to such real property after it is placed in service.

But Congress wants to encourage business owners to improve their properties. So, starting in 2018, the TCJA established a new category of depreciable real property: QIP, which has a much shorter recovery period than regular commercial property—15 years. But even better, for tax years 2021 and 2022, QIP can qualify for that immediate 100 percent bonus depreciation deduction.

QIP consists of improvements, other than personal property, made by the taxpayer to the interior of non-residential real property after the date the building was first placed in service. For example, QIP includes interior improvements or renovations to any of the following:

Office building (or single offices)
Restaurant or bar
Store
Strip mall
Motel or hotel
Warehouse
Factory

Since QIP applies only to non-residential property, improvements to residential rental property such as an apartment building are not QIP.

Transient Property

Airbnb and similar short-term residential rentals also qualify as non-residential property if they are rented on a transient basis—that is, over half of the rental use is by a series of tenants who occupy the unit for less than 30 days per rental.

QIP Examples

Examples of interior improvements that can receive QIP treatment include the following:

Drywall
Ceilings
Interior doors
Modifications to tenant spaces (if the interior walls are not load-bearing)
Fire protection
Mechanical
Electrical
Plumbing
Heating and air interior equipment and ductwork
Security equipment

QIP does not include improvements related to the enlargement of a building, an elevator or escalator, or the internal structural framework of a building. Structural framework includes “all load-bearing internal walls and any other internal structural supports.”

Placed in Service

QIP consists only of improvements made after the building was placed in service. But for these purposes, “placed in service” means the first time the building is placed in service by any person. By reason of this rule, you can purchase an existing property that was placed in service by an owner anytime in the past, renovate it before you place it in service, and still get QIP treatment.

But you have to make the improvements. You can’t acquire a building and treat improvements made by a previous owner as QIP.

How to Deduct Qualified Improvement Property

You may deduct the cost of QIP in one of three ways:

use first-year bonus depreciation,
use IRC Section 179 expensing, or
depreciate the cost over 15 years using straight-line depreciation.

As mentioned earlier, QIP placed in service in 2021 and 2022 is eligible for 100 percent bonus depreciation. That is, you can deduct the entire cost in one year, without limit.

Starting in 2023, the tax code reduces bonus depreciation by 20 percent per year until it is completely phased out for property placed in service in 2027.

If you have questions, don’t hesitate to contact me.

529 withdrawals and more tax-saving tips

October 15, 2021 by John Sanchez

Taxation of 529 College Savings Account Withdrawals

The big advantage of 529 plans is that qualified withdrawals are always federal-income-tax-free—and usually state-income-tax-free too.

What you may not know is that not all 529 withdrawals are tax-free qualified withdrawals, even in years when you have heavy college costs.

Here are six important points to know about 529 withdrawals.

Point No. 1: You Usually Have Several Payment Options

Say you are the 529 account owner or plan participant. Plans commonly use both terms to describe the person who established and controls the account. This letter will use account owner.

As the account owner, you can generally have a withdrawal check cut in your own name or have an electronic deposit made into your own account.

Alternatively, you can have a withdrawal issued in the name of the account beneficiary (the college student for whom you set up the 529 account, usually a child or grandchild) or issued directly to the educational institution for the benefit of the account beneficiary.

You choose your payment option by submitting a withdrawal request to the 529 plan.

Point No. 2: Watch Out for Withdrawals from 529 Accounts Funded with Custodial Account Money

Say you funded the 529 account with money that came from a custodial account that was set up for the account beneficiary—your child or grandchild—under your state’s Uniform Gift to Minors Act (UGMA) or Uniform Transfer to Minors Act (UTMA).

In this situation, you must use any money taken from the custodial account for the benefit of the child or grandchild.

You can’t take a 529 account withdrawal for yourself if the 529 account was funded with money from a child’s or grandchild’s custodial account. Because the money in the 529 account came from the custodial account, the 529 account money legally belongs to your child or grandchild, not you.

On the other hand, if you funded the 529 account with your own money, the money in the account is fair game. You can take withdrawals and do whatever you want with them—subject to the potential federal income tax implications explained later.

Point No. 3: The IRS Knows about Withdrawals

For any year that a 529 withdrawal is taken, the plan must issue a Form 1099-Q, Payments From Qualified Education Programs (Under Sections 529 and 530), by February 1 of the following year.

If the withdrawal goes to the 529 account beneficiary (your child or grandchild), the 1099-Q goes to him or her. If the withdrawal goes to you as the account owner, the 1099-Q goes to you.

Either way, the IRS gets a copy, so the IRS knows what happened.

Point No. 4: Withdrawals May Be Taxable Even in Years When Substantial College Costs Are Incurred

When the Form 1099-Q shows withdrawn earnings, the IRS becomes interested in the 1099-Q recipient’s Form 1040 because some or all of the earnings might be taxable. Here’s the deal on that.

Withdrawn earnings are always federal-income-tax-free and penalty-free when total withdrawals for the year do not exceed what the IRS calls the account beneficiary’s adjusted qualified education expenses, or AQEE, for the year.

AQEE equals the sum of the 529 account beneficiary’s

college tuition and related fees;
room and board (but only if the beneficiary carries at least half of a full-time course load);
required books, supplies, and equipment;
computer hardware and peripherals, software, and internet access costs; and
expenses for special needs services.

Next, you must subtract any federal-income-tax-free educational assistance to calculate the account beneficiary’s AQEE.

According to the IRS, tax-free educational assistance includes costs covered by

tax-free Pell grants;
tax-free scholarships, fellowships, and tuition discounts;
tax-free veterans’ educational assistance;
an employer’s tax-free educational assistance program under Internal Revenue Code Section 127; and
any other tax-free educational assistance (other than assistance received in the form of a gift or an inheritance).

In addition, tax-free educational assistance includes any costs used to claim the American Opportunity tax credit or the Lifetime Learning tax credit.

Key point. You can also include in AQEE

up to $10,000 annually for the account beneficiary’s K-12 tuition costs;
the account beneficiary’s fees, books, supplies, and equipment required to participate in a registered apprenticeship program; and
interest and principal payments on qualified student loan debt owed by the account beneficiary or a sibling of the account beneficiary—subject to a $10,000 lifetime limit.

Bottom line. When withdrawals during the year exceed AQEE for the year, all or part of the withdrawn earnings will be taxable. When withdrawals don’t exceed AQEE, all the withdrawn earnings are federal-income-tax-free.

Point No. 5: When You Keep a Withdrawal, There Are Tax Consequences

Assuming the 529 account was funded with your own money (as opposed to money from a custodial account), you are free to change the 529 account beneficiary to yourself and then take federal-income-tax-free withdrawals to cover your own AQEE if you decide to go back to school.

But if you take a withdrawal that you use for purposes other than education, report the taxable portion of any related account earnings as miscellaneous income on your Form 1040. Taxable amounts may also get hit with a 10 percent penalty tax to boot (see below).

Finally, if you liquidate a loser 529 account (worth less than the total amount of contributions), there are no federal income tax consequences. (The government stopped participating in your losses for tax years 2018-2025.)

Point No. 6: Withdrawals Not Used for Education Can Also Be Hit with a 10 Percent Penalty Tax

As explained earlier, some or all of the earnings included in a 529 withdrawal taken during the year must be included in gross income when the withdrawn earnings exceed the account beneficiary’s AQEE for the year. But there’s more.

According to the general rule, the taxable amount of earnings is also hit with a 10 percent penalty tax.

But the 10 percent penalty tax doesn’t apply to earnings that are taxable only because the account beneficiary’s AQEE was reduced by

tax-free Pell grants;
tax-free scholarships, fellowships, and tuition discounts;
tax-free veterans’ educational assistance;
tax-free employer-provided educational assistance;
any other tax-free educational assistance; or
costs used to claim the American Opportunity or Lifetime Learning tax credit.

In addition, the 10 percent penalty tax doesn’t apply to earnings withdrawn when the account beneficiary attends one of the U.S. military academies (such as West Point, Annapolis, or the Air Force Academy).

Finally, the 10 percent penalty tax doesn’t apply to earnings withdrawn after the account beneficiary dies or becomes disabled.

Tax-Home Rules You Should Know

When you travel out of town overnight, you need to know the tax-home rule. The IRS defines your tax home, and it’s not necessarily in the same town where you have your personal residence.

If you have more than one business location, one of the locations will be your tax home. It’s generally your main place of business.

In determining your main place of business, the IRS takes into account three factors:

the length of time you spend at each location for business purposes;
the degree of business activity in each area; and
the relative financial return from each area.

Here’s a recent court case that illustrates this rule.

Akeem Soboyede, an immigration attorney, was licensed to practice law in both Minnesota and Washington, D.C., and he maintained solo law practices in both Minneapolis and Washington, D.C.

Although Mr. Soboyede’s primary personal residence was in Minneapolis, he divided his time between his office in Minneapolis and his office in Washington, D.C.

Get ready for a chuckle: in court, Mr. Soboyede admitted in his testimony that he did not keep the necessary documentation because he “did not know . . . [he] was going to get audited.”

Due to the lack of records, the IRS disallowed most of the deductions. The remaining issue for the court was the travel expenses for lodging, for which Mr. Soboyede had the records.

The court noted that Mr. Soboyede’s lodging expenses were only deductible if he was “away from home” as required by Section 162(a)(2).

In deciding whether Mr. Soboyede’s tax home was in Minneapolis or Washington, D.C., the court used the following two factors:

Where did he spend more of his time?
Where did he derive a greater proportion of his income?

Answer: Washington, D.C. Think about this: He had his home in Minneapolis, but the court ruled that his “tax home” was in Washington, D.C. As a result, he lost his travel deductions.

Principal Residence Gain Exclusion Break

Here’s a look at how to apply the $250,000 ($500,000, if married) principal residence tax break when getting married or divorced, or when converting another property into your home.

In both marriage and divorce situations, a home sale often occurs. Of course, the principal residence gain exclusion break can come in very handy when an appreciated home is put on the block.

Sale during Marriage

Say a couple gets married. They each own separate residences from their single days. After the marriage, the pair files jointly. In this scenario, it is possible for each spouse to individually pass the ownership and use tests for their respective residences. Each spouse can then take advantage of a separate $250,000 exclusion.

Sale before Divorce

Say a soon-to-be-divorced couple sells their principal residence. Assume they still are legally married as of the end of the year of sale because their divorce is not yet final. In this scenario, the divorcing couple can shelter up to $500,000 of home sale profit in two different ways:

Joint return. The couple could file a joint Form 1040 for the year of sale. Assuming they meet the timing requirements, they can claim the $500,000 joint-filer exclusion.
Separate returns. Alternatively, the couple could file separate returns for the year of sale, using married-filing-separately status. Assuming the home is owned jointly or as community property, each spouse can then exclude up to $250,000 of his or her share of the gain.

To qualify for two separate $250,000 exclusions, each spouse must have

owned his or her part of the property for at least two years during the five-year period ending on the sale date, and
used the home as his or her principal residence for at least two years during that five-year period.

Sale in Year of Divorce or Later

When a couple is divorced as of the end of the year in which their principal residence is sold, they are considered divorced for that entire year. Therefore, they will be unable to file jointly for the year of sale. The same is true, of course, when the sale occurs after the year of divorce.

Key point. Under the preceding rules, both ex-spouses will typically qualify for separate $250,000 gain exclusions when the home is sold soon after the divorce. But when the property remains unsold for some time, the ex-spouse who no longer resides there will eventually fail the two-out-of-five-years use test and become ineligible for the gain exclusion privilege.

Let’s see how we can avoid that unpleasant outcome.

When the Non-Resident Ex Continues to Own the Home for Years after Divorce

Sometimes ex-spouses will continue to co-own the former marital abode for a lengthy period after the divorce. Of course, only one ex-spouse will continue to live in the home. After three years of being out of the house, the non-resident ex will fail the two-out-of-five-years use test. That means when the home is finally sold, the non-resident ex’s share of the gain will be fully taxable.

But with some advance planning, you can prevent this undesirable outcome.

If you will be the non-resident ex, your divorce papers should stipulate that as a condition of the divorce agreement,

your ex-spouse is allowed to continue to occupy the home for as long as he or she wants, or
until the kids reach a certain age, or
for a specified number of years, or
for whatever time period you and your soon-to-be ex can agree on.

At that point, either the home can be put up for sale, with the proceeds split per the divorce agreement, or one ex can buy out the other’s share for current fair market value.

This arrangement allows you, as the non-resident ex, to receive “credit” for your ex’s continued use of the property as a principal residence. So, when the home is finally sold, you should pass the two-out-of-five-years use test and thereby qualify for the $250,000 gain exclusion privilege.

The same strategy works when you wind up with complete ownership of the home after the divorce, but your ex continues to live there. Stipulating as a condition of the divorce that your ex is allowed to continue to live in the home ensures that you, as the non-resident ex, will qualify for the $250,000 gain exclusion when the home is eventually sold.

Little-Known Non-Excludable Gain Rule Can Mean Unexpectedly Higher Taxes on a Property Converted into Your Principal Residence

Once upon a time, you could convert a rental property or vacation home into your principal residence, occupy it for at least two years, sell it, and take full advantage of the home sale gain exclusion privilege of $250,000 for unmarried individuals or $500,000 for married, joint-filing couples. Those were the good old days!

Unfortunately, legislation enacted back in 2008 included an unfavorable provision for personal residence sales that occur after that year. The provision can make a portion of your gain from selling an affected residence ineligible for the gain exclusion privilege.

Let’s call the amount of gain that is made ineligible the non-excludable gain. The non-excludable gain amount is calculated as follows.

Step 1. Take the total gain, and subtract any gain from depreciation deductions claimed against the property for periods after May 6, 1997. Include the gain from depreciation (so-called unrecaptured Section 1250 gain) in your taxable income. Carry the remaining gain to Step 3.

Step 2. Calculate the non-excludable gain fraction.

The numerator of the fraction is the amount of time after 2008 during which the property is not used as your principal residence. These times are called periods of non-qualified use.

But periods of non-qualified use don’t include temporary absences that aggregate two years or less due to changes of employment, health conditions, or other circumstances specified in IRS guidance.

Periods of non-qualified use also don’t include times when the property is not used as your principal residence, if those times are

after the last day of use as your principal residence, and
within the five-year period ending on the sale date.

The denominator of the fraction is your total ownership period for the property.

Step 3. Calculate the non-excludable gain by multiplying the gain from Step 1 by the non-excludable gain fraction from Step 2.

Step 4. Report on Schedule D of Form 1040 the non-excludable gain calculated in Step 3. Also report any Step 1 unrecaptured Section 1250 gain from depreciation for periods after May 6, 1997. The remaining gain is eligible for the gain exclusion privilege, assuming you meet the timing requirements.

The Basics of Depreciation

Are you thinking about buying personal property (such as a car, a computer, or other equipment) or real property (such as a building)? If you use the property for personal purposes, it’s not deductible.

But if you use it in a business, you can deduct the full cost using regular depreciation, bonus depreciation, or IRC Section 179 expensing.

Regular depreciation takes three to 39 years depending on the property involved, while bonus depreciation allows you to deduct 100 percent of the cost of personal property in one year through 2022. Up to $1,050,000 of personal property may also be deducted in one year under IRC Section 179.

But depreciation won’t begin if you purchase property with the intent of beginning a new business. You must actually be in business to claim depreciation. This doesn’t require that you make sales or earn profits—only that your business is a going concern.

Also, depreciation doesn’t begin the moment you purchase property for your business. It begins only when you place property in service in your business. You don’t have to use the property to place it in service, but the property must be available for use in your active business. This could occur after you purchase the property.

Finally, if you use regular depreciation, you must apply rules called conventions to determine the month in which your depreciation deduction begins. The earlier in the year, the larger your deduction for the first year.

The default rule is that regular depreciation for personal property begins July 1 the first year (mid-year convention). But if you purchase 40 percent or more of your total personal property for the year during the fourth quarter, your depreciation begins at the midpoint of the quarter in which it is placed in service (mid-quarter convention).

First-year depreciation for real property begins at the middle of the month during which the property is placed in service (mid-month convention).

If you have questions, don’t hesitate to contact me.

Tax-saving tips September Update

September 20, 2021 by John Sanchez

Save Your Employee Retention Credit

In what clearly must have been a mistake, the IRS issued Notice 2021-49 to deny the employee retention credit (ERC) on the wages paid to most C and S corporation owners.

According to the IRS:

Your corporation can qualify for the ERC on the wages paid to a more than 50 percent owner of an S or C corporation if that owner does not have any living brothers and sisters (whether whole- or half-blood), spouse, ancestors, or lineal descendants.
Your corporation cannot qualify for the ERC on the more than 50 percent owner’s wages if one of those relatives (other than the spouse) is alive.

Example 1. Tom owns 100 percent of his S corporation, and he has no living relatives. Under this new IRS notice, Tom’s corporation can qualify for up to $33,000 in ERC on Tom’s wages.

Example 2. John owns 100 percent of his S corporation, but he has one living relative, a two-year-old daughter. John’s corporation does not qualify for the ERC. Under the new IRS notice, the two-year-old daughter owns by attribution 100 percent of the S corporation, and the IRS says that John, now a tainted relative, works for her and does not qualify for the ERC.

Whoa, that’s not logical!

Also, it may be technically incorrect.

And it’s possible that lawmakers will kill this IRS rule.

To Amend or Not to Amend

Let’s start with this premise. You are a more than 50 percent owner of a corporation. You thought that your corporation qualified for the ERC. At various times before August 4, 2021, the day when the IRS issued Notice 2021-49, you filed your claim to the ERC for 2020 and the first two quarters of 2021.

As we mentioned, when you filed, you believed (as a more than 50 percent owner of a C or S corporation) that wages paid to you by the corporation qualified for the ERC. We did too.

But then, on August 4, 2021, the IRS issued Notice 2021-49 and said no—you don’t qualify. What now? Here’s what we think you should do:

Do nothing now. There’s no hurry. You have until April 15, 2024, before you have to do anything about your 2020 ERC.
Don’t claim the ERC for the more than 50 percent corporate owner for calendar year 2021 quarters 3 and 4 until you have clarification that you qualify. Again, there’s no hurry. You can file a Form 941-X anytime within the three-year statute of limitations.

If you are upset by this IRS notice, it’s a good idea to communicate that dissatisfaction to your U.S. senators and congressional representatives. For some ideas on what message to convey, here’s a sample letter for your use.

Vaccinated? Claim Tax Credits for Your Employees and Yourself

As the nation suffers from the ravages of the super-contagious COVID-19 Delta variant, the federal government desperately wants all American workers and their families to get vaccinated.

If you have employees, you probably feel the same way. Indeed, more and more employers are implementing vaccine mandates—a trend that will likely grow after the FDA gives final approval to the COVID-19 vaccines.

COVID-19 vaccine mandates are highly controversial.

One thing that’s not controversial is giving your employees paid time off to get vaccinated and to deal with the possible side effects of vaccination (usually, short-lived flu-like symptoms). The federal government does not require that employers provide such paid time off, but it strongly encourages them to do so. And it’s putting its money where its mouth is, by providing fairly generous tax credits to repay employers for the lost employee work time.

You can also collect these credits if your employees take time off to help family and household members get the vaccination and/or recover from its side effects. There’s only one thing better than having an employee vaccinated: having an employee’s entire family vaccinated.

How big are the credits?

Employers who give employees paid time off to get vaccinated against COVID-19 and/or recover from the vaccination can collect a sick leave credit of up to $511 per day for 10 days, plus a family leave credit of up to $200 per day for 60 additional days.
Employers who give employees paid time off to help household members get vaccinated and/or recover from the vaccination can get a sick leave credit for 10 days and family leave credit for 60 days, both capped at $200 per day.

What if you are self-employed and have no employees? You haven’t been left out. Similar tax credits are available to self-employed individuals who take time off from work to get vaccinated or who help family or household members do so.

But you must act soon. These sick leave and family leave credits are available only through September 30, 2021.

One more thing: these are refundable tax credits. This means you collect the full amount even if it exceeds your tax liability. Employers can reduce their third-quarter 2021 payroll tax deposits in the amount of their credits. If the credit exceeds these deposits, employers can get paid the difference in advance by filing IRS Form 7200, Advance Payment of Employer Credits Due to COVID-19.

The documentation requirements for these credits are modest, and you’ll have to file a couple of new forms with your 2021 tax return.

IRS Private Letter Rulings: Are They Worth It?

Do you have a question about how to apply the tax law to a potential transaction? Wouldn’t it be great if you could get the IRS to give you an answer in advance of filing your tax return?

You may be able to do so by obtaining a private letter ruling (PLR) from the IRS.

You get a PLR by filing a request with the IRS National Office. The IRS is ordinarily bound by the answer it gives a taxpayer in a PLR. But PLRs may not be relied on by other taxpayers.

This sounds great in theory—but in practice, seeking a PLR is usually not a good idea.

There are many reasons why:

PLRs are expensive. The filing fee is $3,000 for the smallest businesses. Larger businesses must pay as much as $38,000. You’ll also need professional help to prepare a detailed PLR request.
A PLR may not be necessary. The IRS has automatic or simplified methods for obtaining its consent without a PLR for many common situations, including late S corporation elections, late IRA rollovers, and various changes in accounting method.
PLRs are unavailable for many types of tax questions, including those that (a) are under IRS examination, (b) were clearly answered in the past, or (c) are too fact intensive.
PLRs can take a long time to obtain—six months or more for complex questions.
PLRs can backfire. Even if the IRS issues a favorable PLR, you now will be on the agency’s radar, which may increase your chances of an audit.

Given all these drawbacks, you should seek a PLR only when a cheaper alternative is unavailable—for example, when you need to do a late IRA rollover and don’t qualify for the streamlined IRS procedure.

In some instances, it’s wise to seek advance IRS approval of complex transactions involving substantial money. Obtaining a favorable PLR in such a case would assure you the transaction passes IRS muster. But these instances are rare.

Prorated Principal Residence Gain Exclusion Break

Here’s good news. IRS regulations allow you to claim a prorated (reduced) gain exclusion—a percentage of the $250,000 or $500,000 exclusion in select circumstances.

The prorated gain exclusion equals the full $250,000 or $500,000 figure (whichever would otherwise apply) multiplied by a fraction.

The numerator of this fraction is the shorter of

the aggregate period of time you owned and used the property as your principal residence during the five-year period ending on the sale date, or
the period between the last sale for which you claimed an exclusion and the sale date for the home currently being sold.

The denominator for this fraction is two years, or the equivalent in months or days.

When you qualify for the prorated exclusion, it might be big enough to shelter the entire gain from the premature sale. But the prorated exclusion loophole is available only when your premature sale is due primarily to

a change in place of employment,
health reasons, or
specified unforeseen circumstances.

Example. You’re a married joint-filer. You’ve owned and used a home as your principal residence for 11 months. Assuming you qualify under one of the conditions listed above, your prorated joint gain exclusion is $229,167 ($500,000 × 11/24). Hopefully that will be enough to avoid any federal income tax hit from the sale.

Premature Sale Due to Employment Change

Per IRS regulations, you’re eligible for the prorated gain exclusion privilege whenever a premature home sale is primarily due to a change in place of employment for any qualified individual.

“Qualified individual” means

the taxpayer (that would be you),
the taxpayer’s spouse,
any co-owner of the home, or
any person whose principal residence is within the taxpayer’s household.

In addition, almost any close relative of a person listed above also counts as a qualified individual. And any descendent of the taxpayer’s grandparent (such as a first cousin) also counts as a qualified individual.

A premature sale is automatically considered to be primarily due to a change in place of employment if any qualified individual passes the following distance test: the distance between the new place of employment/self-employment and the former residence (the property that is being sold) is at least 50 miles more than the distance between the former place of employment/self-employment and the former residence.

Premature Sale Due to Health Reasons

Per IRS regulations, you are also eligible for the prorated gain exclusion privilege whenever a premature sale is primarily due to health reasons. You pass this test if your move is to

obtain, provide, or facilitate the diagnosis, cure, mitigation, or treatment of disease, illness, or injury of a qualified individual, or
obtain or provide medical or personal care for a qualified individual who suffers from a disease, an illness, or an injury.

A premature sale is automatically considered to be primarily for health reasons whenever a doctor recommends a change of residence for reasons of a qualified individual’s health (meaning to obtain, provide, or facilitate care, as explained above). If you fail the automatic qualification, your facts and circumstances must indicate that the premature sale was primarily for reasons of a qualified individual’s health.

You cannot claim a prorated gain exclusion for a premature sale that is merely beneficial to the general health or well-being of a qualified individual.

Premature Sale Due to Other Unforeseen Circumstances

Per IRS regulations, a premature sale is generally considered to be due to unforeseen circumstances if the primary reason for the sale is the occurrence of an event that you could not have reasonably anticipated before purchasing and occupying the residence.

But a premature sale that is primarily due to a preference for a different residence or an improvement in financial circumstances will not be considered due to unforeseen circumstances, unless the safe-harbor rule applies.

Under the safe-harbor rule, a premature sale is deemed to be due to unforeseen circumstances if any of the following events occur during your ownership and use of the property as your principal residence:

Involuntary conversion of the residence
A natural or man-made disaster or acts of war or terrorism resulting in a casualty to the residence
Death of a qualified individual
A qualified individual’s cessation of employment, making him or her eligible for unemployment compensation
A qualified individual’s change in employment or self-employment status that results in the taxpayer’s inability to pay housing costs and reasonable basic living expenses for the taxpayer’s household
A qualified individual’s divorce or legal separation under a decree of divorce or separate maintenance
Multiple births resulting from a single pregnancy of a qualified individual

If you have questions, don’t hesitate to contact me.

Tax-Saving Tips

September 11, 2021 by John Sanchez

Don’t Miss Out on the Employee Retention Credit

It’s hard to imagine that a small business does not qualify for some or all of the employee retention credit (ERC).

And remember, this is a tax credit—one of the very best things that tax law has to offer. True, it’s not as valuable as some other tax credits, because you have to reduce your payroll income tax deductions for the credits, but the ERC certainly puts you ahead.

And you can be looking at big bucks. The possible ERC is $5,000 per employee for 2020 and $28,000 per employee for 2021. That’s $33,000 per employee.

For 2020, you have two ways to qualify:

You had a gross receipts drop during a 2020 calendar quarter of more than 50 percent when compared to the same calendar quarter of 2019. The more than 50 percent test is the trigger for the ERC, and you automatically qualify for that quarter and the following 2020 quarter.
You suffered from a federal, state, or local government order that fully or partially suspended your operations (under this rule, you qualify for the ERC on the days you suffered the full or partial suspension, even if you did not lose any money).

For 2021, you have three ways to qualify:

You suffered a federal, state, or local government order that fully or partially suspended your operations (under this rule, you qualify for the ERC on the days you suffered the full or partial suspension, even if you did not lose any money).
Your gross receipts for a 2021 calendar quarter are less than 80 percent of gross receipts from the same quarter in calendar year 2019.
As an alternative to number 2 above, using the preceding quarter to your 2021 calendar quarter, your gross receipts are less than the comparable quarter in 2019.

You can see by the rules that the government wants to help your small business. Take advantage.

One final note. You may not double-dip. Wages you use for the ERC may not be used for the Paycheck Protection Program (PPP), family leave credit, or similar COVID-19 programs.

Loophole: Harvest Tax Losses on Bitcoin and Other Cryptocurrency

Here’s something to know about cryptocurrencies.

Because cryptocurrencies are classified as “property” rather than as securities, the wash-sale rule does not apply if you sell a cryptocurrency holding for a loss and acquire the same cryptocurrency before or after the loss sale.

You just have a garden-variety short-term or long-term capital loss, depending on your holding period. No wash-sale rule worries. This favorable federal income tax treatment is consistent with the long-standing treatment of foreign currency losses.

That’s a good thing, because folks who actively trade cryptocurrencies know that prices are volatile. And this volatility gives you two opportunities:

profits on the upswings
loss harvesting on the downswings

Let’s take a look at the harvesting of losses:

On day 1, Lucky pays $50,000 for a cryptocurrency.
On day 50, Lucky sells the cryptocurrency for $35,000. He captures and deducts the $15,000 loss ($50,000 - $35,000) on his tax return.
On day 52, Lucky buys the same cryptocurrency for $35,000. His tax basis is $35,000.
On day 100, Lucky sells the cryptocurrency for $15,000. He captures and deducts the $20,000 loss ($35,000 - $15,000) on his tax return.
On day 103, Lucky buys the same cryptocurrency for $15,000.
On day 365, the cryptocurrency is trading at $55,000. Lucky is happy.

Observations:

Assuming Lucky had $35,000 in capital gains, Lucky deducted his $35,000 in cryptocurrency capital losses. If he had no capital gains, he had a $3,000 deductible loss and carried the other $32,000 forward to next year.
On day 365, Lucky has his cryptocurrency, which was his plan on day 1. He thought it would go up in value. It did, from its original $50,000 to $55,000.
Lucky’s tax basis in the cryptocurrency on day 365 is $15,000.

Here’s what Lucky did:

He kept his cryptocurrency.
He banked $35,000 in losses.

Be alert. Losses from crypto-related securities, such as Coinbase, can fall under the wash-sale rule because the rule applies to losses from assets classified as securities for federal income tax purposes. For now, cryptocurrencies themselves are not classified as securities.

Planning point. If you want to harvest losses, make sure you hold a cryptocurrency and not a security.

Don’t Make a Big Mistake by Filing Your Tax Return Late

Three bad things happen when you file your tax return late.

What’s Late?

You can extend your tax return and file during the period of extension; that’s not a late-filed return.

The late-filed return is filed after the last extension expired. That’s what causes the three bad things to happen.

Bad Thing 1

The IRS notices that you filed late or not at all.

Of course, the “I didn’t file at all” people receive the IRS’s “come on down and bring your tax records” letter. In general, the meeting with the IRS about non-filed tax returns does not go well.

For the late filers, the big problem is exposure to an IRS audit. Say you’re in the group that the IRS audits about 3 percent of the time, but you file your tax return late. Your chances of an IRS audit increase significantly, perhaps to 50 percent or higher.

Simply stated, bad thing 1 is this: file late and increase your odds of saying “Hello, IRS examiner.”

Bad Thing 2

When you file late, you trigger the big 5 percent a month, not to exceed 25 percent of the tax-due penalty.

Here, the bad news is 5 percent a month. The good news (if you want to call it that) is this penalty maxes out at 25 percent.

Bad Thing 3

Of course, if you owe the “failure to file” penalty, you likely also owe the penalty for “failure to pay.” The failure-to-pay penalty equals 0.5 percent a month, not to exceed 25 percent of the tax due.

The penalty for failure to pay offsets the penalty for failure to file such that the 5 percent is the maximum penalty during the first five months when both penalties apply.

But once those five months are over, the penalty for failure to pay continues to apply. Thus, you can owe 47.5 percent of the tax due by not filing and not paying (25 percent plus 0.5 percent for the additional 45 months it takes to get to the maximum failure-to-pay penalty of 25 percent).

The Principal Residence Gain Exclusion Break

The $250,000 ($500,000, if married) home sale gain exclusion break is one of the great tax-saving opportunities.

Unmarried homeowners can potentially exclude gains up to $250,000, and married homeowners can potentially exclude up to $500,000. You as the seller need not complete any special tax form to take advantage.

To take full advantage of the principal residence gain exclusion break, you must pass two tests: the ownership test and the use test.

To pass the ownership test, you must have owned the home for at least two years out of the five-year period ending on the sale date.
To pass the use test, you must have used the home as your principal residence for at least two years out of the five-year period ending on the sale date.

Key point. These two tests are completely independent. In other words, periods of ownership and use need not overlap.

If you’re married and you and your spouse file your tax returns separately, you can potentially qualify for two separate $250,000 exclusions.

If you’re married and file jointly, you qualify for the $500,000 joint-filer exclusion if

either you pass or your spouse passes the ownership test for the property and
both you and your spouse pass the use test.

When you file jointly, it’s also possible for both you and your spouse to individually pass the ownership and use tests for two separate residences. In that case, you and your spouse would qualify for two separate $250,000 exclusions.

Each spouse’s eligibility for the $250,000 exclusion is determined separately, as if you were unmarried. For this purpose, a spouse is considered to individually own a property for any period the property is actually owned by either spouse.

The other big qualification rule for the home sale gain exclusion privilege goes like this: the exclusion is generally available only when you have not excluded an earlier gain within the two-year period ending on the date of the later sale. In other words, you generally cannot recycle the gain exclusion privilege until two years have passed since you last used it.

You can claim the larger $500,000 joint-filer exclusion only if neither you nor your spouse took advantage of it for an earlier sale within the two-year period. If one spouse claimed the exclusion within the two-year window but the other spouse did not, the exclusion is limited to $250,000.

If you have questions, don’t hesitate to contact me.

COVID-19 Tax Relief Measures

March 24, 2021 by John Sanchez

The Coronavirus Aid, Relief, and Economic Security Act (CARES Act) made many temporary changes in the tax law. The new Consolidated Appropriations Act (CAA) adjusted some of these and left others to die on December 31, 2020.

Below are insights into some of the changes.

Borrow $100,000 from Your IRA and Pay It Back within Three Years with No Tax Consequences

Thanks to the CARES Act, IRA owners who were adversely affected by the COVID-19 pandemic were eligible to take tax-favored coronavirus-related distributions (CRDs) from their IRAs during 2020—but only during 2020.

You could take as much as $100,000. You can then recontribute a CRD back into your IRA within three years of the withdrawal date and treat the withdrawal and later recontribution as a federal-income-tax-free rollover.

In effect, the CRD drill allowed you to borrow up to $100,000 from your IRA(s) and then recontribute (repay) the amount(s) at any time up to three years later, with no federal income tax consequences when all is said and done. There are no limitations on what you can use CRD funds for during the three years.

Status report. The CAA does not extend the CRD deal beyond 2020, but it clarifies that similar tax rules can apply to IRA distributions taken by folks who are affected by specified future disasters.

Suspension of Retirement Account Required Minimum Distributions

In normal times, you must begin taking annual required minimum distributions (RMDs) from traditional IRAs and tax-deferred retirement plan accounts after you reach age 72 (or age 70 1/2 if you turned 70 1/2 before 2020). The CARES Act suspended RMDs for calendar year 2020 as a COVID-19 tax relief measure, but only for that one year.

Status report. So far, lawmakers have not extended this deal.

Small-Employer Tax Credits to Cover Required COVID-19-Related Employee Paid Leave

The Families First Coronavirus Response Act (FFCRA) granted a federal tax credit to small employers to cover mandatory payments to employees who take time off under the FFCRA’s COVID-19-related emergency sick-leave and family-leave provisions.

Specifically, a small employer could collect a tax credit equal to 100 percent of qualified emergency sick-leave and family-leave payments made by the employer pursuant to the FFCRA. But the credit under the FFCRA covers only leave payments made between April 1, 2020, and December 31, 2020. Equivalent tax credit relief was available to self-employed individuals who took qualified leave between those dates.

Status report. The FFCRA expired by its terms on December 31, 2020. But the COVID-Related Tax Relief Act of 2020 (contained within the CAA) extends the small-employer credit to cover leave payments made between January 1, 2021, and March 31, 2021, that fall within the FFCRA framework.

There is no requirement for small employers to provide emergency sick-leave or family-leave payments after December 31, 2020. But between January 1, 2021, and March 31, 2021, employers can choose to make voluntary leave payments that fall within the FFCRA framework and can collect the credit if they do so.

Equivalent tax credit relief is available to self-employed individuals who take qualified leave between January 1, 2021, and March 31, 2021.

Liberalized Business Net Operating Loss Deduction Rules

Business activities that generate tax losses can cause you or your business entity to have a net operating loss (NOL) for the year. The CARES Act significantly loosened the NOL deduction rules and allows a five-year carryback for NOLs that arose in tax years 2018-2020.

So, an NOL that arose in 2020 can be carried back to 2015. NOL carrybacks allow you to claim refunds for taxes paid in the carryback years. Because tax rates were higher in pre-2018 years, NOLs carried back to those years can result in hefty tax refunds.

Status report. The CAA does nothing for NOLs that arise in tax years beginning in 2021—you can carry them forward only.

Suspension of Excess Business Loss Disallowance Rule

Before the CARES Act relief, the Tax Cuts and Jobs Act (TCJA) disallowed so-called excess business losses incurred by individuals in tax years beginning in 2018-2025. The TCJA defined an excess business loss as a loss that exceeds $250,000, or $500,000 for a married joint-filing couple. The $250,000 and $500,000 limits are adjusted annually for inflation.

The CARES Act suspended the excess business loss disallowance rule for losses that arose in tax years beginning in 2018-2020.

Status report. The CAA does nothing for excess business losses that arise in tax years beginning in 2021. As things stand, you effectively treat a 2021 excess business loss as an NOL that you can carry forward to future years.

Business Tax Breaks Thanks to the Recently Enacted CAA

When you operate a business, you have a variety of tax breaks available.

The recently enacted CAA extends and expands some of the breaks. We bring the following selection of them to your attention as a tax-strategy buffet.

You can deduct 100 percent of your business meals that are provided by restaurants in 2021 and 2022.
For hiring members of 10 targeted groups, you can obtain the work opportunity tax credit for first-year wages through 2025.
You can now qualify for the 39 percent new markets tax credit for investments through 2025.
The empowerment zone tax breaks that were scheduled to expire on December 31, 2020, are extended through 2025, but the new law terminates, for 2021 and later, both (a) the enhanced first-year depreciation rules and (b) the capital gains tax deferral break.
Employers may continue through 2025 making Section 127 education plan payments that cover student loan principal and interest up to the plan maximum of $5,250.
For residential rental property that you placed in service before 2018 and were depreciating over 40 years under the straight-line method, you can now use 30 years if you elect out of the TCJA business interest expense limitations.
Farmers may elect a two-year NOL carryback rather than the five-year carryback retroactively, as if this change were in the original CARES Act.
The $1.80 per-square-foot or $0.60 per-square-foot deductions for energy-efficient improvements to commercial buildings are now permanent.
Small Business Administration Economic Injury Disaster Loan advances and loan repayment assistance are not taxable, and you suffer no tax attribute reductions as a result of the tax-free monies.
Manufacturers of residential homes can claim a credit of $1,000 or $2,000 for homes that meet applicable energy-efficiency standards through 2021.
Your business can claim a business federal income tax credit for up to 30 percent of the cost of installing non-hydrogen alternative-fuel vehicle refueling equipment (say, for your employees’ electric vehicles) through 2021.
Your business can claim a federal income tax credit for buying vehicles propelled by chemically combining oxygen with hydrogen to create electricity, through 2021 (credits range from $4,000 to $40,000).
The new law extends the seven-year recovery period to cover motorsports entertainment complex property placed in service through 2025.
You can elect to claim the first-year write-off for the cost of qualified film, television, and theatrical productions commencing before 2025, subject to a $15 million per-production limit or a $20 million limit for productions in certain disadvantaged areas.
For racehorses that are no more than two years old that you place in service during 2021, you may use three-year depreciation.

Deducting Disaster Losses for Individuals

We seem to be living in an age of natural disasters. Floods, fires, hurricanes, tornados, and other disasters often dominate the news.

If a disaster strikes you, the tax law may help. When defined as such by the tax code, a disaster loss may qualify for deduction from your taxable income. The rules for personal losses are complex and far more restrictive than for business losses.

Only Casualty Losses Are Deductible

Damage to personal property caused by a disaster is deductible only if it qualifies as a casualty loss. A casualty is damage to, destruction of, or loss of property from events such as fires and floods that are sudden, unexpected, or unusual.

The disaster must result in physical damage to property, so economic losses due to the COVID-19 pandemic do not qualify as a casualty loss.

Many, but not all, casualty losses are covered by insurance. The insurance recovery reduces your tax-deductible loss and could result in a taxable gain.

And here’s a possible nasty surprise. Say you have a deductible loss after reducing the loss by the insurance recovery. If you want to deduct the loss on your taxes, you must file a timely insurance claim, even if that insurance claim will result in the cancellation of your policy or an increase in premiums.

Your casualty loss (not your deduction) is equal to the lesser of

the decrease in the property’s fair market value after the disaster, or
the property’s adjusted basis before the disaster (usually its cost).

Subtract any insurance or other reimbursement from the lesser of these two options. To find the decline in the property’s fair market value, you can use an appraisal or the repair costs.

Limits on Casualty Losses

Unfortunately, you can’t deduct all your casualty losses. From 2018 through 2025, you can deduct personal casualty losses only due to a federally declared disaster or to the extent you have casualty gains.

For example, a homeowner can claim a casualty loss if a wildfire (declared a federal disaster) destroys his home. But he gets no deduction if a faulty fireplace caused the fire and destroys his home (no federal disaster).

The law imposes major limits on your casualty-loss deduction. The general rule says that you first reduce the loss by $100 and deduct the remaining loss only to the extent it exceeds 10 percent of your adjusted gross income (AGI). Your final hurdle is that claim the loss as an itemized deduction. These rules significantly reduce or even eliminate many casualty loss deductions.

Fortunately, some casualty losses are not subject to these limits, including disaster losses sustained due to a federally declared major disaster from January 1, 2020, to February 25, 2021. Instead, losses from such disasters are subject to a $500 floor with no 10-percent-of-AGI reduction. Under this rule, you deduct the loss whether or not you itemize. If you don’t itemize, you add the deductible loss to your standard deduction.

You have a choice for losses from a federal disaster: claim the loss in the year of the disaster or on the prior year’s return if it’s before October 15. This can result in a quick refund of all or part of the tax you paid that year.

Casualty Gains

If all this is not complicated enough, there’s one further wrinkle. A casualty such as a fire can result in a casualty gain instead of a casualty loss when the insurance proceeds you receive exceed the property’s adjusted basis (cost).

A casualty gain is taxable. But you may deduct casualty losses from the gains. Here, you don’t need a federal disaster. Also, you can postpone tax on a casualty gain by buying replacement property.

Deducting Disaster Losses for Businesses

Disasters such as storms, fires, floods, and hurricanes damage or destroy property.

If property such as an office building, rental property, a business vehicle, or business furniture is damaged or destroyed in a disaster, your business may qualify for a casualty loss deduction. It’s easier to deduct business casualty losses than personal losses, but the rules are complex.

What Business Casualty Losses Are Deductible

Disasters such as fires and floods can result in a “casualty” because the damage, destruction, or property loss is from a sudden, unexpected, or unusual event.

Car accidents qualify as a casualty so long as they’re not caused by your willful act or willful negligence. Losses due to thefts and vandalism can also qualify.

Insurance covers many casualty losses. You must reduce your casualty loss by the amount of any insurance you receive or expect to receive. But unlike with a personal loss, you are not required to file an insurance claim for a business casualty loss. You may wish not to do so if it will result in your policy’s cancellation or an increase in premiums.

Amount of Business Casualty Loss

Your casualty loss can never exceed the adjusted basis of the property involved—usually its cost plus the value of any improvements, minus all deductions you took for the property, including depreciation or Section 179 expensing. If your adjusted basis is zero, you get no casualty loss deduction and could have a casualty gain.

The amount of your casualty loss for damaged property is equal to the smaller of

the decrease in the property’s fair market value after the disaster, or
the property’s adjusted basis before the disaster.

Subtract any insurance or other reimbursement received from the smaller of these two options.

You can use an appraisal or repair costs to figure the decline in the property’s fair market value. If a casualty destroys business property, the loss is equal to the property’s adjusted basis minus salvage value and insurance proceeds, if any.

Unlike personal casualty losses, business casualty losses are not subject to either (a) the $100 floor or (b) the 10-percent-of-AGI threshold to be deductible.

Business Casualty Losses Due to Federal Disasters

If your casualty loss is due to a federally declared disaster, you have the option of deducting it in the prior year. This way, you can get a refund of all or part of the tax you paid for that year.

Casualty Gains

You’ll have a casualty gain if the insurance proceeds you receive exceed the property’s adjusted basis (cost).

A casualty gain is taxable. But you can postpone tax on a casualty gain by buying replacement property of equal or greater value within two years (four years for federal disasters).

Repair Costs

Repairs of property damaged by a casualty are not part of the casualty loss deduction. You capitalize the cost of the repairs and add them to your basis in the damaged property. But then they may qualify for depreciation or Section 179 expensing.

If you have more questions, feel free to contact us.

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