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Member of Russell Bedford International, a global network of independent professional service firms.
In 2021, taxpayers have an option to fund either a traditional IRA or Roth IRA, up to the maximum limit of $6,000 ($7,000 if you are age 50 or over). Both are good options, with different treatments. The traditional IRA lets you choose to deduct the contributions; however, future distributions are taxed at the then current tax rates. Roth IRAs work differently as there is no deduction on the contributions, likewise, there is no tax when amounts are taken out. Further, Roth IRA does not require Required Minimum Distribution (RMD) and Roth IRAs can be passed down tax free to heirs.
The obvious caveat to the above is that for high income taxpayers —defined as the 2021 adjusted gross income (AGI) over $140,000 for individuals and over $208,000 for married filing jointly—contributions to Roth IRAs are disallowed. While there are AGI limits on deductions for traditional IRA contributions, there are no limits on contributing to a traditional IRA without taking a deduction (known as nondeductible contributions).
This strategy, under current tax laws, allows the taxpayer to fund their Roth IRA via the nondeductible IRA route. Simply put, the high-income taxpayer would contribute to their traditional IRA as a nondeductible amount. As this amount is not deducted on their tax return, they have tax basis in their contribution. Once this is established, then the taxpayer can convert the nondeductible contribution into a Roth IRA, without paying any tax on the conversion. Please note, if between the time you contribute to your IRA and convert to your Roth, the balance increases due to the market changes, then any gains above your basis is taxed. This strategy can be used yearly. Most of our clients usually leave the money in a cash account and then convert it soon after, so the increase in the balance is insignificant.
The above is the simple version that assumes this is the only IRA held by the taxpayer. However, there is a large pitfall you should watch out for as it can produce unexpected taxable income. When you convert your IRA to Roth IRA, the IRS views all your IRAs together as one pool to be converted (not an account-by-account basis, nor by deductible/nondeductible buckets).
Therefore, if you have other traditional IRAs that have both deductible and nondeductible contributions, then a portion of your conversion will be subject to tax.
Example: Mary has $7,000 in an IRA from many years ago, when she was able to take a deduction on her contributions. In 2021, her AGI is $215,000, and she cannot contribute to a Roth or deduct any IRA contributions, so she decides to fund her IRA with a nondeductible contribution of $5,000. Five months later, she converts the $5,000 she contributed as a nondeductible IRA. On her tax return, she will have $2,917 that is subject to tax. This is the pro-rata of both the deductible and nondeductible portions of all her IRA accounts (at all brokerages). In Mary’s case, the total IRA balance is $12,000, her deductible portion is $7,000 and she converted $5,000.
$7,000 / 12,000 = 58.33% that is the taxable portion.
$5,000 * 58.33% = $2,917 amount that is taxable on her return based on $5,000 converted.
There is a way to maneuver around this, which would involve rolling over the deductible IRAs to an employer plan (if allowed), but it does add complication and would be dependent on a few factors specific to the taxpayer.
The rules on creating the backdoor Roth IRA are complex. Cray Kaiser is here to help if you have further questions about utilizing the backdoor Roth IRA strategy. Please contact us today at 630-953-4900.
On Friday, August 27, 2021, Illinois Governor J.B. Pritzker signed Public Act 102-0658 into law. The Act provides a significant tax break to owners of flow through entities (S corporations and partnerships). According to Crain’s Chicago, a rough estimate of tax savings to affected taxpayers is $80 million annually. The tax break will not affect Illinois tax revenues; it will only affect federal tax revenues.
As you may recall, the Tax Cuts and Jobs Act of 2017 created a $10,000 annual federal limitation on the deduction of state taxes (including income taxes and real estate taxes). The federal limitation created an indirect tax increase on owners of flow through entities who could not fully deduct the state taxes paid on their flow through business income.
Certain states began to look for workarounds to the state tax limitation. For example, what if the state allowed a business to pay the state income tax on behalf of their owners, so that it would become a liability to the business and not the individual? As businesses are not subject to the $10,000 tax limitation, could this create an opportunity to deduct state taxes that would have otherwise been nondeductible to the individual owner? The IRS has recently blessed such workarounds, and Illinois has now enacted the workaround into law.
Effective for tax years ending on or after December 31, 2021, and beginning prior to January 1, 2026, Illinois businesses can make an irrevocable annual election to have the business bear the burden of the state tax on the Illinois pass through income. For example, Bob owns an Illinois S corporation that has expected Illinois taxable income of $100,000. Due to high real estate taxes in his home county, Bob gets no benefit from a federal tax deduction of Illinois state taxes paid as his real estate taxes exceed the $10,000 limit. In 2020, Bob paid 4.95% tax on the business income, or $4,950.
Fast forward to 2021. Bob’s S corporation can elect to pay the tax on Bob’s behalf and can claim a federal tax deduction of the $4,950 of tax paid. When Bob files his Illinois income tax return for 2021, he will be allowed a credit of $4,950 on his return. In essence, the Illinois tax stays the same, but Bob has created a federal tax deduction for the state tax paid. Assuming a 37% federal income tax rate, the benefit is a little more than $1,800.
We understand that you may have a lot of questions about how the new law will affect you. Cray Kaiser will be looking out for additional guidance on the provisions. In an upcoming blog, we will take a deeper dive into the reasons why a business may not want to pursue this provision.
If you have questions on how the provision will affect you, please give Cray Kaiser a call at (630) 953-4900.
If you haven’t received your tax refund yet you are not alone. We have heard several reports from clients who are still waiting on refunds from returns filed early in the year. Unless there is an error, the IRS will typically issue most refunds in less than 21 calendar days. However, 2021 is far from a typical year for a number of reasons.
COVID-19 – The IRS computer system can only be accessed from IRS facilities. So, unlike most other employers that had to deal with the COVID-19 outbreak, IRS employees could not work from home. Consequently, during 2020 and 2021 many IRS employees were furloughed. And the IRS got significantly behind in processing returns, especially paper-filed returns that must be input manually. As a result, the IRS was still processing 2019 returns at the beginning of the 2020 return filing season.
Economic Impact Payments – Congress ordered the IRS to handle the task of issuing three economic impact payments, two in 2020 and one in 2021, further tapping IRS resources.
Recovery Rebates – To make matters worse, those first two economic impact payments had to be reconciled on the 2020 tax return. If a taxpayer didn’t receive the amount they were entitled to, they were allowed an equivalent recovery rebate credit on their tax return.
If there is a discrepancy between the amount of the payments reported on the tax return and what the IRS has on file for the economic impact payment amounts, the IRS is manually verifying the tax return for credit eligibility. This is causing additional refund delays.
Unemployment Debacle – In March 2021, after the 2020 tax filing season had gotten underway and millions of taxpayers had already filed their returns, Congress decided to make a portion of the unemployment compensation taxpayers received in 2020 tax-free. To avoid millions of amended returns from being filed, the IRS has undertaken the task of automatically adjusting those returns and issuing refunds.
Using 2019 Income to Compute 2020 EITC and Additional Child Tax Credit – The EITC and the additional child tax credit are based on a taxpayer’s earned income (income from working). However, because a preponderance of those who normally benefited from EITC and the additional child tax credit were unemployed during 2020, Congress allowed the 2019 earned income to be used in computing those credits for 2020, which also is causing processing delays.
You can use the IRS’s online tool “Where’s My Refund” to determine the status of your refund. To use that tool, you will need:
Generally, the IRS will pay interest on the refund due to you starting from the later of the following:
The IRS stops paying interest on overpayments on the date they issue the refund, or it is used to offset an outstanding liability.
Currently, the interest rate the IRS pays individuals on overpayments is 3%; the rate is adjusted quarterly but has been at 3% since July 1, 2020.
Exception: No overpayment interest is paid if the IRS issues the refund within 45 days of the return due date, or actual filing date if later.
As you can see, refunds are not being issued as quickly as they were pre-COVID and there isn’t anything a tax preparer or taxpayer can do about the IRS not paying out refunds once a return is electronically filed and accepted by the IRS.
Cray Kaiser is here to help if you have further questions about your tax refund. Please contact us today or call (630)953-4900.
With mortgage rates at an all-time low, many people are exploring and undertaking the task of buying houses, renovating, making improvements, and selling them for hopefully more than their cost. This could be a profitable endeavor, however, there are tax consequences that should be factored in so you can generate expected returns.
The tax treatment varies based on how you are categorized by the IRS. You can be considered a dealer, investor, or homeowner, all summarized below. In some instances, it is clear cut what you would be treated as, and in some other cases, you would need to discuss with a tax professional.
Dealer in Real Estate
This category is akin to running a business, but without a separate corporate return. The gains are taxed at ordinary taxpayer rates. Since it is considered a business, the taxpayer would be subject to self-employment taxes of 15.3% of the net profit. For high income taxpayers, an additional 0.9% Medicare surcharge would be assessed on the net profit. In general, a dealer would pay more in taxes than an investor would. The upside is that any losses from real estate transactions are considered ordinary and would be fully deductible in the year the loss originates.
Investor
Gains on the home sale are subject to capital gains treatment. If the property is held for more than a year, then the long-term rates would be a maximum of 20% of the gain. If the property is sold within the year, then it would be subject to short-term rates, which would be equivalent to the ordinary tax rate of the taxpayer. For high income taxpayers, there is also an additional 3.8% surtax on the net investment gain. The benefit of being considered an investor is no self-employment tax nor Medicare surcharge is assessed. However, if for any instance you sell the property at a loss, the loss is netted against any other capital gains. If the losses are greater than capital gains in any given year, then the loss is capped at $3,000 with the remainder carried forward and utilized in the following year(s).
Homeowner
There are some benefits if you are considered a homeowner. If you were to live in the property while it is being fixed up and consider it a primary residence, and if you meet the following criteria, you could exclude the gain (up to $250,000 for individuals and $500,000 for married filing jointly) from your income.
Please be aware that if you incur a loss, then none of it will be deductible. In addition, some fix-up costs might be considered repairs instead of improvements, and as a residence, not deductible or contributing to the increase of the cost of your home. Finally, the two-year rules make it difficult to be continuously flipped and getting the homeowner exclusion.
Being a homeowner is easily identifiable, but the classification between investor and dealer might be harder to identify. The distinction between a dealer and an investor is based on the facts and circumstances of each case. The IRS and Tax Court have taken the following into consideration in determining if the taxpayer is a dealer or an investor:
Note that there is a provision in the current tax code for like-kind exchanges (known as Section 1031 transaction), which allows the taxpayer to defer taxes if they purchase another similar property in a defined time frame. This is a complicated transaction, which only applies to investors or dealers in real estate, and would need to be structured correctly to provide Section 1031 benefits.
Cray Kaiser is here to help if you have further questions about your real estate activities. Please contact us today at 630-953-4900.
Selling a property one has owned for a long period of time will frequently result in a large capital gain. Reporting all of the gain in one year will generally expose it to higher-than-normal capital gains rates and subject the gain to the 3.8% surtax on net investment income. With higher capital gains tax rates potentially on the horizon, it’s important to know your options for deferring tax on gains. One of those deferral opportunities is what’s known as an installment sale. An installment sale could fend off taxes imposed at higher levels of income by spreading the income over multiple years.
Here is how it works. If you sell your property for a reasonable down payment and carry the note on the property yourself, you only pay income taxes on the portion of the down payment (and any other principal payments received in the year of sale) that represents taxable gain. You can then collect interest on the note balance at rates near what banks charge. For a sale to qualify as an installment sale, at least one payment must be received after the calendar year in which the sale occurs. Installment sales are most frequently used when the property that is sold is real estate and cannot be used to report the sale of publicly traded stock or securities.
Example: You own a lot for which you originally paid $10,000. You paid it off some time ago, leaving you with no outstanding mortgage on the lot. You sell the property for $300,000 with 20% down and carry a $240,000 first trust deed at 3% interest using the installment sale method. No additional payment is received in the year of sale. The sales costs are $9,000.
Of the $60,000 down payment you received, $9,000 went to pay the selling costs, leaving you with $51,000 cash. The 20% down payment is 93.67% taxable, making $56,202 ($60,000 x .9367) taxable the first year. The amount of principal received and reported each subsequent year will be based upon the terms of the installment agreement. Additionally, the interest payments on the note are taxable and also subject to the investment surtax.
Thus, in the example, by using the installment method the income for the year was reduced by $224,798 ($281,000 – $56,202). The impact on the taxpayer’s overall tax liability depends on the taxpayer’s other income and circumstances.
Here are some additional considerations when contemplating an installment sale.
Existing mortgages – If the property you are considering selling is currently mortgaged, that mortgage must be paid off during the sale. Even if you do not have the financial resources available to pay off the existing loan, there may be ways to work out an installment sale by taking a secondary lending position or wrapping the existing loan into the new loan.
Tying up your funds – Tying up your funds into a mortgage may not fit your long-term financial plans, even though you might receive a higher return on your investment and potentially avoid a higher tax rate and the net investment income surtax. Shorter periods can be obtained by establishing a note due date that is shorter than the amortization period. For example, the note may be amortized over 30 years, which produces a lower payment for the buyer but becomes due and payable in 5 years. However, a large lump sum payment at the end of the 5 years could induce the higher tax rate and surtax to apply to the seller in that year. So pay close attention to the tax consequences when structuring the installment agreement.
Early payoff of the note – The buyer of your property may decide to pay off the installment note early or sell the property, in which case your installment plan would be defeated and the balance of the taxable portion would be taxable in the year the note is paid off early or the property is sold, unless the new buyer assumes the note.
Tax law changes – Income from an installment sale is taxable under the laws in effect when the installment payments are received. If the tax laws are changed, the tax on the installment income could increase or decrease. Based on recent history, it would probably increase.
Installment sales do not always work in all situations. Contact Cray Kaiser to determine whether an installment sale will fit your particular needs and circumstances.
The start of July brings with it fireworks, corn on the cob and yes, the need to start thinking about remaining tax deadlines for 2021. This year, it is also important to start planning for the payroll deferral deadlines that are coming up at year end. For those organizations that chose to defer, there may be significant balances due so it’s important to understand when payments will be required.
Due to the COVID-19 pandemic, employers were allowed to defer the deposit and payment of the employer portion of social security taxes (6.2% rate) that would have otherwise been required for wages paid between March 27, 2020 and December 31, 2020. The deferral also applies to deposits and payments due after January 1, 2021 for wages paid during the quarter ending December 31, 2020.
The IRS is issuing reminder notices for EACH quarter the employer portion of social security taxes were deferred. Employers that deferred amounts in all four quarters of 2020 may receive up to four reminder notices, even though the amounts are all due by the same due dates. The total deferred amount for EACH quarter will be on the reminder notices, however only 50% of the amount must be paid by January 3, 2022. Deferred amounts will be treated as timely deposited and paid according to the following schedule:
An employer can begin repaying the deferred amounts at any time. Any payments or deposits that an employer makes before December 31, 2021, will be first applied against the employer’s payment due on January 3, 2022, and then applied against the employer’s payment due on December 31, 2022.
If you have any questions about the upcoming deadlines or deferred payroll taxes, please call us at 630-953-4900. We are happy to discuss further.
In this audio blog. CK Tax Manager Eric Challenger, CPA shares important tax information for independent contractors including:
Listen to Eric outline what you need to know if you are filing taxes as an independent contractor:
Note – To listen to this audio blog, please make sure you are not using Internet Explorer as your browser.
If you are an independent contractor and need help filing taxes, please don’t hesitate to contact Cray Kaiser today.
As an incentive and to help grow the organization’s market value, many companies will offer stock options to key employees. The options give the employee the right to buy a specified number of shares of the company’s stock at a future date at a specific price. Generally, options are not immediately vested and must be held for a specified period before they can be exercised. Once vested, and assuming the stock price has appreciated to a value higher than the option price of the stock, the employee can exercise the options (buy the shares), paying the lower option price for the stock rather than the current market price. This gives the employee the opportunity to participate in the growth of the company through gains from the sale of the stock without the risk of ownership.
There are two basic types of employee stock options for tax purposes, a non-statutory option and a statutory option (also referred to as the incentive stock option), and their tax treatment is significantly different.
The taxability of a non-statutory option occurs at the time the option is exercised. The gain is considered ordinary income (compensation) and is included in the employee’s W-2 for the year of exercise.
The employee has the option to sell or hold the stock he or she has just purchased, regardless of what he or she does with the stock, the gain, or the difference between the option price and market price of the stock at the time of the exercise, is immediately taxable. Because of the immediate taxation and to generate the cash necessary for purchase, most employees who have been granted options will immediately sell their stock when exercising their option. Under that scenario, the W-2 wage income will reflect the profit on the sale. Since the difference between the option price and market price is included in wages, it is also subject to payroll taxes (FICA).
Form 8949 (the tax form used to report sales of stock and other capital assets) will need to be prepared to show the sale, essentially with no gain or loss, so that the gross proceeds of sale are properly reported on the return. Although the W-2 shows the profit, the brokerage will also report the gross proceeds on Form 1099B. If there was a sales cost, such as a broker’s commission, then the result would be a reportable loss, albeit usually a small amount.
If an employee chooses to hold the stock, he or she would have to pay the tax on the difference between the option price and exercise price, plus the FICA tax, from other funds. If the stock subsequently declines in value, the employee is still stuck with the gain reported when the option was exercised. Any loss on the subsequent sale of the stock would be limited to the overall capital loss limitation of $3,000 per year.
In the taxation of a statutory options, no amount of gain is included as regular income when the option is exercised. Therefore, the employee can continue to hold the stock without any tax liability; and, if he or she holds it long enough, any gain would become a long-term capital gain taxed at a preferential rate. To achieve long-term status, the stock must be held for:
However, there is a dark side to statutory options. The difference between the option price and market price, termed the spread, is what is called a preference item for alternative minimum tax (AMT) purposes. If the spread is great enough, that might cause an additional tax liability due to the AMT. The rules surrounding AMT are complex which is why we recommend you seek the guidance of a tax advisor if you are granted incentive stock options.
With an increase in the value of stock options in 2020 and 2021, we’ve received a number of questions regarding the timing of exercising and/or selling options. While we cannot provide investment advice, we can model the tax and cash flow implications of certain actions at different stock valuations. Using a team that includes both your investment and tax advisors will ensure that you are maximizing the financial benefits of stock options.
If you are planning to exercise employee stock options and have questions or wish to do some tax planning contact us at Cray Kaiser so we can help to minimize the tax bite.
The American Rescue Plan that was signed in March 2021 made a few positive changes regarding the Child Tax Credit for taxpayers in 2021, including increased and fully refundable credits. In addition, for 2021, the IRS will make advance monthly payments of 50% of the estimated annual Child Care Credit on the 15th of each month between July and December this year. These payments will come through as direct deposit, physical check or in some cases, debit cards.
The maximum annual Child Care Credit will be $3,000 per qualifying child between ages 6 and 17 and $3,600 per qualifying child under age 6, as of December 31, 2021. In either case, the child must live with the taxpayer in the U.S. for more than half the year.
The maximum credit is available to taxpayers with a modified Adjusted Gross Income of:
$75,000 or less for single taxpayers
$112,500 or less for head of household
$150,000 or less for married couples filing jointly and qualifying widowers
The maximum credit phases out for higher income taxpayers.
The IRS is sending out letters to families who may be eligible based on the information from their 2019 or 2020 return. If eligible, the IRS will send a second letter out with personalized information, including an estimate of the monthly payment.
If no return was filed in 2019 or 2020, the IRS has created a new non-filer sign-up tool to register for the advanced child tax credit payments.
The biggest difference is that the advances received will be reconciled on your 2021 tax return using the actual 2021 modified Adjusted Gross Income. That means, unlike the stimulus payments, if you receive too much in advance payments you will owe the difference on your 2021 tax return. Likewise, if you do not receive enough in advance payments, you will receive the difference when you file your 2021 tax return. This distinction makes paying attention to the advance payments very important.
The IRS will debut a portal later in June for those families who don’t want the enhanced payments.
Cray Kaiser is here to help if you have further questions about the childcare credit and advances for 2021. Please contact us today or call (630)953-4900.
Effective July 1, 2021 certain taxing jurisdictions in Illinois have imposed a local sales tax or changed their local sales tax rate on general merchandise sales. The following taxes are affected:
To be in compliance with the new tax rates, you must adjust your point of sale and/or accounting system to ensure that you will collect and pay the correct sales tax effective July 1, 2021. You may need to contact your software vendor to confirm that they will correct their systems to the appropriate tax rate. Remember that even if you under-collect tax, the tax is still due. That means it will be your responsibility to pay the difference.
To verify your new combined sales tax rate (state and local tax), click here.
Who is impacted?
The sales tax rate change does not affect anyone collecting sales tax in the city of Chicago. However, it does affect some cities in DuPage County, Cook County and other jurisdictions. To see a full list of all the cities impacted and the new rates, please click here.
What is taxed?
These rate changes do not impact what is and is not subject to sales tax. As a reminder, most sales are subject to both the state sales tax and the locally imposed sales tax.
Note that some jurisdictions may impose and administer taxes not collected by the Illinois Department of Revenue. Contact your municipal or county clerk’s office for more information.
If you have any questions regarding the sales tax rate change, please don’t hesitate to contact Cray Kaiser today.
