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Tax update

IRS Makes It Harder to Use the Section 530 Safe Harbor

May 12, 2025 by John Sanchez

It can cost you a bundle if you misclassify a worker as an independent contractor instead of an employee for federal employment tax purposes.

The IRS can make you pay back payroll taxes plus penalties—in some cases, these can equal 40 percent of gross payroll or more. That’s the bad news.

The good news: hiring firms have a “get out of jail free” card—the Section 530 safe harbor. 

If your company qualifies for Section 530 relief, the IRS can’t impose assessments or penalties for worker misclassification, and you may continue to treat the class of workers involved as independent contractors for employment tax purposes. This is so even if you should have classified the workers as employees under the regular IRS common law test.

Sounds great. What’s the catch? The catch is that it can be hard for a hiring firm to qualify for Section 530.

You must satisfy three requirements to qualify for Section 530 relief:

  1. You must have filed all required Form 1099-NEC returns (or other required information returns) for the workers involved.
  2. You must have treated all workers doing substantially similar work consistently as independent contractors.
  3. You must have a reasonable basis for treating the workers as independent contractors, such as a legal case, prior IRS audit, or long-standing practice in the industry.

For the first time in 40 years, the IRS has issued a new revenue procedure updating how it should apply Section 530. Unfortunately, the new procedure can make it harder for hiring firms to qualify for Section 530 relief.

The IRS says that in making its determination of whether a hiring firm has a reasonable basis for classifying its workers as independent contractors, it may consider whether the firm treated the workers involved as employees for non-tax purposes, such as for federal or state labor law or for state unemployment insurance or workers’ compensation insurance coverage. 

This can be problematic for hiring firms because there are various reasons why a firm might treat a worker as an employee for non-tax purposes—reasons that have nothing to do with whether the firm reasonably believed the worker qualified as an independent contractor for IRS purposes.

The IRS’s new approach makes it more important than ever for hiring firms that use independent contractors to plan ahead to ensure that they qualify for Section 530 relief. Hiring firms must document that they qualify for relief when they classify the workers as independent contractors. You can’t wait until you are audited, and the IRS questions your worker classification practices, to think about Section 530. 

 

Protect Yourself: Digitize Tax Receipts

When it comes to IRS audits, one of the most common reasons taxpayers lose deductions is the lack of proper documentation. 

While your credit card or bank statements prove you spent money, they don’t show what you purchased. Without supporting receipts or invoices, these records are considered “naked”—and during an audit, that’s a problem.

To fully protect your deductions, especially for business-related expenses such as meals, travel, vehicle use, and gifts, you need to keep receipts that document five key facts: the date, the amount, the place, the business purpose, and the business relationship. The best way to do this is by capturing digital copies of your receipts.

Fortunately, it’s now easier than ever. Using your smartphone, you can snap a photo of your receipt and store it securely using apps such as Shoeboxed, Expensify, Zoho Expense, and others. These tools often let you add notes, categorize expenses, and sync directly with accounting software like QuickBooks or FreshBooks.

Why go digital? Paper receipts fade—especially those printed on thermal paper. Digitizing them ensures they’re legible and accessible when needed, whether for year-end tax preparation or an unexpected audit.

Taking a few seconds now to scan or photograph each receipt can save you time, stress, and potential lost deductions later.

 

Avoid Unwanted Partnership Tax Status: Elect Out

If you’re involved in a real estate or investment venture with one or more other parties—perhaps co-owning property or collaborating on a business project—you might think you’re simply sharing ownership. 

But the IRS may see it differently. Without proper precautions, your arrangement could be classified as a partnership for federal tax purposes, triggering filing requirements and potential penalties you weren’t expecting.

 

Why It Matters

Under IRS rules, many informal joint ventures—such as syndicates, pools, and unincorporated business arrangements—can be treated as partnerships, even without a legal partnership agreement. 

This could mean:

  • You would need to file Form 1065 annually.
  • You would have to issue Schedule K-1s to all co-owners.
  • You might lose eligibility for Section 1031 like-kind exchanges.
  • You could incur potential IRS penalties of up to $255 a month per partner, limited to 12 months.

Fortunately, if your situation qualifies, you can elect out of partnership status and avoid these headaches.

 

How to Elect Out

The IRS allows co-owners of certain investments—such as real estate or oil and gas ventures—to opt out by filing a “blank” Form 1065 with specific details and a formal election statement. This proactive step ensures each owner can independently report income and deductions on their return, often using Schedule E or Schedule F of Form 1040.

 

Take Action Now

Failing to file a partnership return when required can be costly.

 

Greed or Goodwill? Your Motive Makes a Scam Loss Deductible

Scams are incredibly common. 

According to recent Federal Trade Commission data, consumers reported losing more than $12.5 billion to fraud in 2024. They reported losing more money to investment scams—$5.7 billion—than any other category. Older people are particularly prone to being scammed. 

If you’re the victim of a scam, can you deduct your losses as a theft loss? In the past, you often could because losses due to fraud and larceny were deductible theft losses subject to certain limits.

All this changed in 2017 when Congress enacted the Tax Cuts and Jobs Act (TCJA). The TCJA added a new provision to the tax code, providing that from 2017 to 2025, personal theft losses are deductible only if they are attributable to a federally declared disaster. This means almost all theft losses are not deductible at all during these years.

But all is not necessarily lost for fraud victims. Thefts involving business property and those involving transactions entered into for profit are deductible without the need for a disaster. Thefts arising from for-profit activities are deductible as a miscellaneous itemized deduction on Schedule A, not subject to the 2 percent of adjusted gross income floor.

Thus, if you’re the victim of a scam, you can get a theft loss deduction if it arose from a for-profit transaction.

The IRS chief counsel has provided helpful guidance explaining when common scams are deductible. The scams clarified involve victims transferring money from their IRA and non-IRA accounts to scammers, typically overseas.

The IRS chief counsel advised that losses due to compromised account scams, “pig butchering” investment scams, and phishing scams are deductible because the victims of these scams all have a profit motive: earning more investment returns or safeguarding IRA and non-IRA accounts established to earn a profit.

On the other hand, losses due to romance scams or fake kidnapping scams are not deductible as theft losses because the victims voluntarily transferred their money to the scammers out of mistaken love or intending to protect loved ones—which are not profit motives. Their losses were non-deductible personal theft losses.

In short, losses due to scams that rely on the victim’s greed are deductible. Losses from scams that count on the victim’s love or desire to help others are not deductible. 

This seems ridiculous, but it is the natural result of the very harsh rule established by the TCJA, which states that personal theft losses are never deductible. The IRS chief counsel tries to ameliorate the harshness of this rule by taking a relatively liberal view of what constitutes a transaction entered into for profit.

Filed Under: Tax update, Tax-saving tips, Tax-savings

Court Battles Rage: File Your FinCEN BOI Report Now or Wait?

January 20, 2025 by John Sanchez

Court Battles Rage: File Your FinCEN BOI Report Now or Wait?

Here’s an update on the Corporate Transparency Act (CTA) and its beneficial ownership information (BOI) reporting requirements. Recent legal developments have created uncertainty around filing deadlines, and it’s important to understand your options and responsibilities.

 

Background on the CTA

The CTA requires many smaller corporations and LLCs to file a BOI report with FinCEN, identifying and providing contact information for the individuals who own or control the entity. This report is used solely for law enforcement purposes and is not made public.

Initially, businesses in existence before 2024 were required to file by January 1, 2025, while new businesses formed in 2024 had a 90-day filing deadline. However, recent court rulings have disrupted these deadlines.

 

Current Status

As of January 1, 2025, a nationwide injunction is in place, delaying all BOI filing requirements. While the injunction is active, you are not required to file a BOI report, and no penalties apply for non-filing. The injunction impacts the following entities:

  • Businesses formed before 2024 with a January 1, 2025, deadline
  • New businesses formed in 2024 with a 90-day filing deadline
  • Businesses with changes requiring updates to previously filed reports

 

Voluntary Filing Option

Although filing is not currently required, you may file voluntarily. This can simplify compliance by avoiding last-minute deadlines if the injunction is lifted. Should the injunction end, deadlines may resume with little notice, so being prepared is essential.

 

Takeaways

While the CTA remains under judicial review, you are not obligated to file your BOI report. But it may be prudent to prepare now by gathering the necessary information. If you have already filed, no further action is needed unless there are reportable changes.

 

Can Real Estate Professional Status Free Up Old Passive Losses?

Deducting your rental property tax losses against your other income is tricky, as you likely know. You have to get the tax law to treat you—say, a computer engineer—as a tax-code–defined real estate professional.

Let’s say you get there. Does that status allow immediate use of suspended passive losses? Unfortunately, the answer is no. Here’s why.

 

Understanding Passive Loss Rules

The tax code limits passive loss deductions to passive income, with any excess carried forward to future years. You release the carried-forward losses when you have offsetting passive income from the same or other passive activities, or when you completely dispose of the activity generating the loss.

 

Real Estate Professional Status

Qualifying as a real estate professional under IRS rules requires meeting two tests annually:

  1. Spend more than 50 percent of your work time in real property trades or businesses.
  2. Perform at least 750 hours of your work in real property trades or businesses.

 

Material Participation

Additionally, to create non-passive losses, you must materially participate in the rental activity.

 

The Two-Part Solution 

Meeting (1) the real estate professional test and (2) the material participation standard allows current-year rental losses to offset non-passive income, such as wages or business income.

 

Impact on Prior Passive Losses

Qualifying as a real estate professional is not retroactive. Suspended passive losses from prior years remain subject to the original rules. You can use the prior suspended losses in the following ways:

  • To offset passive income from the same or other passive activities
  • When you completely dispose of the activity that created the suspended passive losses

 

Key Takeaways

Real estate professional status offers valuable tax benefits for your rental properties but does not free up prior passive losses. Annual testing is required to maintain this status.

 

Missed an Estimated Tax Payment—Now What?

Missing an estimated tax payment can result in non-deductible penalties. Make timely payments via IRS Direct Pay or EFTPS—secure and convenient methods to help you avoid the penalties.

 

Key Points

  • Due dates. For tax year 2024, payment deadlines are April 15, June 17, and September 16, 2024, and January 15, 2025. For tax year 2025, payments are due April 15, June 16, and September 15, 2025, and January 15, 2026.
  • Avoid penalties. Pay at least 90 percent of your current year’s tax or 100 percent of last year’s tax—or 110 percent if prior-year adjusted gross income (AGI) exceeds $150,000.
  • Exceptions. Uneven income earners can use the annualized income method to align payments with earnings.
  • Catch-up payments. Catching up when you miss a payment stops the penalty from accruing further but does not achieve forgiveness for the previous penalty assessed.

 

Tax-Free Home Sale: When and Why You Need to Report to the IRS

You’re probably aware that when you sell your home, you may exclude up to $250,000 of your gain from tax if you’re unmarried (or married, filing separately) and $500,000 if you are married and file jointly. 

To claim the whole exclusion, you must have owned and lived in your home as your principal residence for an aggregate of at least two of the five years before the sale. You can claim the exclusion once every two years.

The home sale exclusion is one of the great tax benefits of home ownership. Many home sellers owe no tax at all when they sell their homes.

If a home sale is tax-free due to the exclusion, do you need to report the sale to the IRS on your tax return? It depends.

Your home sale may have already been reported to the IRS by your real estate agent, closing company, mortgage lender, or attorney. The IRS has a special information return for this purpose: Form 1099-S, Proceeds from Real Estate Transactions. This form lists 

  • the gross proceeds from the sale, 
  • the property address, and 
  • the closing date.

Typically, the 1099-S is issued at the home sale closing and is included in the closing documents you receive at settlement. If you received a Form 1099-S, you must report the sale on your tax return, even if your entire gain is tax-free due to the $250,000/$500,000 exclusion. Failure to do so will result in the IRS assuming that the selling price is the taxable gain (and that’s a mess).

Form 1099-S need not be filed if your home sold for less than the applicable $250,000/$500,000 exclusion and you sign a certification stating that you qualified for the exclusion. You generally do this at the closing.

If Form 1099-S was not issued, the IRS does not require you to report the sale on your return. But doing so anyway can be a good idea because it can prevent the IRS from asserting that the six-year statute of limitations on audits should apply because you omitted more than 25 percent of gross income from your return.

Reporting the sale of a principal residence is not difficult. You must file IRS Form 8949, Sales and Other Dispositions of Capital Assets, with your annual return and enter your zero gain on IRS Schedule D.

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

Filed Under: Tax update, Tax-saving tips, Tax-savings

Tax Guide to Deducting Long-Term Care Insurance Premiums

August 17, 2024 by John Sanchez

Tax Guide to Deducting Long-Term Care Insurance Premiums

Tax Guide to Deducting Long-Term Care Insurance Premiums

Long-term care costs can be substantial, and neither Medicare nor Medicaid provide comprehensive coverage for most people. Long-term care insurance can help protect your finances, and there may be ways to deduct the premiums, depending on your business structure.

Here are four key points to consider:

  1. C corporations can provide long-term care insurance as a fully deductible, tax-free benefit to owners.
  2. Sole proprietors or single-member LLCs with a spouse as the only employee may be able to deduct 100 percent of the premiums through a Section 105-HRA plan.
  3. S corporation owners, partners, and other sole proprietors may be able to deduct premiums subject to age-based limits.
  4. If you don’t qualify for business-related deductions, you might deduct premiums as itemized deductions subject to age-based limits and the 7.5 percent floor.

Smart Solutions That Decrease Social Security and Medicare Taxes

Here are some important updates and strategies regarding Social Security and Medicare taxes that may significantly impact your business.

For 2024, the Social Security tax ceiling increased to $168,600, resulting in a maximum Social Security tax of $20,906 for high-earners. The Social Security Administration projects this ceiling to rise annually, reaching $242,700 or more by 2033. Additionally, the government adds a 2.9 percent Medicare tax to all wages and self-employment income, with an extra 0.9% for high-income earners.

If you’re self-employed, these taxes can be particularly burdensome. Here are three strategies that can potentially reduce your tax liability:

  1. Operate as an S corporation. This structure allows the corporation to pay you a reasonable salary and distribute the remaining profits to you, exempt from self-employment taxes.
  2. Leverage community property rules. Married filers living in community property states can use IRS rules to eliminate or create a spouse partnership in order to reduce self-employment taxes.
  3. Avoid the husband-wife partnership classification. With close attention to partnership attributes, you can avoid the husband-wife partnership classification and reduce overall self-employment taxes.

Each of these strategies has specific requirements and potential trade-offs.

What Happens When You Die and Your S Corporation Owns the Rental?

You may own an S corporation with a rental property as its sole asset.

A common concern with this approach is what happens when the owner passes away, specifically regarding the step-up in basis.

Here’s good news. While technically the rental property itself doesn’t receive a step-up in basis upon your death, your heirs will achieve the same outcome. It works like this:

  • Your heirs inherit the S corporation stock at its stepped-up fair market value.
  • When the S corporation sells the rental property, it recognizes a gain.
  • The gain on the rental property increases your heirs’ basis in the S corporation stock.
  • Upon liquidation of the S corporation, your heirs recognize a capital loss that offsets the earlier gain.

The result is that your heirs can potentially sell the property without incurring any federal income tax liability, effectively achieving the same outcome as they would with a traditional rental property basis step-up.

Reduce Taxes by Using the Best Cryptocurrency Accounting Method

Consider this happy scenario: You purchased one Bitcoin for $15,000 14 months ago and another six months later for $40,000. Today, you sell one Bitcoin for $60,000. You’re a genius! But is your taxable gain $45,000 or $20,000? 

It all depends on your crypto accounting method.

Many crypto owners are enjoying substantial gains at a time of surging cryptocurrency prices. When you sell multiple crypto units in the same year, you reduce your taxable gains using a crypto accounting method that provides the highest possible tax basis for each unit sold, resulting in the lowest taxable profit.

As you might expect, the default method approved by the IRS doesn’t always provide the highest basis, resulting in higher taxes. The IRS made FIFO (first in, first out) the default method. It requires you to calculate your basis in chronological order for each crypto unit sold. With FIFO, your basis in the above example is $15,000, and your taxable profit is $45,000.

You can use a method other than FIFO. The other methods are called “specific identification methods” and include HIFO (highest in, first out) and LIFO (last in, first out). With HIFO, you are deemed to sell the crypto units with the highest cost basis first; your basis in the above example would be $40,000, and your taxable profit only $20,000.

Because HIFO sells your crypto with the highest cost basis first, it ordinarily results in the lowest capital gains and the largest capital losses. But using HIFO can cause loss of long-term capital gains treatment if you have not held the crypto for more than one year.

Using HIFO or LIFO is more complicated than using FIFO. You must keep records showing

  • the date and time you acquired each crypto unit,
  • your basis and the fair market value of each unit at the time it was acquired,
  • the date and time each unit was sold or disposed of, and
  • the fair market value of each unit when sold or disposed of.

If you lack adequate records, the IRS will default to the FIFO method during an audit, which could result in more taxable profit.

It’s next to impossible to manually create the needed crypto records, particularly if you have many trades. Most crypto owners use specialized crypto tax software that automates the basis and gain/loss calculations and can even fill out the required tax forms.

You can change your crypto accounting method from year to year without obtaining IRS permission—for example, you can change from FIFO to a specific identification method such as HIFO. You don’t have to disclose which method you use on your tax return.

Avoid the Hidden Dangers of the Accumulated Earnings Penalty Tax

If you run your business as a regular C corporation, beware of the accumulated earnings tax (AET). 

The IRS can use the AET to penalize C corporations that retain earnings in the business rather than pay them to shareholders as taxable dividends. When retaining earnings, the C corporation first pays the corporate tax of 21 percent on those earnings.

When the corporation distributes those already taxed earnings to shareholders, the shareholders include those distributed earnings as dividends in their taxable income, where they are taxed again at the shareholders’ capital gains rate.

The AET is a flat 20 percent tax. It is a penalty tax imposed after an audit in which the IRS concludes that the corporation paid out insufficient dividends when compared with the amount of income accumulated by the corporation. 

You have AET exposure when your C corporation has large balances in retained earnings, cash, marketable securities, or loans to shareholders reported on its balance sheet on IRS Form 1120, Schedule L.

The IRS can impose the AET on any C corporation, including public corporations. However, closely held C corporations are the most likely targets because their shareholders have more influence over dividend policy than do public corporations’ shareholders.

Historically, IRS auditors have not prioritized the AET, but anecdotal evidence suggests this may change.

Fortunately, there are many ways to avoid problems with the AET—for example:

  • Elect S corporation status.
  • Retain no more than $250,000 in earnings ($150,000 for corporations engaged in many types of personal services)—all C corporations are allowed to retain this much without incurring the AET.
  • Establish that the corporation needs to retain earnings above $250,000/$150,000 for its reasonable business needs—for example, to provide necessary working capital, fund expansion needs, pay debts, or redeem stock. 

The key to avoiding the AET is to document the reasons for accumulating earnings beyond $250,000/$150,00 in corporate minutes, board resolutions, business plans, budget documents, or other contemporaneous documentation.

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

Filed Under: Tax update, Tax-saving tips, Tax-savings

Claim Up to $32,220 Today

July 12, 2024 by John Sanchez

Claim Up to $32,220 in Missed 2021 Self-Employed COVID-19 Sick and Family Leave Credits Today

Claim Up to $32,220 in Missed 2021 Self-Employed COVID-19 Sick and Family Leave Credits Today

Were you self-employed during 2021? If so, there is a good chance that you could have qualified for COVID-19 sick and family leave credits worth as much as $32,220.

If you’re like many self-employed individuals or partners, you probably never heard about these tax credits. Unlike employee retention credit for employers, the special temporary credits for the self-employed received relatively little publicity. Many tax professionals were unaware of them. As a result, many self-employed individuals and partners never applied for them.

You qualified for the credits if you could not work or telework for various COVID-related reasons—for example, if you suffered from COVID-19; were under quarantine; underwent COVID testing; or looked after a friend, roommate, or family member impacted by the virus.

There are four separate credits:

  1. Credit for Sick Leave—January 1, 2021, through March 31, 2021
  2. Credit for Family Leave—January 1, 2021, through March 31, 2021
  3. Credit for Sick Leave—April 1, 2021, through September 30, 2021
  4. Credit for Family Leave—April 1, 2021, through September 30, 2021

The COVID-related sick leave credit was for up to 10 days from January 1, 2021, through March 31, 2021, plus an additional 10 days from April 1, 2021, through September 30, 2021. The maximum credit was $511 per day ($200 per day if you cared for others).

The COVID-related family leave credit was capped at $200 per day. Up to 50 days of credits were available from January 1, 2021, through March 31, 2021, plus an additional 60 days from April 1, 2021, through September 30, 2021. From January 1, 2021, through March 31, 2021, the credit was available only if you needed to care for a child whose school was closed or whose caregiver was unavailable because of COVID. From April 1, 2021, through September 30, 2021, lawmakers greatly expanded eligibility to include caring for yourself, roommates, friends, and relatives.

You were supposed to claim the credits on your 2021 tax return. But if you overlooked the credits, don’t worry. You can still claim them by amending your 2021 tax return. You need to file a completed 2021 IRS Form 7202, Credits for Sick Leave and Family Leave for Certain Self-Employed Individuals, along with Form 1040-X.

To determine your eligible sick and family leave days, you’ll likely have to consult your calendar for 2021, emails, vaccination or other medical records, school records, or other records showing the days you could not work for COVID-related reasons. 

You don’t need to file any documentation with your amended return. Just keep it with your tax records. 

You must file your amended return within three years (including extensions). The deadline is April 18, 2025, or if you filed for an extension, up to October 15, 2025. But why wait? Amend your 2021 tax return today, and you’ll get your money as soon as possible.

Shutting Down Your S Corporation

As you consider the process of shutting down your S corporation, it is crucial to understand the federal income tax implications that come with it. Here, I outline the tax basics for the corporation and its shareholders under two common scenarios: stock sale and asset sale with liquidation.

Scenario 1: Stock Sale

One way to shut down an S corporation is to sell all your company stock. The gain from selling S corporation stock generates a capital gain. Long-term capital gain tax rates apply if you held the shares for more than a year. The maximum federal rate for long-term capital gains is 20 percent, but this rate affects only high-income individuals.

If you are a passive investor, you may also owe the 3.8 percent Net Investment Income Tax (NIIT) on the gain. But if you actively participate in the business, you are exempt from the NIIT. Additionally, state income tax may apply to the gain from selling your shares.

Scenario 2: Asset Sale and Liquidation

A more common way to shut down an S corporation involves selling all its assets, paying off liabilities, and distributing the remaining cash to shareholders. Here’s how the tax implications unfold.

Taxable gains and losses. The S corporation recognizes taxable gains and losses from selling its assets. These gains and losses are passed to shareholders and reported on their personal tax returns. You will receive a Schedule K-1 showing your share of the gains and losses to report on your Form 1040.

Long-term gains and ordinary income. Gains from assets held for more than a year are typically taxed as Section 1231 gains at long-term capital gains rates. But gains attributable to certain depreciation deductions are taxed at higher ordinary income rates, up to 37 percent. Real estate depreciation gains attributable to straight-line depreciation can be taxed up to 25 percent.

NIIT considerations. Passive investors may owe the 3.8 percent NIIT on passed-through gains, while active participants are exempt.

Liquidating distributions. The cash distributed in liquidation that exceeds the tax basis of your shares results in a capital gain, taxed as a long-term capital gain if held for more than a year. If the cash is less than the basis, it results in a capital loss.

Tax-Saving Strategy for Asset Sales

Your number one strategy for tax savings is to allocate more of the sale price to assets generating lower-taxed gains (e.g., land, buildings) and less to those generating higher-taxed ordinary income (e.g., receivables, heavily depreciated assets).

Compliance and Reporting

Report asset sales and allocations on IRS Form 8594 (Asset Acquisition Statement Under Section 1060).

File the final federal income tax return using Form 1120-S, including final shareholder Schedule K-1s.

Know the Exceptions to the 10 Percent Penalty on Early IRA Withdrawals

Early withdrawals from a traditional IRA before age 59 1/2 generally incur a 10 percent penalty tax on the taxable portion of the withdrawal. There are several exceptions to this rule that can help you avoid the penalty under specific circumstances. Below, we have outlined the key exceptions that may apply to your situation.

Substantially equal periodic payments. You can arrange for a series of substantially equal periodic payments. This method requires careful calculation and adherence to strict rules but allows penalty-free withdrawals.

Medical expenses. Withdrawals for medical expenses exceeding 7.5 percent of your adjusted gross income, or AGI, are exempt from the penalty.

Higher education expenses. You can use penalty-free withdrawals for qualified higher education expenses for you, your spouse, and your children.

First-time home purchase. You can withdraw up to $10,000 (lifetime limit) for qualified home acquisition costs without penalty.

Birth or adoption. You can withdraw up to $5,000 for expenses related to the birth or adoption of a child.

Emergency expenses. Starting January 1, 2024, you can withdraw up to $1,000 annually for emergency personal expenses without penalty.

Disaster recovery. Withdrawals for qualified disaster recovery expenses are exempt from the penalty, up to an aggregate limit of $22,000.

Disability. If you are disabled and cannot engage in substantial gainful activity, you can withdraw funds without penalty.

Long-term care. Beginning December 29, 2025, you can take penalty-free withdrawals for qualified long-term care expenses.

Terminal illness. Withdrawals due to terminal illness are exempt from the penalty.

Post-death withdrawals. Amounts withdrawn after the IRA owner’s death are not subject to the penalty.

Military reservists. Active-duty military reservists called to duty for at least 180 days can withdraw funds without penalty.

Health insurance premiums during unemployment. If you receive unemployment compensation for 12 consecutive weeks, you can withdraw funds to pay for health insurance premiums without penalty.

Domestic abuse victims. Starting January 1, 2024, you can take penalty-free withdrawals of up to $10,000 if you are a victim of domestic abuse.

IRS levies. Withdrawals to pay IRS levies on the IRA account are not subject to the penalty.

It’s important to note that SIMPLE IRAs incur a 25 percent penalty for early withdrawals within the first two years of participation. Additionally, Roth IRAs have different rules, allowing penalty-free access to contributions but potentially taxing and penalizing withdrawals of earnings.  If you have questions, don’t hesitate to contact me.

Filed Under: Tax update, Tax-saving tips

Cost Segregation: Is This Strategy for You?

June 13, 2024 by John Sanchez

Cost Segregation

One significant tax benefit of owning residential rental property or non-residential commercial or investment property is depreciation—a deduction you get without spending any additional money.

But regular depreciation for real property is slow. Residential rental property is depreciated over 27.5 years and non-residential property over 39 years, providing a relatively small deduction each year.

Fortunately, there is a way you can speed up your depreciation deductions—especially during the first year or years you own the property: cost segregation.

“Cost segregation” is the technical term for separately depreciating the elements of property that are not real property. These are elements other than land, buildings, and building components. They include

  • improvements made to the land, such as landscaping, swimming pools, paved parking areas, and fences; and
  • personal property items inside a building that are not building components—for example, refrigerators, stoves, dishwashers, and carpeting in residential rentals.

Using cost segregation does not increase a property owner’s total depreciation deductions, but it does accelerate them over the first few years because personal property has a five- or seven-year depreciation period and land improvements a 15-year period. 

In addition, by using bonus depreciation and/or Section 179 expensing, owners can deduct all or most of the cost of personal property and land improvements the first year they own the property—providing a potentially enormous first-year deduction.

A cost segregation study must be conducted to identify which building elements are personal property and land improvements and then to determine their depreciable basis. Studies can be conducted by engineers or done more cheaply with other methods that the IRS views as less reliable.

Cost segregation may not be advisable for every property owner—for example, where it results in a loss that can’t be deducted due to the passive loss rules, or where the owner intends to sell the property within a few years and has to recapture as ordinary income the cost-segregated depreciation deductions.

The best time to perform a cost segregation study is the same year you buy, build, or remodel your real property. But you can wait until a future year—perhaps when you have enough rental or other passive income to use the speeded-up depreciation deductions.

 

Tax Implications of Shutting Down a Sole Proprietorship

As you consider shutting down your sole proprietorship or your single-member LLC treated as a sole proprietorship for tax purposes, it’s crucial to understand the tax implications of this decision. Here’s an overview of key points you need to consider.

  1. Asset Sale Tax Implications

When you sell a sole proprietorship, you sell its assets, not the company. Federal tax rules tell you how to allocate the total sale price to specific business assets. This allocation is critical as it impacts the calculation of taxable gain and loss.

  1. Taxable Gain and Loss
  • Gain. You have a taxable gain if the allocated sale price exceeds the asset’s tax basis (original cost plus improvements minus depreciation/amortization).
  • Loss. You incur a deductible loss if the tax basis exceeds the sale price.
  1. Special Rules for Depreciable Real Estate

For depreciable real estate, specific federal income tax rules apply:

  • Section 1250 ordinary income recapture. The portion of the gain on sale attributable to tax-code-defined “additional depreciation.” It’s taxed at ordinary income rates. 
  • Section 1231 gains. Gains from the sale or exchange of real estate used in a trade or business, which the tax code treats as long-term capital gains if the gains exceed any non-recaptured Section 1231 losses from the previous five years.
  • Unrecaptured Section 1250 gain. The portion of gain from the sale of real estate attributable to depreciation deductions previously taken on the property that were not recaptured as ordinary income under Section 1250. The unrecaptured 1250 gain is taxed at a maximum rate of 25 percent.
  1. Other Depreciable or Amortizable Assets

Gains attributable to depreciation or amortization deductions are recaptured and taxed at higher ordinary income rates. Remaining gains on assets held for more than one year are taxed at lower long-term capital gains rates.

  1. Non-Compete Agreement Payments

Payments received under a non-compete agreement are treated as ordinary income but are not subject to self-employment tax.

  1. Tax-Saving Strategies

To minimize tax liability, strategically allocate more of the sale price to assets generating lower-taxed long-term capital gains and less to those generating higher-taxed ordinary income.

  1. Tax Return Reporting

Report gains and losses on IRS Form 4797 and Schedule D for capital gains and losses. Use IRS Form 8594 to allocate the sale price and IRS Form 8960 to calculate the net investment income tax, if applicable (not likely).

  1. State Income Tax

You may also owe state income tax on gains from the sale of your business.

Takeaways

Properly managing the shutdown of your sole proprietorship or single-member LLC involves careful planning and accurate reporting to optimize tax outcomes.

 

Limited Partners and Self-Employment Taxes

Self-employment taxes are substantial, and most people want to minimize them. Self-employed taxpayers often avoid self-employment taxes by operating as an S corporation.

The distributions from the S corporation are not subject to self-employment tax. But Social Security and Medicare tax must be paid on the shareholders’ employee compensation (which must be reasonable based on the services they provide). S corporations are also subject to various legal restrictions that can be inconvenient. 

How about using the partnership form to avoid self-employment tax? This doesn’t work for general partnerships because general partners always have to pay self-employment taxes on their distributive share of the ordinary income earned from the partnership’s business.

But what about limited partnerships? These are partnerships that contain two classes of partners:

  1. General partners who are personally liable for partnership debts and manage the business 
  2. Limited partners whose personal liability for partnership debts is limited to the amount of money or other property they contribute

The tax law provides that limited partners “as such” don’t have to pay self-employment tax on their distributive share of partnership income. 

Moreover, in about half the states, limited partnership laws have been revised to permit limited partners to work for the partnership without losing their limited liability.

Does this mean limited partners in many states can work for the partnership and avoid paying self-employment tax on their share of the partnership income? High-earning limited partners—hedge fund managers, for example—could save substantial tax if this were the case.

Unfortunately, in Soroban, a recent precedential decision involving a highly successful hedge fund and well-paid limited partners, the U.S. Tax Court held that the answer to this question is “no.”

The court held that the limited partner exception to self-employment taxes applies only to limited partners who are passive investors, not to those actively involved in the partnership business.

Soroban is the latest in a series of cases involving self-employment taxes for partnership-like entities that the IRS has won. The other cases involved active participants in a state limited liability partnership, a limited liability company taxed as a partnership, and a professional limited liability company. Only passive investors in these entities can avoid self-employment tax.

Encouraged by these victories, the IRS is writing regulations requiring a functional analysis to determine whether a person is a limited partner. The IRS is also likely to conduct more self-employment audits of limited partnerships.

Understanding these scenarios and planning accordingly can help mitigate tax burdens and streamline the dissolution process. If you have questions, don’t hesitate to contact me.

Filed Under: Tax update, Tax-saving tips

IRAs for Young Adults

March 16, 2024 by John Sanchez

IRAs for Young Adults

As we navigate the complexities of financial planning, one opportunity stands out for young adults: individual retirement accounts (IRAs). With the 2023 tax-year contributions deadline fast approaching on April 15, 2024, now is the perfect time to consider how you can leverage an IRA.

Traditional and Roth IRAs: A Brief Overview

Both traditional and Roth IRAs offer unique benefits, so the choice between them largely depends on your current financial situation and future expectations. For the 2023 tax year, you can contribute up to $6,500 or your earned income for the year, whichever is less. This cap increases to $7,000 for the 2024 tax year.

Traditional IRAs provide the potential for tax-deductible contributions, which can be particularly advantageous if you’re looking for immediate tax relief. The deductibility of your contributions may phase out based on your income and whether you’re covered by a workplace retirement plan. It’s also important to note that withdrawals from traditional IRAs are taxable, and early withdrawals may incur penalties.

On the other hand, Roth IRAs offer tax-free growth and tax-free withdrawals in retirement. Although contributions are not tax-deductible, the tax-free withdrawal benefit in retirement can be significant, especially if you expect to be in a higher tax bracket then. Additionally, Roth IRAs do not require minimum distributions during your lifetime, offering more flexibility in retirement planning.

Key Considerations for Young Adults

Income limits and phaseouts. Be mindful of the income-based phaseout ranges that may affect your ability to contribute to Roth IRAs or deduct traditional IRA contributions.

Tax bracket considerations. Your current and expected future tax brackets are critical in deciding between traditional and Roth IRAs. If you anticipate being in a higher tax bracket in retirement, Roth IRAs may offer greater benefits.

Flexibility and future planning. Roth IRAs provide significant flexibility, allowing for tax-free and penalty-free withdrawals of contributions and offering benefits to your heirs.

The Power of Early Contributions

If you can start your IRA contributions while young, you can significantly impact your retirement savings. Even modest annual contributions can grow substantially over time, thanks to the power of compounding.

Get up to $32,220 in Sick and Family Leave Tax Credits  

If you are self-employed or operate a small corporation, it’s likely that you have not applied for your sick and family leave tax credits.

If that’s the case, we will need you to get your act together so we can file amended 2021 and 2020 tax returns now. You could find up to $32,220 in tax credits. 

To see if you qualify for the credits, ask yourself if you were unable to work or perform services from April 1, 2021, through September 30, 2021, on any day, for one or more of the following reasons: 

  1. You were subject to a federal, state, or local quarantine or isolation order related to COVID-19.
  2. You were advised by a health care provider to self-quarantine due to concerns related to COVID-19.
  3. You were experiencing symptoms of COVID-19 and seeking a medical diagnosis of COVID-19.
  4. You were seeking or awaiting the results of a diagnostic test for, or a medical diagnosis of, COVID-19.
  5. You were exposed to COVID-19 or were unable to work pending the results of a test or diagnosis.
  6. You were obtaining immunization related to COVID-19.
  7. You were recovering from any injury, disability, illness, or condition related to such immunization.
  8. You were caring for an individual who was subject to a federal, state, or local quarantine or isolation order related to COVID-19.
  9. You were caring for an individual who had been advised by a health care provider to self-quarantine due to concerns related to COVID-19.
  10. You were caring for your son or daughter because the school or place of care for that child was closed, or because the childcare provider for that child was unavailable, due to COVID-19 precautions.
  11. You were accompanying an individual to obtain immunization related to COVID-19.
  12. You were caring for an individual who was recovering from any injury, disability, illness, or condition related to the immunization.

If you answered yes to any of these 12 questions, you qualify for tax credits. And depending on the number of qualifying days and your income, such credits could total $32,220 just for you. There’s much to this.

New Crypto Tax Reporting Rules Are Coming Soon

If you invest or trade in Bitcoin, non-fungible tokens (NFTs), Stablecoins, or other digital assets, prepare for sweeping new tax reporting requirements.

Congress wants the IRS to crack down on taxpayers who buy and sell crypto but don’t report or pay tax on their gains. To do so, it wants people and companies that facilitate the sale of digital assets to provide the IRS with the same information that stockbrokers must provide when selling stocks and other investments.

Crypto is complicated, so it has taken the IRS two years to draft over 280 pages of proposed regulations explaining how these new reporting requirements should work.

Starting with the 2025 tax year (which is just around the corner), digital asset brokers must file a new Form 1099-DA with the IRS whenever they facilitate the sale of digital assets. The 1099-DA will include such information as the customer name and TIN, sales proceeds, tax basis, and gains and losses.

“Digital asset” is defined broadly to include any digital representation of value recorded on a blockchain, including Bitcoin and other cryptocurrencies, Stablecoins, and NFTs. 

“Digital asset brokers” includes any entities that provide services that facilitate sales of digital assets and that would typically know or be in a position to know the identities of the parties involved in such sales. This includes digital asset trading platforms, payment processors, and many digital wallet providers.

The IRS scheduled the reporting rules to go into effect in two stages: For the 2025 tax year, brokers must report the gross proceeds of digital asset sales. For 2026 and later, brokers must report the adjusted basis and whether any gains or losses are short-term or long-term. Brokers do not have to report digital asset sales for tax years 2023 and 2024.

When the reporting requirements take effect, the IRS estimates that it will receive eight billion new Form 1099-DAs each year filed on behalf of 13 million to 16 million taxpayers.

Receiving Form 1099-DA should make your life easier when you file your tax return. You can rely on the gains and losses reported on the form when you complete your return. 

The new rules will also enable the IRS to compare the amounts reported on Form 1099-DA with the numbers taxpayers report on their returns. If there is a discrepancy, the IRS system will automatically send you a notice to correct your error. So, the days of evading tax on crypto transactions may soon be over.

The proposed regulations are not set in stone. There could be more changes before those rules go into effect.

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

Filed Under: Tax update, Tax-saving tips

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