Small business owners are well aware of the increasing cost of employee health care benefits. As a result, your business may be interested in providing some of these benefits through an employer-sponsored Health Savings Account (HSA). Or perhaps you already have an HSA. It’s a good time to review how these accounts work since the IRS recently announced the relevant inflation-adjusted amounts for 2021.
The basics of HSAs
For eligible individuals, HSAs offer a tax-advantaged way to set aside funds (or have their employers do so) to meet future medical needs. Here are the key tax benefits:
- Contributions that participants make to an HSA are deductible, within limits.
- Contributions that employers make aren’t taxed to participants.
- Earnings on the funds within an HSA aren’t taxed, so the money can accumulate year after year tax free.
- HSA distributions to cover qualified medical expenses aren’t taxed.
- Employers don’t have to pay payroll taxes on HSA contributions made by employees through payroll deductions.
Key 2020 and 2021 amounts
To be eligible for an HSA, an individual must be covered by a “high deductible health plan.” For 2020, a “high deductible health plan” is one with an annual deductible of at least $1,400 for self-only coverage, or at least $2,800 for family coverage. For 2021, these amounts are staying the same.
For self-only coverage, the 2020 limit on deductible contributions is $3,550. For family coverage, the 2020 limit on deductible contributions is $7,100. For 2021, these amounts are increasing to $3,600 and $7,200, respectively. Additionally, for 2020, annual out-of-pocket expenses required to be paid (other than for premiums) for covered benefits cannot exceed $6,900 for self-only coverage or $13,800 for family coverage. For 2021, these amounts are increasing to $7,000 and $14,000.
An individual (and the individual’s covered spouse, as well) who has reached age 55 before the close of the tax year (and is an eligible HSA contributor) may make additional “catch-up” contributions for 2020 and 2021 of up to $1,000.
Contributing on an employee’s behalf
If an employer contributes to the HSA of an eligible individual, the employer’s contribution is treated as employer-provided coverage for medical expenses under an accident or health plan and is excludable from an employee’s gross income up to the deduction limitation. There’s no “use-it-or-lose-it” provision, so funds can be built up for years. An employer that decides to make contributions on its employees’ behalf must generally make comparable contributions to the HSAs of all comparable participating employees for that calendar year. If the employer doesn’t make comparable contributions, the employer is subject to a 35% tax on the aggregate amount contributed by the employer to HSAs for that period.
Paying for eligible expenses
HSA distributions can be made to pay for qualified medical expenses. This generally means those expenses that would qualify for the medical expense itemized deduction. They include expenses such as doctors’ visits, prescriptions, chiropractic care and premiums for long-term care insurance.
If funds are withdrawn from the HSA for any other reason, the withdrawal is taxable. Additionally, an extra 20% tax will apply to the withdrawal, unless it’s made after reaching age 65, or in the event of death or disability.
As you can see, HSAs offer a flexible option for providing health care coverage, but the rules are somewhat complex. Contact us with questions or if you’d like to discuss offering this benefit to your employees.
If your small business is planning for payroll next year, be aware that the “Social Security wage base” is increasing.
The Social Security Administration recently announced that the maximum earnings subject to Social Security tax will increase from $137,700 in 2020 to $142,800 in 2021.
For 2021, the FICA tax rate for both employers and employees is 7.65% (6.2% for Social Security and 1.45% for Medicare).
For 2021, the Social Security tax rate is 6.2% each for the employer and employee (12.4% total) on the first $142,800 of employee wages. The tax rate for Medicare is 1.45% each for the employee and employer (2.9% total). There’s no wage base limit for Medicare tax so all covered wages are subject to Medicare tax.
In addition to withholding Medicare tax at 1.45%, an employer must withhold a 0.9% additional Medicare tax from wages paid to an employee in excess of $200,000 in a calendar year.
Employees working more than one job
You may have employees who work for your business and who also have a second job. They may ask if you can stop withholding Social Security taxes at a certain point in the year because they’ve already reached the Social Security wage base amount. Unfortunately, you generally can’t stop the withholding, but the employees will get a credit on their tax returns for any excess withheld.
If your business has older employees, they may have to deal with the “retirement earnings test.” It remains in effect for individuals below normal retirement age (age 65 to 67 depending on the year of birth) who continue to work while collecting Social Security benefits. For affected individuals, $1 in benefits will be withheld for every $2 in earnings above $18,960 in 2021 (up from $18,240 in 2020).
For working individuals collecting benefits who reach normal retirement age in 2021, $1 in benefits will be withheld for every $3 in earnings above $46,920 (up from $48,600 in 2020), until the month that the individual reaches normal retirement age. After that month, there’s no limit on earnings.
Contact us if you have questions. We can assist you with the details of payroll taxes and keep you in compliance with payroll laws and regulations.
Are you wondering if the passive activity loss rules affect business ventures you’re engaged in — or might engage in?
If the ventures are passive activities, the passive activity loss rules prevent you from deducting expenses that are generated by them in excess of their income. You can’t deduct the excess expenses (losses) against earned income or against other nonpassive income. Nonpassive income for this purpose includes interest, dividends, annuities, royalties, gains and losses from most property dispositions, and income from certain oil and gas property interests. So you can’t deduct passive losses against those income items either.
Any losses that you can’t use aren’t lost. Instead, they’re carried forward, indefinitely, to tax years in which your passive activities generate enough income to absorb the losses. To the extent your passive losses from an activity aren’t used up in this way, you’ll be allowed to use them in the tax year in which you dispose of your interest in the activity in a fully taxable transaction, or in the tax year you die.
Passive vs. material
Passive activities are trades, businesses or income-producing activities in which you don’t “materially participate.” The passive activity loss rules also apply to any items passed through to you by partnerships in which you’re a partner, or by S corporations in which you’re a shareholder. This means that any losses passed through to you by partnerships or S corporations will be treated as passive, unless the activities aren’t passive for you.
For example, let’s say that in addition to your regular professional job, you’re a limited partner in a partnership that cleans offices. Or perhaps you’re a shareholder in an S corp that operates a manufacturing business (but you don’t participate in the operations).
If you don’t materially participate in the partnership or S corporation, those activities are passive. On the other hand, if you “materially participate,” the activities aren’t passive (except for rental activities, discussed below), and the passive activity rules won’t apply to the losses. To materially participate, you must be involved in the operations on a regular, continuous and substantial basis.
The IRS uses several tests to establish material participation. Under the most frequently used test, you’re treated as materially participating in an activity if you participate in it for more than 500 hours in the tax year. While other tests require fewer hours, all the tests require you to establish how you participated and the amount of time spent. You can establish this by any reasonable means such as contemporaneous appointment books, calendars, time reports or logs.
Rental activities are automatically treated as passive, regardless of your participation. This means that, even if you materially participate in them, you can’t deduct the losses against your earned income, interest, dividends, etc. There are two important exceptions:
- You can deduct up to $25,000 of losses from rental real estate activities (even though they’re passive) against earned income, interest, dividends, etc., if you “actively participate” in the activities (requiring less participation than “material participation”) and if your adjusted gross income doesn’t exceed specified levels.
- If you qualify as a “real estate professional” (which requires performing substantial services in real property trades or businesses), your rental real estate activities aren’t automatically treated as passive. So losses from those activities can be deducted against earned income, interest, dividends, etc., if you materially participate.
Contact us if you’d like to discuss how these rules apply to your business.
If you file a joint tax return with your spouse, you should be aware of your individual liability. And if you’re getting divorced, you should know that there may be relief available if the IRS comes after you for certain past-due taxes.
What’s “joint and several” liability?
When a married couple files a joint tax return, each spouse is “jointly and severally” liable for the full tax amount on the couple’s combined income. That means the IRS can come after either spouse to collect the entire tax — not just the part that’s attributed to one spouse or the other. Liability includes any tax deficiency that the IRS assesses after an audit, as well as penalties and interest. (However, the civil fraud penalty can be imposed only on spouses who’ve actually committed fraud.)
When are spouses “innocent?”
In some cases, spouses are eligible for “innocent spouse relief.” This generally involves individuals who didn’t know about a tax understatement that was attributable to the other spouse.
To be eligible, you must show that you were unaware of the understatement and there was nothing that should have made you suspicious. In addition, the circumstances must make it inequitable to hold you liable for the tax. This relief may be available even if you’re still married and living with your spouse.
In addition, spouses may be able to limit liability for a tax deficiency on a joint return if they’re widowed, divorced, legally separated or have lived apart for at least one year.
How can liability be limited?
In some cases, a spouse can elect to limit liability for a deficiency on a joint return to just his or her allocable portion of the deficiency. If you make this election, the tax items that gave rise to the deficiency will be allocated between you and your spouse as if you’d filed separate returns.
The election won’t provide relief from your spouse’s tax items if the IRS proves that you knew about the items when you signed the tax return — unless you can show that you signed it under duress. Also, liability will be increased by the value of any assets that your spouse transferred to you in order to avoid the tax.
What is an “injured” spouse?
In addition to innocent spouse relief, there’s also relief for “injured” spouses. What’s the difference? An injured spouse claim asks the IRS to allocate part of a joint tax refund to one spouse. In these cases, one spouse has all or part of a refund from a joint return applied against certain past-due taxes, child or spousal support, or federal nontax debts (such as student loans) owed by the other spouse. If you’re an injured spouse, you may be entitled to recoup your refund share.
Whether, and to what extent, you can take advantage of the above relief depends on your situation. If you’re interested in trying to obtain relief, there’s paperwork that must be filed and deadlines that must be met. We can assist you with the details.
Also, keep “joint and several liability” in mind when filing future tax returns. Even if a joint return results in less tax, you may want to file a separate return if you want to be responsible only for your own tax.
Under current law, 100% bonus depreciation will be phased out in steps for property placed in service in calendar years 2023 through 2027. Thus, an 80% rate will apply to property placed in service in 2023, 60% in 2024, 40% in 2025, and 20% in 2026, and a 0% rate will apply in 2027 and later years.
For certain aircraft (generally, company planes) and for the pre-January 1, 2027 costs of certain property with a long production period, the phaseout is scheduled to take place a year later, from 2024 to 2028.
Of course, Congress could pass legislation to extend or revise the above rules.
2. Bonus depreciation is available for new and most used property
In the past, used property didn’t qualify. It currently qualifies unless:
- The taxpayer previously used the property and
- The property was acquired in certain forbidden transactions (generally acquisitions that are tax free or from a related person or entity).
3. Taxpayers should sometimes make the election to turn down bonus depreciation
Taxpayers can elect to reject bonus depreciation for one or more classes of property. The election out may be useful for sole proprietorships, and business entities taxed under the rules for partnerships and S corporations, that want to prevent “wasting” depreciation deductions by applying them against lower-bracket income in the year property was placed in service — instead of against anticipated higher bracket income in later years.
Note that business entities taxed as “regular” corporations (in other words, non-S corporations) are taxed at a flat rate.
4. Bonus depreciation is available for certain building improvements
Before the 2017 Tax Cuts and Jobs Act (TCJA), bonus depreciation was available for two types of real property:
- Land improvements other than buildings, for example fencing and parking lots, and
- “Qualified improvement property,” a broad category of internal improvements made to non-residential buildings after the buildings are placed in service.
The TCJA inadvertently eliminated bonus depreciation for qualified improvement property.
However, the 2020 Coronavirus Aid, Relief and Economic Security Act (CARES Act) made a retroactive technical correction to the TCJA. The correction makes qualified improvement property placed in service after December 31, 2017, eligible for bonus depreciation.
5. 100% bonus depreciation has reduced the importance of “Section 179 expensing”
If you own a smaller business, you've likely benefited from Sec. 179 expensing. This is an elective benefit that — subject to dollar limits — allows an immediate deduction of the cost of equipment, machinery, off-the-shelf computer software and some building improvements. Sec. 179 has been enhanced by the TCJA, but the availability of 100% bonus depreciation is economically equivalent and has greatly reduced the cases in which Sec. 179 expensing is useful.
We can help
The above discussion touches only on some major aspects of bonus depreciation. This is a complex area with tax implications for transactions other than simple asset acquisitions. Contact us if you have any questions about how to proceed in your situation.
If you’re a partner in a business, you may have come across a situation that gave you pause. In a given year, you may be taxed on more partnership income than was distributed to you from the partnership in which you’re a partner.
Why is this? The answer lies in the way partnerships and partners are taxed. Unlike regular corporations, partnerships aren’t subject to income tax. Instead, each partner is taxed on the partnership’s earnings — whether or not they’re distributed. Similarly, if a partnership has a loss, the loss is passed through to the partners. (However, various rules may prevent a partner from currently using his share of a partnership’s loss to offset other income.)
While a partnership isn’t subject to income tax, it’s treated as a separate entity for purposes of determining its income, gains, losses, deductions and credits. This makes it possible to pass through to partners their share of these items.
A partnership must file an information return, which is IRS Form 1065. On Schedule K of Form 1065, the partnership separately identifies income, deductions, credits and other items. This is so that each partner can properly treat items that are subject to limits or other rules that could affect their correct treatment at the partner’s level. Examples of such items include capital gains and losses, interest expense on investment debts and charitable contributions. Each partner gets a Schedule K-1 showing his or her share of partnership items.
Basis and distribution rules ensure that partners aren’t taxed twice. A partner’s initial basis in his partnership interest (the determination of which varies depending on how the interest was acquired) is increased by his share of partnership taxable income. When that income is paid out to partners in cash, they aren’t taxed on the cash if they have sufficient basis. Instead, partners just reduce their basis by the amount of the distribution. If a cash distribution exceeds a partner’s basis, then the excess is taxed to the partner as a gain, which often is a capital gain.
Here’s an example
Two individuals each contribute $10,000 to form a partnership. The partnership has $80,000 of taxable income in the first year, during which it makes no cash distributions to the two partners. Each of them reports $40,000 of taxable income from the partnership as shown on their K-1s. Each has a starting basis of $10,000, which is increased by $40,000 to $50,000. In the second year, the partnership breaks even (has zero taxable income) and distributes $40,000 to each of the two partners. The cash distributed to them is received tax-free. Each of them, however, must reduce the basis in his partnership interest from $50,000 to $10,000.
Other rules and limitations
The example and details above are an overview and, therefore, don’t cover all the rules. For example, many other events require basis adjustments and there are a host of special rules covering noncash distributions, distributions of securities, liquidating distributions and other matters.
The tax filing deadline for 2019 tax returns has been extended until July 15 this year, due to the COVID-19 pandemic. After your 2019 tax return has been successfully filed with the IRS, there may still be some issues to bear in mind. Here are three considerations.
1. Some tax records can now be thrown away
You should keep tax records related to your return for as long as the IRS can audit your return or assess additional taxes. In general, the statute of limitations is three years after you file your return. So you can generally get rid of most records related to tax returns for 2016 and earlier years. (If you filed an extension for your 2016 return, hold on to your records until at least three years from when you filed the extended return.)
However, the statute of limitations extends to six years for taxpayers who understate their gross income by more than 25%.
You’ll need to hang on to certain tax-related records longer. For example, keep the actual tax returns indefinitely, so you can prove to the IRS that you filed a legitimate return. (There’s no statute of limitations for an audit if you didn’t file a return or you filed a fraudulent one.)
When it comes to retirement accounts, keep records associated with them until you’ve depleted the account and reported the last withdrawal on your tax return, plus three (or six) years. And retain records related to real estate or investments for as long as you own the asset, plus at least three years after you sell it and report the sale on your tax return. (You can keep these records for six years if you want to be extra safe.)
2. You can check up on your refund
The IRS has an online tool that can tell you the status of your refund. Go to irs.gov and click on “Get Your Refund Status” to find out about yours. You’ll need your Social Security number, filing status and the exact refund amount.
3. You can file an amended return if you forgot to report something
In general, you can file an amended tax return and claim a refund within three years after the date you filed your original return or within two years of the date you paid the tax, whichever is later. So for a 2019 tax return that you file on July 15, 2020, you can generally file an amended return until July 15, 2023.
However, there are a few opportunities when you have longer to file an amended return. For example, the statute of limitations for bad debts is longer than the usual three-year time limit for most items on your tax return. In general, you can amend your tax return to claim a bad debt for seven years from the due date of the tax return for the year that the debt became worthless.
We can help
Contact us if you have questions about tax record retention, your refund or filing an amended return. We’re not just available at tax filing time — we’re here all year!
Traditionally, spring and summer are popular times for selling a home. Unfortunately, the COVID-19 crisis has resulted in a slowdown in sales. The National Association of Realtors (NAR) reports that existing home sales in April decreased year-over-year, 17.2% from a year ago. One bit of good news is that home prices are up. The median existing-home price in April was $286,800, up 7.4% from April 2019, according to the NAR.
If you’re planning to sell your home this year, it’s a good time to review the tax considerations.
Some gain is excluded
If you’re selling your principal residence, and you meet certain requirements, you can exclude up to $250,000 ($500,000 for joint filers) of gain. Gain that qualifies for the exclusion is also excluded from the 3.8% net investment income tax.
To be eligible for the exclusion, you must meet these tests:
- The ownership test. You must have owned the property for at least two years during the five-year period ending on the sale date.
- The use test. You must have used the property as a principal residence for at least two years during the same five-year period. (Periods of ownership and use don’t need to overlap.)
In addition, you can’t use the exclusion more than once every two years.
What if you have more than $250,000/$500,000 of profit when selling your home? Any gain that doesn’t qualify for the exclusion generally will be taxed at your long-term capital gains rate, provided you owned the home for at least a year. If you didn’t, the gain will be considered short term and subject to your ordinary-income rate, which could be more than double your long-term rate.
Here are two other tax considerations when selling a home:
- Keep track of your basis. To support an accurate tax basis, be sure to maintain complete records, including information on your original cost and subsequent improvements, reduced by any casualty losses and depreciation claimed based on business use.
- Be aware that you can’t deduct a loss. If you sell your principal residence at a loss, it generally isn’t deductible. But if a portion of your home is rented out or used exclusively for your business, the loss attributable to that part may be deductible.
If you’re selling a second home (for example, a beach house), it won’t be eligible for the gain exclusion. But if it qualifies as a rental property, it can be considered a business asset, and you may be able to defer tax on any gains through an installment sale or a Section 1031 like-kind exchange. In addition, you may be able to deduct a loss.
For many people, their homes are their most valuable asset. So before selling yours, make sure you understand the tax implications. We can help you plan ahead to minimize taxes and answer any questions you have about your home sale.
If you’re age 65 and older, and you have basic Medicare insurance, you may need to pay additional premiums to get the level of coverage you want. The premiums can be costly, especially if you’re married and both you and your spouse are paying them. But there may be a silver lining: You may qualify for a tax break for paying the premiums.
Tax deductions for Medicare premiums
You can combine premiums for Medicare health insurance with other qualifying health care expenses for purposes of claiming an itemized deduction for medical expenses on your tax return. This includes amounts for “Medigap” insurance and Medicare Advantage plans. Some people buy Medigap policies because Medicare Parts A and B don’t cover all their health care expenses. Coverage gaps include co-payments, co-insurance, deductibles and other costs. Medigap is private supplemental insurance that’s intended to cover some or all gaps.
Many people no longer itemize
Qualifying for a medical expense deduction may be difficult for a couple of reasons. For 2020 (and 2019), you can deduct medical expenses only if you itemize deductions and only to the extent that total qualifying expenses exceeded 7.5% of AGI.
The Tax Cuts and Jobs Act nearly doubled the standard deduction amounts for 2018 through 2025. As a result, fewer individuals are claiming itemized deductions. For 2020, the standard deduction amounts are $12,400 for single filers, $24,800 for married couples filing jointly and $18,650 for heads of household. (For 2019, these amounts were $12,200, $24,400 and $18,350, respectively.)
However, if you have significant medical expenses, including Medicare health insurance premiums, you may itemize and collect some tax savings.
Note: Self-employed people and shareholder-employees of S corporations can generally claim an above-the-line deduction for their health insurance premiums, including Medicare premiums. So, they don’t need to itemize to get the tax savings from their premiums.
Medical expense deduction basics
In addition to Medicare premiums, you can deduct various medical expenses, including those for dental treatment, ambulance services, dentures, eyeglasses and contacts, hospital services, lab tests, qualified long-term care services, prescription medicines and others.
There are also many items that Medicare doesn’t cover that can be written off for tax purposes, if you qualify. In addition, you can deduct transportation expenses to get to medical appointments. If you go by car, you can deduct a flat 17-cents-per-mile rate for 2020 (down from 20 cents for 2019), or you can keep track of your actual out-of-pocket expenses for gas, oil and repairs.
We can help
Contact us if you have additional questions about Medicare coverage options or claiming medical expense deductions on your personal tax return. We can help determine the optimal overall tax-planning strategy based on your situation.
It’s often difficult for married couples to save as much as they need for retirement when one spouse doesn’t work outside the home — perhaps so that spouse can take care of children or elderly parents. In general, an IRA contribution is allowed only if a taxpayer has compensation. However, an exception involves a “spousal” IRA. It allows a contribution to be made for a nonworking spouse.
Under the spousal IRA rules, the amount that a married couple can contribute to an IRA for a nonworking spouse in 2020 is $6,000, which is the same limit that applies for the working spouse.
Two main benefits
As you may be aware, IRAs offer two types of benefits for taxpayers who make contributions to them.
- Contributions of up to $6,000 a year to an IRA may be tax deductible.
- The earnings on funds within the IRA are not taxed until withdrawn. (Alternatively, you may make contributions to a Roth IRA. There’s no deduction for Roth IRA contributions, but, if certain requirements are met, distributions are tax-free.)
As long as the couple together has at least $12,000 of earned income, $6,000 can be contributed to an IRA for each, for a total of $12,000. (The contributions for both spouses can be made to either a regular IRA or a Roth IRA, or split between them, as long as the combined contributions don’t exceed the $12,000 limit.)
In addition, individuals who are age 50 or older can make “catch-up” contributions to an IRA or Roth IRA in the amount of $1,000. Therefore, in 2020, for a taxpayer and his or her spouse, both of whom will have reached age 50 by the end of the year, the combined limit of the deductible contributions to an IRA for each spouse is $7,000, for a combined deductible limit of $14,000.
There’s one catch, however. If, in 2020, the working spouse is an active participant in either of several types of retirement plans, a deductible contribution of up to $6,000 (or $7,000 for a spouse who will be 50 by the end of the year) can be made to the IRA of the non-participant spouse only if the couple’s AGI doesn’t exceed $104,000. This limit is phased out for AGI between $196,000 and $206,000.
Contact us if you’d like more information about IRAs or you’d like to discuss retirement planning.
The economic impact of the novel coronavirus (COVID-19) is unprecedented and many taxpayers with student loans have been hard hit.
The Coronavirus Aid, Relief and Economic Security (CARES) Act contains some assistance to borrowers with federal student loans. Notably, federal loans were automatically placed in an administrative forbearance, which allows borrowers to temporarily stop making monthly payments. This payment suspension is scheduled to last until September 30, 2020.
Tax deduction rules
Despite the suspension, borrowers can still make payments if they choose. And borrowers in good standing made payments earlier in the year and will likely make them later in 2020. So can you deduct the student loan interest on your tax return?
The answer is yes, depending on your income and subject to certain limits. The maximum amount of student loan interest you can deduct each year is $2,500. The deduction is phased out if your adjusted gross income (AGI) exceeds certain levels.
For 2020, the deduction is phased out for taxpayers who are married filing jointly with AGI between $140,000 and $170,000 ($70,000 and $85,000 for single filers). The deduction is unavailable for taxpayers with AGI of $170,000 ($85,000 for single filers) or more. Married taxpayers must file jointly to claim the deduction.
The interest must be for a “qualified education loan,” which means debt incurred to pay tuition, room and board, and related expenses to attend a post-high school educational institution. Certain vocational schools and post-graduate programs also may qualify.
The interest must be on funds borrowed to cover qualified education costs of the taxpayer, his or her spouse or a dependent. The student must be a degree candidate carrying at least half the normal full-time workload. Also, the education expenses must be paid or incurred within a reasonable time before or after the loan is taken out.
It doesn’t matter when the loan was taken out or whether interest payments made in earlier years on the loan were deductible or not. And no deduction is allowed to a taxpayer who can be claimed as a dependent on another taxpayer’s return.
The deduction is taken “above the line.” In other words, it’s subtracted from gross income to determine AGI. Thus, it’s available even to taxpayers who don’t itemize deductions.
Taxpayers should keep records to verify eligible expenses. Documenting tuition isn’t likely to pose a problem. However, take care to document other qualifying expenditures for items such as books, equipment, fees, and transportation. Documenting room and board expenses should be simple if a student lives in a dormitory. Student who live off campus should maintain records of room and board expenses, especially when there are complicating factors such as roommates.
Contact us if you have questions about deducting student loan interest or for information on other tax breaks related to paying for college.