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Member of Russell Bedford International, a global network of independent professional service firms.
Some in Congress have proposed “free” (i.e., government-paid) tuition for community college attendance. Even if that proposal were to become law, it still leaves parents and their children-students responsible for paying for college and university attendance if the student wants a bachelor or higher degree. Over the years, Congress has provided a variety of tax incentives to help defray the cost of education. Some tax-related education benefits are currently available while others will be beneficial only with long-range planning, and the sooner these plans are implemented, the better.
Education Savings Plans – If your children are below college age, there are tax-advantaged plans that allow you to save for the costs of their higher education. While no Federal tax deduction is allowed for contributions to the plans, they do provide tax-free accumulation of earnings. It, therefore, makes sense that the earlier they are established, the more benefit you’ll get from them. Additionally, state tax deductions of up to $20,000 per year are allowed for certain plans.
In recent years Congress has expanded the definition of eligible expenses 529 Plans can cover to include the following:
Coverdell Education Savings Account—These accounts are actually education trusts that allow nondeductible contributions to be invested for a child’s education. Tax on earnings from these accounts is deferred until the funds are withdrawn, and if used for qualified education purposes the entire withdrawal can be tax-free. Qualified use of these funds includes elementary and secondary education expenses in addition to post-secondary schools. A total of $2,000 per year can be contributed (but is not deductible) for each beneficiary under the age of 18. The ability to contribute to these plans phases out when the modified adjusted gross income of the contributor is between $190,000 and $220,000 for married taxpayers filing jointly, and between $95,000 and $110,000 for all others.
Education Tax Credits—If you currently have a child or children attending college, there are two tax credits, the American Opportunity Credit (partially refundable) and the Lifetime Learning Credit (nonrefundable), that may benefit you. Both are available for qualified post-secondary education expenses for a taxpayer, spouse, and eligible dependents. Both credits will reduce your tax liability dollar for dollar until the tax reaches zero.
Qualifying expenses for these credits are generally limited to tuition. However, if required for the enrollment or attendance of the student, activity fees and fees for course-related books, supplies, and equipment qualify. For those accessing the Lifetime Learning Credit, course materials and supplies are eligible only if purchased directly from the educational institution.
Qualified tuition and related expenses paid by a student are treated as if paid by the taxpayer if the student is a claimed dependent of the taxpayer. So if a third party (most typically a grandparent, but it could be anyone besides you or the dependent) makes a payment directly to an eligible educational institution for the student’s qualified tuition and related expenses, the student would be treated as having received the payment from the third party and would qualify as having paid the tuition and related expenses personally. If the student is your dependent, you could be eligible to claim the credit.
Education Loan Interest—You can deduct qualified education loan interest of up to $2,500 per year in computing AGI. This is not limited to government student loans and could include home equity loans, credit card debt, etc., if the debt was incurred solely to pay for qualified higher education expenses. For 2022, the student loan interest deduction phases out for married taxpayers with an AGI between $145,000 and $175,000 and for unmarried taxpayers between $70,000 and $85,000. These amounts are subject to annual inflation adjustment. This deduction is not allowed for taxpayers who file married separate returns.
While it is possible that Congress may add more tax-related benefits for assisting parents and students to pay for higher education costs, you shouldn’t depend on their actions (or inactions). We recommend starting the planning process as soon as possible, and making sure not to overlook the credits and deductions available for the current students in your family. If you would like assistance in planning for your children’s future education or would like more information about the education benefits available now, please call us at (630) 953-4900.
Throughout 2020 and 2021 we’ve encouraged our business clients to take advantage of the Employee Retention Credit (ERC) that was first introduced in the 2020 Coronavirus Aid, Relief, and Economic Security (CARES) Act and further modified in the Consolidated Appropriations Act of 2021 and the American Rescue Plan Act of 2021. We assisted dozens of clients in realizing benefits from this program, but now that we are past the December 31, 2021 deadline to claim an ERC credit, all attention is now on the tax status of these funds.
The IRS has determined ERC funds are not to be included in an employer’s gross income, rather the credit is subject to “expense disallowance rules.” This means an employer’s wage deduction should be reduced by the amount of the ERC, resulting in a smaller wage expense and essentially rendering the credit taxable.
For businesses who received an ERC in 2021, as indicated above, the IRS has mandated that the amount received from your ERC be a reduction from your expenses, thereby increasing your taxable income. We are reminding all clients who received an ERC to prepare for this impact as they begin tax preparations.
For businesses that received an ERC in 2020, the regulations indicate that the same rules will apply. We are uncertain if the IRS will provide additional guidance, as this could require numerous amended tax returns.
The ERC program provided welcome relief to a number of businesses, but the tax ramifications are complicated. As always, please contact Cray Kaiser at 630-935-4900 for assistance in understanding your specific situation.
If you have children under 18, you may have already received your first advance child tax credit payment, either by check or by direct deposit. However, keep in mind you would have received this credit on your 2021 tax return when you file anyway. While we’ve discussed the Advance Child Tax Credit previously, now that the government is issuing payments, we thought we would revisit if it makes sense to opt out of the credit.
The American Rescue Plan Act of 2021 authorized advance credit payments for one year only (2021). The monthly payments are automatically made to all qualifying individuals unless they go to the IRS website and opt-out. The Biden Administration estimates that 39 million families are qualified for the advance payment, with about 2.6% opting out of the first payment (July 15, 2021).
The estimated payments are determined based on a taxpayer’s family makeup (number of children and filing status) and income, using information from 2020 tax returns (or 2019 if the 2020 return hasn’t yet been filed).
A taxpayer whose advance credit payments exceed what their actual credit turns out to be will need to repay the excess with their 2021 tax return.
Some taxpayers may be in for an unpleasant surprise when they discover they were not qualified for the advance payments they received. There are several scenarios where this could happen, such as:
Example: On their 2020 tax return Harry and Mary claimed two children, one age two and the other age seven, and their income was under the $150,000 threshold. Thus, for 2021 they would have a child age three and another age eight, and the IRS would estimate their credit for 2021 to be $6,600 ($3,600 + $3,000). Therefore, their advance monthly payments would be $550 ($6,600 x 50%) divided by six months.
In 2021, Harry and Mary both received pay increases pushing their income above the income thresholds. With their higher income, they are no longer eligible to receive the credit. As a result, they would have an additional tax due of $6,600, the amount of the advance credit received.
If you’ve received advance child credit payments, in January 2022 the IRS will send you a letter recapping the amount of advance credit they sent you. This information will be needed when reconciling the advance credit payments with the actual credit on your 2021 return.
Contact Cray Kaiser at (630) 953-4900 if you have questions about how the advance payments may impact your 2021 tax return, whether you should opt-out of additional advance payments, or if you want to adjust your withholding or estimated tax payments to account for the advance credits.
The Internal Revenue Service (IRS) is reminding entities with Employer Identification Numbers (EINs) of their responsibility to update that information whenever the contact information or responsible party changes. IRS regulations require EIN holders to update responsible party information within 60 days of any change. Notifying the IRS of those changes is easily accomplished by filing Form 8822-B, Change of Address or Responsible Party – Business.
Especially given the pandemic, taxpayer contact information may be outdated due to moves, office closures, etc. By alerting the IRS to your new address, you will ensure that you are receiving tax notifications on a timely basis.
The IRS is urging those entities with EINs to update their applications if there has been a change in the responsible party or contact information, calling it a key security issue. According to the IRS, the data around the “responsible parties” for business-type entities is often outdated or incorrect, meaning that the IRS does not have accurate records of who to contact for potential fraudulent claims or identity theft issues. Inaccurate information results in a time-consuming process to identify the point of contact so the IRS can inquire about a suspicious tax filing.
It is estimated that there are approximately 100,000 EIN holders with outdated responsible party information. The IRS completed a mail campaign to these EIN holders in August.
Responsible Party: Generally, a responsible party is the individual (a natural person) who ultimately owns or controls the entity or who exercises ultimate effective control over the entity. The person identified as the responsible party should have a level of control over, or entitlement to, the funds or assets in the entity that, as a practical matter, enables the person, directly or indirectly, to control, manage, or direct the entity and the disposition of its funds and assets.
Here are some tips for completing Form 8822-B (used by businesses):
If you need to change both the business and personal contact information, use Form 8822 to change your home address. Although the IRS will automatically update their records to match a taxpayer’s most recent tax filing, it is wise to file Form 8822 to make sure you receive any correspondence from the IRS since the IRS is only required to mail correspondence to your last known address.
If you have a state filing obligation, you should also notify the appropriate state agencies of the changes.
After you file either Form 8822-B or Form 8822, please forward a copy to this office so we can update your file. If you need assistance with these tax forms, Cray Kaiser can help. Please give us a call to discuss changes in your contact information.
More and more Americans are on the move these days. Remote work is increasingly popular and allows employees the flexibility to not necessarily live where they work. Additionally, tax changes introduced by the 2017 Tax Cuts and Jobs Act (TCJA) limited the important SALT (State and Local Tax) deduction to $10,000 for single and married individuals. That deduction had previously made residing in high-tax states less costly for affluent individuals.
When you combine those two factors alone, it makes sense that people are looking to see where the grass may be greener. There’s also the fact that states may begin adding new taxes to make up for budget shortfalls, or in the case of Illinois, seeking to increase taxes among select taxpayers. So, it comes as no surprise we are getting a lot of questions about relocating.
If you’ve found yourself looking at real estate ads in a different state, it is important that you take a 360-degree view of what moving would mean for you. As attractive as it may seem to pack up your things and move to a state with a more appealing tax scheme, there are other things to think about. If you move, make sure you do so in a way that accomplishes your tax goals.
Be sure to factor the following into your decision-making process.
Moving to another community is a shock to the system in more ways than one, but moving to a different state will have an even greater impact. Not only do you need to think about the quality-of-life issues involved, but also the implications of owning multiple homes in multiple states. You will need to choose where your primary residence is going to be, and make sure you can prove compliance. Non-tax-related considerations include:
If you’ve already included the non-tax considerations listed above and you are still intent on making a move, then it is time to understand what doing so will mean to your economic picture. It’s a good idea to sit down and discuss your plans with your financial advisors long before putting your home up for sale, as you may have second thoughts after weighing the consequences of a move. Among your considerations are:
Like everything else in life, relocating to another state and making it your primary residence is not as easy as just deciding to do it. It is important that you do your due diligence to make sure that you have complied with everything required of your new home. You need to follow several essential steps in order to reap the tax rewards that you are seeking. Here are just a few of those steps:
Add contacting the Cray Kaiser office at (630) 953-4900 to your to-do list to make sure that all-important items have been addressed and everything is reviewed and updated with your estate plan.
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.
