Tax update

The IRS recently issued new guidance on electric vehicles. There are four ways you can potentially benefit from a federal tax credit for an EV you place in service in 2023 or later:

1. Purchase an EV, and claim the clean vehicle credit.
2. Lease an EV, and benefit from the lessor’s EV discount.
3. Purchase a used EV that qualifies for the used EV tax credit.
4. Purchase an EV for business use, and claim the new commercial clean vehicle tax credit.

The new clean vehicle credit is available through 2032, with a maximum credit of $7,500. 

To qualify for the clean vehicle credit, you must meet specific criteria, including income limits, vehicle price caps, and domestic assembly requirements. The credit amount for vehicles delivered on or after April 18, 2023, depends on the vehicle meeting critical minerals sourcing and/or battery components sourcing requirements.

If you can’t find an EV that qualifies for the credit or your income is too high, you can lease an EV from a leasing company that can claim up to a $7,500 commercial clean vehicle tax credit. The leasing company may then pass on all or part of the credit to you through reduced leasing costs.

For used EV purchases, you can earn a credit of up to $4,000, but you must buy the vehicle from a dealer and meet the law’s income caps and other restrictions. 

Finally, if you purchase an EV for business use, you can qualify for the commercial clean vehicle tax credit, which is not subject to critical minerals or battery components rules, making it easier to qualify for this credit starting April 18, 2023.

To claim an EV credit, the seller must complete a seller’s report and provide a copy to you and the IRS. For the clean vehicle credit, you will file IRS Form 8936; for the commercial clean vehicle credit, you will file IRS Form 8936-A.

Using Family Loans to Secure Better Home Loan Interest Rates 

Here’s some information on how you can help a family member buy a home by making a loan to them while ensuring that you and the family member benefit from a tax-smart loan structure.

With the current national average interest rates for 30-year and 15-year fixed-rate mortgages at 6.81 percent and 6.13 percent, respectively, family loans can offer a much more attractive alternative. By charging the Applicable Federal Rate (AFR) as interest, you can give the borrower a good deal without giving yourself a tax headache.

The IRS issues new AFRs for term loans every month. The rates for April 2023 are as follows:

• Short-term loan (three years or less): 4.86 percent
• Mid-term loan (over three years but not more than nine years): 4.15 percent
• Long-term loan (over nine years): 4.02 percent

Charging at least the AFR for a term loan to a family member allows you to avoid federal income tax and federal gift tax complications. 

But if you charge less than the AFR, you may need to navigate some tax complications. Two tax-law exceptions, the $10,000 and $100,000 loopholes, can help you avoid these complications, although they may not be suitable for all home loans.

It is crucial to document the loan with a written promissory note and secure it with the borrower’s home for them to claim deductions for qualified residence interest expenses. Make sure the borrower signs the note and that the note includes details such as the interest rate, a schedule of interest and principal payments, and any security or collateral for the loan.

In conclusion, family loans can provide homebuyers with better interest rates than commercial lenders offer, especially if family members charge the AFR. Remember to consider the loan terms and tax consequences when structuring the loan.

Basic Estate Planning

You need an estate plan, regardless of whether or not you are among the ultra-rich. As recent news has shown, even those who have won the lottery or have substantial wealth can fall victim to poor estate planning.

While federal estate taxes may not concern you, you need a will to have your wishes honored after your death. Without a will, state law dictates the distribution of your assets, which may not align with your intentions. Additionally, if you have minor children, a will allows you to name a guardian to care for them in the event of your untimely passing.

Your heirs will want to avoid probate because it can be a costly and time-consuming legal process. A living trust gives you a valuable tool to avoid probate. By transferring legal ownership of your assets to the trust, you can ensure that your beneficiaries receive them without suffering through probate. 

You can amend your living trust as circumstances change, providing flexibility and control over your assets.

It is also essential to keep your beneficiary designations up-to-date, as they take precedence over wills and living trusts regarding asset distribution. 

Additionally, if your estate will suffer from federal or state death taxes, you should plan to minimize your exposure.

Estate planning is not a one-time event but a process that you should review and update regularly to accommodate life changes and fluctuations in estate and death tax rules. It is recommended that you check your estate plan annually to ensure it aligns with your wishes and circumstances.

One Ugly Rule for S Corp Owners Deducting Health Insurance

When your S corporation covers or reimburses your more-than-2-percent-shareholder-employee health insurance expenses, it classifies the payments as box 1 W-2 wages but not box 3 or box 5 wages.

When calculating the amount eligible for the Form 1040 self-employed health insurance deduction, you must use your Medicare wages (listed in box 5 of Form W-2) as your “earned income” rather than the amount reported in box 1.

Here are two examples that show you the impact of this rule:

• Ted’s S corporation pays him $0 in cash wages and reimburses him $18,000 for health insurance. His W-2 shows $18,000 as box 1 wages and $0 as box 3 and box 5 wages. Although Ted has $18,000 in taxable wage income from the corporation’s reimbursement of his health insurance, his Form 1040 self-employed health insurance deduction is $0 due to his lack of Medicare wages.
• Janet’s corporation pays her $107,000 in cash wages and reimburses her $22,000 for health insurance. Janet’s W-2 from her S corporation shows box 1 wages of $129,000, box 3 wages of $107,000, and box 5 wages of $107,000. The IRS allows her Form 1040 self-employed health insurance deduction of $22,000 because her Medicare wages exceed the insurance cost.

To avoid unfavorable tax outcomes, ensure that your S corporation reports Medicare wages (box 5) equal to or greater than the health insurance costs paid or reimbursed.

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

Good or Bad Idea?

As the real estate market has cooled off in many parts of the country, investing in property may seem wise in the long run. But taxes can be a significant concern. 

Owning real estate in a C corporation may not be wise when considering taxes because it puts you at risk of being double-taxed. 

This means that if you sell the property and make a profit, the gain may be subject to taxation twice—once at the corporate level and again at the shareholder level when the corporation pays out profits to shareholders as dividends.

The Tax Cuts and Jobs Act reduced the double taxation threat, but with our current federal debt, you face the risk that lawmakers will hike the corporate tax rates and possibly also tax dividends at higher ordinary income rates.

To avoid this threat, I usually recommend using a single-member LLC or revocable trust to hold real property. A disregarded single-member LLC delivers super-simple tax treatment combined with corporation-like liability protection, while a revocable trust can avoid probate and save time and money.

If you are a co-owner of real property, it is advisable to set up a multi-member LLC to hold the property. The partnership taxation rules that multi-member LLCs follow have several advantages, including pass-through taxation.

In conclusion, holding real property in a C corporation can expose you to the risk of double taxation, and I don’t recommend it. Instead, consider a single-member LLC, revocable trust, or multi-member LLC, depending on your situation.

Helicopter View of 2023 Meals and Entertainment 

As you may already know, there have been some major changes to the business meal deduction for 2023 and beyond. The deduction for business meals has been reduced to 50 percent, a significant change from the previous 100 percent deduction for business meals in and from restaurants, which was applicable only for the years 2021 and 2022.

To help you better understand the current situation, see the table below:

Are You a Regular Investor or a Tax-Favored Securities Trader?

As we navigate the recent volatility in the stock market, you may want to think about the possible favorable federal income tax treatment the tax code gives to a securities trader. 

Suppose you can qualify as a securities trader for federal income tax purposes. In that case, you deduct your trading-related expenses on Schedule C of Form 1040 and make the taxpayer-friendly mark-to-market election, which is not available to garden-variety investors.

The mark-to-market election has two important federal income tax advantages: 

1. Exemption from the capital loss deduction limitation 
2. Exemption from the wash sale rule

But there is a price to pay for these tax advantages. As a trader who has made the mark-to-market election, you must pretend to sell your entire trading portfolio at market on the last trading day of the year, which may have little or no tax impact if you have little or nothing in your trading portfolio at year-end.

Your trading activities must constitute a business for you to qualify as a securities trader, and you must meet both of the following requirements: 

1. Your trading must be frequent and substantial.
2. You must seek to profit from short-term market swings rather than longer-term strategies.

If you are a calendar-year taxpayer, the deadline to make the mark-to-market election for your 2023 tax year is April 18, 2023 (that’s right around the corner). You make the election by including a statement with your 2022 Form 1040 filed by that date or with a Form 4868 extension request for your 2022 return filed by that date.

Avoid This Family-Member S Corporation Health Insurance Mistake

There are two important issues related to health insurance deductions for S corporations. 

First, if you own more than 2 percent of an S corporation, there are three steps you need to follow to claim a deduction for health insurance:

• Step 1. The cost of the insurance must be on the S corporation’s books.
• Step 2. The corporation must include the cost of the health insurance premiums on your W-2 form as taxable income (but not subject to payroll taxes).
• Step 3. If eligible, you must claim the health insurance deduction as an above-the-line deduction on Schedule 1 of Form 1040.

Second, this three-step procedure applies to your spouse, children, grandchildren, great-grandchildren, parents, grandparents, and great-grandparents if they work for your S corporation and the corporation covers them with health insurance. 

The three rules apply to the relatives listed above who work in the S corporation, even if they don’t own any stock directly. For health insurance purposes, the tax code attributes your stock ownership to them and deems that they own what you own.

It’s crucial to get this right, as failing to do so could result in a lost health insurance deduction for your family members and zero deductions or the S corporation.

If you or your S corporation did not handle this correctly in the past, you need to amend the returns to ensure that you create and protect the proper tax deductions.

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

Here’s an update on the latest developments in 2023 health insurance for S corporation owners. As a more-than-2-percent S corporation owner, you are entitled to some good news when it comes to your health insurance.

To ensure that your health insurance deductions are in order, and to avoid the $100-a-day penalties for violating the rules of the Affordable Care Act (ACA), you should take the following steps:

1. Get the cost of the health insurance on the S corporation’s books, either by making the premium payments directly or through reimbursement.
2. Ensure that the S corporation includes the health insurance premiums on the owner-employee’s W-2 form, including the additional compensation in box 1 but not in boxes 3 or 5.
3. If you are an owner-employee with more than 2 percent ownership, claim the health insurance deduction as “self-employed health insurance” on line 17 of Schedule 1 of Form 1040. You must meet the two rules of not having access to employer-subsidized health insurance and having adequate salary.

For rank-and-file employees, the S corporation does not have to provide health insurance benefits, but if it does, it must use an acceptable ACA plan, such as (among others) the qualified small employer health reimbursement arrangement (QSEHRA) or the individual coverage HRA (ICHRA). 

The S corporation can reimburse more-than-2-percent owners for individually purchased insurance without any penalties, but if it reimburses rank-and-file employees without using the QSEHRA or ICHRA, it faces the $100-a-day penalty per employee.

If you are looking to provide health benefits to employees through the S corporation, there are many tax-advantaged options available. If the S corporation provides group health insurance to all employees, including the shareholder-employee, the same rules apply.

 

SECURE 2.0 Act Creates New Tax Strategies for RMDs 

 

As you are likely aware, if you have an IRA or other tax-deferred retirement account, you must start taking required minimum distributions (RMDs) once you reach a certain age. 

The SECURE 2.0 Act raises the age at which RMDs must first be taken, from age 72 to age 75, over the next 10 years. Specifically, the RMD age will be 73 for those born between 1951 and 1959 and 75 for those born in 1960 or later.

The purpose of RMDs is to ensure that you use the funds in your retirement accounts while you are still alive, rather than using those accounts as an estate planning device to pass money to your heirs tax-free.

The amount you are required to withdraw as an RMD depends on your age and the balance of your retirement account as of December 31 of the previous year. RMDs are required for traditional IRAs; SEP-IRAs; SIMPLE IRAs; solo 401(k) plans; and all employer-sponsored tax-deferred retirement plans, including 401(k) plans, 403(b) plans, profit-sharing plans, and 457(b) plans.

Your first RMD must be taken by April 1 of the year following the year you reach the age of RMD. For example, if you turn 73 in 2024, you have until April 1, 2025, to take your first taxable RMD. And then, including in 2025 and every year thereafter, you must take an annual RMD on or before December 31.

It’s important to note that taking two RMDs in one year could increase your tax bracket and even your Medicare premiums. If you are faced with this situation, it’s best to take the first RMD in the year you reach the age of RMD.

In the past, the IRS imposed an “excess accumulation” penalty tax of 50 percent if you failed to take your full RMD by the deadline. But starting in 2023, the SECURE 2.0 Act reduces the penalty to 25 percent. If you correct the shortfall within the “correction window,” you can reduce the penalty to 10 percent. The correction window begins on January 1 of the year following the RMD shortfall and ends on the earlier of 

• when the IRS mails a Notice of Deficiency, 
• when the penalty is assessed, or 
• the last day of the second tax year after the penalty is imposed.

If the shortfall was due to reasonable error and you took reasonable steps to remedy it, you may request a penalty waiver by filing IRS Form 5329 and a letter explaining the reasonable error. Before filing the waiver request, you should make a catch-up distribution from your retirement accounts to make up for the RMD shortfall.

 

Plan Your Passive Activity Losses for Tax-Deduction Relevance

 

In 1986, lawmakers drove a stake through the heart of your rental property tax deductions.

That stake, called the passive-loss rules, causes myriad complications that now, 37 years later, are still commonly misunderstood.

 

The Trap

 

In 1986, lawmakers made you shovel your taxable activities into three basic tax buckets. Looking at the buckets from a business perspective, you find the following:

1. Portfolio bucket for your stocks and bonds
2. Active business bucket for your material participation business activities
3. Passive-loss bucket for your rentals plus other activities in which you do not materially participate

This letter explains three escapes from the passive-loss trap so that you can realize the tax benefits from your rental losses.

 

Escape 1: Get Out of Jail Free

 

Lawmakers allow taxpayers with a modified adjusted gross income of $100,000 or less to deduct up to $25,000 of rental property losses. Once your income goes above $100,000, the get-out-of-jail-free loss deduction drops by 50 cents on the dollar and disappears altogether at $150,000 of modified adjusted gross income.

 

Escape 2: Changes in Operations

 

If you, or you and your spouse, have modified adjusted gross income that exceeds the threshold, you need a different plan to obtain immediate benefit from your rental property tax losses. 

To begin, let’s review how the tax-benefit dollars get trapped in the first place. As you may remember, to benefit from your rental property tax loss, you must either

1. have passive income from other properties or another source, or
2. both qualify as a real estate professional and materially participate in the rental property. 

Example. Say the taxable income on your Form 1040 is $200,000 and you have one rental property. Say further that rental has produced a tax loss of $10,000 a year for the past six years, none of which you have been able to deduct because you have no other passive income and you do not qualify as a tax-law-defined real estate professional.

So here you sit: $60,000 in tax deductions trapped in the passive-loss bucket—not available for deduction against the income from the other buckets.

 

Not Lost, Just Waiting

 

This is sad, no doubt, but there’s some good news even in this bucket as you now see it. The $60,000 is not going to drown, disappear, or lose its tax-deduction attributes in some other way. That $60,000 simply waits in the bucket for you to give it an escape route.

Here are four possibilities for the escape route:

1. Generate passive income.
2. Change the character of the rental to non-passive.
3. Change your status to that of a real estate professional, and pass the material participation test for this property.
4. Sell the property, as explained in Escape 3 below.

 

Escape 3: Total Release

 

The $60,000 that’s trapped in the passive-loss bucket is like money in the bank. You can tap the trap when you want to release the deductions. It’s really quite easy.

Here we are talking about releasing the entire $60,000 at once (a major jailbreak). You might want to do this right now, or you can wait. You have many options, and the good news is that you are the one in charge of this total release of your passive losses.

To release the losses, you need to make a complete disposition. For example, say you sell 100 percent of the property to a third party. Presto! You now deduct the entire $60,000 in trapped passive losses.

 

Takeaway

 

The one thing to know is that if you have rental property losses that are trapped by the passive-loss rules, you have some strategies available.

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